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AAME > SEC Filings for AAME > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for ATLANTIC AMERICAN CORP

Form 10-Q for ATLANTIC AMERICAN CORP


9-Nov-2012

Quarterly Report


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

The following is management's discussion and analysis of the financial condition and results of operations of Atlantic American Corporation ("Atlantic American" or the "Parent") and its subsidiaries (collectively with the Parent, the "Company") as of and for the three month and nine month periods ended September 30, 2012. This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included elsewhere herein, as well as with the audited consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Atlantic American is an insurance holding company whose operations are conducted primarily through its insurance subsidiaries: American Southern Insurance Company and American Safety Insurance Company (together known as "American Southern") and Bankers Fidelity Life Insurance Company ("Bankers Fidelity"). Each operating company is managed separately, offers different products and is evaluated on its individual performance.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ significantly from those estimates. The Company has identified certain critical estimates that involve a higher degree of judgment and are subject to a significant degree of variability. The Company's critical accounting policies and the resultant estimates considered most significant by management are disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2011. During the nine month period ended September 30, 2012, there were no changes to the critical accounting policies or related estimates previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Recently Issued Accounting Standards

For a discussion of recently issued accounting standards applicable to the Company, see Note 2 of the accompanying notes to the unaudited condensed consolidated financial statements.

OVERALL CORPORATE RESULTS

On a consolidated basis, the Company had net income of $1.1 million, or $0.04 per diluted share, for the three month period ended September 30, 2012, compared to net income of $1.7 million, or $0.07 per diluted share, for the three month period ended September 30, 2011. The Company had net income of $3.5 million, or $0.15 per diluted share, for the nine month period ended September 30, 2012, compared to net income of $2.4 million, or $0.09 per diluted share, for the nine month period ended September 30, 2011. The decrease in net income for the three month period ended September 30, 2012 was solely due to a decrease in realized investment gains. During the three month period ended September 30, 2011 the Company had $0.9 million in realized investment gains. There were no realized investment gains in the comparable 2012 quarter. The increase in net income for the nine month period ended September 30, 2012 was primarily due to an increase in premium revenue, investment income and realized investment gains, in conjunction with maintaining a relatively consistent level of fixed general and administrative expenses. Premium revenue for the three month period ended September 30, 2012 increased $5.2 million, or 19.0%, to $32.4 million. For the nine month period ended September 30, 2012, premium revenue increased $15.8 million, or 20.1%, to $94.7 million. The increase in premium revenue was primarily attributable to an increase in Medicare supplement business in the life and health operations. Operating income (income before income taxes and realized investment gains) was $1.0 million in the three month period ended September 30, 2012 compared to $0.9 million in the three month period ended September 30, 2011. Operating income in the nine month periods ended September 30, 2012 and 2011 was $2.1 million and $1.8 million, respectively. While the life and health operations experienced significant growth in premium revenue and related profitability during the three month and nine month periods ended September 30, 2012, operating income was moderated by unfavorable loss experience in the property and casualty operations.

A more detailed analysis of the individual operating companies and other corporate activities is provided below.

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Table of Contents

American Southern

The following is a summary of American Southern's premiums for the three month
and nine month periods ended September 30, 2012 and the comparable periods in
2011 (in thousands):

                           Three Months Ended          Nine Months Ended
                              September 30,              September 30,
                            2012          2011         2012          2011

Gross written premiums   $   10,885     $ 11,919     $  32,464     $ 31,736
Ceded premiums               (1,910 )     (1,631 )      (5,729 )     (4,605 )
Net written premiums     $    8,975     $ 10,288     $  26,735     $ 27,131
Net earned premiums      $    9,362     $  9,023     $  28,840     $ 28,187

Gross written premiums at American Southern decreased $1.0 million, or 8.7%, during the three month period ended September 30, 2012 from the three month period ended September 30, 2011, and increased $0.7 million, or 2.3%, during the nine month period ended September 30, 2012, over the comparable period in 2011. The decrease in gross written premiums for the three month period ended September 30, 2012 was primarily attributable to a decrease in commercial automobile business due to agency cancellations, as described below, and the cancellation of certain general liability programs. The increase in gross written premiums for the nine month period ended September 30, 2012 was primarily attributable to increases of $3.1 million in commercial automobile business written by a newly appointed agency and $1.8 million in commercial automobile business written by an existing agency. Partially offsetting the increase in gross written premiums for the nine month period ended September 30, 2012 was a decrease of $3.4 million in commercial automobile written premiums resulting from the cancellation of two agencies in the first quarter of 2012 due to unfavorable loss experience; as well as the cancellation of certain general liability programs.

