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BWINA > SEC Filings for BWINA > Form 10-Q on 6-Nov-2012All Recent SEC Filings

Show all filings for BALDWIN & LYONS INC

Form 10-Q for BALDWIN & LYONS INC


6-Nov-2012

Quarterly Report


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

Liquidity and Capital Resources

The Company generally experiences positive cash flow from operations resulting from the fact that premiums are collected on insurance policies in advance of the disbursement of funds in payment of claims. Operating costs of the property/casualty insurance subsidiaries, other than loss and loss expense payments and commissions paid to related agency companies, generally average less than 30% of premiums earned and the remaining amount is available for investment for varying periods of time pending the settlement of claims relating to the insurance coverage provided. The Company's cash flow relating to premiums is significantly affected by reinsurance programs in effect from time-to-time whereby the Company cedes both premium and risk to other insurance and reinsurance companies. These programs vary significantly among products.

For the first nine months of 2012, the Company experienced positive cash flow from operations totaling $24.2 million which compares to positive cash flow from operations of $44.6 million generated during the first nine months of 2011. The decrease in cash flow from the 2011 period is primarily due to an increased level of gross premiums being ceded resulting from changes in reinsurance programs, increased loss payments associated with the settlement of 2011 catastrophe losses and increased federal income tax estimated payments.

The Company's investment philosophy has emphasized the purchase of relatively short-term instruments with maximum quality and liquidity. The average life of the Company's fixed income (bond and short-term investment) portfolio, using contractual maturities applied to par value, was 3.55 years at September 30, 2012, which is substantially shorter than the average life of the Company's liabilities.

Financing activity for the first nine months of 2012 included regular dividend payments to shareholders of $11.2 million ($.75 per share).

The Company's assets at September 30, 2012 included $62.9 million in investments classified as cash equivalents that were readily convertible to cash without significant market penalty. An additional $162.3 million of fixed maturity investments (at par) will mature within the twelve-month period following September 30, 2012. The Company believes that these liquid investments are more than sufficient to provide for projected claim payments and operating cost demands.

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Consolidated shareholders' equity is composed largely of GAAP shareholders' equity of the insurance subsidiaries. As such, there are statutory restrictions on the transfer of substantial portions of this equity to the parent company. At September 30, 2012, $40.5 million may be transferred by dividend or loan to the parent company during the remainder of 2012 without approval by, or prior notification to, regulatory authorities. An additional $210.6 million of shareholder's equity of the insurance subsidiaries could, theoretically, be advanced or loaned to the parent company with prior notification to, and approval from, regulatory authorities, although it is unlikely that transfers of this size would be practical. The Company believes that these restrictions pose no material liquidity concerns to the Company. The Company also believes that the financial strength and stability of the subsidiaries would permit ready access by the parent company to short-term and long-term sources of credit. The parent company had cash and marketable securities valued at $7.5 million at September 30, 2012.

The Company's annualized net premium writing to surplus ratio for the first nine months of 2012 was approximately 69%. Regulatory guidelines generally allow for writings of between 100% and 300% of surplus, depending on the line of business. Accordingly, the Company could increase net premium writings significantly with no need to raise additional capital. Further, the insurance subsidiaries' individual capital levels are several times higher than the minimum amounts designated by the National Association of Insurance Commissioners.

Results of Operations

Comparison of Third Quarter, 2012 to Third Quarter, 2011

Direct and assumed premiums written during the third quarter of 2012 increased $0.7 million (1.0%) and net premiums earned decreased $5.6 million (9.2%) as compared to the same period of 2011. The Company's Property and Casualty Insurance segment reported an increase in premium written of 4.1% but a decrease in earned premiums of 6.2% while the Reinsurance segment reported a decrease in premium written of 12.7% and a decrease in premium earned of 18.6%. In the Property and Casualty Insurance segment, direct and assumed premiums written were impacted by an ongoing reduction in commercial multi-peril business combined with lower personal automobile premium resulting from rate increases implemented during 2012; however, these decreases were more than offset by increased premium from fleet transportation business resulting from higher activity-sensitive premium on existing accounts and the addition of new business. The Company's property reinsurance program was the main driver of the decrease to the Reinsurance segment, as a strategic reduction in global catastrophe risk was implemented effective January 1, 2012. The following table provides information regarding premiums written and earned for each segment for the quarter ended September 30 (dollars in thousands):

