As filed with the Securities and Exchange Commission on November 1, AS FILED WITH THE2006
Registration No. 333-137583
UNITED STATES SECURITIES AND EXCHANGE COMMISSION ON AUGUST 13, 1996
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM
Washington, D.C. 20549
PRE-EFFECTIVE AMENDMENT NO. 1
TO
Form S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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AMERISAFE, INC.
(ExactInc.
(Exact name ofRegistrantregistrant as specified in its charter)
(Exact name of
| Texas | 6331 | 75-2069407 | ||
| (State or other jurisdiction of | (Primary Standard | (I.R.S. Employer | ||
| incorporation or organization) | Classification | Identification Number) |
2301 HIGHWAYHighway 190 WEST
DERIDDER, LOUISIANAWest
DeRidder, Louisiana 70634
318-463-9052
(Address
(337) 463-9052
(Address, including zip code, and telephone number, including area code, ofRegistrant'sregistrant’s principal executive offices)
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MARK R. ANDERSON
PRESIDENT
DeRidder, Louisiana 70634
(337) 463-9052
(Address, including zip code, and telephone number, including area code, of
Todd Walker
Executive Vice President, General Counsel and Secretary
2301HIGHWAYHighway 190 WEST
DERIDDER, LOUISIANAWest
DeRidder, Louisiana 70634
318-463-9052
(Name,
(337) 463-9052
(Name, address, including zip code, and telephone number, including area code, of agent for service)
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Executive Vice President, General Counsel and Secretary
2301
DeRidder, Louisiana 70634
(337) 463-9052
(Name, address, including zip code, and telephone number, including area code, of agent for service)
Copies to:
| James E. Larry D. Cannon Jones Day 2727 North Harwood Street Dallas, Texas 75201 (214) 220-3939 | J. Brett Pritchard Lord, Bissell & 111 South Wacker Drive Chicago, Illinois 60606 (312) 443-0700 |
Approximate date of commencement of proposed sale to the public: As soon as practicable after thisthe Registration Statement becomes effective.
If any of the securities being registered on this Formform are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. / /
o
If this Formform is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / /
o
If this Formform is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / /
o
If delivery of the prospectusthis form is expected to be madea post-effective amendment filed pursuant to Rule 434,
please462(d) under the Securities Act, check the following box. / /
box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
CALCULATION OF REGISTRATION FEE
| Proposed Maximum | Proposed Maximum | |||||||||||||||||||
| Title of Each Class of | Amount to be | Offering Price | Aggregate | Amount of | ||||||||||||||||
| Securities to be Registered | Registered | Per Unit | Offering Price(1)(2) | Registration Fee(3) | ||||||||||||||||
| Common Stock, par value $0.01 per share | 9,071,576 | $ | 11.40 | $ | 91,002,215 | $ | 9,738 | |||||||||||||
| (1) | Includes amount attributable to shares of common stock that may be purchased by the underwriters under an option granted by the selling shareholders to purchase additional shares at the public offering price, less the underwriting discount. | |
| (2) | Estimated solely for the purpose of calculating the amount of the registration fee in accordance with Rule 457(c) under the Securities Act of 1933, as amended. |
| (3) | Based on proposed maximum aggregate offering price of $77,153,825 for 7,856,805 shares of common stock included in the original filing on September 26, 2006, plus proposed maximum aggregate offering price of $13,848,390 for 1,214,771 additional shares of common stock being registered in this amendment. Of the $9,738 registration fee, $8,256 was previously paid in connection with the original filing on September 26, 2006, and $1,482 is paid herewith. |
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on the date as the Commission, acting pursuant to said Section 8(a), may determine.
| The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not a solicitation of an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. |
SUBJECT TO COMPLETION, DATED NOVEMBER 1, 2006
7,888,326 Shares
 | AMERISAFE, Inc. |
Common Stock
This prospectus covers the sale of 7,888,326 shares whichof our common stock by the Underwritersselling shareholders named in this prospectus. We will not receive any proceeds from the sale of the shares by the selling shareholders.
Our common stock is listed on the NASDAQ Global Select Market under the symbol “AMSF.” On October 31, 2006, the last sale price of our common stock as reported by the NASDAQ Global Select Market was $12.46 per share.
Investing in our common stock involves risks. See “Risk Factors” beginning on page 9 to read about factors you should consider before buying our common stock.
| Per Share | Total | |||
| Public offering price | $ | $ | ||
| Underwriting discount* | $ | $ | ||
| Proceeds, before expenses, to the selling shareholders | $ | $ |
* See “Underwriting” on page 106 for a description of the underwriters’ compensation.
To the extent that the underwriters sell more than 7,888,326 shares of common stock, certain of the selling shareholders have granted the underwriters a30-day option to purchase up to 1,183,250 additional shares of common stock at the public offering price, less the underwriting discount, to cover over-allotments, if any.
(2) Estimated solely for
Neither the purposeSecurities and Exchange Commission nor any state securities commission or other regulatory body has approved or disapproved of determiningthese securities or passed upon the registration fee
pursuantaccuracy or adequacy of this prospectus. Any representation to Rule 457(a).
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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* *
* INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A *
* REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED *
* WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT *
* BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE *
* REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT *
* CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY *
* NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH *
* SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO *
* REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH *
* STATE. *
* *
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SUBJECT TO COMPLETION, DATED AUGUST 13, 1996
PROSPECTUS
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All ofthe contrary is a criminal offense.
The underwriters expect to deliver the shares of Class A Common Stock offered hereby (the "Offering")
are being sold by AMERISAFE, Inc. ("AMERISAFE" or the "Company"). Priorcommon stock to this
Offering, there has not been a public market for the Class A Common Stock of the
Company. It is currently estimated that the initial public offering price will
be $15.00 per share. See "Underwriting" for information relating to the factors
considered in determining the initial public offering price. Application has
been made to have the Class A Common Stock listed on the New York Stock Exchange
under the symbol "ASF." Each share of Class A Common Stock has one vote and each
share of the Company's Class B Common Stock has ten votes on all matters that
may be submitted to a vote or consent of the shareholders of the Company.
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SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF
THE CLASS A COMMON STOCK OFFERED HEREBY.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(2) Before deducting expenses of the Offering estimated at $ payable by
the Company.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
1,650,000 additional shares of Class A Common Stock on the same terms as set
forth above solely to cover over-allotments, if any. If such option is
exercised in full, the total Price to Public, Underwriting Discounts and
Commissions, and Proceeds to Company will be $ , $ and
$ , respectively. See "Underwriting."
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The shares of Class A Common Stock are being offered by the several
Underwriters named herein, subject to prior sale, when, as and if accepted by
them and subject to certain conditions. It is expected that certificates for
shares of Class A Common Stock offered hereby will be available for deliverypurchasers on or about , 1996, at2006.
| Friedman Billings Ramsey |
| William Blair & Company |
| SunTrust Robinson Humphrey |
| Cochran Caronia Waller |
The date of this prospectus is , 2006.
TABLE OF CONTENTS
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| F-1 | ||||||||
| Form of Underwriting Agreement | ||||||||
| Opinion/Consent of Jones Day | ||||||||
| Consent of Ernst & Young LLP | ||||||||
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus. Before making a decision to purchase our common stock, you should read the offices of Smith Barney Inc., 333 West 34th
Street, New York, New York 10001.
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SMITH BARNEY INC. PIPER JAFFRAY INC.
, 1996.
3
AMERISAFE, INC.
sm
THE MANAGED RESULTS COMPANY
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NOTICE TO NORTH CAROLINA PURCHASERS: THE COMMISSIONER OF INSURANCE OF THE
STATE OF NORTH CAROLINA HAS NOT APPROVED OR DISAPPROVED THIS OFFERING NOR HAS
THE COMMISSIONER PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE CLASS A COMMON
STOCK OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE
OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
THE MANAGED RESULTS COMPANYSM IS A SERVICE MARK OF THE COMPANY. AN
APPLICATION HAS BEEN FILED TO REGISTER THIS MARK WITH THE UNITED STATES PATENT
AND TRADEMARK OFFICE; HOWEVER, NO ASSURANCE CAN BE GIVEN THAT SUCH APPLICATION
WILL BE ACCEPTED.
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4
PROSPECTUS SUMMARY
The following summary is qualified in its entirety byentire prospectus carefully, including the more detailed
information“Risk Factors” and “Forward-Looking Statements” sections and our consolidated financial statements and the notes appearing elsewhereto those financial statements.
Overview
We are a specialty provider of workers’ compensation insurance focused on small to mid-sized employers engaged in this Prospectus. Unless otherwise indicated, informationhazardous industries, principally construction, trucking, logging, agriculture, oil and gas, maritime and sawmills. We have more than 20 years of experience underwriting the complex workers’ compensation exposures inherent in this Prospectus
(i) assumes no exercisethese industries. We provide coverage to employers under state and federal workers’ compensation laws. These laws prescribe wage replacement and medical care benefits that employers are obligated to provide to their employees who are injured in the course and scope of the Underwriters' optiontheir employment.
Employers engaged in hazardous industries tend to purchase up to 1,650,000
additional shares of Class A Common Stock to cover over-allotments, if any, and
(ii) reflects a reorganization of the Company (the "Reorganization") to be
effected immediately prior to the closing of this Offering. See "Recent
Reorganization." Unless the context otherwise requires, references in this
Prospectus to "AMERISAFE" or the "Company" refer to AMERISAFE, Inc. and its
subsidiaries.
THE COMPANY
AMERISAFE provides managed care workers' compensation products and services
primarilyhave less frequent but more severe claims as compared to employers in hazardous occupation industries. The Company offers
its client-employersother industries due to the nature of their businesses. We employ a fully integrated program designed to lower the overall
costs of workers' compensation claims by: (i) implementingproactive, disciplined approach in underwriting employers and applying
workplace safety programs designed to prevent occupational injuries; (ii)
providing immediate, efficient and appropriate managed medical care to injured
workers; and (iii) using intensive personal claims management practices to guide
and encourage injured workers through the recovery and rehabilitation process
with the primary goal of returning the injured worker to work as promptly as
practicable. From 1991 through 1995, the Company has increased its revenues from
$20.3 million to $69.7 million, or a compound annual growth rate of 36.1%. In
this same period, the Company's net income (before cumulative effect of
accounting change) increased from $1.8 million to $9.3 million, or a compound
annual growth rate of 50.8%. As of March 31, 1996, the Company was licensed to
provide workers' compensation coverage andcomprehensive services, in 25 states and the U.S.
Virgin Islands and provided its products and services to approximately 2,900
employers in 16 states, primarily in the southeastern United States.
The Company integrates proactiveincluding safety services withand intensive claims management practices, and quality managed care to produce "managed results." The
Company's managed results approach focuses on creating and maintaining direct,
personal relationships with employers, employees and health care providers in
order to design and promote services which are intended to produce lowerlessen the overall occupational injury costs. The Company designates service teams for each client
in order to foster personal relationships, provide continuityincidence and cost of services and
implement specific solutions for individual client workers' compensation needs.
Since it began operations in 1986, the Company has focused on providing its
managed results products and services toworkplace injuries. Hazardous industry employers whose employees are engaged
in hazardous occupations, primarily the logging industry. Beginning in 1994, the
Company began expanding its client base by targeting employers in other
hazardous occupation industries, including general contracting, trucking, and
oil and gas exploration. Employers engaged in hazardous occupation industries pay substantially higher than average workers'rates for workers’ compensation rates. For example,
the Company's logging clients pay generally an amount equal to 20% to 50% of
their payroll to obtain workers' compensation coverage for their employees,insurance compared to employers in other industries, as measured per payroll dollar. The higher premium rates are due to the nature of clerical workers who pay generally less than 1% of
their payroll to obtain such coverage. The Company believes that the high
severity injuries typically suffered by employees engaged in hazardous
occupationswork performed and the resulting high cost typically incurredinherent workplace danger of our target employers. Our policyholders paid an average rate of $7.60 per $100 of payroll for workers’ compensation insurance in 2005, which was approximately three times the average for all reported occupational class codes, according to the most recent market analyses provided by the National Council on Compensation Insurance, Inc., or NCCI.
We believe the workers’ compensation market in the hazardous industries we target is underserved and competition is fragmented. We compete on the basis of coverage availability, claims management, safety services, payment terms and premium rates. According to the most recent market data reported by the NCCI, which is the official ratings bureau in the majority of states in which we are licensed, total premiums reported for the specific occupational class codes for which we underwrite business was $16 billion. Total premiums reported for all occupational class codes reported by the NCCI for these same jurisdictions was $39 billion.
Targeted Industries
We provide workers’ compensation insurance primarily to employers in providing the mandatory workers'following targeted hazardous industries:
| • | Construction. Includes a broad range of operations such as highway and bridge construction, building and maintenance of pipeline and powerline networks, excavation, commercial construction, roofing, iron and steel erection, tower erection and numerous other specialized construction operations. Our gross premiums written in 2005 for employers in the construction industry were $117.1 million, or 40.3% of total gross premiums written in 2005. | |
| • | Trucking. Includes a large spectrum of diverse operations including contract haulers, regional and local freight carriers, special equipment transporters and other trucking companies that conduct a variety of short- and long-haul operations. Our gross premiums written in 2005 for employers in the trucking industry were $59.3 million, or 20.4% of total gross premiums written in 2005. | |
| • | Logging. Includes tree harvesting operations ranging from labor intensive chainsaw felling and trimming to sophisticated mechanized operations using heavy equipment. Our gross premiums written in 2005 for employers in the logging industry were $26.3 million, or 9.0% of gross premiums written in 2005. |
1
We also provide workers’ compensation coverage for such employees
provideinsurance to employers in the greatest opportunity to lower costs by applying the Company's
managed results approach. By focusing on developingagriculture, oil and implementing
client-specific workplace safety techniquesgas, maritime, sawmill and intensive claims management, the
Company believes that substantial cost savings can be achieved when compared to
the traditional workers' compensation approach toother hazardous occupation
industries. By reducing the overall costOur operations are geographically diverse, with no more than 10.5% of providing workers' compensation
coverage to its employer-clients, the Company believes its managed results
approach permits it to price its products and services competitively.our gross premiums written in 2005 derived from any one state. In 2005, there were nine states in which 5.0% or more of our total gross premiums written were derived. As of March 31, 1996, more than two-thirds of AMERISAFE's client-employers were
involved in hazardous occupation industries.
The cost to employers of providing workers' compensation benefits in the
United States totaledSeptember 30, 2006, we had approximately $58 billion in 1994. From 1984 to 1990,
workers' compensation costs increased6,700 voluntary business policyholders with an average annual premium per workers’ compensation policy of 13.3% per yearapproximately $40,000.
Our gross premiums are derived from direct premiums and assumed premiums. Direct premiums include premiums from 1990employers who purchase insurance directly from us and who we voluntarily agree to 1992, workers' compensation costs increased an average of 6.3% per year.
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5
The substantial growth in the workers' compensationinsure, which we refer to as our voluntary business, as well as employers assigned to us under residual market is primarily
attributable to the increased costs of medical treatment and an increase in
workers' compensation litigation, which affects both medical benefits and
indemnity payments. The Company believes that successful containment of these
expenses depends largely upon early intervention in the claims process and
promptly enabling an injured employee to return to work. The Company also
believes that traditional insurers have focused on high premium volume and
generally maintain minimal staffing. As a result, the Company believes that the
workers' compensation industry is generally characterizedprograms implemented by limited safety
services, inefficient claims adjustment processes and ineffective medical cost
management.
The Company's strategy is to utilize its managed results approach in an
effort to prevent workplace injuries, and, when an injury does occur, to arrange
for timely, high quality and cost-effective managed care. The key elementssome of the Company's strategy arestates in which we operate, which we refer to (i) focus on hazardous occupation employers, (ii)
improve workplace safety to reduce workplace accidents, (iii) manage care
through personal, direct contact, (iv) direct injured workers to appropriate
health care providers, and (v) pursue growth both internally and through
acquisitions.
BENEFITS TO EXISTING SHAREHOLDERS
The Company will use a portionas our assigned risk business. Assumed premiums include premiums from our participation in mandatory pooling arrangements under residual market programs implemented by some of the net proceedsstates in which we operate. For the year ended December 31, 2005, our voluntary business accounted for 92.8% of our gross premiums written.
We are rated “A−” (Excellent) by A.M. Best Company, which rating is the fourth highest of 15 rating levels. In December 2005, A.M. Best affirmed our financial strength rating of A− (Excellent). The rating has a stable outlook for AMERISAFE and our subsidiaries. A.M. Best ratings are directed toward the concerns of policyholders and insurance agencies and are not intended for the protection of investors or as a recommendation to buy, hold or sell our securities.
Recent Operating Results
We completed the initial public offering of our common stock in November 2005. The table below sets forth selected operating results for each of the Offering to repay
indebtedness under the Company's existing credit facility. This credit facility
is secured by a pledge of the Company's outstanding Class B Common Stock held by
Millard E. Morris, the Company's Chairman of the Board of Directors and Chief
Executive Officer, and the stock of certain of the Company's subsidiaries. Upon
this repayment, the credit facility will be cancelled and the pledge of such
stock will be released. Further, in connection with a reorganization of the
Company to be effected immediately prior to the completion of the Offering, the
Company will distribute (i) all of the outstanding capital stock of Auto One
Acceptance Corporation ("AOAC") to Mr. Morris and Mark R. Anderson, the
Company's President, and (ii) shares of two of the Company's existing
subsidiaries to Mr. Morris. Prior to such distribution, the Company will
contribute to AOAC additional capital in the form of a note in the amount of $50
million. This note will be repaid with the proceeds of the Offering. See "Recent
Reorganization" and "Use of Proceeds."
RISK FACTORS
Prospective purchasers of the Class A Common Stock should consider certain
factors affecting the Company and an investment in the Class A Common Stock. See
"Risk Factors."
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6
THE OFFERING
four quarters ending after our initial public offering.
| As of and for the | ||||||||||||||||
| Three Months Ended | ||||||||||||||||
| September 30, | June 30, | March 31, | December 31, | |||||||||||||
| 2006 | 2006 | 2006 | 2005 | |||||||||||||
| (Unaudited) (In thousands) | ||||||||||||||||
| Gross premiums written | $ | 82,951 | $ | 92,151 | $ | 80,819 | $ | 59,709 | ||||||||
| Net premiums written | 78,057 | 87,427 | 76,368 | 53,098 | ||||||||||||
| Net premiums earned | 74,991 | 72,107 | 67,874 | 67,198 | ||||||||||||
| Net investment income | 6,316 | 5,843 | 5,973 | 4,897 | ||||||||||||
| Net income | 8,265 | 7,818 | 7,236 | 5,404 | ||||||||||||
| Cash, cash equivalents and investments | $ | 639,553 | $ | 616,755 | $ | 600,767 | $ | 582,904 | ||||||||
| Total shareholders’ equity and redeemable preferred stock | 171,666 | 162,510 | 156,184 | 147,346 | ||||||||||||
| Net combined ratio(1) | 93.6 | % | 95.2 | % | 95.0 | % | 96.7 | % | ||||||||
| Return on average equity(2) | 19.8 | % | 19.6 | % | 19.1 | % | 18.3 | % | ||||||||
| Book value per share(3) | $ | 8.64 | $ | 8.18 | $ | 7.86 | $ | 7.42 | ||||||||
| (1) | The net combined ratio is the sum of the net loss ratio, the net underwriting expense ratio and the net dividend ratio. | |
| (2) | Return on average equity is calculated as annualized net income divided by average shareholders’ equity plus redeemable preferred stock. |
| (3) | Book value per share is calculated by dividing shareholders’ equity plus redeemable preferred stock at the date indicated by the |
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Competitive Advantages
We believe we have the following competitive advantages:
| • | Focus on Hazardous Industries. We have extensive experience insuring employers engaged in hazardous industries and have a history of profitable underwriting in these industries. Our specialized knowledge of these hazardous industries helps us better serve our policyholders, which leads to greater employer loyalty and policy retention. Our policy renewal rate on voluntary business that we elected to quote for renewal was 90.6% in 2005, 93.0% in 2004 and 91.4% in 2003. | |
| • | Focus on Small to Mid-Sized Employers. We believe large insurance companies generally do not target small to mid-sized employers in hazardous industries due to their smaller premium size, type of operations, mobile workforce and extensive service needs. We provide enhanced customer services to our policyholders. For example, unlike many of our competitors, our premium payment plans enable our policyholders to better match their premium payments with their payroll costs. |
| • | Specialized Underwriting Expertise. Based on our20-year underwriting history of insuring employers engaged in hazardous industries, we have developed industry specific risk analysis and rating tools to assist our underwriters in risk selection and pricing. Our 18 underwriting professionals average approximately 12 years of experience underwriting workers’ compensation insurance, most of which was focused on hazardous industries. We are highly disciplined when quoting and binding new business. In 2005, we offered quotes on approximately one out of four applications submitted. We do not delegate underwriting authority to agencies that sell our insurance or to any other third party. |
| • | Comprehensive Safety Services. We provide proactive safety reviews of employers’ worksites, which are often located in rural areas. These safety reviews are a vital component of our underwriting process and also assist our policyholders in loss prevention and encourage the safest workplaces possible by deploying experienced field safety professionals, or FSPs, to our policyholders’ worksites. Our 52 FSPs have an average of approximately 14 years of workplace safety or related industry experience. In 2005, approximately 91.0% of our new voluntary business policyholders were subject to pre-quotation safety inspections. We perform periodicon-site safety surveys on all of our voluntary business policyholders. |
| • | Proactive Claims Management. As of September 30, 2006, our employees managed more than 98% of our open claims in-house utilizing our intensive claims management practices that emphasize a personal approach and quality, cost-effective medical treatment. Our claims management staff includes 93 field case managers, or FCMs, who average approximately 17 years of experience in the |
3
Strategy
We intend to leverage our competitive advantages to pursue profitable growth and favorable returns on equity using the following strategies:
| • | Expand in our Existing Markets. Our market share in each of the nine states where we derived 5% or more of our gross premiums written in 2005 did not exceed 3% of the workers’ compensation market in that state based on data received from NCCI. Competition in our target markets is fragmented by state and employer industry focus. We believe that our specialized underwriting expertise and safety, claims and audit services position us to profitably increase our market share in our existing |
| • | Prudent and Opportunistic Geographic Expansion. We currently market our insurance in 26 states and the |
| • | Focus on Underwriting Profitability. We intend to maintain our underwriting discipline and profitability throughout market cycles. Our strategy is to focus on underwriting workers’ compensation insurance in hazardous industries and to maintain adequate rate levels commensurate with the | |
| • | Leverage Existing Information Technology. We believe our customized information system, ICAMS, enhances our ability to select risk, write profitable business and cost-effectively administer our billing, claims and audit functions. We also believe our infrastructure is scalable and will enable us to accommodate our anticipated premium growth at current staffing levels and at minimal cost, which should have a positive effect on our expense ratio over time as we grow our premium base. | |
| • | Maintain Capital Strength. We completed our initial public offering in November 2005. Of the $53.0 million of net proceeds we retained from our initial public offering, we contributed $45.0 million to our insurance subsidiaries. The remaining $8.0 million will be used to make additional capital |
4
Challenges
As part of Class A Common Stock that
may be sold pursuant toyour evaluation of our business, you should consider the Underwriters' over-allotment option. See
"Underwriting."
(2) Excludes (i) 600,000 sharesfollowing challenges we face in implementing our business strategies:
| • | Adequacy of
For further discussion of these and other challenges we face, see “Risk Factors.” AMERISAFE is an insurance holding company and |
5
The Offering
| Shares of common stock offered by selling shareholders | 7,888,326 shares |
| Over-allotment shares of common stock offered by selling shareholders | 1,183,250 shares |
| Shares of common stock to be outstanding after the offering | 18,660,881 shares, including 1,214,771 shares issued immediately prior to the completion of this offering upon conversion of 250,000 shares of our convertible preferred stock held by certain of the selling shareholders. | |
| Use of proceeds | All of the common stock offered hereby is being sold by the selling shareholders. We will not receive any proceeds from the sale of our common stock in this offering. | |
| Dividend policy | We currently intend to retain any additional future earnings to finance our operations and growth. As a result, we do not expect to pay any cash dividends on our common stock for the foreseeable future. | |
| Our ability to pay dividends is subject to restrictions in our articles of incorporation that prohibit us from paying dividends on our common stock (other than in additional shares of common stock) without the consent of the holders of two-thirds of the outstanding shares of our convertible preferred stock. In addition, because AMERISAFE is a holding company and has no direct operations, our ability to pay dividends in the future may be limited by regulatory restrictions on the payment of dividends to AMERISAFE by our insurance company subsidiaries. | ||
| NASDAQ Global Select Market Symbol | “AMSF” |
The number of shares of common stock to be outstanding after the offering excludes:
| • | 1,214,770 shares issuable upon conversion of our then-outstanding Series C and Series D convertible preferred stock, subject to adjustment in certain circumstances; | |
| • | 1,648,500 shares that may be issued pursuant to employee stock options outstanding as of the date of this prospectus, of which 1,548,500 were granted in November 2005 and 100,000 were granted in September 2006; all options vest 20% each year commencing on the first anniversary of the grant date; and | |
| • | 276,112 additional shares available for future issuance under our equity incentive plans. |
6
Summary Financial Information
The following income statement data for the years ended December 31, 2005, 2004 and 2003 and the balance sheet data as of December 31, 2005 and 2004 were derived from our consolidated financial statements included elsewhere in this prospectus. The income statement data for the years ended December 31, 2002 and 2001 and the balance sheet data as of December 31, 2003, 2002 and 2001 were derived from our audited consolidated financial statements, which are not included in this prospectus. The income statement data for the nine-month periods ended September 30, 2006 and 2005 and the balance sheet data as of September 30, 2006 and 2005 were derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus, which include all adjustments, consisting of normal recurring adjustments, that management considers necessary for a Louisiana corporation ("American Interstate"). See "Business."
RISK FACTORS
In additionfair presentation of our financial position and results of operations for the periods presented. These historical results are not necessarily indicative of results to be expected from any future period. You should read the following summary financial information together with the other information contained in this Prospectus, prospective
investors should consider carefully the following factors in evaluating an
investment in the shares of the Class A Common Stock offered hereby.
GOVERNMENT REGULATION
The Company is subject to substantial regulation by the governmental
agencies in the states in which it operates, and will be subject to such
regulation in any state in which the Company provides workers' compensation
coverage and services in the future. These regulations are primarily intended to
protect covered employees and policyholders rather than insurance companies or
their shareholders. State regulatory agencies have broad administrative power
with respect to all aspects of the Company's business,prospectus, including premium rates,
capital and surplus requirements, reserve requirements, transactions with
affiliates, changes in control, investment criteria and policy forms. Under
Louisiana law, an insurance company may not, without regulatory approval, pay to
its shareholders within a 12-month period dividends or other distributions of
cash or property the total fair market value of which exceeds the lesser of (i)
ten percent of surplus as to policyholders at the end of the prior calendar year
or (ii) the prior calendar year's net income (less any realized capital gains).
This requirement would limit American Interstate's ability to make distributions
to AMERISAFE in 1996 to approximately $2.7 million. There is no assurance that
the Company will seek approval from state regulatory authorities to permit its
insurance subsidiaries to pay dividends or make distributions or that, if
sought, such approval will be obtained. This approval requirement may limit the
amount of distributions which may be made by such subsidiaries and may decrease
the amount of capital available to the Company for expansion opportunities and
other purposes.
Workers' compensation coverage is a creation of state law, is subject to
change by the applicable state legislature and is influenced by the political
process in each state. Several states have mandated that employers receive
coverage only from funds operated by the state. New laws affecting the workers'
compensation system in states where the Company presently operates or may
operate in the future, including laws that require all employers to participate
in state sponsored funds or that mandate premium reductions, could have a
materially adverse effect on the demand for the Company's services and programs,
as well as on the Company's business, financial condition or results of
operations.
From time to time, Congress has also considered federal regulation of the
health insurance industry. In 1993, the Clinton administration proposed
legislation that would have put into effect substantial changes in the health
care industry. Such legislation has not been adopted. Any legislation relating
to a comprehensive health care program could adversely affect the Company. See
"Business -- Regulation."
CONTROL BY A SINGLE SHAREHOLDER
The Company's equity currently consists of Class A Common Stock and Class B
Common Stock (collectively, the "Common Stock"), which vote together as a single
class on all issues, except as otherwise required by law. Following the
Offering, Millard E. Morris, the Chairman of the Board of Directors and Chief
Executive Officer of the Company, will beneficially own 17,126,521 shares of the
Company's Class B Common Stock, each share of which has ten times the voting
power of a share of Class A Common Stock. As a result, Mr. Morris will control
approximately 92.6% of the voting power of the Common Stock (91.8% if the
7
9
Underwriters' over-allotment option is exercised in full) and will control the
outcome of all shareholder votes, including those relating to amending the
Company's Amended and Restated Articles of Incorporation (the "Articles") or
Restated Bylaws (the "Bylaws"), election of directors and certain mergers and
other significant corporate transactions. This could have the effect of
delaying, deferring or preventing a change in control of the Company. See
"Principal Shareholders" and "Description of Capital Stock -- Class A Common
Stock and Class B Common Stock."
TRANSACTIONS WITH CONTROLLING SHAREHOLDER
After the consummation of the Offering, the Company will have business
relationships with certain entities controlled by Millard E. Morris, the
principal shareholder, Chairman of the Board of Directors and Chief Executive
Officer of the Company. Some of these entities will receive services (e.g.,
administrative services and aviation services) from the Company for a fee. The
Company also subleases office space from one of these entities. In addition, the
Company has entered into a Tax Sharing Agreement in connection with the
Reorganization. See "Certain Transactions and Relationships" and "Recent
Reorganization."
HOLDING COMPANY STRUCTURE
The Company is a holding company, the primary assets of which are the
capital stock of its subsidiaries. Accordingly, the Company is dependent on the
cash flow from its subsidiaries, received through dividends or other
intercompany transfers of funds, to meet its obligations. Although the Company
does not intend to pay dividends for the foreseeable future, the Company will be
dependent on such sources to pay, if and when declared by the Company's Board of
Directors, dividends on the Common Stock or any outstanding shares of the
Company's preferred stock, $.01 par value per share ("Preferred Stock"). See
"Dividend Policy." Dividends and other payments received from the Company's
subsidiaries, together with any net proceeds from the Offering retained by the
Company for general corporate purposes, are expected, for the foreseeable
future, to be the Company's major source of liquidity. None of the Company's
subsidiaries will be obligated to declare or pay dividends or make other capital
distributions to the Company. In addition, the payment of dividends by the
Company's subsidiaries may be restricted under applicable law. See
"-- Government Regulation" above. Limitations on the ability of the Company's
subsidiaries to make such payments could adversely impact the Company's
liquidity.
Under Louisiana law applicable to insurance holding companies, the
Company's insurance subsidiaries may not enter into certain transactions,
including certain reinsurance agreements, management agreements, service
contracts and cost sharing arrangements, with members of their insurance holding
company system unless they have notified the Commissioner of Insurance of their
intention to enter into such a transaction at least 30 days in advance and the
Commissioner of Insurance has not disapproved the transaction within such
period. Among other things, such transactions are subject to the requirements
that their terms be fair and reasonable, that charges or fees for services
performed must be reasonable and that the interests of policyholders not be
adversely affected.
NEED FOR CAPITAL
The Company may from time to time need additional capital and surplus to
meet certain state regulatory requirements. In particular, the Company
anticipates that its insurance subsidiaries will require capital to meet current
statutory surplus needs and any additional funding requirements that may
periodically arise. From time to time, the Company may be required to increase
the capital and surplus of its insurance subsidiaries to remain in compliance
with state regulatory requirements. The Company intends to use a portion of the
net proceeds from this Offering for this purpose. The Company expects that
additional capital will be required by regulatory authorities for the Company to
further expand into additional states. If the Company is unable to generate
sufficient capital, either internally or from outside sources, it could be
required to reduce its growth or to delay or abandon plans to expand into
additional states. Although the Company has met its capital needs in the past,
there can be no assurance that capital will continue to be available when needed
or, if available, will be on terms acceptable to the Company. Additionally, if
such capital is not available, there can be no assurance that the Company will
be able to maintain its current rating of "A" (Excellent) from A.M. Best
8
10
Company, Inc. See "Use of Proceeds," "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations -- LiquidityOperations” and Capital
Resources"the financial statements and "Business -- A.M. Best Rating."
The National Associationrelated notes included elsewhere in this prospectus.
| Nine Months Ended | Year Ended | |||||||||||||||||||||||||||
| September 30, | December 31, | |||||||||||||||||||||||||||
| 2006 | 2005 | 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||||||||
| (Unaudited) | ||||||||||||||||||||||||||||
| (In thousands, except share and per share data) | ||||||||||||||||||||||||||||
Income Statement Data | ||||||||||||||||||||||||||||
| Gross premiums written | $ | 255,920 | $ | 231,182 | $ | 290,891 | $ | 264,962 | $ | 223,590 | $ | 185,093 | $ | 204,752 | ||||||||||||||
| Ceded premiums written | (14,069 | ) | (14,930 | ) | (21,541 | ) | (21,951 | ) | (27,600 | ) | (26,563 | ) | (49,342 | ) | ||||||||||||||
| Net premiums written | $ | 241,851 | $ | 216,252 | $ | 269,350 | $ | 243,011 | $ | 195,990 | $ | 158,530 | $ | 155,410 | ||||||||||||||
| Net premiums earned | $ | 214,972 | $ | 189,370 | $ | 256,568 | $ | 234,733 | $ | 179,847 | $ | 163,257 | $ | 170,782 | ||||||||||||||
| Net investment income | 18,132 | 11,985 | 16,882 | 12,217 | 10,106 | 9,419 | 9,935 | |||||||||||||||||||||
| Net realized gains (losses) on investments | 2,581 | 1,337 | 2,272 | 1,421 | 316 | (895 | ) | 491 | ||||||||||||||||||||
| Fee and other income | 550 | 426 | 561 | 589 | 462 | 2,082 | 1,367 | |||||||||||||||||||||
| Total revenues | 236,235 | 203,118 | 276,283 | 248,960 | 190,731 | 173,863 | 182,575 | |||||||||||||||||||||
| Loss and loss adjustment expenses incurred | 149,989 | 155,625 | 204,056 | (2) | 174,186 | 129,250 | 121,062 | 123,386 | ||||||||||||||||||||
| Underwriting and certain other operating costs(1) | 26,524 | 23,578 | 33,008 | 28,987 | 23,062 | 22,674 | 23,364 | |||||||||||||||||||||
| Commissions | 13,811 | 11,869 | 16,226 | 14,160 | 11,003 | 9,189 | 14,351 | |||||||||||||||||||||
| Salaries and benefits | 12,404 | 10,968 | 14,150 | 15,034 | 15,037 | 16,541 | 17,148 | |||||||||||||||||||||
| Interest expense | 2,579 | 2,061 | 2,844 | 1,799 | 203 | 498 | 735 | |||||||||||||||||||||
| Policyholder dividends | 563 | 451 | 4 | 1,108 | 736 | 156 | 2,717 | |||||||||||||||||||||
| Total expenses | 205,870 | 204,552 | 270,288 | 235,274 | 179,291 | 170,120 | 181,701 | |||||||||||||||||||||
| Income (loss) before taxes | 30,365 | (1,434 | ) | 5,995 | 13,686 | 11,440 | 3,743 | 874 | ||||||||||||||||||||
| Income tax expense (benefit) | 7,046 | (1,960 | ) | 65 | 3,129 | 2,846 | (1,438 | ) | (395 | ) | ||||||||||||||||||
| Net income (loss) | 23,319 | 526 | 5,930 | 10,557 | 8,594 | 5,181 | 1,269 | |||||||||||||||||||||
Payment-in-kind preferred dividends(3) | — | (7,142 | ) | (8,593 | ) | (9,781 | ) | (10,133 | ) | (9,453 | ) | (8,820 | ) | |||||||||||||||
| Net income (loss) available to common shareholders | $ | 23,319 | $ | (6,616 | ) | $ | (2,663 | ) | $ | 776 | $ | (1,539 | ) | $ | (4,272 | ) | $ | (7,551 | ) | |||||||||
| Portion allocable to common shareholders(4) | 87.8 | % | 100.0 | % | 100.0 | % | 70.2 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||||||||
| Net income (loss) allocable to common shareholders | $ | 20,474 | $ | (6,616 | ) | $ | (2,663 | ) | $ | 545 | $ | (1,539 | ) | $ | (4,272 | ) | $ | (7,551 | ) | |||||||||
| Diluted earnings per common share equivalent | $ | 1.17 | $ | (22.07 | ) | $ | (1.25 | ) | $ | 2.14 | $ | (8.55 | ) | $ | (23.72 | ) | $ | (41.93 | ) | |||||||||
| Diluted weighted average of common share equivalents outstanding | 17,422,413 | 299,774 | 2,129,492 | 255,280 | 180,125 | 180,125 | 180,125 | |||||||||||||||||||||
Selected Insurance Ratios | ||||||||||||||||||||||||||||
| Current accident year loss ratio(5) | 69.8 | % | 70.6 | % | 71.0 | % | 68.5 | % | 70.6 | % | 71.8 | % | 66.9 | % | ||||||||||||||
| Prior accident year loss ratio(6) | 0.0 | % | 11.6 | % | 8.5 | % | 5.7 | % | 1.3 | % | 2.4 | % | 5.3 | % | ||||||||||||||
| Net loss ratio | 69.8 | % | 82.2 | % | 79.5 | % | 74.2 | % | 71.9 | % | 74.2 | % | 72.2 | % | ||||||||||||||
| Net underwriting expense ratio(7) | 24.5 | % | 24.5 | % | 24.7 | % | 24.8 | % | 27.3 | % | 29.7 | % | 32.1 | % | ||||||||||||||
| Net dividend ratio(8) | 0.3 | % | 0.2 | % | 0.0 | % | 0.5 | % | 0.4 | % | 0.1 | % | 1.6 | % | ||||||||||||||
| Net combined ratio(9) | 94.6 | % | 106.9 | % | 104.2 | % | 99.5 | % | 99.6 | % | 104.0 | % | 105.9 | % | ||||||||||||||
7
| September 30, | December 31, | |||||||||||||||||||||||||||
| 2006 | 2005 | 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||||||||
| (Unaudited) | ||||||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
Balance Sheet Data | ||||||||||||||||||||||||||||
| Cash and cash equivalents | $ | 61,778 | $ | 28,843 | $ | 49,286 | $ | 25,421 | $ | 49,815 | $ | 44,677 | $ | 44,270 | ||||||||||||||
| Investments | 577,775 | 469,316 | 533,618 | 364,868 | 257,729 | 205,315 | 148,305 | |||||||||||||||||||||
| Amounts recoverable from reinsurers | 122,792 | 122,774 | 122,562 | 198,977 | 211,774 | 214,342 | 298,451 | |||||||||||||||||||||
| Premiums receivable, net | 145,621 | 140,061 | 123,934 | 114,141 | 108,380 | 95,291 | 104,907 | |||||||||||||||||||||
| Deferred income taxes | 26,689 | 23.232 | 22,413 | 15,624 | 12,713 | 11,372 | 14,716 | |||||||||||||||||||||
| Deferred policy acquisition costs | 19,785 | 18,189 | 16,973 | 12,044 | 11,820 | 9,505 | 11,077 | |||||||||||||||||||||
| Deferred charges | 4,003 | 3,601 | 3,182 | 3,054 | 2,987 | 1,997 | 2,588 | |||||||||||||||||||||
| Total assets | 985,034 | 830,308 | 892,320 | 754,187 | 678,608 | 603,801 | 645,474 | |||||||||||||||||||||
| Reserves for loss and loss adjustment expenses | 520,843 | 469,894 | 484,485 | 432,880 | 377,559 | 346,542 | 383,032 | |||||||||||||||||||||
| Unearned premiums | 151,403 | 138,623 | 124,524 | 111,741 | 103,462 | 87,319 | 92,047 | |||||||||||||||||||||
| Insurance-related assessments | 39,647 | 33,847 | 35,135 | 29,876 | 26,133 | 23,743 | 25,964 | |||||||||||||||||||||
| Debt | 36,090 | 36,090 | 36,090 | 36,090 | 16,310 | 8,000 | 9,000 | |||||||||||||||||||||
| Redeemable preferred stock(10) | 50,000 | 136,292 | 50,000 | 131,916 | 126,424 | 121,300 | 116,520 | |||||||||||||||||||||
| Shareholders’ equity (deficit)(11) | 121,666 | (46,969 | ) | 97,346 | (42,862 | ) | (20,652 | ) | (25,100 | ) | (10,980 | ) | ||||||||||||||||
| (1) | Includes policy acquisition expenses, such as assessments, premium taxes and other general and administrative expenses, excluding commissions and salaries and benefits, related to insurance operations and corporate operating expenses. | |
| (2) | Includes (a) a pre-tax loss of $13.2 million in connection with a commutation agreement with Converium Reinsurance (North America), one of our reinsurers, pursuant to which Converium paid us $61.3 million in exchange for a termination and release of three of our five reinsurance agreements with Converium and (b) an $8.7 million pre-tax increase in our reserves for loss and loss adjustment expenses related to prior accident years. | |
| (3) | Under the terms of our articles of incorporation, holders of our Series C and Series D convertible preferred stock are no longer entitled to receivepay-in-kind dividends as a result of the redemption and exchange of all of our outstanding shares of Series A preferred stock in connection with the initial public offering of our common stock in November 2005. | |
| (4) | Reflects the participation rights of the Series C and Series D convertible preferred stock. See Note 15 to our audited financial statements. | |
| (5) | The current accident year loss ratio is calculated by dividing loss and loss adjustment expenses incurred for the current accident year by the current year’s net premiums earned. | |
| (6) | The prior accident year loss ratio is calculated by dividing the change in loss and loss adjustment expenses incurred for prior accident years by the current year’s net premiums earned. | |
| (7) | The net underwriting expense ratio is calculated by dividing underwriting and certain other operating costs, commissions and salaries and benefits by the current year’s net premiums earned. | |
| (8) | The net dividend ratio is calculated by dividing policyholder dividends by the current year’s net premiums earned. | |
| (9) | The net combined ratio is the sum of the net loss ratio, the net underwriting expense ratio and the net dividend ratio. |
| (10) | Includes our Series C and Series D convertible preferred stock, each of which is mandatorily redeemable upon the occurrence of certain events that are deemed to be outside our control. For periods presented prior to November 2005, also includes our Series A preferred stock, which was mandatorily redeemable upon the occurrence of certain events that were deemed to be outside our control. In connection with the initial public offering of our common stock in November 2005, all outstanding shares of our Series A preferred stock were redeemed and exchanged for shares of our common stock. |
| (11) | In 1997, we entered into a recapitalization transaction with Welsh, Carson, Anderson & Stowe VII, L.P. and WCAS Healthcare Partners, L.P., our principal shareholders, that resulted in a $164.2 million charge to retained earnings. For periods presented prior to November 2005, shareholders’ equity (deficit) included our Series E preferred stock. In connection with the initial public offering of our common stock in November 2005, all outstanding shares of our Series E preferred stock were redeemed for cash. |
8
RISK FACTORS
An investment in our common stock involves a number of Insurance Commissioners ("NAIC") has adoptedrisks. Before making a system of assessing minimum capital adequacy, which system is applicabledecision to purchase our common stock, you should carefully consider the Company's insurance subsidiaries. This system, known as risk-based capital
("RBC"), is used to identify companies that merit further regulatory action by
comparing adjusted surplus tofollowing information about these risks, together with the required surplus, which reflects the risk
profileother information contained in this prospectus. Any of the insurer. Insurers having less statutory surplus than that
required by the RBC model formula are subject to regulatory action dependingrisks described below could result in a significant or material adverse effect on the level of capital inadequacy. At December 31, 1995, the RBC ratios of the
Company's insurance subsidiaries were in excess of statutory minimums.
MANAGEMENT OF GROWTH; EXPANSION STRATEGY
Since it began operations in 1986, the Company has experienced significant
growth in its revenues, the number of its employees and the scope of its
operations. This growth has and will require the Company to obtain additional
capital. See "-- Need for Capital" above. This growth has also resulted in, and
is expected to continue to create, new and increased responsibilities for
management personnel, as well as additional demands on the Company's operating
and financial systems. The Company's business and future growth will depend on
the efforts of key management personnel and the Company's ability to attract and
retain qualified management personnel. The Company's continued growth also will
require it to recruit qualified persons, to enhance managerial systems for its
operations, and to successfully integrate new employees and systems into its
existing operations. If the Company is unable to continue to manage growth
effectively, the Company'sour business, financial condition or results of operations, and a decline in the market price of our common stock. You could lose all or part of your investment.
Risks Related to Our Business
Our loss reserves are based on estimates and may be materially adversely affected. See "Management's Discussioninadequate to cover our actual losses.
We must establish and Analysismaintain reserves for our estimated liability for loss and loss adjustment expenses. We establish loss reserves that represent an estimate of Financial Conditionamounts needed to pay and Resultsadminister claims with respect to insured events that have occurred, including events that have occurred but have not yet been reported to us. Reserves are based on estimates of Operations"the ultimate cost of individual claims. These estimates are inherently uncertain. Judgment is required to determine the relevance of historical payment and "Business --
Strategy -- Pursue Growth Opportunities."claim settlement patterns under current facts and circumstances. The Company intendsinterpretation of this historical data can be impacted by external forces, principally legislative changes, economic fluctuations and legal trends. If there are unfavorable changes in our assumptions, our reserves may need to pursue growth opportunities through both greater
market penetrationbe increased.
Workers’ compensation claims often are paid over a long period of time. In addition, there are no policy limits on our liability for workers’ compensation claims as there are for other forms of insurance. Therefore, estimating reserves for workers’ compensation claims may be more uncertain than estimating reserves for other types of insurance claims with shorter or more definite periods between occurrence of the claim and final determination of the loss and with policy limits on liability for claim amounts. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would result in existing marketsadjustments to our reserves and expansion into new markets, targeting
employersour loss and loss adjustment expenses incurred in industries and geographic areasthe period in which the Company does not
presently conduct business.estimates are changed. If the estimate is increased, our pre-tax income for the period in which we make the change will decrease by a corresponding amount. In addition, the Company intendsincreasing reserves results in a reduction in our surplus and could result in a downgrade in our A.M. Best rating. Such a downgrade could, in turn, adversely affect our ability to pursue
acquisitionssell insurance policies.
If we do not accurately establish our premium rates, our results of other workers' compensation insurers or books of indemnity
business. To date, the Company has never acquired another workers' compensation
insurer and is unable to predict whether or when any prospective acquisition
candidate will become available or the likelihood that any acquisitionoperations will be completed. The Company will competeadversely affected.
In general, the premium rates for acquisitionour insurance policies are established when coverage is initiated and, expansion opportunities
with many entities that have substantially greater resources. In addition,
acquisitions may involve difficulties in the retention of personnel, diversion
of management's attention, unexpected legal liabilities and tax and accounting
issues. There can be no assurance that the Company will be able to successfully
identify suitable acquisition candidates, complete acquisitions, integrate
acquired businesses into its operations or expand into new markets. Once
integrated, acquisitions may not achieve levels of revenues, profitability or
productivity comparable to the existing businesstherefore, before all of the Company or otherwise
perform as expected. The occurrence of any of these eventsunderlying costs are known. Like other workers’ compensation insurance companies, we rely on estimates and assumptions in setting our premium rates. Establishing adequate rates is necessary, together with investment income, to generate sufficient revenue to offset losses, loss adjustment expenses and other underwriting expenses and to earn a profit. If we fail to accurately assess the risks that we assume, we may fail to charge adequate premium rates to cover our losses and expenses, which could havereduce our net income and cause us to become unprofitable. For example, when initiating coverage on a materially adverse effect on the Company's business, financial condition or
results of operations. See "Business -- Strategy."
Future growth of the Company's operations depends,policyholder, we estimate future claims expense based, in part, on itsprior claims information provided by the policyholder’s previous insurance carriers. If this prior claims information is not accurate, we may underprice our policy by using claims estimates that are too low. As a result, our actual costs for providing insurance coverage to our policyholders may be significantly higher than our premiums. In order to set premium rates accurately, we must:
| • | collect and properly analyze a substantial volume of data; | |
| • | develop, test and apply appropriate rating formulae; | |
| • | closely monitor and timely recognize changes in trends; and | |
| • | project both frequency and severity of losses with reasonable accuracy. |
9
We must also implement our pricing accurately in accordance with our assumptions. Our ability to enter markets in additional states. To achieve this objective, the Company
must obtain regulatory approval, win acceptance in the local market, adapt its
procedures to each state's regulatory system (which differs materially from
state to state) and expand its network of agents. The time required to obtain
regulatory approval varies from state to state, and there can be no assurance
that the Company will obtain such approval in each state it may seek to enter.