Ceded premiums increased $0.3 million, or 17.1%, during the three month period ended September 30, 2012, and $1.1 million, or 24.4%, during the nine month period ended September 30, 2012, over the comparable periods in 2011. The increase in ceded premiums for the three month and nine month periods ended September 30, 2012 was primarily due to increased cession rates as well as an increase in commercial automobile earned premiums which have higher contractual cession rates than other lines of business. Also contributing to the increase in ceded premiums was the increase in related earned premiums. As American Southern's premiums are determined and ceded as a percentage of earned premiums, an increase in ceded premiums occurs when earned premiums increase.

The following presents American Southern's net earned premiums by line of business for the three month and nine month periods ended September 30, 2012 and the comparable periods in 2011 (in thousands):

                          Three Months Ended          Nine Months Ended
                             September 30,              September 30,
                           2012          2011         2012          2011

Commercial automobile   $    6,371      $ 5,798     $  19,231     $ 18,367
General liability              745          958         2,691        3,158
Property                       523          547         1,521        1,550
Surety                       1,723        1,720         5,397        5,112
Total                   $    9,362      $ 9,023     $  28,840     $ 28,187

Net earned premiums increased $0.3 million, or 3.8%, during the three month period ended September 30, 2012, and $0.7 million, or 2.3%, during the nine month period ended September 30, 2012, over the comparable periods in 2011. The increase in net earned premiums for the three month and nine month periods ended September 30, 2012 was primarily related to the volume of commercial automobile and surety business written in the current year and during 2011. Premiums are earned ratably over their respective policy terms, and therefore premiums earned in the current year are related to policies written during both the current year and immediately preceding year.

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Table of Contents

The following sets forth American Southern's loss and expense ratios for the three month and nine month periods ended September 30, 2012 and for the comparable periods in 2011:

                   Three Months Ended          Nine Month Ended
                      September 30,              September 30,
                    2012          2011         2012         2011

Loss ratio             69.1 %       72.8 %        73.6 %      62.7 %
Expense ratio          40.4 %       32.2 %        32.6 %      38.2 %
Combined ratio        109.5 %      105.0 %       106.2 %     100.9 %

The loss ratio for the three month period ended September 30, 2012 decreased to 69.1% from 72.8% in the three month period ended September 30, 2011 and increased to 73.6% in the nine month period ended September 30, 2012 from 62.7% in the comparable period of 2011. The decrease in the loss ratio for the three month period ended September 30, 2012 was primarily attributable to more favorable loss experience in the surety line of business in the three month period ended September 30, 2012 as compared to the three month period ended September 30, 2011. The increase in the loss ratio for the nine month period ended September 30, 2012 was due to increases in the frequency and severity of claims in the commercial automobile line of business and higher claims in the general liability line of business during the nine month period ended September 30, 2012 as compared to the same period in 2011.

The expense ratio for the three month period ended September 30, 2012 increased to 40.4% from 32.2% in the three month period ended September 30, 2011 and decreased to 32.6% in the nine month period ended September 30, 2012 from 38.2% in the comparable period of 2011. The increase in the expense ratio for the three month period ended September 30, 2012 and the decrease in the expense ratio for the nine month period ended September 30, 2012 was primarily due to American Southern's variable commission structure, which compensates the company's agents in relation to the loss ratios of the business they write. During periods in which the loss ratio increases, commissions and underwriting expenses will generally decrease, and conversely, during periods in which the loss ratio decreases, commissions and underwriting expenses will generally increase. During the three month period ended September 30, 2012, these commissions at American Southern increased $0.6 million over the three month period ended September 30, 2011 due primarily to the favorable loss experience in the surety line of business, which has higher variable commission rates than other larger lines of business. During the nine month period ended September 30, 2012 these commissions decreased $1.6 million from the comparable period in 2011 due to unfavorable loss experience in the commercial automobile and general liability lines of business.