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                                                      Direct and
                                                        Assumed
                                                        Premium        Net Premium     Net Premium
                                                        Written          Written         Earned
2012

Property & Casualty Insurance                        $      68,072     $    41,488     $    42,972
Reinsurance                                                 13,165          12,586          11,881

Totals                                               $      81,237     $    54,074     $    54,853

2011

Property & Casualty Insurance                        $      65,419     $    44,606     $    45,833
Reinsurance                                                 15,072          14,594          14,596

Totals                                               $      80,491     $    59,200     $    60,429

Premium ceded to reinsurers on insurance business produced by the Property and Casualty Insurance segment averaged 39.1% of premium written for the current quarter compared to 31.8% in the 2011 third quarter, with the increase reflective of changes in treaty structures whereby the Company retains lower amounts of risk and premium as well as the impact of the proportion of new products which are ceded at generally higher proportions than legacy products. In addition, a single, non-recurring reinsurance transaction related to a retrospectively-rated reinsurance contract added 1.7% to the current quarter ceded rate.

Net investment income, before tax, during the third quarter of 2012 was 15.7% lower than the third quarter of 2011 due primarily to lower available interest rates for bonds. Pre-tax bond yields averaged 2.4% during the current quarter compared to 2.8% for the prior year period. Overall after-tax yields decreased from 1.8% to 1.6% while average invested funds, impacted by positive cash flow, were over 2% higher. The short term nature of the Company's fixed income portfolio is expected to place downward pressure on investment income for the foreseeable future.

The third quarter 2012 net realized investment gains of $8.8 million resulted primarily from $6.3 million in gains reported by limited partnerships, $1.7 million reported from direct trading and $0.5 million net reversals of mark-to-market adjustments. Comparative third quarter 2011 overall net realized investment losses were $17.5 million, reflective of unfavorable global market results. Investment gains and losses result from decisions regarding the sale of individual securities and the change in total value of limited partnerships and, as such, are not expected to be consistent from period to period.

Losses and loss expenses incurred during the third quarter of 2012 were $18.2 million lower than that experienced during the third quarter of 2011 due primarily to the impact of the unprecedented level of catastrophe losses during the prior year period. The loss ratios for each segment were as follows:

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                                   2012       2011
Property and Casualty Insurance     65.0 %      66.2 %
Reinsurance                         21.6       125.3
Total                               55.6        80.5

Other operating expenses, for the third quarter of 2012, increased $0.5 million, or 2.7%, from the third quarter of 2011. The ratio of consolidated other operating expenses to operating revenue was 32.9% during the third quarter of 2012 compared to 29.0% for the 2011 third quarter.

The effective federal tax rate on consolidated income for the third quarter of 2012 was 33.4%. The effective rate differs from the normal statutory rate primarily as a result of tax-exempt investment income.

As a result of the factors mentioned above, net income increased $24.7 million during the third quarter of 2012 as compared to the 2011 period.

Comparison of Nine Months Ended September 30, 2012 to Nine Months Ended September 30, 2011

Direct and assumed premiums written during the first nine months of 2012 increased $1.5 million (0.6%) while net premiums earned decreased $4.3 million (2.4%) as compared to the same period of 2011. The Company's Property and Casualty Insurance segment reported an increase in written and earned premiums of 1.6% and 0.2%, respectively while the Reinsurance segment reported a decrease in written and earned premium of 4.0% and 11.2%, respectively. The reasons for the segment fluctuations are similar to those detailed in the quarterly comparison, preceding. The following table provides information regarding premiums written and earned for each segment for the nine months ended September
30 (dollars in thousands):

                                                      Direct and
                                                        Assumed
                                                        Premium        Net Premium     Net Premium
                                                        Written          Written         Earned
2012

Property & Casualty Insurance                        $     208,058     $   133,653     $   139,048
Reinsurance                                                 42,085          40,349          37,011

Totals                                               $     250,143     $   174,002     $   176,059

2011

Property & Casualty Insurance                        $     204,832     $   143,536     $   138,703
Reinsurance                                                 43,821          42,387          41,671

Totals                                               $     248,653     $   185,923     $   180,374

Premium ceded to reinsurers on insurance business produced by the Property and Casualty Insurance segment averaged 35.8% of premium written for the current year period compared to 29.9% a year earlier with the increase reflective of changes in treaty structures as well as the impact of new products which are ceded at generally higher proportions than legacy products.