See "Business -- Regulation."
The Company plans to manage its growth in a manner intended to maintain its
"A" (Excellent) rating from A.M. Best Company, Inc., although there can be no
assurances in this regard. See "Business -- A.M. Best Rating."
9
11
FOCUS ON HAZARDOUS OCCUPATION INDUSTRIES
Since it began operations in 1986, the Company has focused on providing
workers' compensation products and services to employers whose employees are
engaged in hazardous occupationsundertake these efforts successfully, and as a result are susceptibleset premium rates accurately, is subject to serious
injuries. Such injuries typically result in substantial costs for both medical
treatment and indemnity payments, as well as the costs of managing the delivery
of care to injured employees. To limit its exposure, the Company has "excess of
loss" reinsurance in effect with a number of reinsurance carriers. The failurerisks and uncertainties, principally:
| • | insufficient reliable data; | |
| • | incorrect or incomplete analysis of available data; | |
| • | uncertainties generally inherent in estimates and assumptions; | |
| • | our inability to implement appropriate rating formulae or other pricing methodologies; | |
| • | costs of ongoing medical treatment; | |
| • | our inability to accurately estimate retention, investment yields and the duration of our liability for loss and loss adjustment expenses; and | |
| • | unanticipated court decisions, legislation or regulatory action. |
Consequently, we could set our premium rates too low, which would negatively affect our results of any such reinsureroperations and our profitability, or we could set our premium rates too high, which could reduce our competitiveness and lead to lower revenues.
A downgrade in our A.M. Best rating would likely reduce the amount of business we are able to write.
Rating agencies evaluate insurance companies based on their ability to pay claims. We are currently assigned a group letter rating of “A−” (Excellent) from A.M. Best, which is the rating agency that we believe has the most influence on our business. This rating is assigned to companies that, in the opinion of A.M. Best, have demonstrated an excellent overall performance when compared to industry standards. A.M. Best considers “A−” rated companies to have an excellent ability to meet itstheir ongoing obligations to policyholders. The ratings of A.M. Best are subject to periodic review using, among other things, proprietary capital adequacy models, and are subject to revision or withdrawal at any time. A.M. Best ratings are directed toward the Companyconcerns of policyholders and insurance agencies and are not intended for the protection of investors or as a recommendation to buy, hold or sell securities. Our competitive position relative to other companies is determined in part by our A.M. Best rating. Any downgrade in our rating would likely adversely affect our business through the loss of certain existing and potential policyholders and the loss of relationships with certain independent agencies.
The workers’ compensation insurance industry is cyclical in nature, which may affect our overall financial performance.
The financial performance of the workers’ compensation insurance industry has historically fluctuated with periods of low premium rates and excess underwriting capacity resulting from increased competition followed by periods of high premium rates and shortages of underwriting capacity resulting from decreased competition. Although the financial performance of an individual insurance company is dependent on its own specific business characteristics, the profitability of most workers’ compensation insurance companies generally tends to follow this cyclical market pattern. Beginning in 2000 and accelerating in 2001, the workers’ compensation insurance industry experienced a market reflecting increasing premium rates, more restrictive policy coverage terms and more conservative risk selection. We believe these trends slowed beginning in 2004. We also believe the current workers’ compensation insurance market is slowly transitioning to a more competitive market environment in which underwriting capacity and price competition may increase. This additional underwriting capacity may result in increased competition from other insurance carriers expanding the kinds or amounts of business they write or seeking to maintain or increase market share at the expense of underwriting discipline. Because this cyclicality is due in large part to the actions of our competitors and general economic factors, we cannot predict the timing or duration of changes in the market cycle. We believe that the workers’ compensation insurance industry is slowly transitioning to a more competitive market environment. These cyclical patterns could cause our revenues and net income to fluctuate, which may cause the price of our common stock to be volatile.
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If we are unable to obtain reinsurance on favorable terms, our ability to write policies could be adversely affected.
We purchase reinsurance to protect us from the impact of large losses. Reinsurance is an arrangement in which an insurance company, called the ceding company, transfers insurance risk by sharing premiums with another insurance company, called the reinsurer. Conversely, the reinsurer receives or assumes reinsurance from the ceding company. Our 2006 reinsurance program provides us with reinsurance coverage for each loss occurrence up to $30.0 million, subject to applicable deductibles, retentions and aggregate limits. However, for any loss occurrence involving only one person, our reinsurance coverage is limited to $10.0 million, subject to applicable deductibles, retentions and aggregate limits. We retain the first $1.0 million of each loss and are subject to an annual aggregate deductible of approximately $10.8 million for losses between $1.0 million and $2.0 million before our reinsurers are obligated to reimburse us. After the deductible is satisfied, we retain 25.0% of each loss between $1.0 million and $2.0 million. The aggregate limit for all claims for losses between $1.0 million and $2.0 million is approximately $5.4 million. For losses between $2.0 million and $5.0 million, we are subject to an annual aggregate deductible of approximately $7.3 million before our reinsurers are obligated to reimburse us. The aggregate limit for all claims for losses between $2.0 million and $5.0 million is approximately $39.0 million. See “Business—Reinsurance.” The availability, amount and cost of reinsurance are subject to market conditions and our experience with insured losses.
Due to the increased cost of reinsurance, we have increased our levels of retention on a materially adverse effectper occurrence basis each year since 2003. As a result, we are exposed to increased risk of loss resulting from volatility in the frequency and severity of claims, which could adversely affect our financial performance.
If any of our current reinsurers were to terminate participation in our 2006 reinsurance treaty program, we could be exposed to an increased risk of loss.
The agreements under our 2006 reinsurance treaty program may be terminated by us or our reinsurers upon 90 days prior notice effective on any January 1. If our reinsurance treaty program is terminated and we enter into a new program, any decrease in the Company'samount of reinsurance at the time we enter into a new program, whether caused by the existence of more restrictive terms and conditions or decreased availability, will also increase our risk of loss and, as a result, could adversely affect our business, financial condition orand results of operations. See "-- RelianceWe currently have eleven reinsurers participating in our reinsurance treaty program, and we believe that this is a sufficient number of reinsurers to provide us with the reinsurance coverage we require. However, because our reinsurance treaty program may be terminated on Reinsurance."
RELIANCE ON REINSURANCE
Due toany January 1, it is possible that one or more of our current reinsurers could terminate participation in our program. In addition, we may terminate the Company's exposure to significant claims resulting from injuries
sufferedparticipation of one or more of our reinsurers under certain circumstances as permitted by the employeesterms of its clients,our reinsurance agreements. In either of those events, if our reinsurance broker is unable to spread the Company has "excessterminated reinsurance among the remaining reinsurers in the program, it could take a significant amount of loss"
reinsurance in effecttime to identify and negotiate agreements with a numberreplacement reinsurer. During this time, we would be exposed to an increased risk of loss, the extent of which would depend on the volume of terminated reinsurance.
We may not be able to recover amounts due from our reinsurers, which would adversely affect our financial condition.
Reinsurance does not discharge our obligations under the insurance policies we write. We remain liable to our policyholders even if we are unable to make recoveries that we are entitled to receive under our reinsurance carriers. This reinsurance,
incontracts. As a result, we are subject to credit risk with respect to our reinsurers. Losses are recovered from our reinsurers as claims are paid. In long-term workers’ compensation claims, the aggregate, currently provides coverage for each claim occurrence upcreditworthiness of our reinsurers may change before we recover amounts to $50,000,000 in excess of the Company's retention of $200,000. The Company
presently intends to increase its retention level under these policies upon
their expiration in July 1997. The Company regularly performs internal reviews
of the financial strength of its reinsurers. However,which we are entitled. Therefore, if a reinsurer is unable to meet any of its obligations to the Company under the reinsurance agreements,
whether due to the incurrence of multiple large claims by the Company's clients
or otherwise, the Companyus, we would be responsible for the payment of all claims and claim settlement expenses for which we would have otherwise received payment from the reinsurer.
In the past, we have been unable to recover amounts from our reinsurers. In 2001, Reliance Insurance Company, has cededone of our former reinsurers, was placed under regulatory supervision by the Pennsylvania Insurance Department and was subsequently placed into liquidation. As a result, between 2001 and
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September 30, 2006, we recognized losses related to such reinsurer. Any
such failureuncollectible amounts due from Reliance aggregating $21.3 million.
As of September 30, 2006, we had $122.8 million of recoverables from reinsurers. Of this amount, $106.5 million was unsecured. As of September 30, 2006, our largest recoverables from reinsurers included $27.9 million from Munich Reinsurance America, Inc., $22.1 million from Odyssey America Reinsurance Company, $12.3 million from St. Paul Fire and Marine Insurance Company and $11.6 million from Clearwater Insurance Company. If we are unable to collect amounts recoverable from our reinsurers, our financial condition would be adversely affected.
A downgrade in the A.M. Best rating of one or more of our significant reinsurers could adversely affect our financial condition.
Our financial condition could be adversely affected if the A.M. Best rating of one or more of our significant reinsurers is downgraded. For example, our A.M. Best rating may be downgraded if our amounts recoverable from a reinsurer are significant and the A.M. Best rating of that reinsurer is downgraded. If one of our reinsurers suffers a rating downgrade, we may consider various options to lessen the impact on our financial condition, including commutation, novation and the use of letters of credit to secure amounts recoverable from reinsurers. However, these options may result in losses to our company, and there can be no assurance that we could implement any of these options.
In 2004, A.M. Best downgraded the financial strength rating of Converium Reinsurance (North America), our largest reinsurer at that time. Subsequently, in June 2005, A.M. Best placed our “A−” rating under review with negative implications, citing, among other things, concerns about credit risk associated with amounts recoverable from our reinsurers. Although Converium continued to reimburse us under the terms of our reinsurance agreements, we entered into a commutation agreement with Converium in June 2005 pursuant to which Converium paid us $61.3 million in exchange for a termination and release of three of our five reinsurance agreements with Converium. Under the commutation agreement, all liabilities reinsured with Converium under these three reinsurance agreements have reverted back to us. We recorded a pre-tax loss of $13.2 million in 2005 related to this commutation agreement. Converium remains obligated to us on the partremaining two agreements. We cannot assure you that the cash payment we received from Converium, and any investment income we may earn on that amount, will be sufficient to cover all claims for which we would otherwise have been contractually entitled to recover from Converium under the three reinsurance agreements subject to the commutation agreement.
Negative developments in the workers’ compensation insurance industry would adversely affect our financial condition and results of operations.
We principally offer workers’ compensation insurance. We have no current plans to focus our efforts on offering other types of insurance. As a result, negative developments in the Company's reinsurerseconomic, competitive or regulatory conditions affecting the workers’ compensation insurance industry could have an adverse effect on our financial condition and results of operations. Negative developments in the workers’ compensation insurance industry could have a materially
adversegreater effect on the Company's business, financial condition or resultsus than on more diversified insurance companies that also sell other types of operations. See "Business -- Reinsurance."
QUARTERLY FLUCTUATIONS IN OPERATING RESULTS
The Company establishes reserves to cover its estimated liability for
claims and claim settlement expenses with respect to reported claims and claims
incurred but not yet reported as of the end of each accounting period. The
process of establishing reserves involves many factors and is inherently
uncertain. The Company's results of operations may fluctuate on a quarterly
basis due in part to the seasonal nature of the businesses conducted by its
clients and also as a result of changesinsurance.
A decline in the Company's reserve estimates, as
well as other factors.
CONCENTRATION IN LOGGING INDUSTRY
Since it began operations in 1986, the Company has focused on providing its
workers' compensation products and services to employerslevel of business activity of our policyholders, particularly those engaged in the construction, trucking and logging industry, primarily in the southeastern United States. industries, could negatively affect our earnings and profitability.
In 1994, the Company
began a program2005, approximately 69.7% of providing its services to businesses in other hazardous
occupation industries. For the year ended December 31, 1995 and the three months
ended March 31, 1996, approximately 59.6% and 45.5%, respectively, of the
Company'sour gross premiums earnedwritten were derived from its clientspolicyholders in the construction, trucking and logging industry.industries. Because premiumspremium rates are calculated, in general, determined as a percentage of its
clients'a policyholder’s payroll expense, (or, in the case of its logging clients, the clients'
production of wood products), premiums fluctuate depending upon the level of business activity and number of its clients.employees of our policyholders. As a result, the Company'sour gross premiums earnedwritten are primarily dependent upon the economic conditions in the construction, trucking and logging industries and upon economic conditions generallygenerally.
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Unfavorable changes in economic conditions affecting the states in which we operate could adversely affect our financial condition or results of operations.
We market our insurance in 26 states and in particular, the demand for the wood products harvested by its logging clients. Further, dueDistrict of Columbia. Although we have expanded our operations into new geographic areas and expect to the concentration of the Company's clientscontinue to do so in the logging industry, the
Company'sfuture, approximately 57.7% of our gross premiums earned tend to be lower during periods of inclement
weather when logging activity is reduced. See "-- Quarterly Fluctuations in
Operating Results" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview."
RELIANCE ON INDEPENDENT AGENTS
The Company markets a portion of its workers' compensation products and
services through independent agents. Forwritten for the year ended December 31, 1995 and2005 were derived from the three months ended March 31, 1996, independent agents accounted for
approximately 39.1% and 47.8%, respectively,nine states in which we generated 5.0% or more of the Company'sour gross premiums earned.written in 2005. No independent agentother state accounted for 5.0% or more of the Company's gross premiums earned for either period.
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These agentswritten in 2005. In the future, we may be exposed to economic and regulatory risks or risks from natural perils that are not obligated to promotegreater than the Company's products and services
and may sell competitors'risks faced by insurance products. As a result, the Company's
business depends in part on the marketing effort of these agents and on the
Company's ability to continue to offer workers' compensation products and
servicescompanies that meet the requirements of these agents and their customers. In
addition, as the Company expands into additional states and industries, it may
elect to establish additional independent agents to market its products. Failure
of these independent insurance agents to market successfully the Company's
products and services could have a materially adverse effect onlarger percentage of their gross premiums written diversified over a broader geographic area. Unfavorable changes in economic conditions affecting the Company'sstates in which we write business could adversely affect our financial condition or results of operations. See "Business --“Business—Policyholders.”
Our revenues and results of operations may fluctuate as a result of factors beyond our control, which fluctuation may cause the price of our common stock to be volatile.
The revenues and results of operations of insurance companies historically have been subject to significant fluctuations and uncertainties. Our profitability can be affected significantly by:
| • | rising levels of claims costs, including medical and prescription drug costs, that we cannot anticipate at the time we establish our premium rates; | |
| • | fluctuations in interest rates, inflationary pressures and other changes in the investment environment that affect returns on invested assets; | |
| • | changes in the frequency or severity of claims; | |
| • | the financial stability of our reinsurers and changes in the level of reinsurance capacity and our capital capacity; | |
| • | new types of claims and new or changing judicial interpretations relating to the scope of liabilities of insurance companies; | |
| • | volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes or terrorist attacks; and | |
| • | price competition. |
If our revenues and results of operations fluctuate as a result of one or more of these factors, the price of our common stock may be volatile.
We operate in a highly competitive industry and may lack the financial resources to compete effectively.
There is significant competition in the workers’ compensation insurance industry. We believe that our competition in the hazardous industries we target is fragmented and not dominated by one or more competitors. We compete with other insurance companies, individual self-insured companies, state insurance pools and self-insurance funds. Many of our existing and potential competitors are significantly larger and possess greater financial, marketing and management resources than we do. Moreover, a number of these competitors offer other types of insurance in addition to workers’ compensation and can provide insurance nationwide. We compete on the basis of many factors, including coverage availability, claims management, safety services, payment terms, premium rates, policy terms, types of insurance offered, overall financial strength, financial ratings and reputation. If any of our competitors offer premium rates, policy terms or types of insurance that are more competitive than ours, we could lose market share. No assurance can be given that we will maintain our current competitive position in the markets in which we currently operate or that we will establish a competitive position in new markets into which we may expand.
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If we cannot sustain our relationships with independent agencies, we may be unable to operate profitably.
We market a substantial portion of our workers’ compensation insurance through independent agencies. As of September 30, 2006, independent agencies produced approximately 84% of our voluntary in-force premiums. No independent agency accounted for more than 1.2% of our voluntary in-force premiums at that date. Independent agencies are not obligated to promote our insurance and may sell insurance offered by our competitors. As a result, our continued profitability depends, in part, on the marketing efforts of our independent agencies and on our ability to offer workers’ compensation insurance and maintain financial strength ratings that meet the requirements of our independent agencies and their policyholders.
An inability to effectively manage the growth of our operations could make it difficult for us to compete and affect our ability to operate profitably.
Our continuing growth strategy includes expanding in our existing markets, entering new geographic markets and further developing our agency relationships. Our growth strategy is subject to various risks, including risks associated with our ability to:
| • | identify profitable new geographic markets for entry; | |
| • | attract and retain qualified personnel for expanded operations; | |
| • | identify, recruit and integrate new independent agencies; and | |
| • | augment our internal monitoring and control systems as we expand our business. |
Because we are subject to extensive state and federal regulation, legislative changes may negatively impact our business.
We are subject to extensive regulation by the Louisiana Department of Insurance and the insurance regulatory agencies of other states in which we are licensed and, to a lesser extent, federal regulation. State agencies have broad regulatory powers designed primarily to protect policyholders and their employees, and not our shareholders. Regulations vary from state to state, but typically address:
| • | standards of solvency, including risk-based capital measurements; | |
| • | restrictions on the nature, quality and concentration of our investments; | |
| • | restrictions on the terms of the insurance policies we offer; | |
| • | restrictions on the way our premium rates are established and the premium rates we may charge; | |
| • | required reserves for unearned premiums and loss and loss adjustment expenses; | |
| • | standards for appointing general agencies; | |
| • | limitations on transactions with affiliates; | |
| • | restrictions on mergers and acquisitions; | |
| • | restrictions on the ability of our insurance company subsidiaries to pay dividends to AMERISAFE; | |
| • | certain required methods of accounting; and | |
| • | potential assessments for state guaranty funds, second injury funds and other mandatory pooling arrangements. |
We may be unable to comply fully with the wide variety of applicable laws and regulations that are continually undergoing revision. In addition, we follow practices based on our interpretations of laws and regulations that we believe are generally followed by our industry. These practices may be different from interpretations of insurance regulatory agencies. As a result, insurance regulatory agencies could preclude us from conducting some or all of our activities or otherwise penalize us. For example, in order to enforce
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applicable laws and regulations or to protect policyholders, insurance regulatory agencies have relatively broad discretion to impose a variety of sanctions, including examinations, corrective orders, suspension, revocation or denial of licenses and the takeover of one or more of our insurance subsidiaries. The extensive regulation of our business may increase the cost of our insurance and may limit our ability to obtain premium rate increases or to take other actions to increase our profitability.
The effects of emerging claim and coverage issues on our business are uncertain.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until after we have issued insurance policies that are affected by the changes. As a result, the full extent of our liability under an insurance policy may not be known until many years after the policy is issued. For example, medical costs associated with permanent and partial disabilities may increase more rapidly or be higher than we currently expect. Changes of this nature may expose us to higher claims than we anticipated when we wrote the underlying policy. As of September 30, 2006, approximately 8.5% of our 2004 reported claims and 1.0% of our pre-2004 reported claims were open.
Additional capital that we may require in the future may not be available to us or may be available to us only on unfavorable terms.
Our future capital requirements will depend on many factors, including state regulatory requirements, the financial stability of our reinsurers and our ability to write new business and establish premium rates sufficient to cover our estimated claims. We may need to raise additional capital or curtail our growth if the capital of our insurance subsidiaries is insufficient to support future operating requirementsand/or cover claims. If we had to raise additional capital, equity or debt financing may not be available to us or may be available only on terms that are not favorable. In the case of equity financings, dilution to our shareholders could result and the securities sold may have rights, preferences and privileges senior to the common stock sold in this offering. In addition, under certain circumstances, the sale of our common stock, or securities convertible or exchangeable into shares of our common stock, at a price per share less than the market value of our common stock may result in an adjustment to the conversion price at which shares of our existing convertible preferred stock may be converted into shares of our common stock. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition or results of operations could be adversely affected.
If we are unable to realize our investment objectives, our financial condition and results of operations may be adversely affected.
Investment income is an important component of our net income. As of September 30, 2006, our investment portfolio, including cash and cash equivalents, had a carrying value of $639.6 million. For the year ended December 31, 2005, we had $16.9 million of net investment income. Our investment portfolio is managed under investment guidelines approved by our board of directors. Although these guidelines stress diversification and capital preservation, our investments are subject to a variety of risks, including risks related to general economic conditions, interest rate fluctuations and market volatility. General economic conditions may be adversely affected by U.S. involvement in hostilities with other countries and large-scale acts of terrorism, or the threat of hostilities or terrorist acts.
Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. Changes in interest rates could have an adverse effect on the value of our investment portfolio and future investment income. For example, changes in interest rates can expose us to prepayment risks on mortgage-backed securities included in our investment portfolio. When interest rates fall, mortgage-backed securities are prepaid more quickly than expected and the holder must reinvest the proceeds at lower interest rates. In periods of increasing interest rates, mortgage-backed securities
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are prepaid more slowly, which may require us to receive interest payments that are below the interest rates then prevailing for longer than expected.
These and other factors affect the capital markets and, consequently, the value of our investment portfolio and our investment income. Any significant decline in our investment income would adversely affect our revenues and net income and, as a result, increase our shareholders’ deficit and decrease our surplus.
Our business is dependent on the efforts of our executive officers because of their industry expertise, knowledge of our markets and relationships with the independent agencies that sell our insurance.
Our success is dependent on the efforts of our executive officers because of their industry expertise, knowledge of our markets and relationships with our independent agencies. Our executive officers are C. Allen Bradley, Jr., Chairman, President and Chief Executive Officer; Geoffrey R. Banta, Executive Vice President and Chief Financial Officer; Arthur L. Hunt, Executive Vice President; Craig P. Leach, Executive Vice President, Sales and Marketing."
TAX-FREE REORGANIZATIONMarketing; David O. Narigon, Executive Vice President; and Todd Walker, Executive Vice President, General Counsel and Secretary. Mr. Hunt will retire from our company effective as of November 30, 2006. We have entered into employment agreements with each of our executive officers. The employment agreements with Messrs. Bradley, Banta, Hunt and Leach expire in January 2008, unless extended. The employment agreements with Messrs. Narigon and Walker expire in September 2009, unless extended. These employment agreements are more fully described under “Management—Employment and Consulting Agreements.” Should any of our executive officers cease working for us, we may be unable to find acceptable replacements with comparable skills and experience in the workers’ compensation insurance industry and the hazardous industries that we target. As a result, our operations may be disrupted and our business may be adversely affected. We do not currently maintain life insurance policies with respect to our executive officers.
AMERISAFE is an insurance holding company and does not have any direct operations.
AMERISAFE is a holding company that transacts business through its operating subsidiaries, including American Interstate. AMERISAFE’s primary assets are the capital stock of these operating subsidiaries. The ability of AMERISAFE to pay dividends to our shareholders depends upon the surplus and earnings of our subsidiaries and their ability to pay dividends to AMERISAFE. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds, and could be subject to contractual restrictions in the future, including those imposed by indebtedness we may incur in the future. See “Business—Regulation—Dividend Limitations.” As a result, at times, AMERISAFE may not be able to receive dividends from its insurance subsidiaries and may not receive dividends in amounts necessary to pay dividends on our capital stock. Based on reported capital and surplus at December 31, 2005, American Interstate would have been permitted under Louisiana insurance law to pay dividends to AMERISAFE in 2006 in an amount up to $3.9 million without approval by the Louisiana Department of Insurance.
In addition, our ability to pay dividends is subject to restrictions in the articles of incorporation of AMERISAFE that prohibit us from paying dividends on our common stock (other than in additional shares of common stock) without the consent of the holders of two-thirds of the outstanding shares of our convertible preferred stock. If holders of our convertible preferred stock consent to the payment of a dividend, we must pay a dividend to the holders of our convertible preferred stock on an as-converted to common stock basis equal to the dividend we pay to holders of our common stock. Currently, we do not intend to pay dividends on our common stock.
Assessments and premium surcharges for state guaranty funds, second injury funds and other mandatory pooling arrangements may reduce our profitability.
Most states require insurance companies licensed to do business in their state to participate in guaranty funds, which require the insurance companies to bear a portion of the unfunded obligations of impaired, insolvent or failed insurance companies. These obligations are funded by assessments, which are expected to
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continue in the future. State guaranty associations levy assessments, up to prescribed limits, on all member insurance companies in the state based on their proportionate share of premiums written in the lines of business in which the impaired, insolvent or failed insurance companies are engaged. See “Business—Regulation.” Accordingly, the assessments levied on us may increase as we increase our written premium. Some states also have laws that establish second injury funds to reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. These funds are supported by either assessments or premium surcharges based on paid losses.
In addition, as a condition to conducting business in some states, insurance companies are required to participate in residual market programs to provide insurance to those employers who cannot procure coverage from an insurance carrier on a negotiated basis. Insurance companies generally can fulfill their residual market obligations by, among other things, participating in a reinsurance pool where the results of all policies provided through the pool are shared by the participating insurance companies. Although we price our insurance to account for obligations we may have under these pooling arrangements, we may not be successful in estimating our liability for these obligations. Accordingly, mandatory pooling arrangements may cause a decrease in our profits. At September 30, 2006 we participated in mandatory pooling arrangements in 17 states and the District of Columbia. As we write policies in new states that have mandatory pooling arrangements, we will be required to participate in additional pooling arrangements. Further, the impairment, insolvency or failure of other insurance companies in these pooling arrangements would likely increase the liability for other members in the pool. The effect of assessments and premium surcharges or changes in them could reduce our profitability in any given period or limit our ability to grow our business.
Being a public company has increased our expenses and administrative workload.
We completed our initial public offering in November 2005. As a public company, we must comply with various laws and regulations, including the Sarbanes-Oxley Act of 2002 and related rules of the Securities and Exchange Commission, or the SEC, and requirements of the NASDAQ Global Select Market. We were not required to comply with these laws and requirements as a private company. Complying with these laws and regulations requires the time and attention of our board of directors and management and increases our expenses. Among other things, we must:
| • | design, establish, evaluate and maintain a system of internal controls over financial reporting in compliance with the requirements of Section 404 of the Sarbanes-Oxley Act and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board; | |
| • | prepare and distribute periodic reports in compliance with our obligations under the federal securities laws; | |
| • | establish new internal policies, principally those relating to disclosure controls and procedures and corporate governance; | |
| • | institute a more comprehensive compliance function; and | |
| • | involve to a greater degree our outside legal counsel and accountants in the above activities. |
In addition, being a public company has made it more expensive for us to obtain director and officer liability insurance. In the future, we may be required to accept reduced coverage or incur substantially higher costs to obtain this coverage. These factors could also make it more difficult for us to attract and retain qualified executives and members of our board of directors, particularly directors willing to serve on our audit committee.
We will be exposed to risks relating to evaluations of our internal controls over financial reporting required by Section 404 of the Sarbanes-Oxley Act of 2002.
We are in the process of evaluating our internal control systems to allow management to report on, and our independent auditors to assess, our internal controls over financial reporting. We will be performing the system and process evaluation and testing (and any necessary remediation) required to comply with the
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management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act. We are required to comply with Section 404 by no later than December 31, 2006. However, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations. Furthermore, upon completion of this process, we may identify control deficiencies of varying degrees of severity under applicable SEC and Public Company Accounting Oversight Board rules and regulations that remain unremediated. As a public company, we will be required to report, among other things, control deficiencies that constitute a “material weakness” or changes in internal controls that materially affect, or are reasonably likely to materially affect, internal controls over financial reporting. A “material weakness” is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. If we fail to implement the requirements of Section 404 in a timely manner, we might be subject to sanctions or investigation by regulatory agencies such as the SEC. In addition, failure to comply with Section 404 or the report by us of a material weakness may cause investors to lose confidence in our financial statements and the trading price of our common stock may decline. If we fail to remedy any material weakness, our financial statements may be inaccurate, our access to the capital markets may be restricted and the trading price of our common stock may decline.
We may have exposure to losses from terrorism for which we are required by law to provide coverage.
When writing workers’ compensation insurance policies, we are required by law to provide workers’ compensation benefits for losses arising from acts of terrorism. The impact of any terrorist act is unpredictable, and the ultimate impact on us would depend upon the nature, extent, location and timing of such an act. Our 2006 reinsurance treaty program affords coverage for up to $28.0 million for losses arising from terrorism, subject to applicable deductibles, retentions and aggregate limits. Notwithstanding the protection provided by reinsurance and the Terrorism Risk Insurance Extension Act of 2005, the risk of severe losses to us from acts of terrorism has not been eliminated because our reinsurance treaty program includes various sub-limits and exclusions limiting our reinsurers’ obligation to cover losses caused by acts of terrorism. Accordingly, events constituting acts of terrorism may not be covered by, or may exceed the capacity of, our reinsurance and could adversely affect our business and financial condition. In addition, the Terrorism Risk Insurance Extension Act of 2005 is set to expire on December 31, 2007. If this law is not extended or replaced by legislation affording a similar level of protection to the insurance industry against insured losses arising out of acts of terrorism, reinsurance for losses arising from terrorism may be unavailable or prohibitively expensive, and we may be further exposed to losses arising from acts of terrorism.
Risks Related to Our Common Stock and This Offering
The trading price of our common stock may decline after this offering.
The trading price of our common stock may decline after this offering for many reasons, some of which are beyond our control, including, among others:
| • | our results of operations; | |
| • | changes in expectations as to our future results of operations, including financial estimates and projections by securities analysts and investors; | |
| • | results of operations that vary from those expected by securities analysts and investors; | |
| • | developments in the healthcare or insurance industries; | |
| • | changes in laws and regulations; | |
| • | announcements of claims against us by third parties; and | |
| • | future issuances or sales of our common stock, including issuances upon conversion of our outstanding convertible preferred stock. |
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In addition, the stock market in general has experienced significant volatility that often has been unrelated to the operating performance of companies whose shares are traded. These market fluctuations could adversely affect the trading price of our common stock, regardless of our actual operating performance. As a result, the trading price of our common stock may decrease and you may not be able to sell your shares at or above the price you pay to purchase them.
Securities analysts may not continue coverage of our common stock or may issue negative reports, which may adversely affect the trading price of our common stock.
There is no assurance that securities analysts will continue to cover our company. If securities analysts do not cover our company, this lack of coverage may adversely affect the trading price of our common stock. The trading market for our common stock relies in part on the research and reports that securities analysts publish about us or our business. If one or more of the analysts who cover our company downgrades our common stock, the trading price of our common stock may decline rapidly. If one or more of these analysts ceases to cover our company, we could lose visibility in the market, which, in turn, could also cause the trading price of our common stock to decline. Because of our small market capitalization, it may be difficult for us to attract securities analysts to cover our company, which could adversely affect the trading price of our common stock.
Our principal shareholders have the ability to significantly influence our business, which may be disadvantageous to other shareholders and adversely affect the trading price of our common stock.
As of September 30, 2006, Welsh, Carson, Anderson & Stowe VII, L.P. and WCAS Healthcare Partners, L.P., or Welsh Carson collectively, beneficially owned approximately 44.1% of our outstanding common stock and possess approximately 40.7% of the total voting power. As a result, these shareholders, acting together, have the ability to exert substantial influence over all matters requiring approval by our shareholders, including the election and removal of directors, any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. Upon completion of this offering, Welsh Carson will beneficially own 1,161,022 shares, or 6.2%, of our common stock (Welsh Carson will not own any shares of our common stock if the over-allotment option is exercised in full).
Future sales of our common stock may affect the trading price of our common stock and the future exercise of options or the exercise of the conversion rights of our convertible preferred stock may lower our stock price.
We cannot predict what effect, if any, future sales of our common stock, or the availability of shares for future sale, will have on the trading price of our common stock. Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, may adversely affect the trading price of our common stock and may make it more difficult for you to sell your shares at a time and price that you determine appropriate. See “Shares Eligible for Future Sale” for further information regarding circumstances under which additional shares of our common stock may be sold. As of the date of this prospectus, there were 17,446,110 shares of our common stock outstanding. Immediately prior to the completion of the Offering, the Company
distributed thethis offering, we will issue 1,214,771 shares of common stock upon conversion of shares of our convertible preferred stock held by certain subsidiary corporations to existing
shareholders of the Company in transactions intended to qualify as tax-free
distributions for federal income tax purposes under section 355 ofselling shareholders. After the Internal
Revenue Code of 1986, as amended (the "Code"). Prior to such distributions, the
Board of Directors of the Company received an opinion of counsel to the effect
that such distributions should so qualify for federal income tax purposes. The
opinion of counsel received by the Board of Directors of the Company is not
binding on the Internal Revenue Service (the "IRS"), and there can be no
assurance that the IRS will agree with the opinion. No ruling with respect to
such distributions has been requested from the IRS, however, and there can be no
assurance that the IRS will not take the position that such distributions do not
qualify as tax-free. If the distributions were not to qualify for tax-free
treatment under section 355 of the Code, the Company would recognize taxable
gain on the distributions equal to the difference on such date between (i) the
fair market value of the distributed stock and (ii) the Company's adjusted basis
in such stock. See "Recent Reorganization."
DEPENDENCE ON KEY PERSONNEL
The Company's success is largely dependent on the efforts of Millard E.
Morris, its Chairman of the Board of Directors and Chief Executive Officer, and
Mark R. Anderson, its President. The loss of the services of either of these
individuals could have a materially adverse effect on the Company. Further, the
employment agreement between the Company and Mr. Morris does not provide for him
to devote full time to the business of the Company. See
"Management -- Employment Agreements."
ABSENCE OF PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE
Prior to the Offering, there has been no public market for the Class A
Common Stock and there can be no assurance that an active trading market for the
Class A Common Stock will develop or be sustained after the Offering. The
initial public offering price of the Class A Common Stock will be determined
through negotiations between the Company and representatives of the
Underwriters, and may not be indicative of the market price. Additionally, the
market price of the Class A Common Stock could be subject to significant
fluctuations in response to period-to-period variations in operating results of
the Company, changes in general conditions in the economy or the financial
markets, developments in the health care or insurance industries or other
developments affecting the Company, its customers or its competitors, some of
which may be unrelated to the Company's performance. See "Underwriting."
COMPETITION
The workers' compensation industry is highly competitive. The Company's
competitors include, among others, insurance companies, specialized provider
groups, in-house benefits administrators, state insurance pools and other
significant providers of health care and insurance services. A number of the
Company's current and potential competitors are significantly larger, with
greater financial and operating resources than the Company and can offer their
services nationwide. Additionally, the Company does not offer the full line of
insurance products which is offered by some of its competitors. There can be no
assurance that the Company will be able to compete effectively in the future.
See "Business -- Competition."
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SHARES ELIGIBLE FOR FUTURE SALE
After completion of the Offering, the Company will have outstanding
11,000,000this offering, an additional 1,214,770 shares of Class A Common Stock (12,650,000 shares ifour common stock will remain issuable upon the Underwriters' over-allotment option is exercised in full) and 17,400,000conversion of shares of Class B Common Stock. Of those shares, 11,000,000our outstanding convertible preferred stock. Upon conversion, these shares of Class A Common
Stock offered hereby (12,650,000 if the Underwriter's over-allotment option is
exercised in full)common stock will be freely tradable without restriction or further registration under the Securities ActAct. See “Description of 1933,Capital Stock.” We and our current directors, our officers and the selling shareholders have entered into90-daylock-up agreements as amended (the "Securities
Act"), unless purchased by "affiliates"described in “Shares Eligible for Future Sale—Lock-Up Agreements.” Thelock-up agreement with Arthur L. Hunt will terminate on November 30, 2006 upon his retirement from the company. Upon completion of the Company, as that term is defined
in Rule 144 under the Securities Act ("Rule 144"). Allthis offering, an aggregate of the1,543,359 shares of Class B
Common Stock were issued byour common stock, including shares issuable upon the Company in private transactions prior to the
Offering and are "restricted securities" as that term is defined in Rule 144 and
are tradable subject to compliance with Rule 144. The Company and its existing
shareholders, who upon completionexercise of the Offering will own 17,400,000 sharesoptions exercisable within 60 days of
Class B Common Stock, have agreed not to dispose of any shares of Class A Common
Stock or any securities convertible into or exchangeable for such Class A Common
Stock (other than shares and stock options to be granted pursuant to the Stock
Incentive Plan) for a period of 180 days from the date of this Prospectus,
without the prior written consent of Smith Barney Inc., on behalf of the
Underwriters. Sales of substantial amounts of Class A Common Stock or Class B
Common Stock, or the perception that such sales could occur, could adversely
affect market prices for the Class A Common Stock and could impair the Company's
future ability to obtain capital through an offering of equity securities. See
"Shares Eligible for Future Sale." In addition, Messrs. Morris and Anderson are
entitled to certain registration rights with respect to the shares of the Class
A Common Stock. See "Description of Capital Stock -- Class A Common Stock and
Class B Common Stock -- Registration Rights Agreement."
IMMEDIATE AND SUBSTANTIAL DILUTION
Purchasers of Class A Common Stock in the Offeringprospectus, will experience
immediate and substantial dilution, approximately $10.61 per share, in the net
tangible book value per share of Class A Common Stock and may incur additional
dilution upon the exercise of outstanding stock options. See "Dilution" and
"Management -- Stock Incentive Plan -- Awards."
ANTI-TAKEOVER PROVISIONS
The Board of Directors of the Company is authorized to issue up to
25,000,000 shares of Preferred Stock and to fix the rights, preferences,
privileges and restrictions, including voting rights, of those shares without
any further vote or action by the shareholders of the Company. The rights and
preferences of any such Preferred Stock may be superior to those of the Class A
Common Stock and may adversely affect the rights of the holders of the Class A
Common Stock. The Company has no present intention to issue any shares of
Preferred Stock. The voting structure of the Common Stock and other provisions
of the Articles are intended to encourage a person interested in acquiring the
Company to negotiate with, and to obtain the approval of, the Board of Directors
of the Company in connection with any such transaction. However, certain of
these provisions may discourage a future acquisition of the Company, including
an acquisition in which shareholders might otherwise receive a premium for their
shares. As a result, shareholders who might desire to participate in such a
transaction may not have the opportunity to do so. Moreover, the existence of
these provisions may have a depressive effect on the market price of the Class A
Common Stock. In addition, the Company is subject to the provisions of Louisiana
law applicable to insurance holding companies that prohibit a merger or change
in control of the Company without the approval of the Louisiana Department of
Insurance. See "Description of Capital Stock -- Anti-Takeover Provisions."
12
14
USE OF PROCEEDS
Assuming a public offering price of $15 per share, the net proceeds to the
Company from the sale of the 11,000,000theselock-up agreements (360,109 shares of Class A Common Stock offered
hereby, after deducting the estimated underwriting discounts and commissions and
Offering expenses, are estimated to be approximately $152.5 million ($175.5
million if the Underwriters' over-allotment option is exercised in full). There are outstanding options exercisable to purchase 1,648,500 shares of our common stock, of which 1,548,500 were granted in
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November 2005 and 100,000 were granted in September 2006. All options vest 20% each year commencing on the first anniversary of the date of grant.
The Company intendsterms of our convertible preferred stock could adversely affect the value of our common stock.
The conversion price of our convertible preferred stock is currently $20.58 per share and our outstanding convertible preferred stock is presently convertible into 2,429,541 shares of common stock. After the completion of this offering, 1,214,770 shares of our common stock will be issuable upon conversion of our convertible preferred stock. Subject to usecertain exceptions, the netconversion price of our convertible preferred stock may decrease if we issue additional shares of our common stock for less than the market price of our common stock. No adjustment to the conversion price of our convertible preferred stock will result from this offering because we are not issuing additional shares of our common stock.
Holders of our convertible preferred stock have the right to cause us to file a registration statement with the SEC to sell the shares of common stock issuable upon conversion of the convertible preferred stock. See “Certain Relationships and Related Transactions—Registration Rights Agreement.” Sales of shares of common stock issuable upon conversion of our convertible preferred stock could adversely affect the trading price of our common stock.
We may not pay dividends on our common stock (other than in additional shares of common stock) without the consent of the holders of two-thirds of the outstanding shares of our convertible preferred stock. If holders of our convertible preferred stock consent to the payment of a dividend by us, we must pay a dividend to the holders of our convertible preferred stock on an as-converted to common stock basis equal to the dividend we pay to holders of our common stock.
The terms of our articles of incorporation relating to our convertible preferred stock could impede a change of control of our company. Following a change of control, holders of our convertible preferred stock have the right to require us to redeem their shares at a redemption price of $100 per share plus the cash value of any accrued and unpaid dividends. The redemption provisions of our convertible preferred stock could have the effect of discouraging a future change of control of our company. See “Description of Capital Stock—Authorized Capital Stock—Convertible Preferred Stock—Redemption.”
Provisions of our articles of incorporation and bylaws and under the laws of the states of Louisiana and Texas could impede an attempt to replace or remove our directors or otherwise effect a change of control of our company, which could diminish the value of our common stock.
Our articles of incorporation and bylaws contain provisions that may make it more difficult for shareholders to replace or remove directors even if the shareholders consider it beneficial to do so. In addition, these provisions could delay or prevent a change of control of our company that shareholders might consider favorable. Our articles of incorporation and bylaws contain the following provisions that could have an anti-takeover effect:
| • | election of our directors is classified, meaning that the members of only one of three classes of our directors are elected each year; | |
| • | shareholders have limited ability to call shareholder meetings and to bring business before a meeting of shareholders; | |
| • | shareholders may not act by written consent, unless the consent is unanimous; and | |
| • | our board of directors may authorize the issuance of junior preferred stock with such rights, preferences and privileges as the board deems appropriate. |
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These provisions may make it difficult for shareholders to replace management and could have the effect of discouraging a future takeover attempt that is not approved by our board of directors, but which individual shareholders might consider favorable.
We are incorporated in Texas and are subject to Part 13 of the Texas Business Corporation Act. Under this statute, our ability to enter into a business combination with any affiliated shareholder is limited. See “Description of Capital Stock—Anti-Takeover Provisions.”
In addition, two of our three insurance company subsidiaries, American Interstate and Silver Oak Casualty, are incorporated in Louisiana and the other, American Interstate of Texas, is incorporated in Texas. Under Louisiana and Texas insurance law, advance approval by the state insurance department is required for any change of control of an insurer. “Control” is presumed to exist through the direct or indirect ownership of 10% or more of the voting securities of a domestic insurance company or any entity that controls a domestic insurance company. Obtaining these approvals may result in the material delay of, or deter, any such transaction.
21
CERTAIN IMPORTANT INFORMATION
You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any other person to provide you with information that is different from that contained in this prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. The selling shareholders and the underwriters are offering to sell and seeking offers to buy these securities only in jurisdictions where offers and sales are permitted. You should assume that the information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of common stock. Our business, financial condition, results of operations and prospects may have changed since that date.
In this prospectus:
| • | references to the “company,” “we,” “us” or “our” refer to AMERISAFE, Inc. and its subsidiaries, unless the context suggests otherwise; and | |
| • | references to “AMERISAFE” refer solely to AMERISAFE, Inc., unless the context suggests otherwise. |
Unless otherwise stated, all amounts in this prospectus assume no exercise of the underwriters’ over-allotment option.
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FORWARD-LOOKING STATEMENTS
This prospectus includes certain statements that we believe are, or may be considered to be, forward-looking statements within the meaning of various provisions of the Securities Act of 1933 and of the Securities Exchange Act of 1934. You should not place undue reliance on these statements. These forward-looking statements include statements that reflect the current views of our senior management with respect to our financial performance and future events with respect to our business and the insurance industry in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements. Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:
| • | greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than our underwriting, reserving or investment practices anticipate based on historical experience or industry data; | |
| • | changes in rating agency policies or practices; | |
| • | the cyclical nature of the workers’ compensation insurance industry; | |
| • | changes in the availability, cost or quality of reinsurance and the failure of our reinsurers to pay claims in a timely manner or at all; | |
| • | negative developments in the workers’ compensation insurance industry; | |
| • | decreased level of business activity of our policyholders; | |
| • | decreased demand for our insurance; | |
| • | increased competition on the basis of coverage availability, claims management, safety services, payment terms, premium rates, policy terms, types of insurance offered, overall financial strength, financial ratings and reputation; | |
| • | changes in regulations or laws applicable to us, our policyholders or the agencies that sell our insurance; | |
| • | changes in legal theories of liability under our insurance policies; | |
| • | developments in capital markets that adversely affect the performance of our investments; | |
| • | loss of the services of any of our senior management or other key employees; | |
| • | the effects of U.S. involvement in hostilities with other countries and large-scale acts of terrorism, or the threat of hostilities or terrorist acts; and | |
| • | changes in general economic conditions, including interest rates, inflation and other factors. |
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this prospectus, including under “Risk Factors.” If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Any forward-looking statements you read in this prospectus reflect our views as of the date of this prospectus with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. Before making a decision to purchase our common stock, you should carefully consider all of the factors identified in this prospectus that could cause actual results to differ.
23
USE OF PROCEEDS
All of our common stock offered hereby is being sold by the selling shareholders. We will not receive any proceeds from the Offering as follows:
(i) $50.0 million to repay a note issued as a capital contribution
to Auto One Acceptance Corporationsale of our common stock in connection withthis offering.
DIVIDEND POLICY
We have not paid cash dividends on our common stock in the Reorganization
(Immediately prior to the Reorganization AOAC was a wholly owned
subsidiary of the Company; immediately following the Reorganization AOAC
will be owned by Messrs. Morris and Anderson);
(ii) $12.1 million to repay notes issued to a former shareholder and
former subsidiaries in connection with the Reorganization;
(iii) $10.0 million to repay in full indebtedness to Banc One Capital
Partners II, Ltd., which matures in January 2002 and bears interest at a
rate equal to the London Interbank Offered Rate plus 6.0% (11.5% at July
31, 1996); and
(iv) $900,000 to repay in full indebtedness to certain individuals
incurred by the Company in September 1995 in connection with the
acquisition of Hammerman & Gainer, Inc., a subsidiary of the Company. Such
indebtedness bears interest at 2.667% per annum and is repayable in four
equal installments with the last such payment due in September 1999.
The balance of the estimated net proceeds from the Offering (approximately $79.5
million, or $102.5 million if the Underwriters' over-allotment option is
exercised in full) will be retained by the Company and used to increase its
capital and surplus and for other general corporate purposes. Pending such use,
the Company intends to invest such proceeds in investment-grade debt securities.
For information relating to the Reorganization, see "Recent Reorganization"
below.
DIVIDEND POLICY
The Company does nottwo years. We currently intend to retain any future earnings to finance our operations and growth. As a result, we do not expect to pay any cash dividends to its
shareholders.on our common stock for the foreseeable future. Any future determination to pay cash dividends in the future and their
amounts, however,on our common stock will be at the discretion of the Boardour board of Directorsdirectors and will depend upon the Company'sbe dependent on our earnings, financial condition, operating results, capital requirements, plans for expansion,any contractual, regulatory or other restrictions restrictions imposedon the payment of dividends by applicable law and regulationsour subsidiaries to AMERISAFE, and other factors deemed relevant bythat our board of directors deems relevant.
AMERISAFE is a holding company and has no direct operations. Our ability to pay dividends in the Boardfuture depends on the ability of Directors. The principal source for cash from whichour operating subsidiaries to make dividend payments
will be dividends and other distributions from the Company's subsidiaries. The
Company has not paid anypay dividends to its shareholdersus. Our insurance company subsidiaries are regulated insurance companies and therefore are subject to significant regulatory restrictions limiting their ability to declare and pay dividends.
Our ability to pay dividends is also subject to restrictions set forth in our articles of incorporation, which prohibit us from paying dividends on our common stock (other than in additional shares of common stock) without the past two years
except for the distributions described below under "Recent Reorganization." See
"Risk Factors -- Government Regulation" and "Management's Discussion and
Analysis of Results of Operations -- Liquidity and Capital Resources."
