AMERICAN PHYSICIANS SERVICE GROUP, INC.


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

___________________________

FORM 10-Q

þ

Quarterly Report Pursuant to Sections 13 or 15(d) of the Securities Exchange Act of 1934

For the period ended

June 30, 2010

 

or

¨

Transition Report Pursuant to Sections 13 or 15(d) of

the Securities and Exchange Act of 1934

For the transition period from

__________ to __________

 

Commission File Number 001-31434

 

AMERICAN PHYSICIANS SERVICE GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

Texas

75-1458323

(State or other jurisdiction of

incorporation or organization)

(I.R.S. employer

Identification No.)

 

1301 S. Capital of Texas Highway, Suite C-300, Austin, Texas  78746

(Address of principal executive offices)(Zip Code)

 

(512) 328-0888

(Registrant’s telephone number, including area code)


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

 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

 

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

 

Large accelerated filer ¨                                                                                        Accelerated filer þ                

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

 

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

 

 

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

 


Title of Each Class

Common Stock, $.10 par value

Number of Shares Outstanding At

July 30, 2010

6,834,369









AMERICAN PHYSICIANS SERVICE GROUP, INC.


Table of Contents to Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2010


 

 

 

Page

 

 

Part I

Financial Information

 

 

 

 

 

Item 1.

 

Financial Statements

3

 

 

Unaudited Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009

3

 

 

Unaudited Consolidated Statements of Operations for the Three and Six Months ended June 30, 2010 and 2009

5

 

 

Unaudited Consolidated Statement of Shareholders' Equity and Comprehensive Income for the Six Months ended June 30, 2010 and 2009

7

 

 

Unaudited Consolidated Statements of Cash Flows for the Six Months ended June 30, 2010 and 2009

9

 

 

Notes to the Unaudited Consolidated Financial Statements

10

Item 2.

 

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

29

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

47

Item 4.

 

Controls and Procedures

49

 

 

 

 

 

 

 

Part II

Other Information

 

 

 

 

 

Item 1.

 

Legal Proceedings

50

Item 1A.

 

Risk Factors

50

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

50

Item 3.

 

Defaults Upon Senior Securities

51

Item 4.

 

(Removed and Reserved)

51

Item 5.

 

Other Information

51

Item 6.

 

Exhibits

52




2






PART 1

 

FINANCIAL INFORMATION

 

 

AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONSOLIDATED BALANCE SHEETS

 

 

 

 

 

 

 

 

(in thousands)

June 30,

 

December 31,

 

2010

 

2009

Assets

(Unaudited)

 

 

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturities available for sale, at fair value

$

235,401

 

$

226,583

Equity securities available for sale, at fair value

 

10,934

 

 

12,944

Other invested assets

 

1,703

 

 

1,534

Total investments

 

248,038

 

 

241,061

 

 

 

 

 

 

Cash and cash equivalents

 

15,781

 

 

18,277

Accrued investment income

 

1,735

 

 

1,700

Premiums receivable

 

17,543

 

 

15,678

Reinsurance recoverables on paid and unpaid loss and loss adjustment expenses

 

6,590

 

 

8,897

Other amounts receivable under reinsurance contracts

 

-

 

 

785

Deferred policy acquisition costs

 

2,369

 

 

2,335

Income tax receivable

 

2,484

 

 

623

Deferred tax assets

 

5,488

 

 

6,015

Property and equipment, net

 

436

 

 

406

Intangible assets

 

2,535

 

 

2,563

Other assets

 

4,237

 

 

1,432

 

 

 

 

 

 

Total assets

$

307,236

 

$

299,772


The accompanying notes are an integral part of these consolidated financial statements.



3






AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONSOLIDATED BALANCE SHEETS

 

 

 

 

 

 

 

 

(in thousands, except share and per share amounts)

June 30,

 

December 31,

 

2010

 

2009

Liabilities

(Unaudited)

 

 

 

 

 

 

 

 

 

Reserve for loss and loss adjustment expense

$

87,721

 

$

88,668

Unearned premiums

 

36,988

 

 

36,341

Reinsurance premiums payable

 

15

 

 

30

Funds held under reinsurance treaties

 

2,700

 

 

2,379

Trade payables

 

1,922

 

 

94

Accrued expenses and other liabilities

 

5,724

 

 

6,371

Mandatorily redeemable preferred stock

 

5,576

 

 

6,679

 

 

 

 

 

 

Total liabilities

 

140,646

 

 

140,562

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders' Equity

 

 

 

 

 

 

 

 

 

 

 

Common stock, $0.10 par value, 20,000,000 shares authorized, 6,807,369 and 6,876,215 issued and outstanding at June 30, 2010 and December 31, 2009

 

681

 

 

688

Additional paid-in capital

 

81,391

 

 

81,784

Accumulated other comprehensive income

 

5,660

 

 

5,345

Retained earnings

 

78,858

 

 

71,393

 

 

 

 

 

 

Total shareholders' equity

 

166,590

 

 

159,210

 

 

 

 

 

 

Total liabilities & shareholders' equity

$

307,236

 

$

299,772


The accompanying notes are an integral part of these consolidated financial statements.



4






AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2010

 

2009

 

2010

 

2009

REVENUES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross premiums written

$

14,456 

 

$

14,682 

 

$

33,080 

 

$

32,222 

Premiums ceded

 

(104)

 

 

335 

 

 

(253)

 

 

663 

Change in unearned premiums

 

1,719 

 

 

1,808 

 

 

(647)

 

 

397 

 

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

16,071 

 

 

16,825 

 

 

32,180 

 

 

33,282 

 

 

 

 

 

 

 

 

 

 

 

 

Investment income, net of investment expense

 

2,454 

 

 

2,666 

 

 

4,954 

 

 

5,217 

Realized capital gains (losses), net

 

185 

 

 

(142)

 

 

136 

 

 

(517)

Other-than-temporary impairments

 

(59)

 

 

(1,100)

 

 

(100)

 

 

(2,007)

Financial services

 

2,074 

 

 

1,827 

 

 

3,514 

 

 

3,275 

Other revenue

 

16 

 

 

45 

 

 

72 

 

 

102 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

20,741 

 

 

20,121 

 

 

40,756 

 

 

39,352 

 

 

 

 

 

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

4,874 

 

 

6,797 

 

 

11,815 

 

 

12,918 

Other underwriting expenses

 

2,529 

 

 

2,510 

 

 

5,688 

 

 

5,731 

Change in deferred policy acquisition costs

 

61 

 

 

264 

 

 

(34)

 

 

83 

Financial services expenses

 

2,363 

 

 

1,747 

 

 

4,055 

 

 

3,375 

General and administrative expenses

 

1,538 

 

 

1,164 

 

 

3,004 

 

 

2,388 

 

 

 

 

 

 

 

 

 

 

 

 

Total expenses

 

11,365 

 

 

12,482 

 

 

24,528 

 

 

24,495 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

9,376 

 

 

7,639 

 

 

16,228 

 

 

14,857 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

3,176 

 

 

2,718 

 

 

5,500 

 

 

5,206 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

6,200 

 

$

4,921 

 

$

10,728 

 

$

9,651 


The accompanying notes are an integral part of these consolidated financial statements.



5






AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands, except share data)

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2010

 

2009

 

2010

 

2009

Net income per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

 

 

Net Income

$

0.91

 

$

0.71

 

$

1.57

 

$

1.39

 

 

 

 

 

 

 

 

 

 

 

 

Diluted:

 

 

 

 

 

 

 

 

 

 

 

Net Income

$

0.90

 

$

0.70

 

$

1.54

 

$

1.36

 

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

6,813

 

 

6,923

 

 

6,835

 

 

6,958

 

 

 

 

 

 

 

 

 

 

 

 

Diluted weighted average shares outstanding

 

6,923

 

 

7,007

 

 

6,950

 

 

7,089


The accompanying notes are an integral part of these consolidated financial statements.



6






AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

For the Six Months ended June 30, 2010

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands, except share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Other

 

 

 

 

Total

 

Shares

 

Common

 

Paid-In

 

Retained

 

Comprehensive

 

Comprehensive

 

Treasury

 

Shareholders'

 

Outstanding

 

Stock

 

Capital

 

Earnings

 

Income

 

Income

 

Stock

 

Equity

Balance December 31, 2009

6,876,215 

 

$

688 

 

$

81,784 

 

$

71,393 

 

 

   

 

$

5,345 

 

$

 

$

159,210 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

4,528 

 

 

4,528

 

 

 

 

 

 

4,528 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on securities, (net of reclassification adjustment)

 

 

 

 

 

 

 

 

507

 

 

507 

 

 

 

 

507 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

$

5,035

 

 

 

 

 

 

 

 

 

Stock options expensed

 

 

 

 

112 

 

 

 

 

   

 

 

 

 

 

 

112 

Stock options exercised- proceeds

18,000 

 

 

 

 

230 

 

 

 

 

   

 

 

 

 

 

 

232 

Stock options exercised- exchanged

5,200 

 

 

 

 

81 

 

 

 

 

   

 

 

 

 

 

 

81 

Tax benefit from exercise of stock options

 

 

 

 

87 

 

 

 

 

   

 

 

 

 

 

 

87 

Treasury stock purchases

 

 

 

 

 

 

 

 

   

 

 

 

 

(608)

 

 

(608)

Cancelled treasury stock - purchased

(23,608)

 

 

(2)

 

 

(281)

 

 

(237)

 

 

   

 

 

 

 

520 

 

 

Cancelled treasury stock - exchanged

(3,350)

 

 

 

 

(40)

 

 

(48)

 

 

   

 

 

 

 

88 

 

 

Balance March 31, 2010

6,872,457 

 

$

687 

 

$

81,973 

 

$

75,635 

 

 

   

 

$

5,852 

 

$

 

$

164,147 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

6,200 

 

 

6,200 

 

 

 

 

 

 

6,200 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on securities, (net of reclassification adjustment)

 

 

 

 

 

 

 

 

(192)

 

 

(192)

 

 

 

 

(192)

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

$

6,009 

 

 

 

 

 

 

 

 

 

Stock options expensed

 

 

 

 

114 

 

 

 

 

   

 

 

 

 

 

 

114 

Stock options exercised- proceeds

10,000 

 

 

 

 

115 

 

 

 

 

   

 

 

 

 

 

 

116 

Stock options exercised- exchanged

9,700 

 

 

 

 

117 

 

 

 

 

   

 

 

 

 

 

 

118 

Tax benefit from exercise of stock options

 

 

 

 

85 

 

 

 

 

   

 

 

 

 

 

 

85 

Treasury stock purchases

 

 

 

 

 

 

 

 

   

 

 

 

 

(1,987)

 

 

(1,987)

Cancelled treasury stock - purchased

(78,700)

 

 

(8)

 

 

(940)

 

 

(887)

 

 

   

 

 

 

 

1,835 

 

 

Cancelled treasury stock - exchanged

(6,088)

 

 

 

 

(73)

 

 

(79)

 

 

   

 

 

 

 

152 

 

 

Dividends paid

 

 

 

 

 

 

(2,011)

 

 

   

 

 

 

 

 

 

(2,011)

Balance June 30, 2010

6,807,369 

 

$

681 

 

$

81,391 

 

$

78,858 

 

 

   

 

$

5,660 

 

$

 

$

166,590 


The accompanying notes are an integral part of these consolidated financial statements.




