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AFSI > SEC Filings for AFSI > Form 10-Q on 9-May-2013All 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-May-2013

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., National General Holding Corp., 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, 2012, 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, through acquisitions of 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 the Personal Lines Quota
          Share with the GMACI personal lines insurance companies.


We transact business primarily through our eight insurance subsidiaries domiciled in the United States and four insurance subsidiaries domiciled in Europe. We are authorized to write business in all 50 states in the United States and in the European Union. Our principal operating subsidiaries are rated "A" (Excellent) by A.M. Best Company ("A.M. Best").

For the three months ended March 31, 2013, our results of operations include activity for the following entities that were acquired subsequent to the three months ended March 31, 2012:

         CNH Capital Insurance Agency Inc. and CNH Capital Canada Insurance
          Agency, Ltd., collectively known as "CNH Capital Insurance Agencies" or
          "CNH"

First Nonprofit Companies, Inc. ("FNC")

Car Care Plan (Holdings) Limited ("CCPH" or "Car Care")

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 we ceded to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on the 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 24 months, but range in duration from one month to 120 months.

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) on those securities classified as available-for-sale separately within accumulated other comprehensive income on our balance sheet.

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 the contractual formula contained therein.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 nine 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. We also offer programs and alternative funding options for
          non-profit and public sector organizations for the management of their
          state unemployment insurance obligations.


         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 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, National General Holdings Corp ("NGHC"), which
          changed its name from American Capital Acquisition Corp, or ACAC, in
          April 2013, and ACP Re, Ltd. for which we receive a management fee.


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

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 (loss) on Investment in Life Settlement Contracts. The gain (loss) on investment in life settlement contracts includes the gain on acquisition of life settlement contracts, the gain realized upon a mortality event, the change in fair value of the investments in life settlements as evaluated at the end of each reporting period and changes in reserves life expectancy and contestability reserves. We determine fair value based upon our estimate of 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 increased 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 (loss) realized upon a mortality event is the difference between the death benefit received and the recorded fair value of that particular policy. We allocate gain (loss) on investment in life settlement contracts to our segments based on gross 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 LAE 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 each segment's proportionate share 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 22.2% and 16.9% for the three months ended March 31, 2013 and 2012, 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 89.5% and 88.5% for the three months ended March 31, 2013 and 2012, 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, 2012.


Results of Operations

Consolidated Results of Operations for the Three Months Ended March 31, 2013 and
2012 (Unaudited)

                                                              Three Months Ended March 31,
(Amounts in Thousands)                                          2013                 2012
Gross written premium                                     $      943,922       $      601,687

Net written premium                                       $      532,106       $      359,777
Change in unearned premium                                      (124,112 )            (45,753 )
Net earned premiums                                              407,994              314,024
Ceding commission - primarily related party                       63,958               46,274
Service and fee income (related parties - $10,507;
$6,092)                                                           60,513               40,538
Net investment income                                             18,095               14,518
Net realized gain (loss) on investments                           17,284               (1,148 )
Total revenues                                                   567,844              414,206
Loss and loss adjustment expense                                 272,256              199,929
Acquisition costs and other underwriting expenses                156,820              124,025
Other                                                             52,152               35,639
Total expenses                                                   481,228              359,593
Income before other income (expense), income taxes and
equity in earnings of unconsolidated subsidiaries                 86,616               54,613
Other income (expense):
Interest expense                                                  (7,361 )             (7,091 )
Net (loss) gain on investment in life settlement
contracts                                                         (1,076 )                 90
Foreign currency gain                                              1,272                  421
Total other income (expense)                                      (7,165 )             (6,580 )
Income before income taxes and equity in earnings (loss)
of unconsolidated subsidiaries                                    79,451               48,033
Provision for income taxes                                        17,660               11,177
Income before equity in earnings of unconsolidated
subsidiaries                                                      61,791               36,856
Equity in earnings of unconsolidated subsidiaries -
related party                                                      1,551                2,364
Net income                                                        63,342               39,220
Non-controlling interest                                             876                 (134 )
Net income attributable to AmTrust Financial Services,
Inc.                                                      $       64,218       $       39,086