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15
RECENT REORGANIZATION
Immediately prior to completionconsent of the Offering, the Company effected
certain transactions to separate certain non-workers' compensation related
businesses from its workers' compensation businesses and otherwise facilitate
the Offering (the "Reorganization"). The Reorganization principally consistedholders of two-thirds of the following steps:
(i) The Company distributed all of the stock of certain corporations
conducting insurance agency and other unrelated businesses (the "MorTem
Corporations") and 51% of the capital stock of two other
subsidiaries -- Southern Underwriters, Inc. ("SU"), and Morris, Temple &
Trent Financial Services, Inc. ("MTTFS") -- to a former shareholder of the
Company in exchange for alloutstanding shares of Class B Common Stock then owned by
such shareholder. In addition, the Company paid such shareholder $8.0
million and contributed additional capitalour convertible preferred stock. If holders of our convertible preferred stock consent to the MorTem Corporations in
the amount of $4.1 million, in each case, in the form of notes, bearing
interest at 8.0%. Such notes will be paid with the proceeds of the
Offering.
(ii) The Company distributed all of the capital stock of Auto One
Acceptance Corporation ("AOAC") to Messrs. Morris and Anderson on a pro
rata basis and the remaining 49% of the capital stock of SU and MTTFS to
Mr. Morris. Prior to such distribution, the Company contributed to AOAC
additional capital in the amount of $50 million, in the formpayment of a note
bearing interest at 8.0%. Such note will be paid with proceeds of the
Offering.
The Board of Directors of the Company, in reliance upon the advice of
counseldividend by us, we must pay a dividend to the Company, believes that the distributionsholders of theour convertible preferred stock of the
MorTem Corporations, AOAC, SU and MTTFS (the "Distributed Subsidiaries")
described in steps (i) and (ii) above (the "Distributions") should qualify as
tax-free under section 355 of the Code. In general, if the Distributions so
qualify as tax-free under section 355 of the Code, (i) the Company will not be
taxed on any unrealized appreciation on the value of thean as-converted to common stock of the
Distributed Subsidiaries, and (ii) the shareholders receiving such Distributions
will not be taxed on the value of the stock received.
The Board of Directors of the Company received an opinion of Jones, Day,
Reavis & Pogue, counsel to the Company, to the effect that for federal income
tax purposes the Distributions should qualify as tax-free under section 355 of
the Code. Such opinion of counsel was based upon and subject to certain
assumptions, facts and representations provided by the Company and certain of
the Company's shareholders. The Company is not aware of any present facts or
circumstances which should make such assumptions, facts, representations and
advice unobtainable or untrue. However, certain future events not within the
control of the Company, including, for example, certain dispositions of stock of
the Company or the Distributed Subsidiaries after the Distributions, could cause
the Distributions not to qualify as tax-free.
The opinion of counsel received by the Board of Directors of the Company
has no binding effect on the IRS and there can be no assurance that the IRS will
agree with the opinion. A ruling has not been sought from the IRS with respect
to the federal income tax consequences of the Reorganization, and it is possible
that the IRS may take the position that some or all of the Distributions do not
qualify as tax-free, whether or not the assumptions, facts, representations and
advice referred to above are received and are true at the time of the
Reorganization, and such position may ultimately be upheld. If a Distribution
were not to qualify for tax-free treatment under section 355 of the Code, the
Company would recognize taxable gain on the Distributionbasis equal to the difference
on such date between (i) the fair market valuedividend we pay to holders of the distributed stock and (ii)
the Company's adjusted basis in suchour common stock. The Company believes that any
taxable gain recognized if the Distributions fail to qualify for tax-free
treatment would be substantial and would have a materially adverse effect
For additional information regarding restrictions on the Company's business, financial condition or resultspayment of operations. Further, each
Company shareholder receivingdividends by us and our insurance company subsidiaries, see “Business—Regulation—Dividend Limitations.”
PRICE RANGE OF COMMON STOCK
Our common stock of a Distributed Subsidiary in a
distribution not qualifying as tax-free would be treated as receiving a
distribution, taxable as a dividend, in an amount equal to the fair market value
of such stockis traded on the date of distribution.
The foregoing summary of the anticipated principal federal income tax
consequences of the Reorganization under current law is for general information
only and does not purport to cover all federal income tax consequences or any
tax consequences that may ariseNASDAQ Global Select Market under the tax laws of other jurisdictions.symbol “AMSF” and has been traded on the NASDAQ since our initial public offering on November 18, 2005. The Company has not requested, and its counsel will not be rendering, any opinion
with respect to the tax consequences of the Reorganization under the laws of any
state, local or foreign government.
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16
CAPITALIZATION
The following table below sets forth the reported high and low sales prices for our common stock, as reported on the NASDAQ for the periods indicated.
| High | Low | |||||||
2005 | ||||||||
| Fourth Quarter (beginning November 18, 2005) | $ | 10.98 | $ | 8.12 | ||||
2006 | ||||||||
| First Quarter | $ | 12.50 | $ | 8.36 | ||||
| Second Quarter | $ | 14.35 | $ | 10.25 | ||||
| Third Quarter | $ | 13.50 | $ | 9.30 | ||||
| Fourth Quarter (through October 31, 2006) | $ | 13.30 | $ | 9.43 | ||||
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CAPITALIZATION
The table below sets forth our consolidated capitalization as of the
Company at March 31, 1996,September 30, 2006 on an actual basis and on an as adjusted basis giving effect to reflect the transactions consummatedissuance of 1,214,771 shares of common stock upon conversion of 250,000 shares of our convertible preferred stock immediately prior to the completion of this offering.
We are not issuing additional shares of common stock in connection with the Reorganization (see "Recent Reorganization")this offering and as
further adjusted to reflectwe will not receive any proceeds from the sale of the 11,000,000 shares by the selling shareholders. Accordingly, our total capitalization will not change as a result of Class A Common
Stock offered herebythis offering, except for the expenses related to this offering to be paid by us.
| As of September 30, 2006 | ||||||||
| Actual | As Adjusted | |||||||
| (Unaudited) | ||||||||
| (In thousands, except | ||||||||
| share data) | ||||||||
Subordinated debt securities | $ | 36,090 | $ | 36,090 | ||||
Redeemable preferred stock: | ||||||||
| Series C convertible preferred stock, par value $0.01 per share, $100 per share redemption value, 300,000 shares authorized; 300,000 shares issued and outstanding, actual; 50,000 shares issued and outstanding, as adjusted | 30,000 | 5,000 | ||||||
| Series D convertible preferred stock, par value $0.01 per share, $100 per share redemption value, 200,000 shares authorized; 200,000 shares issued and outstanding, actual; 200,000 shares issued and outstanding, as adjusted | 20,000 | 20,000 | ||||||
| Total redeemable preferred stock | 50,000 | 25,000 | ||||||
Shareholders’ equity: | ||||||||
| Common stock, par value $0.01 per share, 50,000,000 shares authorized; 17,446,110 shares issued and outstanding, actual; 18,660,881 shares issued and outstanding, as adjusted | 174 | 187 | ||||||
| Additional paid-in capital | 145,860 | 170,847 | ||||||
| Accumulated deficit | (31,027 | ) | (31,575 | )(1) | ||||
| Accumulated other comprehensive income | 6,659 | 6,659 | ||||||
| Total shareholders’ equity | 121,666 | 146,118 | ||||||
Total capitalization | $ | 207,756 | $ | 207,208 | ||||
| (1) | Reflects the effect of the payment by the Company in the fourth quarter of 2006 of approximately $747,000, or $548,000 after tax, of the estimated expenses related to this offering. |
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SELECTED FINANCIAL INFORMATION
The following income statement data for the years ended December 31, 2005, 2004 and 2003 and the applicationbalance sheet data as of the net proceeds therefrom as
described under "Use of Proceeds," assuming a public offering price of $15 per
shareDecember 31, 2005 and 2004 were derived from our consolidated financial statements included elsewhere in this prospectus. The income statement data for the Class A Common Stockyears ended December 31, 2002 and no exercise2001 and the balance sheet data as of December 31, 2003, 2002 and 2001 were derived from our audited consolidated financial statements, which are not included in this prospectus. The income statement data for the Underwriters'
over-allotment option. This tablethree- and nine-month periods ended September 30, 2006 and 2005 and the balance sheet data as of September 30, 2006 and 2005 were derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus, which include all adjustments, consisting of normal recurring adjustments, that management considers necessary for a fair presentation of our financial position and results of operations for the periods presented. These historical results are not necessarily indicative of results to be expected from any future period. You should be read the following selected financial information together with the other information contained in conjunction with
"Management'sthis prospectus, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations"Operations” and the Company's Consolidated Financial Statementsfinancial statements and the Notes
thereto,related notes included elsewhere in this Prospectus.
prospectus.
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2006 | 2005 | 2006 | 2005 | |||||||||||||
| (Unaudited) | ||||||||||||||||
| (In thousands, except share and per share data) | ||||||||||||||||
| Income Statement Data | ||||||||||||||||
| Gross premiums written | $ | 82,951 | $ | 70,658 | $ | 255,920 | $ | 231,182 | ||||||||
| Ceded premiums written | (4,894 | ) | (5,233 | ) | (14,069 | ) | (14,930 | ) | ||||||||
| Net premiums written | $ | 78,057 | $ | 65,425 | $ | 241,851 | $ | 216,252 | ||||||||
| Net premiums earned | $ | 74,991 | $ | 64,338 | $ | 214,972 | $ | 189,970 | ||||||||
| Net investment income | 6,316 | 4,335 | 18,132 | 11,985 | ||||||||||||
| Net realized gains on investments | 346 | 563 | 2,581 | 1,337 | ||||||||||||
| Fee and other income | 195 | 120 | 550 | 426 | ||||||||||||
| Total revenues | 81,848 | 69,356 | 236,235 | 203,118 | ||||||||||||
| Loss and loss adjustment expenses incurred | 51,743 | 45,189 | 149,989 | 155,625 | (2) | |||||||||||
| Underwriting and certain other operating costs(1) | 9,089 | 8,881 | 26,524 | 23,578 | ||||||||||||
| Commissions | 4,925 | 4,047 | 13,811 | 11,869 | ||||||||||||
| Salaries and benefits | 4,195 | 3,920 | 12,404 | 10,968 | ||||||||||||
| Interest expense | 923 | 735 | 2,579 | 2,061 | ||||||||||||
| Policyholder dividends | 216 | 65 | 563 | 451 | ||||||||||||
| Total expenses | 71,091 | 62,837 | 205,870 | 204,552 | ||||||||||||
| Income (loss) before taxes | 10,757 | 6,519 | 30,365 | (1,434 | ) | |||||||||||
| Income tax expense (benefit) | 2,492 | 1,709 | 7,046 | (1,960 | ) | |||||||||||
| Net income | 8,265 | 4,810 | 23,319 | 526 | ||||||||||||
| Payment-in-kind preferred dividends(3) | — | (2,422 | ) | — | (7,142 | ) | ||||||||||
| Net income (loss) available to common shareholders | $ | 8,265 | $ | 2,388 | $ | 23,319 | $ | (6,616 | ) | |||||||
| Portion allocable to common shareholders(4) | 87.8 | % | 75.8 | % | 87.8 | % | 100.0 | % | ||||||||
| Net income (loss) allocable to common shareholders | $ | 7,257 | $ | 1,812 | $ | 20,474 | $ | (6,616 | ) | |||||||
| Diluted earnings per common share equivalent | $ | 0.42 | $ | 6.05 | $ | 1.17 | $ | (22.07 | ) | |||||||
| Diluted weighted average of common share equivalents outstanding | 17,432,597 | 299,774 | 17,431,263 | 299,774 | ||||||||||||
| Selected Insurance Ratios | ||||||||||||||||
| Current accident year loss ratio(5) | 69.0 | % | 70.2 | % | 69.8 | % | 70.6 | % | ||||||||
| Prior accident year loss ratio(6) | 0.0 | % | 0.0 | % | 0.0 | % | 11.6 | % | ||||||||
| Net loss ratio | 69.0 | % | 70.2 | % | 69.8 | % | 82.2 | % | ||||||||
| Net underwriting expense ratio(7) | 24.3 | % | 26.2 | % | 24.5 | % | 24.5 | % | ||||||||
| Net dividend ratio(8) | 0.3 | % | 0.1 | % | 0.3 | % | 0.2 | % | ||||||||
| Net combined ratio(9) | 93.6 | % | 96.5 | % | 94.6 | % | 106.9 | % | ||||||||
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| Year Ended December 31, | ||||||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||
| (In thousands, except share and per share data) | ||||||||||||||||||||
| Income Statement Data | ||||||||||||||||||||
| Gross premiums written | $ | 290,891 | $ | 264,962 | $ | 223,590 | $ | 185,093 | $ | 204,752 | ||||||||||
| Ceded premiums written | (21,541 | ) | (21,951 | ) | (27,600 | ) | (26,563 | ) | (49,342 | ) | ||||||||||
| Net premiums written | $ | 269,350 | $ | 243,011 | $ | 195,990 | $ | 158,530 | $ | 155,410 | ||||||||||
| Net premiums earned | $ | 256,568 | $ | 234,733 | $ | 179,847 | $ | 163,257 | $ | 170,782 | ||||||||||
| Net investment income | 16,882 | 12,217 | 10,106 | 9,419 | 9,935 | |||||||||||||||
| Net realized gains (losses) on investments | 2,272 | 1,421 | 316 | (895 | ) | 491 | ||||||||||||||
| Fee and other income | 561 | 589 | 462 | 2,082 | 1,367 | |||||||||||||||
| Total revenues | 276,283 | 248,960 | 190,731 | 173,863 | 182,575 | |||||||||||||||
| Loss and loss adjustment expenses incurred | 204,056 | (2) | 174,186 | 129,250 | 121,062 | 123,386 | ||||||||||||||
| Underwriting and certain other operating costs(1) | 33,008 | 28,987 | 23,062 | 22,674 | 23,364 | |||||||||||||||
| Commissions | 16,226 | 14,160 | 11,003 | 9,189 | 14,351 | |||||||||||||||
| Salaries and benefits | 14,150 | 15,034 | 15,037 | 16,541 | 17,148 | |||||||||||||||
| Interest expense | 2,844 | 1,799 | 203 | 498 | 735 | |||||||||||||||
| Policyholder dividends | 4 | 1,108 | 736 | 156 | 2,717 | |||||||||||||||
| Total expenses | 270,288 | 235,274 | 179,291 | 170,120 | 181,701 | |||||||||||||||
| Income before taxes | 5,995 | 13,686 | 11,440 | 3,743 | 874 | |||||||||||||||
| Income tax expense (benefit) | 65 | 3,129 | 2,846 | (1,438 | ) | (395 | ) | |||||||||||||
| Net income | 5,930 | 10,557 | 8,594 | 5,181 | 1,269 | |||||||||||||||
| Payment-in-kind preferred dividends(3) | (8,593 | ) | (9,781 | ) | (10,133 | ) | (9,453 | ) | (8,820 | ) | ||||||||||
| Net income (loss) available to common shareholders | $ | (2,663 | ) | $ | 776 | $ | (1,539 | ) | $ | (4,272 | ) | $ | (7,551 | ) | ||||||
| Portion allocable to common shareholders(4) | 100.0 | % | 70.2 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||||
| Net income (loss) allocable to common shareholders | $ | (2,663 | ) | $ | 545 | $ | (1,539 | ) | $ | (4,272 | ) | $ | (7,551 | ) | ||||||
| Diluted earnings per common share equivalent | $ | (1.25 | ) | $ | 2.14 | $ | (8.55 | ) | $ | (23.72 | ) | $ | (41.93 | ) | ||||||
| Diluted weighted average of common share equivalents outstanding | 2,129,492 | 255,280 | 180,125 | 180,125 | 180,125 | |||||||||||||||
| Selected Insurance Ratios | ||||||||||||||||||||
| Current accident year loss ratio(5) | 71.0 | % | 68.5 | % | 70.6 | % | 71.8 | % | 66.9 | % | ||||||||||
| Prior accident year loss ratio(6) | 8.5 | % | 5.7 | % | 1.3 | % | 2.4 | % | 5.3 | % | ||||||||||
| Net loss ratio | 79.5 | % | 74.2 | % | 71.9 | % | 74.2 | % | 72.2 | % | ||||||||||
| Net underwriting expense ratio(7) | 24.7 | % | 24.8 | % | 27.3 | % | 29.7 | % | 32.1 | % | ||||||||||
| Net dividend ratio(8) | 0.0 | % | 0.5 | % | 0.4 | % | 0.1 | % | 1.6 | % | ||||||||||
| Net combined ratio(9) | 104.2 | % | 99.5 | % | 99.6 | % | 104.0 | % | 105.9 | % | ||||||||||
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| September 30, | December 31, | |||||||||||||||||||||||||||
| 2006 | 2005 | 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||||||||
| (Unaudited) | ||||||||||||||||||||||||||||
| (In thousands, except share and per share data) | ||||||||||||||||||||||||||||
| Balance Sheet Data | ||||||||||||||||||||||||||||
| Cash and cash equivalents | $ | 61,778 | $ | 28,843 | $ | 49,286 | $ | 25,421 | $ | 49,815 | $ | 44,677 | $ | 44,270 | ||||||||||||||
| Investments | 577,775 | 469,316 | 533,618 | 364,868 | 257,729 | 205,315 | 148,305 | |||||||||||||||||||||
| Amounts recoverable from reinsurers | 122,792 | 122,774 | 122,562 | 198,977 | 211,774 | 214,342 | 298,451 | |||||||||||||||||||||
| Premiums receivable, net | 145,621 | 140,061 | 123,934 | 114,141 | 108,380 | 95,291 | 104,907 | |||||||||||||||||||||
| Deferred income taxes | 26,689 | 23,232 | 22,413 | 15,624 | 12,713 | 11,372 | 14,716 | |||||||||||||||||||||
| Deferred policy acquisition costs | 19,785 | 18,189 | 16,973 | 12,044 | 11,820 | 9,505 | 11,077 | |||||||||||||||||||||
| Deferred charges | 4,003 | 3,601 | 3,182 | 3,054 | 2,987 | 1,997 | 2,588 | |||||||||||||||||||||
| Total assets | 985,034 | 830,308 | 892,320 | 754,187 | 678,608 | 603,801 | 645,474 | |||||||||||||||||||||
| Reserves for loss and loss adjustment expenses | 520,843 | 469,894 | 484,485 | 432,880 | 377,559 | 346,542 | 383,032 | |||||||||||||||||||||
| Unearned premiums | 151,403 | 138,623 | 124,524 | 111,741 | 103,462 | 87,319 | 92,047 | |||||||||||||||||||||
| Insurance-related assessments | 39,647 | 33,847 | 35,135 | 29,876 | 26,133 | 23,743 | 25,964 | |||||||||||||||||||||
| Debt | 36,090 | 36,090 | 36,090 | 36,090 | 16,310 | 8,000 | 9,000 | |||||||||||||||||||||
| Redeemable preferred stock(10) | 50,000 | 136,292 | 50,000 | 131,916 | 126,424 | 121,300 | 116,520 | |||||||||||||||||||||
| Shareholders’ equity (deficit)(11) | 121,666 | (46,969 | ) | 97,346 | (42,862 | ) | (20,652 | ) | (25,100 | ) | (10,980 | ) | ||||||||||||||||
| (1) | Includes policy acquisition expenses, such as assessments, premium taxes and other general and administrative expenses, excluding commissions and salaries and benefits, related to insurance operations and corporate operating expenses. | |
| (2) | Includes (a) a pre-tax loss of $13.2 million in connection with a commutation agreement with Converium Reinsurance (North America), one of our reinsurers, pursuant to which Converium paid us $61.3 million in exchange for a termination and release of three of our five reinsurance agreements with Converium and (b) an $8.7 million pre-tax increase in our reserves for loss and loss adjustment expenses related to prior accident years. | |
| (3) | Under the terms of our articles of incorporation, holders of our Series C and Series D convertible preferred stock are no longer entitled to receivepay-in-kind dividends as a result of the redemption and exchange of all of our outstanding shares | |
| (4) | Reflects the participation rights of the Series C and Series D convertible preferred stock. See Note 15 to our audited financial statements. | |
| (5) | The current accident year loss ratio is calculated by dividing loss and loss adjustment expenses incurred for the current accident year by the current year’s net premiums earned. | |
| (6) | The prior accident year loss ratio is calculated by dividing the change in loss and loss adjustment expenses incurred for prior accident years by the current year’s net premiums earned. | |
| (7) | The net underwriting expense ratio is calculated by dividing underwriting and certain other operating costs, commissions and salaries and benefits by the current year’s net premiums earned. | |
| (8) | The net dividend ratio is calculated by dividing policyholder dividends by the current year’s net premiums earned. | |
| (9) | The net combined ratio is the sum of the net loss ratio, the net underwriting expense ratio and the net dividend ratio. |
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| (10) | Includes our Series C and Series D convertible preferred stock, each of which is mandatorily redeemable upon the occurrence of certain events that are deemed to be outside our control. For periods presented prior to November 2005, also includes our Series A preferred stock, which was mandatorily redeemable upon the occurrence of certain events that were deemed to be outside our control. In connection with the initial public offering of our common stock in November 2005, all outstanding shares |
| (11) | In 1997, we entered into a recapitalization transaction with Welsh Carson, our principal shareholder, that resulted in a $164.2 million charge to retained earnings. For periods presented prior to November 2005, shareholders’ equity (deficit) included our Series E preferred stock. In connection with the initial public offering of our common stock in November 2005, all outstanding |
29
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table illustrates this dilution on a per share basis:
- ---------------
(1) Adjusted to give effect to the Reorganization.
The following table compares the numberdiscussion of sharesour financial condition and results of Common Stock acquired
from the Company, the total consideration paid and the average consideration per
share of Common Stock paid by (i) existing shareholders and (ii) new investors
purchasing shares of Class A Common Stock in the Offering, based upon an assumed
public offering price of $15 per share.
The foregoing information assumes (i) no exercise of the Underwriters'
over-allotment option and (ii) no exercise of outstanding stock options to
purchase 600,000 shares of Class A Common Stock granted pursuant to the Stock
Incentive Plan. Such stock options have an exercise price of $12.00 per share.
To the extent that these stock options are exercised, there would be further
dilution per share to new investors. See "Management -- Stock Incentive Plan."
16
18
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data of the
Company as of and for each of the five fiscal years ended December 31, 1995, and
as of and for the three months ended March 31, 1995 and 1996. The statements of
income and balance sheet data for each of the three fiscal years ended December
31, 1995 have been derived from the Company's consolidated financial statements,
which were audited by Ernst & Young LLP, independent certified public
accountants. The statements of income and balance sheet data for the years ended
December 31, 1991 and 1992 and for the three months ended March 31, 1995 and
1996 are unaudited, but include, in the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation of such data. The results for the three months ended March 31, 1996
are not necessarily indicative of the results expected for the entire year. The
information set forth belowoperations should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations," the
Company's Consolidated Financial Statementsour consolidated financial statements and the Notesnotes thereto and other
financial information included elsewhere in this Prospectus.
prospectus. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described under the caption “Risk Factors.” These factors could cause our actual results in 2006 and beyond to differ materially from those expressed in, or implied by, those forward-looking statements. See “Forward-Looking Statements.”
Overview
AMERISAFE is a holding company that markets and underwrites workers’ compensation insurance through its subsidiaries. Workers’ compensation insurance covers statutorily prescribed benefits that employers are obligated to provide to their employees who are injured in the course and scope of their employment. Our business strategy is focused on providing this coverage to small to mid-sized employers engaged in hazardous industries, principally construction, trucking and logging. Employers engaged in hazardous industries pay substantially higher than average rates for workers’ compensation insurance compared to employers in other industries, as measured per payroll dollar. The higher premium rates are due to the nature of the work performed and the inherent workplace danger of our target employers. Hazardous industry employers also tend to have less frequent but more severe claims as compared to employers in other industries due to the nature of their businesses. We provide proactive safety reviews of employers’ workplaces. These safety reviews are a vital component of our underwriting process and also promote safer workplaces. We utilize intensive claims management practices that we believe permit us to reduce the overall cost of our claims. In addition, our audit services ensure that our policyholders pay the appropriate premiums required under the terms of their policies and enable us to monitor payroll patterns or aberrations that cause underwriting, safety or fraud concerns. We believe that the higher premiums typically paid by our policyholders, together with our disciplined underwriting and safety, claims and audit services, provide us with the opportunity to earn attractive returns on equity.
We market our insurance in 26 states and the District of Columbia through independent agencies, as well as through our wholly owned insurance agency subsidiary. We are also licensed in an additional 19 states and the U.S. Virgin Islands.
One of the key financial measures that we use to evaluate our operating performance is return on average equity. We calculate return on average equity by dividing net income by the average of shareholders’ equity plus redeemable preferred stock. Our return on average equity was 5.0% in 2005, 10.8% in 2004 and 8.5% in 2003. Our return on average equity was 19.8% and 19.5% for the three months and nine months ended September 30, 2006, respectively. Based upon results for the nine months ended September 30, 2006, we presently expect gross premiums written for 2006 near the upper end of the range from our earlier guidance of between $317 and $325 million. Absent any extraordinary loss occurrence or occurrences in the remainder of 2006, we presently expect, for the full year 2006, a combined ratio of 95% or better and a return on average equity, including net gains on investments, of 19% or better. Our overall financial objective is to produce a return on equity of at least 15% over the long term. We target producing a combined ratio of 96% or lower while maintaining optimal operating leverage in our insurance subsidiaries that is commensurate with our A.M. Best rating objective. Our combined ratio was 93.6% for the three months ended September 30, 2006, 94.6% for the nine months ended September 30, 2006, 104.2% in 2005, 99.5% in 2004 and 99.6% in 2003.
Investment income is an important part of our business. Because the period of time between our receipt of premiums and the ultimate settlement of claims is often several years or longer, we are able to invest cash from premiums for significant periods of time. As a result, we are able to generate more investment income from our premiums as compared to insurance companies that operate in many other lines of business. From December 31, 2001 to September 30, 2006, our investment portfolio, including cash and cash equivalents, increased from $192.6 million to $639.6 million and produced net investment income of $6.3 million in the three months ended September 30, 2006, $18.1 million in the nine months ended September 30, 2006,
30
$16.9 million in 2005, $12.2 million in 2004 and $10.1 million in 2003. In the third quarter of 2005, we received a $61.3 million payment from one of our reinsurers pursuant to a commutation agreement. In the fourth quarter of 2005 we completed our initial public offering, and we retained approximately $53.0 million of the net proceeds from the offering. Of the net proceeds we retained, we contributed $45.0 million to our insurance subsidiaries. The remaining $8.0 million will be used to make additional capital contributions to our insurance company subsidiaries as necessary to supplement our anticipated growth and for general corporate purposes.
The use of reinsurance is an important component of our business strategy. We purchase reinsurance to protect us from the impact of large losses. Our reinsurance program for 2006 includes eleven reinsurers that provide coverage to us in excess of a certain specified loss amount, or retention level. Under our reinsurance program, we pay our reinsurers a percentage of our gross premiums earned and, in turn, the reinsurers assume an allocated portion of losses for the accident year. Our 2006 reinsurance program provides us with reinsurance coverage for each loss occurrence up to $30.0 million, subject to applicable deductibles, retentions and aggregate limits. However, for any loss occurrence involving only one person, our reinsurance coverage is limited to $10.0 million, subject to applicable deductibles, retentions and aggregate limits. We retain the first $1.0 million of each loss and are subject to an annual aggregate deductible of approximately $10.8 million for losses between $1.0 million and $2.0 million before our reinsurers are obligated to reimburse us. After the deductible is satisfied, we retain 25.0% of each loss between $1.0 million and $2.0 million. The aggregate limit for all claims for losses between $1.0 million and $2.0 million is approximately $5.4 million. We are subject to an annual aggregate deductible of approximately $7.3 million for losses between $2.0 million and $5.0 million before our reinsurers are obligated to reimburse us. The aggregate limit for all claims for losses between $2.0 million and $5.0 million is approximately $39.0 million. See “Business—Reinsurance.” As losses are incurred and recorded, we record amounts recoverable from reinsurers for the portion of the losses ceded to our reinsurers.
With limited exceptions, we historically have retained a significant amount of losses under our reinsurance programs. From 1998 through 2000, we substantially lowered our retention to approximately $18,000 per loss occurrence, which means that we ceded a greater portion of our premiums to our reinsurers. The effect of these lower retention levels was a significant increase in the amount of estimated losses assumed by our reinsurers. In addition, our amounts recoverable from reinsurers increased, reaching a high of $360.9 million at April 30, 2001. In 2001 and 2002, we increased our retention level to $500,000. In 2003, we increased our retention to $500,000 plus 20% of each loss occurrence between $500,000 and $5.0 million. In 2004, we further increased our retention level to $1.0 million. In addition, for losses between $1.0 million and $2.0 million, we had an annual aggregate deductible of approximately $300,000 and, after we satisfied the deductible, retained 10% of each loss occurrence. For losses between $2.0 million and $5.0 million, we had an annual aggregate deductible of approximately $1.3 million and, after we satisfied the deductible, retained 20% of each loss occurrence. In 2005, we continued to retain the first $1.0 million of each loss occurrence. However, for losses between $1.0 million and $5.0 million, we increased our annual aggregate deductible to approximately $5.6 million and, after we satisfied the deductible, retained 10% of each loss occurrence. As described below under “—Liquidity and Capital Resources,” effective as of June 30, 2005, we entered into a commutation agreement with one of our reinsurers. Pursuant to this agreement, we released this reinsurer from all liabilities to us under certain reinsurance agreements in exchange for a cash payment of $61.3 million. As a result of increases in our retention levels, the commutation agreement and collections from our reinsurers in the normal course of business, our amounts recoverable from reinsurers have decreased from $199.0 million at December 31, 2004 to $122.8 million at September 30, 2006.
Our most significant balance sheet liability is our reserve for loss and loss adjustment expenses. We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain. Judgment is required to determine the relevance of our historical experience and industry information under current facts
31
and circumstances. The interpretation of this historical and industry data can be impacted by external forces, principally frequency and severity of future claims, length of time to achieve ultimate settlement of claims, inflation of medical costs and wages, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings. We increased our estimates for prior year loss reserves by $8.7 million in 2005, $13.4 million in 2004 and $2.3 million in 2003. We also recorded a $13.2 million loss in connection with our commutation with Converium in 2005. These increased estimates and the commutation decreased our net income approximately $14.2 million in 2005, $8.7 million in 2004 and $1.5 million in 2003. We have not increased our estimates for prior year loss reserves during the last five consecutive quarters.
The workers’ compensation insurance industry is cyclical in nature and influenced by many factors, including price competition, medical cost increases, natural and man-made disasters, changes in interest rates, changes in state laws and regulations and general economic conditions. A hard market cycle in our industry is characterized by decreased competition that results in higher premium rates, more restrictive policy coverage terms and lower commissions paid to agencies. In contrast, a soft market cycle is characterized by increased competition that results in lower premium rates, expanded policy coverage terms and higher commissions paid to agencies. We believe that the workers’ compensation insurance industry is slowly transitioning to a more competitive market environment. Our strategy across market cycles is to maintain premium rates, deploy capital judiciously, manage our expenses and focus on underserved markets within our target industries that we believe will provide opportunities for greater returns.
Principal Revenue and Expense Items
Our revenues consist primarily of the following:
Net Premiums Earned. Net premiums earned is the earned portion of our net premiums written. Net premiums written is equal to gross premiums written less premiums ceded to reinsurers. Gross premiums written includes the estimated annual premiums from each insurance policy we write in our voluntary and assigned risk businesses during a reporting period based on the policy effective date or the date the policy is bound, whichever is later, as well as premiums from mandatory pooling arrangements.
Premiums are earned on a daily 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 and are earned in subsequent periods over the remaining term of the policy. Our insurance policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2005 for an employer with constant payroll during the term of the policy, we would earn half of the premiums in 2005 and the other half in 2006.
Net Investment Income and Net Realized Gains and Losses on Investments. We invest our statutory surplus funds and the funds supporting our insurance liabilities in fixed maturity and equity securities. In addition, a portion of these funds are held in cash and cash equivalents to pay current claims. Our net investment income includes interest and dividends earned on our invested assets. We assess the performance of our investment portfolio using a standard tax equivalent yield metric. Investment income that is tax-exempt is grossed up by our marginal federal tax rate of 35% to express yield on tax-exempt securities on the same basis as taxable securities. Net realized gains and losses on our investments are reported separately from our net investment income. Net realized gains occur when our investment securities are sold for more than their costs or amortized costs, as applicable. Net realized losses occur when our investment securities are sold for less than their costs or amortized costs, as applicable, or are written down as a result of another-than-temporary impairment. We classify all of our fixed maturity securities, other than redeemable preferred stock, asheld-to-maturity, and all of our equity securities and redeemable preferred stock asavailable-for-sale. Net unrealized gains (losses) on our equity securities and redeemable preferred stock are reported separately within accumulated other comprehensive income on our balance sheet.
32
Fee and Other Income. We recognize commission income earned on policies issued by other carriers that are sold by our wholly owned insurance agency subsidiary as the related services are performed. We also recognize a small portion of interest income from mandatory pooling arrangements in which we participate.
Our expenses consist primarily of the following:
Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses incurred represents our largest expense item and, for any given reporting period, includes 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 oncase-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 claims to take several years to settle and we revise our estimates as we receive additional information about the condition of injured employees. 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.
Underwriting and Certain Other Operating Costs. Underwriting and certain other operating costs are those expenses that we incur to underwrite and maintain the insurance policies we issue. These expenses include state and local premium taxes and fees and other operating costs, offset by commissions we receive from reinsurers under our reinsurance treaty program. We pay state and local taxes, licenses and fees, assessments and contributions to state workers’ compensation security funds based on premiums. In addition, other operating costs include general and administrative expenses, excluding commissions and salaries and benefits, incurred at both the insurance company and corporate levels.
Commissions. We pay commissions to our subsidiary insurance agency and to the independent agencies that sell our insurance based on premiums collected from policyholders.
Salaries and Benefits. We pay salaries and provide benefits to our employees.
Policyholder Dividends. In limited circumstances, we pay dividends to policyholders in particular states as an underwriting incentive.
Interest Expense. Interest expense represents amounts we incur on our outstanding indebtedness at the then-applicable interest rate.
Income Tax Expense. We incur federal, state and local income tax expense.
Critical Accounting Policies
It is important to understand our accounting policies in order to understand our financial statements. Management considers some of these policies to be very important to the presentation of our financial results because they require us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of our assets, liabilities, revenues and expenses and the related disclosures. Some of the estimates result from judgments that can be subjective and complex and, consequently, actual results in future periods might differ from these estimates.
Management believes that the most critical accounting policies relate to the reporting of reserves for loss and loss adjustment expenses, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from reinsurers, assessments, deferred policy acquisition costs, deferred income taxes and the impairment of investment securities.
The following is a description of our critical accounting policies.
Reserves for Loss and Loss Adjustment Expenses. We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known
33
facts and circumstances. Our reserves for loss and loss adjustment expenses are estimated usingcase-by-case valuations and statistical analyses.
In establishing these estimates, we make various assumptions regarding a number of factors, including frequency and severity of claims, length of time to achieve ultimate settlement of claims, projected inflation of medical costs and wages, insurance policy coverage interpretations and judicial determinations. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may be different from our original estimates. On a quarterly basis, we review our reserves for loss and loss adjustment expenses to determine whether further adjustments are required. Any resulting adjustments are included in the current period’s results. In establishing our reserves, we do not use loss discounting, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income. Additional information regarding our reserves for loss and loss adjustment expenses can be found in “Business—Loss Reserves.”
Amounts Recoverable from Reinsurers. Amounts recoverable from reinsurers represent the portion of our paid and unpaid loss and loss adjustment expenses that are assumed by reinsurers. These amounts are separately reported on our balance sheet as assets and do not reduce our reserves for loss and loss adjustment expenses because reinsurance does not relieve us of liability to our policyholders. We are required to pay claims even if a reinsurer fails to pay us under the terms of a reinsurance contract. We calculate amounts recoverable from reinsurers based on our estimates of the underlying loss and loss adjustment expenses, as well as the terms and conditions of our reinsurance contracts, which could be subject to interpretation. In addition, we bear credit risk with respect to our reinsurers, which can be significant because some of the unpaid loss and loss adjustment expenses for which we have reinsurance coverage remain outstanding for extended periods of time.
Assessments. We are subject to various assessments and premium surcharges related to our insurance activities, including assessments and premium surcharges for state guaranty funds and second injury funds. Assessments based on premiums are generally paid one year after the calendar year in which the policies are written. Assessments based on losses are generally paid within one year of when claims are paid by us. State guaranty fund assessments are used by state insurance oversight agencies to pay claims of policyholders of impaired, insolvent or failed insurance companies and the operating expenses of those agencies. Second injury funds are used by states to reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. In some states, these assessments and premium surcharges may be partially recovered through a reduction in future premium taxes.
Deferred Policy Acquisition Costs. We defer commission expenses, premium taxes and certain marketing, sales, underwriting and safety costs that vary with and are primarily related to the acquisition of insurance policies. These acquisition costs are capitalized and charged to expense ratably as premiums are earned. In calculating deferred policy acquisition costs, these costs are limited to their estimated realizable value, which gives effect to the premiums to be earned, anticipated losses and settlement expenses and certain other costs we expect to incur as the premiums are earned, less related net investment income. Judgments as to the ultimate recoverability of these deferred policy acquisition costs are highly dependent upon estimated future profitability of unearned premiums. If the unearned premiums were less than our expected claims and expenses after considering investment income, we would reduce the deferred costs.
Deferred Income Taxes. We use the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities resulting from a tax rate change impacts our net income or loss in the reporting period that includes the enactment date of the tax rate change.
In assessing whether our deferred tax assets will be realized, management considers whether it is more likely than not that we will generate future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, tax
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planning strategies and projected future taxable income in making this assessment. If necessary, we establish a valuation allowance to reduce the deferred tax assets to the amounts that are more likely than not to be realized.
Impairment of Investment Securities. Impairment of an investment security results in a reduction of the carrying value of the security and the realization of a loss when the fair value of the security declines below our cost or amortized cost, as applicable, for the security and the impairment is deemed to beother-than-temporary. We regularly review our investment portfolio to evaluate the necessity of recording impairment losses forother-than-temporary declines in the fair value of our investments. We consider various factors in determining if a decline in the fair value of an individual security isother-than-temporary. Some of these factors include:
| • | how long and by how much the fair value of the security has been below its cost; | |
| • | the financial condition and near-term prospects of the issuer of the security, including any specific events that may affect its operations or earnings; | |
| • | our intent and ability to keep the security for a sufficient time period for it to recover its value; | |
| • | any downgrades of the security by a rating agency; and | |
| • | any reduction or elimination of dividends, or nonpayment of scheduled interest payments. |
Share-Based Compensation. As of January 1, 2005 we adopted Statement of Financial Accounting Standards (SFAS) No. 123(R)—Share-Based Payment. In accordance with SFAS No. 123(R) we are using the “modified prospective” method to record prospectively compensation costs for new and modified stock option awards over the applicable vesting periods.
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Results of Operations
The table below summarizes certain operating results and key measures we use in monitoring and evaluating our operations.
| Three Months Ended | Nine Months Ended | Year Ended | ||||||||||||||||||||||||||
| September 30, | September 30, | December 31, | ||||||||||||||||||||||||||
| 2006 | 2005 | 2006 | 2005 | 2005 | 2004 | 2003 | ||||||||||||||||||||||
| (Unaudited) | (Unaudited) | |||||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
Income Statement Data | ||||||||||||||||||||||||||||
| Gross premiums written | $ | 82,951 | $ | 70,658 | $ | 255,920 | $ | 231,182 | $ | 290,891 | $ | 264,962 | $ | 223,590 | ||||||||||||||
| Ceded premiums written | (4,894 | ) | (5,233 | ) | (14,069 | ) | (14,930 | ) | (21,541 | ) | (21,951 | ) | (27,600 | ) | ||||||||||||||
| Net premiums written | $ | 78,057 | $ | 65,425 | $ | 241,851 | $ | 216,252 | $ | 269,350 | $ | 243,011 | $ | 195,990 | ||||||||||||||
| Net premiums earned | $ | 74,991 | $ | 64,338 | $ | 214,972 | $ | 189,370 | $ | 256,568 | $ | 234,733 | $ | 179,847 | ||||||||||||||
| Net investment income | 6,316 | 4,335 | 18,132 | 11,985 | 16,882 | 12,217 | 10,106 | |||||||||||||||||||||
| Net realized gains on investments | 346 | 563 | 2,581 | 1,337 | 2,272 | 1,421 | 316 | |||||||||||||||||||||
| Fee and other income | 195 | 120 | 550 | 426 | 561 | 589 | 462 | |||||||||||||||||||||
| Total revenues | 81,848 | 69,356 | 236,235 | 203,118 | 276,283 | 248,960 | 190,731 | |||||||||||||||||||||
| Loss and loss adjustment expenses incurred | 51,743 | 45,189 | 149,989 | 155,625 | (2) | 204,056 | (2) | 174,186 | 129,250 | |||||||||||||||||||
| Underwriting and certain other operating costs(1) | 9,089 | 8,881 | 26,524 | 23,578 | 33,008 | 28,987 | 23,062 | |||||||||||||||||||||
| Commissions | 4,925 | 4,047 | 13,811 | 11,869 | 16,226 | 14,160 | 11,003 | |||||||||||||||||||||
| Salaries and benefits | 4,195 | 3,920 | 12,404 | 10,968 | 14,150 | 15,034 | 15,037 | |||||||||||||||||||||
| Interest expense | 923 | 735 | 2,579 | 2,061 | 2,844 | 1,799 | 203 | |||||||||||||||||||||
| Policyholder dividends | 216 | 65 | 563 | 451 | 4 | 1,108 | 736 | |||||||||||||||||||||
| Total expenses | 71,091 | 62,837 | 205,870 | 204,552 | 270,288 | 235,274 | 179,291 | |||||||||||||||||||||
| Income (loss) before taxes | 10,757 | 6,519 | 30,365 | (1,434 | ) | 5,995 | 13,686 | 11,440 | ||||||||||||||||||||
| Income tax expense (benefit) | 2,492 | 1,709 | 7,046 | (1,960 | ) | 65 | 3,129 | 2,846 | ||||||||||||||||||||
| Net income | $ | 8,265 | $ | 4,810 | $ | 23,319 | $ | 526 | $ | 5,930 | $ | 10,557 | $ | 8,594 | ||||||||||||||
Selected Insurance Ratios | ||||||||||||||||||||||||||||
| Current accident year loss ratio(3) | 69.0 | % | 70.2 | % | 69.8 | % | 70.6 | % | 71.0 | % | 68.5 | % | 70.6 | % | ||||||||||||||
| Prior accident year loss ratio(4) | 0.0 | % | 0.0 | % | 0.0 | % | 11.6 | % | 8.5 | % | 5.7 | % | 1.3 | % | ||||||||||||||
| Net loss ratio | 69.0 | % | 70.2 | % | 69.8 | % | 82.2 | % | 79.5 | % | 74.2 | % | 71.9 | % | ||||||||||||||
| Net underwriting expense ratio(5) | 24.3 | % | 26.2 | % | 24.5 | % | 24.5 | % | 24.7 | % | 24.8 | % | 27.3 | % | ||||||||||||||
| Net dividend ratio(6) | 0.3 | % | 0.1 | % | 0.3 | % | 0.2 | % | 0.0 | % | 0.5 | % | 0.4 | % | ||||||||||||||
| Net combined ratio(7) | 93.6 | % | 96.5 | % | 94.6 | % | 106.9 | % | 104.2 | % | 99.5 | % | 99.6 | % | ||||||||||||||
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| September 30, | December 31, | |||||||||||||||||||
| 2006 | 2005 | 2005 | 2004 | 2003 | ||||||||||||||||
| (Unaudited) | ||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Balance Sheet Data | ||||||||||||||||||||
| Cash and cash equivalents | $ | 61,778 | $ | 28,843 | $ | 49,286 | $ | 25,421 | $ | 49,815 | ||||||||||
| Investments | 577,775 | 469,316 | 533,618 | 364,868 | 257,729 | |||||||||||||||
| Amounts recoverable from reinsurers | 122,792 | 122,774 | 122,562 | 198,977 | 211,774 | |||||||||||||||
| Premiums receivable, net | 145,621 | 140,061 | 123,934 | 114,141 | 108,380 | |||||||||||||||
| Deferred income taxes | 26,689 | 23,232 | 22,413 | 15,624 | 12,713 | |||||||||||||||
| Deferred policy acquisition costs | 19,785 | 18,189 | 16,973 | 12,044 | 11,820 | |||||||||||||||
| Deferred charges | 4,003 | 3,601 | 3,182 | 3,054 | 2,987 | |||||||||||||||
| Total assets | 985,034 | 830,308 | 892,320 | 754,187 | 678,608 | |||||||||||||||
| Reserves for loss and loss adjustment expenses | 520,843 | 469,894 | 484,485 | 432,880 | 377,559 | |||||||||||||||
| Unearned premiums | 151,403 | 138,623 | 124,524 | 111,741 | 103,462 | |||||||||||||||
| Insurance-related assessments | 39,647 | 33,847 | 35,135 | 29,876 | 26,133 | |||||||||||||||
| Debt | 36,090 | 36,090 | 36,090 | 36,090 | 16,310 | |||||||||||||||
| Redeemable preferred stock(8) | 50,000 | 136,292 | 50,000 | 131,916 | 126,424 | |||||||||||||||
| Shareholders’ equity (deficit)(9) | 121,666 | (46,969 | ) | 97,346 | (42,862 | ) | (20,652 | ) | ||||||||||||
| (1) | Includes policy acquisition expenses, such as assessments, premium taxes and other | |
| (2) | Includes (a) a pre-tax loss of $13.2 million in connection with a commutation agreement with Converium Reinsurance (North America), one of our reinsurers, pursuant to which Converium paid us $61.3 million in exchange for a termination and release of three of our five reinsurance agreements with Converium and (b) an $8.7 million pre-tax increase in our reserves for loss and loss adjustment expenses related to prior accident years. | |
| (3) | The current accident year loss ratio is calculated by dividing loss and loss adjustment expenses incurred for the current accident year by the current year’s net premiums earned. | |
| (4) | The prior accident year loss ratio is calculated by dividing the change in | |
| (5) | The net underwriting expense ratio is calculated by dividing underwriting and certain other operating costs, commissions and salaries and benefits by the current year’s net premiums earned. | |
| (6) | The net dividend ratio is calculated by dividing policyholder dividends by the current year’s net premiums earned. | |
| (7) | The net combined ratio is the sum of | |
| (8) | Includes our Series C and Series D convertible preferred stock, each of which is mandatorily redeemable upon the occurrence of certain events that are deemed to be outside our control. For periods presented prior to November 2005, also includes our Series A preferred stock, which was mandatorily redeemable upon the occurrence of certain events that were deemed to be outside our control. In connection with the initial public offering of our common stock in |
| (9) | In 1997, we entered into a recapitalization transaction with Welsh Carson, our principal shareholder, that resulted in a $164.2 million charge to retained earnings. For periods presented prior to November 2005, shareholders’ equity (deficit) included our Series E preferred stock. In connection with the initial public offering of our common stock in November 2005, all outstanding shares of our Series E preferred stock were redeemed for |
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Overview of Operating Results
Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005
Gross Premiums Written. Gross premiums written for the three months ended September 30, 2006 were $83.0 million, compared to $70.7 million for the same period in 2005, an increase of 17.4%. The Company provides managed care workers'increase was attributable to a $6.5 million increase in annual premiums on voluntary policies written during the period and a $7.1 million increase in premiums resulting from payroll audits and related premium adjustments. These increases were offset by an $826,000 decrease in direct assigned risk premiums and a $535,000 decrease in assumed premiums from mandatory pooling arrangements.
Net Premiums Written. Net premiums written for the three months ended September 30, 2006 were $78.1 million, compared to $65.4 million for the same period in 2005, an increase of 19.3%. The increase was attributable to the growth in gross premiums written and a $339,000 decrease in premiums ceded to reinsurers for the third quarter of 2006, as compared to the prior-year period. As a percentage of gross premiums written, ceded premiums were 5.9% for the third quarter of 2006, compared to 7.4% for the third quarter of 2005.
Net Premiums Earned. Net premiums earned for the three months ended September 30, 2006 were $75.0 million, compared to $64.3 million for the same period in 2005, an increase of 16.6%. The increase was attributable primarily to growth in net premiums written in the previous four quarters.