7






AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

For the Six Months ended June 30, 2009

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands, except share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Other

 

 

 

 

Total

 

Shares

 

Common

 

Paid-In

 

Retained

 

Comprehensive

 

Comprehensive

 

Treasury

 

Shareholders'

 

Outstanding

 

Stock

 

Capital

 

Earnings

 

Income

 

Income

 

Stock

 

Equity

Balance December 31, 2008

7,014,386 

 

$

701 

 

$

82,329 

 

$

53,067 

 

 

   

 

$

368 

 

$

 

$

136,465 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

4,730 

 

 

4,730 

 

 

 

 

 

 

4,730 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on securities, (net of reclassification adjustment)

 

 

 

 

 

 

 

 

1,821

 

 

1,821

 

 

 

 

1,821

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

$

6,551

 

 

 

 

 

 

 

 

 

Stock options expensed

 

 

 

 

161 

 

 

 

 

   

 

 

 

 

 

 

161 

Stock options exercised- exchanged

30,000 

 

 

 

 

415 

 

 

 

 

   

 

 

 

 

 

 

418 

Tax benefit from exercise of stock options

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

Treasury stock purchases

 

 

 

 

 

 

 

 

   

 

 

 

 

(1,506)

 

 

(1,506)

Cancelled treasury stock - purchased

(55,082)

 

 

(5)

 

 

(648)

 

 

(435)

 

 

   

 

 

 

 

1,088 

 

 

Cancelled treasury stock - exchanged

(20,480)

 

 

(2)

 

 

(241)

 

 

(175)

 

 

   

 

 

 

 

418 

 

 

Deferred compensation granted

2,300 

 

 

 

 

45 

 

 

 

 

 

 

 

 

 

 

 

45 

Balance March 31, 2009

6,971,124 

 

$

697 

 

$

82,066 

 

$

57,187 

 

 

   

 

$

2,189 

 

$

 

$

142,139 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

4,921 

 

 

4,921 

 

 

 

 

 

 

4,921 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on securities, (net of reclassification adjustment)

 

 

 

 

 

 

 

 

754 

 

 

754 

 

 

 

 

754 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

$

5,675 

 

 

 

 

 

 

 

 

 

Stock options expensed

 

 

 

 

121 

 

 

 

 

   

 

 

 

 

 

 

121 

Stock options exercised- exchanged

70,450 

 

 

 

 

860 

 

 

 

 

   

 

 

 

 

 

 

867 

Tax benefit from exercise of stock options

 

 

 

 

181 

 

 

 

 

   

 

 

 

 

 

 

181 

Treasury stock purchases

 

 

 

 

 

 

 

 

   

 

 

 

 

(2,709)

 

 

(2,709)

Cancelled treasury stock - purchased

(84,020)

 

 

(8)

 

 

(990)

 

 

(685)

 

 

   

 

 

 

 

1,683 

 

 

Cancelled treasury stock - exchanged

(48,073)

 

 

(5)

 

 

(568)

 

 

(453)

 

 

   

 

 

 

 

1,026 

 

 

Dividends paid ($0.30 per share)

 

 

 

 

 

 

(2,028)

 

 

   

 

 

 

 

 

 

(2,028)

Balance June 30, 2009

6,909,481 

 

$

691 

 

$

81,670 

 

$

58,942 

 

 

   

 

$

2,943 

 

$

 

$

144,246 


The accompanying notes are an integral part of these consolidated financial statements.



8






AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

(in thousands)

June 30,

 

2010

 

2009

Cash flows from operating activities:

 

 

 

 

 

Net Income

$

10,728 

 

$

9,651 

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

 

 

 

 

 

Amortization and accretion of investments

 

261 

 

 

(98)

Depreciation and amortization

 

222 

 

 

377 

Realized (gains) losses on investments

 

(136)

 

 

517 

Other than temporary impairments

 

100 

 

 

2,007 

Change in deferred acquisition costs

 

(34)

 

 

83 

Common stock awarded

 

 

 

45 

Stock options expensed

 

226 

 

 

282 

Deferred income tax benefit

 

357 

 

 

(802)

Excess tax benefits from stock-based compensation

 

(172)

 

 

(186)

Other non-cash items

 

 

 

125 

Changes in operating assets and liabilities, net of business acquisition:

 

 

 

 

 

Premium receivables, net

 

(1,865)

 

 

(230)

Other amounts receivable under reinsurance contracts

 

785 

 

 

1,497 

Reinsurance recoverables on unpaid and paid loss expenses

 

2,307 

 

 

3,274 

Funds held under reinsurance treaties

 

321 

 

 

286 

Reserve for losses and loss adjustment expenses

 

(947)

 

 

(1,738)

Unearned premiums

 

647 

 

 

(396)

Other receivables and assets

 

136 

 

 

409 

Federal income tax receivable/payable

 

(1,689)

 

 

(100)

Accrued expenses & other liabilities

 

(385)

 

 

184 

Net cash provided by operating activities

 

10,862 

 

 

15,187 

 

 

 

 

 

 

Cash flows used in investing activities:

 

 

 

 

 

Capital expenditures

 

(222)

 

 

(170)

Proceeds from the sale and maturities of available-for-sale equity and fixed maturity securities

 

35,657 

 

 

64,794 

Purchase of available-for-sale equity and fixed maturity securities

 

(43,687)

 

 

(67,343)

Collection of notes receivable and other

 

 

 

125 

Net cash used in  investing activities

 

(8,252)

 

 

(2,594)

 

 

 

 

 

 

Cash flows used in financing activities:

 

 

 

 

 

Excess tax benefits from stock-based compensation

 

172 

 

 

186 

Exercise of stock options

 

348 

 

 

Repurchases of common stock

 

(2,355)

 

 

(2,771)

Dividend paid

 

(2,011)

 

 

(2,028)

Preferred stock redemption

 

(1,260)

 

 

(1,209)

Net cash used in financing activities

 

(5,106)

 

 

(5,822)

 

 

 

 

 

 

Net change in cash and cash equivalents

 

(2,496)

 

 

6,771 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

18,277 

 

 

22,060 

Cash and cash equivalents at end of period

$

15,781 

 

$

28,831 


The accompanying notes are an integral part of these consolidated financial statements.



9





AMERICAN PHYSICIANS SERVICE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2010

(Unaudited)


1.

Basis of Presentation


The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The consolidated unaudited financial statements as of and for the three and six month periods ended June 30, 2010 and 2009 reflect all adjustments which are, in our opinion , necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. These consolidated financial statements have not been audited by our independent registered public accounting firm. The operating results for the interim periods are not necessarily indicative of results for the full fiscal year.


The notes to consolidated financial statements appearing in our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC should be read in conjunction with this Quarterly Report on Form 10-Q.


2.

Management’s Estimates


The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.


On an on-going basis, we evaluate our estimates, including our most significant estimates related to: reserve for losses and loss adjustment expenses; death, disability and retirement reserves; reinsurance premiums recoverable/payable; premiums ceded; deferred policy acquisition costs; impairment of assets including the fair value of investments; bad debts; income taxes; and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.


Although considerable judgment is inherent in these estimates, we believe that the current estimates are reasonable in all material respects. The estimates are reviewed regularly and adjusted, as necessary. Adjustments related to changes in estimates are reflected in our results of operations, or other comprehensive income (OCI), in the period in which those estimates are changed.



10





3.

New Accounting Pronouncements


In January 2010, the Financial Accounting Standards Board issued Accounting Standards Update No. 2010-06, Fair Value Measurements and Disclosures (subtopic ASC 820-10).  ASC 820-10 provides guidance as to how the fair value of a security may be measured, and describes three levels of inputs that may be used to measure fair value.  This update requires new disclosures regarding transfers in and out of Levels 1 and 2, and activity in Level 3 fair value measurements. A reporting entity shall disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers.  We did not have any transfers in or out of Level 1 and Level 2 fair value measurements for the three or six months periods ended June 30, 2010. With respect to Level 3 fair value measurements, activity in the reconciliation for these fair value measurements using significant unobservable inputs now requires the reporting entity to separately present information about purchases, sales, issuances and settlements on a gross basis instead of as a net number.  This update also clarifies existing disclosures with respect to the level of aggregation disclosed and disclosures about inputs and valuation techniques.  Specifically, a reporting entity shall provide fair value measurements for each class of assets and liabilities. A reporting entity shall also provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements, which are required for fair value measurements that fall in either Level 1 or Level 2. The new disclosures are effective for interim and annual reporting periods after December 15, 2009, except for disclosures about purchases, sales, issuances and settlements in the roll forward in Level 3 activity. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. We adopted the requirements of the Accounting Standards Update No. 2010-06 effective January 1, 2010.


4.

Investments


Available-For-Sale Fixed Maturities. Of the total $235,401,000 portfolio balance in available-for-sale fixed income maturities at June 30, 2010, all but $2,271,000 are considered investment grade securities.


Our entire fixed income portfolio consists of investment grade securities rated “BBB” or higher by Standard and Poor’s, Moody’s or Fitch rating agencies with the exception of one corporate bond and six collateralized mortgage obligations (“CMOs”) with a combined fair market value of approximately $2,271,000. The following table reflects the composition of our fixed income portfolio by security rating category of the issuer as of June 30, 2010. In cases where the rating agencies had a different rating assigned to a security, the classification in the table is the lower rating.


 

 

Fair Value

(in thousands)

 

 

Rating Category

 

 

Percentage

AAA / Aaa

 

$

156,872

 

67%

AA / Aa

 

 

27,340

 

11%

A / A

 

 

33,249

 

14%

BBB

 

 

15,669

 

7%

Non-investment grade

 

 

2,271

 

1%

Total

 

$

235,401

 

100%


Available-For-Sale Equity Securities.  We account for equity securities as available-for-sale. Our equity portfolio totals $10,934,000 as of June 30, 2010.




11





The amortized cost and estimated fair values of investments in fixed income and equity securities at June 30, 2010 and December 31, 2009 are as follows (in thousands):


 

Cost or

 

 

 

 

 

 

 

Estimated

June 30, 2010

Amortized

 

Gross Unrealized

 

Fair

 

Cost

 

Gains

 

Losses

 

Value

Fixed Maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. treasury notes / bills

$

16,776

 

$

889

 

$

-

 

$

17,665

U.S. government agency mortgage-backed bonds

 

18,886

 

 

1,738

 

 

-

 

 

20,624

U.S. government agency collateralized mortgage obligations

 

39,219

 

 

2,065

 

 

6

 

 

41,278

Collateralized mortgage obligations:

 

 

 

 

 

 

 

 

 

 

 

Prime CMOs

 

2,057

 

 

148

 

 

-

 

 

2,205

Alt A CMOs

 

2,158

 

 

125

 

 

-

 

 

2,283

U.S. government agency bonds / notes

 

17,512

 

 

207

 

 

-

 

 

17,719

Government tax-exempt bonds

 

32,264

 

 

1,811

 

 

-

 

 

34,075

Corporate bonds

 

98,046

 

 

2,165

 

 

659

 

 

99,552

Total fixed maturities

 

226,918

 

 

9,148

 

 

665

 

 

235,401

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

10,708

 

 

697

 

 

471

 

 

10,934

 

 

 

 

 

 

 

 

 

 

 

 

Total fixed maturities and equity securities

$

237,626

 

$

9,845

 

$

1,136

 

$

246,335


 

Cost or

 

Gross

 

Gross

 

Estimated

December 31, 2009

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

Cost

 

Gains

 

Losses

 

Value

Fixed Maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. treasury notes / bills

$

19,098

 

$

897

 

$

-

 

$

19,995

U.S. government agency mortgage-backed bonds

 

22,525

 

 

1,419

 

 

-

 

 

23,944

U.S. government agency collateralized mortgage obligations

 

42,762

 

 

2,169

 

 

-

 

 

44,931

Collateralized mortgage obligations:

 

 

 

 

 

 

 

 

 

 

 

Alt A CMOs

 

2,287

 

 

114

 

 

-

 

 

2,401

Prime CMOs

 

2,375

 

 

25

 

 

-

 

 

2,400

U.S. government agency bonds / notes

 

22,052

 

 

274

 

 

64

 

 

22,262

Government tax-exempt bonds

 

35,212

 

 

1,584

 

 

1

 

 

36,795

Corporate bonds

 

72,910

 

 

983

 

 

38

 

 

73,855

Total fixed maturities

 

219,221

 

 

7,465

 

 

103

 

 

226,583

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

12,081

 

 

1,013

 

 

150

 

 

12,944

 

 

 

 

 

 

 

 

 

 

 

 

Total fixed maturities and equity securities

$

231,302

 

$

8,478

 

$

253

 

$

239,527


Of our entire invested assets at June 30, 2010, including cash and cash equivalents:


·

23% is comprised of agency-backed mortgage obligations, with underlying collateral consisting of GNMA, FHLMC, or FNMA loans;

·

2% is comprised of non-agency CMOs;

·

64% is comprised of U.S. Treasury, government agency bonds and notes, municipal tax exempt bonds and corporate bonds; and

·

11% is comprised of cash, equities and other invested assets.




