1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

                   Quarterly Report Under Section 13 or 15 (d)
                     of the Securities Exchange Act of 1934


             ------------------------------------------------------

          For Quarter Ended                    Commission file number
         JuneSeptember 30, 2004                            0-5534

                              BALDWIN & LYONS, INC.
             (Exact name of registrant as specified in its charter)

            INDIANA                                   35-0160330
            -------                                   ----------
    (State or other jurisdiction of               (I.R.S. Employer
     incorporation or organization)             Identification Number)

1099 NORTH MERIDIAN STREET, INDIANAPOLIS, INDIANA        46204
- -------------------------------------------------        -----
     (Address of principal executive offices)          (Zip Code)

Registrant's telephone number, including area code:  (317) 636-9800
                                                     --------------

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, and (2) has been subject to such filing
requirements for the past 90 days.

Yes    X       No
     -----        -----

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).

Yes    X       No
     -----        -----


Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of AugustNovember 4, 2004:


       TITLE OF CLASS                       NUMBER OF SHARES OUTSTANDING

Common Stock, No Par Value:
      Class A (voting)                               2,666,666
      Class B (nonvoting)                           11,969,74612,009,683


Index to Exhibits located on page 15.

                          Page 1 of a total of 22 pages17.


 2

                         PART I - FINANCIAL INFORMATION

ITEM 1  FINANCIAL STATEMENTS
- ----------------------------

BALDWIN & LYONS, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) JUNESEPTEMBER 30 December 31 2004 2003 ----------------- ---------------- ----------------- ASSETS Investments: Fixed maturities $ 322,445327,649 $ 321,193 Equity securities 127,367127,558 130,139 Short-term and other 33,53845,149 36,545 ----------------- ---------------- ----------------- 483,350500,356 487,877 Cash and cash equivalents 46,12752,145 30,078 Accounts receivable 39,10940,793 37,333 Reinsurance recoverable 208,872219,440 185,457 Notes receivable from employees 3,3623,220 4,828 Current federal income taxes 511 - Other assets 18,81417,695 17,634 ----------------- ---------------- ----------------- $ 799,634834,160 $ 763,207 ================= ================ ================= LIABILITIES AND SHAREHOLDERS' EQUITY Reserves for losses and loss expenses $ 377,328407,724 $ 343,724 Reserves for unearned premiums 41,06837,908 36,803 Accounts payable and accrued expenses 43,15752,637 44,005 Current federal income taxes 781- 901 Deferred federal income taxes 10,9119,171 13,200 ----------------- ---------------- ----------------- 473,245507,440 438,633 Shareholders' equity: Common stock-no par value 624625 623 Additional paid-in capital 35,88135,982 35,419 Unrealized net gains on investments 39,78838,430 44,837 Retained earnings 250,096251,683 243,695 ----------------- ---------------- 326,720 324,574 ----------------- 326,389 324,574 ---------------- ----------------- $ 799,634834,160 $ 763,207 ================= ================ ================= Number of common and common equivalent shares outstanding 14,76514,739 14,752 Book value per outstanding share $22.11$22.17 $22.00
See notes to condensed consolidated financial statements. 3
BALDWIN & LYONS, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) Three Months Ended SixNine Months Ended JuneSeptember 30 JuneSeptember 30 ------------------------------ ------------------------------ 2004 2003 2004 2003 ------------- ------------- ------------- ------------- REVENUES Net premiums earned $ 43,40344,384 $ 36,960 $81,900 $68,66137,513 $126,284 $106,174 Net investment income 3,008 3,124 6,180 6,4972,958 2,987 9,138 9,484 Realized net gains on investments 2,290 5,739 8,108 3,28727 2,048 8,135 5,335 Other income 1,803 1,443 3,709 2,9451,752 1,547 5,461 4,492 ------------- ------------- ------------- ------------- 50,504 47,266 99,897 81,39049,121 44,095 149,018 125,485 EXPENSES Losses and loss expenses incurred 29,735 23,900 54,981 44,41136,923 24,411 91,904 68,822 Other operating expenses 7,720 8,145 15,809 15,1287,286 7,694 23,095 22,822 ------------- ------------- ------------- ------------- 37,455 32,045 70,790 59,53944,209 32,105 114,999 91,644 ------------- ------------- ------------- ------------- INCOME BEFORE FEDERAL INCOME TAXES 13,049 15,221 29,107 21,8514,912 11,990 34,019 33,841 Federal income taxes 4,185 4,920 9,344 7,0181,452 3,868 10,796 10,886 ------------- ------------- ------------- ------------- NET INCOME $ 8,8643,460 $ 10,301 $19,7638,122 $23,223 $ 14,83322,955 ============= ============= ============= ============= PER SHARE DATA: DILUTED EARNINGS $ .60.23 $ .70.55 $ 1.341.57 $ 1.011.56 ============= ============= ============= ============= BASIC EARNINGS $ .61.24 $ .71.56 $ 1.351.59 $ 1.021.58 ============= ============= ============= ============= DIVIDENDS PAID TO SHAREHOLDERS $ .40.15 $ .10 $ .901.05 $ .20.30 ============= ============= ============= ============= RECONCILIATION OF SHARES OUTSTANDING: Average shares outstanding - basic 14,62414,641 14,558 14,614 14,55614,623 14,557 Dilutive effect of options outstanding 171 157 189 116144 184 172 141 ------------- ------------- ------------- ------------- Average shares outstanding - diluted 14,785 14,742 14,795 14,715 14,803 14,67214,698 ============= ============= ============= =============
See notes to condensed consolidated financial statements. 4
BALDWIN & LYONS, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) SixNine Months Ended JuneSeptember 30 2004 2003 ------------- ------------- Net cash provided by operating activities $ 26,57147,177 $ 25,56542,170 Investing activities: Purchases of long-term investments (92,640) (90,297)(132,928) (166,364) Proceeds from sales or maturities of long-term investments 90,574 104,475129,901 153,554 Net sales (purchases)purchases of short-term investments 3,479 (8,946)(8,019) (14,489) Decrease in notes receivable from employees 1,364 4951,533 2,316 Other investing activities (500) (1,278)(627) (1,920) ------------- ------------- Net cash provided byused in investing activities 2,277 4,449(10,140) (26,903) Financing activities: Dividends paid to shareholders (13,157) (2,913)(15,354) (4,369) Repayment on line of credit - (7,500) Proceeds from sales of common stock 358 4384 5 ------------- ------------- Net cash used in financing activities (12,799) (10,409)(14,970) (11,864) ------------- ------------- Increase in cash and cash equivalents 16,049 19,60522,067 3,403 Cash and cash equivalents at beginning of period 30,078 41,699 ------------- ------------- Cash and cash equivalents at end of period $46,127 $61,304$52,145 $45,102 ============= =============
See notes to condensed consolidated financial statements. NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION: The accompanying unaudited condensed financial statements have been prepared in accordance with the instructions to Form 10Q and do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. Interim financial statements should be read in conjunction with the Company's annual audited financial statements. 5 NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (2) FORWARD-LOOKING STATEMENTS: Forward-looking statements in this report are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve inherent risks and uncertainties. Readers are encouraged to review the Company's annual report for its full statement regarding forward-looking information. (3) REINSURANCE: The following table summarizes the Company's transactions with reinsurers for the 2004 and 2003 comparative periods.
2004 2003 ------------- ---------------------- ----------- Quarter ended JuneSeptember 30: Premiums ceded to reinsurers $ 21,63721,803 $ 17,37719,000 Losses and loss expenses ceded to reinsurers 30,170 21,18923,465 18,795 Commissions from reinsurers 5,733 4,765 Six5,665 5,150 Nine months ended JuneSeptember 30: Premiums ceded to reinsurers 40,886 35,09062,688 54,090 Losses and loss expenses ceded to reinsurers 48,118 42,28271,583 61,077 Commissions from reinsurers 10,936 9,59016,601 14,740
(4)(3) COMPREHENSIVE INCOME OR LOSS: Total realized and unrealized income for the quarter ended JuneSeptember 30, 2004 was $3,286$2,426 and compares to total realized and unrealized income of $20,556$9,547 for the quarter ended JuneSeptember 30, 2003. For the sixnine months ended JuneSeptember 30, 2004, total realized and unrealized income was $14,509$16,935 and compares to total realized and unrealized income of $24,194$33,741 for the sixnine months ended JuneSeptember 30, 2003. 6 NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (5)(4) REPORTABLE SEGMENTS - PROFIT OR LOSS: The following table provides certain profit and loss information for each reportable segment. All amounts presented are computed based upon generally accepted accounting principles. In addition, segment profit for fleet trucking includes the direct marketing agency operations conducted by the parent company and is computed after elimination of inter-company commissions and, accordingly, segment profit presented here will not agree with statutory underwriting gains for this segment which may be quoted elsewhere in the Company's financial statements.