Net Investment Income. Net investment income for the third quarter of 2006 was $6.3 million, compared to $4.3 million for the same period in 2005, an increase of 45.7%. The change was attributable to a 36.2% increase in our investment portfolio, including cash and cash equivalents, from an average of $461.2 million in the third quarter of 2005 to an average of $628.2 million for the same period of 2006. Also contributing to this growth was an increase in the pre-tax investment yield on our investment portfolio from 3.8% per annum for the three months ended September 30, 2005, to 4.0% per annum for the three months ended September 30, 2006.
Net Realized Gains on Investments. Net realized gains on investments for the three months ended September 30, 2006 totaled $346,000, compared to $563,000 for the same period in 2005. The decrease was attributable to the recognition of $1.3 million of unrealized losses on equity securities in our investment portfolio pursuant to a strategic assessment of our investment guidelines as discussed below under “—Investment Portfolio.”
Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses (LAE) incurred totaled $51.7 million for the three months ended September 30, 2006, compared to $45.2 million for the same period in 2005, an increase of $6.6 million, or 14.5%. The increase resulted from increased net premiums earned in the third quarter of 2006 as compared to the same period in 2005. We experienced no adverse prior accident year development in either third quarter of 2006 or third quarter of 2005.
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for the third quarter of 2006 were $18.2 million, compared to $16.8 million for the same period in 2005, an increase of 8.1%. This increase was partially due to an $883,000 increase in premium-based assessments; an $878,000 increase in commissions attributable to the increase in gross premiums written; and a $275,000 increase in salary and benefits resulting partially from a $193,000 increase in salary expense attributable to share-based compensation. Offsetting these increases was a decrease of $1.4 million in loss-based assessments. This decrease was related to assessments accrued in the third quarter of 2005 for the State of South Carolina.
Interest Expense. Interest expense for the third quarter of 2006 was $923,000, compared to $735,000 for the comparable period of 2005. Our weighted average borrowings for both periods were $36.1 million. The weighted average interest rate increased to 9.4% per annum for the third quarter of 2006 from 7.6% per annum for the third quarter of 2005.
Income Tax Expense. Income tax expense for the three months ended September 30, 2006 was $2.5 million, compared to $1.7 million for the same period in 2005. The increase in tax expense was
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attributable primarily to the increase in pre-tax income, from $6.5 million in the third quarter of 2005, to $10.8 million in the third quarter of 2006.
Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
Gross Premiums Written. Gross premiums written for the nine months ended September 30, 2006 were $255.9 million, compared to $231.2 million for the same period in 2005, an increase of 10.7%. The increase was attributable primarily to a $20.2 million increase in annual premiums on voluntary policies written during the period and an $8.9 million increase in premiums resulting from payroll audits and related premium adjustments. These increases were offset by a $2.2 million decrease in assumed premiums from mandatory pooling arrangements and a $2.1 million decrease in direct assigned risk premiums.
Net Premiums Written. Net premiums written for the nine months ended September 30, 2006 were $241.9 million, compared to $216.3 million for the same period in 2005, an increase of 11.8%. The increase was attributable to the growth in gross premiums written and an $861,000 decrease in premiums ceded to reinsurers for the nine months ended September 30, 2006 compared to the same prior-year period. As a percentage of gross premiums written, ceded premiums were 5.5% for the nine months ended September 30, 2006 compared to 6.5% for same period in 2005.
Net Premiums Earned. Net premiums earned for the nine months ended September 30, 2006 were $215.0 million, compared to $189.4 million for the same period in 2005, an increase of 13.5%. The increase was attributable to growth in net premiums written over the previous four quarters.
Net Investment Income. Net investment income for the nine months ended September 30, 2006 was $18.1 million, compared to $12.0 million for the same period in 2005, an increase of 51.3%. The change was attributable to a 37.6% increase in our investment portfolio, including cash and cash equivalents, from an average of $444.2 million in the nine months ended September 30, 2005 to an average of $611.2 million for the same period of 2006. Also contributing to this growth was an increase in the pre-tax investment yield on our investment portfolio, from 3.6% per annum for the nine months ended September 30, 2005, to 4.0% per annum for the nine months ended September 30, 2006.
Net Realized Gains on Investments. Net realized gains on investments for the nine months ended September 30, 2006 totaled $2.6 million, compared to $1.3 million for the same period in 2005. The increase was attributable to the timing of the sale of equity securities offset by the recognition of $1.3 million of unrealized losses on equity securities in our investment portfolio pursuant to a strategic assessment of our investment guidelines as discussed below under “—Investment Portfolio.”
Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses (LAE) incurred totaled $150.0 million for the nine months ended September 30, 2006, compared to $155.6 million for the same period in 2005, a decrease of $5.6 million, or 3.6%. The decrease was the result of $21.9 million in additional prior accident year reserves recorded in the second quarter of 2005, which amount included $13.2 million related to the commutation of certain reinsurance contracts. We experienced no adverse prior accident year development in the nine months ended September 30, 2006. The decrease in loss and LAE incurred resulting from additional prior accident year reserves recorded in 2005 was partially offset by an increase in loss and LAE incurred resulting from increased net premiums earned in the nine months ended September 30, 2006 as compared to the same period in 2005.
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for the nine months ended September 30, 2006 were $52.7 million, compared to $46.4 million for the same period in 2005, an increase of 13.6%. This increase was partially due to a $1.9 million increase in commissions; a $1.4 million increase in salaries and benefits, which included a $651,000 increase in salary expense attributable to share-based compensation; a $1.4 million increase in premium-based assessments, which resulted from growth in our gross premiums earned in 2006; a $1.1 million increase in deferred policy acquisition costs; and a $969,000 increase in professional fees attributable to Sarbanes Oxley compliance and expenses associated with effecting a registered offering of our common stock on behalf of certain of our shareholders. Offsetting these increases
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was a $1.4 million increase in ceding commissions from reinsurers, which acts to reduce underwriting expenses.
Interest Expense. Interest expense for the nine months ended September 30, 2006 was $2.6 million, compared to $2.1 million for the comparable period of 2005. Our weighted average borrowings for both periods were $36.1 million. The weighted average interest rate increased to 8.7% per annum for the nine months ended September 30, 2006 from 7.0% per annum for the same period of 2005.
Income Tax Expense (Benefit). Income tax expense for the nine months ended September 30, 2006 was $7.0 million, compared to a tax benefit $2.0 million for the same period in 2005. The increase in tax expense was attributable to $30.4 million of pre-tax income for the nine months ended September 30, 2006, compared to a $1.4 million pre-tax loss for the same period in 2005. This increase was offset by a $571,000 decrease in a tax accrual related to the resolution of prior year taxes.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Gross Premiums Written. Gross premiums written in 2005 were $290.9 million, compared to $265.0 million in 2004, an increase of 9.8%. The increase was attributable primarily to a $16.8 million increase in annual premiums on policies written during the period, a $5.8 million increase in premiums resulting from payroll audits and related premium adjustments, and a $3.5 million increase in assigned risk premiums, offset by a decrease of $1.1 million in assumed premiums from mandatory pooling arrangements.
Net Premiums Written. Net premiums written in 2005 were $269.4 million, compared to $243.0 million in 2004, an increase of 10.8%. The increase was attributable to growth in gross premiums written and a small decrease in premiums ceded to reinsurers, $21.5 million in 2005 compared to $22.0 million in 2004. As a percentage of gross premiums written, ceded premiums were 7.4% in 2005 compared to 8.3% in 2004.
Net Premiums Earned. Net premiums earned in 2005 were $256.6 million, compared to $234.7 million in 2004, an increase of 9.3%. This increase was primarily the result of an increase in premiums written during 2004 compared to 2003, which resulted in higher premiums earned in 2005 compared to 2004.
Net Investment Income. Net investment income in 2005 was $16.9 million, compared to $12.2 million in 2004, an increase of 38.2%. The change was attributable to an increase in our investment portfolio, including cash and cash equivalents, from a monthly average of $350.9 million in 2004 to an average of $467.0 million in 2005, an increase of 33.0%.
Net Realized Gains on Investments. Net realized gains on investments in 2005 totaled $2.3 million, compared to $1.4 million in 2004. The increase was attributable to the timing of the sale of equity securities in accordance with our investment guidelines.
Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses incurred totaled $204.1 million in 2005, compared to $174.2 million in 2004, an increase of $29.9 million, or 17.2%. Increases in our reserves resulting from our commutation with one of our reinsurers and reserve strengthening for prior accident years accounted for $21.9 million, or 73.3%, of this increase. Our net loss ratio was 79.5% in 2005, compared to 74.2% in 2004.
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits in 2005 were $63.4 million, compared to $58.2 million in 2004, an increase of 8.9%. This increase was primarily due to a $2.1 million increase in agent commissions, a $1.8 million increase in loss-based assessments and a $2.4 million decrease in ceding commissions. This increase was partially offset by an $884,000 decrease in salaries. In 2005, we transferred our employee agents from our insurance company subsidiary to our insurance agency subsidiary, which resulted in a change in their compensation products and
services designedexpense from salary to commission expense. The increase in our loss-based assessments resulted primarily from state second injury funds. Ceding commissions, which are commissions we receive from reinsurers, reduce our total underwriting expenses. Ceding commissions decreased in 2005 compared to 2004 as a result of changes in our reinsurance program for that year.
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Interest Expense. Interest expense in 2005 was $2.8 million, compared to $1.8 million in 2004. Our weighted average borrowings increased to $36.1 million in 2005 from $31.1 million in 2004. The increase in weighted average borrowings resulted from the issuance of $25.8 million of subordinated notes in April 2004, the proceeds of which were used to redeem outstanding shares of our Series E preferred stock. In addition, our weighted average interest rate increased to 7.3% per annum for 2005 from 4.9% per annum for 2004.
Income Tax Expense. Our income tax expense in 2005 was $65,000, compared to income tax expense of $3.1 million in 2004. The decrease in tax expense was attributable to lower net income and a 25.9% increase in tax-exempt interest from 2004 to 2005.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Gross Premiums Written. Gross premiums written in 2004 were $265.0 million, compared to $223.6 million in 2003, an increase of 18.5%. The increase was attributable primarily to a $26.9 million increase in annual premiums on policies written during the period, a $10.6 million increase in premiums resulting from payroll audits and related premium adjustments and a $3.5 million increase in assumed premiums from mandatory pooling arrangements.
Net Premiums Written. Net premiums written in 2004 were $243.0 million, compared to $196.0 million for the same period in 2003, an increase of 24.0%. The increase was attributable to growth in gross premiums written and a decrease in premiums ceded to reinsurers from $27.6 million in 2003 to $22.0 million in 2004 resulting from increased retention levels under our reinsurance treaty program in 2004 as compared to 2003. As a percentage of gross premiums written, ceded premiums were 8.3% in 2004 compared to 12.3% in 2003.
Net Premiums Earned. Net premiums earned in 2004 were $234.7 million, compared to $179.8 million for the same period in 2003, an increase of 30.5%. The increase was attributable to the growth in net premiums written and an increase in the amount of premiums written in the first half of 2004 as compared to the first half of 2003.
Net Investment Income. Net investment income in 2004 was $12.2 million, compared to $10.1 million in 2003, an increase of 20.9%. The increase was attributable to the growth in our investment portfolio from an average of $278.8 million in 2003 to an average of $348.9 million in 2004, an increase of 25.2%. The growth in our investment portfolio resulted primarily from our cash flows from operations, which totaled $91.9 million in 2004.
Net Realized Gains on Investments. Net realized gains on investments in 2004 totaled $1.4 million, compared to $316,000 in 2003. The increase was due to $1.2 million in gains from the sale of equity securities in our investment portfolio.
Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses incurred increased to $174.2 million in 2004 from $129.3 million in 2003, an increase of 34.8%. The increase resulted from a growth in net premiums earned of 30.5%, and an increase in loss and loss adjustment expenses incurred of $13.4 million for prior accident years. The increase for prior accident years related primarily to the 2002 accident year, which increased by $9.4 million. The unfavorable development in 2002 was the result of adverse development in certain existing claims and increased estimates in our reserves for that accident year. Our net loss ratio was 74.2% in 2004 compared to 71.9% in 2003.
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits in 2004 were $58.2 million, compared to $49.1 million for the same period in 2003, an increase of 18.5%. The increase was primarily attributable to a $3.1 million increase in agent commissions, a $1.9 million increase in premium-based assessments and premium taxes and a $1.1 million increase in mandatory pooling arrangement fees. In addition, there was a decrease in commissions received from our reinsurers related to premiums ceded, which commissions are netted against our underwriting and certain other operating costs, from $7.3 million in 2003 to $4.8 million in 2004. Commissions increased 28.7% from 2003 to 2004 corresponding with our premium growth. Salaries and benefits remained flat during this period. Our underwriting expense ratio decreased from 27.3% in 2003 to 24.8% in 2004.
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Interest Expense. Interest expense in 2004 was $1.8 million, compared to $203,000 in 2003. Our weighted average borrowings increased to $31.1 million in 2004 from $7.1 million in 2003 as a result of the issuance of $25.8 million of subordinated notes in April 2004, offset by the repayment of $6.0 million of a note payable. Our weighted average interest rate increased to 4.9% per annum in 2004 from 2.9% per annum in 2003 as a result of the higher weighted average interest rate on our subordinated notes as compared to our note payable.
Income Tax Expense. Income tax expense in 2004 was $3.1 million, compared to $2.8 million in 2003, an increase of 9.9%. As a percentage of pre-tax income, our effective income tax rate decreased from 24.9% in 2003 to 22.9% in 2004. The decrease in the effective rate resulted from a larger percentage of tax-exempt fixed maturity securities in our investment portfolio in 2004 and a positive adjustment to our prior year’s tax liability.
Liquidity and Capital Resources
Our principal sources of operating funds are premiums, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash in fixed maturity and equity securities. We presently expect that the $53.0 million of net proceeds we retained from our initial public offering, combined with projected cash flow from operations, will provide us sufficient liquidity to fund our anticipated growth, including payment of claims and operating expenses, payment of interest on our subordinated notes and other holding company expenses, for at least the next 18 months.
We forecast claim payments based on our historical trends. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on a short- and long-term basis. Cash payments, net of reinsurance, for claims were $113.4 million in the nine months ended September 30, 2006, $139.2 million in 2005, $113.9 million in 2004 and $99.2 million in 2003. In 2005, we also received $61.3 million in a commutation with one of our reinsurers, as described below. Since December 31, 2001, we have funded claim payments from cash flow from operations, principally premiums, net of amounts ceded to our reinsurers, and net investment income. We presently expect to maintain sufficient cash flow from operations to meet our anticipated claim obligations and operating and capital expenditure needs. Our investment portfolio, including cash and cash equivalents, has increased from $192.6 million at December 31, 2001 to $639.6 million at September 30, 2006. We do not presently anticipate selling securities in our investment portfolio to pay claims or to fund operating expenses. Accordingly, we currently classify all fixed maturity securities, other than redeemable preferred stock, in theheld-to-maturity category. Should circumstances arise that would require us to do so, we may incur losses on such sales, which would adversely affect our results of operations and could reduce investment income in future periods.
As discussed above under “—Overview,” we purchase reinsurance to protect us against severe claims and catastrophic events. Based on our estimates of future claims, we believe we are sufficiently capitalized to satisfy the deductibles, retentions and aggregate limits in our 2006 reinsurance program. We reevaluate our reinsurance program at least annually, taking into consideration a number of factors, including cost of reinsurance, our liquidity requirements, operating leverage and coverage terms.
Even if we maintain our existing retention levels, if the cost of reinsurance increases, our cash flow from operations would decrease as we would cede a greater portion of our written premiums to our reinsurers. Conversely, our cash flow from operations would increase if the cost of reinsurance declined relative to our retention.
Net cash provided by operating activities was $56.5 million for the nine months ended September 30, 2006, which represented a $54.9 million decrease in cash provided by operating activities from the $111.4 million in net cash provided by operating activities for the nine months ended September 30, 2005. Premiums collected for the nine months ended September 30, 2006 increased $31.1 million compared to the same period in 2005 and claim payments decreased by $1.8 million. This increase was offset by an $11.9 million reduction in recoveries from reinsurers, a $13.0 million increase in federal income taxes paid,
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and a $3.7 million increase in expense disbursements. In addition, we received $61.3 million for the commutation of certain reinsurance contracts in the third quarter of 2005.
Under the terms of the registration rights agreement, we are obligated to pay the expenses associated with this offering, other than underwriting discounts and commissions. We presently expect to incur pre-tax expenses of approximately $1.1 million in connection with this offering, of which $303,000 was expensed in the third quarter of 2006.
Net cash provided by operating activities was $142.0 million in 2005, as compared to $91.9 million in 2004 and $50.4 million in 2003. Major components of cash provided by operating activities in 2005 were net premiums collected of $260.1 million and amounts recovered from reinsurers of $85.0 million, offset by claim payments of $161.7 million and operating expenditures of $41.4 million. Major components of cash provided by operating activities in 2004 were net premiums collected of $237.8 million and amounts recovered from reinsurers of $54.1 million, offset by claim payments of $160.6 million and operating expenditures of $39.4 million. Major components of cash provided by operating activities in 2003 were net premiums collected of $183.2 million and amounts recovered from reinsurers of $61.0 million, offset by claim payments of $159.6 million and operating expenditures of $34.2 million.
Net cash used in investing activities was $44.0 million for the nine months ended September 30, 2006, compared to $106.0 million for the same period in 2005. The decrease was attributable to the $61.3 million received in the third quarter of 2005 related to the commutation of certain reinsurance contracts.
Net cash used by investing activities was $171.3 million in 2005, as compared to $109.0 million in 2004 and $53.6 million in 2003. In 2005, major components of net cash used by investing activities included investment purchases of $296.2 million and purchases of furniture, fixtures and equipment of $1.4 million, offset by proceeds from sales and maturities of investments of $126.3 million. In 2004, major components of net cash used by investing activities included investment purchases of $145.3 million and net purchases of furniture, fixtures and equipment of $2.8 million, offset by proceeds from sales and maturities of investments of $36.7 million and proceeds of $2.4 million from repayment of a loan. In 2003, major components of net cash used by investing activities included investment purchases of $90.7 million and net purchases of furniture, fixtures and equipment of $600,000, offset by proceeds from sales and maturities of investments of $37.6 million.
Net cash provided by financing activities was $3,000 for the nine months ended September 30, 2006, compared to $2.0 million used in financing activities for the same period in 2005. For the nine months ended September 30, 2005, the Company incurred $2.0 million of costs associated with its initial public offering.
Net cash provided by financing activities was $53.1 million in 2005, as compared to $7.4 million of net cash used in 2004. Major components of cash provided by financing were in 2005 included gross proceeds of $72.0 million from the initial public offering, offset by $8.8 million of underwriting discounts and other costs related to the initial public offering and $10.2 million to redeem shares of Series A and Series E preferred stock. In 2004, major components of net cash used in financing activities included the redemption of $27.2 million of Series E preferred stock and the repayment of the remaining $6.0 million of a note payable, offset by proceeds of $25.8 million from the issuance of subordinated notes pursuant to a trust preferred securities transaction. Net cash provided by financing activities was $8.3 million in 2003. AMERISAFE entered into a trust preferred securities transaction in 2003 pursuant to which it issued $10.3 million of subordinated notes. The proceeds from this issuance were offset by the repayment of $2.0 million under a bank line of credit.
Interest on the outstanding subordinated notes accrues at a floating rate equal to the three-month LIBOR plus a marginal rate. Our $10.3 million issuance of subordinated notes due 2034 has a marginal rate of 4.1%, and, as of September 30, 2006, had an effective rate of 9.6%. These notes are prepayable at par beginning in January 2009. Our $25.8 million issuance of subordinated notes due 2034 has a marginal rate of 3.8% and, as of September 30, 2006, had an effective rate of 9.2%. These notes are prepayable at par beginning in April 2009.
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During 2004, Converium Reinsurance (North America), one of our reinsurers, reported a significant loss, resulting in a downgrade in its A.M. Best rating. Although Converium continued to reimburse us under the terms of our reinsurance agreements, we initiated discussions with Converium to seek to reduce the credit risk associated with the amounts due to us. Effective June 30, 2005, we entered into a commutation agreement with Converium. In the third quarter of 2005, Converium paid us $61.3 million pursuant to this agreement in exchange for a termination and full release of three of our five reinsurance agreements with Converium. Under the commutation agreement, all liabilities reinsured with Converium under these three reinsurance agreements have reverted back to us. We recorded a pre-tax loss of $13.2 million related to this commutation agreement. Converium remains obligated to us under the remaining two agreements. At September 30, 2006, the amounts recoverable from Converium under the remaining two reinsurance agreements totaled $7.1 million. The $61.3 million we received in connection with the commutation with Converium was contributed to our investment portfolio.
AMERISAFE is a holding company that transacts business through its operating subsidiaries, including American Interstate, Silver Oak Casualty and American Interstate of Texas. AMERISAFE’s primary assets are the capital stock of these operating subsidiaries. The ability of AMERISAFE to fund its operations depends upon the surplus and earnings of its subsidiaries and their ability to pay dividends to AMERISAFE. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds. See “Business—Regulation—Dividend Limitations.” Based on reported capital and surplus at December 31, 2005, American Interstate is permitted under Louisiana insurance law to pay dividends to AMERISAFE in 2006 in an amount up to $3.9 million without approval by the Louisiana Department of Insurance.
Investment Portfolio
The first priority of our investment strategy is capital preservation, with a secondary focus on maximizing an appropriate risk adjusted return. We presently expect to maintain sufficient liquidity from funds generated from operations to meet our anticipated insurance obligations and operating and capital expenditure needs, with excess funds invested in accordance with our investment guidelines. Our investment portfolio is managed by an independent asset manager that operates under investment guidelines approved by our board of directors. We allocate our portfolio into three categories; cash and cash equivalents, fixed maturity securities and equity securities. Cash and cash equivalents include cash on deposit, commercial paper, short-term municipal securities, pooled short-term money market funds and certificates of deposit. Our fixed maturity securities include obligations of the U.S. Treasury or U.S. agencies, obligations of states and their subdivisions, long-term certificates of deposit, U.S. dollar-denominated obligations of U.S. corporations, mortgage-backed securities, mortgages guaranteed by the Federal National Mortgage Association and the Government National Mortgage Association, asset-backed securities and preferred stocks that are mandatorily redeemable or are redeemable at the option of the holder. Our equity securities include U.S. dollar-denominated common stocks of U.S. corporations, master limited partnerships and nonredeemable preferred stock.
Under Louisiana and Texas law, as applicable, each of American Interstate, Silver Oak Casualty and American Interstate of Texas is required to invest only in securities that are either interest-bearing or eligible for dividends, and must limit its investment in the securities of any single issuer to five percent of the insurance company’s assets. As of September 30, 2006, we were in compliance with these requirements.
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We employ diversification policies and balance investment credit risk and related underwriting risks to minimize our total potential exposure to any one business sector or security. Our investment portfolio, including cash and cash equivalents, had a carrying value of $639.6 million as of September 30, 2006, and is summarized in the table below by type of investment.
| Percentage | ||||||||
| Carrying Value | of Portfolio | |||||||
| (In thousands) | ||||||||
| Fixed maturity securities: | ||||||||
| State and political subdivisions | $ | 299,278 | 46.8% | |||||
| Mortgage-backed securities | 117,062 | 18.3% | ||||||
| U.S. Treasury securities and obligations of U.S. Government agencies | 79,162 | 12.4% | ||||||
| Corporate bonds | 22,700 | 3.5% | ||||||
| Asset-backed securities | 5,884 | 0.9% | ||||||
| Redeemable preferred stocks | 633 | 0.1% | ||||||
| Total fixed maturity securities | 524,719 | 82.0% | ||||||
| Equity securities: | ||||||||
| Common stocks | 49,377 | 7.7% | ||||||
| Nonredeemable preferred stocks | 3,679 | 0.6% | ||||||
| Total equity securities | 53,056 | 8.3% | ||||||
| Cash and cash equivalents | 61,778 | 9.7% | ||||||
| Total investments, including cash and cash equivalents | $ | 639,553 | 100.0% | |||||
We regularly evaluate our investment portfolio to identifyother-than-temporary impairments in the fair values of the securities held in our investment portfolio. We consider various factors in determining whether a decline in the fair value of a security isother-than-temporary, including:
| • | how long and by how much the fair value of the security has been below its cost; | |
| • | the financial condition and near-term prospects of the issuer of the security, including any specific events that may affect its operations or earnings; | |
| • | our intent and ability to keep the security for a sufficient time period for it to recover its value; | |
| • | any downgrades of the security by a rating agency; and | |
| • | any reduction or elimination of dividends, or nonpayment of scheduled interest payments. |
The tax-equivalent investment yield on our investment portfolio was 5.4% per annum as of September 30, 2006.
In 2006, we began a strategic review of our investment management and related policies. As a result of this review, we have revised our investment guidelines. Under our revised guidelines, the market value of the equity securities in our investment portfolio will range from 20% and 30% of shareholders’ equity, plus redeemable preferred stock, at the end of the most recently completed fiscal year. Under our prior investment guidelines, the portion of our investment portfolio invested in equity securities was limited to 12% of the carrying value and 15% of the market value of the total portfolio. As a result of the changes in our investment guidelines, we expect to hold a smaller percentage of our investment portfolio in equity securities. In anticipation of the change in our investment guidelines, we sold all equity securities in our investment portfolio. These sales began in the third quarter and were completed in the fourth quarter of 2006. As a result of our intention to sell all our equity securities, we recognized $1.3 million of unrealized losses on equity securities held as of September 30, 2006. We will record a net realized gain in the fourth quarter of 2006 resulting from this sale of the remaining equity securities.
In connection with the review of our investment guidelines, we have retained Prudential Investment Management, Inc., a registered investment advisory firm and a wholly owned indirect subsidiary of Prudential Financial, Inc. to manage our portfolio of fixed maturity securities effective November 1, 2006.
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As described above, we presently intend to reposition the equity portion of our investment portfolio to consist of a combination of exchange-traded index funds and an externally managed portfolio of individual equity securities. To achieve this repositioning, we have purchased approximately $21.0 million of value-oriented, equity index funds. Until such time as a new equity portfolio manager is appointed, we may purchase additional equity index funds to bring the percentage of our total portfolio invested in equity securities within our current investment guidelines.
Contractual Obligations and Commitments
We manage risk on certain long-duration claims by settling these claims through the purchase of annuities from unaffiliated life insurance companies. In the event these companies are unable to meet their obligations under these annuity contracts, we could be liable to the claimants, but our reinsurers remain obligated to indemnify us for all or part of these obligations in accordance with the terms of our reinsurance contracts. As of December 31, 2005, the present value of these annuities was $54.7 million, as estimated by our annuity providers. Each of the life insurance companies issuing these annuities, or the entity guaranteeing the life insurance company, has an A.M. Best rating of “A−” (Excellent) or better.
We lease equipment and office space under noncancelable operating leases. Future minimum lease payments at December 31, 2005, were as follows:
| Future Minimum | ||||
Year | Lease Payments | |||
| (In thousands) | ||||
| 2006 | $ | 958 | ||
| 2007 | 677 | |||
| 2008 | 522 | |||
| 2009 | 463 | |||
| 2010 | 8 | |||
| $ | 2,628 | |||
Rental expense was approximately $924,000 in 2005, $956,000 in 2004 and $1.1 million in 2003.
The table below provides information with respect to our long-term debt and contractual commitments as of December 31, 2005.
| Payment Due By Period | ||||||||||||||||||||
| Less Than | More Than | |||||||||||||||||||
Contractual Obligations | Total | 1 Year | 1-3 Years | 4-5 Years | 5 Years | |||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Subordinated notes(1) | $ | 36,090 | $ | 0 | $ | 0 | $ | 0 | $ | 36,090 | ||||||||||
| Loss and loss adjustment expenses(2) | 484,485 | 121,121 | 123,059 | 62,983 | 177,322 | |||||||||||||||
| Loss-based insurance assessments(3) | 17,684 | 4,421 | 4,492 | 2,299 | 6,472 | |||||||||||||||
| Capital lease obligations | 1,162 | 567 | 595 | 0 | 0 | |||||||||||||||
| Operating lease obligations | 2,628 | 958 | 1,199 | 471 | 0 | |||||||||||||||
| Purchase obligations | 372 | 271 | 101 | 0 | 0 | |||||||||||||||
| Total | $ | 542,421 | $ | 127,338 | $ | 129,446 | $ | 65,753 | $ | 219,884 | ||||||||||
| (1) | Amounts do not include interest payments associated with these obligations. Interest rates on our subordinated notes are variable and may change on a quarterly basis. See “—Liquidity and Capital Resources” for further discussion of our subordinated notes. | |
| (2) | The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of December 31, 2005 and actuarial estimates of expected payout patterns and are not contractual liabilities as to a time certain. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and loss adjustment expense |
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| payments due by period is subject to the same uncertainties associated with determining the level of loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and loss adjustment expense process, see “Business—Loss Reserves.” Actual payments of loss and loss adjustment expenses by period will vary, perhaps materially, from the table above to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors—Risks Related to Our Business—Our loss reserves are based on estimates and may be inadequate to cover our actual losses” for a discussion of the uncertainties associated with estimating loss and loss adjustment expenses. | ||
| (3) | We are subject to various annual assessments imposed by certain of the states in which we write insurance policies. These assessments are generally based upon the amount of premiums written or losses paid during the applicable year. Assessments based on premiums are generally paid within one year after the calendar year in which the policies are written, while assessments based on losses are generally paid within one year after the loss is paid. When we establish a reserve for loss and loss adjustment expenses for a reported claim, we accrue our obligation to pay any applicable assessments. If settlement of the claim is to be paid out over more than one year, our obligation to pay any related loss-based assessments extends for the same period of time. Because our reserves for loss and loss adjustment expenses are based on estimates, our accruals for loss- based insurance assessments are also based on estimates. Actual payments of loss and loss adjustment expenses may differ, perhaps materially, from our reserves. Accordingly, our actual loss-based insurance assessments may vary, perhaps materially, from our accruals. |
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are credit risk, interest rate risk and equity price risk. We currently have no exposure to foreign currency risk.
Credit Risk. Credit risk is the potential loss arising principally from adverse changes in the financial condition of the issuers of our fixed maturity securities and the financial condition of our reinsurers. We address the credit risk related to the issuers of our fixed maturity securities by investing in fixed maturity securities that are rated “BBB” or higher by Standard & Poor’s. We also independently, and through our independent asset manager, monitor the financial condition of all issuers of our fixed maturity securities. To limit our risk exposure, we employ stringent diversification policies that limit the credit exposure to any single issuer or business sector.
We are subject to credit risk with respect to our reinsurers. Although our reinsurers are obligated to reimburse us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks we have reinsured. As a result, reinsurance contracts do not limit our ultimate obligations to pay claims and we might not collect amounts recoverable from our reinsurers. We address this credit risk by initially selecting reinsurers with an A.M. Best rating of “A−” (Excellent) or better and by performing, along with our reinsurance broker, quarterly credit reviews of our reinsurers. If one of our reinsurers suffers a credit downgrade, we may consider various options to lessen the risk of asset impairment including commutation, novation and letters of credit. See “—Liquidity and Capital Resources.”
Interest Rate Risk. We had fixed maturity securities with a fair value of $460.5 million and a carrying value of $467.3 million as of December 31, 2005 that are subject to interest rate risk. We are also subject to interest rate risk on our subordinated debt securities, which have quarterly adjustable interest rates based on
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LIBOR plus a fixed margin. Interest rate risk is the risk that we may incur losses due to adverse changes in interest rates. Fluctuations in interest rates have a direct impact on the market valuation of our fixed maturity securities and the cost to service our subordinated debt securities. We manage our exposure to interest rate risk through a disciplined asset and liability matching and capital management process. In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements. These risks are assessed regularly and balanced within the context of our liability and capital position.
The table below summarizes the interest rate risk associated with our fixed maturity securities by illustrating the sensitivity of the fair value and carrying value of our fixed maturity securities as of December 31, 2005 to selected hypothetical changes in interest rates, and the associated impact on our shareholders’ deficit. We classify our fixed maturity securities, other than redeemable preferred stock, asheld-to-maturity and carry them on our balance sheet at cost or amortized cost, as applicable. Our redeemable preferred stock is classified asavailable-for-sale and carried on our balance sheet at fair value. Temporary changes in the fair value of our fixed maturity securities that areheld-to-maturity, such as those resulting from interest rate fluctuations, do not impact the carrying value of these securities and, therefore, do not affect our shareholders’ equity. However, temporary changes in the fair value of our fixed maturity securities that are held asavailable-for-sale do impact the carrying value of these securities and are reported in our shareholders’ equity as a component of other comprehensive income, net of deferred taxes. The selected scenarios in the table below are not predictions of future events, but rather are intended to illustrate the effect such events may have on the fair value and carrying value of our fixed maturity securities and on our shareholders’ equity.
| Hypothetical | ||||||||||||||||||||
| Percentage | ||||||||||||||||||||
| Estimated | Increase | |||||||||||||||||||
| Estimated | Change in | (Decrease) in | ||||||||||||||||||
| Hypothetical Change | Change in | Carrying | Carrying | Shareholders’ | ||||||||||||||||
in Interest Rates | Fair Value | Fair Value | Value | Value | Deficit | |||||||||||||||
| 200 basis point increase | $ | 418,314 | $ | (42,200 | ) | $ | 467,182 | $ | (161 | ) | (0.07 | )% | ||||||||
| 100 basis point increase | 438,426 | (22,088 | ) | 467,256 | (87 | ) | (0.04 | )% | ||||||||||||
| No change | 460,514 | — | 467,343 | — | — | |||||||||||||||
| 100 basis point decrease | 484,897 | 24,383 | 467,583 | 240 | 0.11 | % | ||||||||||||||
| 200 basis point decrease | 511,965 | 51,451 | 467,711 | 368 | 0.16 | % | ||||||||||||||
Equity Price Risk. Equity price risk is the risk that we may incur losses due to adverse changes in the market prices of the equity securities we hold in our investment portfolio, which include common stocks, nonredeemable preferred stocks and master limited partnerships. We classify our portfolio of equity securities asavailable-for-sale and carry these securities on our balance sheet at fair value. Accordingly, adverse changes in the market prices of our equity securities result in a decrease in the value of our total assets and an increase in our shareholders’ equity. As of December 31, 2005, the equity securities in our investment portfolio had a fair value of $66.3 million, representing 7.4% of our total assets on that date. In order to minimize our exposure to equity price risk, we invest primarily inmid-to-large capitalization issues and seek to diversify our equity holdings across several business sectors.
As described above in “—Investment Portfolio,” in the third quarter of 2006, we revised our investment guidelines related to equity securities. Under our revised guidelines, the market value of the equity securities in our investment portfolio will range from 20% and 30% of shareholders’ equity, plus redeemable preferred stock, at the end of the most recently completed fiscal year. Under our prior investment guidelines, the portion of our investment portfolio invested in equity securities was limited to 12% of the carrying value and 15% of the market value of the total portfolio. As a result of the changes in our investment guidelines, we expect to hold a smaller percentage of our investment portfolio in equity securities. In anticipation of the change in our investment guidelines, we sold all equity securities in our investment portfolio. These sales began in the third quarter and were completed in the fourth quarter of 2006.
As described above in “ — Investment Portfolio,” we have invested approximately $21.0 million in value-oriented, exchange-traded index funds. Until a new equity portfolio manager is appointed, we may invest additional funds in value-oriented, equity index funds to bring the portion of our total investment portfolio invested in equity securities within our current investment guidelines.
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BUSINESS
Overview
We are a specialty provider of workers’ compensation insurance focused on small to mid-sized employers engaged in hazardous industries, principally construction, trucking, logging, agriculture, oil and gas, maritime and sawmills. We have more than 20 years of experience underwriting the complex workers’ compensation exposures inherent in these industries. We provide coverage to employers under state and federal workers’ compensation laws. These laws prescribe wage replacement and medical care benefits that employers are obligated to provide to their employees who are injured in the course and scope of their employment. Our workers’ compensation insurance policies provide benefits to injured employees for, among other things, temporary or permanent disability, death and medical and hospital expenses. The benefits payable and the duration of those benefits are set by state or federal law. The benefits vary by jurisdiction, the nature and severity of the injury and the wages of the employee. The employer, who is the policyholder, pays the premiums for coverage.
Hazardous industry employers tend to have less frequent but more severe claims as compared to employers in other industries due to the nature of their businesses. Injuries that occur are often severe in nature including death, dismemberment, paraplegia and quadriplegia. As a result, employers engaged in hazardous industries pay substantially higher than average rates for workers’ compensation insurance compared to employers in other industries, as measured per payroll dollar. The higher premium rates are due to the nature of the work performed and the inherent workplace danger of our target employers. For example, our construction employers generally paid premium rates equal to $7.53 per $100 of payroll to obtain workers’ compensation coverage for all of their employees in 2005, including clerical employees for which the average rate was $0.39 per $100 of payroll.
We employ a proactive, disciplined approach in underwriting employers and providing comprehensive services intended to lessen the overall costsincidence and cost of workplace injuries. We provide safety services at employers’ workplaces as a vital component of our underwriting process and to its employer-clientspromote safer workplaces. We utilize intensive claims management practices that we believe permit us to reduce the overall cost of providing workers' compensation benefitsour claims. In addition, our audit services ensure that our policyholders pay the appropriate premiums required under the terms of their policies and enable us to their employees. Since itmonitor payroll patterns or aberrations that cause underwriting, safety or fraud concerns.
We believe that the higher premiums typically paid by our policyholders, together with our disciplined underwriting and safety, claims and audit services, provide us with the opportunity to earn attractive returns on equity.
We completed our initial public offering in November 2005. In the offering, we issued 8,000,000 shares of common stock at $9.00 per share. Upon the completion of the offering, we issued an additional 9,120,948 shares of common stock in exchange for shares of our Series A preferred stock. Of the $63.2 million of net proceeds from this offering, we contributed $45.0 million to our insurance subsidiaries and used $10.2 million to redeem shares of our preferred stock. We expect to use the balance of the net proceeds to make additional capital contributions to our insurance subsidiaries as necessary to support our anticipated growth and for general corporate purposes.
AMERISAFE is an insurance holding company and was incorporated in Texas in 1985. We began operations in 1986 by focusing on workers’ compensation insurance for logging contractors in the southeast United States. In 1994, we expanded our focus to include the other hazardous industries we serve today. Two of our three insurance subsidiaries, American Interstate Insurance Company and Silver Oak Casualty, are domiciled in Louisiana. Our other insurance subsidiary, American Interstate Insurance Company of Texas, is domiciled in Texas.
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Competitive Advantages
We believe we have the following competitive advantages:
Focus on Hazardous Industries. We have extensive experience insuring employers engaged in hazardous industries and have a history of profitable underwriting in these industries. Our specialized knowledge of these hazardous industries helps us better serve our policyholders, which leads to greater employer loyalty and policy retention. Our policy renewal rate on voluntary business that we elected to quote for renewal was 90.6% in 2005, 93.0% in 2004 and 91.4% in 2003.
Focus on Small to Mid-Sized Employers. We believe large insurance companies generally do not target small to mid-sized employers in hazardous industries due to their smaller premium size, type of operations, mobile workforce and extensive service needs. We provide enhanced customer services to our policyholders. For example, unlike many of our competitors, our premium payment plans enable our policyholders to better match their premium payments with their payroll costs. Our premium payment plans are not only attractive to our policyholders but also allow us to monitor the payroll patterns of our policyholders and identify any aberrations that may cause safety, underwriting or fraud concerns. In addition, we believe that because many of our policyholders are owner-operated small to mid-sized businesses with more limited resources, they rely on our services and expertise to assist them in improving workplace safety and managing workplace injuries when they occur.
Specialized Underwriting Expertise. Based on our20-year underwriting history of insuring employers engaged in hazardous industries, we have developed industry specific risk analysis and rating tools to assist our underwriters in risk selection and pricing. For example, when underwriting a trucking employer, we use these tools to analyze numerous factors, including the age, condition and types of vehicles used, distances traveled, whether the trucks are used to transport truckload or less than truckload cargo, the nature of the cargo and whether trucking employees are required to load and unload cargo, tarp and secure their own loads and drive regular or irregular routes. These factors were developed based on our historical experience in writing workers’ compensation insurance policies for trucking employers. Our 18 underwriting professionals average approximately 12 years of experience underwriting workers’ compensation insurance, most of which has focused on providing itshazardous industries. In addition, our underwriting professionals serve specific state markets, thereby gaining valuable knowledge and expertise in the statutory benefit schemes and market conditions of their assigned states. We are highly disciplined when quoting and binding new business. In 2005, we offered quotes on approximately one out of four applications submitted. We believe this disciplined underwriting approach provides us a competitive advantage in evaluating potential policyholders. We do not delegate underwriting authority to agencies that sell our insurance or to any other third party.
Comprehensive Safety Services. Most of our policyholders utilize mobile workforces, often located in rural areas, due to the nature of their business operations. We provide proactive safety reviews of employers’ worksites, which are often located in rural areas. These safety reviews are a vital component of our underwriting process and also assist our policyholders in loss prevention and encourage the safest workplaces possible by deploying experienced field safety professionals, or FSPs, to our policyholders’ worksites. Our 52 FSPs have an average of approximately 14 years of workplace safety or related industry experience. In 2005, more than 91% of our new voluntary business policyholders were subject to pre-quotation safety inspections. We perform periodicon-site safety surveys on all of our voluntary business policyholders. We believe our proactive safety services are essential in achieving underwriting profitability in the industries we target.
Our safety services are valuable to our policyholders because we provide them with the opportunity to reduce their long-term cost of workers’ compensation insurance by enhancing workplace safety and reducing the incidence and cost of workplace injuries.
Proactive Claims Management. As of September 30, 2006, our employees managed resultsmore than 98% of our open claims in-house utilizing our intensive claims management practices that emphasize a personal approach and quality, cost-effective medical treatment. Our claims management staff includes 93 field case managers, or FCMs, who average approximately 17 years of experience in the workers’ compensation
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insurance industry. We currently average approximately 62 open indemnity claims per FCM, which we believe is significantly less than the industry average.
We seek to limit the number of claim disputes with injured employees by intervening early in the claims process. We encourage immediate notification of workplace injuries using our toll-free claims reporting system. When a severe injury occurs, the policyholder’s pre-designated FCM promptly visits the injured employee or the employee’s family members to discuss the benefits provided and treatment options. Our focus is to facilitate a favorable medical outcome for the injured employee to allow that employee to return to work as quickly as possible.
Guiding injured workers to appropriate medical providers is an important part of our approach to claims management. Because of our experience with similar injuries and our relationships with local medical providers, we can arrange for quality, cost-effective medical services to injured employees. We seek to select and develop relationships with medical providers in each of the regional and local markets in which our policyholders operate. We emphasize implementation of the most expeditious and cost-effective treatment programs for each employer rather than imposing a single standardized system on all employers whoseand their employees. In order to support our personal claims approach, qualified staff nurses are available to our FCMs to assist in facilitating effective medical outcomes. In coordination with this process, we use a full complement of medical cost containment tools to ensure the optimum medical savings possible. These tools include peer review, utilization review, provider networks and quantity purchase discounting for durable medical supplies, pharmacy and diagnostic testing.
We believe our claims management practices allow us to achieve a more favorable claim outcome, accelerate an employee’s return to work, lessen the likelihood of litigation and more rapidly close claims, all of which ultimately lead to lower overall costs. Only 8.5% and 19.0% of all claims reported for accident years 2004 and 2005, respectively, were open as of September 30, 2006.
Strong Distribution Network. We market our workers’ compensation insurance through more than 2,200 independent agencies and our wholly owned insurance agency subsidiary. We compensate these agencies by paying a commission based on the premium collected from the policyholder. As of September 30, 2006, independent agencies produced approximately 84% of our voluntary in-force premiums. We are selective in establishing and maintaining relationships with independent agencies. We establish and maintain relationships only with those agencies that provide quality applications from prospective policyholders that are reasonably likely to accept our quotes.
Customized Information Systems. We have developed customized information technology that we believe enables our FSPs, FCMs and field premium auditors to efficiently perform their duties. In addition, our business intelligence system enables all of our employees nationwide to seamlessly access, manage and analyze the data that underlies our business. We believe these technologies provide us with a significant advantage in the marketplace.
Experienced Management Team. Members of our senior management team have extensive insurance industry and related experience. The majority of this experience has been focused on workers’ compensation insurance exposures in construction, trucking, logging and other hazardous industries while employed with our company. We believe the experience, depth and continuity of our management will permit us to execute our business strategy and earn attractive returns on equity.
Strategy
We intend to leverage our competitive advantages to pursue profitable growth and favorable returns on equity using the following strategies:
Expand in our Existing Markets. Our market share in each of the nine states where we derived 5% or more of our gross premiums written in 2005 did not exceed 3% of the workers’ compensation market in that state, based on data received from NCCI. Competition in our target markets is fragmented by state and employer industry focus. We believe that our specialized underwriting expertise and safety, claims and audit
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services position us to profitably increase our market share in our existing principal markets, with minimal increase in field service employees.
Prudent and Opportunistic Geographic Expansion. We currently market our insurance in 26 states and the District of Columbia. At September 30, 2006, approximately 58.0% of our voluntary in-force premiums were generated in the nine states where we derived 5% or more of our gross premiums written in 2005. We are engagedlicensed in an additional 19 states and the U.S. Virgin Islands. Our existing licenses and rate filings will expedite our ability to write policies in these markets when we decide it is prudent to do so.
Focus on Underwriting Profitability. We intend to maintain our underwriting discipline and profitability throughout market cycles. Our strategy is to focus on underwriting workers’ compensation insurance in hazardous occupations,
primarilyindustries and to maintain adequate rate levels commensurate with the risks we underwrite. We will also continue to strive for improved risk selection and pricing, as well as reduced frequency and severity of claims through comprehensive workplace safety reviews, rapid closing of claims through personal, direct contact with our policyholders and their employees, and effective medical cost containment measures.
Leverage Existing Information Technology. We believe our customized information system, ICAMS, enhances our ability to select risk, write profitable business and cost-effectively administer our billing, claims and audit functions. We also believe our infrastructure is scalable and will enable us to accommodate our anticipated premium growth at current staffing levels and at minimal cost, which should have a positive effect on our expense ratio over time as we grow our premium base.
Maintain Capital Strength. We completed our initial public offering in November 2005. Of the $53.0 million of net proceeds we retained from our initial public offering, we contributed $45.0 million to our insurance subsidiaries. The remaining $8.0 million will be used to make additional capital contributions to our insurance company subsidiaries as necessary to support our anticipated growth and for general corporate purposes. We plan to manage our capital to achieve our growth and profitability goals while maintaining a prudent operating leverage for our insurance company subsidiaries. To accomplish this objective, we intend to maintain underwriting profitability throughout market cycles, optimize our use of reinsurance and maximize an appropriate risk adjusted return on our growing investment portfolio. We presently expect that the net proceeds we retained from our initial public offering, combined with projected cash flow from operations, will provide us sufficient liquidity to fund our anticipated growth for at least the next 18 months.
Operating History
We commenced operations in 1986 to underwrite workers’ compensation insurance for employers engaged in the logging industry. Beginning in 1994, the Company began
expanding its clientwe expanded our customer base by targetinginsuring employers in other hazardous occupation industries, including general contracting, trucking, and oil and gas
exploration.
The Company's revenues consist primarilyindustries. We believe we were able to operate profitably by applying disciplined underwriting criteria based on our experience insuring employers in these hazardous industries. Integral to our underwriting processes was the implementation of premiums earned from workers'
compensation coverage, service fee income and investment income. Premiums earned
during a period are the direct premiums earned by the Company on in-force
policies, net of premiums ceded to reinsurers. Premiums earned primarily
represent workers' compensation products, although the Company has historically
provided other insurance products, including general liability and automobile
coverage. Service fee income represents fees the Company earns for providingcomprehensive safety reviews, active in-house claims management, mandatory premium audits and other servicesstrong relationships with agents and employers.
Beginning in 1997 and into 2000, we employed a strategy to self-insured businesses, otherincrease revenue through rapid geographic expansion and underwriting workers’ compensation insurance companies, trade associations and governmental entities. Net investment income
represents net earnings on the Company's investment portfolio, less investment
expenses. Fees and other from affiliates represent various administrative and
management services provided to affiliates for a fee.
The Company's expenses consist primarily of claims and claim settlement
expenses, commissions and other underwriting expenses and general and
administrative expenses. Claims and claim settlement expenses include (i)
payments and reserves for current and future medical care and rehabilitation
costs, (ii) indemnity payments for lost wages and third-party claim settlement
expensesemployers engaged in non-hazardous industries, such as independent medical examinations, surveillance costsservice and legal
expenses,retail businesses. This strategy did not produce the results anticipated, and (iii) staff and related expenses incurred to administer and settle
claims. Certain claims and claim settlement expenses paid are offset by
estimated recoveries from reinsurers under specific excess of loss reinsurance
agreements. Commissions and other underwriting expenses consist of agencies'
commissions, state premium taxes, fees and other expenses directly related to
the production of premiums. General and administrative expenses include the
costs of providing executive, administrative and support services.