12





We regularly review our fixed maturity and equity securities for declines in fair value that we determine to be other-than-temporary impairments (“OTTI”).  For an equity security, if we do not have the ability and intent to hold the security for a sufficient period of time to allow for a recovery in value, we conclude that an OTTI has occurred, and the cost of the equity security is written down to the current fair value, with a corresponding charge to realized loss in our consolidated statements of operations.  During the three and six months ended June 30, 2010, we evaluated our equity portfolio for OTTI of certain securities. We based our review on a number of factors including, but not limited to, the severity and duration of the decline in fair value of the equity security as well as the cause of the decline, the length of time we have held the equity security, any third party research reports or analysis, and the financial condition and near-term prospects of the security’s issuer, taking into consideration the economic prospects of the issuer’s industry and geographical location. For the three and six months ended June 30, 2010, there were no write-downs in equity securities.


Within our portfolio at June 30, 2010, there were seven CMO securities classified as “Alternative-A” or “Alt-A”. These Alt-A securities are generally considered to have underlying mortgages with underwriting characteristics that are stronger than “subprime” mortgages but less stringent than “prime” mortgages. None of our CMOs have underlying mortgages classified as “subprime.” Also, all underlying mortgages of our CMOs have fixed rates.  


Beginning with the three months ended September 30, 2007, we saw a significant and rapid decline in the market value of our non-agency CMOs, specifically our Alt-A securities. We have considered the deepening national housing crisis and its potential effects on the underlying collateral in evaluating this decline, and concluded that the continued decreases in value of our Alt-A securities should be considered to be OTTI. Beginning in the fourth quarter of 2008, we also began to observe an increase in the market-reported delinquency rates for not only our Alt-A CMOs, but also our non-agency CMOs backed by prime loans. The delinquency data suggests that continuing home price declines and growth in unemployment are now affecting the behavior by a broader sector of mortgage borrowers, particularly those mortgages originated subsequent to 2005. Rising unemployment, housing price declines, tight credit conditions, volatility in interest rates and weakening consumer confidence not only contributed to rising delinquencies, but also significantly impacted our expectations regarding future performance, both of which are critical to assessing our OTTI.  


While we have the ability to hold our remaining non-agency CMOs to maturity, we have concluded that we have the intent to sell these securities which will further reduce our exposure to a continued deterioration of the housing sector provided we can obtain an appropriate price. For the six months ended June 30, 2010, we recognized a loss on our non-agency CMOs of $100,000, being the difference between the book value and their fair value as of June 30, 2010.  There were no sales of our non-agency CMOs during the six months ending June 30, 2010, and the fair market value of our non-agency CMOs is $4,488,000 as of June 30, 2010.


The pretax charges taken as a result of OTTIs that were recognized in earnings and included in realized loss for the three and six months ended June 30, 2010 and 2009 were as follows (in thousands):


 

Three Months Ended

 

Six Months Ended

 

June 30, 2010

 

June 30, 2009

 

June 30, 2010

 

June 30, 2009

Fixed Maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collateralized mortgage obligations:

 

 

 

 

 

 

 

 

 

 

 

Prime

$

-

 

$

867

 

$

-

 

$

1,151

Alt-A

 

59

 

 

233

 

 

100

 

 

504

Total fixed maturities

 

59

 

 

1,100

 

 

100

 

 

1,655

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

-

 

 

-

 

 

-

 

 

352

 

 

 

 

 

 

 

 

 

 

 

 

Total fixed maturities and equity securities

$

59

 

$

1,100

 

$

100

 

$

2,007




13





The aggregate write-down on the Alt-A securities beginning with the quarter ended September 30, 2007 through June 30, 2010 is $11,103,000 and the book value of all the Alt-A securities is $2,158,000 as of June 30, 2010. As of June 30, 2010, outside of our Alt-A and prime CMOs as shown in the table above, no other fixed maturities were deemed to have an OTTI.  


Gross realized gains and losses as a result of both sales and OTTI write-downs included in net realized loss in the consolidated statements of operations for the three and six month periods ended June 30, 2010 and 2009 were as follows (in thousands):


 

Three Months

 

Six Months

 

Ended

 

Ended

 

June 30,

 

June 30,

 

2010

 

2009

 

2010

 

2009

Realized gains (losses):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

Gross realized gain

$

73 

 

$

40 

 

$

80 

 

$

273 

Gross realized loss

 

(43)

 

 

(139)

 

 

(47)

 

 

(435)

Other-than-temporary losses

 

(59)

 

 

(1,100)

 

 

(100)

 

 

(1,655)

Net realized loss

 

(29)

 

 

(1,199)

 

 

(67)

 

 

(1,817)

 

 

 

 

 

 

 

 

 

 

 

 

Equities:

 

 

 

 

 

 

 

 

 

 

 

Gross realized gain

 

174 

 

 

82 

 

 

255 

 

 

93 

Gross realized loss

 

(19)

 

 

(125)

 

 

(152)

 

 

(448)

Other-than-temporary losses

 

 

 

 

 

 

 

(352)

Net realized loss

 

155 

 

 

(43)

 

 

103 

 

 

(707)

 

 

 

 

 

 

 

 

 

 

 

 

Total net realized loss

$

126 

 

$

(1,242)

 

$

36 

 

$

(2,524)


A summary of the amortized cost and fair market value of the Company’s investments in fixed maturities as of June 30, 2010, by contractual maturity, is as follows (in thousands):


 

June 30, 2010

 

Cost or

 

Estimated

 

Amortized

 

Fair

 

Cost

 

Value

Fixed maturity securities:

 

 

 

 

 

Due one year or less

$

14,041

 

$

14,097

Due after one year through five years

 

97,740

 

 

99,542

Due after five years through ten years

 

29,003

 

 

30,445

Due after ten years

 

23,813

 

 

24,927

 

 

 

 

 

 

 

 

164,597

 

 

169,011

Mortgage backed securities

 

62,321

 

 

66,390

Total

$

226,918

 

$

235,401




14





The following two tables reflect securities whose fair values were lower than the related cost basis at June 30, 2010 and December 31, 2009, respectively (in thousands). However, these declines in value were not deemed to constitute OTTIs. The tables show the fair value and the unrealized losses, aggregated by investment category and category of duration, of individual securities in a continuous unrealized loss position.  


 

Less than 12 Months

 

12 Months or More

 

Total

June 30, 2010

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Fair Value

 

Loss

 

Fair Value

 

Loss

 

Fair Value

 

Loss

U.S. government agency bonds / notes

$

-

 

$

-

 

$

-

 

$

-

 

$

-

 

$

-

U.S. government agency collateralized mortgage obligations

 

507

 

 

6

 

 

-

 

 

-

 

 

507

 

 

6

Corporate bonds

 

9,252

 

 

659

 

 

-

 

 

-

 

 

9,252

 

 

659

Total fixed maturities

$

9,759

 

$

665

 

$

-

 

$

-

 

$

9,759

 

$

665

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

$

2,093

 

$

152

 

$

2,647

 

$

319

 

$

4,740

 

$

471

Total fixed maturities and equity securities

$

11,852

 

$

817

 

$

2,647

 

$

319

 

$

14,499

 

$

1,136


 

Less than 12 Months

 

12 Months or More

 

Total

December 31, 2009

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Fair Value

 

Loss

 

Fair Value

 

Loss

 

Fair Value

 

Loss

U.S. government agency bonds / notes

$

5,925

 

$

64

 

$

-

 

$

-

 

$

5,925

 

$

64

Government tax-exempt bonds

 

1,106

 

 

1

 

 

-

 

 

-

 

 

1,106

 

 

1

Corporate bonds

 

12,312

 

 

35

 

 

205

 

 

3

 

 

12,517

 

 

38

Total fixed maturities

$

19,343

 

$

100

 

$

205

 

$

3

 

$

19,548

 

$

103

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

$

388

 

$

20

 

$

2,584

 

$

130

 

$

2,972

 

$

150

Total fixed maturities and equity securities

$

19,731

 

$

120

 

$

2,789

 

$

133

 

$

22,520

 

$

253


The unrealized losses are primarily due to market fluctuations resulting from cyclical and other economic pressures including the recent economic crisis and market dislocation. All fixed maturities with an unrealized loss of 12 months or more are investment grade securities. As of June 30, 2010, we believe that these unrealized losses are temporary and that the fair value will recover to a level equal to or greater than the cost basis. In addition, as of June 30, 2010, we had the ability to hold all of our fixed maturity securities to maturity and, except for our investments in non-agency CMOs; we do not have the intent to sell these investments until there is a recovery in fair value, or until maturity. In the future, circumstances may change that would cause us to record an OTTI or sell fixed maturity or equity securities and possibly, incur a realized loss.




15





The major categories of net investment income included in the consolidated statements of operations are summarized for the three and six months ended June 30, 2010 and 2009, as follows (in thousands):


(in thousands)

Three Months

 

Six Months

 

Ended

 

Ended

 

June 30,

 

June 30,

 

2010

 

2009

 

2010

 

2009

Investment income:

 

 

 

 

 

 

 

 

 

 

 

Fixed Maturities

$

2,306

 

$

2,544

 

$

4,663

 

$

4,930

Equity Securities

 

99

 

 

95

 

 

195

 

 

179

Short-term investments and other

 

50

 

 

65

 

 

89

 

 

151

Finance charges on premiums receivable

 

24

 

 

26

 

 

57

 

 

61

Structured annuity

 

19

 

 

18

 

 

37

 

 

36

 

 

 

 

 

 

 

 

 

 

 

 

Total investment income

 

2,498

 

 

2,748

 

 

5,041

 

 

5,357

 

 

 

 

 

 

 

 

 

 

 

 

Investment expense

 

44

 

 

82

 

 

87

 

 

140

 

 

 

 

 

 

 

 

 

 

 

 

Net investment income

$

2,454

 

$

2,666

 

$

4,954

 

$

5,217


In connection with our acquisition of our insurance subsidiary, the Texas Department of Insurance (“TDI”) required that funds be set aside in an escrow account with a bank to remain until the aggregate remaining redemption obligation of our Series A redeemable preferred stock is less than the amount of the escrow balance, with no withdrawals to be made from this escrow account without prior approval from TDI. To satisfy this requirement, we maintain a fixed income security in escrow in the amount of $2,500,000. This security is included in fixed maturities, available-for-sale.


At June 30, 2010, investments with a fair market value of $3,924,000 were on deposit with state insurance departments to satisfy regulatory requirements and these securities are included in fixed maturities, available-for-sale.


5.

Other Comprehensive Income


Other comprehensive income (loss) shown in the consolidated statement of shareholders’ equity is comprised of net unrealized gains (losses) on securities available for sale, net of taxes. The components of other comprehensive income (loss) for the three and six month periods ended June 30, 2010 and 2009 are as follows (in thousands):


 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2010

 

2009

 

2010

 

2009

Unrealized holdings (losses) gains before taxes

$

(25)

 

$

911 

 

$

779 

 

$

3,726 

Tax expense

 

 

 

(319)

 

 

(273)

 

 

(1,304)

 

 

 

 

 

 

 

 

 

 

 

 

Net gain after tax

 

(16)

 

 

592 

 

 

506 

 

 

2,422 

 

 

 

 

 

 

 

 

 

 

 

 

Less reclassification adjustments for gains (losses) included in net income

 

270 

 

 

(249)

 

 

294 

 

 

(236)

Tax (expense) benefit

 

(94)

 

 

87 

 

 

(103)

 

 

83 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income—net of tax

$

(192)

 

$

754 

 

$

315 

 

$

2,575 




16





6.

Fair Value Disclosures


Fair value is used on a recurring basis for our equity and fixed maturity, available-for-sale securities in which fair value is the primary basis of accounting.  We measure fair value for each security depending on whether we have Level 1, Level 2 or Level 3 inputs, as described below.  