Bankers Fidelity

The following summarizes Bankers Fidelity's earned premiums for the three month
and nine month periods ended September 30, 2012 and the comparable periods in
2011 (in thousands):

                        Three Months Ended          Nine Months Ended
                           September 30,              September 30,
                         2012          2011         2012          2011

Medicare supplement   $   18,720     $ 14,196     $  53,339     $ 38,960
Other health               1,133        1,103         3,367        3,209
Life                       3,166        2,889         9,108        8,474
Total                 $   23,019     $ 18,188     $  65,814     $ 50,643

Premium revenue at Bankers Fidelity increased $4.8 million, or 26.6%, during the three month period ended September 30, 2012, and $15.2 million, or 30.0%, during the nine month period ended September 30, 2012, over the comparable periods in 2011. Premiums from the Medicare supplement line of business increased $4.5 million, or 31.9%, during the three month period ended September 30, 2012, and $14.4 million, or 36.9%, during the nine month period ended September 30, 2012, due primarily to an increase in business generated from the company's core producers, new business issued in the state of Missouri as a result of favorable pricing compared to competitors, and active management and implementation of rate increases on renewal business, as appropriate. Other health product premiums increased slightly during the same comparable periods, primarily as a result of increased sales of the company's short-term care product. Premiums from the life insurance line of business increased $0.3 million, or 9.6%, during the three month period ended September 30, 2012, and $0.6 million, or 7.5%, during the nine month period ended September 30, 2012 due to new sales activity.

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Table of Contents

The following summarizes Bankers Fidelity's operating expenses for the three month and nine month periods ended September 30, 2012 and the comparable periods in 2011 (in thousands):

                                   Three Months Ended          Nine Months Ended
                                      September 30,              September 30,
                                    2012          2011         2012          2011

Benefits and losses              $   15,818     $ 12,736     $  46,828     $ 36,490
Commissions and other expenses        6,557        5,085        18,709       15,191
Total expenses                   $   22,375     $ 17,821     $  65,537     $ 51,681

Benefits and losses increased $3.1 million, or 24.2%, during the three month period ended September 30, 2012, and $10.3 million, or 28.3%, during the nine month period ended September 30, 2012, over the comparable periods in 2011. As a percentage of premiums, benefits and losses decreased to 68.7% in the three month period ended September 30, 2012 from 70.0% in the three month period ended September 30, 2011. For the nine month period ended September 30, 2012, this ratio decreased to 71.2% from 72.1% in the comparable period in 2011. The decrease in the loss ratio for the three month and nine month periods ended September 30, 2012 was primarily attributable to more favorable loss experience in the Medicare supplement line of business during 2012 as compared to the same periods in 2011. The company continues to implement rate increases on its Medicare supplement line of business which has helped to mitigate the impact of higher medical costs and contributed to the more favorable loss experience.

Commissions and other expenses increased $1.5 million, or 28.9%, during the three month period ended September 30, 2012, and $3.5 million, or 23.2%, during the nine month period ended September 30, 2012, over the comparable periods in 2011. The increase in commissions and other expenses was primarily attributable to the increased level of premiums earned as well as increases in advertising and agency related expenses. Advertising expenses for the three month and nine month periods ended September 30, 2012 included charges for television commercials, social media campaigns, and branding initiatives all of which did not occur in the comparable periods of 2011. As a percentage of premiums, these expenses increased to 28.5% in the three month period ended September 30, 2012 from 28.0% in the three month period ended September 30, 2011. The slight increase in the expense ratio for the three month period ended September 30, 2012 was primarily attributable to increases in advertising and agency related expenses discussed previously. For the nine month period ended September 30, 2012, this ratio decreased to 28.4% from 30.0% in the comparable period in 2011. The decrease in the expense ratio for the nine month period ended September 30, 2012 was primarily due to the increase in earned premiums coupled with a relatively consistent level of overall fixed general and administrative expenses.