The following table identifies the markets in which the Company's premiums
were earned and the percentage of the gross premiums earned in those markets to
total gross premiums earned for the periods indicated.
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RESULTS OF OPERATIONS
The following table sets forth income statement information expressed as a percentage of total revenues for the periods indicated.
Three Months Ended March 31, 1996 Compared To Three Months Ended March 31, 1995
Total Revenue. Total revenue increased from $12.8 million for the three
months ended March 31, 1995 to $18.5 million for the three months ended March
31, 1996, an increase of approximately 44.5%. The increase was primarily due to
the Company's expansion into other hazardous occupation industries. This
increase was partially offset by a decrease in premiums earned in the logging
industry which resulted primarily from a downturn in pulp and paper production
due to reduced demand. Service fee income increased approximately $1.1 million
in the 1996 period compared to the 1995 period. This increase was primarily due
to the acquisition of Hammerman & Gainer, Inc. ("H&G") on September 1, 1995,
which contributed $919,000 to service fee income in the three months ended March
31, 1996. Investment income increased by approximately $486,000 in the 1996
period compared to the 1995 period, primarily due to an increase in invested
assets from $61.7 million at March 31, 1995 to $88.8 million at March 31, 1996.
Fees and other from affiliates remained essentially unchanged.
Claims and Claim Settlement Expenses. Claims and claim settlement expenses
increased from $6.7 million for the three months ended March 31, 1995 to $9.3
million for the three months ended March 31, 1996, an increase of approximately
38.8%. This increase was commensurate with the increase in premiums earned. The
loss ratios for these three month periods were higher than theresult our weighted average gross accident year loss ratio for the period 1997 through 2000 was 120.2%, as compared to 57.7% for the period 1994 through 1996.
In September 2000, we undertook several strategic initiatives to improve the profitability of our existing in-force book of business and new business. These initiatives included the following:
| • | Renewed focus on core hazardous industries. We undertook action to non-renew policies with higher frequency, non-hazardous industries and refocused our efforts on employers engaged in the hazardous industries that we underwrite today. Our renewed focus on hazardous industries has contributed to sharply reducing claims frequency. In 2005, we had 7,073 claims reported compared to 28,509 claims in 2000, while gross earned premiums were $278.1 million in 2005 and $267.2 million in 2000. |
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| • | Commenced re-underwriting our book of business. We commenced re-underwriting our core hazardous industry book of business to improve our risk selection and establish rates commensurate with the risks we were underwriting. Since January 1, 2000, we have made 68 filings with state regulatory agencies to increase our loss cost multipliers to maintain rates at profitable levels. As a result of these initiatives and our renewed focus on core hazardous industries, our average policy premium for voluntary workers’ compensation has increased from approximately $18,500 in 2000 to approximately $40,000 for the nine months ended September 30, 2006. |
| • | Reduced or ceased underwriting in certain states. We reduced or ceased underwriting in states where we lacked a sufficient level of premium production to effectively deploy our field resources or where we believed the rate environment did not adequately compensate us for the risks we were underwriting. | |
| • | Increased pre-quotation safety inspection of employers on new business. As we expanded geographically and began underwriting policies for employers engaged in non-hazardous industries, the ability of our safety services personnel to review new and existing business became constrained. As a result, we had difficulty deploying our safety personnel to inspect employer worksites efficiently and began to outsource safety inspections. In conjunction with our refocus on core hazardous industries, we began mandating, with limited exceptions, a pre-quotation safety inspection of employers for new business that we utilize today. Our pre-quotation inspection rate of new voluntary policyholders increased from approximately 29% in 2000 to approximately 91% in 2005. |
| • | Took action to manage substantially all claims in-house. We made the strategic decision to take substantially all of our claims in-house and limit reliance on third-party administrators. We believe this action has reduced the number of open claims and improved our ability to close claims promptly and therefore reduce costs. At September 30, 2006, we managed 98% of claims in-house utilizing our intensive claims management practices as compared to 85% at December 31, 2000. We have also reduced the number of third-party administrators that we utilize to six at year-end 2005 from 44 at the end of 2000. |
| • | Implemented incentive program. Effective January 1, 2001, we implemented a new incentive program under which our underwriters and field safety professionals are compensated in part based on the achievement of certain loss ratio targets. We believe this program has contributed to our ability to maintain underwriting discipline. |
We believe these actions have contributed to improved underwriting profitability as measured on an accident year ended December 31, 1995 due to seasonality. Claims are more frequently
incurredbasis. As shown in the first threetable below, during the period 1996 through 2005, our weighted average accident year gross and net loss ratios were 92.9% and 69.7%, respectively. The weighted average accident year gross and net loss ratios for this same time period for the workers’ compensation insurance industry were 85.6% and 84.4%, respectively.
| Weighted | ||||||||||||||||||||||||||||||||||||||||||||
| Accident Year Loss Ratio | 1996 | 1997 | 1998 | 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | Average | |||||||||||||||||||||||||||||||||
Gross Basis: | ||||||||||||||||||||||||||||||||||||||||||||
| AMERISAFE(1) | 61.5% | 84.0% | 108.0% | 146.2% | 123.2% | 96.3% | 83.3% | 69.5% | 65.8% | 72.6% | 92.9% | |||||||||||||||||||||||||||||||||
| Workers’ Compensation Industry(2) | 76.9% | 89.6% | 101.9% | 113.3% | 109.5% | 101.2% | 81.2% | 70.5% | 69.6% | 73.7% | 85.6% | |||||||||||||||||||||||||||||||||
Net Basis: | ||||||||||||||||||||||||||||||||||||||||||||
| AMERISAFE(1) | 56.7% | 76.1% | 63.3% | 67.1% | 56.6% | 70.5% | 87.0% | 72.3% | 68.8% | 71.3% | 69.7% | |||||||||||||||||||||||||||||||||
| Workers’ Compensation Industry(2) | 78.1% | 89.5% | 99.2% | 106.3% | 102.9% | 93.9% | 81.4% | 72.7% | 71.0% | 75.9% | 84.4% | |||||||||||||||||||||||||||||||||
| (1) | Cumulative development through December 31, 2005. | |
| (2) | Source: A.M. Best, statutory basis. |
Our accident year loss ratios on a gross and net basis for the nine months ofended September 30, 2006 were 67.4% and 69.8%, respectively. The principal difference between our gross and net loss experience
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relates to the year aspolicy years 1998 through 2000, during which we were able to purchase reinsurance on favorable pricing and other terms.
We believe that the strategic actions taken since September 2000 to refocus our underwriting operations on core hazardous industries while developing further discipline in underwriting, safety services, claims management and premium audit has positioned us to achieve profitable underwriting results and favorable returns on equity.
Industry
Overview
Workers’ compensation is a result of lower activitystatutory system under which an employer is required to pay for its employees’ medical, disability, vocational rehabilitation and death benefit costs for work-related injuries or illnesses. Most employers satisfy this requirement by purchasing workers’ compensation insurance. The principal concept underlying workers’ compensation laws is that employees injured in the logging industry during which period workerscourse and scope of their employment have historically reported
claims more frequently. See "-- Seasonality."
Commissionsonly the legal remedies available under workers’ compensation laws and Other Underwriting Expenses. Commissions anddo not have any other underwriting expenses increased from $2.4 million forrecourse against their employer. An employer’s obligation to pay workers’ compensation does not depend on any negligence or wrongdoing on the three months ended
March 31, 1995 to $3.5 million for the three months ended March 31, 1996, an
increase of approximately 45.8%. This increase is commensurate with the increase
in premiums earned. Commissions and other underwriting expenses as a percentage
of premiums earned were 22.2% and 23.4% for the 1995 and 1996 periods,
respectively.
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Other Expenses. General and administrative expenses increased from $1.0
million for the three months ended March 31, 1995 to $2.0 million for the three
months ended March 31, 1996, an increase of 100%. This increase was primarily
due to the acquisition of H&G on September 1, 1995 which added approximately
$888,000 in the three months ended March 31, 1996. Depreciation and amortization
increased by approximately $163,000 in the 1996 period compared to the 1995
period due to an increase in depreciable assets, primarily furniture, equipment
and automobiles. Interest expense increased by approximately $69,000 in the 1996
period compared to the 1995 period due to increases in both total borrowings and
the weighted average cost of funds.
Year Ended December 31, 1995 Compared To Year Ended December 31, 1994
Total Revenue. Total revenue increased from $47.1 million for the year
ended December 31, 1994 to $69.7 million for the year ended December 31, 1995,
an increase of approximately 48.0%. This increase was primarily due to increased
premiums earned resulting from the Company's expansion of its operations into
other hazardous occupation industries. Service fee income increased
approximately $1.6 million from 1994 to 1995 primarily as a result of the
acquisition of H&G on September 1, 1995. Investment income increased
approximately $2.0 million, or 81.9%, in 1995 as a result of an increase in
invested assets. Invested assets, including cash, increased by approximately
$25.4 million in the 1995 period compared to the 1994 period. Fees and other
from affiliates increased by approximately $1.1 million in the 1995 period
compared to the 1994 period, primarily as a result of a $1.0 million dividend
which was received from an affiliated entity during 1995. There were no such
dividends received in 1994 or 1993. The stock of this affiliate was distributed
to a shareholder immediately prior to the Offering as part of the Reorganization. See "Recent Reorganization."
Claimsemployer and Claim Settlement Expenses. Claims and claim settlement expenses
increased from $25.3 millionexists even for the year ended December 31, 1994 to $32.9
million for the year ended December 31, 1995, an increase of approximately
30.0%. However, the loss ratio (i.e., the ratio of claims and claim settlement
expenses to premiums earned) decreased from 62.4% in 1994 to 56.6% in 1995. The
improvement in the loss ratio resulted primarily from settling claims related to
losses from prior periods for amounts less than originally estimated.
Commissions and Other Underwriting Expenses. Commissions and other
underwriting expenses increased from $8.5 million for the year ended December
31, 1994 to $13.5 million for the year ended December 31, 1995, an increase of
approximately 58.8%, primarily due to increases in premiums earned. Commissions
and other underwriting expenses as a percentage of insurance premiums earned
increased from 21.0% in 1994 to 23.3% in 1995 as theinjuries that result of the Company's use
of independent agents to produce workers' compensation premiums in industries
outside the logging industry.
Other Expenses. General and administrative expenses increased from $4.4
million for the year ended December 31, 1994 to $6.8 million for the year ended
December 31, 1995, an increase of approximately 54.5%. This increase was
primarily due to the acquisition of H&G on September 1, 1995 (which added
approximately $1.1 million in 1995) and the build-up of staff and facilities.
Depreciation and amortization increased by approximately $303,000 in the 1995
period compared to the 1994 period due to an increase in depreciable assets,
primarily furniture, equipment and automobiles. Interest expense increased
$119,000, or 16.4%, during 1995 due to increases in both total borrowings and
the weighted average cost of funds.
Year Ended December 31, 1994 Compared To Year Ended December 31, 1993
Total Revenue. Total revenue increased from $41.2 million for the year
ended December 31, 1993 to $47.1 million for the year ended December 31, 1994,
an increase of approximately 14.3%. This increase was primarily due to increased
premiums earned from other insurance products, primarily automobile coverage.
Service fee income increased approximately $1.5 million in the 1994 period
compared to the 1993 period, primarily from expansion of the range of services
offered to include claim settlement services. Fees and other from affiliates
decreased from $2.2 million to $1.7 million or as a percentage of revenue from
5.2% in 1993 to 3.7% in 1994.
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Claims and Claim Settlement Expenses. Claims and claim settlement expenses
increased from $20.3 million for the year ended December 31, 1993 to $25.3
million for the year ended December 31, 1994, an increase of approximately
24.6%.
Commissions and Other Underwriting Expenses. Commissions and other
underwriting expenses increased from $7.6 million for the year ended December
31, 1993 to $8.5 million for the year ended December 31, 1994, an increase of
approximately 11.8%. The increase in commissions and other underwriting expenses
was commensurate with the increase in premiums earned. Commissions and other
underwriting expenses as a percentage of premiums earned was 21.0% for each of
the years ended December 31, 1993 and 1994.
Other Expenses. General and administrative expenses increased from $2.8
million for the year ended December 31, 1993 to $4.4 million for the year ended
December 31, 1994, an increase of approximately 57.1%. This was primarily due to
the expansion of the range of services offered to include claim settlement
services. Depreciation and amortization increased by approximately $463,000 in
the 1994 period compared to the 1993 period due to an increase in depreciable
assets, primarily furniture, equipment and automobiles. Interest expense
decreased $124,000, or 14.6%, during 1994 because the Company refinanced its
debt at a lower average interest rate.
RESERVES FOR CLAIMS AND CLAIM SETTLEMENT EXPENSE
The Company's consolidated financial statements include estimated reserves
for unpaid claims and claim settlement expenses. The reserves for these expenses
are estimated using individual case-basis valuations and statistical analyses
and represent estimates of the ultimate gross and net costs of all unpaid claims
and claim settlement expenses incurred through the balance sheet date of each
period presented. Those estimates are subject to the effects of trends in claim
severity and frequency. The Company's estimates are continually reviewed and, as
experience develops and new information becomes known, the reserves are adjusted
as necessary. Adjustments, including increases and decreases, are included in
current operations net of reinsurance, and in the estimate of reserves for
insured events of prior periods.
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The following table shows changes in historical claims and claim settlement
expense reserves, net of reinsurance recoverables, for the Company from 1986
through 1995. The top line of the table indicates the estimated reserves for
unpaid claims and claim settlement expenses recorded at each year end date. Each
amount in the top line represents the estimated amount of claims and claim
settlement expenses for the claims incurred in that year as well as future
payments on claims occurring in prior years. The upper portion (net reserve
re-estimated) shows the year-by-year development of the previously recorded
reserves based on experience as of the end of each succeeding year. The
estimates change as more information becomes known about the actual claims on
which the initial reserves were carried. Any adjustments to the carrying value
of unpaid claims for a prior year will also be reflected in the adjustments for
each subsequent year. For example, an adjustment in 1995 for 1993 loss reserves
will be reflected in the re-estimated net reserve for 1993 and 1994. The net
cumulative redundancy (deficiency) line represents the cumulative changes in
estimates since the initial reserves were established. It is equal to the
difference between the initial reserve and the latest re-estimated net reserve
amount. The lower portion of the table (cumulative amount of reserve paid)
presents the amounts paid as of the end of subsequent years on those claims for
which reserves were carried as of the end of each specific year.
The foregoing table indicates that reserves for claims and claim settlement
expenses, net of related reinsurance recoverables, at December 31, 1989 through
1994 were decreased from their original amounts. These decreases resulted
primarily from settling claims related to losses prior to those dates for
amounts less than originally estimated. Most of the favorable development has
resulted from the Company's managed results approach and claims management
process.
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The following table providesnegligence or fault of another person, a reconciliation ofco-employee or, in most instances, the beginning and ending
reserve balances, net of reinsurance recoverables for 1993, 1994 and 1995:
The Company's reserves for claims and claim settlement expenses, net of
related reinsurance recoverables, at December 31, 1992, 1993 and 1994, were
decreased in 1993, 1994 and 1995, by $1,911,000, $1,387,000 and $3,150,000,
respectively, for claimsinjured employee.
Workers’ compensation insurance policies generally provide that had occurred on or prior to those balance sheet
dates. The decreases were due to settling case-basis liabilities related to
claims in those periods for less than originally estimated. Most of the favorable development has resulted frominsurance carrier will pay all benefits that the Company's managed results approach
and claims management process. No return premiums are due as a result of
prior-year effects.
The Company continually attempts to improve its claims estimation process
by refining its ability to analyze claims development and settlement patterns,
claims payments and other information. However, there are uncertainties inherent
in the claims estimation process and claims estimates haveinsured employer may become increasingly
subject to changes in social and legal trends that may expand the liability of
insurers, establish new liabilities and interpret contracts to provide
unanticipated coverage long after the related policies were written. In
management's judgment, information currently available has been appropriately
considered in estimating the Company's claims and claim settlement expense
reserves. However, there can be no assurance that future events will not cause
incurred claims to exceed estimated reserves. Accordingly, it may not be
appropriate to extrapolate future redundancies or deficiencies based on the
above reserve tables.
Loss reserve development without the effects of reinsurance would not be
significantly different than that presented above.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations historically have provided substantial positive
cash flow. Net cash provided by operating activities was $10.2 million, $13.0
million and $29.1 million in 1993, 1994 and 1995, respectively, and $6.8 million
and $5.6 million for the three months ended March 31, 1995 and 1996,
respectively. Net cash
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provided by operations primarily consists of premiums collected, investment
income, service fee income and reinsurance recoverable balances collected, less
claims and claim settlement expenses paid, premiums paid for reinsurance
protection and operating expenses. Generally, premiums are collected months or
years before claims are paid. Premiums are used firstobligated to pay current claims and
expenses. The balance, if any, is invested in marketable securities to generate
investment income.
The Company follows an investment strategy which is based on many factors,
including underwriting results and the Company's resulting tax position,
fluctuations in interest rates and regulatory requirements. The majority of the
Company's investment assets are in fixed maturity securities. The following
table shows the quality composition of the Company's investment portfolio
(percentages determined on the basis of amortized cost) by rating, as assigned
by Standard & Poor's, Inc. or Moody's Investor's Services, Inc. at March 31,
1996.
The Company historically has held its investments in these securities to
maturity. Management of the Company believes substantially all of the Company's
investment assets are readily marketable. However, because of the Company's
strategy of generally holding fixed maturity securities to maturity, the Company
has classified the majority of these securities as held-to-maturity for
financial accounting purposes. See Note 1 of the Notes to Consolidated Financial
Statements. Management currently intends to classify a portion of fixed maturity
securities purchased with the proceeds from the Offering as available-for-sale.
Cash proceeds from the sales and maturities of fixed income securities in 1995
were $10.2 million compared to $12.1 million in 1994, and $4.4 million in 1993
and $7.2 for the three months ended March 31, 1996.
Aggregate invested assets, including cash, were $56.3 million and $81.7
million at December 31, 1994 and 1995, respectively, and $88.8 million at March
31, 1996. The increases were primarily due to the investment of cash provided by
operating activities.
The Company's principal need for capital is to fund growth of its core
managed results workers'under applicable workers’ compensation business. The Company is restricted by
statute in the amount of net premiums it can write on the basis of certain
leverage guidelines established by insurance regulators. Exceeding these factors
limits a company's ability to generate premium income. A common measurement of
leverage is the ratio of net premiums written to statutory surplus. American
Interstate's leverage factors are within the maximum factors specified by the
states in which it operates. However, private rating agencies generally have
stricter leverage standards, and management believes the Company must stay well
within these industry leverage guidelines to maintain its favorable ratings from
these agencies. Additionally, beginning in 1994, the Company was required to
calculate the Risk-Based Capital (RBC) ratio for each of its insurance
subsidiaries, which measures the adequacy of statutory capital and surplus in
relation to investment and insurance risks and other business factors. The RBC
formula is used by state insurance regulators to identify, for the purpose of
initiating regulatory action, insurance companies that potentially are
inadequately capitalized. The RBC ratio of each of the Company's insurance
subsidiaries exceeds the minimum required ratio. The National Association of
Insurance Commissioners has proposed a new Model Investment Law that, if adopted
by the State of Louisiana (American Interstate's state of domicile), may affect
the statutory carrying values of certain investments; however, the final outcome
of that proposal is not certain, nor is it possible to predict what impact the
proposal will have on the Company or whether the proposal will be adopted in the
foreseeable future. The Company intends to use a portion of the net proceeds
from the Offering to expand its insurance business into additional markets and,
if necessary, to increase the capital and surplus of its insurance subsidiaries
to remain in compliance with regulatory requirements.
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The Company is a holding company and, accordingly, the primary source of
the Company's liquidity will be from dividends and management fees paid by one
of its subsidiaries, American Interstate. The Company provides management
services to American Interstate in exchange for these management fees.
Additionally, American Interstate and its insurance subsidiary are limited by
statute in their ability to pay dividends and fees to the Company. See Note 8 of
the Notes to Consolidated Financial Statements and "Risk Factors -- Holding
Company Structure." Additionally, management currently expects to invest a
portion of the Offering proceeds in marketable securities, using the income to
provide liquidity.
AMERISAFE has historically received fees from various affiliated entities
for the costs of providing certain executive, administrative and support
services to those affiliates. Fees received from affiliated entities were $2.2
million, $1.7 million and $2.9 million in 1993, 1994 and 1995, respectively, and
$534,000 for the three months ended March 31, 1996. The Company expects to
continue to provide a certain level of these services to certain of these
affiliates and will enter into annually renewable agreements with such
affiliates. However, management expects the level of fees and other revenues
received from affiliates to decline following the Offering. See "Certain
Transactions and Relationships -- Services Agreement," and "-- Aircraft
Agreement."
IMPACT OF INFLATION
Inflation can have a significant impact on the Company because premium
rates are established before the amount of claims and claim settlement expenses
is known. The Company attempts to anticipate increases in inflation when
establishing rates, subject to limitations imposed by competitive pricing.
The Company also considers inflation when estimating liabilities for claims
and claim settlement expenses, particularly for claims having a long period
between occurrence and settlement. The liabilities for claims and claim
settlement expenses are management's estimates of the ultimate net cost of the
underlying claims and expenses and are not discounted for the time value of
money. In times of high inflation, the normally higher yields on investments may
partially offset potentially higher claims and expenses.
SEASONALITY
The Company's operations are affected by general trends and business cycles
affecting the logging industry. Generally, the Company experiences higher
premium volume in the late summer and early fall when dryer weather allows the
harvesting and processing of trees and higher claims volume in the winter and
spring when inclement weather prevents the harvesting of trees and workers in
the logging industry have historically reported claims more frequently.
EFFECTS OF OFFERING AND RELATED TRANSACTIONS
The Company will receive net proceeds of approximately $152.5 million from
the Offering (approximately $175.5 million if the Underwriters' over-allotment
option is exercised in full). Approximately $73.0 million will be used for the
repayment of indebtedness, including the indebtedness incurred in connection
with the Reorganization. See "Use of Proceeds" and "Recent Reorganization."
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BUSINESS
OVERVIEW
AMERISAFE provides managed care workers' compensation products and services
primarily to employers in hazardous occupation industries. The Company offers
its client-employers a fully integrated program designed to lower the overall
cost of workers' compensation claims by: (i) implementing and applying workplace
safety programs designed to prevent occupational injuries, (ii) providing
immediate, efficient and appropriate managed medical care to injured workers,
and (iii) using intensive personal claims management practices to guide and
encourage injured workers through the recovery and rehabilitation process with
the primary goal of returning the injured worker to work as promptly as
practicable. The Company integrates proactive safety services with intensive
claims management practices and quality managed medical care to produce "managed
results." The Company's managed results approach focuses on creating and
maintaining direct personal relationships with employers, employees and health
care providers in order to design and promote services which are intended to
produce lower overall occupational injury costs. The Company designates service
teams for each client in order to foster personal relationships, provide
continuity of service and to implement specific solutions for individual client
workers' compensation needs.
Since it began operations in 1986, the Company has focused on providing its
managed results products and services to employers whose employees are engaged
in hazardous occupations, primarily the logging industry. Beginning in 1994, the
Company began expanding its client base by targeting employers in other
hazardous occupation industries, including general contracting, trucking, and
oil and gas exploration. The Company believes that the high severity injuries
typically suffered by employees engaged in hazardous occupations and the
resulting high cost typically incurred by employers in providing the mandatory
workers' compensation coverage for such employees provide the greatest
opportunity to lower costs by applying the Company's managed results approach.
By focusing on developing and implementing client-specific workplace safety
techniques and intensive claims management, the Company believes that
substantial cost savings can be achieved when compared to the traditional
workers' compensation approach to hazardous occupation industries. By reducing
the overall cost of providing workers' compensation coverage to its
employer-clients, the Company believes its managed results approach permits it
to price its products and services competitively.
From 1991 through 1995, the Company has increased its revenues from $20.3
million to $69.7 million, or a compound annual growth rate of 36.1%. In this
same period, the Company's net income (before cumulative effect of accounting
change) increased from $1.8 million to $9.3 million, or a compound annual growth
rate of 50.8%. As of March 31, 1996, the Company was licensed to provide
workers' compensation coverage and services in 25 states and the U.S. Virgin
Islands and provided its products and services to approximately 2,900 employers
in 16 states, primarily in the southeastern United States. As of that date, more
than two-thirds of AMERISAFE's employer-clients were involved in hazardous
occupation industries.
INDUSTRY
Workers' compensation benefits are state-mandated and regulated programs,
which generally require employers to provide medical benefits and wage
replacement to employees injured at work, regardless of fault.laws. Each individual state has a regulatory and adjudicatory system whichthat quantifies the level of wage replacement to be paid, determines the level of medical care required to be provided and the cost of permanent impairment and provides whetherspecifies the options in selecting medical providers available to the injured employee or the employer has certain options in selecting health care providers.
Stateemployer. These state laws generally require two types of benefits for injured employees: (i)(1) medical benefits, thatwhich include expenses related to diagnosis and treatment of the injury, as well as any required rehabilitation, if necessary, and (ii)(2) indemnity payments, thatwhich consist of temporary wage replacement, permanent disability payments orand death benefits to surviving family members. The Company believes that medical
benefits presently account for approximately half of all workers' compensation
benefits paid, with the remainder paid for lost wages and death benefits. To fulfill thisthese mandated financial obligation,obligations, virtually all employers are required either to purchase workers'workers’ compensation insurance or, if permitted by state law or approved by the U.S. Department of Labor, to self-insure. The employers may purchase workers’ compensation insurance from a private insurance carrier, a state-sanctioned assigned risk pool or a self-insuredself-insurance fund, (anwhich is an entity that allows employers to pool their liabilities for obtaining workers'
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28obtain workers’ compensation coverage buton a pooled basis, typically subjectssubjecting each employer to joint and several liability for the entire fund), or, if permitted by their state, to self-insure.
The cost to employers of providing workers'fund.
Workers’ compensation benefitswas the fourth-largest property and casualty insurance line in the United States totaledin 2005, according to A.M. Best. Direct premiums written in 2005 for the workers’ compensation insurance industry were approximately $58$56 billion, in 1994. From 1984and direct premiums written for the property and casualty industry as a whole were approximately $489 billion, according to 1990,
workers' compensation costs increased an average of 13.3% per year and, from
1990A.M. Best. According to 1992, workers' compensation costs increased an average of 6.3% per year.
The substantial growththe most recent market data reported by the NCCI, which is the official ratings bureau in the workers'majority of states in which we are licensed, total premiums reported for the specific occupational class codes for which we underwrite business was $16 billion. Total premiums reported for all occupational class codes reported by the NCCI for these same jurisdictions was $39 billion.
Outlook
We believe the challenges faced by the workers’ compensation market is primarilyinsurance industry over the past decade have created significant opportunity for workers’ compensation insurers to increase the amount of business that they write. The year 2002 marked the first year in five years that private carriers in the property and casualty insurance industry experienced an increase in annual after-tax returns on surplus, including capital gains, according to NCCI. Workers’ compensation insurance industry calendar year combined ratios declined for the first time in seven years, falling from 122% (with 1.9% attributable to the increased costs of medical treatmentSeptember 11, 2001 terrorist attacks) to 105% in 2004 as premium rates have increased. In addition, claims frequency has declined. From 1991 through 2004, the cumulative decline in lost-time claims frequency was 45.8%. The NCCI estimates that lost-time claims frequency declined an additional 4.5% in 2005. We believe that opportunities remain for us to
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provide needed underwriting capacity at attractive rates and an increase in
workers' compensation litigation, which affects both medical benefitsupon terms and indemnity payments. The Company believes that successful containment of these
expenses depends largely upon early interventionconditions more favorable to insurers than in the claims processpast.
Policyholders
As of September 30, 2006, we had more than 6,700 voluntary business policyholders with an average annual workers’ compensation policy premium of approximately $40,000. As of September 30, 2006, our ten largest voluntary business policyholders accounted for less than 3% of our in-force premiums. Our policy renewal rate on voluntary business that we elected to quote for renewal was 91.3% for the nine months ended September 30, 2006, 90.6% in 2005, 93.0% in 2004 and promptly enabling an injured employee91.4% in 2003.
In addition to returnour voluntary workers’ compensation business, we underwrite workers’ compensation policies for employers assigned to work.us and assume reinsurance premiums from mandatory pooling arrangements, in each case to fulfill our obligations under residual market programs implemented by the states in which we operate. In addition, we separately underwrite general liability insurance policies for our workers’ compensation policyholders in the logging industry on a select basis. Our assigned risk business fulfills our statutory obligation to participate in residual market plans in six states. See “—Regulation—Residual Market Programs” below. For the nine months ended September 30, 2006 and the year ended December 31, 2005, our assigned risk business accounted for 3.7% and 4.8%, respectively, of our gross premiums written, and our assumed premiums from mandatory pooling arrangements accounted for 1.3% and 2.4%, respectively, of our gross premiums written. In addition, our general liability insurance business accounted for 0.7% and 1.2%, respectively, of our gross premiums written for the nine months ended September 30, 2006 and the year ended December 31, 2005.
Targeted Industries
We provide workers’ compensation insurance primarily to employers in the following targeted hazardous industries:
Construction. Includes a broad range of operations such as highway and bridge construction, building and maintenance of pipeline and powerline networks, excavation, commercial construction, roofing, iron and steel erection, tower erection and numerous other specialized construction operations. A substantial portion of our revenue is generated from states on the Gulf Coast and Atlantic Seaboard. We experience increased revenue following hurricanes and other severe weather due to increased construction activity resulting from rebuilding efforts in the affected states. Our gross premiums written in 2005 for employers in the construction industry were $117.1 million, or 40.3% of total gross premiums written in 2005. Our average policy premium for voluntary workers’ compensation within the construction industry in 2005 was $42,657, or $7.53 per $100 of payroll.
Trucking. Includes a large spectrum of diverse operations including contract haulers, regional and local freight carriers, special equipment transporters and other trucking companies that conduct a variety of short- and long-haul operations. Our gross premiums written in 2005 for employers in the trucking industry were $59.3 million, or 20.4% of total gross premiums written in 2005. Our average policy premium for voluntary workers’ compensation within the trucking industry in 2005 was $46,953, or $7.35 per $100 of payroll.
Logging. Includes tree harvesting operations ranging from labor intensive chainsaw felling and trimming to sophisticated mechanized operations using heavy equipment. Our gross premiums written in 2005 for employers in the logging industry were $26.3 million, or 9.0% of gross premiums written in 2005. Our average policy premium for voluntary workers’ compensation within the logging industry in 2005 was $18,239, or $15.90 per $100 of payroll.
Agriculture. Including crop maintenance and harvesting, grain and produce operations, nursery operations, meat processing and livestock feed and transportation. Our gross premiums written for employers in the agriculture industry were $13.1 million, or 4.5% of gross premiums written in 2005. Our average policy premium for voluntary workers’ compensation within the agricultural industry in 2005 was $30,868, or $9.39 per $100 of payroll.
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Oil and Gas. Including various oil and gas activities including gathering, transportation, processing, production and field service operations. Our gross premiums written for employers in the oil and gas industry were $8.0 million, or 2.8% of gross premiums written in 2005. Our average policy premium for voluntary workers’ compensation within the oil and gas industry in 2005 was $59,962, or $6.42 per $100 of payroll.
Maritime. Including ship building and repair, pier and marine construction, inter-coastal construction and stevedoring. Our gross premiums written for employers in the maritime industry were $7.3 million, or 2.5% of gross premiums written in 2005. Our average policy premium for voluntary workers’ compensation within the maritime industry in 2005 was $51,140, or $8.59 per $100 of payroll.
Sawmills. Including sawmills and various other lumber-related operations. Our gross premiums written for employers in the sawmill industry were $4.4 million, or 1.5% of gross premiums written in 2005. Our average policy premium for the sawmill industry in 2005 was $32,414, or $8.75 per $100 of payroll.
Our gross premiums are derived from:
| • | Direct Premiums. Includes premiums from workers’ compensation and general liability insurance policies that we issue to: |
| • | employers who seek to purchase insurance directly from us and who we voluntarily agree to insure, which we refer to as our voluntary business; and | |
| • | employers assigned to us under residual market programs implemented by some of the states in which we operate, which we refer to as our assigned risk business. |
| • | Assumed Premiums. Includes premiums from our participation in mandatory pooling arrangements under residual market programs implemented by some of the states in which we operate. |
In addition to workers’ compensation insurance, we also offer general liability insurance coverage only to our workers’ compensation policyholders in the logging industry on a select basis. As of September 30, 2006, less than 1.0% of our voluntary in-force premiums were derived from general liability policies.
Gross premiums written during the years ended December 31, 2005, 2004 and 2003 and the allocation of those premiums among the hazardous industries we target are presented in the table below.
| Percentage of | ||||||||||||||||||||||||
| Gross Premiums Written | Gross Premiums Written | |||||||||||||||||||||||
| 2005 | 2004 | 2003 | 2005 | 2004 | 2003 | |||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||
| Voluntary business: | ||||||||||||||||||||||||
| Construction | $ | 117,134 | $ | 101,298 | $ | 80,693 | 40.3% | 38.3% | 36.1% | |||||||||||||||
| Trucking | 59,348 | 57,822 | 47,104 | 20.4% | 21.8% | 21.1% | ||||||||||||||||||
| Logging | 26,324 | 30,340 | 32,008 | 9.0% | 11.5% | 14.3% | ||||||||||||||||||
| Agriculture | 13,119 | 11,203 | 8,502 | 4.5% | 4.2% | 3.8% | ||||||||||||||||||
| Oil and Gas | 8,035 | 7,226 | 7,221 | 2.8% | 2.7% | 3.2% | ||||||||||||||||||
| Maritime | 7,262 | 5,909 | 6,076 | 2.5% | 2.2% | 2.7% | ||||||||||||||||||
| Sawmills | 4,441 | 5,566 | 4,009 | 1.5% | 2.1% | 1.8% | ||||||||||||||||||
| Other | 34,382 | 28,117 | 24,239 | 11.8% | 10.6% | 10.8% | ||||||||||||||||||
| Total voluntary business | 270,045 | 247,481 | 209,852 | 92.8% | 93.4% | 93.9% | ||||||||||||||||||
| Assigned risk business | 13,924 | 9,431 | 9,216 | 4.8% | 3.6% | 4.1% | ||||||||||||||||||
| Assumed premiums | 6,922 | 8,050 | 4,522 | 2.4% | 3.0% | 2.0% | ||||||||||||||||||
| Total | $ | 290,891 | $ | 264,962 | $ | 223,590 | 100.0% | 100.0% | 100.0% | |||||||||||||||
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Geographic Distribution
We are licensed to provide workers’ compensation insurance in 45 states, the District of Columbia and the U.S. Virgin Islands. We operate on a geographically diverse basis with no more than 10.5% of our gross premiums written in 2005 derived from any one state. The Company also
believes that,table below identifies, for the nine months ended September 30, 2006 and the years ended December 31, 2005, 2004 and 2003, the states in which the percentage of our gross premiums written exceeded 3.0% for any of the periods presented.
| Percentage of Gross Premiums Written | ||||||||||||||||
| Nine Months | ||||||||||||||||
| Ended | Year Ended December 31, | |||||||||||||||
State | September 30, 2006 | 2005 | 2004 | 2003 | ||||||||||||
| Georgia | 9.4% | 10.5% | 9.5% | 9.4% | ||||||||||||
| Louisiana | 8.4% | 8.3% | 10.6% | 11.8% | ||||||||||||
| North Carolina | 6.8% | 6.7% | 6.3% | 5.9% | ||||||||||||
| Florida | 6.8% | 5.9% | 4.9% | 4.6% | ||||||||||||
| Virginia | 6.2% | 5.3% | 5.2% | 5.2% | ||||||||||||
| Pennsylvania | 5.3% | 5.3% | 4.5% | 3.9% | ||||||||||||
| Texas | 5.0% | 5.0% | 6.5% | 7.9% | ||||||||||||
| Alaska | 4.6% | 5.3% | 4.4% | 3.3% | ||||||||||||
| South Carolina | 4.6% | 4.9% | 4.6% | 3.9% | ||||||||||||
| Minnesota | 4.6% | 4.2% | 3.6% | 3.9% | ||||||||||||
| Illinois | 4.4% | 5.4% | 6.4% | 5.7% | ||||||||||||
| Oklahoma | 4.4% | 4.1% | 3.3% | 3.9% | ||||||||||||
| Tennessee | 4.3% | 4.2% | 3.9% | 3.5% | ||||||||||||
| Mississippi | 4.3% | 3.5% | 3.9% | 3.6% | ||||||||||||
| Arkansas | 3.7% | 3.9% | 4.7% | 5.2% | ||||||||||||
| Wisconsin | 2.8% | 3.5% | 3.3% | 2.3% | ||||||||||||
| Alabama | 2.6% | 2.7% | 2.7% | 3.2% | ||||||||||||
Lines of Business
Workers’ Compensation
Workers’ compensation insurance provides coverage to date, traditional insurers have focused on high premium volume
and generally maintain minimal staffing. As a result, the Company believes that
the workers' compensation industry is generally characterized by limited safety
services, inefficient claims adjustment processes and ineffective medical cost
management.
Employers engaged in hazardous occupation industries pay substantially
higher than average workers' compensation rates. While these rates vary
significantly across industries and from state toemployers under state and federal workers’ compensation laws. These laws prescribe benefits that employers are dependent upon
the individual employer's loss history, workers' compensation costs are
typically a significant component of these hazardous occupation employers'
overall operating expenses. For example, the Company's logging clients typically
pay an amount equalobligated to 20%provide to 50% of payroll to obtain workers' compensation
benefits for their employees comparedwho are injured in the course and scope of their employment. Our workers’ compensation insurance policies also provide employer liability coverage, which generally provides coverage for an employer for claims by non-employees.
The most basic insurance policy we provide to employers of clerical workers who
generallyour policyholders is a guaranteed cost contract. Under our guaranteed cost contracts, policyholders pay an amount less than 1%premiums based on a percentage of their payroll determined by job classification. Our premium rates for these policies vary depending upon certain factors, including the type of work to obtain such benefits.
Thisbe performed by employees and the general business of the policyholder. In return for premium payments, we assume statutorily imposed obligations of the policyholder to provide workers’ compensation benefits to its employees. There are no policy limits on our liability for workers’ compensation claims as there are for other forms of insurance. We conduct a premium audit at the expiration of the policy to verify that the policyholder’s correct payroll expense and job classifications were reported to us.
In addition to guaranteed cost disparity resultscontracts, historically we have written, and may offer, a variety of other insurance options designed to fit the needs of our policyholders. A policyholder who desires to assume financial risk in exchange for reduced premiums may elect a deductible that makes the policyholder responsible for the first portion of any claim. We also offer loss sensitive plans on a limited basis, including dividend plans. These plans provide for a portion of the premium to be returned to the policyholder in the form of a dividend, based on the policyholder’s losses during the policy period. Premiums from guaranteed
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cost contracts accounted for all of our gross premiums written for the nine months ended September 30, 2006 and for the year ended December 31, 2005.
We have three insurance subsidiaries, American Interstate, Silver Oak Casualty and American Interstate of Texas. Our principal subsidiary, American Interstate, is licensed to provide workers’ compensation insurance in 45 states, the District of Columbia and the U.S. Virgin Islands. Silver Oak Casualty is licensed in nine states and the District of Columbia and American Interstate of Texas is licensed only in Texas. We utilize Silver Oak Casualty and American Interstate of Texas to file alternative workers’ compensation rate structures that permit us to offer our workers’ compensation insurance to a broader range of potential policyholders. We currently intend to pursue licensing of Silver Oak Casualty and American Interstate of Texas in additional states.
General Liability
General liability insurance is a form of casualty insurance that covers a policyholder’s liability resulting from its act or omission that causes bodily injury or property damage to a third party. With general liability insurance, the amount of a covered loss is the amount of the claim or payment made on the policyholder’s behalf, subject to the deductible, limits of liability and other features of the insurance policy. We offer general liability insurance coverage only to our workers’ compensation policyholders in the logging industry on a select basis. As of September 30, 2006, less than 1.0% of our voluntary in-force premiums were derived from general liability policies.
Sales and Marketing
We sell our workers’ compensation insurance through agencies. As of September 30, 2006, our insurance was sold through more than 2,200 independent agencies and our wholly owned insurance agency subsidiary, Amerisafe General Agency, which is licensed in 23 states. We are selective in establishing and maintaining relationships with independent agencies. We establish and maintain relationships only with those agencies that provide quality application flow from prospective policyholders that are reasonably likely to accept our quotes. We compensate these agencies by paying a commission based on the premium collected from the substantial expenses associated with high
severity injuries occurring within hazardous occupation industries. The Company
believespolicyholder. Our average commission rate for our independent agencies was 7.0% for the nine months ended September 30, 2006 and 7.1% for the year ended December 31, 2005. We pay our insurance agency subsidiary a commission rate of 8.0%. Neither our independent agencies nor our insurance agency subsidiary has authority to underwrite or bind coverage. We do not pay contingent commissions.
As of September 30, 2006, independent agencies accounted for approximately 84% of our voluntary in-force premiums, and no independent agency accounted for more than 1.2% of our voluntary in-force premiums at that the difficulties associated with controlling catastrophic injury
costs have historically caused a number of insurance companies to withdraw from
the higher-risk market segments. As a result, the Company believes that
hazardous occupation industries offer a significant opportunity to workers'
compensation providers.
STRATEGY
The Company'sdate.
Underwriting
Our underwriting strategy is to utilizefocus on employers in certain hazardous industries that operate in those states where our underwriting efforts are the most profitable and efficient. We analyze each prospective policyholder on its own merits relative to known industry trends and statistical data. Our underwriting guidelines specify that we do not write workers’ compensation insurance for certain hazardous activities, including sub-surface mining and the use of explosives.
Underwriting is a multi-step process that begins with the receipt of an application from one of our agencies. We initially review the application to confirm that the prospective policyholder meets certain established criteria, including that it is engaged in one of our targeted hazardous industries and industry classes and operates in the states we target. If the application satisfies these criteria, the application is forwarded to our underwriting department for further review.
Our underwriting department reviews the application to determine if the application meets our underwriting criteria and whether all required information has been provided. If additional information is required, the underwriting department requests additional information from the agency. This initial review
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process is generally completed within three days after the application is received by us. Once this initial review process is complete, our underwriting department requests that a pre-quotation safety inspection be performed.
After the pre-quotation safety inspection has been completed, our underwriting professionals review the results of the inspection to determine if a rate quote should be made and, if so, prepare the quote. The rate quote must be reviewed and approved by our underwriting department before it is delivered to the agency. All decisions by our underwriting department, including decisions to decline applications, are subject to review and approval by our management-level underwriters.
Our underwriting department is managed results approachby experienced underwriting professionals who specialize in the hazardous industries we target. As of September 30, 2006, we had 59 employees in our underwriting department, including 18 underwriting professionals and 41 support level staff members. The average length of underwriting experience of our underwriting professionals is approximately 12 years.
Our underwriting professionals participate in an effortincentive compensation program under which bonuses are paid quarterly based upon achieving premium underwriting volume and loss ratio targets. The determination of whether targets have been satisfied is made 18 months after the relevant incentive compensation period.
Pricing
In the majority of states, workers’ compensation insurance rates are based upon the published “loss costs.” Loss costs are derived from wage and loss data reported by insurers to the state’s statistical agent, in most states the NCCI. The state agent then promulgates loss costs for specific job descriptions or class codes. Insurers file requests for adoption of a loss cost multiplier, or LCM, to be applied to the loss costs to support operating costs and profit margins. In addition, most states allow pricing flexibility above and below the filed LCM, within certain limits.
We obtain approval of our rates, including our LCMs, from state regulatory authorities. To maintain rates at profitable levels, we regularly monitor and adjust our LCMs. The effective LCM for our voluntary business was 1.55 for the nine months ended September 30, 2006, 1.56 for policy year 2005, 1.53 for policy year 2004, 1.43 for policy year 2003, 1.37 for policy year 2002 and 1.14 for policy year 2001. If we are unable to charge rates in a particular state or industry to produce satisfactory results, we seek to control and reduce our premium volume in that state or industry and redeploy our capital in other states or industries that offer greater opportunity to earn an underwriting profit.
Safety
Our safety inspection process begins with a request from our underwriting department to perform a pre-quotation safety inspection. Our safety inspections focus on a prospective policyholder’s operations, loss exposures and existing safety controls to prevent workplace injury,potential losses. The factors considered in our inspection include employee experience, turn-over, training, previous loss history and when an injury does occur, to arrange
for timely, high quality and cost-effective managed care, thereby lowering the
overall costs to its employer-clients of providing workers' compensation
benefits to their employees. The Company's strategy includes the following
principal elements:
- Focus on Hazardous Occupation Employers. The Company targets those
employers who, due to the nature of their businesses and the
susceptibility of their employees to serious injury, pay substantially
higher than average workers' compensation rates. Because the Company
focuses its efforts on clients in selected industries, the Company
believes that it has developed expertise in assessing not only the risks
associated with those industries, but also the operating practices of
individual employers. As a result, the Company believes it can more
accurately determine the profit opportunity of providing its managed
results services. The Company also believes that less competition exists
in providing workers' compensation services to hazardous occupation
employers because of the potential for severe injuries to their
employees and due to the fact that many hazardous occupation employers
operate in rural areas, a market not pursued by many traditional
insurers. The Company believes that its commitment to working with its
client-employers to implement a program designed to benefit both parties
results in cost savings for its client-employers and the establishment
of long-term relationships with them.
- Improve Workplace Safety. The Company believes that implementing
comprehensive safety services to reduce workplace accidents is the key
element to effect significant reductions in workers' compensation costs
for employers in hazardous occupation industries. The Company presently
employs a staff of 29 safety professionals. Many of these individuals
were previously employed in hazardous occupation industries and use
their personal experience and expertise in these industries to assist
employer-clients in designing safety and injury prevention programs and
to assist in the Company's underwriting process. In most cases, before
offering the Company's managed results
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products and services to a potential new client, a Company safety
professional will visit the potential client's place of business to
assess the existing safety programscorrective actions, and workplace practices.conditions, including equipment condition and, where appropriate, use of fall protection, respiratory protection or other safety devices. Our field safety professionals, or FSPs, travel to employers’ worksites to perform these safety inspections. This initial in-depth analysis allows our underwriting professionals to make decisions on both insurability and pricing. In certain circumstances, the Companywe will agree to provide workers'workers’ compensation products and servicesinsurance only if the employer agrees to implement and maintain specificthe safety recommendations. Oncemanagement practices that we recommend. In 2005, more than 91% of our new voluntary business policyholders were inspected prior to our offering a premium quote. The remaining voluntary business policyholders were not inspected prior to a premium quote for a variety of reasons, including small premium size or the policyholder was previously a policyholder subject to our safety inspections.
After an employer becomes a client, the Company continuespolicyholder, we continue to emphasize workplace safety bythrough periodic workplace visits, assisting the clientpolicyholder in designing and implementing enhanced safety management programs, providing current industry-specific safety-related information and conducting rigorous post-accident
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management. - Manage Care Through Personal, Direct Contact.Generally, we may cancel or decline to renew an insurance policy if the policyholder does not implement or maintain reasonable safety management practices that we recommend.
Our safety department is comprised of 52 FSPs, including three field vice presidents. Our FSPs participate in an incentive compensation program under which bonuses are paid quarterly based upon an FSP’s production and their policyholders’ aggregate loss ratios. The Company believes that
itsresults are measured 18 months after the inception of the subject policy period.
Claims
We have structured our claims operation to provide immediate, intensive and personal direct contact approach reducesmanagement of all claims to guide injured employees through medical treatment, rehabilitation and recovery with the overall costprimary goal of medical care, resultsreturning the injured employee to work as promptly as practicable. We seek to limit the number of claim disputes with injured employees through early intervention in the claims process.
We have claims offices located throughout the markets we serve. Our field case managers, or FCMs, are located in the geographic areas where our policyholders are based. We believe the presence of our FCMs in the field enhances our ability to guide an injured worker returningemployee to work more
quicklythe appropriate conclusion in a friendly, dignified and lessens the likelihood of litigation and fraudulent claims.