The following table presents the estimated fair value of our financial instruments measured on a recurring basis as of June 30, 2010:


(in thousands)

 

 

 

Fair Value Measurements at June 30, 2010 Using:

 

 

 

 

Quoted prices

 

Significant

 

Significant

 

Total

 

in active markets

 

other ob-

 

other unob-

 

June 30,

 

for identical assets

 

servable inputs

 

servable inputs

Description

2010

 

Level 1

 

Level 2

 

Level 3

Fixed Maturities:

 

 

 

 

 

 

 

 

 

 

 

U.S. treasury notes / bills

$

17,665

 

$

17,665

 

$

-

 

$

-

U.S. government agency mortgage-backed bonds

 

20,624

 

 

 

 

 

20,624

 

 

-

U.S. government agency collateralized mortgage obligations

 

41,278

 

 

 

 

 

41,278

 

 

-

Collateralized mortgage obligations:

 

 

 

 

 

 

 

 

 

 

 

Alt-A CMOs

 

2,283

 

 

 

 

 

320

 

 

1,963

Prime CMOs

 

2,205

 

 

 

 

 

1,777

 

 

428

U.S. government agency bonds / notes

 

17,719

 

 

 

 

 

17,719

 

 

-

Government tax-exempt bonds

 

34,075

 

 

 

 

 

34,075

 

 

-

Corporate bonds

 

99,552

 

 

 

 

 

99,552

 

 

-

Total fixed maturities

$

235,401

 

$

17,665

 

$

215,345

 

$

2,391

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

10,934

 

 

10,879

 

 

-

 

 

55

 

 

 

 

 

 

 

 

 

 

 

 

Total fixed maturities and equity securities

$

246,335

 

$

28,544

 

$

215,345

 

$

2,446


Level 1 consists of instruments whose values are based on quoted market prices in active markets. We receive quoted market prices from a third party, independent, nationally recognized pricing service. We utilize the pricing service, both for market values obtained based on quoted, actively traded market prices (Level 1) and for quoted prices for similar assets in active markets or market prices obtained from third-party pricing services for identical or comparable assets (Level 2). As of June 30, 2010, approximately 99% of our fixed income securities are priced either as Level 1 or Level 2. The fair value estimate for our equity portfolio of $10,879,000 and our U.S. Treasury fixed income securities of $17,665,000 are based on Level 1 pricing provided by the pricing service since there is an active, readily tradable market value based on quoted prices, as of June 30, 2010, or the measurement date. Active markets are those in which transactions occur in significant frequency and volume to provide pricing information on an on-going basis. Valuation of Level 1 securities does not entail a significant degree of judgment since an active market exists and quoted prices are readily and regularly available.  


With the exception of U.S. Treasury securities, very few of our fixed income securities are actively traded. Most of our fixed income securities, such as government or agency mortgage backed securities, tax-exempt municipal securities and corporate securities are valued using a pricing service and fall within Level 2. Level 2 pricing in our fair value hierarchy comprises $215,345,000 or 87% of our investment portfolio, which as of June 30, 2010 includes U.S. Government agency bonds/notes of $17,719,000; U.S Government agency mortgage backed bonds of $20,624,000; U.S. Government agency CMOs of $41,278,000; Government tax-exempt bonds of $34,075,000; corporate bonds of $99,552,000; “prime” non-agency CMOs of $1,777,000; and “Alt-A” non-agency CMOs of $320,000.  




17





In regards to Level 2 pricing, fair values are based on the market prices from the pricing service where valuations are based on quoted market prices for identical or similar assets and/or valuations using industry-standard models such as matrix pricing. The pricing service evaluates each asset based on relevant market information, credit information, perceived market movements and sector news.  The market inputs utilized in the pricing evaluation include, benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets benchmark securities, bids and offers, quoted forward prices, time value, volatility factors, current market and contractual prices for the underlying instrument, and industry news and economic events. For mortgage related products, the pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.  Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. We utilize our subsidiary, APS Asset Management, Inc., to review the estimates and assumptions of fair value of each security provided by the pricing service for Level 1 and Level 2 pricing and compare these estimates to our custodial bank statement, which also provides a fair market value for the securities we hold, to determine if the estimates are representative of the prices in the market. Comparing our fair value pricing obtained from our custodial bank statement serves as a cross-check to the validity of the information provided from the pricing service. Valuations are reviewed for reasonableness based upon the specifics of the security, including class, maturity, credit rating, durations, collateral and comparable markets for similar securities. We may adjust the valuation of securities from the independent pricing service when we believe its pricing does not fairly represent the market value of the investment. For example, a significant decrease in volume and level of activity for a security is an indication that transactions or quoted prices may not be determinative of fair value because in such market conditions there may be increased instances of transactions that are not orderly. In those circumstances, further analysis of transactions or quoted prices is needed, and a significant adjustment to the transaction or quoted price may be necessary to determine fair value. We evaluate the following factors to determine whether there has been a significant decrease in the volume and level of activity for the securities we hold when compared to the normal activity for those securities (or similar securities):


·

there are few recent transactions;

·

price quotations are not based on current information;

·

price quotations vary substantially either over time or amount market makers (for example, broker markets);

·

indexes that were previously highly correlated with the fair values of the security are demonstrably uncorrelated with recent indications of fair value for that security;

·

there is a significant increase in the implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, considering all available market data about credit or nonperformance risk for the security;

·

there is wide bid-ask spread or significant increase in the bid-ask spread;

·

there is a significant decline or absence of a market for new issuances (that is, a primary market) for the security or similar securities; and

·

little information is available publicly.


When market observable data is not as readily available as a result of a significant decrease in volume or level of activity for a security, the valuation of these financial instruments becomes more subjective and could involve substantial judgment, resulting in Level 3 pricing. Under Level 3 pricing, fair values are based on inputs that are considered unobservable where there is little, if any, market activity for a security. In this circumstance, we evaluate fair values derived from our internal pricing models, as well as values derived from the independent pricing service and non-binding indications received from dealers.




18





The national housing crisis and its impact or potential impact on the underlying collateral of our non-agency CMOs, specifically our Alt-A securities and 2006 origination year prime non-agency CMOs, resulted in a significant and rapid decline of the fair market value of these securities, especially in relation to the market prices provided by the outside pricing service. Beginning as early as the third quarter of 2007 for Alt-A securities and the fourth quarter of 2008 for certain of our prime non-agency CMOs, the market became increasingly inactive based on: the limited number of transactions; varying market prices provided by dealers; significant increases in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices; significant declines or absence of a market for new issuances; and the limited availability of market data for these securities. The inactivity was also evidenced by a significant widening of the bid and ask spread in the dealer markets in which these securities trade and a significant decrease in the volume of trades relative to historical levels.


Consistent with our approach to pricing our entire portfolio, we initially received market pricing on these securities from the pricing service. We also generally obtain two to three indications from dealers who actively trade in these or similar securities, but are not binding offers. We then reviewed the pricing on these non-agency CMO securities based on the market environment and the specific characteristics, including: the overall structure of the instrument; 60-day delinquencies, loss severities and default rates; demographic and geographic characteristics of the underlying mortgages; support levels; and loan to value ratios. We also utilized internal pricing models to assist us in determining estimated fair values. Our internal pricing model incorporates cash flows for each security based on projected losses discounted using a liquidity risk premium that market participant would demand because of the inherent uncertainty in the cash flows. The risk premium is reflective of an orderly transaction between market participants at the measurement date under current market conditions. Determining the price at which willing market participants would transact at the measurement date under current market conditions if there has been a significant decrease in volume or level of activity for these securities depends on the facts and circumstances and requires the use of significant judgment. We weigh the indications of fair value resulting from multiple valuation techniques, considering both an income approach such as our internal pricing model and a market approach that provides estimates of fair value from the pricing service and non-binding quotes from market participants. Based on these indications, we consider the reasonableness of the range of estimates to determine the point within the range that is more representative of fair value under current market conditions. We select a fair value estimate based on professional judgment utilizing a weighting or blending of internal pricing models, the fair value provided by the pricing service and non-binding indications. This is consistent with FASB ASC 820-10 and is appropriate in determining the fair value when the volume or level of activity has decreased in markets that are not orderly.


As a result of this review, as of June 30, 2010, we have classified as Level 3 pricing five non-agency CMOs (4 Alt-A CMOs and 1 non-agency CMO with 2006 origination years) and one non-publicly traded equity security. The total fair market value of these securities is $2,446,000, which represents approximately 1% of our investment portfolio.




19





A reconciliation of the beginning and ending balances of our financial instruments for fair value measurements made using significant unobservable inputs (Level 3) follows (in thousands):


 

Three Months Ended

 

Six Months Ended

 

June 30, 2010

 

June 30, 2010

Balance at beginning of period

$

2,549 

 

$

2,106 

Total gains or losses realized/unrealized:

 

 

 

 

 

Included in earnings (or changes in net assets)

 

70 

 

 

112 

Included in other comprehensive income

 

(36)

 

 

39 

Purchases, issuances, and settlements

 

(137)

 

 

(231)

Transfers in and/or out of Level 3

 

 

 

420 

 

 

 

 

 

 

Balance at end of period

$

2,446 

 

$

2,446 

 

 

 

 

 

 

The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at June 30, 2010

$

(2)

 

$

(3)

 

 

 

 

 

 

Gains and losses (realized and unrealized) included in earnings for the period are reported in net realized investment gains (losses) as follows:

 

 

 

 

 

 

 

 

 

 

 

Total gains or losses included in earnings for the period (above)

$

(2)

 

$

(3)

 

 

 

 

 

 

Change in unrealized gains or losses related to assets held at end of period

$

(36)

 

$


As included in the table above, a net of $420,000 was transferred into Level 3 from Level 2 during the six months ended June 30, 2010. This is the result of one transfer with a fair value of $690,000 and one transfer out with a fair value of $270,000. These transfers are the result of changes in pricing due to market data becoming more or less observable since December 31, 2009. The updated pricing information is based on a current review as of June 30, 2010 of all the various methods described above for Levels 2 and 3.


We attempt to apply consistent methods and techniques utilized to determine fair value for these securities; however, assumptions regarding delinquency levels and default rates, realized losses and projected timing of those losses and prepayment speeds may vary significantly, especially over time, an could materially impact valuations. For example, we recognized a realized loss of $2,000 and $3,000 for the three and six months ended June 30, 2010, respectively, as a result of valuing these securities based on Level 3 pricing assumptions. However, had we selected our pricing based on Level 2 pricing assumptions, we would have recorded no realized losses for the three and six months ended June 30, 2010 and we would have increased our fixed maturities, available-for-sale and accumulated, OCI by $1,027,000 as of June 30, 2010 based on higher pricing assumptions.


In addition to the above assets, we also have other financial assets, including a structured annuity classified as other invested assets and a financial liability for our mandatorily redeemable preferred stock, that are not carried at fair market value. At June 30, 2010, the structured annuity has a book value of $1,570,000 and a fair market value of $1,732,000. The mandatorily redeemable preferred stock has a book value of $5,576,000 and a fair market value of $5,086,000. The fair market estimates were based on an evaluation of similar securities with like terms and estimated credit risk.


7.

Reserve for Loss and Loss Adjustment Expense


The reserve for unpaid losses and loss adjustment expenses represents the estimated liability for unpaid claims reported to us, plus claims incurred but not reported and the related estimated loss adjustment expenses. The reserve for losses and loss adjustment expenses is determined based on our actual experience, available industry data and projections as to future claims frequency, severity, inflationary trends and settlement patterns.