INVESTMENT INCOME AND REALIZED GAINS

Investment income increased $0.2 million, or 8.6%, during the three month period ended September 30, 2012, and $0.7 million, or 8.9%, during the nine month period ended September 30, 2012, over the comparable periods in 2011. The increase in investment income was primarily attributable to an increase in yield on invested assets and a higher average balance of fixed maturities held by the Company in the three month and nine month periods ended September 30, 2012 as compared to the same periods of 2011.

The Company had net realized investment gains of $1.4 million during the nine month period ended September 30, 2012, compared to net realized investment gains of $1.0 million in the nine month period ended September 30, 2011. Net realized investment gains for the nine month periods ended September 30, 2012 and 2011 were primarily due to the sale of several of the Company's investments in fixed maturities. Also, included in the three month and nine month periods ended September 30, 2011 was a $0.3 million gain from the sale of an outparcel of land held within one of the Company's real estate partnership investments. Management continually evaluates the Company's investment portfolio and, as may be determined to be appropriate, makes adjustments for impairments and/or will divest investments.

INTEREST EXPENSE

Interest expense increased slightly during the three month and nine month periods ended September 30, 2012 from the comparable periods in 2011. The increase in interest expense was due to an increase in the London Interbank Offered Rate ("LIBOR"), as the interest rates on the Company's bank debt and outstanding trust preferred obligations are directly related to LIBOR. The Company's revolving credit facility with Wells Fargo Bank, National Association ("Wells Fargo") expired on August 31, 2012, the stated maturity date, by its terms. See Note 4 of the accompanying notes to the unaudited condensed consolidated financial statements.

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Table of Contents

OTHER EXPENSES

Other expenses (commissions, underwriting expenses, and other expenses) increased $2.3 million, or 25.5%, during the three month period ended September 30, 2012, and $2.1 million, or 7.3%, during the nine month period ended September 30, 2012, over the comparable periods in 2011. The increase in other expenses for the three month and nine month periods ended September 30, 2012 was primarily due to increased commission and underwriting costs in the life and health operations associated with increased premiums as well as increases in advertising and agency related expenses. Also contributing to the increase in other expenses for the three month period ended September 30, 2012 were increased commission accruals at American Southern due to more favorable loss experience in the surety line of business in the 2012 third quarter. During the three month period ended September 30, 2012, commissions at American Southern increased $0.6 million over the comparable period in 2011. Partially offsetting the increase in other expenses for the nine month period ended September 30, 2012 were decreased commission accruals at American Southern due to the less favorable year to date loss experience, as discussed previously. During the nine month period ended September 30, 2012, American Southern's commissions decreased $1.6 million from the comparable period in 2011. The majority of American Southern's business is structured in a way that agents are compensated based upon the loss ratios of the business they place with the company. During periods in which the loss ratio increases, commissions and underwriting expenses will generally decrease, and conversely, during periods in which the loss ratio decreases, commissions and underwriting expenses will generally increase. On a consolidated basis, as a percentage of earned premiums, other expenses increased to 35.2% in the three month period ended September 30, 2012 from 33.4% in the three month period ended September 30, 2011. For the nine month period ended September 30, 2012, this ratio decreased to 33.0% from 36.9% in the comparable period of 2011. The increase in the expense ratio for the three month period ended September 30, 2012 was due primarily to the increases in advertising and agency related expenses as well as the increase in American Southern's commission accrual. The decrease in the expense ratio for the nine month period ended September 30, 2012 was primarily attributable to the increase in earned premiums coupled with a relatively consistent level of fixed general and administrative expenses and a reduction in American Southern's commission expense as discussed previously.

INCOME TAXES

The primary differences between the effective tax rate and the federal statutory income tax rate for the three month and nine month periods ended September 30, 2012 and 2011 resulted from the dividends received deduction ("DRD"), the small life insurance company deduction ("SLD") and the change in deferred tax asset valuation allowance. The current estimated DRD is adjusted as underlying factors change and can vary from the estimates based on, but not limited to, actual distributions from investments as well as the amount of the Company's taxable income. The SLD varies in amount and is determined at a rate of 60 percent of the tentative life insurance company taxable income ("LICTI"). The SLD for any taxable year is reduced (but not below zero) by 15 percent of the tentative LICTI for such taxable year as it exceeds $3.0 million and is ultimately phased out at $15.0 million. The change in deferred tax asset valuation allowance was primarily due to the unanticipated utilization of certain capital loss carryforward benefits that had been previously reduced to zero through an existing valuation allowance reserve. The provision-to-filed return adjustments are generally updated at the completion of the third quarter of each fiscal year, after the Company's tax return for the previous year is filed with the IRS.

LIQUIDITY AND CAPITAL RESOURCES

The primary cash needs of the Company are for the payment of claims and operating expenses, maintaining adequate statutory capital and surplus levels, and meeting debt service requirements. Current and expected patterns of claim frequency and severity may change from period to period but generally are expected to continue within historical ranges. The Company's primary sources of cash are written premiums, investment income and proceeds from the sale and maturity of its invested assets. The Company believes that, within each operating company, total invested assets will be sufficient to satisfy all policy liabilities and that cash inflows from investment earnings, future premium receipts and reinsurance collections will be adequate to fund the payment of claims and expenses as needed.

Cash flows at the Parent are derived from dividends, management fees, and tax-sharing payments, as described below, from the subsidiaries. The cash needs of the Parent are for the payment of operating expenses, the acquisition of capital assets and debt service requirements. At September 30, 2012, the Parent had approximately $28.4 million of unrestricted cash and investments. The Company believes that traditional funding sources for the Parent, combined with current cash and investments, should provide sufficient liquidity for the Company for the foreseeable future.

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Table of Contents

The Parent's insurance subsidiaries reported statutory net income of $3.0 million for the nine month period ended September 30, 2012 compared to statutory net income of $4.9 million for the nine month period ended September 30, 2011. Statutory results are impacted by the recognition of all costs of acquiring business. In a scenario in which the Company is growing, statutory results are generally lower than results determined under generally accepted accounting principles ("GAAP"). Statutory results for the Company's property and casualty operations may differ from the Company's results of operations under GAAP due to the deferral of acquisition costs for financial reporting purposes. The Company's life and health operations' statutory results may differ from GAAP results primarily due to the deferral of acquisition costs for financial reporting purposes, as well as the use of different reserving methods.

Over 90% of the invested assets of the Parent's insurance subsidiaries are invested in marketable securities that can be converted into cash, if required; however, the use of such assets by the Company is limited by state insurance regulations. Dividend payments to a parent corporation by its wholly owned insurance subsidiaries are subject to annual limitations and are restricted to the greater of 10% of statutory surplus or statutory earnings before recognizing realized investment gains of the individual insurance subsidiaries. At September 30, 2012, American Southern had $37.1 million of statutory surplus and Bankers Fidelity had $34.5 million of statutory surplus. In 2012, dividend payments by the Parent's insurance subsidiaries in excess of $7.8 million would require prior approval.

The Parent provides certain administrative and other services to each of its insurance subsidiaries. The amounts charged to and paid by the subsidiaries include reimbursements for various shared services and other expenses incurred directly on behalf of the subsidiaries by the Parent. In addition, there is in place a formal tax-sharing agreement between the Parent and its insurance subsidiaries. It is anticipated that this agreement will provide the Parent with additional funds from profitable subsidiaries due to the subsidiaries' use of the Parent's tax loss carryforwards, which totaled approximately $5.3 million at September 30, 2012.

The Company's revolving credit facility (the "Credit Agreement") with Wells Fargo expired on August 31, 2012, the stated maturity date, by its terms. There were no balances outstanding under the Credit Agreement at that time. The Company has not entered into any replacement credit facility, but expects that it will evaluate the need to enter into any such facility when, as and if necessary in the future.

The Company has two statutory trusts which exist for the exclusive purpose of issuing trust preferred securities representing undivided beneficial interests in the assets of the trusts and investing the gross proceeds of the trust preferred securities in junior subordinated deferrable interest debentures ("Junior Subordinated Debentures"). The outstanding $18.0 million and $23.2 million of Junior Subordinated Debentures mature on December 4, 2032 and May 15, 2033, respectively, are callable quarterly, in whole or in part, only at the . . .

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