The Company encourages its employer-clientssupportive manner. Our FCMs have broad authority to immediately notify the
Companymanage claims from occurrence of a workplace injury. injury through resolution, including authority to retain many different medical providers at our expense, including not only our recommended medical providers but also nurse case managers, independent medical examiners, vocational specialists, rehabilitation specialists and other specialty providers of medical services necessary to achieve a quality outcome.
Following notification of a claims
representative contactsworkplace injury, an FCM will contact the employer,policyholder, the injured employeeand/or the treating physician to determine the nature and severity of the injury. In the case ofIf a serious injury occurs, the employer's pre-designated claims
representativeFCM will promptly visit the injured employee or the employee'semployee’s family members to discuss the benefits provided and will also visit the treating physician to discuss the proposed treatment plan. The
Company's claims representative acts as a facilitator to assure thatOur FCM assists the injured employee receives anin receiving appropriate medical treatment plan and to
encourageencourages the use of Company-recommended health careour recommended medical providers and facilities. The Company limitsFor example, our FCM may suggest that a treating physician refer an injured worker to another physician or treatment facility that we believe has had positive outcomes for other workers with similar injuries. We actively monitor the number of activeopen cases handled by a single claims representativeFCM in order to permit the claims
representative to bettermaintain focus on the services best suited for theeach specific injured employee. - Direct Injured Workers to Appropriate Health Care Providers. The Company
believes that directing injured workers to appropriate health care
providersAs of September 30, 2006, we averaged approximately 62 open indemnity claims per FCM, which we believe is a vital part of its workers' compensation managed care
program. The Company believes that it is able to arrange for high
quality, cost-effective health care services to injured workers due to
its experience with managing claims involving severe injuries ofsignificantly less than the types most often suffered by its clients' employees and its
relationships with health care providers within the regional and local
markets it serves. Certain states permit the Company to require injured
workers to utilize Company-recommended health care providers and
facilities. Even in states in which the injured employee is permitted to
choose a health care provider, the Company believes that it is generally
successful in encouraging injured workers to use Company-recommended
providers and facilities, allowing the Company to more effectively
manage health care.
- Pursue Growth Opportunities. The Company intends to grow internally and
through acquisitions. Internal growth is expected to result from both
greater penetration of existing markets and expansion into new markets
through targeting employers in geographic areas and hazardous occupation
industries that the Company does not presently serve. The Company
currently provides products and services in 16 states and expects to
target its expansion to additional states in which it is authorized to
provide workers' compensation products and services. In addition, due to
the fragmented nature of the workers' compensation market, the Company
believes that there are a significant number of smaller, traditional
workers' compensation insurers or books of indemnity business that the
Company could acquire and convert to its managed results approach. The
Company's proceeds from this Offering will provide substantial
additional capital that will allow the Company to more rapidly expand
its business. However, while there can be no assurances, the Company
plans to manage its growth in a manner intended to maintain its "A"
(Excellent) rating from A.M. Best Company, Inc. See "-- A.M. Best
Rating" below.
OPERATIONS
The Company's managed results approach employs an operating process
designed to improve workplace safety and thereby reduce work-related injuries,
and, when an injury does occur, to provide for prompt medical intervention,
integrated claims management and effective medical care management. The
Company's managed care approach directs injured workers to appropriate health
care providers and facilities. The Company is divided into multidisciplinary
geographic service teams which concentrate on providing managed workers'
compensation services and products within assigned regions of the Company's
market territory. These
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teams actively enlist employers, employees and health care providers in the
common goal of rapid return-to-work in as care-effective and cost-efficient a
manner as possible.
The components of the Company's managed results approach include:
Improve Workplace Safety. Preventing work-related injuries is a key element
of the Company's managed results approach. In most cases, before offering the
Company's managed results products and services to a potential new client, a
Company safety professional will visit the potential client's place of business
to assess the existing safety programs and workplace practices. Company
representatives also assess the employer's attitude toward workplace safety and
toward creating, improving and maintaining a safe work environment. The safety
professional will prepare a written report to assist the underwriter in
evaluating the risk and pricing it appropriately. In certain circumstances, the
Company will agree to provide workers' compensation products and services only
if the employer agrees to implement and maintain specific safety
recommendations.
The Company employs 29 safety professionals throughout its market
territory. Many of these individuals were previously employed in logging or
other hazardous occupation industries and use their personal experience and
expertise in these industries to better assess the safety risks associated with
a client's operations. These individuals also use their knowledge of the
specific hazards associated with these hazardous occupation industries to assist
employers in designing safety and injury prevention programs and to provide
information about the industries to assist in the Company's underwriting
process. After identifying a client's specific safety risks, the Company's
safety professionals work with the client to minimize these risks and reduce
accidents through monitoring the client's safety programs. Each of the Company's
safety professionals is required to pursue professional development programs
leading to specific certifications or designations, and to participate in
Company-sponsored periodic training in OSHA and DOT regulations and guidelines.
The Company also publishes a periodic logging-specific safety and industry newsletter titled "The Timberleaf" which is distributed to more than 3,000
clients, potential clients, facilitators, mill managers and paper and lumber
industry executives. Company safety professionals also participate in state
forestry association sponsored logging safety councils, write safety articles
published in industry periodicals, and work as members of the American Pulpwood
Association's various safety committees.
After accepting a client, the Company continues to emphasize workplace
safety by making periodic, and sometimes unannounced, visits to the
client-employer's workplace. All serious injuries are investigated by a Company
representative to determine whether steps can be taken to avoid similar
accidents. The Company monitors the activity of its safety professionals in
order to assure that appropriate safety services are available to each
client-employer.
Prompt Medical Intervention. Managing a claim from the earliest possible
time is critical in minimizing its ultimate cost. A 1994 industry study
indicates that claims reported between 11 and 20 days after the date of injury
cost an average of 29% more than claims reported 1 to 10 days after the date of
injury, and that the difference escalated to an average of an additional 48% if
the claim was reported more than 30 days after the injury occurred. To ensure
early intervention in the claims process, the Company encourages immediate
notification from the employer of all injuries and provides the employer with
24-hour toll-free assistance or direct contact with the Company's designated
service representative.
Promptly upon receiving notification of an injury, a claims representative
contacts the employer, the injured employee and/or the treating physician to
determine the nature and severity of the injury. The claims representative acts
as a facilitator to assure that the injured employee receives an appropriate
medical treatment plan and to encourage the use of Company-recommended health
care providers and facilities. The Company believes that this personal, direct
contact approach reduces the overall cost of medical care, results in the
injured worker returning to work more quickly and lessens the likelihood of
litigation and fraudulent claims. In cases involving a serious or complex
injury, the Company provides comprehensive field case management to address both
the ongoing medical needs of the injured employee as well as the economic and
social issues facing the employee and the employee's family. These professionals
establish ongoing communication with an injured employee, often at the initial
treatment, help coordinate care with the attending physicians and the health
care facilities, assist with paperwork and provide ongoing advice to both the
injured
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worker and the employee's family, with the goal of increasing satisfaction
through prompt, responsive service and a demonstrated concern for the injured
employee's well-being.
Because the Company's managed results approach emphasizes direct, personal
contact between the designated claims representative and the injured employee
and his employer, the Company limits the number of active cases for which any
single claims representative is responsible. With a lower case load, each claims
representative can better focus on the injured employee and access the medical,
rehabilitative and social services that are best suited for the specific
individual.
The Company's claims representatives are located in the geographic area in
which their designated employer-clients are based. By locating its claims
representativesaverage.
Locating our FCMs in the field the Company derives additional benefits from the
fact that its representativesalso allows us to build professional relationships with local health
care providers. When expanding into a new geographic market, the Company seeks
to hire experienced claims representatives who have established professional
contacts with local health care providers and who demonstrate the attitude and
ability to enhance the Company's managed results approach.
Direct Injured Workers to Appropriate Health Care Providers. The Company
believes effective managed care depends largely upon the selection of
appropriate health care providers and ongoing review to ensure that medical care
is being delivered in a cost-effective manner. The Company seeks to select and
develop relationships with health care providers in each of the regional and
local markets in which the Company's employer-clients operate. Emphasis is
placed on implementing the most expeditious and cost-effective managed care
treatment programs for each employer rather than imposing a single standardized
system on all employers and their employees.
The Company has established relationships with local and regional health
care providers and facilities ranging from individual physicians to fully
integrated occupational health care networks. In certain circumstances, these
relationships are evidenced by formal contracts; in many cases the arrangements
are more informal. The Company believes that its personal approach to managed
care depends upon selecting a well-qualified, local source of medical care,
regardless of any affiliation with existing networks. When entering a market,
the Company seeks to enter into strategic relationships with local and regional
medical care providers. In selecting its medical care providers, the Company
relies,we rely, in part, on the recommendations of its claims representativesour FCMs who have developed professional relationships within their geographic areas. The CompanyWe also seeksseek input from the employersour policyholders and other contacts in the market in which it
intends to provide services.markets that we serve. While cost factors are considered in selecting health caremedical providers, we consider the Company considersmost important factor in the ability ofselection process to be the health care
providermedical provider’s ability to achieve a "quality outcome" -- definedquality outcome. We define quality outcome as the injured worker’s rapid, conclusive recovery and return to sustained, full capacity employment by the injured worker -- as
the most important factor in the selection process.
The Company's claims representatives maintain primary responsibility for
managing the entire claim from occurrence through resolution and are given
significant responsibility and authority to ensure the most effective,
cost-efficient resolution of claims that will enable the employee to return to
work as promptly as practicable. Each claims representative has the authority to
retain at the Company's expense independent nurse case managers, independent
medical examiners, vocational and rehabilitation specialists or other specialty
providers of medical services necessary to achieve the quality outcome desired
by the Company. In addition to retaining independent service providers required
for a particular injured worker, the claims representative works to reinforce
the Company's managed results approach by utilizing existing arrangements that
have been established by the Company to meet the needs of employer-clients
within a particular geographic market. The Company provides its claims
representatives with cars or car allowances, personal computers, cellular
phones, facsimile machines, pagers and a full range of additional administrative
and technical support to assist them with the prompt, efficient resolution of
employee claims.
The Company generally requires pre-certification to determine the medical
necessity and appropriateness of non-acute medical treatment before it is
provided to an injured worker. The Company also conducts fee schedule and
medical bill reviews to ensure that it has been billed appropriately for the
approved services, to prevent over-utilization of medical services and to detect
variances from agreed-upon fee schedules, unbundling of charges and unnecessary
or unrelated charges. Because of the variance in regulatory schemes in
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the states in which the Company provides managed care products and services, the
Company also contracts with medical bill review specialists in certain of the
markets in which it operates.
Dispute and Litigation Management. Through early intervention and its
personal claims management approach, the Company seeks to limit the number of
disputes with injured workers. The Company's primary goal is rapid, conclusive
recovery and return to sustained, full capacity employment by the injured
worker. The personal presence of the Company's claims representative throughout
this process permits an evaluation of the injured employee's psychological
propensity to return to work, to retain counsel and litigate, or, as an
alternative, to reasonably settle any disputes with the Company without
litigation. The Company believes that the personal presence of the claims
representative also enhances the Company's ability to guide the injured employee
to the appropriate conclusion in a friendly, dignified, supportive manner and
diminishes the injured employee's desire toemployment.
While we seek larger settlement amounts than
would be the case if the Company was perceived by the injured employee to be
adversarial or hostile toward the employee's individual situation. The Company
seeks to promptly settle valid claims; however, itclaims, we also aggressively defendsdefend against what it considersclaims we consider to be non-meritorious claims.non-meritorious. Litigation expenses accounted for less than 5.4% of our gross claims and claim settlement expenses in 2005 and for the nine months ended September 30, 2006. As of March 31, 1996, the
CompanySeptember 30, 2006, we had closed approximately 98%91.5% of its pre-1995our 2004 reported claims and 86%approximately 99.0% of its 1995our pre-2004 reported claims, thereby substantially reducing the risk of future adverse claims development. OverWhere possible, we purchase annuities on longer life claims to close the last several years, certain states have adopted regulations better
enabling workers' compensation providersclaim while still providing an appropriate level of benefits to actively investigate and pursue
allegedly fraudulent claims. The Company believes that its claim
representatives' physical presence, and direct face-to-face contact with its
employer-clients andan injured workers, better enables it to uncover fraudulent
claims.
PRODUCTS AND SERVICES
Workers' Compensation Managed Care Products. The Company's products and
rating plans encompassemployee. We also mitigate against potential losses from improper premium reporting or delinquent premium payment by collecting from the policyholder a continuumdeposit, typically representing 15% of options designed to fittotal premium, at the needs of its
client-employers. The most basic product, accounting for approximately 97.0%inception of the Company's premiums in force at March 31, 1996,policy, which deposit can be utilized to offset losses from inadequate premium submissions.
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Premium Audits
We conduct premium audits on all of our voluntary business policyholders annually, upon the expiration of each policy, including when the policy is a guaranteed cost
contract, in whichrenewed. The purpose of these audits is to verify that policyholders have accurately reported their payroll expenses and employee job classifications, and therefore have paid us the premium required under the terms of their policies. In addition to annual audits, we selectively perform interim audits on certain classes of business if significant or unusual claims are filed or if the monthly reports submitted by a policyholder reflect a payroll pattern or any aberrations that cause underwriting, safety or fraud concerns.
Loss Reserves
We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at a given point in time. In establishing our reserves, we do not use loss discounting, which involves recognizing the time value of money and offsetting estimates of future payments by future expected investment income. Our process and methodology for estimating reserves applies to both our voluntary and assigned risk business and does not include our reserves for mandatory pooling arrangements. We record reserves for mandatory pooling arrangements as those reserves are reported to us by the pool administrators. We use a consulting actuary to assist in the evaluation of the adequacy of our reserves for loss and loss adjustment expenses.
When a claim is setreported, we establish an initial case reserve for the estimated amount of our loss based on our estimate of the most likely outcome of the claim at that time. Generally, a case reserve is established within 14 days after the claim is reported and consists of anticipated medical costs, indemnity costs and specific adjustment expenses, which we refer to as defense and cost containment expenses, or DCC expenses. At any point in advance and changes onlytime, the amount paid on a claim, plus the reserve for future amounts to be paid, represents the estimated total cost of the claim, or the case incurred amount. The estimated amount of loss for a reported claim is based upon various factors, including:
| • | type of loss; | |
| • | severity of the injury or damage; | |
| • | age and occupation of the injured employee; | |
| • | estimated length of temporary disability; | |
| • | anticipated permanent disability; | |
| • | expected medical procedures, costs and duration; | |
| • | our knowledge of the circumstances surrounding the claim; | |
| • | insurance policy provisions, including coverage, related to the claim; | |
| • | jurisdiction of the occurrence; and | |
| • | other benefits defined by applicable statute. |
The case incurred amount can vary due to uncertainties with respect to medical treatment and outcome, length and degree of disability, employment availability and wage levels and judicial determinations. As changes occur, the case incurred amount is adjusted. The initial estimate of the case incurred amount can vary significantly from the amount ultimately paid, especially in circumstances involving severe injuries with comprehensive medical treatment. Changes in case incurred amounts, or case development, is an important component of our historical claim data.
In addition to case reserves, we establish reserves on an aggregate basis for loss and DCC expenses that have been incurred but not reported, or IBNR. Our IBNR reserves are also intended to provide for aggregate
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changes in the client's operations or payroll. In return, the Company agrees to
assume statutorily imposed obligations of the client-employer to provide
workers' compensation benefits to its employees. The premium for these policies
varies depending upon the type of work performed by each employee and the
general business of the insured. An employer large enough to qualify, typically
those paying more than $5,000 in annual premium, will have its premium based on
its loss experience relative to its peers as determined over a three-year
period. This loss experience is adjusted by the type of business and associated
risks. A client who desires to assume a certain amount of financial risk may
elect a deductible which makes the client responsible for the first portion of
any claim. In exchange for the deductible election, the employer receives a
premium reduction. The Company also offers several loss sensitive plans
(retrospective rating plans and dividend plans) which determine the final
premium paid for the current policy period based on the insured's losses during
that same period.
TPA and Claims Adjustment Services. The Company has historically provided
both independent claims adjusting services and third party administration
("TPA") services in Louisiana and Texas. These services include independent
adjusting in multiple lines of coverage. Additionally, the Company provides
third-party administration services. Current plans involve the expansion of
existing servicescase incurred amounts as well as the deliveryunpaid cost of workers' compensationrecently reported claims for which an initial case reserve has not been established.
The third component of our reserves for loss and employee
benefits, third-party administration, provider networks, medicalloss adjustment expenses is our adjusting and other reserve, or AO reserve. Our AO reserve is established for the costs of future unallocated loss adjustment expenses for all known and unknown claims. Our AO reserve covers primarily the estimated cost of administering claims. The final component of our reserves for loss and loss adjustment expenses is the reserve for mandatory pooling arrangements.
In establishing reserves, we rely on the analysis of our more than 145,000 claims in our20-year history. Using statistical analyses and actuarial methods, we estimate reserves based on historical patterns of case management, medical billdevelopment, payment patterns, mix of business, premium rates charged, case reserving adequacy, operational changes, adjustment philosophy and severity and duration trends.
We review loss prevention programs, occupational health
programs, risk management consulting, alternative dispute resolutionour reserves by industry and risk
financing consulting. The Company presently offers its servicesstate on a negotiated
fee-for-servicequarterly basis. Individual open claims are reviewed more frequently by our field case managers and adjustments to case incurred amounts are made based on expected outcomes. The number of claims reported or occurring during a period, combined with a calculation of average case incurred amounts, and measured over time, provide the foundation for our reserve estimates. In establishing our reserve estimates, we use historical trends in claim reporting timeliness, frequency of claims in relation to earned premium or covered payroll, premium rate levels charged and case development patterns. However, the number of variables and judgments involved in establishing reserve estimates, combined with some random variation in loss development patterns, results in uncertainty regarding projected ultimate losses. As a result, our ultimate liability for loss and loss adjustment expenses may be more or less than our reserve estimate.
Our analysis of our historical data provides the factors we use in our statistical and actuarial analysis in estimating our loss and DCC expense reserve. These servicesfactors are typically rendered to self-insured
businesses,primarily measures over time of claims reported, average case incurred amounts, case development, duration, severity and payment patterns. However, these factors cannot be directly used as these factors do not take into consideration changes in business mix, claims management, regulatory issues, medical trends, employment and wage patterns and other insurance companies, trade associationssubjective factors. We use this combination of factors and governmental
entities.
Other Products. In addition to providing workers' compensation products and
services,subjective assumptions in the Company presently offers certain of its workers' compensation
clients general liability coverage. In addition, oneuse of the Company's
subsidiaries has traditionally provided automobile liabilityfollowing six actuarial methodologies:
| • | Paid Development Method—uses historical, cumulative paid losses by accident year and develops those actual losses to estimated ultimate losses based upon the assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous to prior years. | |
| • | Paid Cape Cod Method—multiplies estimated ultimate claims for each accident year by a weighted average, trended severity. The estimated ultimate claims used in this method are based on paid claim count development. The selected severity for a given accident year is then derived by giving some weight to all of the accident years in the experience history rather than treating each accident year independently. | |
| • | Paid Bornhuetter-Ferguson (“BF”) Method—a combination of the Paid Development Method and the Paid Cape Cod Method, the Paid BF Method estimates ultimate losses by adding actual paid losses and projected, future unpaid losses. The amounts produced are then added to cumulative paid losses to produce the final estimates of ultimate incurred losses. | |
| • | Incurred Development Method—uses historical, cumulative incurred losses by accident year and develops those actual losses to estimated ultimate losses based upon the assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous to prior years. | |
| • | Incurred Cape Cod Method—multiplies estimated ultimate claims for each accident year by a weighted average, trended severity. The estimated ultimate claims used in this method are based on incurred claim count development. The selected severity for a given accident year is then derived by giving some weight to all of the accident years in the experience history rather than treating each accident year independently. |
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| • | Incurred Bornhuetter-Ferguson Method—a combination of the Incurred Development Method and the Incurred Cape Cod Method, the Incurred BF Method estimates ultimate losses by adding actual incurred losses and projected, future unreported losses. The amounts produced are then added to cumulative incurred losses to produce an estimate of ultimate incurred losses. |
For each method, we calculate the amount of our total loss and property
insurance coverage in two states. The Company also utilizes this subsidiaryDCC expenses that we estimate will ultimately be paid by our reinsurers, which is subtracted from our total gross reserve to file alternative workers' compensation rate structures in certain states in
order to permitproduce our total net reserve. We then analyze the Company to offer its workers' compensation productsresults and services to a
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broader range of potential clients. For the three months ended March 31, 1996,
general liability and automobile coverage respectively accounted for 3.2% and
2.6% of the Company's gross premiums earned. In 1995, general liability and
automobile coverage respectively accounted for 3.7% and 4.7% of the Company's
gross premiums earned.
CLIENTS
Since it began operations in 1986, the Company has marketed its workers'
compensation products and services to employers whose employees are engaged in
hazardous occupations, and as a result, pay substantially higher than average
workers' compensation rates. From 1986 through 1993, substantiallymay emphasize or deemphasize some or all of the Company's clients were employers engagedoutcomes to reflect our judgment of their reasonableness in relation to supplementary information and operational and industry changes. These outcomes are then aggregated to produce a single weighted average point estimate that is the logging industry. Beginningbase estimate for net loss and DCC expense reserves.
In determining the level of emphasis that may be placed on some or all of the methods, we review statistical information as to which methods are most appropriate, whether adjustments are appropriate within the particular methods, and if results produced by each method include inherent bias reflecting operational and industry changes. This supplementary information may include:
| • | open and closed claim counts; | |
| • | statistics related to open and closed claim count percentages; | |
| • | claim closure rates; | |
| • | changes in average case reserves and average loss and loss adjustment expenses incurred on open claims; | |
| • | reported and ultimate average case incurred changes; | |
| • | reported and projected ultimate loss ratios; and | |
| • | loss payment patterns. |
In establishing our AO reserves, we review our past adjustment expenses in 1994,relation to paid claims and estimated future costs based on expected claims activity and duration.
The sum of our net loss and DCC expense reserve, our AO reserve and our reserve for mandatory pooling arrangements is our total net reserve for loss and loss adjustment expenses.
As of December 31, 2005, our best estimate of our ultimate liability for loss and loss adjustment expenses, net of amounts recoverable from reinsurers, was $364.3 million, which includes $9.5 million in reserves for mandatory pooling arrangements as reported by the Company beganpool administrators. This estimate was derived from the process and methodology described above which relies on substantial judgment. There is inherent uncertainty in estimating our reserves for loss and loss adjustment expenses. It is possible that our actual loss and loss adjustment expenses incurred may vary significantly from our estimates.
As noted above, our reserve estimate is developed based upon our analysis of our historical data, and factors derived from that data, including claims reported, average claim amount incurred, case development, duration, severity and payment patterns, as well as subjective assumptions. We view our estimate of loss and DCC expenses as the most significant component of our reserve for loss and loss adjustment expenses.
We prepared a sensitivity analysis of our net loss and DCC expense reserve as of December 31, 2005 by analyzing the effect of reasonably likely changes to expand its clientthe assumptions used in deriving our estimates. Since the base by employersestimate for our net loss and DCC expense reserve is derived from the outcomes of the six actuarial methodologies discussed above, the most significant assumption in other
hazardous occupation industries, such as general contracting, trucking,establishing our reserve is the adjustment of and oilemphasis on those methods that we believe are most appropriate.
Of the six actuarial methods we use, three are “incurred” methods and gas.three are “paid” methods. The selected development factors within each method are derived from our data and the design characteristics of the particular method. The six different methods each have inherent biases in their respective designs that are more or less predictive in their use. “Incurred” methods rely on historical development factors derived from
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changes in our incurred estimates of claims paid and reserve amounts over time, while “paid” methods focus on our claim payment patterns and ultimate paid costs. “Incurred” methods focus on the measurement of the adequacy of case reserves at points in time. As a result, if reserving practices change over time, the “incurred” methods may produce significant variation in the estimates of ultimate losses. “Paid” methods rely on actual claims payment patterns and therefore are not sensitive to changes in reserving practices.
The low end of the Company's expansion efforts, gross premiums earned
from these other industries increased from approximately $550,000 in 1994 to
approximately $16.9 million in 1995, accounting for approximately 1.1%range of our sensitivity analysis was derived by placing more emphasis (63%) on the outcomes generated by the three “paid” methods and 25.3%less emphasis (37%) on the outcomes generated by the three “incurred” methods. The high end of the Company's earned premiumsrange was derived by placing more emphasis (63%) on the outcomes generated by the three “incurred” methods and less emphasis (37%) on the outcomes generated by the three “paid” methods. We believe that changing the emphasis on the “incurred” and “paid” methods better reflects reasonably likely outcomes than adjusting selected development factors or other variables used within each method. We believe the results of this sensitivity analysis, which are summarized in 1994the table below, constitute a reasonable range of the expected outcomes of our reserve for net loss and 1995, respectively. Gross premiums
earnedDCC expenses.
| As of December 31, 2005 | ||||||||||||||||
| Mandatory | ||||||||||||||||
| Loss and | Pooling | |||||||||||||||
| DCC Expenses | AO | Arrangements | Total | |||||||||||||
| (In thousands) | ||||||||||||||||
| Low end of range | $ | 310,400 | $ | 16,533 | $ | 9,513 | $ | 336,446 | ||||||||
| Net reserve | 338,207 | 16,533 | 9,513 | 364,253 | ||||||||||||
| High end of range | 350,191 | 16,533 | 9,513 | 376,237 | ||||||||||||
The resulting range derived from this sensitivity analysis would have increased net reserves by $12.0 million or decreased net reserves by $27.8 million, at December 31, 2005. The increase would have reduced net income and stockholders’ equity by $7.8 million. The decrease would have increased net income and stockholders’ equity by $18.1 million. A change in our net loss and DCC expense reserve would not have an immediate impact on our liquidity, but would affect cash flow in future periods as the losses are paid.
Given the numerous factors and assumptions used in our estimate of reserves, and consequently this sensitivity analysis, we do not believe that it would be meaningful to provide more detailed disclosure regarding specific factors and assumptions and the individual effects of these other industriesfactors and assumptions on our net reserves. Furthermore, there is no precise method for subsequently evaluating the impact of any specific factor or assumption on the adequacy of reserves, because the eventual deficiency or redundancy is affected by multiple interdependent factors.
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Reconciliation of Loss Reserves
The table below shows the reconciliation of loss reserves on a gross and net basis for the periodnine months ended MarchSeptember 30, 2006 and the years ended December 31, 19962005, 2004 and 2003, reflecting changes in losses incurred and paid losses.
| Nine Months | Year Ended December 31, | |||||||||||||||
| Ended | | | | |||||||||||||
| September 30, 2006 | 2005 | 2004 | 2003 | |||||||||||||
| (In thousands) | ||||||||||||||||
| Balance, beginning of period | $ | 484,485 | $ | 432,880 | $ | 377,559 | $ | 346,542 | ||||||||
| Less amounts recoverable from reinsurers on unpaid loss and loss adjustment expenses | 120,232 | 189,624 | 194,558 | 193,634 | ||||||||||||
| Net balance, beginning of period | 364,253 | 243,256 | 183,001 | 152,908 | ||||||||||||
| Add incurred related to: | ||||||||||||||||
| Current year | 149,989 | 182,174 | 160,773 | 126,977 | ||||||||||||
| Prior years | — | 8,673 | 13,413 | 2,273 | ||||||||||||
| Loss on Converium commutation | — | 13,209 | — | — | ||||||||||||
| Total incurred | 149,989 | 204,056 | 174,186 | 129,250 | ||||||||||||
| Less paid related to: | ||||||||||||||||
| Current year | 23,701 | 42,545 | 40,312 | 32,649 | ||||||||||||
| Prior years | 89,720 | 96,620 | 73,619 | 66,508 | ||||||||||||
| Total paid | 113,421 | 139,165 | 113,931 | 99,157 | ||||||||||||
| Add effect of Converium commutation(1) | — | 56,106 | — | — | ||||||||||||
| Net balance, end of period | 400,821 | 364,253 | 243,256 | 183,001 | ||||||||||||
| Add amounts recoverable from reinsurers on unpaid loss and loss adjustment expenses | 120,022 | 120,232 | 189,624 | 194,558 | ||||||||||||
| Balance, end of period | $ | 520,843 | $ | 484,485 | $ | 432,880 | $ | 377,559 | ||||||||
| (1) | The total payment from Converium was $61.3 million, of which $56.1 million was for ceded reserves and $5.2 million was for paid recoverables as of June 30, 2005. |
Our gross reserves for loss and loss adjustment expenses were approximately $6.3$520.8 million accounting for approximately 36.9% of the Company's
earned premiums.
Because the Company focuses on potential clients in selected industries, it
believes it has developed expertise in assessing not only the risks associated
with those industries, but also the operating practices of individual employers.
A substantial majority of the Company's safety professionals and claims
representatives have educational backgrounds and/or prior work experience in
safety-related fields or in the businesses in which the Company's clients
operate. The Company believes that this knowledge of its clients' businesses
provides it with the ability to better evaluate the profit opportunities of
providing its managed results services. In addition, the Company's employees
evaluate the employer's attitude toward maintaining and improving workplace
safety as well as the employer's willingness to partner with the Company in its
managed results approach to providing solutions to the employer's workers'
compensation needs.
The Company provided workers' compensation services and products to
approximately 2,900 employers as of March 31, 1996. ForSeptember 30, 2006 are expected to cover all unpaid loss and loss adjustment expenses as of that date. As of September 30, 2006, we had 6,170 open claims, with an average of $84,415 in unpaid loss and loss adjustment expenses per open claim. During the threenine months ended MarchSeptember 30, 2006, 5,385 new claims were reported, and 5,270 claims were closed.
As of December 31, 1996, approximately 7.7%2005, our gross reserves for loss and loss adjustment expenses were $484.5 million. The increase in our reserves from December 31, 2005 to September 30, 2006 was due to our premium growth during this time period. As of the Company's gross premiums earned were
derived from state residual market programs and clients assigned to the Company
through assigned risk pools. See "-- Regulation -- Participation in State
Residual Market Programs" below. The average client, excluding clients in
assigned-risk pools, hasDecember 31, 2005, we had 6,055 open claims, with an average annual premium of approximately $30,000.$80,014 in unpaid loss and loss adjustment expenses per open claim. During the year ended December 31, 1995, the Company's ten largest clients
accounted for approximately 5.1% of its premiums in force. Approximately 90.0%
of the policies scheduled to expire in 19952005, 7,073 new claims were renewed by the Company's
clients, while approximately 84.0% of the policies scheduled to expire in 1994reported, and 6,702 claims were renewed by the Company's clients.
SALES AND MARKETING
closed.
As of MarchDecember 31, 1996, the Company's workers' compensation products2004, our gross reserves for loss and servicesloss adjustment expenses were sold both through 20 direct agents employed$432.9 million. The increase in our reserves from December 31, 2004 to December 31, 2005 was due to our premium growth during this time period, which was offset by the Companyan increase in loss and 188
independent agents. Mostloss adjustment expenses related to prior years. As of the Company's direct agents either have degreesDecember 31, 2004, we had 5,684 open claims, with an average of $76,158 in forestry or have worked extensively in the forestry industry. Similar to the
Company's safety professionalsunpaid loss and claims representatives, direct agents live in
their assigned territories throughout the United States. The Company's direct
agents receive competitive salaries, commissions and a bonus based on the
profitability to the Company of their assigned client-employers. Although most
of the Company's products and services are sold through direct agents,
independent agents are also utilized in some areas, and are selected based upon
their proven expertise in industries targeted by the Company.
Forloss adjustment expenses per open claim. During the year ended December 31, 2004, 7,015 new claims were reported, and 7,086 claims were closed.
As of December 31, 2003, our gross reserves for loss and loss adjustment expenses were $377.6 million. The increase in our reserves from December 31, 2003 to December 31, 2004 was due to our premium growth during this time period and an increase in our reserves for prior accident years from $2.3 million in 2003 to $13.4 million in 2004. The increase for prior accident years related primarily to the 2002 accident year, which increased by $9.4 million as a result of claim settlements in excess of our established case reserves and
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increased estimates in our reserves for that accident year. As of December 31, 2003, we had 5,755 open claims, with an average of $65,605 in unpaid loss and loss adjustment expenses per open claim. During the year ended December 31, 2003, 6,433 new claims were reported and 7,566 claims were closed.
Loss Development
The table below shows the net loss development for business written each year from 1995 through 2005. The table reflects the changes in our loss and loss adjustment expense reserves in subsequent years from the prior loss estimates based on experience as of the end of each succeeding year on a GAAP basis.
The first line of the table shows, for the threeyears indicated, our liability including the incurred but not reported loss and loss adjustment expenses as originally estimated, net of amounts recoverable from reinsurers. For example, as of December 31, 1996, it was estimated that $44.0 million would be sufficient to settle all claims not already settled that had occurred on or prior to December 31, 1996, whether reported or unreported. The next section of the table sets forth the re-estimates in later years of incurred losses, including payments, for the years indicated. The next section of the table shows, by year, the cumulative amounts of loss and loss adjustment expense payments, net of amounts recoverable from reinsurers, as of the end of each succeeding year. For example, with respect to the net loss reserves of $44.0 million as of December 31, 1996, by December 31, 2005 (nine years later) $35.9 million had actually been paid in settlement of the claims that relate to liabilities as of December 31, 1996.
The “cumulative redundancy/(deficiency)” represents, as of December 31, 2005, the difference between the latest re-estimated liability and the amounts as originally estimated. A redundancy means that the original estimate was higher than the current estimate. A deficiency means that the current estimate is higher than the original estimate.
Analysis of Loss and Loss Adjustment Expense Reserve Development
| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||
| 1995 | 1996 | 1997 | 1998 | 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | ||||||||||||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||||||||||||||||||
| Reserve for loss and loss adjustment expenses, net of reinsurance recoverables | $ | 43,299 | $ | 43,952 | $ | 55,096 | $ | 43,625 | $ | 72,599 | $ | 86,192 | $ | 119,020 | $ | 152,908 | $ | 183,001 | $ | 243,256 | $ | 364,253 | ||||||||||||||||||||||
| Net reserve estimated as of: | ||||||||||||||||||||||||||||||||||||||||||||
| One year later | 36,613 | 35,447 | 54,036 | 49,098 | 75,588 | 96,801 | 123,413 | 155,683 | 196,955 | 265,138 | ||||||||||||||||||||||||||||||||||
| Two years later | 29,332 | 34,082 | 60,800 | 50,764 | 82,633 | 98,871 | 116,291 | 168,410 | 217,836 | |||||||||||||||||||||||||||||||||||
| Three years later | 28,439 | 34,252 | 63,583 | 57,750 | 86,336 | 92,740 | 119,814 | 187,225 | ||||||||||||||||||||||||||||||||||||
| Four years later | 28,700 | 35,193 | 68,754 | 59,800 | 86,829 | 93,328 | 132,332 | |||||||||||||||||||||||||||||||||||||
| Five years later | 29,647 | 38,318 | 69,610 | 60,074 | 87,088 | 101,417 | ||||||||||||||||||||||||||||||||||||||
| Six years later | 31,524 | 38,339 | 70,865 | 61,297 | 90,156 | |||||||||||||||||||||||||||||||||||||||
| Seven years later | 31,185 | 39,459 | 70,684 | 61,578 | ||||||||||||||||||||||||||||||||||||||||
| Eight years later | 32,161 | 38,888 | 70,577 | |||||||||||||||||||||||||||||||||||||||||
| Nine years later | 31,627 | 39,249 | ||||||||||||||||||||||||||||||||||||||||||
| Ten years later | 31,957 | |||||||||||||||||||||||||||||||||||||||||||
| Net cumulative redundancy (deficiency) | $ | 11,342 | $ | 4,703 | $ | (15,481 | ) | $ | (17,953 | ) | $ | (17,557 | ) | $ | (15,225 | ) | $ | (13,312 | ) | $ | (34,317 | ) | $ | (34,835 | ) | $ | (21,882 | ) | ||||||||||||||||
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| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||
| 1995 | 1996 | 1997 | 1998 | 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | ||||||||||||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||||||||||||||||||
| Cumulative amount of reserve paid, net of reserve recoveries, through: | ||||||||||||||||||||||||||||||||||||||||||||
| One year later | 17,716 | 19,143 | 35,005 | 26,140 | 45,095 | 51,470 | 51,114 | 66,545 | 73,783 | 40,514 | ||||||||||||||||||||||||||||||||||
| Two years later | 23,158 | 27,843 | 46,735 | 37,835 | 62,141 | 62,969 | 71,582 | 101,907 | 65,752 | |||||||||||||||||||||||||||||||||||
| Three years later | 26,058 | 30,766 | 54,969 | 45,404 | 67,267 | 70,036 | 84,341 | 73,391 | ||||||||||||||||||||||||||||||||||||
| Four years later | 27,039 | 32,576 | 60,249 | 48,184 | 70,894 | 73,680 | 42,919 | |||||||||||||||||||||||||||||||||||||
| Five years later | 28,007 | 34,765 | 62,361 | 50,045 | 72,744 | 38,939 | ||||||||||||||||||||||||||||||||||||||
| Six years later | 29,394 | 35,313 | 64,296 | 50,831 | 58,809 | |||||||||||||||||||||||||||||||||||||||
| Seven years later | 29,603 | 36,367 | 64,659 | 51,863 | ||||||||||||||||||||||||||||||||||||||||
| Eight years later | 30,331 | 36,379 | 64,289 | |||||||||||||||||||||||||||||||||||||||||
| Nine years later | 30,242 | 35,870 | ||||||||||||||||||||||||||||||||||||||||||
| Ten years later | 29,745 | |||||||||||||||||||||||||||||||||||||||||||
| Net reserve—December 31 | $ | 43,299 | $ | 43,952 | $ | 55,096 | $ | 43,625 | $ | 72,599 | $ | 86,192 | $ | 119,020 | $ | 152,908 | $ | 183,001 | $ | 243,256 | $ | 364,253 | ||||||||||||||||||||||
| Reinsurance recoverables | 12,127 | 9,525 | 12,463 | 37,086 | 183,818 | 293,632 | 264,013 | 193,634 | 194,558 | 189,624 | 120,232 | |||||||||||||||||||||||||||||||||
| Gross reserve—December 31 | $ | 55,426 | $ | 53,477 | $ | 67,559 | $ | 80,711 | $ | 256,417 | $ | 379,824 | $ | 383,033 | $ | 346,542 | $ | 377,559 | $ | 432,880 | $ | 484,485 | ||||||||||||||||||||||
| Net re-estimated reserve | $ | 31,957 | $ | 39,249 | $ | 70,577 | $ | 61,578 | $ | 90,156 | $ | 101,417 | $ | 132,332 | $ | 187,225 | $ | 217,836 | $ | 265,138 | ||||||||||||||||||||||||
| Re-estimated reinsurance recoverables | 18,641 | 26,966 | 35,219 | 123,604 | 281,481 | 384,447 | 346,555 | 271,446 | 217,593 | 179,585 | ||||||||||||||||||||||||||||||||||
| Gross re-estimated reserve | $ | 50,598 | $ | 66,215 | $ | 105,796 | $ | 185,182 | $ | 371,637 | $ | 485,864 | $ | 478,887 | $ | 458,671 | $ | 435,429 | $ | 444,723 | ||||||||||||||||||||||||
| Gross cumulative redundancy (deficiency) | $ | 4,828 | $ | (12,738 | ) | $ | (38,237 | ) | $ | (104,471 | ) | $ | (115,220 | ) | $ | (106,040 | ) | $ | (95,854 | ) | $ | (112,129 | ) | $ | (57,870 | ) | $ | (11,843 | ) | |||||||||||||||
Our net cumulative redundancy (deficiency) set forth in the table above is net of amounts recoverable from our reinsurers, including Reliance Insurance Company, one of our former reinsurers. In 2001, Reliance was placed under regulatory supervision by the Pennsylvania Insurance Department and was subsequently placed into liquidation. As a result, we recognized losses related to uncollectible amounts due from Reliance of $260,000 in 2004, $1.3 million in 2003, $2.0 million in 2002 and $17.0 million in 2001.
Investments
We derive net investment income from our invested assets. As of September 30, 2006, the carrying value of our investment portfolio, including cash and cash equivalents, was $639.6 million and the fair value of the portfolio was $633.7 million.
Our investment strategy is to maximize after tax income and total return on invested assets while maintaining high quality and low risk investments within the portfolio. We pay investment management fees based on the market value of assets under management. The investment committee of our board of directors has established investment guidelines and periodically reviews portfolio performance for compliance with our guidelines.
In 2006 we began a strategic review of our investment management and related policies. As a result of this review, we retained Prudential Investment Management, Inc., a registered investment advisory firm and a wholly owned indirect subsidiary of Prudential Financial, Inc., to manage our portfolio of fixed maturity securities effective as of November 1, 2006. We expect to retain a new equity portfolio manager in the fourth quarter. Prior to November 1, 2006, our investment portfolio was managed by Hibernia Asset Management, LLC.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Investment Portfolio” for further information on the composition and results of our investment portfolio.
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The table below shows the carrying values of various categories of securities held in our investment portfolio, the percentage of the total carrying value of our investment portfolio represented by each category and the annualized tax-equivalent yield for the nine months ended March
31, 1996, independent agents accounted for approximately 39.1% and 47.8%,
respectively,September 30, 2006 based on the carrying value of each category as of September 30, 2006:
| Annualized | ||||||||||||
| Percentage | Tax-Equivalent | |||||||||||
| Carrying Value | of Portfolio | Yield | ||||||||||
| (In thousands) | ||||||||||||
| Fixed maturity securities: | ||||||||||||
| State and political subdivisions | $ | 299,278 | 46.8% | 5.8% | ||||||||
| Mortgage-backed securities | 117,062 | 18.3% | 5.7% | |||||||||
| U.S. Treasury securities and obligations of U.S. Government agencies | 79,162 | 12.4% | 5.2% | |||||||||
| Corporate bonds | 22,700 | 3.5% | 5.6% | |||||||||
| Asset-backed securities | 5,884 | 0.9% | 5.4% | |||||||||
| Redeemable preferred stocks | 633 | 0.1% | 6.3% | |||||||||
| ; | ||||||||||||
| Total fixed maturity securities | 524,719 | 82.0% | ||||||||||
| Equity securities: | ||||||||||||
| Common stocks | 49,377 | 7.7% | 2.5% | |||||||||
| Nonredeemable preferred stocks | 3,679 | 0.6% | 6.3% | |||||||||
| Total equity securities | 53,056 | 8.3% | ||||||||||
| Cash and cash equivalents | 61,778 | 9.7% | 5.0% | |||||||||
| Total investments, including cash and cash equivalents | $ | 639,553 | 100.0% | |||||||||
As of September 30, 2006, our fixed maturity securities had a carrying value of $524.7 million, which represented 82.0% of the Company'scarrying value of our investments, including cash and cash equivalents. For the nine months ended September 30, 2006, the pre-tax investment yield of our investment portfolio was 4.0% per annum.
The gross premiums earned. No independent agent
accountedunrealized gains and losses on, and the cost and fair value of, our investment portfolio as of September 30, 2006 are summarized as follows:
| Cost or | Gross | Gross | ||||||||||||||
| Amortized | Unrealized | Unrealized | ||||||||||||||
| Cost | Gains | Losses | Fair Value | |||||||||||||
| (In thousands) | ||||||||||||||||
Fixed maturity securities,held-to-maturity | $ | 524,086 | $ | 3,952 | $ | (9,810 | ) | $ | 518,228 | |||||||
Fixed maturity securities,available-for-sale | 633 | — | — | 633 | ||||||||||||
Equity securities,available-for-sale | 47,874 | 5,182 | — | 53,056 | ||||||||||||
| Totals | $ | 572,593 | $ | 9,134 | $ | (9,810 | ) | $ | 571,917 | |||||||
The amortized cost for more than 5.0%the fixed maturity securities classified asheld-to-maturity includes an unamortized gain of approximately $5.1 million. This gain resulted in 2004 from the difference between each security’s par value and fair value at the date of transfer fromavailable-to-sale toheld-to-maturity and is being amortized as a yield adjustment over the respective security’s life.
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The table below summarizes the credit quality of our fixed maturity securities as of September 30, 2006, as rated by Standard and Poor’s.
| Percentage | ||||
| of Total | ||||
Credit Rating | Carrying Value | |||
| “AAA” | 86.6% | |||
| “AA” | 9.3% | |||
| “A” | 2.5% | |||
| “BBB” | 1.6% | |||
| Total | 100.0% | |||
As of September 30, 2006, the average composite rating of our fixed maturity securities was “AAA.”
The table below shows the composition of our fixed maturity securities by remaining time to maturity as of September 30, 2006. For securities that are redeemable at the option of the Company's gross premiums earned in either
period. In Mississippi,issuer and have a carrying value that is greater than par value, the Company has a contract with an independent general
agent who, in turn, has contractual arrangements with approximately 150
additional independent agents inmaturity used for the table below is the earliest redemption date. For securities that state. Forare redeemable at the three months ended March
31, 1996, approximately 2.3%option of the Company's earned premiums were generated by
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independent agents retained by this general agent. Althoughissuer and have a carrying value that is less than par value, the Company expects
this contract to continuematurity used for the foreseeable future,table below is the lossfinal maturity date.
| As of September 30, 2006 | ||||||||
Remaining Time to Maturity | Carrying Value | Percentage | ||||||
| (In thousands) | ||||||||
| Less than one year | $ | 22,031 | 4.2% | |||||
| One to five years | 221,744 | 42.3% | ||||||
| Five to ten years | 101,498 | 19.3% | ||||||
| More than ten years | 55,882 | 10.7% | ||||||
| Mortgage-backed securities | 116,975 | 22.3% | ||||||
| Asset-backed securities | 5,956 | 1.1% | ||||||
| Redeemable preferred stocks | 633 | 0.1% | ||||||
| Total | $ | 524,719 | 100.0% | |||||
The fixed maturity securities in our investment portfolio as of this general
agent contract would require the CompanySeptember 30, 2006 had an effective duration of 3.4 years.
Reinsurance
We purchase reinsurance to enter intoreduce our net liability on individual risks and claims and to protect against catastrophic losses. Reinsurance involves an arrangement with
another general agentinsurance company transferring to, or enter into arrangements with individual independent
agents in Mississippi.
A.M. BEST RATING
The Company is currently assignedceding, a group letter rating of "A" (Excellent)
from A.M. Best Company, Inc. ("A.M. Best"), the leading national insurance
rating agency. The Company was awarded an "A-" rating in 1991, its first year of
eligibility. The rating was raised to "A" in 1993. A.M. Best ratings are based
on a comparative analysis of the financial condition and operating performance
of insurance companies as determined by their publicly available reports and
meetings with the entities' officers. A.M. Best's ratings are based on factors
of concern to insureds and are not directed toward the protection of investors.
Furthermore, A.M. Best ratings are not ratings of any of the Company's
securities nor are such ratings a warranty of the Company's current or future
ability to meet its contractual obligations. A.M. Best ratings include Secure
Ratings, which consist of Superior (A++, A+), Excellent (A, A-) and Very Good
(B++, B+). A.M. Best also provides Vulnerable Ratings, which range from Adequate
(B, B-) to In Liquidation (F). The Company believes that its current A.M. Best
rating provides it with a competitive advantage over certain competitors because
certain potential clients will not purchase coverage from unrated or lower rated
companies and certain independent insurance agencies will not place coverage
with such companies. The Company presently intends to expand its business
through internal growth and acquisitions. However, while there can be no
assurances, the Company plans to manage its growth in a manner intended to
maintain its "A" (Excellent) rating. See "-- Strategy -- Pursue Growth
Opportunities" above.
REINSURANCE
Through reinsurance, the Company is able to transfer certain of the
financial risks of severe and catastrophic injury suffered by a client's
employee. The Company's reinsurance program includes a number of reinsurance
carriers, all of which have A.M. Best ratings of "A-" or better. The Company has
in effect specific "excess of loss" reinsurance agreements under which it pays
its reinsurers a percentage of gross premiums earned and whereby the reinsurers
agree to assume their allocated portion of the risks relating to claims over
$200,000exposure on a per occurrence basis uprisk to their limita reinsurer. The reinsurer assumes the exposure in return for a portion of liability.our premium. The Company carries multiplecost and limits of reinsurance agreements, each with a specific
limitwe purchase can vary from year to year based upon the availability of liabilityquality reinsurance at an acceptable price and our desired level of retention. Retention refers to the amount of risk that in the aggregate, provide protectionwe retain for each claims
occurrence up to $50,000,000our own account. Under excess of loss reinsurance, covered losses in excess of the Company's retention of $200,000.
