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

Show all filings for AMTRUST FINANCIAL SERVICES, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for AMTRUST FINANCIAL SERVICES, INC.


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q.

Note on Forward-Looking Statements

This Form 10-Q contains certain forward-looking statements that are intended to be covered by the safe harbors created by The Private Securities Litigation Reform Act of 1995. When we use words such as "anticipate," "intend," "plan," "believe," "estimate," "expect," or similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include the plans and objectives of management for future operations, including those relating to future growth of our business activities and availability of funds, and are based on current expectations that involve assumptions that are difficult or impossible to predict accurately, many of which are beyond our control. There can be no assurance that actual developments will be those anticipated by us. Actual results may differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including, but not limited to, non-receipt of expected payments from insureds or reinsurers, changes in interest rates, a downgrade in the financial strength ratings of our insurance subsidiaries, the effect of the performance of financial markets on our investment portfolio, our estimates of the fair value of our life settlement contracts, development of claims and the effect on loss reserves, accuracy in projecting loss reserves, the cost and availability of reinsurance coverage, the effects of emerging claim and coverage issues, changes in the demand for our products, our degree of success in integrating acquired businesses, the effect of general economic conditions, state and federal legislation, regulations and regulatory investigations into industry practices, risks associated with conducting business outside the United States, developments relating to existing agreements, disruptions to our business relationships with Maiden Holdings, Ltd., American Capital Acquisition Corporation, or third party agencies and warranty administrators, difficulties with technology or breaches in data security, heightened competition, changes in pricing environments, and changes in asset valuations. Additional information about these risks and uncertainties, as well as others that may cause actual results to differ materially from those projected, is contained in our filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2011, and our quarterly reports on Form 10-Q. The projections and statements in this report speak only as of the date of this report and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

Overview

We are a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. We provide insurance coverage for small businesses and products with high volumes of insureds and loss profiles that we believe are predictable. We target lines of insurance that we believe generally are underserved by the market. We have grown by hiring teams of underwriters with expertise in our specialty lines and acquiring companies and assets that, in each case, provide access to distribution networks and renewal rights to established books of specialty insurance business. We have operations in four business segments:

         Small Commercial Business. We provide workers' compensation, commercial
          package and other commercial insurance lines produced by wholesale
          agents, retail agents and brokers in the United States.


         Specialty Risk and Extended Warranty. We provide coverage for consumer
          and commercial goods and custom designed coverages, such as accidental
          damage plans and payment protection plans offered in connection with
          the sale of consumer and commercial goods, in the United States and
          Europe, and certain niche property, casualty and specialty liability
          risks in the United States and Europe, including general liability,
          employers' liability and professional and medical liability.


         Specialty Program. We write commercial insurance for narrowly defined
          classes of insureds, requiring an in-depth knowledge of the insured's
          industry segment, through general and other wholesale agents.


         Personal Lines Reinsurance. We reinsure 10% of the net premiums of the
          GMACI personal lines business, pursuant to a quota share reinsurance
          agreement ("Personal Lines Quota Share") with the GMACI personal lines
          insurance companies.


We transact business primarily through eleven insurance company subsidiaries:

                                                                     Coverage
Company                 A.M. Best Rated   Coverage Type Offered       Market         Domiciled
Technology Insurance     A (Excellent)    Small Commercial        United States    New Hampshire
Company, Inc. ("TIC")                     Business, Specialty
                                          Program and Specialty
                                          Risk & Extended
                                          Warranty
Rochdale Insurance       A (Excellent)    Small Commercial        United States      New York
Company ("RIC")                           Business, Specialty
                                          Program and Specialty
                                          Risk & Extended
                                          Warranty
Wesco Insurance          A (Excellent)    Small Commercial        United States      Delaware
Company ("WIC")                           Business, Specialty
                                          Program and Specialty
                                          Risk & Extended
                                          Warranty
Associated Industries    A (Excellent)                            United States       Florida
Insurance Company,                        Workers' Compensation
Inc. ("AIIC")                             and Specialty Program
Milwaukee Casualty       A (Excellent)                            United States      Wisconsin
Insurance Co.                             Small Commercial
("MCIC")                                  Business
Security National        A (Excellent)                            United States        Texas
Insurance Company                         Small Commercial
("SNIC")                                  Business
AmTrust Insurance        A (Excellent)                            United States       Kansas
Company of Kansas,                        Small Commercial
Inc. ("AICK")                             Business
AmTrust Lloyd's          A (Excellent)                            United States        Texas
Insurance Company                         Small Commercial
("ALIC")                                  Business
AmTrust International    A (Excellent)    Specialty Risk and      European Union      Ireland
Underwriters Limited                      Extended Warranty;        and United
("AIU")                                   Specialty Program           States
AmTrust Europe, Ltd.     A (Excellent)    Specialty Risk and      European Union      England
("AEL")                                   Extended Warranty
AmTrust International    A (Excellent)                            United States       Bermuda
Insurance Ltd.                                                     and European
("AII")                                   Reinsurance                 Union