2004 2003 --------------------------------------------- ---------------------------------------------------------------------------------------- ------------------------------------------- DIRECT AND NET Direct and Net ASSUMED NET PREMIUM SEGMENT Assumed Net Premium Segment PREMIUM EARNED AND PROFIT Premium Earned and Profit WRITTEN FEE INCOME (LOSS) Written Fee Income (Loss) ------------ ------------- ----------- ----------- ------------ ------------ ------------- ------------ QUARTERTHREE MONTHS ENDED JUNESEPTEMBER 30: Protective products:PROTECTIVE PRODUCTS: Fleet trucking $ 44,34546,688 $ 25,65027,689 $ 7,1417,334 $ 36,04837,803 $ 20,80321,023 $ 8,1538,241 Reinsurance assumed 1,918 2,913 1,756 2,786 3,271 500 Sagamore products:1,842 2,195 (2,934) 2,993 2,881 607 SAGAMORE PRODUCTS: Personal division 8,799 11,600 1,820 9,857 10,241 8498,441 11,208 1,549 9,522 10,552 1,163 Commercial division: Small fleet trucking 4,338 2,559 136 4,760 2,111 243,970 2,644 (33) 4,407 2,620 59 Workers' compensation 3,110 2,125 (441) 2,350 1,553 (469)1,790 2,055 (1,440) 2,595 1,630 (313) ------------- ----------- ----------- ------------ ------------- ------------ ------------ ------------- ------------ Total Commercial division 7,448 4,684 (305) 7,110 3,664 (445)5,760 4,699 (1,473) 7,002 4,250 (254) All other 379 307 (105) 342 272 (207)294 280 (227) 224 196 (202) ------------- ----------- ----------- ------------ ------------- ------------ ------------ ------------- ------------ Totals $ 62,88963,025 $ 45,15446,071 $ 10,3074,249 $ 56,14357,544 $ 38,25138,902 $ 8,850 ============9,555 ============= =========== =========== ============ ============ ============= ============ SIXNINE MONTHS ENDED JUNESEPTEMBER 30: Protective products:PROTECTIVE PRODUCTS: Fleet trucking $ 83,516130,204 $ 46,91674,606 $ 13,46220,796 $ 70,486108,290 $ 38,91059,933 $ 15,03423,279 Reinsurance assumed 4,836 5,988 3,663 5,609 5,830 983 Sagamore products:6,678 8,183 729 8,602 8,711 1,590 SAGAMORE PRODUCTS: Personal division 23,980 22,828 3,171 23,594 19,484 1,48532,420 34,037 4,720 33,117 30,035 2,647 Commercial division: Small fleet trucking 8,203 5,083 468 8,337 3,903 17712,173 7,727 436 12,744 6,523 237 Workers' compensation 5,898 4,070 (670) 4,542 2,685 (480)7,689 6,124 (2,110) 7,137 4,315 (792) ------------- ----------- ----------- ------------ ------------- ------------ ------------ ------------- ------------ Total Commercial division 14,101 9,153 (202) 12,879 6,588 (303)19,862 13,851 (1,674) 19,881 10,838 (555) All other 619 549 (187) 445 371 (50)912 829 (414) 668 567 (258) ------------- ----------- ----------- ------------ ------------- ------------ ------------ ------------- ------------ Totals $ 127,052190,076 $ 85,434131,506 $ 19,90724,157 $ 113,013170,558 $110,084 $ 71,183 $ 17,14926,703 ============= =========== =========== ============ ============= ============ ============ ============= ============
7 NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (6)(5) REPORTABLE SEGMENTS - RECONCILIATION TO CONSOLIDATED REVENUE AND CONSOLIDATED PROFIT OR LOSS: The following tables are reconciliations of reportable segment revenues and profits to the Company's consolidated revenue and income before federal income taxes, respectively.
Three Months Ended SixNine Months Ended JuneSeptember 30 JuneSeptember 30 2004 2003 2004 2003 ------------- -------------- --------------- -------------- -------------- REVENUE: Net premium earned and fee income $ 45,15446,071 $ 38,25138,902 $ 85,434131,506 $ 71,183110,084 Net investment income 3,008 3,124 6,180 6,4972,958 2,987 9,138 9,484 Realized net gains (losses) on investments 2,290 5,739 8,108 3,28727 2,048 8,135 5,335 Other 52 152 175 42365 158 239 582 ------------- -------------- --------------- -------------- -------------- Total consolidated revenue $ 50,50449,121 $ 47,26644,095 $ 99,897149,018 $ 81,390125,485 ============= ============== =============== ============== ============== PROFIT: Segment profit $ 10,3074,249 $ 8,8509,555 $ 19,90724,157 $ 17,14926,703 Net investment income 3,008 3,124 6,180 6,4972,958 2,987 9,138 9,484 Realized net gains (losses) on investments 2,290 5,739 8,108 3,28727 2,048 8,135 5,335 Corporate expenses (2,556) (2,492) (5,088) (5,082)(2,322) (2,600) (7,411) (7,681) ------------- -------------- --------------- -------------- -------------- Income before federal income taxes $ 13,0494,912 $ 15,22111,990 $ 29,10734,019 $ 21,85133,841 ============= ============== =============== ============== ==============
(7)(6) LOANS TO EMPLOYEES: In 2000, 2001 and 2002 the Company provided loans to certain key employees for the sole purpose of purchasing the Company's Class B common stock in the open market. $7,260 of such full-recourse loans were issued and $3,362$3,220 remain outstanding at JuneSeptember 30, 2004 and carry interest rates of between 4.75% and 6%, payable annually on the loan anniversary date. The underlying securities serve as collateral for these loans, which must be repaid no later than 10 years from the date of issue. No additional loans will be made under this program. (7) RECENTLY ISSUED ACCOUNTING STANDARDS: In October 2004, the Financial Accounting Standards Board ("FASB") finalized the Statement of Financial Accounting Standards No. 123R, SHARE-BASED PAYMENT, effective