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Net investment income, before tax, during the first nine months of 2012 was 10.9% lower than the first nine months of 2011 for the same reasons noted in the quarterly comparison. Overall pre-tax yields averaged 2.0% during the current period compared to 2.4% for the prior year period. Overall after-tax yields decreased from 1.8% to 1.6%. Average funds invested were approximately 5% higher in the 2012 period as the result of positive cash flow.

Net realized investment gains for the first nine months of 2012 were $8.7 million before tax, resulting primarily from $6.8 million in gains reported by limited partnerships and $1.5 million in direct trading gains. Realized investment losses were $20.9 million for the same period of 2011.

Losses and loss expenses incurred during the first nine months of 2012 were $70.4 million lower than that experienced during the first nine months of 2011 which included $65.1 million in catastrophe losses. The lower loss ratio for the Property and Casualty segment was attributable to improvements in most product groupings. The loss ratios for each segment were as follows:

                                   2012       2011
Property and Casualty Insurance     65.0 %      69.0 %
Reinsurance                         23.7       177.1
Total                               56.3        94.0

Other operating expenses, for the first nine months of 2012, increased $2.2 million, or 3.9%, from the 2011 nine-month period. The ratio of consolidated other operating expenses to operating revenue was 30.6% during the 2012 period compared to 28.6% for the 2011 period.

The effective federal tax rate on consolidated income for the first nine months of 2012 was 31.6%. The effective rate differs from the normal statutory rate primarily as a result of tax-exempt investment income.

As a result of the factors mentioned above, net income increased $60.9 million as compared to the 2011 period.

Forward-Looking Information

Any forward-looking statements in this report, including without limitation, statements relating to the Company's plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following: (i) the Company's plans, strategies, objectives, expectations and intentions are subject to change at any time at the discretion of the Company; (ii) the Company's business is highly competitive and the entrance of new competitors into or the expansion of the operations by existing competitors in the Company's markets and other changes in the market for insurance products could adversely affect the Company's plans and results of operations; (iii) other risks and uncertainties indicated from time to time in the Company's filings with the Securities and Exchange Commission; and (iv) other risks and factors which may be beyond the control or foresight of the Company. Readers are encouraged to review the Company's annual report for its full statement regarding forward-looking information.

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Critical Accounting Policies

There have been no changes in the Company's critical accounting policies as disclosed in the Form 10-K filed for the year ended December 31, 2011.

Concentrations of Credit Risk

The insurance subsidiaries cede portions of their gross premiums to numerous reinsurers under quota share and excess of loss treaties as well as facultative placements. These reinsurers assume commensurate portions of the risk of loss covered by the contracts. As losses are reported and reserved, portions of the gross losses attributable to reinsurers are established as receivable assets and losses incurred are reduced. At September 30, 2012, amounts due from reinsurers on paid and unpaid losses, are estimated to total approximately $129 million. Of this total, approximately $39 million (30%) represents the Company's provision for incurred but not reported losses and loss adjustment expenses attributable to reinsurers. Because of the large policy limits reinsured by the Company, the ultimate amount of incurred but not reported losses and loss adjustment expenses attributable to reinsurers could vary significantly from the estimate provided; however, absent the inability to collect from reinsurers, such variance would not result in changes in net claim losses incurred by the Company.

At September 30, 2012, limited partnership investments include approximately $40.6 million consisting of three partnerships which are managed by organizations in which certain of the Company's directors are officers, directors, general partners or owners. Each of these investments contains profit sharing agreements to the affiliated organizations.

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