20





We write medical malpractice insurance policies which have a lengthy period for reporting a claim (long-tail) and a long process of litigating a claim through the courts and whose risk factors expose its reserves for loss and loss adjustment expenses to significant variability. These conditions subject our insurance subsidiary’s open reported claims and incurred but not reported claims to increases due to inflation, changes in legal proceedings and changes in the law. While the anticipated effects of inflation is implicitly considered when estimating reserves for loss and loss adjustment expenses, an increase in average severity of claims is caused by a number of factors. Future average severities are projected based on historical trends adjusted for changes in underwriting standards, policy provisions and general economic trends. Those anticipated trends are monitored based on actual experience and are modified as necessary to reflect any changes in the development of ultimate losses and loss adjustment expenses. These specific risks, combined with the variability that is inherent in any reserve estimate, could result in significant adverse deviation from our carried reserve amounts. The ultimate resolution of claims is subject to considerable uncertainty. Actual developments will likely vary, perhaps significantly, from the current estimated amounts reflected in the accompanying financial statements. We believe the reserves for loss and loss adjustment expenses are reasonably stated as of June 30, 2010.


We recorded $11,815,000 for losses and loss adjustment expenses for the six months ended June 30, 2010, which included $24,558,000 for the current accident year and was reduced by $12,743,000 of favorable development for prior report years. The favorable development was the result of reductions in our estimates of ultimate loss costs for the 2006 through 2009 accident years as compared to prior period estimates. For the six months ended June 30, 2009, we recorded $12,918,000 for losses and loss adjustment expenses, which included $22,516,000 for the 2009 accident year, reduced by $9,598,000 of favorable development for prior accident years. The favorable development was the result of reductions in ultimate loss costs for the 2002 through 2008 accident years as compared to prior period estimates.  The favorable development experienced during these periods noted above was the result of better than expected trends in paid loss severity (i.e. the expected average cost of claims) and a lower number of claims actually closed with indemnity than anticipated. The 2010 accident year loss and loss adjustment expenses increased by $2,042,000 to $24,558,000 for the six months ended June 30, 2010 as compared to $22,516,000 for the 2009 accident year due to an 8% increase in policyholder headcount from 6,268 as of June 30, 2009 to 6,783 as of June 30, 2010 resulting in additional loss exposures over this time period; higher reinsurance retention levels; and our recent entry into new geographic markets with a shift to higher policy limits.  


8.

Reinsurance


Reinsurance Premiums Ceded. Certain premiums are ceded to other insurance companies under reinsurance agreements. These reinsurance contracts provide us with increased capacity to write additional risk and the ability to write specific risks within our capital resources and underwriting guidelines. The 2010 reinsurance agreement is a fixed-rated treaty and provides 100% coverage in excess of our retention of $750,000 up to $1,000,000 with an additional retention of 10% of claims for policy limits that are greater than $1,000,000 with no aggregate limit. The 2009 reinsurance agreement is a fixed-rated treaty and provides 100% coverage in excess of our retention of $1,000,000 with a $5,000,000 aggregate limit. Prior to 2009, our insurance subsidiary, American Physicians Insurance Company (“API”) entered into reinsurance contracts, which provided for losses in excess of the retention of $250,000 on individual claims and beginning in 2002 through 2005, $350,000 on multiple insured claims related to a single occurrence. The 2006, 2007 and 2008 reinsurance treaties provide for these same terms with API retaining an additional 10%, 20% and 40% of the risk above the aforementioned retention levels for 2006, 2007 and 2008, respectively.




21





The reinsurance contracts for 2002 through 2008 contain variable premium ceding rates based on loss experience. The ceded premium charged under these contracts is dependent upon the development of ultimate losses ceded to the reinsurers under their retrospective treaties. For the three and six months ended June 30, 2010, we recorded favorable development to ceded premiums of $413,000 and $777,000, respectively, primarily due to adjustments to treaty years 2002 through 2003 and 2006 through 2008. For the three and six months ended June 30, 2009, we recorded favorable development to ceded premiums of $848,000 and $1,680,000, respectively, primarily due to adjustments to treaty years 2003, 2006 and 2008. These adjustments reflect reductions in our estimates of ultimate claims severity and loss experience as a result of claims closures at less than reserved amounts driven by better than expected trends in claims severity coupled with relatively stable payment patterns in the reinsurance layer.


In addition to an adjustment to premiums ceded, estimates of ultimate reinsurance ceded premium amounts compared to the amounts paid on a provisional basis for the 2002 through 2008 reinsurance treaties give rise to a balance sheet asset classified as “Other Amounts Receivable Under Reinsurance Contracts” or a balance sheet liability classified as “Funds Held Under Reinsurance Treaties.” Furthermore, each retrospective treaty requires a 24- or 36-month holding period before any premium adjustments or cash can be returned or paid. The ultimate settlement amount is not determined until all losses have been settled under the respective treaties. As of June 30, 2010, we recorded a balance sheet liability, “Funds Held Under Reinsurance Treaties” of $2,700,000, which represents the difference between the estimates of ultimate reinsurance premiums ceded amounts for the 2002 through 2008 treaty years and the amounts paid on a provisional basis.


Reinsurance Recoverables. Ceded reserves for loss and loss adjustment expenses are recorded as reinsurance recoverables. Reinsurance recoverables are the estimated amount of future loss payments that will be recovered from reinsurers, and represent the portion of losses incurred during the period that are estimated to be allocable to reinsurers. There are several factors that can directly affect the ability to accurately forecast the reinsurance recoverables. Many of the factors discussed in Note 7 related to the sensitivities of forecasting total loss and loss adjustment expense reserves also apply when analyzing reinsurance recoverables. Since we cede excess losses above $250,000 on individual claims and $350,000 on multiple insured claims for treaty years 2002 through 2008, the trends related to severity significantly affect this estimate. Current individual claims severity can be above or fall below our retention level over the period it takes to resolve a claim.


Similar to the estimate for reserves, due to the long-tailed nature of the medical professional liability line of insurance, relatively small changes in the actuarial assumptions for trends, inflation, severity and frequency for projected ultimate loss and loss adjustment expense reserves can have a greater impact on the recorded balance for reinsurance recoverables than with most other property and casualty insurance lines. While we believe that our estimate for ultimate projected losses related to loss and loss adjustment expense is adequate based on reported and open claim counts, there can be no assurance that additional significant reserve enhancements will not be necessary in the future given the many variables inherent in such estimates and the extended period of time that it can take for claim patterns to emerge.


Reinsurance contracts do not relieve us from our obligations to policyholders. We continually monitor our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. Any amount found to be uncollectible is written off in the period in which the uncollectible amount is identified.


Unsecured reinsurance recoverables at June 30, 2010 that exceeded 10% of total reinsurance paid and unpaid loss and loss adjustment expenses are summarized below (in thousands):


Company Name

 

June 30,

2010

Swiss Reinsurance

 

$

1,825

Transatlantic Reinsurance

 

 

1,759

ACE Tempest Re USA

 

 

1,311

Hannover Ruckversicherrungs

 

 

826

General Reinsurance Corp

 

 

773




22





As of June 30, 2010, ACE Tempest Re USA was A.M. Best rated “A+” (Superior). Swiss Reinsurance (“Swiss Re”), Transatlantic Reinsurance (“Transatlantic”) and Hannover Ruckversicherrungs (“Hannover”) were A.M. Best rated “A” (Excellent). To date, all of our reinsurers have continued to reimburse us for paid claims in a manner consistent with past practices and contractual obligations.


The reinsurers on the 2010 treaty include Hannover, Transatlantic and General Reinsurance Corporation (“General Re”). General Re is A.M. Best rated “A++” (Superior) as of June 30, 2010.


As of June 30, 2010, all of API’s reinsurance contracts were with companies in adequate financial condition and we believe there was not any need to establish an allowance for doubtful reinsurance recoverable.  We have not experienced any material problems collecting from our reinsurers.


9.

Income Taxes


The provision for income taxes is based on amounts reported in the statements of income after exclusion of nontaxable income such as interest on state and municipal securities.  Also, certain items of income and expenses are recognized in different time periods for financial statement purposes than for income tax purposes.  Thus, provisions for deferred taxes are recorded in recognition of such temporary differences between the reported amount of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company and its subsidiaries file a consolidated federal income tax return. Consolidated income tax expense is allocated on the basis of each company's income adjusted for permanent differences.


Our effective income tax rate for the three and six months ended June 30, 2010 was approximately 33.9%. Our effective income tax rate for the three and six months ended June 30, 2009 was approximately 35.6% and 35.0%, respectively.


10.

Mandatorily Redeemable Preferred Stock


In conjunction with the acquisition of API we issued 10,198 shares of Series A redeemable preferred stock, par value $1.00 per share, from the 10,500 shares authorized. Holders of Series A redeemable preferred stock are entitled to cumulative dividends thereon at the rate of three percent (3%) per annum payable on the remaining redemption value per share, in priority to the payments of dividends on the common shares. Holders of our Series A redeemable preferred stock have no preemptive rights and have the same voting rights as the holders of our common stock. The shares are non-certificated and mandatorily redeemable. They will be redeemed ratably at not less than $1,000,000 per year, with all remaining outstanding shares being redeemed by December 31, 2016. During the six months ended June 30, 2010, 1,050 shares of our Series A redeemable preferred stock were redeemed from our preferred shareholders for $1,260,000, which included accrued dividends of $209,000. During 2009, 2008 and 2007, 1,075, 1,104 and 1,019 shares of our Series A redeemable preferred stock were redeemed for $1,230,000, $1,368,000 and $1,058,000, which included dividends of $177,000, $297,000 and $40,000, respectively. In the event of any liquidation, the holders of our Series A redeemable preferred stock receive an amount equal to the remaining redemption value before any distribution is made to the holders of our common stock.


We classify our redeemable preferred stock as a liability because it constitutes an unconditional obligation that requires us to redeem the shares at a specified or determinable date and therefore, the preferred stock dividend has been classified as interest expense.




23





11.

Stock-Based Compensation


We use the Black-Scholes-Merton option-pricing model to determine the fair value of stock-based awards. For the three and six months ended June 30, 2010, we recorded compensation cost related to stock options of $115,000 and $226,000, respectively, and a related reduction in income taxes of $40,000 and $79,000, respectively. The compensation cost is the total fair value, at date of grant, of stock options that vested during the period. No compensation costs were capitalized in the three and six month periods ended June 30, 2010.


During the three months ended June 30, 2010, 20,000 options were exercised with an intrinsic value of $244,000. During the six months ended June 30, 2010, 43,000 options were exercised with an intrinsic value of $527,000. For the three and six months ended June 30, 2010, we received cash proceeds of $115,000 and $347,000, respectively, and we received $118,000 and $199,000, respectively, in value through cashless exercises/exchanges for the options exercised. Also, as of June 30, 2010, there was $830,000 of total unrecognized compensation cost related to non-vested shares under our 2005 Incentive and Non-Qualified Stock Option Plan (the "Stock Option Plan"), which is expected to be recognized over a weighted-average period of 1.4 years.


The Stock Option Plan provides for the issuance of up to 1,250,000 shares of common stock to our employees, including officers and directors and non-employee directors. A total of 1,052,000 of these options have been granted as of June 30, 2010 and 198,000 are available for grants. Of those granted, 171,000 shares have been exercised, 503,000 options are exercisable and 378,000 are not yet exercisable.


The exercise price for each non-qualified option share is determined by the Compensation Committee of the Board of Directors (the “Committee”). Under the Stock Option Plan, option grants are limited to a maximum of ten-year terms; however, the Committee has issued all currently outstanding grants with five-year terms. The Committee also determines vesting for each option grant and traditionally has had options vest in two to three approximately equal annual installments beginning one year from the date of grant. Presented below is a summary of the stock options held by our employees and our directors and the related transactions for the three and six months ended June 30, 2010.


 

Three Months Ended

June 30, 2010

 

 

Six Months Ended

June 30, 2010

 

Shares

 

Weighted

Average

Exercise

Price

 

 

Shares

 

Weighted

Average

Exercise

Price

Balance at April 1

751,000

 

$

18.01

 

Balance at January 1

774,000

 

$

17.87

Options granted

150,000

 

 

24.15

 

Options granted

150,000

 

 

24.15

Options exercised

20,000

 

 

11.83

 

Options exercised

43,000

 

 

12.74

Options forfeited/expired

-

 

 

-

 

Options forfeited/expired

-

 

 

-

Balance at June 30

881,000

 

 

19.20

 

Balance at June 30

881,000

 

 

19.20

Options exercisable

503,000

 

 

16.55

 

Options exercisable

503,000

 

 

16.55


The following table summarizes our outstanding and exercisable options at June 30, 2010:


Stock Options Outstanding

 

Stock Options Exercisable

Shares

 

Weighted Average Exercise Price

 

Aggregate Intrinsic Value (1)

 

Average Remaining Contractual Life

 

Shares

 

Weighted Average Exercise

Price

 

Aggregate Intrinsic

Value (1)

 

Average Remaining Contractual Life

881,000

 

$

19.20

 

$

4,629,000

 

2.9

 

503,000

 

$

16.55

 

$

3,973,000

 

1.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Based on the $24.45 closing price of our stock at June 30, 2010.




24





12.

Commitments and Contingencies


Leases


We are obligated under certain operating lease arrangements for our office space.  The leases expire in 2011. The remaining contractual obligations for these leases are $353,000 and $692,000 for the years ended December 31, 2010 and 2011, respectively.  


Litigation and Regulatory Inquiries


We are involved in various claims, legal actions and regulatory inquiries that have arisen out of the conduct of our business.  


During the second quarter, APS Financial Corporation (“APS Financial”), the Company’s broker-dealer subsidiary, received a notice from the staff of the Financial Industry Regulatory Authority (“FINRA”) indicating that the FINRA staff had made a preliminary determination to recommend disciplinary action against the broker-dealer.  The allegations were that, in 2005 and 2006, APS Financial charged excessive markups in 60 transactions, out of approximately 2,000 transactions conducted during the time period.  We are currently in discussions with FINRA to resolve this proposed disciplinary action and do not anticipate this will have a material impact on our consolidated financial position, results of operation or cash flows.


Certain of our financial services subsidiaries are also parties to a FINRA arbitration proceeding initiated by family members of a former client of APS Financial and another financial services subsidiary, APS Capital Corp. (“APS Capital”), who allege that APS Financial made unsuitable investment recommendations to the former client.  The allegations also name the parent companies and an employee of APS Financial.  This matter is still in the preliminary stages.  We intend to vigorously defend our position in this case.


APS Capital is currently party to litigation regarding a disputed bankruptcy trade claim.


While we cannot predict the outcome of any pending or future claim, legal action or regulatory inquiry or enforcement action, and although no assurances can be given, we do not believe that any pending matter will have a material adverse effect on our consolidated financial position, results of operation or cash flows.




25





13.

Earnings Per Share


Basic earnings per share are based on the weighted average shares outstanding without any dilutive effects considered. Diluted earnings per share reflect dilution from all contingently issuable shares, such as options. A reconciliation of income and weighted average shares outstanding used in the calculation of basic and diluted income per share from operations follows:


(in thousands except share data)

Three Months Ended

June 30,

 

Six Months Ended

June 30,

 

2010

 

2009

 

2010

 

2009

Numerator for basic and diluted income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

6,200

 

$

4,921

 

$

10,728

 

$

9,651

 

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Denominator for basic income per common share - weighted average shares outstanding

 

6,813

 

 

6,923

 

 

6,835

 

 

6,958

Effect of dilutive stock options and awards

 

110

 

 

84

 

 

115

 

 

131

Denominator for diluted income per common share - adjusted weighted average shares outstanding

 

6,923

 

 

7,007

 

 

6,950

 

 

7,089

 

 

 

 

 

 

 

 

 

 

 

 

Net income - basic

$

0.91

 

$

0.71

 

$

1.57

 

$

1.39

Net income - diluted

$

0.90

 

$

0.70

 

$

1.54

 

$

1.36




26





14.

Segment Information


The Company’s segments are distinct by type of service provided. Comparative financial data for the three and six month periods ended June 30, 2010 and 2009 are shown as follows:


 

Three Months Ended

June 30,

 

Six Months Ended

June 30,

 

2010

 

2009

 

2010

 

2009

Operating Revenues

 

 

 

 

 

 

 

 

 

 

 

Insurance services

$

18,246 

 

$

17,813 

 

$

36,371 

 

$

35,092 

Financial services

 

2,147 

 

 

1,922 

 

 

3,704 

 

 

3,470 

All other

 

5,464 

 

 

5,117 

 

 

5,855 

 

 

5,582 

Total segment revenues

$

25,857 

 

$

24,852 

 

$

45,930 

 

$

44,144 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to Consolidated Statements of Operations:

 

 

 

 

 

 

 

 

 

 

 

Total segment revenues

$

25,857 

 

$

24,852 

 

$

45,930 

 

$

44,144 

Less: intercompany interest and dividends

 

(5,116)

 

 

(4,731)

 

 

(5,174)

 

 

(4,792)

Total revenues

$

20,741 

 

$

20,121 

 

$

40,756 

 

$

39,352 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Income:

 

 

 

 

 

 

 

 

 

 

 

Insurance services

$

10,782 

 

$

8,242 

 

$

18,902 

 

$

16,360 

Financial services

 

(216)

 

 

175 

 

 

(351)

 

 

95 

All other

 

(1,190)

 

 

(778)

 

 

(2,323)

 

 

(1,598)

Total segment operating income

$

9,376 

 

$

7,639 

 

$

16,228 

 

$

14,857 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit):

 

 

 

 

 

 

 

 

 

 

 

Insurance services

$

3,628 

 

$

2,969 

 

$

6,376 

 

$

5,750 

Financial services

 

(74)

 

 

67 

 

 

(122)

 

 

41 

All other

 

(378)

 

 

(318)

 

 

(754)

 

 

(585)

Total segment income tax expense (benefit)

$

3,176 

 

$

2,718 

 

$

5,500 

 

$

5,206 

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures:

 

 

 

 

 

 

 

 

 

 

 

Insurance services

$

99 

 

$

87 

 

$

150 

 

$

164 

Financial services

 

 

 

 

 

19 

 

 

All other

 

22 

 

 

 

 

52 

 

 

Total segment capital expenditures

$

129 

 

$

90 

 

$

221 

 

$

170 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation/amortization expenses:

 

 

 

 

 

 

 

 

 

 

 

Insurance services

$

72 

 

$

85 

 

$

141 

 

$

184 

Financial services

 

 

 

 

 

13 

 

 

16 

All other

 

34 

 

 

32 

 

 

67 

 

 

65 

Total segment depreciation/amortization expenses:

$

112 

 

$

125 

 

$

221 

 

$

265 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance sheet data:

June 30,

 

December 31,

 

 

 

 

 

 

 

2010

 

2009

 

 

 

 

 

 

Identifiable assets

 

 

 

 

 

 

 

 

 

 

 

Insurance services

$

255,144 

 

$

247,358 

 

 

 

 

 

 

Financial services

 

2,550 

 

 

4,830 

 

 

 

 

 

 

All other

 

49,542 

 

 

47,584 

 

 

 

 

 

 

Total segment assets

$

307,236 

 

$

299,772 

 

 

 

 

 

 




27





15.

Subsequent Events


On July 29, 2010, APS Financial and its parent, APS Investment Services, Inc. (“APS Investment Services”), entered into an agreement with an unaffiliated broker-dealer pursuant to which the unaffiliated broker-dealer agreed to hire most of APS Financial’s employees and assume certain contractual obligations of APS Financial.  In return, APS Financial and APS Investment Services will receive certain payments tied to the contractual obligations assumed and the unaffiliated broker-dealer’s future financial performance, and APS Financial plans to cease operations as a broker-dealer. 


Prior to entering into this transaction, we had made a preliminary decision to exit our Financial Services business and had been actively marketing the segment for sale.  That decision was based on the weak financial performance of our Financial Services business in recent years and concerns that a return to materially improved, sustained financial performance would require more capital than could be produced from the Financial Services segment’s operations.  We also plan to discontinue the day-to–day operations of our bank debt and trade claim subsidiary, APS Capital Corp.  Our remaining Financial Services subsidiary, APS Asset Management, Inc., will continue to operate until it can be sold or appropriately discontinued.


The cessation of operations of our Financial Services business is not expected to have a material effect on our consolidated financial position, results of operation or cash flows.



28






ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), “APS,” “we,” “our,” “us” and the “Company” refer to American Physicians Service Group, Inc., together with its subsidiaries, unless the context requires otherwise. The following MD&A should be read in conjunction with the accompanying unaudited consolidated financial statements for the three and six months ended June 30, 2010, included in Part I, Item 1, as well as the audited, consolidated financial statements and notes in our Annual Report on Form 10-K for the year ended December 31, 2009, which was filed with the United States Securities and Exchange Commission (the “SEC”) on March 3, 2010.


CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS


This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements involve risks and uncertainties, as well as assumptions that, if they do not materialize or prove correct, could cause our results to differ materially from those expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including statements: of our plans, strategies and objectives for future operations; concerning new products, services or developments; regarding future economic conditions, performance or outlook; as to the outcome of contingencies; of beliefs or expectations; and of assumptions underlying any of the foregoing.


Forward-looking statements may be identified by their use of forward-looking terminology, such as “believes,” “expects,” “may,” “should,” “would,” “intends,” “plans,” “estimates,” “anticipates,” “projects” and similar words or expressions. You should not place undue reliance on these forward-looking statements, which reflect our management’s beliefs and assumptions only as of the date of the filing of this Quarterly Report on Form 10-Q.  We undertake no obligation, other than that imposed by law, to update forward-looking statements to reflect further developments or information obtained after the date of filing of this Quarterly Report on Form 10-Q or, in the case of any document incorporated by reference, the date of that document.


The following important factors, in addition to those referenced under “Risk Factors” in Part II, Item 1A and Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the Securities and Exchange Commission on March 3, 2010, could affect the future results of our operations and could cause those results to differ materially from those expressed in or implied by such forward-looking statements:


general economic conditions, either nationally or in our market area, that are worse than expected;


changes in the healthcare industry;


regulatory and legislative actions or decisions that adversely affect our business plans or operations;


inflation and changes in the interest rate environment, and/or changes in the securities markets including the performance of financial markets affecting the fair value of our investments or making it difficult to determine the value of our investments;


uncertainties inherent in the estimate of loss and loss adjustment expense reserves and reinsurance;


significantly increased competition among insurance providers;



29






changes in the availability or cost of reinsurance including our ability to renew our existing reinsurance treaty or obtain new reinsurance;


failure or inability of our reinsurers to pay claims or amounts due us in a timely manner;


loss of key executives, personnel, accounts or customers; and


potential losses, regulatory enforcement and litigation risk associated with our Financial Services businesses.


The foregoing factors should not be construed as exhaustive and we caution you not to place undue reliance on forward-looking statements, which speak only as of the date of this report. In addition to any risks and uncertainties specifically identified in the text surrounding forward-looking statements, you should consult our other filings under the Securities Act of 1933 and the Securities Exchange Act of 1934 for factors that could cause our actual results to differ materially from those presented.


Business Overview


We provide (1) insurance services, specifically medical professional liability insurance in Texas, Arkansas, Oklahoma and Colorado and (2) financial services, including brokerage and investment services to individuals and institutions.


Insurance Services. We provide medical professional liability insurance primarily in Texas, where our insurance subsidiary has written business for over 33 years. Our insurance subsidiary is authorized to do business in the States of Texas, Arkansas and Oklahoma and was recently also licensed to write business in Colorado. Our insurance subsidiary specializes in writing medical professional liability insurance for physicians and other healthcare providers, including physician extenders and clinical staff. Our insurance subsidiary currently insures over 6,700 physicians, dentists, and other healthcare providers, the majority of whom are located in Texas. For the six months ended June 30, 2010, approximately 90%, 8% and 2% of our premiums were written in Texas, Oklahoma and Arkansas, respectively. Colorado written premiums amounted to less than 1% of our total premiums written.


Financial Services.  We provide investment and investment advisory services to institutions and individuals throughout the United States through the following subsidiaries:


o

APS Financial. APS Financial Corporation (“APS Financial”) is a fully licensed broker-dealer that provides brokerage and investment services primarily to institutional and high net worth individual clients. APS Financial also provides portfolio accounting, analysis and other services to insurance companies, banks and public funds. We recognize commission revenue, and the related compensation expense, on a trade date basis.


o

APS Capital. APS Capital Corp. is dedicated to the clearing and settlement of trades involving non-securities including syndicated bank loans, trade claims and distressed private loan portfolios. We seek to develop business with clients who trade in distressed markets. We recognize commission revenue, and the related compensation expense, when the transaction is complete and fully funded.


o

APS Asset Management. APS Asset Management, Inc., a registered investment adviser under the Investment Advisers Act of 1940, manages fixed income and equity assets for institutional and individual clients on a fee basis. We recognize fee revenues monthly based on the amount of funds under management.




30





Critical Accounting Policies and Estimates


The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires us to make estimates and assumptions that affect amounts reported in the accompanying unaudited Consolidated Financial Statements and Notes thereto. These estimates and assumptions are evaluated on an on-going basis based on historical developments, market conditions, industry trends and other information we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, or that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. Adjustments related to changes in estimates are reflected in our results of operations in the period in which those estimates changed.


Our “critical” accounting policies are those policies that we believe to be most sensitive to estimates and judgments. These policies are more fully described in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2009 and Note 3 to our audited consolidated financial statements contained in that report. There have been no material changes to these policies since the most recent year end.


Results of Operations


Despite continued pricing pressure in our Insurance Services segment over the last several years, improvements in the terms of our reinsurance contracts coupled with continued favorable prior year reserve development allowed us to deliver solid results from this operating segment for the three and six months ended June 30, 2010. As a result of continued favorable development in the claim environment post-tort reform and increased competition, we lowered our rates on renewing business approximately 3% on average during the six months ended June 30, 2010 as compared to approximately 6% for the six months ended June 30, 2009. The 2010 reductions were the result of negotiated discounts to retain certain group practices with favorable loss histories. Policyholder retention was strong for the first six months of 2010 at approximately 91% as compared to 93% during the first six months of 2009. We have seen continued competition by existing professional liability carriers. Many of these carriers have been aggressive in seeking new business and are willing to compete on price. As a result of this increased competition, we continue to be faced with price pressure on both existing renewals and new business. As a result of these market forces, we expect to continue to face extensive competition throughout 2010, but will continue to price insurance products at rates we believe are adequate for the risks assumed.


Furthermore, even though reported claims remain at historically low levels and claim severity payment patterns have been better than anticipated, we increased loss and loss adjustment expenses by $2,042,000 to $24,558,000 for the six months ended June 30, 2010 for the 2010 accident year as compared to $22,516,000 for the 2009 accident year for the six months ended June 30, 2009. This increase reflects additional policyholders from 6,268 as of June 30, 2009 to 6,783 as of June 30, 2010 resulting in additional loss exposures over this time period; higher reinsurance retention levels; and our recent entry into new geographic markets with a shift to higher policy limits.


Our Financial Services segment, which had returned to profitability in 2009, experienced a loss in the first six months of 2010 even though financial service revenues increased 7% for the six months of 2010 as compared to the same period in 2009.  Driving this loss was an increase in expenses primarily related to on-going legal and regulatory disputes. See Note 15 to our Consolidated Financial Statements contained herein for information about subsequent events affecting our Financial Services business.




31





The following table sets forth selected historical financial and operating data for the Company. The selected income statement data below for the three and six months ended June 30, 2010 and 2009 is derived from our consolidated unaudited financial statements included herein which management believes incorporate all of the adjustments necessary for the fair presentation of the financial condition and results of operations for such periods and have been prepared in accordance with GAAP. Actual financial results through June 30, 2010 may not be indicative of future financial performance.


Selected Consolidated Financial and

Operating Data of American Physicians Service Group, Inc.


(in thousands, except per share and ratio data)

Three Months Ended

June 30,

 

Six Months Ended

June 30,

 

2010

 

2009

 

2010

 

2009

Income Statement Data:

 

 

 

 

 

 

 

 

 

 

 

Gross premiums written

$

14,456 

 

$

14,682 

 

$

33,080 

 

$

32,222 

Premiums ceded

 

(104)

 

 

335 

 

 

(253)

 

 

663 

Net premiums written

 

14,352 

 

 

15,017 

 

 

32,827 

 

 

32,885 

 

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

16,071 

 

 

16,825 

 

 

32,180 

 

 

33,282 

Investment income, net of investment expenses

 

2,454 

 

 

2,666 

 

 

4,954 

 

 

5,217 

Net realized capital gains (losses) and OTTI

 

126 

 

 

(1,242)

 

 

36 

 

 

(2,524)

Financial services

 

2,074 

 

 

1,827 

 

 

3,514 

 

 

3,275 

Other revenue

 

16 

 

 

45 

 

 

72 

 

 

102 

Total revenues

 

20,741 

 

 

20,121 

 

 

40,756 

 

 

39,352 

Losses and loss adjustment expenses

 

4,874 

 

 

6,797 

 

 

11,815 

 

 

12,918 

Other underwriting expenses

 

2,529 

 

 

2,510 

 

 

5,688 

 

 

5,731 

Change in deferred acquisition costs

 

61 

 

 

264 

 

 

(34)

 

 

83 

Financial services expenses

 

2,363 

 

 

1,747 

 

 

4,055 

 

 

3,375 

General and administrative expenses

 

1,538 

 

 

1,164 

 

 

3,004 

 

 

2,388 

Total expenses

 

11,365 

 

 

12,482 

 

 

24,528 

 

 

24,495 

Income from operations

 

9,376 

 

 

7,639 

 

 

16,228 

 

 

14,857 

Income tax expense

 

3,176 

 

 

2,718 

 

 

5,500 

 

 

5,206 

Net income

$

6,200 

 

$

4,921 

 

$

10,728 

 

$

9,651 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted weighted average shares outstanding

 

6,923 

 

 

7,007 

 

 

6,950 

 

 

7,089 

Diluted earnings per common share

$

0.90 

 

$

0.70 

 

$

1.54 

 

$

1.36 

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting Ratios:

 

 

 

 

 

 

 

 

 

 

 

Loss ratio (1)

 

 

 

 

 

 

 

 

 

 

 

Current accident year

 

83%

 

 

68%

 

 

76%

 

 

68%

Prior accident years

 

-53%

 

 

-28%

 

 

-39%

 

 

-29%

Calendar year

 

30%

 

 

40%

 

 

37%

 

 

39%

Expense ratio (2)

 

16%

 

 

16%

 

 

18%

 

 

17%

Combined ratio (3)

 

46%

 

 

56%

 

 

54%

 

 

56%


(1)  Loss ratio is defined as the ratio of losses and loss adjustment expenses to net premiums earned.

(2)  Expense ratio is defined as the ratio of other underwriting expenses and net change in deferred acquisition costs to net premiums earned.

(3)  Combined ratio is the sum of the loss ratio and the expense ratio.



32






(in thousands)

June 30,

 

December 31,

 

2010

 

2009

Balance Sheet Data:

 

 

 

 

 

Cash and cash equivalents and investments

$

263,819

 

$

259,338

Premiums receivable

 

17,543

 

 

15,678

Reinsurance recoverables

 

6,590

 

 

9,682

All other assets

 

19,284

 

 

15,074

Total Assets

$

307,236

 

$

299,772

 

 

 

 

 

 

Reserve for losses and loss adjustment expenses

$

87,721

 

$

88,668

Unearned premiums

 

36,988

 

 

36,341

Mandatorily redeemable preferred stock

 

5,576

 

 

6,679

All other liabilities

 

10,361

 

 

8,874

Total Liabilities

 

140,646

 

 

140,562

Total Stockholders'  Equity

 

166,590

 

 

159,210

Total Liabilities & Stockholders' Equity

$

307,236

 

$

299,772


The discussion that follows should be read in connection with the unaudited Consolidated Financial Statements and Notes thereto included elsewhere in this report.


Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009


Condensed income statement data for the three months ended June 30, 2010 and 2009 are included in the following table:


(in thousands except per share data and percentages)

Three Months ended June 30,

 

2010

 

2009

 

Change

 

% Change

Revenues

$

20,741

 

$

20,121

 

$

620

 

3%

Income from Operations

 

9,376

 

 

7,639

 

 

1,737

 

23%

Net Income

 

6,200

 

 

4,921

 

 

1,279

 

26%

Diluted Net Income Per Share

$

0.90

 

$

0.70

 

$

0.20

 

29%


Further explanation for the quarter over quarter variances are described below.


Premium related income statement data for the three months ended June 30, 2010 and 2009 are included in the following table:


($ in thousands)

Three Months ended June 30,

 

2010

 

2009

 

Change

 

% Change

Gross premiums written

$

14,456 

 

$

14,682 

 

$

(226)

 

-2%

 

 

 

 

 

 

 

 

 

 

 

Premium ceded:

 

 

 

 

 

 

 

 

 

 

Current year

 

(517)

 

 

(513)

 

 

(4)

 

1%

Prior year

 

413 

 

 

848 

 

 

(435)

 

-51%

Net premiums ceded

 

(104)

 

 

335 

 

 

(439)

 

-131%

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

$

16,071 

 

$

16,825 

 

$

(754)

 

-4%




33





Gross Premiums Written


Gross premiums written decreased $226,000 (2%) to $14,456,000 for the three months ended June 30, 2010 from $14,682,000 for the three months ended June 30, 2009. The primary cause for this decrease was due to continued rate decreases on renewal business which, on average decreased 3% for the current quarter as a result of competitive pricing pressures and lower new written business of $693,000 for the current year quarter as compared to $741,000 of new business for the prior year quarter. Policyholder retention was approximately 92% for the quarter ended June 30, 2010. We anticipate that we will continue to experience competitive pricing pressures.


Premiums Ceded


Premiums ceded increased $439,000 (131%) to $(104,000) for the three months ended June 30, 2010 from $335,000 for the three months ended June 30, 2009. The reinsurance contracts we utilized from 2002 through 2008 were variable premium treaties that have various minimum and maximum rates. The actual premium rate is dependent upon the ultimate losses ceded to the reinsurer under the related treaty. The increase in premiums ceded of $439,000 is primarily the result of recognizing $413,000 in favorable development on these variable premium treaties during the current year quarter as compared to recognizing $848,000 in favorable development during the prior year quarter. The favorable development reflects reductions in our estimates of claim severity and loss experience as a result of claim closures at less than reserved amounts driven by better than expected trends in claims severity coupled with relatively stable payment patterns in the reinsurance layer. Effective January 1, 2009, we changed our reinsurance treaty such that we retained the first $1,000,000 of any loss occurrence. The 2009 reinsurance contract is a fixed-rated treaty and provides 100% coverage in excess of our retention of $1,000,000 with a $5,000,000 aggregate limit. The 2010 reinsurance agreement is a fixed-rated treaty and provides 100% coverage in excess of our retention of $750,000 up to $1,000,000 with an additional retention of 10% of claims for policy limits that are greater than $1,000,000 with no aggregate limit. We are retaining this additional risk in the reinsurance layer in order to lower our ceding costs based on decreases in claims. Due to the increased retention, the 2009 and 2010 ceded premium rates are lower which resulted in $517,000 in 2010 treaty year ceded premiums versus $513,000 for the same period in 2009. The 2009 and 2010 treaties provide us with coverage against large losses and multiple claims arising from a single event, as well as excess policy limit coverage. While we anticipate that the 2009 and 2010 treaties will reduce our ceded premiums as a percentage of direct premiums written, thus resulting in a relative increase in net premiums written and earned, the overall impact on earnings is uncertain as the frequency and severity of losses in future periods is not yet known.


Net Premiums Earned  


Net premiums earned decreased by $754,000 (4%) to $16,071,000 from $16,825,000 for the three months ended June 30, 2010 as compared to the same period in 2009. Net earned premiums were lower primarily due to lower favorable development recognized on the 2002 through 2008 variable premium reinsurance treaties during the current quarter as compared to the prior year quarter as well as continued rate decreases and lower new business written.




34





Investment Income


Investment income statement data for the three months ended June 30, 2010 and 2009 are included in the following table:


($ in thousands)

Three Months Ended June 30,

 

2010

 

2009

 

Change

 

% Change

Investment income:

 

 

 

 

 

 

 

 

 

 

Fixed Maturities

$

2,306

 

$

2,544

 

$

(238)

 

-9%

Equity Securities

 

99

 

 

95

 

 

 

4%

Short-term investments and other

 

50

 

 

65

 

 

(15)

 

-23%

Finance charges on premiums receivable

 

24

 

 

26

 

 

(2)

 

-8%

Structured annuity

 

19

 

 

18

 

 

 

6%

 

 

 

 

 

 

 

 

 

 

 

Total investment income

$

2,498

 

$

2,748

 

$

(250)

 

-9%

 

 

 

 

 

 

 

 

 

 

 

Investment expense

 

44

 

 

82

 

 

(38)

 

-46%

 

 

 

 

 

 

 

 

 

 

 

Net investment income

$

2,454

 

$

2,666

 

$

(212)

 

-8%


Investment income, net of investment expenses, decreased by $212,000 (8%) to $2,454,000 from $2,666,000 for the three months ended June 30, 2010 as compared to the same period for 2009. The proceeds from the sale of approximately $17,288,000 of non-agency CMOs in 2009 and additional cash generated from operations have been reinvested generally in high quality investment grade fixed income securities with short maturity dates and lower yields. We shortened maturities to continue to focus on preservation of principal over yield during the economic crisis.  In addition, interest rates on money market funds continue to remain at historically low levels. This rebalancing of our fixed income investment portfolio resulted in a corresponding decrease in investment income for the three months ended June 30, 2010 as compared to the same period in 2009 even though our investment portfolio continues to grow.  


Net Realized Capital Gains (Losses) and Other-Than-Temporary Impairments  


Realized capital gains and losses income statement data for the three months ended June 30, 2010 and 2009 are included in the following table:


($ in thousands)

Three Months ended June 30,

 

2010

 

2009

 

Change

 

% Change

Gross realized gains

$

247 

 

$

122 

 

$

125

 

102%

Gross realized (losses)

 

(62)

 

 

(264)

 

 

202

 

77%

Other -than-temporary impairment (losses)

 

(59)

 

 

(1,100)

 

 

1,041

 

95%

Net realized gains (losses) and OTTI

$

126 

 

$

(1,242)

 

$

1,368

 

110%


Net realized capital gains and other-than-temporary impairments (“OTTI”) were $126,000 for the three months ended June 30, 2010, as compared to a net loss of $1,242,000 for the three months ended June 30, 2009. OTTI losses decreased $1,041,000 primarily due to the lower write-downs in OTTI for the current quarter as a result of our reduced position in non-agency CMOs and improved performance in the equity markets. The changes in realized gains and realized losses is attributable to lower trading activity for the three months ending June 30, 2010 as compared to the same period in 2009. In the first quarter of 2009 trading activity increased as we reduced our position in non-agency CMOs and selected equities which resulted in additional gains and losses.




35





Financial Services Revenues


Financial Services revenue for the three months ended June 30, 2010 and 2009 are included in the following table:


($ in thousands)

Three Months ended June 30,

 

2010

 

2009

 

$ Change

 

% Change

Broker/dealer commissions

$

1,804

 

$

1,669

 

$

135

 

8%

Bank debt/Trade claims

 

172

 

 

142

 

 

30

 

21%

Management fees and other

 

98

 

 

16

 

 

82

 

513%

Total financial services revenues

$

2,074

 

$

1,827

 

$

247

 

14%


Our Financial Services revenue increased $247,000 (14%) for the three months ended June 30, 2010 compared to the same period in 2009. APS Financial, our broker-dealer, derives most of its revenue from transactions in the fixed income market, in both investment and non-investment grade securities. As the table above shows, commission revenue at APS Financial was up $135,000 (8%) for the three months ended June 30, 2010 compared to the same period in 2009 resulting primarily from the hiring of additional experienced brokers. Our bank debt/trade claim revenues increased $30,000 (21%) in the three months ended June 30, 2010 compared to the same period in 2009. This revenue stream is often irregular and generally is characterized by longer lead times to close a transaction compared to our traditional broker-dealer transactions. The increase in 2010 is due to a combination of an increase in bankruptcy default rates over the last twelve months as well as from a timing issue of closing these lengthy transactions. The $82,000 (513%) increase in management fees and other revenues is primarily the result of higher investment banking fees in the current period. Though we no longer actively seek investment banking business, we will on occasion participate in private placements if the right opportunity is presented to us, as was the case in the current period.


Loss and Loss Adjustment Expenses  


Loss and loss adjustment expenses for the three months ended June 30, 2010 and 2009 are included in the following table:


($ in thousands)

Three Months ended June 30,

 

2010

 

2009

 

Change

 

% Change

Losses and loss adjustment expenses:

 

 

 

 

 

 

 

 

 

 

Current accident year

$

13,309 

 

$

11,496 

 

$

1,813 

 

16%

Prior accident years

 

(8,435)

 

 

(4,699)

 

 

(3,736)

 

80%

Calendar year

$

4,874 

 

$

6,797 

 

$

(1,923)

 

-28%




36





Loss and loss adjustment expenses for the three months ended June 30, 2010 decreased by $1,923,000 (28%) to $4,874,000 from $6,797,000 for the three months ended June 30, 2009. The decrease of $1,923,000 is primarily the result of higher favorable development of $3,736,000 (80%) on prior year losses for the three months ended June 30, 2010 as compared to the same period in 2009. For the three months ended June 30, 2010, current accident year loss and loss adjustment expenses totaled $13,309,000, an increase of $1,813,000 (16%) over the prior current year comparable quarter. We increased the current accident year estimated losses based on 105 new claims reported during the current quarter for the 2010 accident year and the increase in loss exposures associated with the growth in policyholders at June 30, 2010; higher reinsurance retention levels; and our recent entry into new geographic markets with a shift to higher policy limits. Prior year losses developed favorably by $8,435,000 as a result of reductions in our estimates of claims severity, principally the 2002 and the 2006 through 2009 accident years, driven by closure of 108 claims during the period. For the three months ended June 30, 2009, current accident year loss and loss adjustment expenses were $11,496,000 based on 100 claims reported and a policyholder head count of 6,268 and there was $4,699,000 of favorable development on prior years’ claims. The favorable development experienced during these periods, is the result of better than expected trends in paid loss severity and a lower number of claims closed with indemnity than anticipated.  The positive effects of tort reform in Texas on average claim severity has resulted in continued favorable development of reserves and improved claim development patterns. During the quarter we continued to favorably settle a significant number of post-tort reform claims at below the reserved amounts. The historically low levels of reported claims in recent years would typically be indicative that those claims still being reported are of a more meritorious nature.  Accordingly, the actuarial projection of ultimate losses includes an assumption that those claims closed in future periods with damages should be increasing.  However, the trend of increasing paid claim frequency has not materialized.  As a result, the actuarial projection of ultimate losses pertaining to prior accident years has decreased, resulting in favorable prior year development.

  

Other Underwriting Expenses and Net Change in Deferred Acquisition Costs


Other underwriting expenses and net change in deferred acquisition costs for the three months ended June 30, 2010 and 2009 are included in the following table:


($ in thousands)

Three Months ended June 30,

 

2010

 

2009

 

Change

 

% Change

Salaries and related benefits

$

871

 

$

926

 

$

(55)

 

-6%

Commission expense

 

974

 

 

656

 

 

318 

 

48%

Premium taxes

 

255

 

 

256

 

 

(1)

 

0%

Professional fees

 

82

 

 

84

 

 

(2)

 

-2%

Other expenses

 

347

 

 

588

 

 

(241)

 

-41%

Total other underwriting expenses

 

2,529

 

 

2,510

 

 

19 

 

1%

 

 

 

 

 

 

 

 

 

 

 

Change in deferred acquisition costs

 

61

 

 

264

 

 

(203)

 

-77%

Total

$

2,590

 

$

2,774

 

$

(184)

 

-7%


Other underwriting expenses increased by $19,000 (1%) to $2,529,000 from $2,510,000 for the three months ended June 30, 2010 as compared to the same period in 2009. Other underwriting expenses consist primarily of commissions to agents, premium taxes and other general underwriting expenses related to managing our Insurance Services segment. Salaries decreased $55,000 due to the departure of an officer of our Insurance Services division in July 2009. Those responsibilities were assumed by other employees of the segment. Commissions to agents increased $318,000 even though written premiums decreased due to certain policyholders paying the agents on a direct basis as opposed to API paying the agents during the 2009 quarter. Professional fees were incurred primarily for actuarial and accounting services. The net change in deferred acquisition costs, which is comprised of the change in deferred and amortized commissions paid to agents on new and renewal business and deferred and amortized premium taxes, decreased for three months ended June 30, 2010 by $203,000 to $61,000 from $264,000 for the comparable period in 2009 due to new costs capitalized exceeding the amortization of prior deferred expenses.




37





Financial Services Expenses


Financial Services expenses for the three months ended June 30, 2010 and 2009 are included in the following table:


($ in thousands)

Three Months ended June 30,

 

2010

 

2009

 

$ Change

 

% Change

Broker Commissions

$

1,200

 

$

992

 

$

208 

 

21%

Payroll and Benefits

 

360

 

 

442

 

 

(82)

 

-19%

Information Services

 

140

 

 

115

 

 

25 

 

22%

Legal and Professional Fees

 

442

 

 

53

 

 

389 

 

734%

Other

 

221

 

 

145

 

 

76 

 

52%

Total Financial Services Expenses

$

2,363

 

$

1,747

 

$

616 

 

35%


Our Financial Services expenses increased $616,000 (35%) for the three months ended June 30, 2010 compared to the same period in 2009. This increase is primarily due to a $389,000 (734%) increase in legal and professional fees which is primarily the result of fees related to ongoing legal disputes and regulatory enforcement activities. See Note 12 to our Consolidated Financial Statements contained herein for more information.  In addition, broker commissions were $208,000 (21%) higher in the current period as a result of higher commission revenues mentioned above. Information services increased $25,000 (22%) in the three months ended June 30, 2010 compared to the same period in 2009 as a result of an increase in the number of brokers. Partially offsetting these expense increases was an $82,000 (19%) decrease in payroll and benefits in the three months ended June 30, 2010 compared to the same period in 2009. These cuts were a continuation of the cost reductions begun in 2008.  


General and Administrative Expenses


General and administrative expenses for the three months ended June 30, 2010 and 2009 are included in the following table:


($ in thousands)

Three Months Ended June 30,

 

2010

 

2009

 

$ Change

 

% Change

Payroll and Benefits

$

408

 

$

397

 

$

11 

 

3%

Incentive Compensation

 

463

 

 

300

 

 

163 

 

54%

Board Compensation and Fees

 

128

 

 

108

 

 

20 

 

19%

Options and Other Compensation

 

20

 

 

18

 

 

 

11%

Legal and Professional Fees

 

333

 

 

152

 

 

181 

 

119%

Interest and Dividends

 

73

 

 

80

 

 

(7)

 

-9%

Other

 

113

 

 

109

 

 

 

4%

Total General & Administrative Expenses

$

1,538

 

$

1,164

 

$

375 

 

32%


General and administrative expenses for the three months ended June 30, 2010 increased $375,000 (32%) compared to the same period in 2009. Legal and professional fees increased $181,000 (119%) due to fees associated with one-time projects. Incentive compensation expenses increased $163,000 (54%) for the three months ended June 30, 2010 compared to the same period in 2009 due to accruals for cash incentive compensation in lieu of deferred stock awards for 2010. Payroll and benefits increased $11,000 (3%) in the current period due to normal annual merit raises. In addition, board compensation costs increased $20,000 (19%) in the current three month period due in part to annual committee chair stipends as well as an increase in the number of board-related meetings in the current period. Partially offsetting these expense increases was a $7,000 (9%) decrease in interest and dividends in the current quarter as a result of lower interest expense on a lower balance for our mandatorily redeemable preferred stock.




38





Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009


Condensed income statement data for the six months ended June 30, 2010 and 2009 are included in the following table:</