for public companies for interim and annual periods beginning after June 15, 2005. Statement No. 123R requires all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value. Retroactive application of the requirements of FASB 123 to the beginning of the fiscal year that includes the effective date is permitted, but not required. The Corporation is currently evaluating the impact, the implementation strategy and the related timing of implementation of FASB 123R on the consolidated financial statements. In March 2004, the FASB's Emerging Issues Task Force ("EITF") approved the consensus reached on Issue No. 03-1, THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS. The objective of this consensus is to provide guidance for identifying impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. Originally, the accounting provisions of EITF 03-1 were effective for all reporting periods beginning after June 15, 2004, while the disclosure requirements are effective only for annual periods ending after June 15, 2004. In September 2004, the FASB issued two Staff Positions (FSP), FSP EITF 03-1-a and FSP EITF 03-1-1, which delayed the measurement and recognition paragraphs of the consensus for further 8 discussion. The disclosure requirements remain effective as originally issued under EITF 03-1 and have been adopted by the company. The Corporation has evaluated the impact of the adoption of EITF 03-1, as written, and does not believe the impact is significant to the Corporation's overall results of operations or financial position at September 30, 2004. However, as currently written, the consensus could have a significant impact on future results. The Corporation will continue to monitor the developments of the FASB and EITF regarding the measurement and recognition paragraphs of this consensus. 9 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF - ----------------------------------------------- FINANCIAL CONDITION - ------------------------------------------------------------------- AND RESULTS OF OPERATIONS - ---------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES ------------------------------- The Company generally experiences positive cash flow from operations resulting from the fact that premiums are collected on insurance policies in advance of the disbursement of funds in payment of claims. Operating costs of the property/casualty insurance subsidiaries, other than loss and loss expense payments and commissions paid to related agency companies, generally average between 25% and 35% of premiums earned and the remaining amount is available for investment for varying periods of time pending the settlement of claims relating to the insurance coverage provided. The Company's cash flow relating to premiums is significantly affected by reinsurance programs in effect from time-to-time whereby the Company cedes both premium and risk to other insurance and reinsurance companies. These programs vary significantly among products and overall premium ceded rates, net of ceding commission allowances, have generally decreased since 2001, reflective of the effect of the provisions of reinsurance agreements currently in place. For the sixnine months ended JuneSeptember 30, 2004, the Company experienced positive cash flow from operations totaling $26.6$47.2 million, up slightly from12% higher than the $25.5$42.2 million in positive cash flow generated during the first halfnine months of 2003. Increased premium collections and sales of equity security investments were largely offset by related increases in losses paid and operating expenses that normally follow such a premium volume increase. In addition, premium deposits held on behalf of insureds rose by $2.2 million from December 31, 2003.primarily responsible for the improved cash flow this year. For several years, the Company's investment philosophy has emphasized the purchase of relatively short-term instruments with maximum quality and liquidity. The average life of the Company's fixed income (bond and short-term investment) portfolio was approximately 2.6 years at JuneSeptember 30, 2004 compared to 2.8 years at December 31, 2003. The decrease in the average life resulted from management's belief that meaningful long term interest rate increases are imminent. The Company's assets at JuneSeptember 30, 2004 included $46.1$52.1 million in investments classified as short-term or cash equivalents that were readily convertible to cash without significant market penalty. An additional $89.8$104.9 million of fixed maturity investments will mature within the twelve-month period following JuneSeptember 30, 2004. The Company believes that these liquid investments are more than sufficient to provide for projected claim payments and operating cost demands even before consideration of current positive cash flows. Consolidated shareholders' equity is composed largely of GAAP shareholder's equity of the insurance subsidiaries. As such, there are statutory restrictions on the transfer of portions of this equity to the parent holding company. At JuneSeptember 30, 2004, $47.2$47.1 million may be transferred by dividend or loan to the parent company without approval by, or notification to, regulatory authorities. An additional $199.8$196.5 million of shareholder's equity of the insurance subsidiaries may be advanced or loaned to the parent holding company with prior notification to, and approval from, regulatory authorities. The Company believes that these restrictions pose no material liquidity concerns to the Company. The financial strength and stability of the subsidiaries would permit ready access by the parent company to short-term and long-term sources of credit. The parent company had cash and marketable securities valued at $48.6$53.4 million at JuneSeptember 30, 2004. 910 The Company's annualized premium writing to surplus ratio for the first halfnine months of 2004 was approximately 43%. Regulatory guidelines generally allow for writings of 200% of surplus. Accordingly, the Company can continue to increase premium writings significantly with no need to raise additional capital. Further, the Insurance Subsidiaries' individual capital structures are several times higher than the minimum amounts designated by the National Association of Insurance Commissioners. RESULTS OF OPERATIONS --------------------- COMPARISONS OF SECONDTHIRD QUARTER, 2004 TO SECONDTHIRD QUARTER, 2003 -------------------------------------------------------------------------------------------------------------------- Net premiums earned during the secondthird quarter of 2004 increased $6.4$6.9 million (17%(18%) as compared to the same period of 2003. The increase is due primarily to a 24%32% increase in premiums from the Company's fleet trucking program as the market has allowed the Company to maintainresulting from premium rate levels while continuing to addincreases, higher trucking revenues upon which premiums are based and new accounts. In addition, premiums from the Company's small business workers' compensation, private passenger automobile and small fleet trucking and private passenger automobile programs increased 37%26%, 20%5% and 12%2%, respectively,respectively. It should be noted that all of the Company's product lines are facing increased competitive pressures and, therefore, such gains are likely to slow in the short term. Also, the Company announced the discontinuance of its small business workers' compensation program resulting from poor underwriting performance. This program is now in run-off and premiums earned from this product will decline as these products also found increased market acceptance.existing policies reach expiration. Direct premiums written and assumed during the secondthird quarter of 2004 totaled $62.9$63.0 million, a 12%10% increase from the $56.1$57.5 million reported a year earlier. This increase is due largely to an $8.3$8.9 million (23%(24%) increase in direct premiums written from the Company's fleet trucking program. This increase was partially offset by decreases in premium writings for the Company's private passenger automobile and small fleet trucking programs of 11% and 9%, respectively, due to a concentration of renewals in the first quarter for each of these two products andprimarily due to increased competitive pressurepressures in the past fewseveral months. Several competitors have lowered prices and increased incentives to producers recently which if continued, will impacthave impacted premium production for these product lines. Premiums written by the small business workers' compensation division declined 31% as underwriting restrictions were implemented in an effort to remediate this product line. Premium assumed from property catastrophe pools also decreased by 11% from the prior year quarter as a single large property catastrophe treaty was terminated to maintain the Company's maximum probable exposure to loss. Premium ceded to reinsurers averaged 35.8%36% of direct premium production for the current quarter compared to 32.8%35% a year earlier owing to changes in the mix of business and individual policy characteristics rather than reinsurance program changes. Net investment income, before tax, during the secondthird quarter of 2004 was 4%1% lower than the secondthird quarter of 2003 due primarily to the continuing historically low level of investment yields. The short-term natureyields and the transfer of the Company's fixed income investment portfolio has been negatively impacted byinvestments from taxable to tax-exempt securities. After tax income increased 3% from the numerous interest rate reductions by the Federal Reserve Board since January 1, 2001.prior year. Pre-tax yields dropped nearly 50over 30 basis points from the prior year quarter. After tax yields posted a smaller decline as the Company holds a larger percentage of tax-exempt securities in its fixed income portfolio. The average life of the Company's fixed income portfolio decreased from 2.8 years at the prior year end to 2.6 years at JuneSeptember 30, 2004 as investment mangers kept the maturities of available funds short in anticipation of increasing interest rates which began late in the quarter.rates. 11 The secondthird quarter 2004 net realized gain of $2.3 million$27,000 consisted of net gains on equity securities of $1.7$.8 million and a decreasean increase in impairment charges on equity securities and fixed maturity investments of $1.0$.6 million. The aboveFurther depressing capital gains were partially offset by a net losslosses on short term and fixed maturity and other investments. 10 Losses and loss expenses incurred during the secondthird quarter of 2004 increased $5.8$12.5 million from that experienced during the secondthird quarter of 2003, which is consistent with the increase in premium volume previously discussed.discussed, after consideration of $5.0 million in losses related to the hurricanes in Florida and other southeastern states included in the current year quarter. Loss ratios for each of the Company's major product lines were as follows:
2004 2003 ---- ----------- ------- Fleet trucking 78.4% 63.3%78.8% 65.5% Private passenger automobile 56.7 62.758.2 60.8 Small fleet trucking 60.7 59.267.9 66.2 Voluntary reinsurance assumed 17.8 61.8215.4 60.0 Small business workers' compensation 87.8 96.1136.6 80.2 All lines 68.5 64.783.2 65.1
The increase in the fleet trucking ratio is due to higher frequency and severity of reported claims and a smaller redundancy on the closing of prior year claims compared to the prior year quarter. The Company's large policy limits and net retention of risk in its fleet trucking products allows for significant variation in loss activity from period to period. The loss ratio reported for the current quarter is relatively high compared to historical experience while the ratio reported in the secondthird quarter of 2003 was closer to the low endmidpoint of the historical range. The lowhigh loss ratio for reinsurance assumed reflects the lack of major catastropheshurricane activity this quarter.quarter, as previously mentioned. Other operating expenses for the secondthird quarter of 2004 decreased 5% from the secondthird quarter of 2003. Adjusted for ceding allowances, operating expenses increased 4%less than 1% from the secondthird quarter of 2003 and compares favorably with the 17%18% increase in premiums earned from the 2003 quarter as many of the Company's expenses do not vary directly with premium volume. Ceding allowances as a percentage of direct expenses have declined due to changes in the Company's reinsurance structure whereby the Company now retains a greater percentage of the risk compared to prior periods, particularly within the fleet trucking products. In addition, ceding allowance rates are slightly lower under current reinsurance agreements compared to rates in effect under prior period agreements. Available capacity within each of the Company's divisions has allowed for the expansion of business with only minimal additions to personnel and other fixed costs over the past year. Management believes that significant additional capacity exists before most divisions would be obliged to incur meaningful increases in personnel or other fixed costs. The Company cedes a large portion of its direct premiums to reinsurers and these reinsurance premiums carry significant expense offsets. Ceding allowances totaled $5.7 million for the 2004 quarter compared to $4.8$5.1 million for the 2003 quarter. Ceding allowances, as a percentage of direct expenses, have declined due to changes in the Company's reinsurance structure whereby the Company now retains a greater percentage of the risk compared to prior periods, particularly within the fleet trucking products. The ratio of consolidated other operating expenses to operating revenue (defined as total revenue less realized capital gains) was 16.0%14.8% during the secondthird quarter of 2004 compared to 19.6%18.3% for the 2003 secondthird quarter reflecting the relationship of operating expenses to growing revenues as discussed earlier in this paragraph. The effective federal tax rate for consolidated operations for the secondthird quarter of 2004 was 32.1%29.6% and is less than the statutory rate primarily because of tax exempt investment income. 12 As a result of the factors mentioned above , principally the hurricane losses in the current quarter and a $3.4$2.0 decrease in realized capital gains, net income decreased $1.4$4.7 million (14%(57%) during the secondthird quarter of 2004 as compared with the 2003 secondthird quarter. 11 COMPARISONS OF SIXNINE MONTHS ENDED JUNESEPTEMBER 30, 2004 TO ------------------------------------------------ SIX------------------------------------------------------ NINE MONTHS ENDED JUNESEPTEMBER 30, 2003 ------------------------------------------------------------------ Net premiums earned increased $13.2$20.1 million (19%) during the first sixnine months of 2004 as compared to the same period of 2003. The increased premium volume is primarily attributable to a 21%24% increase in the Company's fleet trucking product for the same reasons mentioned above in the quarterly comparison. In addition, net premiums earned for the small business workers' compensation, small fleet and private passenger automobile products increased 50%41%, 27%17% and 16%12%, respectively, again for reasons discussed in the quarterly comparison. Direct premiums written and assumed during the first halfnine months of 2004 totaled $127.1$190.1 million, a 12%11% increase from the $113.0$170.1 million reported a year earlier. All divisions, excluding voluntary reinsurance assumed and small fleet trucking, experienced direct premium growth with the Company's fleetFleet trucking and small business workers' compensation products postingposted gains of 20% and 8%, respectively while gross production for the most significant gains at 18% and 30%, respectively.other product groups was down slightly from the prior year. Premium ceded to reinsurers averaged 33.7%34.9% of direct premium production for the current period compared to 32.6%33.8% a year earlier.earlier owing to the fact that fleet trucking premium, which carries a higher average ceding rate, was a greater proportion of total premium in 2004. Net investment income during the first halfnine months of 2004 was 5%4% lower than the 2003 period for the same reasons as indicated in the quarterly comparison above. After tax investment income declined only 1.5% owing tofor the increase in holdings of tax-exempt municipal bonds in 2004.current year-to-date period was level with the prior year. Overall pre-tax and after tax yields were lower during the current period while average invested funds increased 12%11% from the prior year resulting from positive cash flow. The net realized gain on investments of $8.1 million for the first sixnine months of 2004 consists of net gains on equity securities and fixed maturity investments of $6.8$7.3 million and $1.5$.5 million, respectively, and was partially offset by $.2$.3 million in losses in short-term and other investments, after considerationinvestments. The net realized gain also included the reversal of impairment changescharges on securities sold of $.6 million during the period.period, adding to the overall net realized gain. Losses and loss expenses incurred during the first sixnine months of 2004 increased $10.6$23.1 million from the first sixnine months of 2003, consistent with the increased premium volume and hurricane losses previously discussed. Loss and loss expense ratios for the comparative six-monthnine-month periods were as follows:
2004 2003 ---- ----------- ------- Fleet trucking 77.1% 65.3%77.8% 65.4% Private passenger automobile 58.3 62.962.2 Small fleet trucking 59.2 56.762.2 60.5 Voluntary reinsurance assumed 14.7 63.768.5 62.5 Small business workers' compensation 85.2 81.1102.7 80.7 All lines 67.1 64.772.8 64.8
13 With reference to comments regarding the increase in the fleet trucking loss ratio in the quarterly comparison, current accident year losses were near the upper end of historical ranges in both of the 2004 quarters while 2003 losses were nearer the midpoint of historical experience. Other operating expenses increased $.7 million (5%)only 1% during the first sixnine months of 2004, compared to the same period of 2003.2003 despite the 19% increase in premium earned. Ceding commission allowances included in net expenses were $10.9$16.6 million for the 2004 period compared to $9.6$14.7 million in the prior year period.period, but the ratio of ceding commissions to premium earned declined from 14.0% in 2003 to 13.2% in 2004 as Protective retained more risk on trucking policies. The ratio of other operating expenses to total operating revenue (adjusted for realized gains) was 17.2%16.4% for 2004 compared to 19.4%19.0% for 2003 for reasons mentioned in the quarterly comparison. 12 The effective federal tax rate for consolidated operations for the first sixnine months of 2004 was 32.1%31.7% and is less than the statutory rate primarily because of tax exempt investment income. As a result of the factors mentioned above, net income increased $4.9$.3 million (33.2%(1.2%) during the first halfnine months of 2004 as compared with the 2003 period. DISCONTINUANCE OF PRODUCT LINE ------------------------------ Sagamore Insurance Company will no longer market and underwrite workers' compensation coverage for small businesses. This product line, the Company's smallest with approximately $9.6 million of premium inforce at September 30, 2004, has performed below expectations for several quarters and remediation measures undertaken late last year have failed to improve underwriting results. Policies currently inforce will run off through normal expiration dates and all quotes outstanding will be honored. However, no new business