Net realized gain (loss) on investments:
Total other-than-temporary impairment loss                $            -       $            -
Portion of loss recognized in other comprehensive income               -                    -
Net impairment losses recognized in earnings                           -                    -
Other net realized gain on investments                            17,284               (1,148 )
Net realized investment gain (loss)                       $       17,284       $       (1,148 )

Key measures:
Net loss ratio                                                      66.7 %               63.7 %
Net expense ratio                                                   22.8 %               24.8 %
Net combined ratio                                                  89.5 %               88.5 %


Gross Written Premium. Gross written premium increased $342.2 million, or 56.9%, to $943.9 million from $601.7 million for the three months ended March 31, 2013 and 2012, respectively. The increase of $342.2 million was primarily attributable to growth in our three primary segments. The increase in Small Commercial Business resulted primarily from increases in the number of policies issued as well as the average policy size. The largest increases came from the states of California, Florida, New Jersey and New York. Additionally, we had an increase in our assigned risk premium. The increase in Specialty Program resulted primarily from growth in existing in workers' compensation programs and commercial package programs.

Net Written Premium. Net written premium increased $172.3 million, or 47.9%, to $532.1 million from $359.8 million for the three months ended March 31, 2013 and 2012, respectively. The increase by segment was: Small Commercial Business - $54.8 million, Specialty Risk and Extended Warranty - $43.2 million, Specialty Program - $74.2 million and Personal Lines - $0.1 million. Net written premium increased for the three months ended March 31, 2013 compared to the same period in 2012 due to the increase in gross written premium in 2013 compared to 2012 and was partially offset by lower retention of premiums written on programs in our Small Commercial Business segment and Specialty Risk and Extended Warranty segment that are not covered by the Maiden Quota Share. Our overall retention rates were 56.4% and 59.8% for the three months ended March 31, 2013 and 2012, respectively.

Net Earned Premium. Net earned premium increased $94.0 million, or 29.9%, to $408.0 million from $314.0 million for the three months ended March 31, 2013 and 2012, respectively. The increase by segment was: Small Commercial Business - $34.3 million, Specialty Risk and Extended Warranty - $5.6 million, Specialty Program - $51.8 million, and Personal Lines - $2.3 million. The increase in net earned premium corresponded to the increase in net written premium, which was partially offset by the increase in the Specialty Risk and Extended Warranty segment because premiums in that segment are earned over an average of 24 months.

Ceding Commission. Ceding commission represents commission earned primarily through the Maiden Quota Share, whereby we receive a ceding commission of 31% of premiums ceded for all business except retail commercial package business, and 34.375% for retail commercial package business. The ceding commission earned during the three months ended March 31, 2013 and 2012 was $64.0 million and $46.3 million, respectively. Ceding commission increased period over period as a result of increased premium writings and was consistent period over period as a percentage of earned premium.

Service and Fee Income. Service and fee income increased $20.0 million, or 49.3%, to $60.5 million from $40.5 million for the three months ended March 31, 2013 and 2012, respectively. The increase primarily related to additional fee income from acquisitions, as well as organic growth. We produced additional fee income of approximately $13.6 million during the three months ended March 31, 2013 related to the acquisitions of Car Care in February 2013 and FNC and CNH in the second half of 2012. Additionally, we had higher technology fee income from NGHC of approximately $2.9 million and higher reinsurance brokerage fees from Maiden of approximately $1.5 million.

Net Investment Income. Net investment income increased $3.6 million, or 24.6%, to $18.1 million from $14.5 million for the three months ended March 31, 2013 and 2012, respectively. The increase resulted primarily from having a higher average portfolio of fixed security investment securities during the three months ended March 31, 2013 compared to the three months ended March 31, 2012 partially offset by lower yields.

Net Realized Gains (Losses) on Investments. We had a net realized gain on investments of $17.3 million for the three months ended March 31, 2013, compared to a net realized loss on investments of $1.1 million for the three months ended March 31, 2012. The increase in 2013 resulted from an effort to sell securities with sizable unrealized gain positions in our investment portfolio during the three months ended March 31, 2013.

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $72.4 million, or 36.2%, to $272.3 million from $199.9 million for the three months ended March 31, 2013 and 2012, respectively. Our loss ratio for the three . . .

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