As a resultlevel up to the limit of the Company's increased capitalization followingprogram are paid by the Offering,reinsurer. Our excess of loss reinsurance is written in layers, in which our reinsurers accept a band of coverage up to a specified amount. Any liability exceeding the Company intendslimit of the program reverts to increase its retentionus as the ceding company. Reinsurance does not legally discharge us from primary liability for the full amount due under these agreements upon their
renewal in July 1997. Exclusions relativeour policies. However, our reinsurers are obligated to indemnify us to the Company's managed workers'
compensation productsextent of the coverage provided in our reinsurance agreements.
We believe reinsurance is critical to our business. Our reinsurance purchasing strategy is to protect against unforeseenand/or catastrophic loss activity that would adversely impact our income and servicescapital base. We only select financially strong reinsurers with an A.M. Best rating of “A−” (Excellent) or better at the time we enter into a reinsurance contract. In addition, to minimize our exposure to significant losses from reinsurer
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insolvencies, we evaluate the financial condition of our reinsurers and monitor concentrations of credit risk. We do not purchase finite reinsurance.
2006 Excess of Loss Reinsurance Treaty Program
Effective January 1, 2006, we entered into a new excess of loss reinsurance treaty program related to our voluntary and assigned risk business that applies to losses incurred between January 1, 2006 and the date on which our reinsurance agreements are generallyterminated. Our reinsurance treaty program provides us with reinsurance coverage for each loss occurrence up to $30.0 million, subject to applicable deductibles, retentions and aggregate limits. However, for any loss occurrence involving only one person, our reinsurance coverage is limited to occupational disease
exposuresa maximum of $10.0 million, subject to applicable deductibles, retentions and aggregate limits. We currently have eleven reinsurers participating in our 2006 reinsurance treaty program. Under certain circumstances, including a downgrade of a reinsurer’s A.M. Best rating to “B++” (Very Good) or below, our reinsurers may be required to provide us with security for amounts due under the terms of our reinsurance program. This security may take the form of, among other things, cash advances or the issuance of letters of credit to us. If security is required because of a ratings downgrade, the form of security must be mutually agreed between the reinsurer and us.
Our 2006 reinsurance treaty program provides coverage in the following five layers:
| • | First Layer. Affords coverage for the first $2.0 million of each loss occurrence. We retain the first $1.0 million of each loss and are subject to an annual aggregate deductible of approximately $10.8 million for losses between $1.0 million and $2.0 million before our reinsurers are obligated to reimburse us. After the deductible is satisfied, we retain 25.0% of each loss between $1.0 million and $2.0 million. The aggregate limit for all claims under this layer is approximately $5.4 million. The annual aggregate deductible and aggregate limit are calculated as a percentage of subject premium. This layer also affords coverage for up to an aggregate of $1.0 million for certain losses caused by terrorism. | |
| • | Second Layer. Affords coverage up to $3.0 million for each loss occurrence in excess of $2.0 million. We are subject to an annual aggregate deductible of approximately $7.3 million for losses between $2.0 million and $5.0 million before our reinsurers are obligated to reimburse us. The annual aggregate deductible is calculated as a percentage of subject premium. This layer also affords coverage for up to an aggregate of $3.0 million for certain losses caused by terrorism. The aggregate limit to all claims under this layer is $39.0 million. | |
| • | Third Layer A. Affords coverage up to $5.0 million for each loss occurrence in excess of $5.0 million, with a limit of $5.0 million for any one person for workers’ compensation coverage. The aggregate limit for all claims under this layer is $10.0 million. | |
| • | Third Layer B. Affords coverage up to $5.0 million for any one person for each loss occurrence in excess of $5.0 million. We retain 20.0% of each loss between $5.0 million and $10.0 million. The aggregate limit for all claims under this layer is $10.0 million. | |
| • | Fourth Layer. Affords coverage up to $10.0 million for each loss occurrence in excess of $10.0 million. The aggregate limit for all claims under this layer is $20.0 million. | |
| • | Fifth Layer. Affords coverage up to $10.0 million for each loss occurrence in excess of $20.0 million. The aggregate limit for all claims under this layer is $20.0 million. |
The agreements under our 2006 reinsurance treaty program may be terminated by us or our reinsurers upon 90 days prior notice effective on any January 1. In addition, we may terminate the participation of one or more of our reinsurers under certain circumstances as permitted by the terms of our reinsurance agreements.
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The table below sets forth the reinsurers participating in our 2006 reinsurance program:
| A.M. Best | ||||
Reinsurer | Rating | |||
| Amlin Underwriting | A | |||
| Aspen Insurance UK | A | |||
| AXA Re | A | |||
| Brit Syndicates | A | |||
| Chubb Re/Federal Insurance Company | A++ | |||
| Hannover Re | A | |||
| IOA Re/Catlin Insurance Company | A | |||
| Liberty Syndicate | A | |||
| M.J. Harrington | A | |||
| Partner Reinsurance Company | A+ | |||
| Platinum Underwriters Reinsurance | A | |||
Due to the nature of reinsurance, we have receivables from reinsurers that apply to accident years prior to 2006. The table below summarizes our amounts recoverable from reinsurers as of September 30, 2006.
| A.M. Best | Amount Recoverable as | |||||||
Reinsurer | Rating | of September 30, 2006 | ||||||
| (In thousands) | ||||||||
| Munich Reinsurance America, Inc. | A | $ | 27,909 | |||||
| Odyssey America Reinsurance Company | A | 22,139 | ||||||
| St. Paul Fire and Marine Insurance Company | A+ | 12,265 | ||||||
| Clearwater Insurance Company | A | 11,611 | ||||||
| SCOR Reinsurance Company | A− | 8,217 | ||||||
| Converium Reinsurance (North America) | B− | 7,070 | ||||||
| Hannover Re(1) | A | 6,083 | ||||||
| Aspen Insurance UK(1) | A | 5,427 | ||||||
| Partner Reinsurance Company(1) | A+ | 3,689 | ||||||
| American National Insurance Company | A+ | 2,945 | ||||||
| Connecticut General Life Insurance Company | A− | 2,030 | ||||||
| Other (21 reinsurers) | — | 13,407 | ||||||
| Total | $ | 122,792 | ||||||
| (1) | Current participant in our 2006 reinsurance program. |
Terrorism Reinsurance
The Terrorism Risk Insurance Act of 2002 (the “2002 Act”) was enacted in response to the events of September 11, 2001 and has been extended by the Terrorism Risk Insurance Extension Act of 2005 (the “2005 Act”). Both the 2002 Act and the 2005 Act were designed to ensure the availability of insurance coverage for losses resulting from certain acts of terrorism in the United States. The 2005 Act continues a federal program established under the 2002 Act through the end of 2007. This program provides federal reimbursement to insurance companies for a portion of their losses arising from certain acts of terrorism and requires insurance companies to offer coverage for such acts. The program only applies to insured losses arising out of acts of terrorism committed on behalf of foreign persons or foreign interests that are certified as asbestosis, silicosis, brown lung“acts of terrorism” by the Secretary of the Treasury. In addition, the program does not provide any reimbursement for any portion of aggregate industry-wide insured losses from certified acts of terrorism that exceed $100.0 billion in any one year and black lung. The Company
reviewsis subject to certain other limitations and restrictions.
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For insured losses in 2006, each prospective client-employerinsurance company is responsible for a statutory deductible under the 2005 Act that is equal to assess17.5% of its direct earned property and casualty insurance premiums. For insured losses in 2007, this statutory deductible will increase to 20% of these premiums. For losses occurring in 2006, the potential exposurefederal government will reimburse 90% of an insurance company’s covered losses over the statutory deductible, but the amount of federal reimbursement will be decreased for acts of terrorism occurring in 2007 to 85% of covered losses over the deductible. In addition, no federal reimbursement is available unless the aggregate insurance industry-wide losses from a certified act of terrorism exceed $50.0 million for any act of terrorism occurring after March 31, 2006 and $100.0 million for any act of terrorism occurring in 2007. However, there is no relief from the requirement under the 2005 Act that insurance companies offer coverage for certified acts of terrorism if those acts do not cause losses exceeding these typesthreshold amounts and thus do not result in any federal reimbursement payments.
Under the 2005 Act, insurance companies must offer coverage for losses due to certified acts of excluded diseases beforeterrorism in all their commercial property and casualty policies, including workers’ compensation policies. Moreover, even in the Company's productsabsence of this federal law requirement, the workers’ compensation laws of the various states generally do not permit the exclusion of coverage for losses arising from acts of terrorism, including terrorism that involves the use of nuclear, biological or chemical agents. In addition, state law prohibits us from limiting our workers’ compensation insurance losses arising from any one catastrophe or any one claimant. We have reinsurance protection in our 2006 reinsurance treaty program that affords coverage for up to $28.0 million for losses arising from terrorism or nuclear, biological and services are
offered.
INFORMATION TECHNOLOGY AND COMMUNICATIONS SYSTEMS
The Company uses its proprietarychemical attacks, subject to the deductibles, retentions and otheraggregate limits.
Technology
We use our internally developed and purchased management information systems as an integral part of itsour operations and makesmake a substantial ongoing investment in improving itsour systems. The Company believes that the services it provides to
its clients and their employees are enhanced by integrating its information
systems to utilize more effectively the information it obtains in its
underwriting processes in conjunction with information regarding claims, billing
and claims management.
The Company's direct agents,We provide our field premium auditors, field safety professionals and claims
representatives are providedfield case managers with laptop computerscomputer and other communication equipment in order to more timely and efficiently complete the underwriting process,process. This technology also helps to facilitate communication and to report and monitor claims. For
example,All of our systems development and infrastructure operation and maintenance is performed by our information technology professionals, with limited assistance from outside vendors.
Core Systems
ICAMS. Our internally developed Insurance Claims and Accounting Management System, or ICAMS, is an application designed to support our workers’ compensation insurance business. ICAMS provides comprehensive rating, analysis, quotation, audit, claims, policy issuance and policy-level accounting transaction processes. By combining the Company'sinformation we obtain in our underwriting process with information on claims billing and claims management, we are able to enhance our services to our policyholders.
RealSafe. RealSafe is an internally developed application that supports our field safety professionals, have the ability to prepare survey
reports on-siteas well as safety, claims and immediately assist
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potential clients with the design of workplace safety programsunderwriting departments in our home office, by providing examplesrisk assessment and reporting of information to support safety plans implementedand loss control initiatives.
CLAIMExpert. CLAIMExpert is a purchased application utilized by our claims department to assist in work flow management. The application distributes all claims-related mail to the appropriate FCM. This application allows for the use of multiple cost containment vendors and routes our claims-related invoices. CLAIMExpert also serves as the file repository for claims-related mail and documents and is web accessible by our authorized users.
Document Management System. Our document management system is a purchased application currently being used by our underwriting, audit, finance and treasury departments to scan, index and store imaged documents to facilitate the movement of work items from one authority level to the next. The system will ultimately include all departments. The system allows departmental management to closely monitor and modify employee workloads as needed.
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Freedom Enterprise. FFS-Enterprise is a Fiserv product that functions as our general ledger and accounts payable systems using an MS SQL database platform. We also use Fiserv companion products for report writing, check printing and annual statement preparation. Transactions can be manually entered into Enterprise, interfaced via an ASCII file or copied and pasted from a spreadsheet application. Enterprise is currently set up to accept transaction detail by department, cost center, line of business and state. Enterprise also offers the capability of batch processing, which enables off-peak hour work.
Visual Audit. Visual Audit is a purchased application used by our field premium auditors to input information necessary to complete an interim or final premium audit.
Information Warehouse. Information Warehouse is an internally developed SQL Server-based set of OLAP cubes, queries and processes that extracts operational data from ICAMS and other employers in similar businesses.
COMPETITION
The marketof our applications and transforms that data for porting to Freedom Enterprise andfnet.
fnet. fnetis an internally developed data analysis portal.fnetis populated by our Information Warehouse, and used throughout our company to generate key performance statistics.
Operating Systems
We use Microsoft Active Directory services to provide managed care workers'application access, domain authentication and network services. Our server hardware is predominately Compaq/HP, but includes Dell servers as well. Our production servers are under manufacturer warranties.
Business Continuity/Disaster Recovery
Our Storage Area Network solution provides us with continuous operations using mirrored servers and storage situated in two separate corporate buildings, with built-in failover capabilities to minimize business interruption. We utilize software from Veritas for backup and recovery purposes. Full system backups are performed nightly using oneon-site and one off-site facility for tape storage.
Competition
The insurance industry, in general, is highly competitive and there is significant competition in the workers’ compensation insurance industry. Competition in the insurance business is based on many factors, including coverage availability, claims management, safety services, payment terms, premium rates, policy terms, types of insurance offered, overall financial strength, financial ratings assigned by independent rating organizations, such as A.M. Best, and servicesreputation. Some of the insurers with which we compete have significantly greater financial, marketing and management resources and experience than we do. We may also compete with new market entrants in the future.
We believe the workers’ compensation market for the hazardous industries we target is highly competitive. The Company'sunderserved and competition is fragmented and not dominated by one or more competitors. Our competitors include among others,other insurance companies, specialized provider groups, in-house benefits
administrators,individual self insured companies, state insurance pools and other significant providers of health
care and insurance services. A number of the Company's current and potential
competitors are significantly larger, with greater financial and operating
resourcesself-insurance funds. We believe that more than those of the Company, and can offer their services nationwide.
After a period of absence from the market, traditional national330 insurance companies have recently re-entered the workers' compensation insurance market,
thereby increasing competition.
Competitive factorsparticipate in the workers'workers’ compensation market. The insurance fieldcompanies with which we compete vary state by state and by the industries we target.
We believe our competitive advantages include premium rates (in some states), levels ofour safety service and claims management practices, our A.M. Best ratings, levelsrating of capitalization, quality of managed care services, the ability to reduce loss
ratios“A–” (Excellent) and theour ability to reduce claims expense. The Company believes that its
products and services are competitively priced.through implementation of our work safety programs. In addition, the Company
believes itswe believe that our insurance is competitively priced and our premium rates are typically lower than those for clientspolicyholders assigned to the state-sponsored riskstate insurance pools, allowing the Companyus to provide a viable alternative for employerspolicyholders in suchthose pools. The Company also believes that its
level of service, its "A" (Excellent)
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Ratings
Many insurance buyers and agencies use the ratings assigned by A.M. Best and other rating agencies to assist them in assessing the financial strength and overall quality of the companies from which they are considering purchasing insurance. We were assigned a rating of “A−” (Excellent) by A.M. Best. An “A−” rating is the fourth highest of 15 rating categories used by A.M. Best.
In December 2005, A.M. Best announced that it had affirmed our financial strength rating of “A−” (Excellent). The rating has a stable outlook for AMERISAFE and our insurance company subsidiaries. In evaluating a company’s financial and operating performance, A.M. Best reviews the company’s profitability, indebtedness and liquidity, as well as its book of business, the adequacy and soundness of its reinsurance, the quality and estimated fair value of its assets, the adequacy of its loss reserves, the adequacy of its surplus, its capital structure, the experience and competence of its management and its market presence. This rating is intended to provide an independent opinion of an insurer’s ability to reduce
claimsmeet its obligations to policyholders and is not an evaluation directed at investors.
Employees
As of September 30, 2006, we had 452 full-time employees and four part-time employees. We have employment agreements with each of our executive officers, which are strong competitive factorsdescribed under “Management—Employment and Consulting Agreements.” None of our employees is subject to collective bargaining agreements. We believe that have enabled itour employee relations are good.
Properties
We own our 45,000 square foot executive offices located in DeRidder, Louisiana. In addition, we lease an additional 28,000 square feet of office space in DeRidder, Louisiana, pursuant to retain existing
clientsa lease agreement that requires annual lease payments of $250,000 and attract new clients. Competitive factors relating to the Company's
TPA products are primarily based upon pricing,expires on December 31, 2007. This lease agreement may be extended for two additional one-year periods, at our option. We also lease space at other locations for our service and reputation.
REGULATION
General. Managed health care programsclaims representative offices.
Legal Proceedings
In the ordinary course of our business, we are involved in the adjudication of claims resulting from workplace injuries. We are not involved in any legal or administrative claims that we believe are likely to have a materially adverse effect on our business, financial condition or results of operations.
Regulation
Holding Company Regulation
Nearly all states have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Under these laws, the respective state insurance departments may examine us at any time, require disclosure of material transactions and require prior notice of or approval for certain transactions. All transactions within a holding company system affecting an insurer must have fair and reasonable terms and are subject to variousother standards and requirements established by law and regulation.
Change of Control
The insurance holding company laws and
regulations. Bothof nearly all states require advance approval by the nature and degreerespective state insurance departments of applicable government regulation vary
greatly depending uponany change of control of an insurer. “Control” is generally presumed to exist through the specific activities involved. Generally partiesdirect or indirect ownership of 10% or more of the voting securities of a domestic insurance company or any entity that actually provide or arrange for the provision of managed care workers'
compensation programs, assume financial risk relatedcontrols a domestic insurance company. In addition, insurance laws in many states contain provisions that require pre-notification to the provisioninsurance commissioners of a change of control of a non-
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domestic insurance company licensed in those programsstates. Any future transactions that would constitute a change of control of American Interstate, Silver Oak Casualty or undertake direct responsibility for making payment or payment
decisions for those services are subjectAmerican Interstate of Texas, including a change of control of AMERISAFE, would generally require the party acquiring control to a number of complex regulatory
schemes that govern many aspects of their conduct and operations. The managed
health care field is a rapidly expanding and changing industry; it is possible
thatobtain the applicable regulatory frameworks will expand to have an even greater
impact upon the conduct and operationprior approval of the Company's business.
The Company's businessdepartment of insurance in the state in which the insurance company being acquired is subject to state-by-state regulationincorporated and may require pre-notification in the states where pre-notification provisions have been adopted. Obtaining these approvals may result in the material delay of, workers'
compensation insuranceor deter, any such transaction.
These laws may discourage potential acquisition proposals and workers' compensation insurance management services.
Under the workers' compensation system, employer insurancemay delay, deter or self-funded
coverage is governed by individual lawsprevent a change of control of AMERISAFE, including through transactions, and in each of the fifty states and by
certain federal laws. Changes in individual state regulation of workers'
compensation or managed health care may create a greater or lesser demand forparticular unsolicited transactions, that some or all of the Company's services or may requireshareholders of AMERISAFE might consider to be desirable.
State Insurance Regulation
Insurance companies are subject to regulation and supervision by the Companydepartment of insurance in the state in which they are domiciled and, to develop new
or modified servicesa lesser extent, other states in orderwhich they conduct business. American Interstate and Silver Oak Casualty are primarily subject to meetregulation and supervision by the needsLouisiana Department of Insurance, Workers’ Compensation Commission and Insurance Rating Commission. American Interstate of Texas is primarily subject to regulation and supervision by the marketplaceTexas Department of Insurance and compete
effectively in that marketplace. Under Louisiana law, an insurance company may
not, withoutWorkers’ Compensation Commission. These state agencies have broad regulatory, approval, paysupervisory and administrative powers, including among other things, the power to its shareholders within a 12-month
period dividends or other distributionsgrant and revoke licenses to transact business, license agencies, set the standards of cash or propertysolvency to be met and maintained, determine the total fair
market valuenature of, which exceeds the lesser of (i) ten percent of surplus as to
policyholders at the end of the prior calendar year or (ii) the prior calendar
year's net income (less any realized capital gains). This requirement would
limit American Interstate's ability to make distributions to AMERISAFE in 1996
to approximately $2.7 million.
Premium Rate Restrictions. State regulations governing the workers'
compensation system and insurance business in general impose restrictions and limitations on, investments and dividends, approve policy forms and rates in some states, periodically examine financial statements, determine the Company's business operations thatform and content of required financial statements, and periodically examine market conduct.
Detailed annual and quarterly financial statements and other reports are not imposed on
unregulated businesses. Among other matters, state laws regulate not only what
workers' compensation benefits mustrequired to be paidfiled with the department of insurance in all states in which we are licensed to injured workers, but also the
premium rates that may be charged by the Company to insure employers for those
liabilities. As a consequence, the Company's ability to pay insured workers'
compensation claims outtransact business. The financial statements of the premium revenue generated from the Company's saleAmerican Interstate, Silver Oak Casualty and American Interstate of such insurance is dependent on the level of premium rates permitted by state
laws. In this regard it is significant
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that the state regulatory agency that regulates workers' compensation benefits
may not be the same agency that regulates workers' compensation insurance
premium rates.
Financial and Investment Restrictions. Insurance company operations alsoTexas are subject to financial restrictions that are not imposed on other businesses.
State laws require insurance companies to maintain minimum surplus balances and
place limits onperiodic examination by the amountdepartment of insurance a company may write based on the amount
of the company's surplus. These limitations restrict the rate at which the
Company's insurance operations can grow. The Company currently meets applicablein each state capital and surplus requirements.
State laws also require insurance companies to establish reserves for
payment of policyholder liabilities and impose restrictions on the kinds of
assets in which it is licensed to do business.
In addition, many states have laws and regulations that limit an insurer’s ability to withdraw from a particular market. For example, states may limit an insurer’s ability to cancel or not renew policies. Furthermore, certain states prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant to a plan that is approved by the state insurance companiesdepartment. The state insurance department may invest. These restrictionsdisapprove a plan that may require
the Companylead to invest its assets more conservatively than it would if it were
notmarket disruption. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict our ability to exit unprofitable markets.
Insurance agencies are subject to regulation and supervision by the department of insurance in the state law restrictionsin which they are licensed. Our wholly owned subsidiary, Amerisafe General Agency, Inc., is licensed in 23 states and may preventis domiciled in Louisiana. Amerisafe General is primarily subject to regulation and supervision by the Company from
obtaining as high a return on its assets as it might otherwise be able to
realize.
Insurance Regulatory Information System. The National AssociationLouisiana Department of Insurance Commissioners ("NAIC") has developed a setInsurance. This agency regulates the solicitation of financial relationships
or "tests" calledinsurance and the Insurance Regulatory Information System ("IRIS") that were
designed for early identificationqualification and licensing of companiesagents and agencies that may require special
attentiondesire to conduct business in Louisiana.
State Insurance Department Examinations
We are subject to periodic examinations by insurance regulatory authorities. These tests were developed
primarily to assist state insurance departments in executing their statutory
mandate to oversee the financial conditionstates in which we operate. The Louisiana Department of Insurance generally examines each of its domiciliary insurance companies. Insurance
companies submit data on a triennial basis. We underwent an annual basis toexamination in the NAIC, whichfirst half of 2006 that covered calendar years 2001 through 2005. We have not yet received the results of this examination. American Interstate of Texas was formed in turn analyzes the
date using ratios covering twelve categoriesDecember 2004 and began operations in January 2005. Under Texas insurance law, American Interstate of financial data with defined
"usual ranges" for each category.
Falling outside the usual range of IRIS ratios is not considered a failing
result; rather, unusual values are viewed as part of the regulatory early
monitoring system. Furthermore, in some years, it may notTexas will be unusual for
financially sound companies to have several ratios with results outside the
usual ranges. An insurance company may fall out of the usual range for one or
more ratios because of specific transactions that are in themselves immaterial
or eliminated at the consolidated level. Generally, an insurance company will
become subject to regulatory scrutiny if it falls outside the usual rangesexamination each year in its first three years of four or moreoperations.
Guaranty Fund Assessments
In most of the ratios. In normal years, 15% of the companies included in
the IRIS system are expected by the NAIC to be outside the usual range on four
or more ratios. For the years 1991 through 1996, the Company's insurance
subsidiaries were not outside the usual ranges for more than two ratios.
Participation in State Guaranty Funds. Every state has established one or
more insurance guaranty funds or associations which are charged by state law to
pay claims of policyholders insured by a company that becomes insolvent. All
insurance companies must participate in the guaranty associations in the states where they dowe are licensed to transact business, there is a requirement that property and are assessable for the associations' operating costs,
including the cost of paying policyholder claims against an insolvent insurer.
The Company's financial performance could be adversely affected bycasualty insurers doing business within each such state participate in a guaranty association, which is
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organized to pay contractual benefits owed pursuant to insurance policies issued by impaired, insolvent or failed insurers. These associations levy assessments, asup to prescribed limits, on all member insurers in a consequenceparticular state on the basis of the insolvencyproportionate share of otherthe premium written by member insurers overin the lines of business in which the Company has no control.
Participationimpaired, insolvent or failed insurer is engaged. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets.
Property and casualty insurance company insolvencies or failures may result in State additional security fund assessments to us at some future date. At this time, we are unable to determine the impact, if any, such assessments may have on our financial position or results of operations. We have established liabilities for guaranty fund assessments with respect to insurers that are currently subject to insolvency proceedings.
Residual Market Programs. Programs
Many of the states in which the Company is licensed,we conduct business or intendsintend to become licensed, to provide its
managed workers' compensation products and servicesconduct business, require that all licensed insurers participate in a program to provide workers'workers’ compensation insurance to those employers who have not or cannot procure coverage from a carrier on a negotiated basis. The level of required participation in such programs is generally determined by calculating the volume of the Company'sour voluntarily
written business in that state as a percentage of all voluntarily written business in that state by all insurers. The resulting factor is the proportion of premium the Companywe must accept as a percentage of all of the premiums in policies residing in that state'sstate’s residual market program.
Companies generally have two methods of fulfillingcan fulfill their residual market obligations: (i) they may joinobligations by either issuing insurance policies to employers assigned to them, or participating in a reinsurance pool in whichwhere the results of all policies provided through the pool are shared by the participating companies, or
(ii) they may accept directly assigned policies for which they are obligated to
provide all services and assume the underwriting results.companies. Currently, the Company
utilizeswe utilize both methods, depending on management'smanagement’s evaluation of the most efficientcost-efficient method to adopt in each state. Generally, the Company believesstate that the direct-assignment methodallows a choice of assigned risk or participation in a pooling arrangement. In general, we believe that assigned risk produces better results as the Company applies its
managed results
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37we apply our cost management approach to these involuntary client-employers. In 1995policyholders. We currently have assigned risk in six states: Alabama, Alaska, Georgia, North Carolina, South Carolina, and for the three months
ended March 31, 1996, approximately 6.7% and 7.7% of the Company's gross
premiums earned, respectively, were from direct assignment residual market
obligations.
Statutory Accounting and Solvency Regulation. State regulation of insurance
company financial transactions and financial condition is based on statutory
accounting principles ("SAP"). SAP differs in a number of ways from generally
accepted accounting principles ("GAAP") which govern the financial reporting of
most other businesses. In general, SAP financial reports are more conservative
than GAAP financial reports.
State insurance regulators closely monitor the financial condition of
insurance companies reflected in SAP financial statements and can impose
significant financial and operating restrictions on an insurance company that
becomes financially impaired. Regulators generally have the power to impose
restrictions or conditions on the following kinds of activities of a financially
impaired insurance company: the transfer or disposition of assets; the
withdrawal of funds from bank accounts; the extension of credit or making of
loans; and the investment of funds.
State SubsequentVirginia.
Second Injury Funds. Funds
A number of states operate trust funds that reimburse insurers and employers and carriers for excess workers' compensation benefitsclaims paid to injured employees when an employee is injured on the job and the injury to the
physically disabled worker merges with, aggravatesfor aggravation of prior conditions or accelerates a preexisting
work-related impairment.injuries. The state-managed trust funds are funded through assessments against insurers and self-insurers providing workers'workers’ compensation coverage in a specific state. At MarchOur recoveries from state-managed trust funds for the years ended December 31, 1996,2005, 2004 and 2003 were approximately $7.6 million, $8.1 million and $7.3 million respectively. Our cash paid for assessments to state-managed trust funds for the Companyyears ended December 31, 2005, 2004 and 2003 was approximately $3.9 million, $3.6 million and $4.2 million, respectively.
Dividend Limitations
Under Louisiana law, American Interstate and Silver Oak Casualty cannot pay dividends to their shareholders in excess of the lesser of 10% of statutory surplus, or statutory net income, excluding realized investment gains, for the preceding12-month period without the prior approval of the Louisiana Commissioner of Insurance. However, net income from the previous two calendar years may be carried receivablesforward to the extent that it has not already been paid out as dividends. Based on reported capital and surplus at December 31, 2005, this requirement limits American Interstate’s ability to make distributions to AMERISAFE in 2006 to approximately $3.9 million without approval by the Louisiana Department of Insurance. Further, under Texas law, American Interstate of Texas cannot pay dividends to its books from state subsequent injury fundsshareholder in excess of the greater of 10% of statutory surplus, or statutory net income, for the preceding12-month period without the prior approval of the Texas Commissioner of Insurance.
Federal Law and Regulations
As of September 30, 2006, less than $500,000.
Possible Future Regulation. State legislatures3% of our voluntary in-force premiums were derived from employers engaged in the maritime industry. As a provider of workers’ compensation insurance for employers
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engaged in the maritime industry, we are subject to the United States Longshore and Harbor Workers’ Compensation Act, or the USL&H Act, and the Merchant Marine Act of 1920, or Jones Act. We are also subject to regulations related to the USL&H Act and the Jones Act.
The USL&H Act, which is administered by the U.S. Department of Labor, generally covers exposures on the navigable waters of the United States and in adjoining waterfront areas, including exposures resulting from stevedoring. The USL&H Act requires employers to provide medical benefits, compensation for lost wages and rehabilitation services to longshoremen, harbor workers and other maritime workers who may suffer injury, disability or death during the course and scope of their employment. The Department of Labor has the authority to require us to make deposits to serve as collateral for losses incurred under the USL&H Act.
The Jones Act is a federal governmentlaw, the maritime employer provisions of which provide injured offshore workers, or seamen, with a remedy against their employers for injuries arising from negligent acts of the employer or co-workers during the course of employment on a ship or vessel.
Privacy Regulations
In 1999, Congress enacted the Gramm-Leach-Bliley Act, which, among other things, protects consumers from the unauthorized dissemination of certain personal information. Subsequently, a majority of states have consideredimplemented additional regulations to address privacy issues. These laws and regulations apply to all financial institutions, including insurance and finance companies, and require us to maintain appropriate policies and procedures for managing and protecting certain personal information of our policyholders and to fully disclose our privacy practices to our policyholders. We may also be exposed to future privacy laws and regulations, which could impose additional costs and impact our results of operations or financial condition. In 2000, the National Association of Insurance Commissioners, or the NAIC, adopted the Privacy of Consumer Financial and Health Information Model Regulation, which assisted states in promulgating regulations to comply with the Gramm-Leach-Bliley Act. In 2002, to further facilitate the implementation of the Gramm-Leach-Bliley Act, the NAIC adopted the Standards for Safeguarding Customer Information Model Regulation. Several states have now adopted similar provisions regarding the safeguarding of policyholder information. We have established policies and procedures intended to ensure that we are considering a number of cost containmentin compliance with the Gramm-Leach-Bliley related privacy requirements.
Federal and health care
reform proposals. The Company believes it may benefit from someState Legislative and Regulatory Changes
From time to time, various regulatory and legislative changes have been proposed in the insurance industry. Among the proposals that favorhave in the growthpast been or are at present being considered are the possible introduction of managed care. However,federal regulation in addition to, or in lieu of, the current system of state regulation of insurers and proposals in various state legislatures (some of which proposals have been enacted) to conform portions of their insurance laws and regulations to various model acts adopted by the NAIC. We are unable to predict whether any of these laws and regulations will be adopted, the form in which any such laws and regulations would be adopted or the effect, if any, these developments would have on our operations and financial condition.
For information related to the Terrorism Risk Insurance Act, see “—Reinsurance—Terrorism Reinsurance.”
The National Association of Insurance Commissioners
The NAIC is a group formed by state Insurance Commissioners to discuss issues and formulate policy with respect to regulation, reporting and accounting of insurance companies. Although the NAIC has no assurance can be givenlegislative authority and insurance companies are at all times subject to the laws of their respective domiciliary states and, to a lesser extent, other states in which they conduct business, the NAIC is influential in determining the form in which such laws are enacted. Model Insurance Laws, Regulations and Guidelines, which we refer to as the Model Laws, have been promulgated by the NAIC as a minimum standard by which state regulatory systems and regulations are measured. Adoption of state laws that provide for substantially similar regulations to those described in the Model Laws is a requirement for accreditation by the NAIC. The
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NAIC provides authoritative guidance to insurance regulators on current statutory accounting issues by promulgating and updating a codified set of statutory accounting practices in itsAccounting Practices and Procedures manual. The Louisiana and Texas legislatures have adopted these codified statutory accounting practices.
The NAIC has recently proposed a Model Law that would require insurance brokers to obtain the written consent of the insured before receiving compensation from the insurer. This proposed Model Law would also require all insurance producers (including agents) to disclose to its customers that the stateproducer will receive compensation from the insurer, that the compensation received by the producer may differ depending upon the product and insurer and that the producer may receive additional compensation from the insurer based upon other factors, such as premium volume placed with a particular insurer and loss or federal government willclaims experience. We do not adopt future health care reformssell insurance through brokers. We do sell insurance through agents. We do not believe that the disclosure obligations under the Model Law proposed by the NAIC would adversely affecthave any significant effect on our business if it were adopted in the Company.
In recent years the state insurance regulatory framework has come under
increased federal scrutiny,states in which we conduct our business.
Under Louisiana law, American Interstate and certain state legislatures have considered or
enacted laws that alteredSilver Oak Casualty are required to maintain minimum capital and in many cases, increased state authoritysurplus of $3.0 million. Under Texas law, American Interstate of Texas is required to regulatemaintain minimum capital and surplus of $1.0 million. Property and casualty insurance companies are subject to certain risk based capital requirements by the NAIC. Under those requirements, the amount of capital and surplus maintained by a property and casualty insurance holding companies. Further,company is to be determined based on the various risk factors related to it. As of December 31, 2005, American Interstate, Silver Oak Casualty, and American Interstate of Texas exceeded the minimum risk based capital requirements.
The key financial ratios of NAIC’s Insurance Regulatory Information System, or IRIS, which ratios were developed to assist insurance departments in overseeing the financial condition of insurance companies, are reviewed by experienced financial examiners of the NAIC and state insurance departments to select those companies that merit highest priority in the allocation of the regulators’ resources. IRIS identifies 12 industry ratios and specifies “usual values” for each ratio. Departure from the usual values on four or more of the ratios can lead to inquiries from individual state insurance commissioners as to certain aspects of an insurer’s business.
The 2005 IRIS results for both American Interstate and Silver Oak Casualty showed the ratio of two-year reserve development to policyholders’ surplus outside the expected range for such ratio. This result was attributable, in part, to the Converium commutation. Silver Oak Casualty’s ratios of one-year reserve development to policyholders’ surplus and net change in adjusted policyholders’ surplus were outside the expected ranges for such ratios. This occurred because of Silver Oak Casualty’s smaller surplus base and the impact of the Converium commutation.
The 2005 IRIS results for American Interstate of Texas showed a change in net writings greater than the expected range. This result was anticipated because 2005 was American Interstate of Texas’s first year of premium writings and assumed intercompany pool premiums. American Interstate of Texas also had an investment yield below the expected range. This occurred because higher levels of liquidity were maintained at American Interstate of Texas to ensure that it could meet all of its current obligations. Yields on short-term instruments were relatively low during 2005. As American Interstate of Texas increases its investment portfolio, its incremental yields are expected to improve.
Statutory Accounting Practices
Statutory accounting practices, or SAP, are a basis of accounting developed to assist insurance regulators are re-examining existing lawsin monitoring and regulations,
specifically focusing on investment laws for insurers, modificationsregulating the solvency of insurance companies. SAP is primarily concerned with measuring an insurer’s surplus to holding
company regulations, codification ofpolicyholders. Accordingly, statutory accounting focuses on valuing assets and liabilities of insurers at financial reporting dates in accordance with appropriate insurance law and regulatory provisions applicable in each insurer’s domiciliary state.
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Generally accepted accounting principles, or GAAP, are concerned with a company’s solvency, but are also concerned with other financial measurements, principally income and cash flows. Accordingly, GAAP gives more consideration to appropriate matching of revenue and expenses and accounting for management’s stewardship of assets than does SAP. As a direct result, different assets and liabilities and different amounts of assets and liabilities will be reflected in financial statements prepared in accordance with GAAP as compared to SAP.
Statutory accounting practices risk-based
capital guidelines, interpretations of existing lawsestablished by the NAIC and the development of new
laws. In addition, Congress and certain federal agencies are investigating the
current condition of the insurance industryadopted in part by the United States to determine
whether to impose federal regulation. The Company cannot predict with certainty
the effect any proposed or future legislation or NAIC initiatives may have on
the conduct of the Company's business or the financial condition or results of
operations of the Company.
PROPERTIES
The Company owns its 43,000 square foot executive offices in DeRidder, Louisiana and leases its executive offices in Dallas, Texas. The Company also
leases space atTexas insurance regulators, determine, among other locations for its service offices and claims
representative offices. See "Certain Transactions -- Executive Office Lease."
EMPLOYEES
The Company had 315 full-time employees at July 31, 1996. Of the Company's
employees, approximately 50 perform administrative and financial functions and
265 serve on service and marketing teams providing its managed results services
to its employer-clients. None of the Company's employees is subject to
collective bargaining agreements. The Company believes that its employee
relations are good.
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38
LEGAL PROCEEDINGS
In the ordinary course of administering its workers' compensation managed
results program, the Company is routinely involved in the adjudication of claims
resulting from workplace injuries. Except as described below, the Company is not
involved in any legal or administrative claims that it believes are likely to
have a materially adverse effect on the Company's business, financial condition
or results of operations.
The Company's federal income tax return with respect to its 1992 tax year
is currently subject to an audit by the IRS. The principal issues with respect
to which the IRS has proposed adjustments relate to (i) whether the Company
should have included in income at the time of receipt certain deposits it
received from its clients to secure the payment of premiums, and (ii) whether
the Company's reserves for future claims were excessive. The aggregate amount of
additional tax which would be owed by the Company if the proposed adjustments
were sustained is approximately $3.3 million, plus accrued interest. Because the
proposed adjustments relate to the timing of the receipt of income, they would
not, if sustained, be expected to have an impact on the Company's results of
operations, but would impact the Company's cash flow. The Company believes that
it has meritorious defenses to the proposed adjustments and intends to contest
them vigorously.
The federal income tax returns filed by a subsidiary of the Company with
respect to its 1990 and 1991 tax years are also presently subject to an audit by
the IRS. During the years in question the corporation was not a subsidiary of
the Company. The principal issue in this audit relates to the reasonableness of
compensation paid by such corporation to Mr. Morris and another former
officer-shareholder of the Company during such years. The IRS has proposed that
a portion of the compensation paid to these individuals during such years is not
deductible for federal income tax purposes, and that as a result the corporation
owes additional tax inthings, the amount of approximately $2.1 million, plus accrued
interest. No penalties have been asserted bystatutory surplus and statutory net income of American Interstate, Silver Oak Casualty and American Interstate of Texas and thus determine, in part, the IRS. amount of funds that are available to pay dividends to AMERISAFE.
As of September 30, 2006, the amount of statutory capital and surplus of American Interstate was $181.4 million.
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MANAGEMENT
Directors, Executive Officers and Key Employees
The corporation believes
that it has meritorious defenses to the proposed adjustmentstable below sets forth information about our directors, executive officers and is contesting
them vigorously. In connectionkey employees. Our directors are divided into three classes with the Reorganization,number of directors in each class as nearly equal as possible. Each director serves for a three-year term. Executive officers serve at the MorTem Corporations
have agreed to indemnify the Company and its affiliates for any liability they
may have with respect to this tax audit.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The namesrequest of the directors and executive officersour board of the Company and their
ages and positions are as follows:
directors.
Name | Age | Position | ||||
Directors and Executive Officers | ||||||
| C. Allen Bradley, Jr.(2) | 55 | Chairman, | ||||
| Geoffrey R. | 57 | Executive Vice President and Chief Financial Officer | ||||
| Arthur L. | 61 | Executive Vice President | ||||
| Craig P. Leach | 56 | Executive Vice President, | ||||
| David O. Narigon | 54 | Executive Vice President | ||||
| Todd Walker | 50 | Executive Vice President, General Counsel | ||||
| Thomas W. Hallagan(3) | 45 | Director | ||||
| Jared A. Morris(1) | 31 | Director | ||||
| Paul B. Queally(3) | 42 | Director | ||||
| Sean M. Traynor(1) | 37 | Director | ||||
| Austin P. Young III (2) | 65 | Director | ||||
Key Employees | ||||||
| Allan E. Farr | 48 | Senior Vice President, | ||||
| Kelly R. Goins | 40 | Senior Vice President, | ||||
| Cynthia P. | 52 | Senior Vice President, | ||||
| Leon J. | 55 | Senior Vice President, Safety Operations | ||||
| Henry O. Lestage, IV | 45 | Senior Vice President, Claims Operations | ||||
| Edwin R. Longanacre | 49 | Senior Vice President, Information Technology | ||||
| G. Janelle Frost | 36 | Vice President, Controller | ||||
| Angela S. Lannen | 60 | Vice President, Treasurer | ||||
| (1) | Term expires at the annual meeting of shareholders in 2007. | |
| (2) | Term expires at the annual meeting of shareholders in 2008. | |
| (3) | Term expires at the annual meeting of shareholders in 2009. |
Set forth below is certain background information relating to our directors, executive officers and key employees.
C. Allen Bradley, Jr. has beenserved as Chairman of the Board,our board of directors since October 2005, our President since November 2002, our Chief Executive Officer and principal shareholder of the Company since its inception in 1985. Mr. Morris
began his insurance career in 1972, and has owned and managed many diverse
financial services operations. He is currently the Chairman of the Board and
principal shareholder of Auto One Acceptance Corporation, a Dallas based
financial services company. Mr. Morris has a Bachelor of Business Administration
in AccountingDecember 2003 and a Master of Science in Economics, both from Baylor University,
and is a Certified Public Accountant. Mr. Morris serves in the class of
Directors whose terms expire at the Company's 1999 annual meeting of
shareholders.
Mark R. Anderson began his insurance career in 1979 and joined the Company
in 1986Director since June 2003. From November 2002 until December 2003 he served as Vice President,our Chief Operating OfficerOfficer. Since joining our company in 1994, Mr. Bradley has had principal responsibility for the management of our underwriting operations (December 2000 through June 2005) and Director. He was elected
President in 1996,safety services (September 2000 through November 2002) and has served as Presidentour General Counsel (September 1997 through December 2003) and Secretary (September 1997 through November 2002). Prior to joining our company, he was engaged in the private practice of American Interstate since
1987. Mr. Anderson has served on various legislative insurance advisory
committees in Louisiana, and law.
Geoffrey R. Bantahas served as a workers' compensation rate and
reform consultant to several southern Insurance Commissioners. He holds a
Bachelor of Science degree from Louisiana State University and a Master of
Science degree in Business Administration from Boston University. Mr. Anderson
serves in the class of directors whose terms expire at the Company's 1998 annual
meeting of shareholders.
John R. Buck has beenour Executive Vice President and Chief Financial Officer since December 2003. Prior to joining our company in 2003, he held the positions of President and Chief Executive Officer from 2001 until November 2003, and Chief Operating Officer from 1996 until 2001, at Scruggs Consulting, an actuarial and management consulting firm. From 1994 to 1996, Mr. Banta was Chief Financial
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Officer of the Company since 1989 andAtlanta Casualty Companies, an issuer of non-standard auto insurance whose holding company was a Director since 1994. He served in various accounting
positions with Zale Corporation's Insurancesubsidiary of American Financial Group from 1983 to 1988 and joined
American Interstate as Controller in 1988. Mr. Buck has Bachelor of Science
degrees in Accounting and Business Administration from Illinois State
University, and became a Certified Public Accountant in 1985. Mr. Buck serves in
the class of directors whose terms expire at the Company's 1997 annual meeting
of shareholders.
Holdings, Inc.
Arthur L. Hunthas served as Secretary of the Company since 1991, was
electedan Executive Vice President -- Risk Group in August 1996,since 1999. Prior to September 2006, he also served as our General Counsel and Secretary. He has been employed with our company since 1991. Mr. Hunt will retire from our company effective as of November 30, 2006.
Craig P. Leachhas served as our Executive Vice President, Sales and Marketing since November 2002. He has served in a Directorvariety of sales and key marketing positions within our company since 1994.beginning his insurance career with a predecessor to our company in 1980, including Senior Vice President, Sales and Marketing from 1997 until November 2002.
David O. Narigonhas served as an Executive Vice President with responsibility for Claims, Information Technology and Premium Audit since September 2006. Prior to joining our company, he provided consulting, mediation, arbitration and expert witness services to the Company,insurance industry through his company, Narigon Consulting & Settlement Services, from March 2005 until August 2006. Prior to March 2005, Mr. Hunt served twenty years inNarigon was employed by EMC Insurance Companies where he held the United States Army. He served as a Judge Advocate General officer and retired
after attaining the rankpositions of Colonel. Mr. Hunt has a Bachelor of Science degree
in Psychology from Loyola University and a law degree from the Loyola University
School of Law, Chicago. Mr. Hunt serves in the class of directors whose terms
expire at the Company's 1997 annual meeting of shareholders.
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C. Allen Bradley, Jr. was elected Vice President, --Claims from 1988 to June 1998 and Senior Vice President, Claims from June 1998 until March 2005, and President of EMC Risk Services Group andfrom 1993 until March 2005.
Todd Walkerjoined our company in September 2006 as our Executive Vice President, General Counsel in August 1996. He joined a subsidiary of the Company in 1994 as
an executive officer, and prior to that timeSecretary. From 2002 through September 2006, he was engaged in the private practice of law. Prior to 2002, Mr. Bradley alsoWalker held various legal positions with Ultramar Diamond Shamrock Corp., a New York Stock Exchange listed refining and marketing company, where he had been employed since 1987.
Thomas W. Hallaganhas served as a Louisiana State Representative from 1984 to
1992. He holds a BachelorDirector of Arts degree from Southeastern Louisiana University
and a law degree from Louisiana State University.
Andre Comeaux, Jr. has been Vice President -- Product Developmentour company since August 1996 and has been Industries Manager of American Interstate since April
1995. Mr. Comeaux began his career in the insurance industry in 1987 with AEtna
Casualty & Surety Co., serving as an Engineering Consultant and Commercial
Account Representative. In 1993, he joined American International Group as an
Account Executive, Loss Control Services, and served in that capacity until he
joined American Interstate. Mr. Comeaux holds a Bachelor of Science degree in
Mechanical Engineering from the University of Southwestern Louisiana and is a
Chartered Property Casualty Underwriter, a Certified Safety Professional and is
licensed as a Professional Engineer by the state of California.May 2006. He is recognized
ascurrently a Qualified Field Safety Representative by the statesprivate investor. Mr. Hallagan was Managing Director—Head of TexasU.S. Private Equity for Najeti Ventures, LLC, a private equity investment firm, from May 2002 until December 2005. From 2000 until May 2002, he was a private investor. Mr. Hallagan has served on numerous public and Arkansasprivate company boards and is recognized as an Associate in Loss Control Management by the Insurance
Institute of America.
Zoniewas a certified public accountant with Deloitte Haskins & Sells.
Jared A. Harris was elected Vice President -- Claims Services in August
1996. Since 1986 he Morrishas also served as Vice President, Claims for American
Interstate. Mr. Harris has served with various affiliates of the Company and
other insurance firms in claims management since 1972. Prior to his insurance
career, Mr. Harris spent twenty years in the U.S. Air Force as a communications
specialist.
Craig P. Leach was elected Vice President -- Business Development in August
1996. He has served since 1994 as Senior Vice President of American Interstate,
and has served in similar roles with affiliated firms since beginning his
insurance career in 1980. Prior to 1980 Mr. Leach held various management
positions with companies engaged in the paper and lumber industries. He holds
both a Bachelor of Science degree and a Master of Science degree in Forestry
from Louisiana State University. Mr. Leach currently serves on the board of
directors of the Louisiana Forestry Association, and has served in an advisory
capacity for the Southern Forest Insurance Coalition and various wood product
companies throughout the country.
Daniel J. Jessee has been a Director of the Companyour company since August 1996.September 2005. Since January 1995,2002, Mr. JesseeMorris has been Vice Chairman of Banc One Capital
Corporation ("BOCC"), an investment banking firmofficer and a subsidiaryprincipal owner of BancDumont Land, LLC and Marine One Corporation. Prior to becomingAcceptance Corp., both of which are subprime finance companies. He was an Assistant Vice Chairman, he wasPresident, Underwriter of CIT Business Credit, a Managing Director of BOCC
since August 1990. Mr. Jessee serves in the class of directors whose terms
expire at the Company's 1999 annual meeting of shareholders. Mr. Jessee is also
a director of RAC Financial Group, Inc.