will be written after December 31, 2004. FORWARD-LOOKING INFORMATION --------------------------- Any forward-looking statements in this report, including without limitation, statements relating to the Company's plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following: (i) the Company's plans, strategies, objectives, expectations and intentions are subject to change at any time at the discretion of the Company; (ii) the Company's business is highly competitive and the entrance of new competitors into or the expansion of the operations by existing competitors in the Company's markets and other changes in the market for insurance products could adversely affect the Company's plans and results of operations; (iii) other risks and uncertainties indicated from time to time in the Company's filings with the Securities and Exchange Commission; and (iv) other risks and factors which may be beyond the control or foresight of the Company. CRITICAL ACCOUNTING POLICIES ---------------------------- There have been no changes in the Company's critical accounting policies as disclosed in the Form 10K filed for the year ended December 31, 2003. 14 CONCENTRATIONS OF CREDIT RISK ----------------------------- The insurance subsidiaries cede portions of their gross premiums to numerous reinsurers under quota share and excess of loss treaties as well as facultative placements. These reinsurers assume commensurate portions of the risk of loss covered by the contracts. As losses are reported and reserved, portions of the gross losses attributable to reinsurers are established as receivable assets and losses incurred are reduced. At September 30, 2004, amounts due from reinsurers on paid and unpaid losses total approximately $219 million. Included in this total are known losses of approximately $19 million due from Converium Insurance (North America) Inc. and approximately $8 million due from PMA Re each of which have reported substantial reserve strengthening and/or impairment of assets which have negatively affected their previously reported financial positions. All amounts currently due from these reinsurers have been received and the Company has no information at this time to indicate that all obligations of these reinsurers will not be met. ITEM 4. CONTROLS AND PROCEDURES - ------------------------------- Baldwin & Lyons, Inc. management, including the Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in internal controls, or in factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation. 1315 PART II - OTHER INFORMATION ITEM 6 (a) EXHIBITS - -------------------- NUMBER AND CAPTION FROM EXHIBIT TABLE OF REGULATION S-K ITEM 601 EXHIBIT NO. - -------------------------------- ----------- (11) Statement regarding computation EXHIBIT 11 - of per share earnings Computation of Per Share Earnings (31.1) Certification of CEO EXHIBIT 31.1 pursuant to Section 302 of the Certification of CEO Sarbanes-Oxley Act of 2002 And 18 U.S.C. 1350 (31.2) Certification of CFO EXHIBIT 31.2 pursuant to Section 302 of the Certification of CFO Sarbanes-Oxley Act of 2002 And 18 U.S.C. 1350 (32.1) Certification of CEO EXHIBIT 32.1 pursuant to Section 906 of the Certification of CEO Sarbanes-Oxley Act of 2002 And 18 U.S.C. 1350 (32.2) Certification of CFO EXHIBIT 32.2 pursuant to Section 906 of the Certification of CFO Sarbanes-Oxley Act of 2002 And 18 U.S.C. 1350 ITEM 6 (b) REPORTS ON FORM 8-K - ------------------------------- A Form 8-K was filed by the registrant on AprilJuly 28, 2004 regarding its earnings announcement for the firstsecond quarter of 2004. A Form 8-K was also filed by the registrant on May 4,September 2, 2004 regarding amendmentsthe Company's estimate of its exposure to its By-laws and Code of Conduct.recent hurricane losses. 1416 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. BALDWIN & LYONS, INC. Date AUGUSTNOVEMBER 4, 2004 By /s/ GARY W. MILLER -------------- ------------------------------------------- -------------------------------- Gary W. Miller, Chairman and CEO Date AUGUSTNOVEMBER 4, 2004 By /s/ G. PATRICK CORYDON -------------- ------------------------------------------- -------------------------- G. Patrick Corydon, Senior Vice President - Finance (Principal Financial and Accounting Officer) 1517 BALDWIN & LYONS, INC. Form 10-Q for the fiscal quarter ended JuneSeptember 30, 2004 INDEX TO EXHIBITS Begins on sequential page number of Form Exhibit NumberBEGINS ON SEQUENTIAL PAGE NUMBER OF FORM EXHIBIT NUMBER 10-Q -------------- ------------------------------------------------- EXHIBIT 11 1618 Computation of per share earnings EXHIBIT 31.1 1719 Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act and 18 U.S.C. 1350 EXHIBIT 31.2 1921 Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act and 18 U.S.C. 1350 EXHIBIT 32.1 2123 Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act and 18 U.S.C. 1350 EXHIBIT 32.2 2224 Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act and 18 U.S.C. 1350