Insurance, particularly workers' compensation, is generally affected by seasonality. The first quarter generally produces greater premiums than subsequent quarters. Nevertheless, the impact of seasonality on our Small Commercial Business and Specialty Program segments has not been significant. We believe that this is because we serve many small businesses in different geographic locations. In addition, we believe seasonality is muted by our acquisition activity.

We evaluate our operations by monitoring key measures of growth and profitability. We measure our growth by examining our net income, return on average equity, and our loss, expense and combined ratios. The following summary provides further explanation of the key measures that we use to evaluate our results:

Gross Written Premium. Gross written premium represents estimated premiums from each insurance policy that we write, including as a servicing carrier for assigned risk plans, during a reporting period based on the effective date of the individual policy. Certain policies that we underwrite are subject to premium audit at that policy's cancellation or expiration. The final actual gross premiums written may vary from the original estimate based on changes to the final rating parameters or classifications of the policy.

Net Written Premium. Net written premium is gross written premium less that portion of premium that is ceded to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreements.

Net Earned Premium. Net earned premium is the earned portion of our net written premiums. We earn insurance premiums on a pro-rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums, which are earned in subsequent periods over the remaining term of the policy. Our workers' compensation insurance and commercial package policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2012 for an employer with a constant payroll during the term of the policy, we would earn half of the premiums in 2012 and the other half in 2013. We earn our specialty risk and extended warranty coverages over the estimated exposure time period. The terms vary depending on the risk and have an average duration of approximately 23 months, but range in duration from one month to 120 months.


Ceding Commission Revenues. Ceding commission is a commission we receive from ceding gross written premium to third party reinsurers. We earn commissions on reinsurance premiums ceded in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured. In connection with the Maiden Quota Share, which is our primary source of ceding commission, the amount we receive is a blended rate based on a contractual formula contained in the individual reinsurance agreements, and the rate may not correlate specifically to the cost structure of our individual segments. As such, we allocate earned ceding commissions to our segments based on each segment's proportionate share of total acquisition costs and other underwriting expenses recognized during the period.

Service and Fee Income. We currently generate service and fee income from the following sources:

         Product warranty registration and service - Our Specialty Risk and
          Extended Warranty business generates fee revenue for product warranty
          registration and claims handling services provided to unaffiliated
          third parties.


         Servicing carrier - We act as a servicing carrier for workers'
          compensation assigned risk plans in eight states. In addition, we also
          offer claims adjusting and loss control services for fees to
          unaffiliated third parties.


         Management services - We provide services to insurance consumers,
          traditional insurers and insurance producers by offering flexible and
          cost effective alternatives to traditional insurance tools in the form
          of various risk retention groups and captive management companies, as
          well as management of workers' compensation and commercial property
          programs.


         Installment, reinstatement and policy fees - We recognize fee income
          associated with the issuance of workers' compensation policies for
          installment fees, in jurisdictions where it is permitted and approved,
          and reinstatement fees, which are fees charged to reinstate a policy
          after it has been canceled for non-payment, in jurisdictions where it
          is permitted and approved. Additionally, we recognize policy fees
          associated with general liability policies placed by Builders &
          Tradesmen's Insurance Services, Inc. ("BTIS").


         Broker services - We provide brokerage services to Maiden in connection
          with our reinsurance agreement for which we receive a fee.


         Asset management services - We currently manage the investment
          portfolios of Maiden, ACAC and ACP Re, Ltd. for which we receive a
          management fee.


         Information technology services - We provide information technology and
          printing and mailing services to ACAC and its affiliates for a fee.

Net Investment Income and Realized Gains and (Losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment. We classify equity securities and our fixed maturity securities as available-for-sale. We report net unrealized gains (losses) separately within accumulated other comprehensive income on our balance sheet.

Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses ("LAE") incurred represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and loss adjustment expenses related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle and we revise our estimates as we receive additional information about the condition of injured employees and claimants and the costs of their medical treatment. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our insurance policies is a critical factor in our profitability.

Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses consist of policy acquisition expenses, salaries and benefits and general and administrative expenses. These items are described below:

         Policy acquisition expenses comprise commissions directly attributable
          to those agents, wholesalers or brokers that produce premiums written
          on our behalf. In most instances, we pay commissions based on collected
          premium, which reduces our credit risk exposure associated with
          producers in case a policyholder does not pay a premium. We pay state
          and local taxes, licenses and fees, assessments and contributions to
          various state guaranty funds based on our premiums or losses in each
          state. Surcharges that we may be required to charge and collect from
          insureds in certain jurisdictions are recorded as accrued liabilities,
          rather than expense.


         Salaries and benefits expenses are those salaries and benefits expenses
          for employees that are directly involved in the origination, issuance
          and maintenance of policies, claims adjustment and accounting for
          insurance transactions. We classify salaries and benefits associated
          with employees that are involved in fee generating activities as other
          expenses.


         General and administrative expenses are comprised of other costs
          associated with our insurance activities, such as federal excise tax,
          postage, telephones and internet access charges, as well as legal and
          auditing fees and board and bureau charges.

Gain on Investment in Life Settlement Contracts. The gain on investment in life settlement contracts includes the gain on acquisition of life settlement contracts, the gain realized upon a mortality event and the change in fair value of the investments in life settlements as evaluated at the end of each reporting period. We determine fair value based upon the discounted cash flow of the anticipated death benefits, incorporating a number of factors, such as current life expectancy assumptions, expected premium payment obligations and cost assumptions, credit exposure to the insurance companies that issued the life insurance policies and the rate of return that a buyer would require on the policies. The gain realized upon mortality event is the difference between the death benefit received and the recorded fair value of that particular policy. We allocate gain on investment in life settlement contracts to our segments based on net written premium by segment.

Net Loss Ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company's business. Expressed as a percentage, this is the ratio of net losses and loss adjustment expense incurred to net premiums earned.

Net Expense Ratio. The net expense ratio is a measure of an insurance company's operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs and other underwriting expenses less ceding commission revenue to net premiums earned. As we allocate certain acquisition costs and other underwriting expenses based on premium volume to our segments, net loss ratio on a segment basis may be impacted period over period by a shift in the mix of net written premium.

Net Combined Ratio. The net combined ratio is a measure of an insurance company's overall underwriting profit. This is the sum of the net loss and net expense ratios. If the net combined ratio is at or above 100%, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.

Net Premiums Earned less Expenses Included in Combined Ratio (Underwriting Income). Underwriting income is a measure of an insurance company's overall operating profitability before items such as investment income, interest expense and income taxes.

Return on Equity. We calculate return on equity by dividing net income by the average of shareholders' equity.

One of the key financial measures that we use to evaluate our operating performance is return on average equity. Our return on annualized average equity was 16.7% and 17.9% for the three months ended September 30, 2012 and 2011, respectively, and 16.6% and 22.7% for the nine months ended September 30, 2012 and 2011, respectively. In addition, we target a net combined ratio of 95% or lower over the long term, while seeking to maintain optimal operating leverage in our insurance subsidiaries commensurate with our A.M. Best rating objectives. Our net combined ratio was 90.2%% and 89.3% for the three months ended September 30, 2012 and 2011, respectively, and 89.2% and 89.0% for the nine months ended September 30, 2012 and 2011, respectively.

Critical Accounting Policies

Our discussion and analysis of our results of operations, financial condition and liquidity are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts of assets and liabilities, revenues and expenses and disclosure of contingent assets and liabilities as of the date of the financial statements. As more information becomes known, these estimates and assumptions could change, which would have an impact on actual results that may differ materially from these estimates and judgments under different assumptions. We have not made any changes in estimates or judgments that have had a significant effect on the reported amounts as previously disclosed in our Annual Report on Form 10-K for the fiscal period ended December 31, 2011.


Results of Operations
 Consolidated Results of Operations for the Three and Nine Months Ended
September 30, 2012 and 2011 (Unaudited)
                                    Three Months Ended September 30,          Nine Months Ended September 30,
(Amounts in Thousands)                  2012                 2011                 2012                 2011
Gross written premium            $       736,556       $       561,222     $      1,975,681       $  1,563,711

Net written premium              $       483,659       $       321,903     $      1,235,025       $    931,603
Change in unearned premium               (96,212 )             (33,055 )           (199,560 )         (194,135 )
Net earned premiums                      387,447               288,848            1,035,465            737,468
Ceding commission - primarily
related party                             49,860                40,732              140,684            111,830
Service and fee income (related
parties - three months $7,171;
$4,189 and nine months $20,195;
$12,089)                                  44,561                28,815              118,110             78,546
Net investment income                     18,429                14,456               49,291             41,815
Net realized gain on investments           2,213                   550                3,768              1,581
Total revenues                           502,510               373,401            1,347,318            971,240
Loss and loss adjustment expense        (255,646 )            (185,352 )           (667,362 )         (484,056 )
Acquisition costs and other
underwriting expenses                   (143,736 )            (113,270 )           (397,474 )         (284,084 )
Other                                    (42,337 )             (24,045 )           (110,296 )          (62,805 )
Total expenses                          (441,719 )            (322,667 )         (1,175,132 )         (830,945 )
Income before other income
(expense), income taxes and
equity in earnings (loss) of
unconsolidated subsidiary                 60,791                50,734              172,186            140,295
Other income (expense):
Interest expense                          (7,218 )              (3,946 )            (21,303 )          (12,034 )
Foreign currency (loss) gain                (951 )              (4,063 )             (2,985 )           (1,827 )
Bargain purchase on Majestic
transaction                                    -                 5,850                    -              5,850
Net gain on investment in life
settlement contracts                       3,251                 6,822                5,302             48,346
Total other income (expense)              (4,918 )               4,663              (18,986 )           40,335
Income before income taxes and
equity in earnings (loss) of
unconsolidated subsidiary                 55,873                55,397              153,200            180,630
Provision for income taxes               (13,187 )             (14,297 )            (36,106 )          (30,623 )
Income before equity in earnings
(loss) of unconsolidated
subsidiary and non-controlling
interest                                  42,686                41,100              117,094            150,007
Equity in earnings of
unconsolidated subsidiary -
related party                              3,207                  (918 )              8,659              3,415
Net income                                45,893                40,182              125,753            153,422
Non-controlling interest                  (2,663 )              (3,016 )             (3,079 )          (20,911 )
Net income attributable to
AmTrust Financial Services, Inc. $        43,230       $        37,166     $        122,674       $    132,511
Net realized gain (loss) on
investments:
Total other-than-temporary
impairment loss                  $             -       $             -     $         (1,208 )     $       (345 )
Portion of loss recognized in
other comprehensive income                     -                     -                    -                  -
Net impairment losses recognized
in earnings                                    -                     -               (1,208 )             (345 )
Other net realized gain on
investments                                2,213                   550                4,976              1,926
Net realized investment gain     $         2,213       $           550     $          3,768       $      1,581
Key measures:
Net loss ratio                              66.0 %                64.2 %               64.5 %             65.6 %
Net expense ratio                           24.2 %                25.1 %               24.8 %             23.4 %
Net combined ratio                          90.2 %                89.3 %               89.2 %             89.0 %


Consolidated Result of Operations for the Three Months Ended September 30, 2012 and 2011

Gross Written Premium. Gross written premium increased $175.4 million, or 31.3%, to $736.6 million from $561.2 million for the three months ended September 30, 2012 and 2011, respectively. The increase of $175.4 million was primarily attributable to growth in our Small Commercial Business and Specialty Program segments. The increase in Small Commercial Business resulted primarily from increases in workers' compensation policy counts, the acquisitions of Majestic and BTIS in 2011 and rate increases in some of our key states. The increase in Specialty Program resulted primarily from programs developed from new underwriting teams we hired in 2010 and 2011.

Net Written Premium. Net written premium increased $161.8 million, or 50.2%, to $483.7 million from $321.9 million for the three months ended September 30, 2012 and 2011, respectively. The increase(decrease) by segment was: Small Commercial Business - $54.4 million, Specialty Risk and Extended Warranty - $(12.1) million, Specialty Program - $115.9 million and Personal Lines - $3.6 million. Net written premium increased for the three months ended September 30, 2012 compared to the same period in 2011 due to the increase in gross written premium in 2012 compared to 2011 as well as higher retention of gross written premiums on programs we write that are not covered by the Maiden Quota Share.

Net Earned Premium. Net earned premium increased $98.6 million, or 34.1%, to . . .

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