N. David Spence commercial finance company, from 2000 until 2002.
Paul B. Queallyhas beenserved as a Director of the Companyour company since August1997. He is currently a general partner of Welsh, Carson, Anderson & Stowe, a private equity investment firm, that he joined in 1996. Mr. Spence is a Senior Vice President and General Manager -- Paper Division of Boise
Cascade Corporation ("BCC"). Mr. Spence joined BCC in 1969 and has served in
various management positions since that time. Mr. SpenceQueally also serves in the class of
directors whose terms expire at the Company's 1998 annual meeting of
shareholders. Mr. Spence is also a director of the American Forest & Paper
Association and the Pacific Coast Association of Pulp & Paper Manufacturers.
COMMITTEES
The Bylaws provide that the Board of Directors may elect such directorate
committees as it may from time to time determine. Two committees of the Board of
Directors have been established: the Audit Committee and the Compensation
Committee.
The Audit Committee of the Board of Directors (the "Audit Committee") will
review the professional services provided by the Company's independent
accountants and the independence of such accountants from management of the
Company. The Audit Committee will also review the scope of the audit coverage
and annual financial statements of the Company and such other matters with
respect to accounting, auditing practices and procedures of the Company as it
may find appropriate or as may have been brought to its attention. The members
of the Audit Committee are Messrs. Jessee and Spence.
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The Compensation Committee of the Board of Directors (the "Compensation
Committee") will review and approve executive salaries and administer bonus,
stock option and incentive compensation plans of the Company. It will advise and
consult with management regarding significant employee benefit policies and
practices and significant compensation policies and practices of the Company.
The members of the Compensation Committee are Messrs. Jessee and Spence.
LIMITATION OF LIABILITY AND INDEMNIFICATION
As authorized by the Texas Miscellaneous Corporation Laws (the "TMCL"), the
Company's Articles provide that, to the full extent permitted by the TMCL or any
other applicable laws as presently or hereafter in effect, no director of the
Company shall be personally liable to the Company for an act or omission in his
capacity as a director of the Company. The TMCL does not permit limitationMedCath Corporation, Concentra Operating Corporation, AmCOMP Incorporated, United Surgical Partners International, Inc., Ameripath, Inc. and several private companies.
Sean M. Traynorhas served as a Director of liabilityour company since April 2001. He is currently a general partner of any director (i) forWelsh, Carson, Anderson & Stowe, a breach of the director's duty of loyalty to
the Company or its shareholders, (ii) for acts or omissions notprivate equity investment firm, that he joined in good faith
that constitute a breach of duty of the director or an act or omission that
involves intentional misconduct or a knowing violation of the law, (iii) a
transaction from which the director received an improper personal benefit, or
(iv) an act or omission for which liability of a director is expressly provided
by an applicable statute. The principal effect of the limitation of liability
provision is that a shareholder is unable to prosecute an action for monetary
damages against a director of the Company unless the shareholder can demonstrate
one of the specified bases of liability.
Additionally, the Company's Articles and Bylaws provide that the Company
shall indemnify all directors, officers, agents or employees of the Company to
the fullest extent permitted by the Texas Business Corporation Act ("TBCA"). The
TBCA establishes the standard which permits a corporation to provide
indemnification, except when shareholder approval for the indemnification has
been obtained. The TBCA provides that a director may be indemnified for
liabilities and expenses in respect to actions brought against him by reason of
his serving1999. Mr. Traynor also serves as a director if he conducted himself in good faithfor Select Medical Corporation, Ameripath, Inc., AmCOMP Incorporated and reasonably
believed that (i) in the case of conduct in his official capacityseveral private companies.
Austin P. Young IIIhas served as a director,
his conduct was in the Company's best interests, and (ii) in all other cases,
that his conduct was at least not opposed to the best interestsDirector of the Company.
Indemnification for criminal actions also requires the director to have no
reason to believe his conduct was unlawful. In addition, if the director is
found liable to the Company or on the basis that a personal benefit was
improperly received by him, indemnification will be limited to expenses actually
incurred and will not be available if the director is found liable for willful
or intentional misconduct in the performance of his duty to the Company.
The Company has entered into certain agreements ("Indemnification
Agreements") with each of its directors and executive officers designed to give
effect to the foregoing provisions of the Articles and Bylaws and to provide
certain additional assurances against the possibility of uninsured liability.
The effect of these provisions and the Indemnification Agreements will be to
eliminate the right of the Company and its shareholders (through shareholders'
derivative suits on behalf of the Company) to recover monetary damages against a
director for breach of fiduciary dutyour company since November 2005. Mr. Young served as a director except as described therein.
The provisions of the Articles and Bylaws and the Indemnification Agreements
will not alter the liability of directors of the Company under federal
securities laws.
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EXECUTIVE COMPENSATION
The following table provides information concerning the annual and
long-term compensation for services paid or accrued by the Company for the
fiscal year ended December 31, 1995 to (i) the Company's chief executive officer
and (ii) each other executive officer of the Company whose total annual salary
and bonus exceeded $100,000, based on salary and bonuses earned during 1995
(collectively, the "Named Officers").
SUMMARY COMPENSATION TABLE
- ---------------
(1) Reflects bonus earned during the 1995 fiscal year. In all cases, the bonus
has been or will be paid during the 1996 fiscal year.
(2) None of the Named Officers received personal benefits, securities or
property in excess of the lesser of $50,000 or 10% of such individual's
reported salary and bonus.
(3) Consists of Company contributions to the Company's 401(k) Plan (the "401(k)
Plan").
(4) Consists of $1,185 of Company contributions to the 401(k) Plan and $15,660
in premiums on a life insurance policy for Mr. Anderson's benefit.
(5) Consists of $1,185 of Company contributions to the 401(k) Plan and $26,100
in premiums on a life insurance policy for Mr. Leach's benefit.
(6) Consists of Company contributions to the 401(k) Plan.
(7) Consists of $880 of Company contributions to the 401(k) Plan and $5,220 in
premiums on a life insurance policy for Mr. Buck's benefit.
EMPLOYMENT AGREEMENTS
In connection with the Offering, the Company entered into an employment
agreement (the "Employment Agreement") with each of Messrs. Morris, Anderson,
Buck, Leach and Bradley (each, an "Executive Officer") that expire on the third
anniversary of the Offering. Pursuant to the Employment Agreements, Mr. Morris
serves as Chairman of the Board of Directors and Chief Executive Officer of the
Company and is paid an annual base salary of $450,000, Mr. Anderson serves as
President and Chief Operating Officer of the Company and is paid an annual base
salary of $275,000, Mr. Buck serves asSenior Vice President, Chief Financial Officer and Treasurer of CellStar Corporation, a logistics service provider to the Companywireless communications industry, from 1999 until his retirement in December 2001. Prior to joining CellStar Corporation, Mr. Young was a partner in the Houston and New York offices of KPMG LLP for 22 years, Senior Vice President and Chief Financial Officer of American General Corporation for over eight years and Executive Vice President-Finance and Administration of Metamor Worldwide, Inc., an information technology company, for three years. Mr. Young serves as a Director and Chairman of the Finance, Risk Management and Audit Committee of Administaff, Inc. and as a Director and Chairman of the Audit Committee of Tower Group, Inc. Mr. Young also currently serves as Vice President, Treasurer and Director of The Park People, Director and Chairman of the Audit Committee of the Houston Zoo and Director and Chairman of the Houston Zoo Advisory Council.
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Allan E. Farrhas served as our Senior Vice President, Enterprise Risk Management since April 2004. He has been employed with our company since 1998 and served as Vice President, Underwriting Services from 1999 until 2004.
Kelly R. Goinshas served as our Senior Vice President, Underwriting Operations since March 2005. She has been employed with our company since 1986 and served as Vice President, Underwriting Operations from 2000 until March 2005.
Cynthia P. Harrishas served as our Senior Vice President, Human Resources/Client Services since January 2003. She has been employed with our company since 1977 and served as Vice President, Policyholder Services and Administration from 1992 until December 2002.
Leon J. Lagneauxhas served as our Senior Vice President, Safety Operations since March 2005. He has been employed with our company since 1994 and served as Vice President, Safety Operations from 1999 until March 2005.
Henry O. Lestage, IVhas served as our Senior Vice President, Claims Operations since September 2000. He has been employed with our company since 1987 and served as Vice President, Claims Operations from 1998 until 2000.
Edward R. Longanacrehas served as our Senior Vice President, Information Technology since March 2005. He has been employed with our company since 2000 and held the position of Vice President, Information Technology from September 2004 until March 2005 and Information Technology Director from 2000 until September 2004.
G. Janelle Frosthas served as our Controller since May 2004 and Vice President since May 2006. She has been employed with our company since 1992 and served as Assistant Vice President from May 2004 to May 2006 and Deputy Controller from 1998 to April 2004.
Angela S. Lannenhas served as our Vice President, Treasurer since January 2001. She has been employed with our company since 1999 and served as Planning and Analysis Manager from 1999 until December 2000.
Board Composition
We are managed under the direction of our board of directors. Our board consists of six directors, five of whom are not, and have been never been, employees of our company, nor will they have any other relations with us that would result in their being considered other than independent under applicable U.S. federal securities laws and the rules of the National Association of Securities Dealers, or NASD. There are no family relationships among any of our directors or executive officers.
Our board has approved Corporate Governance Guidelines and a Code of Business Conduct and Ethics for all directors, officers and employees, copies of which are available on our website and upon written request by our shareholders at no cost.
Number of Directors; Removal; Vacancies
Our articles of incorporation and bylaws provide that the number of directors shall be fixed from time to time by our board of directors. Our board of directors is divided into three classes with the number of directors in each class as nearly equal as possible. Each director serves a three-year term. The term of office for each of our directors is noted in the table listing our directors and executive officers under “—Directors, Executive Officers and Key Employees.” Pursuant to our bylaws, each director will serve until his or her successor is duly elected and qualified, unless he or she dies, resigns, retires, becomes disqualified or is removed. Our bylaws also provide that any director may be removed for cause, at any meeting of shareholders called for that purpose, by the affirmative vote of the holders of at least two-thirds of the combined voting power of the then-outstanding securities entitled to vote generally in the election of directors.
Our bylaws further provide that newly created directorships in our board may be filled by election at an annual or special meeting of our shareholders called for that purpose or by our board of directors, provided
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that our board may not fill more than two newly created directorships during the period between any two successive annual meetings of our shareholders. Any director chosen to fill a newly created directorship will hold office until the next election of one or more directors by the shareholders. Any other vacancies in our board may be filled by election at an annual or special meeting of our shareholders called for that purpose or by the affirmative vote of a majority of the remaining directors then in office, even if less than a quorum. Any director chosen to fill a vacancy not resulting from a newly created directorship will hold office for the unexpired term of his or her predecessor.
Board Committees
Our board has an audit committee, a compensation committee and a nominating and corporate governance committee. Each of these committees consists of three members, each of whom is “independent” as defined by the rules of the NASD. In addition, all of the members of our audit committee satisfy the SEC requirements relating to independence of audit committee members. In addition, our board has a standing investment committee.
Audit Committee. The audit committee is comprised of three directors. The members of the audit committee are Messrs. Young (Chair), Hallagan and Morris. The audit committee oversees our accounting and financial reporting processes and the audits of our financial statements. The functions and responsibilities of the audit committee include:
| • | establishing, monitoring and assessing our policies and procedures with respect to business practices, including the adequacy of our internal controls over accounting and financial reporting; | |
| • | engaging our independent auditors and conducting an annual review of the independence of our independent auditors; | |
| • | pre-approving any non-audit services to be performed by our independent auditors; | |
| • | reviewing the annual audited financial statements and quarterly financial information with management and the independent auditors; | |
| • | reviewing with the independent auditors the scope and the planning of the annual audit; | |
| • | reviewing the findings and recommendations of the independent auditors and management’s response to the recommendations of the independent auditors; | |
| • | overseeing compliance with applicable legal and regulatory requirements, including ethical business standards; | |
| • | preparing the audit committee report to be included in our annual proxy statement; | |
| • | establishing procedures for the receipt, retention and treatment of complaints received by us regarding accounting, internal accounting controls or auditing matters; | |
| • | establishing procedures for the confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters; and | |
| • | reviewing the adequacy of the audit committee charter on an annual basis. |
Our independent auditors report directly to the audit committee. Each member of the audit committee has the ability to read and understand fundamental financial statements. Our board has determined that each member of the audit committee satisfies the SEC requirements relating to independence of audit committee members. Our board has determined that Mr. Young meets the requirements of an “audit committee financial expert” as defined by the rules of the SEC.
We provide appropriate funding, as determined by the audit committee, for payment of compensation to our independent auditors, any independent counsel or other advisors engaged by the audit committee and for administrative expenses of the audit committee that are necessary or appropriate in carrying out its duties.
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Compensation Committee. The compensation committee is comprised of three directors. The members of the compensation committee are Messrs. Traynor (Chair), Young and Morris. The compensation committee establishes, administers and reviews our policies, programs and procedures for compensating our executive officers and directors. The functions and responsibilities of the compensation committee include:
| • | evaluating the performance of and determining the compensation for our executive officers, including our chief executive officer; | |
| • | administering and making recommendations to our board with respect to our equity incentive plans; | |
| • | overseeing regulatory compliance with respect to compensation matters; | |
| • | reviewing and approving employment or severance arrangements with senior management; | |
| • | reviewing our director compensation policies and making recommendations to our board; | |
| • | preparing the compensation committee report to be included in our annual proxy statement; and | |
| • | reviewing the adequacy of the compensation committee charter. |
Nominating and Corporate Governance Committee. The nominating and corporate governance committee is comprised of three directors. The members of the nominating and corporate governance committee are Messrs. Morris (Chair), Traynor and Young. The functions and responsibilities of the nominating and corporate governance committee include:
| • | developing and recommending corporate governance principles and procedures applicable to our board and employees; | |
| • | recommending committee composition and assignments; | |
| • | identifying individuals qualified to become directors; | |
| • | recommending director nominees; | |
| • | recommending whether incumbent directors should be nominated for re-election to our board; and | |
| • | reviewing the adequacy of the nominating and corporate governance committee charter. |
Investment Committee. The investment committee is comprised of four directors. The members of the investment committee are Messrs. Hallagan (Chair), Bradley, Morris and Traynor. The functions and responsibilities of the investment committee include:
| • | establishing a written investment policy for the company consistent with our strategies, goals and objectives, which investment policy and any amendments must be reviewed and approved by our board of directors; | |
| • | reviewing regulatory requirements and compliance with our written investment policy at least annually; | |
| • | reviewing our investment policy and the investment strategy relative to our investment policy; | |
| • | reviewing the performance of our external investment managers; and | |
| • | reviewing our investment activities and performance at least quarterly. |
Compensation Committee Interlocks and Insider Participation
None of the members of our compensation committee is, or has been, employed by us. None of our executive officers currently serves, or in the past three years has served, as a member of the board of directors, compensation committee or other board committee performing equivalent functions of another entity that has one or more executive officers serving on our board or compensation committee. See “—Board Composition.”
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Director Compensation
Directors who are also our employees receive no compensation for serving as directors. Non-employee directors receive an annual cash retainer of $30,000. The chair of the audit committee receives an additional annual cash retainer of $15,000 and each other member of the audit committee receives an additional annual cash retainer of $5,000. The chairs of the compensation committee, nominating and corporate governance committee and investment committee each receive an additional annual cash retainer of $5,000. Under our 2005 non-employee director restricted stock plan, non-employee directors also receive an annual award of a number of shares of restricted stock equal to $15,000 divided by the closing price of our common stock on the date of our annual shareholders meeting at which the non-employee director is elected or re-elected as a member of the board. We also reimburse all directors for reasonableout-of-pocket expenses they incur in connection with their service as directors.
Management Compensation and Incentive Plans
Our compensation policies are designed to maximize shareholder value over the long term. Through our compensation and incentive plans we seek to attract and retain select employees, officers and directors and motivate these individuals to devote their best efforts to our business and financial success.
The following table sets forth certain information regarding the compensation of our chief executive officer and each of our other executive officers for the years ended December 31, 2005 and December 31, 2004.
| Long Term | ||||||||||||||||||||||||||||
| Compensation Awards | ||||||||||||||||||||||||||||
| Annual Compensation | Restricted | Securities | ||||||||||||||||||||||||||
| Other Annual | Stock | Underlying | All Other | |||||||||||||||||||||||||
Name and Principal Position | Year | Salary | Bonus | Compensation(1) | Awards(2) | Options | Compensation(3) | |||||||||||||||||||||
| C. Allen Bradley, Jr. | 2005 | $ | 294,292 | $ | 225,000 | $— | $ | 75,000 | 475,000 | $ | 4,132 | |||||||||||||||||
| Chairman, President and | 2004 | 275,000 | 125,000 | — | — | 0 | 4,132 | |||||||||||||||||||||
| Chief Executive Officer | ||||||||||||||||||||||||||||
| Geoffrey R. Banta | 2005 | 215,833 | 105,000 | — | 35,000 | 237,500 | 4,132 | |||||||||||||||||||||
| Executive Vice President and | 2004 | 200,000 | 80,000 | — | — | 0 | 2,412 | |||||||||||||||||||||
| Chief Financial Officer | ||||||||||||||||||||||||||||
| Arthur L. Hunt | 2005 | 218,958 | 105,000 | — | 35,000 | 237,500 | 4,132 | |||||||||||||||||||||
| Executive Vice President, | 2004 | 215,000 | 80,000 | — | — | 0 | 4,132 | |||||||||||||||||||||
| General Counsel and Secretary | ||||||||||||||||||||||||||||
| Craig P. Leach | 2005 | 218,958 | 75,000 | — | 25,000 | 237,500 | 4,132 | |||||||||||||||||||||
| Executive Vice President, | 2004 | 215,000 | 70,000 | — | — | 0 | 4,132 | |||||||||||||||||||||
| Sales and Marketing | ||||||||||||||||||||||||||||
| Mark R. Anderson(4) | 2005 | 200,000 | — | — | — | 95,000 | 4,132 | |||||||||||||||||||||
| Former Chairman | 2004 | 352,000 | 40,000 | — | — | 0 | 4,132 | |||||||||||||||||||||
| (1) | Perquisites and other personal benefits received by our named executive officers in 2005 and 2004 are not included in the Summary Compensation Table because the aggregate amount of this compensation did not meet disclosure thresholds established under the SEC’s regulations. | |
| (2) | None of our named executive officers held shares of restricted stock on December 31, 2005. As a portion of the incentive compensation awards for 2005, in March 2006 the following named executive officers were granted shares of restricted stock: Mr. Bradley (7,035 shares), Mr. Banta (3,283 shares), Mr. Hunt (3,283 shares) and Mr. Leach (2,345 shares). These shares of restricted stock will vest on March 10, 2007. Our executive officers will be entitled to receive dividends, if any, on these shares of restricted stock. | |
| (3) | For each of our named executive officers in 2005, these amounts consist of (a) 401(k) plan matching contributions of $4,100 and (b) life insurance premiums paid by us in the amount of $32. | |
| (4) | Mr. Anderson retired on December 31, 2005. He currently is a consultant to the Company. See “Employment and Consulting Agreements—Consulting Agreement” below. |
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Our 2005 incentive compensation program consisted of cash bonuses and grants of restricted stock under our 2005 equity incentive plan. The incentive compensation awarded to our named executive officers was determined by the compensation committee of our board of directors. The amount awarded to each named executive officer was based upon several factors, including company performance as compared to our business plan, the performance of the executive officer in his area of responsibility and the overall profitability of our company.
Option Grants in Last Fiscal Year
The following table contains information regarding stock option grants made to the executive officers named in the Summary Compensation Table during the year ended December 31, 2005.
| Individual Grants | ||||||||||||||||||||||||
| Number of | % of Total | Potential Realizable Value | ||||||||||||||||||||||
| Securities | Options | at Assumed Annual Rates of | ||||||||||||||||||||||
| Underlying | Granted to | Exercise | Stock Price Appreciation | |||||||||||||||||||||
| Options | Employees in | Price per | Expiration | for Option Term(1) | ||||||||||||||||||||
Name | Granted(2) | 2005(3) | Share | Date | 5% | 10% | ||||||||||||||||||
| C. Allen Bradley, Jr. | 475,000 | 30.7 | $ | 9.00 | 11/17/2015 | $ | 2,688,525 | $ | 6,813,249 | |||||||||||||||
| Geoffrey R. Banta | 237,500 | 15.4 | 9.00 | 11/17/2015 | 1,344,262 | 3,406,625 | ||||||||||||||||||
| Arthur L. Hunt | 237,500 | 15.4 | 9.00 | 11/17/2015 | 1,344,262 | 3,406,625 | ||||||||||||||||||
| Craig P. Leach | 237,500 | 15.4 | 9.00 | 11/17/2015 | 1,344,262 | 3,406,625 | ||||||||||||||||||
| Mark. R. Anderson | 95,000 | 6.1 | 9.00 | 11/17/2015 | 537,705 | 1,362,650 | ||||||||||||||||||
| (1) | The 5% and 10% assumed annual rates of compounded stock price appreciation are mandated by rules of the SEC. Potential realizable value is determined by multiplying the per share market value of the Company common stock as of the date of the grant, which is equal to the per share exercise price of the option, and the sum of one plus the adjusted stock price appreciation rate (the assumed rate of appreciation compounded annually over the term of the option), subtracting the exercise price per share from the product, and multiplying the remainder by the number of securities underlying the grant at fiscal year end. | |
| (2) | The options vest with respect to 20% of the option shares on each of the first five anniversaries of the grant date. | |
| (3) | Options to purchase a total of 1,545,168 shares of common stock were granted to employees in 2005. |
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values
There were no options exercised by our executive officers during 2005. The following table contains certain information concerning the value of unexercised options at December 31, 2005.
| Number of Securities Underlying | Value of Unexercised | |||||||||||||||
| Unexercised Options | In-the-Money Options | |||||||||||||||
| at December 31, 2005 | at December 31, 2005(1) | |||||||||||||||
Name | Exercisable | Unexercisable | Exercisable | Unexercisable | ||||||||||||
| C. Allen Bradley, Jr. | 0 | 475,000 | $ | 0 | $ | 508,520 | ||||||||||
| Geoffrey R. Banta | 0 | 237,500 | 0 | 254,125 | ||||||||||||
| Arthur L. Hunt | 0 | 237,500 | 0 | 254,125 | ||||||||||||
| Craig P. Leach | 0 | 237,500 | 0 | 254,125 | ||||||||||||
| Mark. R. Anderson | 0 | 95,000 | 0 | 101,650 | ||||||||||||
| (1) | The value of the options at December 31, 2005 is based upon a market value per share of $10.07, the closing price of the Company’s common stock on December 30, 2005. |
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Employment and Consulting Agreements
The following information summarizes the employment and consulting agreements for our chief executive officer and our other executive officers.
Employment Agreements. We have an employment agreement with each of our executive officers. The employment agreements with Messrs. Bradley, Banta, Hunt and Leach each expire in January 2008, unless extended. The employment agreements with Messrs. Narigon and Walker expire in September 2009, unless extended. Beginning on the applicable expiration date, the term of each agreement is automatically extended for an additional one-year term unless either party provides notice not to extend the term. The agreements provide for an annual base salary of $120,000,not less than $275,000 for Mr. Bradley, $200,000 for Mr. Banta, $215,000 for each of Mr. Hunt and Mr. Leach, serves as Vice President -- Business Development of the Company$185,000 for Mr. Narigon and receives an annual base salary of $125,000, and$175,000 for Mr. Bradley serves as Vice
President -- Risk Services Group and General Counsel of the Company and
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receives an annual base salary of $120,000. In addition to their annual base
salaries, each of the Executive Officers isWalker. They are also entitled to receive an annual bonus atin an amount, if any, determined by our compensation committee. Each executive officer may participate in present and future benefit plans that are provided to our executive officers from time to time.
If we terminate the discretionemployment of one of our executive officers without cause, as defined in the Board of Directors. The Employment Agreements provide
for salary adjustments atemployment agreements, the discretion of the Board of Directors and further
provide that the Executive Officersterminated executive officer will be entitled to participate in
Company-sponsored employee benefit plans or arrangements and other benefits
generally available to employees of the Company. Each Employment Agreement
provides that if the Executive Officer's employment is involuntarily terminated
by the Company other than for "cause" (as defined in the Employment Agreement),
the Executive Officer, subject to certain conditions, shall receive termination
payments calculated in accordance with the Employment Agreementhis base salary for a period of 12 months (or, in the case of Mr. Bradley, 18 months) payable in regular installments after the date of his termination. In addition, we have agreed to pay the terminated executive officer the actual cost of continuing health coverage premiums for a period of 12 months (or, in the case of Mr. Bradley, 18 months) after the date of his termination. Each of our executive officers has agreed during the term of his employment by us not to engage in any business competitive with us or solicit our employees, agents or policyholders without our prior written consent. If one yearof our executive officers is terminated by us without cause, the prohibition on engaging in competitive activities or soliciting our employees, agents or policyholders extends for a period of 12 months (or, in the case of Mr. Bradley, 18 months) after the date of termination. SubjectIf these executive officers are terminated by us for cause or as a result of a resignation, as defined in the employment agreements, or if an executive officer elects not to certain exceptions, each
Executive Officer's Employment Agreement prohibits him from competing withrenew the term of his employment agreement, we have the option to extend the restriction on engaging in competitive or working for a competitor of the Company or any of its subsidiariessolicitation activities for a period of one year12 months (or, in the case of Mr. Bradley, 18 months) after the date of termination or non-renewal by (a) delivering a written notice to the executive officer within 180 days after his termination or non-renewal, and (b) paying his base salary and the actual cost of his continuing health coverage premiums for a period of 12 months (or, in the case of Mr. Bradley, 18 months) after the date of his termination or non-renewal.
Consulting Agreement. Mr. Anderson served as an executive officer of the Company from 1986 until his retirement on December 31, 2005. In connection with his retirement, we entered into an agreement with Mr. Anderson that provides that he will serve as an independent consultant for a five-year period expiring in January 2011. As a consultant, Mr. Anderson will perform general consulting and advisory services as may be requested from time to time by our Chief Executive Officer. Mr. Anderson will receive an annual fee of $125,000, payable quarterly, during the term of the agreement. The consulting agreement may be terminated by Mr. Anderson upon 90 days’ written notice to us, or by us upon notice to Mr. Anderson for cause.
During the term of his agreement, Mr. Anderson is not permitted to engage, directly or indirectly, in a business similar to our business or to solicit our customers, clients or insureds within a designated area, unless he obtains our prior written consent. If the consulting agreement is terminated prior to its expiration, we have the right to extend this restriction for up to 24 months, but not beyond January 1, 2011, if we pay Mr. Anderson the consulting fee that he would otherwise have been entitled to receive during the extended period if the agreement had not been terminated. In addition, during the term of his agreement and for two years after the termination or expiration of his agreement, Mr. Anderson is not permitted, directly or indirectly, to solicit or induce any of our employees, agents (including insurance agents) or consultants to leave his or her employment or terminate his or her consulting agreement with the Company, if his
employment is involuntarily terminated by the Company other than for "cause".
Upon the expiration of the initial three-year term and on each subsequent
anniversary thereof, each Employment Agreement automatically renews for an
additional one-year period unless earlier terminated by either party upon 90
day's notice given prior to the end of the initial term or any extension. Mr.
Morris' Employment Agreement does not provide for him to devote his full time to
the business and affairs of the Company.
STOCK INCENTIVE PLAN
General. The Board of Directors of the Company adopted the AMERISAFE, Inc.
1996 Stockus.
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2005 Equity Incentive Plan (the "Stock Incentive Plan") on August 5, 1996,
subject to approval by the shareholders of the Company. A majority of the
holders of the Common Stock of the Company approved the Stock Incentive Plan on
August 5, 1996.
Plans
| Equity Incentive Plan |
The purpose of the Stock Incentive Planour 2005 equity incentive plan is to enable the Company to attract and retain directors, officers, and other key employees and consultants and to provide them with appropriate incentives and rewards for superior performance. The Stock Incentive
PlanA summary of the provisions of the 2005 incentive plan is to be administeredset forth below. This summary is qualified in its entirety by the Compensation Committee. The Stock Incentive
Plan affordsdetailed provisions of the Compensation Committee2005 incentive plan, a copy of which has been filed as an exhibit to the flexibility to respond to changesregistration statement of which this prospectus is a part. Our board of directors and shareholders approved the 2005 incentive plan in October 2005.
Types of Awards and Eligibility. Our 2005 incentive plan permits awards in the competitive and legal environments, thereby protecting and enhancing the
Company's current and future ability to attract and retain officers and other
key employees and consultants.
The Stock Incentive Plan authorizes the grantingform of incentive stock options, to purchase
shares of Class A Common Stock ("Option Rights"), stock appreciation rights
("Appreciation Rights") and restricted shares ("Restricted Shares"). The terms
applicable to these various types of awards, including those terms that may be
established by the Compensation Committee when making or administering
particular awards, are set forthas defined in detail in the Stock Incentive Plan.
Summary of Stock Incentive Plan.
Shares Available Under the Stock Incentive Plan. Subject to adjustment as
provided in the Stock Incentive Plan, the number of shares of Class A Common
Stock that may be issued or transferred, plus the number of shares of Class A
Common Stock covered by outstanding awards granted under the Stock Incentive
Plan, shall not in the aggregate exceed 3,000,000.
Eligibility. Directors, officers and other salaried employees of the
Company or its subsidiaries may be selected by the Compensation Committee to
receive benefits under the Stock Incentive Plan. Under the Stock Incentive Plan,
the Company's Board of Directors (the "Board") may also make grants and further
provides that only the Board may award grants to members of the Compensation
Committee.
Option Rights. The Compensation Committee may grant Option Rights that
entitle the optionee to purchase shares of Class A Common Stock. The option
price is payable at the time of exercise (i) in cash or cash equivalents, (ii)
by the transfer to the Company of shares of Class A Common Stock that are
already owned by the optionee and have a value at the time of exercise equal to
the option price, (iii) with any other legal consideration the Compensation
Committee may deem appropriate, or (iv) by any combination of the foregoing
methods of payment. Any grant may provide for deferred payment of the option
price from the
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proceeds of sale through a broker of some or all of the shares of Class A Common
Stock to which the exercise relates.
Option Rights granted under the Stock Incentive Plan may be Option Rights
that are intended to qualify as "incentive stock options" within the meaning of
Section 422422(b) of the Internal Revenue Code of 1986, as amended (the "Code"),non-qualified stock options, restricted shares of common stock and restricted stock units. The maximum number of shares of common stock that may be issued pursuant to option grants and restricted stock and restricted stock unit awards under the 2005 incentive plan is 1.9 million shares, subject to the authority of our board to adjust this amount in the event of a merger, consolidation, reorganization, stock dividend, stock split, combination of shares, recapitalization or Option Rightssimilar transaction affecting our common stock. Officers, other key employees, consultants and other persons performing services for us that are equivalent to those typically provided by our employees are eligible to participate in the 2005 incentive plan. However, only employees (including our officers) can receive grants of incentive stock options.
Administration. The 2005 incentive plan is administered by our compensation committee. Subject to the terms of the 2005 incentive plan, the compensation committee may select participants to receive awards, determine the types of awards and terms and conditions of awards, and interpret provisions of the 2005 incentive plan.
Stock Options. Stock options granted under the 2005 incentive plan will have an exercise price of not intended to so qualify. At or afterless than 100% of the fair value of our common stock on the date of grantgrant. However, any stock options granted to holders of any nonqualified Option Rights, the Compensation Committee may provide for
the paymentmore than 10% of dividend equivalents to the optionee on a current, deferred or
contingent basis or may provide that dividend equivalents be credited against
the option price. The Compensation Committee has the authority to specify at the
time Option Rights are granted that sharesour voting stock will have an exercise price of Class A Common Stock will not be
accepted in paymentless than 110% of the fair value of our common stock on the date of grant. Stock option price until they have been ownedgrants are exercisable, subject to vesting requirements determined by the optioneecompensation committee, for a specified period; however, the Stock Incentive Plan does not
require any such holding period and would permit immediate sequential exchangesperiods of shares of Class A Common Stock at the time of exercise of Option Rights.
No Option Right may be exercised more than 10up to ten years from the date of grant.
Each grant, must specifyexcept for any grants to holders of more than 10% of our voting stock, which will have exercise periods limited to a maximum of five years. Stock options generally expire 90 days after the conditions, includingcessation of an optionee’s service as and to the extent
determined by the Compensation Committee, the period of continuous employment or
continuous engagement of consulting services by the Company that are necessary
before the Option Rights will become exercisable, and may provide for the
earlier exercise of the Option Rights, including, without limitation, in the
event of a change in control of the Company or other similar transaction or
event. Successive grants may be made to the same optionee regardless of whether
Option Rights previously granted to him or her remain unexercised.
Appreciation Rights. Appreciation Rights granted under the Stock Incentive
Plan may be either free-standing or granted in tandem with Option Rights. An
Appreciation Right represents the right to receive from the Company the
difference (the "Spread"), or a percentage thereof not in excess of 100 percent,
between the base price per share of Class A Common Stockan employee. However, in the case of a
free-standing Appreciation Right,an optionee’s death or disability, the option price of the related Option
Right in the caseunexercised portion of a tandem Appreciation Right, andstock option remains exercisable for up to one year after the market value of the
Class A Commonoptionee’s death or disability. Stock on the date of exercise of the Appreciation Right. Tandem
Appreciation Rights may only be exercised at a time when the related Option
Right is exercisable and the Spread is positive, and the exercise of a tandem
Appreciation Right requires the surrender of the related Option Right for
cancellation. A free-standing Appreciation Right must have a base price that is
at least equal to the fair market value of a share of Class A Common Stock on
the date of grant, must specify the conditions, including as and to the extent
determined by the Compensation Committee, the period of continuous employment or
continuous engagement of consulting services and may not be exercised more than
10 years from the date of grant. Any grant of Appreciation Rights may specify
that the amount payable by the Company upon exercise may be paid in cash, shares
of Class A Common Stock or combination thereof and the Compensation Committee
may either reserve or grant to the recipient the right to elect among those
alternatives. The Compensation Committee may provide with respect to any grant
of Appreciation Rights for the payment of dividend equivalents thereon in cash
or Class A Common Stock on a current, deferred or contingent basis.
Restricted Shares. An award of Restricted Shares involves the immediate
transfer by the Company to a participant of ownership of a specific number of
shares of Class A Common Stock in consideration of the performance of services.
The participant is entitled immediately to voting, dividend and other ownership
rights in the shares of Class A Common Stock. The transfer may be made without
additional consideration or for consideration in an amount that is less than the
market value of the shares on the date of grant, as the Compensation Committee
may determine.
Restricted Shares may be subject to a "substantial risk of forfeiture"
within the meaning of Section 83 of the Code for a period to be determined by
the Compensation Committee. An example would be a provision that the Restricted
Shares would be forfeited if the participant ceased to serve the Company as a
director, officer or other salaried employee during a specified period of years.
In order to enforce these forfeiture provisions, the transferability of
Restricted Shares will be prohibited or restricted in a manner and to the extent
prescribed by the Compensation Committee for the period during which the
forfeiture provisions are to continue. The Compensation Committee may provide
for a shorter period during which the forfeiture
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provisions are to apply, including, without limitation, in the event of a change
in control of the Company any or other similar transaction or event.
Transferability. Unless the agreement evidencing such grant provides
otherwise, no Option Right, or other "derivative security" within the meaning of
Rule 16b-3options granted under the Exchange Act will be2005 incentive plan are not transferable, by a participant except by will or the laws of descent and distributiondistribution.
Restricted Stock Awards. A restricted stock award is the grant or pursuantsale of common stock with restrictions on transferability, and subject to a qualified
domestic relations order,vesting as that term is defineddetermined by the compensation committee. Restricted stock awards under the Code2005 incentive plan may be made without additional consideration or the Employee
Retirement Income Security Act of 1974, as amended. Option Rights may not be
exercised duringin consideration for a participant's lifetime exceptpayment by the participant that is less than the fair value of our common stock on the date of grant. For as long as an award of restricted stock is subject to vesting, there is a risk of forfeiture if the individual leaves our employment prior to full vesting of the award. Restrictions may lapse separately or in combination at relevant times, such as after a specified period of employment or the satisfaction of pre-established criteria, in installments or otherwise, all as the compensation committee may determine. Except to the extent provided otherwise under the award agreement relating to the restricted stock award, a participant awarded restricted stock will have all of the rights of a shareholder, including, without limitation, the right to vote and the right to receive dividends. Restricted stock awards under the 2005 incentive plan cannot be transferred except as agreed by the compensation committee, and in accordance with applicable U.S. federal and state securities laws.
Restricted Stock Units. The compensation committee may authorize the grant or sale of restricted stock units subject to the conditions and restrictions, and for the restriction period, which will generally be at least one year, that it determines in its discretion. Each restricted stock unit is equivalent in value to one share of
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common stock and entitles the grantee to receive or purchase one share of common stock for each restricted stock unit at the end of the restriction period applicable to such restricted stock unit, subject to the fulfillment during the restriction period of such conditions as the compensation committee may specify. During the applicable restricted period for a given restricted stock unit, the grantee will not have any right to transfer the rights associated with the restricted stock units and will have no ownership or voting rights with respect to the restricted stock units or the underlying shares of common stock.
Amendment or Termination. While our board of directors may terminate or amend the 2005 incentive plan at any time, no amendment may adversely impair the rights of participants with respect to outstanding awards. In addition, an amendment will be contingent upon approval of our shareholders to the extent required by law or if the amendment would increase the aggregate number of shares of common stock for awards under the 2005 incentive plan, decrease the minimum exercise price or change the class of employees eligible to receive incentive stock options under the plan. Unless terminated earlier, the 2005 incentive plan will terminate in 2015, but will continue to govern unexpired awards.
Change of Control. At the discretion of the compensation committee at the time of award, agreements for option, restricted stock and restricted stock unit awards may contain provisions providing for the acceleration of the options, restricted stock or restricted stock units upon a change of control of our company.
| Non-Employee Director Restricted Stock Plan |
The purpose of our 2005 non-employee director restricted stock plan is to attract and retain qualified directors. A summary of the provisions of the 2005 non-employee director plan is set forth below. This summary is qualified in its entirety by the detailed provisions of the 2005 non-employee director plan, a copy of which has been filed as an exhibit to the registration statement of which this prospectus is a part. Our board of directors and shareholders approved the 2005 non-employee director plan in October 2005.
Type of Award and Eligibility. The 2005 non-employee director plan provides for the automatic grant of restricted stock awards to our non-employee directors. The aggregate number of shares of restricted stock that may be issued under the plan is 50,000 shares, subject to the authority of our board to adjust this amount in the event of his or her incapacity, by his or her guardian or legal representative
acting in a fiduciary capacity on behalf of the participant under the state law
and court supervision.
Adjustments. The maximum numbermerger, consolidation, reorganization, stock dividend, stock split, combination of shares, of Class A Common Stock that may
be issuedrecapitalization or transferred under the Stock Incentive Plan, the number of shares
covered by outstanding awardssimilar transaction affecting our common stock.
Administration and the option prices per share applicable
thereto, are subject to adjustment in the event of stock dividends, stock
splits, combinations of shares, recapitalizations, mergers, consolidations,
spin-offs, reorganizations, liquidations, issuances of rights or warranties, and
similar transactions or events. In the event of any such transaction or event,
the Compensation Committee may in its discretion provide in substitution for any
or all outstanding awards under the Stock Incentive Plan such alternative
consideration as it may in good faith determine to be equitable in the
circumstances and may require the surrender of all awards so replaced.
Administration.Terms. The Stock Incentive Plan2005 non-employee director plan is administered by the Compensation Committee. In connection with its administrationcompensation committee of the Stock
Incentive Plan, the Compensation Committee is authorized to interpret the Stock
Incentive Plan and related agreements and other documents. The Compensation
Committee may make grants to participants under any or a combinationour board of all of
the various categories of awards that are authorized under the Stock Incentive
Plan and may provide for special terms fordirectors. Restricted stock awards to participants whonon-employee directors are foreign nationals, asgenerally subject to terms including non-transferability, immediate vesting upon death or total disability of a director, forfeiture of unvested shares upon termination of service by a director and acceleration of vesting upon a change of control of our company.
Automatic Grants. Under the Compensation Committee may consider necessary or
appropriate2005 non-employee director plan, each non-employee director is automatically granted a restricted stock award for a number of full shares equal to accommodate differences in local law, tax policy or custom.
Amendments. The Stock Incentive Plan may be amended from time to time$15,000 divided by the Compensation Committee, but without further approval by the shareholdersclosing price of the Company no such amendment (unless expressly allowed pursuant to the
adjustment provisions described above) may cause Rule 16b-3 under the Exchange
Act to cease to be applicable to the Stock Incentive Plan.
Federal Income Tax Consequences. The following is a brief summary of
certain of the federal income tax consequences of certain transactions under the
Stock Incentive Plan based on federal income tax laws in effectour common stock on the date of this Prospectus. This summaryour annual shareholders meeting at which the non-employee director is not intended to be exhaustive and does not
describe stateelected or local tax consequences.
Nonqualified Option Rights. In general: (i) no income will be recognized by
an optionee atis continuing as a member of the timeboard. If a nonqualified Option Rightnon-employee director is granted; (ii) at the time
of exercise of a nonqualified Option Right, ordinary income will be recognized
by the optionee in an amount equalelected to the difference between the option price
paid for the shares of Class A Common Stock and the fair market value of such
shares if they are nonrestricted on the date of exercise; and (iii)board other than at the time
of sale of shares acquired pursuantan annual shareholders meeting to the exercise offill a nonqualified Option
Right, any appreciation (or depreciation)vacancy or a directorship resulting from an increase in the valuenumber of such shares afterdirectors, the
date of exercise will be treated as either short-term capital gain (or loss)
depending on how long the shares of Class A Common Stock have been held.
Incentive Stock Options. No income generally will be recognized by an
optionee upon the grant or exercise of an incentive stock option. If shares of
Class A Common Stock are issued to an optionee pursuant to the exercise of an
incentive stock option and no disqualifying disposition of the shares is made by
the optionee within two years after the date of grant or within one year after
the transfer of the shares to the optionee, then upon the sale of the shares any
amount realized in excess of the option price will be taxed to the optionee as
long-term capital gain and any loss sustained will be long-term capital loss.
If shares of Class A Common Stock acquired upon the exercise of an
incentive stock option are disposed of prior to the expiration of either holding
period described above, the optionee generally will recognize ordinary income in
the year of disposition in an amount equal to any excess of the fair market
value of the
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shares of Class A Common Stock at the time of exercise (or, if less, the amount
realized on the disposition of the shares in a sale or exchange) over the option
price paid for the shares. Any further gain (or loss) realized by the optionee
generally will be taxed as short-term or long-term capital gain (or loss)
depending on the holding period.
Restricted Shares. A recipient of Restricted Shares generally will be
subject to tax at ordinary income rates on the fair market value of the
Restricted Shares reduced by any amount paid by the recipient at such time as
the shares are no longer subject to a risk of forfeiture or restrictions on
transfer for purposes of Section 83 of the Code. However, a recipient who so
elects under Section 83(b) of the Code within 30 days of the date of transfer of
the shares will have taxable ordinary income on the date of transfer of the
shares equal to the excess of the fair market value of the shares (determined
without regard to the risk of forfeiture or restrictions on transfer) over any
purchase price paid for the shares. If a Section 83(b) election has not been
made, any non-restricted dividends received with respect to Restricted Shares
that are subject at that time to a risk of forfeiture or restrictions on
transfer generally will be treated as compensation that is taxable as ordinary
income to the recipient.
Special Rules Applicable to Officers and Directors. In limited
circumstances where the sale of shares of Class A Common Stock that are received
as the result of a grant of an award could subject an officer or director to
suit under Section 16(b) of the Exchange Act, the tax consequences to the
officer or director may differ from the tax consequences described above. In
these circumstances, unless a special election has been made, the principal
difference usually will be to postpone valuation and taxation of the shares of
Class A Common Stock received so long as the sale of shares of Class A Common
Stock received could subject the officer or director to suit under Section 16(b)
of the Exchange Act, but no longer than six months.
Tax Consequences to the Company. To the extent that a participant
recognized ordinary income in the circumstance described above, the Company or
subsidiary for which the participant performs services will be entitled to a
corresponding deduction provided that, among other things, the income meets the
test of reasonableness, is an ordinary and necessary business expense, is not
subject to the annual compensation limitation set forth in Section 162(m) of the
Code and is not "excess parachute payment" within the meaning of Section 280G of
the Code.
Awards. Option Rights with respect to a total of 600,000 shares of Class A
Common Stock have been granted under the Stock Incentive Plan, including Option
Rights granted to executive officers of the Company as set forth in the table
below. The Option Rights are exercisable at a price equal to $12.00 per share
and vest in equal increments on each of the first five anniversaries of the date
of grant.
In addition, an aggregate of 60,000 Option Rights have been granted to certain
non-executive employees of the Company on the same terms as the grants to
executive officers.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to August 1996, the Company did not have a Compensation Committee or
other committee of the Board of Directors performing similar functions.
Decisions concerning compensation of executive officers of the Company were made
by the Company's Board of Directors. After the Offering, compensation decisions
will be made by the Compensation Committee, currently consisting of Messrs.
Jessee and Spence.
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DIRECTOR COMPENSATION
Directors who are employees of the Company will not be paid any fees or
additional compensation for service as members of the Board of Directors or any
committee thereof. Each non-employee director will receive $3,500 for each
meeting of the Board of Directors attended. Upon completion of the Offering,
non-employee directors will also receive a pro-rated grant of 3,000 Restricted Shares
underrestricted stock based upon the Stock Incentive Plan. Such grantnumber of whole months he or she will vest ratably over a three-year
period with 1,000 shares vesting onserve until the first anniversary of the datemost recent annual shareholders meeting and using the closing price of grant
and 1,000 shares vestingour common stock on each of the next two succeeding anniversaries. If a
non-employee director's membership on the Board of Directors of the Company is
terminated for any reason, the shares of restricted Class A Common Stock that
have not yet vested as of the date of such termination will be forfeited. See
"-- Stock Incentive Plan" above. Allgrant.
Limitations of Liability and Indemnification of Directors and Officers
As permitted by Texas law, our articles of incorporation provide that our directors will not be reimbursedpersonally liable to us or our shareholders for travelor with respect to any acts or omissions in the performance of such person’s duties as a director to the fullest extent permitted by applicable law. Our articles of incorporation and other relatedbylaws provide that we must indemnify our directors and officers to the fullest extent permitted by Texas law. Our bylaws further provide that we must pay or reimburse reasonable expenses incurred by one of our directors or officers who was, is or is threatened to be made a named defendant or respondent in attending meetingsa proceeding
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to the maximum extent permitted under Texas law. We believe that these provisions are necessary to attract and retain qualified persons as directors and officers.
We have entered into indemnification agreements with our directors and officers. These agreements, among other things, require us to indemnify the director or officer to the fullest extent permitted by Texas law, including indemnification for judgments, penalties, fines, settlements and reasonable expenses actually incurred by the director or officer in any action or proceeding, including any action by or in our right, arising out of the Boardperson’s services as our director or officer or as the director or officer of Directorsany subsidiary of ours or any committee thereof.
other company or enterprise to which the person provides services at our request. We have been informed that, in the opinion of the SEC, personal liability of directors for violation of the federal securities laws cannot be limited and that indemnification by us for any such violation is unenforceable.
The indemnification provisions contained in our articles of incorporation and bylaws are in addition to any other right that a person may have or acquire under any statute, bylaw, resolution of shareholders or directors or otherwise. We maintain insurance on behalf of our directors and officers insuring them against any liability asserted against them in their capacities as directors or officers or arising out of their service in these capacities.
We are not aware of any pending or threatened litigation or proceeding involving any of our directors, officers, employees or agencies in which indemnification would be required or permitted. We believe that the provisions of our articles of incorporation and bylaws and our indemnification agreements are necessary to attract and retain qualified persons to serve as directors and officers of our company.
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PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certaintables below contain information regardingabout the beneficial ownership of our common stock and our Series C convertible preferred stock prior to and following the Common Stock ascompletion of July 31, 1996 by: (i) each of the Company'sthis offering for:
