10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-K

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013

Commission File Number: 001-12251

 

 

AMERISAFE, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Texas   75-2069407
(State of Incorporation)  

(I.R.S. Employer

Identification Number)

2301 Highway 190 West,

DeRidder, Louisiana

  70634
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (337) 463-9052

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Class

 

Name of Each Exchange on Which Registered

Common Stock, par value $0.01 per share   Nasdaq Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

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

 

Large accelerated filer

  ¨      Accelerated filer   x

Non-accelerated filer

  ¨   (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

The aggregate market value of the voting common stock held by non-affiliates of the Registrant as of June 30, 2013 (the last business day of the Registrant’s most recently completed second fiscal quarter) was approximately $589.7 million, based upon the closing price of the shares on the NASDAQ Global Select Market on that date.

As of February 14, 2014, there were 18,619,680 shares of the Registrant’s common stock, par value $0.01 per share, outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement relating to the 2014 Annual Meeting of Shareholders are incorporated by reference in Items 10, 11, 12, 13 and 14 of Part III of this report.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

        Page
    No.    
 
PART I    
 

Forward-Looking Statements

    1   
Item 1  

Business

    2   
Item 1A  

Risk Factors

    28   
Item 1B  

Unresolved Staff Comments

    37   
Item 2  

Properties

    37   
Item 3  

Legal Proceedings

    37   
Item 4  

Mine Safety Disclosures

    38   
PART II    
Item 5   Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities     38   
Item 6  

Selected Financial Data

    39   
Item 7   Management’s Discussion and Analysis of Financial Condition and Results of Operations     41   
Item 7A  

Quantitative and Qualitative Disclosures About Market Risk

    58   
Item 8  

Financial Statements and Supplementary Data

    60   
Item 9   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     105   
Item 9A  

Controls and Procedures

    105   
Item 9B  

Other Information

    107   
PART III    
Item 10  

Directors, Executive Officers and Corporate Governance

    107   
Item 11  

Executive Compensation

    107   
Item 12   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     107   
Item 13  

Certain Relationships and Related Transactions, and Director Independence

    107   
Item 14  

Principal Accountant Fees and Services

    107   
PART IV    
Item 15  

Exhibits and Financial Statement Schedules

    108   


Table of Contents

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and 21E of the Securities Exchange Act of 1934. You should not place undue reliance on these statements. These forward-looking statements include statements that reflect the current views of our senior management with respect to our financial performance and future events with respect to our business and the insurance industry in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements. Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:

 

    increased competition on the basis of types of insurance offered, premium rates, coverage availability, payment terms, claims management, safety services, policy terms, overall financial strength, financial ratings and reputation;

 

    greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than our underwriting, reserving or investment practices anticipate based on historical experience or industry data;

 

    general economic conditions, including recession, inflation, performance of financial markets, interest rates, unemployment rates and fluctuating asset values;

 

    the cyclical nature of the workers’ compensation insurance industry;

 

    loss of the services of any of our senior management or other key employees;

 

    decreased level of business activity of our policyholders caused by decreased business activity generally, and in particular in the industries we target;

 

    adverse developments in economic, competitive or regulatory conditions within the workers’ compensation insurance industry;

 

    decreased demand for our insurance;

 

    changes in regulations, laws, rates, or rating factors applicable to us, our policyholders or the agencies that sell our insurance;

 

    changes in rating agency policies, practices or ratings;

 

    changes in the availability, cost or quality of reinsurance and the failure of our reinsurers to pay claims in a timely manner or at all;

 

    changes in legal theories of liability under our insurance policies;

 

    developments in capital markets that adversely affect the performance of our investments;

 

    the effects of U.S. involvement in hostilities with other countries and large-scale acts of terrorism, or the threat of hostilities or terrorist acts; and

 

    other risks and uncertainties described from time to time in the Company’s filings with the Securities and Exchange Commission (“SEC”).

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this report, including under the caption “Risk Factors” in Item 1A of this report. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate.

 

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PART I

 

Item  1. Business.

Overview

We are a specialty provider of workers’ compensation insurance focused on small to mid-sized employers engaged in hazardous industries, principally construction, trucking, manufacturing, oil and gas and agriculture. Since commencing operations in 1986, we have gained significant experience underwriting the complex workers’ compensation exposures inherent in these industries. We provide coverage to employers under state and federal workers’ compensation laws. These laws prescribe wage replacement and medical care benefits that employers are obligated to provide to their employees who are injured in the course and scope of their employment. Our workers’ compensation insurance policies provide benefits to injured employees for, among other things, temporary or permanent disability, death and medical and hospital expenses. The benefits payable and the duration of those benefits are set by state or federal law. The benefits vary by jurisdiction, the nature and severity of the injury and the wages of the employee. The employer, who is the policyholder, pays the premiums for coverage.

Hazardous industry employers tend to have less frequent but more severe claims as compared to employers in other industries due to the nature of their businesses. Injuries that occur are often severe in nature including death, dismemberment, paraplegia and quadriplegia. As a result, employers engaged in hazardous industries pay substantially higher than average rates for workers’ compensation insurance compared to employers in other industries, as measured per payroll dollar. The higher premium rates are due to the nature of the work performed and the inherent workplace danger of our target policyholders. For example, our construction employers on average paid premium rates equal to $8.09 per $100 of payroll to obtain workers’ compensation coverage for all of their employees in 2013.

We employ a proactive, disciplined approach to underwriting employers and providing comprehensive services intended to lessen the overall incidence and cost of workplace injuries. We provide safety services at employers’ workplaces as a vital component of our underwriting process and to promote safer workplaces. We utilize intensive claims management practices that we believe permit us to reduce the overall cost of our claims. In addition, our premium audit services ensure that our policyholders pay the appropriate premiums required under the terms of their policies and enable us to monitor payroll patterns that cause underwriting, safety or fraud concerns.

We believe that the higher premiums typically paid by our policyholders, together with our disciplined underwriting and safety, claims and audit services, provide us with the opportunity to earn attractive returns on equity.

AMERISAFE, Inc. is an insurance holding company, incorporated in Texas in 1985. We began operations in 1986 by focusing on workers’ compensation insurance for logging contractors in the southeast United States. Beginning in 1994, we expanded our focus to include the other hazardous industries we serve today. During 2013, two of our three insurance subsidiaries, American Interstate Insurance Company and Silver Oak Casualty, were re-domesticated to Nebraska from Louisiana. Our other insurance subsidiary, American Interstate Insurance Company of Texas, remains domiciled in Texas.

Competitive Advantages

We believe we have the following competitive advantages:

Focus on Hazardous Industries.  We have extensive experience insuring employers engaged in hazardous industries and have a history of profitably underwriting these industries. Our specialized knowledge of these hazardous industries helps us better serve our policyholders, which leads to greater employer loyalty and policy retention. Our policy renewal rate on voluntary business that we elected to quote for renewal was 92.3% in 2013.

 

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Focus on Small to Mid-Sized Employers.  We believe large insurance companies generally do not target small to mid-sized employers in hazardous industries due to their smaller premium sizes, types of operations, mobile workforces and extensive service needs. We provide these employers enhanced services, including premium payment plans to better match premium payments with our policyholders’ payroll costs and cash flow.

Specialized Underwriting Expertise.  Based on our 28-year history of insuring employers engaged in hazardous industries, we have developed industry specific risk analysis and rating tools that support our underwriters in risk selection and pricing. We are highly disciplined when quoting and binding new and renewal business. We do not delegate underwriting authority to agencies, marketers or to any other third parties that sell our insurance.

Comprehensive Safety Services.  We provide proactive safety reviews of employers’ worksites, which are often located in rural areas. These safety reviews are a vital component of our underwriting process and also assist our policyholders in loss prevention, and encourage safer workplaces by deploying experienced field safety professionals, or FSPs, to our policyholders’ worksites. In 2013, 86.0% of our new voluntary business policyholders were subject to pre-quotation safety inspections. Additionally, we perform periodic on-site safety surveys of all of our voluntary business policyholders.

Proactive Claims Management.  Our employees manage substantially all of our open claims in-house, utilizing intensive claims management practices that emphasize a personalized approach, as well as quality, cost-effective medical treatment. As of December 31, 2013, open indemnity claims per field case manager, or FCM, averaged 53 claims, which we believe is significantly less than the industry average. We also believe our claims management practices allow us to achieve a more favorable claim outcome, accelerate an employee’s return to work, lessen the likelihood of litigation and more rapidly close claims, all of which ultimately lead to lower overall claim costs.

Efficient Operating Platform.  Through extensive cost management initiatives, we maintain one of the most efficient operations in the workers’ compensation industry. In 2013, our expense ratio was 20.3%. We believe that our expense ratio is substantially lower than that of our competitors, which gives us a greater opportunity to generate an underwriting profit.

Strategy

We intend to increase our book value and produce favorable returns on equity using the following strategies:

Focus on Underwriting Profitability.  We intend to maintain our underwriting discipline throughout market cycles with the objective of remaining profitable. Our strategy is to focus on underwriting workers’ compensation insurance in hazardous industries and to maintain adequate rate levels commensurate with the risks we underwrite. We will also continue to strive for improved risk selection and pricing, as well as reduced frequency and severity of claims through comprehensive workplace safety reviews, effective medical cost containment measures and rapid closing of claims through personal, direct contact with our policyholders and their employees.

Increase Market Penetration.  Based on data received from the National Association of Insurance Commissioners, the NAIC, we do not have more than 5.0% of the market share in any state we serve. As a result, we believe we have the opportunity to increase market penetration in each of the states in which we currently operate. Competition in our target markets is fragmented by state, employer size and industry. We believe that our specialized underwriting expertise and safety, claims and audit services position us to profitably increase our market share in our existing principal markets, with minimal increase in field service employees.

Prudent and Opportunistic Geographic Expansion.  While we actively market our insurance in 30 states and the District of Columbia, 44.3% of our voluntary in-force premiums were generated in the five states where we derived 5.0% or more of our gross premiums written in 2013. We are licensed in an additional 17 states and the U.S. Virgin Islands. Our existing licenses and rate filings will expedite our ability to write policies in these markets when we decide it is prudent to do so.

 

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Capitalize on Development of Information Technology System.  We believe our underwriting and agency management system, GEAUX, along with our customized operational system, ICAMS, and the analytical data warehouse that ICAMS feeds, significantly enhance our ability to select risk, write profitable business and cost-effectively administer our billing, claims and audit functions.

Maintain Capital Strength.  We plan to manage our capital to achieve our profitability goals while striving for optimal operating leverage for our insurance company subsidiaries. To accomplish this objective, we intend to maintain underwriting profitability throughout market cycles, optimize our use of reinsurance, deploy appropriate capital management tools and produce an appropriate risk adjusted return on our growing investment portfolio.

Industry

Overview.  Workers’ compensation is a statutory system under which an employer is required to pay for its employees’ medical, disability, vocational rehabilitation and death benefit costs for work-related injuries or illnesses. Most employers satisfy this requirement by purchasing workers’ compensation insurance. The principal concept underlying workers’ compensation laws is that employees injured in the course and scope of their employment have only the legal remedies available under workers’ compensation laws and do not have any other recourse against their employer. An employer’s obligation to pay workers’ compensation does not depend on any negligence or wrongdoing on the part of the employer and exists even for injuries that result from the negligence or fault of another person, a co-employee, or, in most instances, the injured employee.

Workers’ compensation insurance policies generally provide that the insurance carrier will pay all benefits that the insured employer may become obligated to pay under applicable workers’ compensation laws. Each state has a regulatory and adjudicatory system that quantifies the level of wage replacement to be paid, determines the level of medical care required to be provided and the cost of temporary or permanent impairment and specifies the options in selecting medical providers available to the injured employee or the employer. These state laws generally require two types of benefits for injured employees: (1) medical benefits, which include expenses related to the diagnosis and treatment of the injury, as well as any required rehabilitation, and (2) indemnity payments, which consist of temporary wage replacement, permanent disability payments and death benefits to surviving family members. To fulfill these mandated financial obligations, virtually all employers are required to purchase workers’ compensation insurance or, if permitted by state law or approved by the U.S. Department of Labor, to self-insure. The employers may purchase workers’ compensation insurance from a private insurance carrier, a state-sanctioned assigned risk pool, or a self-insurance fund, which is an entity that allows employers to obtain workers’ compensation coverage on a pooled basis, typically subjecting each employer to joint and several liability for the entire fund.

Workers’ compensation was the fourth-largest property and casualty insurance line in the United States in 2012, according to the National Council on Compensation Insurance, Inc., the NCCI. Direct premiums written in 2012 for the workers’ compensation insurance industry were $49 billion, and direct premiums written for the property and casualty industry as a whole were $524 billion. According to the most recent market data reported by the NCCI, which is the official rating bureau in the majority of states in which we are licensed, total premiums reported for the specific occupational class codes for which we underwrite business were $13.4 billion in 2012.

Policyholders

As of December 31, 2013, we had more than 7,600 voluntary business policyholders with an average annual workers’ compensation policy written premium of $43,539. As of December 31, 2013, our ten largest voluntary business policyholders accounted for 3.2% of our in-force premiums. Our policy renewal rate on voluntary business that we elected to quote for renewal was 92.3% in 2013, 91.5% in 2012, and 92.0% in 2011.

In addition to our voluntary workers’ compensation business, we underwrite workers’ compensation policies for employers assigned to us and assume reinsurance premiums from mandatory pooling arrangements, in each case to fulfill our obligations under residual market programs implemented by the states in which we

 

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operate. Our assigned risk business fulfills our statutory obligation to participate in residual market plans in four states. See “—Regulation—Residual Market Programs” below. For the year ended December 31, 2013, our assigned risk business accounted for 1.2% of our gross premiums written, and our assumed premiums from mandatory pooling arrangements accounted for 2.1% of our gross premiums written.

Targeted Industries

We provide workers’ compensation insurance primarily to employers in the following targeted hazardous industries:

Construction.  Includes a broad range of operations such as highway and bridge construction, building and maintenance of pipeline and powerline networks, excavation, commercial construction, roofing, iron and steel erection, tower erection and numerous other specialized construction operations. In 2013, our average policy premium for voluntary workers’ compensation within the construction industry was $44,064, or $8.09 per $100 of payroll.

Trucking.  Includes a broad spectrum of diverse operations including contract haulers, regional and local freight carriers, special equipment transporters and other trucking companies that conduct a variety of short- and long-haul operations. In 2013, our average policy premium for voluntary workers’ compensation within the trucking industry was $44,612, or $10.04 per $100 of payroll.

Manufacturing.  Includes a diverse group of policyholders’ businesses such as the production of goods for use or sale using labor and machines, tools, chemical and biological processing or formulation. In 2013, our average policy premium for voluntary workers’ compensation within the manufacturing industry was $45,435, or $5.66 per $100 of payroll.

Oil and Gas.  Includes various oil and gas activities including gathering, transportation, processing, production, and field service operations. In 2013, our average policy premium for voluntary workers’ compensation within the oil and gas industry was $51,083, or $6.03 per $100 of payroll.

Agriculture.  Includes crop maintenance and harvesting, grain and produce operations, nursery operations, meat processing, and livestock feed and transportation. In 2013, our average policy premium for voluntary workers’ compensation within the agriculture industry was $30,190, or $6.55 per $100 of payroll.

Maritime.  Includes ship building and repair, pier and marine construction, inter-coastal construction, and stevedoring. In 2013, our average policy premium for voluntary workers’ compensation within the maritime industry was $61,838, or $6.67 per $100 of payroll.

Logging.  Includes tree harvesting operations ranging from labor intensive chainsaw felling and trimming to sophisticated mechanized operations using heavy equipment. In 2013, our average policy premium for voluntary workers’ compensation within the logging industry was $29,037, or $14.88 per $100 of payroll.

Our gross premiums are derived from:

 

    Voluntary Business. Includes direct premiums from workers’ compensation insurance policies that we issue to employers who seek to purchase insurance directly from us and who we voluntarily agree to insure.

 

    Assigned Risk Business. Includes direct premiums from workers’ compensation insurance policies that we issue to employers assigned to us under residual market programs implemented by some of the states in which we operate.

 

    Assumed Premiums. Includes premiums from our participation in mandatory pooling arrangements under residual market programs implemented by some of the states in which we operate.

 

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Gross premiums written during the years ended December 31, 2013, 2012 and 2011, and the allocation of those premiums among the hazardous industries we target are presented in the table below.

 

    Gross Premiums Written     Percentage of
Gross Premiums Written
 
    2013     2012     2011     2013     2012     2011  
    (In thousands)                    

Voluntary business:

           

Construction

   $     153,110         $ 132,776        $ 106,115         41.2%        40.4%        39.0%   

Trucking

    71,565          70,294         63,913         19.2%        21.4%        23.5%   

Manufacturing

    27,122          22,792         16,742         7.3%        6.9%        6.1%   

Oil and Gas

    17,976          15,519         11,996         4.8%        4.7%        4.4%   

Agriculture

    15,563          17,204         16,416         4.2%        5.3%        6.0%   

Maritime

    10,883          9,493         6,735         2.9%        2.9%        2.5%   

Logging

    8,132          7,795         11,835         2.2%        2.4%        4.4%   

Other

    55,554          45,123         33,266         14.9%        13.8%        12.3%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total voluntary business

    359,905          320,996         267,018         96.7%        97.8%        98.2%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Assigned risk business

    4,342          2,735         2,386         1.2%        0.7%        0.8%   

Assumed premiums

    7,930          5,092         2,697         2.1%        1.5%        1.0%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $     372,177         $     328,823        $     272,101         100.0%        100.0%        100.0%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Geographic Distribution

We are licensed to provide workers’ compensation insurance in 47 states, the District of Columbia and the U.S. Virgin Islands. We operate on a geographically diverse basis with less than 12.7% of our gross premiums written in 2013 derived from any one state. The table below identifies, for the years ended December 31, 2013, 2012 and 2011, the states in which the percentage of our gross premiums written exceeded 3.0% for any of the three years presented.

 

    Percentage of Gross Premiums Written
Year Ended December 31,
 

State

  2013     2012     2011  

Louisiana

    12.6%          11.1%          11.6%   

Pennsylvania

    9.2%          8.9%          8.0%   

Georgia

    9.2%          8.5%          8.5%   

North Carolina

    6.1%          7.0%          6.4%   

Illinois

    5.6%          5.9%          5.8%   

Oklahoma

    4.8%          5.4%          5.9%   

Virginia

    4.6%          5.5%          5.9%   

Florida

    4.5%          3.5%          2.8%   

Texas

    4.4%          4.2%          4.2%   

Alaska

    3.7%          3.3%          3.4%   

Kansas

    3.5%          3.5%          3.7%   

South Carolina

    3.4%          3.2%          2.9%   

Minnesota

    3.3%          3.4%          3.8%   

Tennessee

    3.2%          3.5%          2.7%   

Arkansas

    2.7%          2.7%          3.3%   

Wisconsin

    2.4%          3.1%          3.5%   
 

 

 

   

 

 

   

 

 

 

Total

            83.2%                  82.7%                    82.4%   
 

 

 

   

 

 

   

 

 

 

 

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Sales and Marketing

We sell our workers’ compensation insurance through agencies. As of December 31, 2013, our insurance was sold through more than 3,175 independent agencies and our wholly-owned insurance agency subsidiary, Amerisafe General Agency, which is licensed in 27 states. We are selective in establishing and maintaining relationships with independent agencies. We seek to do business with those agencies that provide quality application flow from companies operating in our target industries and classes that are reasonably likely to accept our quotes. We compensate these agencies by paying a commission based on the premium collected from the policyholder. Our average commission rate for our independent agencies was 7.5% for the year ended December 31, 2013. We pay our insurance agency subsidiary a commission rate of 8.0%. Neither our independent agencies nor our insurance agency subsidiary has authority to underwrite or bind coverage. We do not pay contingent commissions.

As of December 31, 2013, independent agencies accounted for 95.2% of our voluntary in-force premiums. No single independent agency accounted for more than 1.2% of our voluntary in-force premiums at that date.

Underwriting

Our underwriting strategy is to focus on employers in certain hazardous industries that operate in those states where our underwriting efforts are the most profitable and efficient. We analyze each prospective policyholder on its own merits relative to known industry trends and statistical data. Our underwriting guidelines specify that we do not write workers’ compensation insurance for certain hazardous activities, including sub-surface mining and manufacturing of ammunition or fireworks.

Underwriting is a multi-step process that begins with the receipt of an application from one of our agencies. We initially review the application to confirm that the prospective policyholder meets certain established criteria, including that it is engaged in one of our targeted hazardous industries and industry classes and operates in the states we target. If the application satisfies these criteria, the application is forwarded to our underwriting department for further review.

Our underwriting department reviews the application to determine if the application meets our underwriting criteria and whether all required information has been provided. If additional information is required, the underwriting department requests additional information from the agency submitting it. This initial review process is generally completed within three days after the application is received by us. Once this initial review process is complete, our underwriting department requests that a pre-quotation safety inspection be performed in most cases. In 2013, 86.0% of our new voluntary business policyholders were inspected prior to our offering a premium quote.

After the pre-quotation safety inspection has been completed, our underwriting professionals review the results of the inspection to determine if a quote should be made and, if so, prepare the quote. The quote must be reviewed and approved by our underwriting department before it is delivered to the agency. All decisions by our underwriting department, including decisions to decline applications, are subject to review and approval by our management-level underwriters.

Our underwriting professionals participate in an incentive compensation program under which bonuses are paid quarterly based upon achieving premium underwriting volume and loss ratio targets. The determination of whether targets have been satisfied is made 30 months after the beginning of the relevant incentive compensation period.

Pricing

In the majority of states, workers’ compensation insurance rates are based upon published “loss costs.” Loss costs are derived from wage and loss data reported by insurers to the state’s statistical agent, which in most states is the NCCI. The state agent then promulgates loss costs for specific job descriptions or class codes.

 

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Insurers file requests for adoption of a loss cost multiplier, or LCM, to be applied to the loss costs to support operating expenses and profit margins. In addition, most states allow pricing flexibility above and below the filed LCM, within certain limits.

We obtain approval of our rates, including our LCMs, from state regulatory authorities. To maintain rates at profitable levels, we regularly monitor and adjust our LCMs. The effective LCM for our voluntary business was 1.79 for policy year 2013, 1.64 for policy year 2012, and 1.50 for policy year 2011. If we are unable to charge rates in a particular state or industry to produce satisfactory results, we seek to control and reduce our premium volume in that state or industry and redeploy our capital in other states or industries that offer greater opportunity to earn an underwriting profit.

Safety

Our safety inspection process begins with a request from our underwriting department to perform a pre-quotation safety inspection. Our safety inspections focus on a prospective policyholder’s operations, loss exposures and existing safety controls to prevent potential losses. The factors considered in our inspection include employee experience, turnover, training, previous loss history and corrective actions, and workplace conditions, including equipment condition and, where appropriate, use of fall protection, respiratory protection or other safety devices. Our FSPs travel to employers’ worksites to perform these safety inspections. These initial inspections allow our underwriting professionals to make decisions on both insurability and pricing. In certain circumstances, we will agree to provide workers’ compensation insurance only if the employer agrees to implement and maintain the safety management practices that we recommend. In 2013, 86.0% of our new voluntary business policyholders were inspected prior to our offering a premium quote. The remaining voluntary business policyholders were not inspected prior to a premium quote for a variety of reasons, including small premium size or the fact that the policyholder was previously a policyholder subject to our safety inspections.

After an employer becomes a policyholder, we continue to emphasize workplace safety through periodic workplace visits, assisting the policyholder in designing and implementing enhanced safety management programs, providing safety-related information and conducting rigorous post-accident management. Generally, we may cancel or decline to renew an insurance policy if the policyholder does not implement or maintain reasonable safety management practices that we recommend.

Our FSPs participate in an incentive compensation program under which bonuses are paid semi-annually based upon an FSP’s production and their policyholders’ aggregate loss ratios. The results are measured 33 months after the inception of the subject policy period.

Claims

We have structured our claims operation to provide immediate, intensive and personal management of claims to guide injured employees through medical treatment, rehabilitation and recovery, with the primary goal of returning the injured employee to work as promptly as practicable. We seek to limit the number of claim disputes with injured employees through early intervention in the claims process.

Our FCMs are located in the geographic areas where our policyholders are based. We believe the presence of our FCMs in the field enhances our ability to guide an injured employee to the appropriate conclusion in a friendly, dignified and supportive manner. Our FCMs have broad authority to manage claims from occurrence of a workplace injury through resolution, including authority to retain many different medical providers at our expense. Such providers comprise not only our recommended medical providers, but also nurse case managers, independent medical examiners, vocational specialists, rehabilitation specialists and other specialty providers of medical services necessary to achieve a quality outcome.

Following notification of a workplace injury, an FCM will contact the policyholder, the injured employee and/or the treating physician to determine the nature and severity of the injury. If a serious injury occurs, the FCM will promptly visit the injured employee or the employee’s family members to discuss the benefits provided. The FCM will also visit the treating physician to discuss the proposed treatment plan. Our FCM assists

 

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the injured employee in receiving appropriate medical treatment and encourages the use of our recommended medical providers and facilities. For example, our FCM may suggest that a treating physician refer an injured worker to another physician or treatment facility that we believe has had positive outcomes for other workers with similar injuries. We actively monitor the number of open cases handled by a single FCM in order to maintain focus on each specific injured employee. As of December 31, 2013, we averaged 53 open indemnity claims per FCM, which we believe is significantly less than the industry average.

Locating our FCMs in the field also allows us to build professional relationships with local medical providers. In selecting medical providers, we rely, in part, on the recommendations of our FCMs who have developed professional relationships within their geographic areas. We also seek input from our policyholders and other contacts in the markets that we serve. While cost factors are considered in selecting medical providers, we consider the most important factor in the selection process to be the medical provider’s ability to achieve a quality outcome. We define quality outcome as the injured worker’s rapid, conclusive recovery and return to sustained, full capacity employment.

While we seek to promptly settle valid claims, we also aggressively defend against claims we consider to be non-meritorious. Where possible, we purchase annuities on longer life claims to close such claims, while still providing an appropriate level of benefits to injured employees.

Premium Audits

We conduct premium audits on all of our voluntary business policyholders annually upon the expiration of each policy, including when the policy is renewed. The purpose of these audits is to verify that policyholders have accurately reported their payroll expenses and employee job classifications, and therefore, have paid us the premium required under the terms of their policies. In addition to annual audits, we selectively perform interim audits on certain classes of business if significant or unusual claims are filed or if the monthly reports submitted by a policyholder reflect a payroll pattern or other aberrations that cause underwriting, safety or fraud concerns. We also mitigate potential losses from under-reporting of premium or delinquent premium payment by collecting a deposit from the policyholder at the inception of the policy, typically representing 15% of the total estimated annual premium, which deposit can be utilized to offset losses from non-payment of premium.

Loss Reserves

We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid as of a given point in time.

In establishing our reserves, we review the results of analyses using actuarial methodologies that utilize historical loss data from our more than 28 years of underwriting workers’ compensation insurance. In evaluating the results of those analyses, our management also uses substantial judgment in considering other factors that are not considered in these actuarial analyses. These actuarial methodologies and subjective factors are described in more detail below. Our process and methodology for estimating reserves applies to both our voluntary and assigned risk business, but does not include our reserves for mandatory pooling arrangements. We record reserves for mandatory pooling arrangements as those reserves are reported to us by the pool administrators. We do not use loss discounting when we determine our reserves, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income.

When a claim is reported, we establish an initial case reserve for the estimated amount of our loss based on our estimate of the most likely outcome of the claim at that time. Generally, that case reserve is established within 14 days after the claim is reported and consists of anticipated medical costs, indemnity costs and specific adjustment expenses, which we refer to as defense and cost containment expenses, or DCC expenses. The most complex claims, involving severe injuries, may take a considerable period of time for us to establish a more precise estimate of the most likely outcome of the claim. At any point in time, the amount paid on a claim, plus

 

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the reserve for future amounts to be paid, represents the estimated total cost of the claim, or the case incurred amount. The estimated amount of loss for a reported claim is based upon various factors, including:

 

    type of loss;

 

    severity of the injury or damage;

 

    age and occupation of the injured employee;

 

    estimated length of temporary disability;

 

    anticipated permanent disability;

 

    expected medical procedures, costs and duration;

 

    our knowledge of the circumstances surrounding the claim;

 

    insurance policy provisions related to the claim, including coverage;

 

    jurisdiction of the occurrence; and

 

    other benefits defined by applicable statute.

The case incurred amount varies over time due to uncertainties with respect to medical treatment and outcome, length and degree of disability, recurrence of injury, employment availability and wage levels and judicial determinations. As changes occur, the case incurred amount is adjusted. The initial estimate of the case incurred amount can vary significantly from the amount ultimately paid, especially in circumstances involving severe injuries with comprehensive medical treatment. Changes in case incurred amounts is an important component of our historical claim data.

In addition to case reserves, we establish reserves on an aggregate basis for loss and DCC expenses that have been incurred but not reported, or IBNR. Our IBNR reserves are also intended to provide for aggregate changes in case incurred amounts as well as the unpaid cost of recently reported claims for which an initial case reserve has not been established.

The third component of our reserves for loss and loss adjustment expenses is our adjusting and other reserve, or AO reserve. Our AO reserve covers primarily the estimated cost of administering claims and is established for the costs of future unallocated loss adjustment expenses for all reported and unreported claims.

The final component of our reserves for loss and loss adjustment expenses is the reserve for mandatory pooling arrangements. The mandatory pooling arrangement reserve includes the amount reported to us by the pool administrators.

In establishing reserves, we rely on the analysis of the more than 188,000 claims in our 28-year history. Using statistical analyses and actuarial methods, we estimate reserves based on historical patterns of case development, payment patterns, mix of business, premium rates charged, case reserving adequacy, operational changes, adjustment philosophy and severity and duration trends.

We review our reserves by industry and state on a quarterly basis. Individual open claims are reviewed more frequently and adjustments to case incurred amounts are made based on expected outcomes. The number of claims reported or occurring during a period, combined with a calculation of average case incurred amounts, and measured over time, provide the foundation for our reserve estimates. In establishing our reserve estimates, we use historical trends in claim reporting timeliness, frequency of claims in relation to earned premium or covered payroll, premium rate levels charged and case development patterns. However, the number of variables and judgments involved in establishing reserve estimates, combined with some random variation in loss development patterns, results in uncertainty regarding projected ultimate losses. As a result, our ultimate liability for loss and loss adjustment expenses may be more or less than our reserve estimate.

Our analysis of our historical data provides the factors we use in our statistical and actuarial analysis in estimating our loss and DCC expense reserve. These factors are primarily measures over time of claims reported, average case incurred amounts, case development, duration, severity and payment patterns. However, these factors cannot be solely used as these factors do not take into consideration changes in business mix, claims

 

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management, regulatory issues, medical trends, medical inflation, employment and wage patterns, and other subjective factors. We use this combination of factors and subjective assumptions in the use of six well-accepted actuarial methods, as follows:

 

    Paid Development Method—uses historical, cumulative paid loss patterns to derive estimated ultimate losses by accident year based upon the assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous to prior years.

 

    Paid Weighted Severity Method—multiplies estimated ultimate claims for each accident year by a weighted average, trended and developed severity. The ultimate claims estimate is based on paid claim count development. The selected severity for a given accident year is derived by giving some weight to all of the accident years in the experience history rather than treating each accident year independently.

 

    Paid Loss Ratio Cape Cod Method—similar to the paid weighted severity method, except that on-level premiums replace estimated ultimate claims, based upon paid claim count development, and loss ratios replace selected severities. The selected ultimate loss ratio for a given accident year is derived by giving some weight to all of the accident years in the experience history rather than treating each accident year independently.

 

    Incurred Development Method—uses historical, cumulative incurred loss patterns to derive estimated ultimate losses by accident year based upon the assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous to prior years.

 

    Incurred Weighted Severity Method—multiplies estimated ultimate claims for each accident year by a weighted average, trended and developed severity. The ultimate claims estimate is based on incurred claim count development. The selected severity for a given accident year is derived by giving some weight to all of the accident years in the experience history rather than treating each accident year independently.

 

    Incurred Loss Ratio Cape Cod Method—similar to the incurred weighted severity method, except that on-level premiums replace estimated ultimate claims, based upon incurred claim count development, and loss ratios replace selected severities. The selected ultimate loss ratio for a given accident year is derived by giving some weight to all of the accident years in the experience history rather than treating each accident year independently.

These six methods are applied to both gross and net claims data. We then analyze the results and may emphasize or de-emphasize some or all of the outcomes to reflect our judgment of reasonableness in relation to supplementary information and operational and industry changes. These outcomes are then aggregated to produce a single weighted average point estimate that is the base estimate for loss and DCC expense reserves.

In determining the level of emphasis that may be placed on some or all of the methods, we review statistical information as to which methods are most appropriate, whether adjustments are appropriate within the particular methods, and if results produced by each method include inherent bias reflecting operational and industry changes. This supplementary information may include:

 

    open and closed claim counts;

 

    statistics related to open and closed claim count percentages;

 

    claim closure rates;

 

    changes in average case reserves and average loss and DCC expenses incurred on open claims;

 

    reported and ultimate average case incurred changes;

 

    reported and projected ultimate loss ratios; and

 

    loss payment patterns.

In establishing our AO reserves, we review our past adjustment expenses in relation to paid claims as well as estimated future costs based on expected claims activity and duration.

 

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The sum of our net loss and DCC expense reserve, our AO reserve and our reserve for mandatory pooling arrangements is our total net reserve for loss and loss adjustment expenses.

As of December 31, 2013, our best estimate of our ultimate liability for loss and loss adjustment expenses, net of amounts recoverable from reinsurers, was $565.9 million, which includes $12.6 million in reserves for mandatory pooling arrangements as reported by the pool administrators. The estimate of our ultimate liability was derived from the process and methodology described above, which relies on substantial judgment. There is inherent uncertainty in estimating our reserves for loss and loss adjustment expenses. It is possible that our actual loss and loss adjustment expenses incurred may vary significantly from our estimates. We view our estimate of loss and DCC expenses as the most significant component of our reserve for loss and loss adjustment expenses.

Additional information regarding our reserve for unpaid loss and loss adjustment expenses (“LAE”) as of December 31, 2013, 2012, and 2011 is set forth below:

 

    2013      2012      2011  
    (In thousands)  

Gross case loss and DCC reserves

   $     473,019           $ 431,356           $ 404,626      

AO reserves

    17,187            15,736            13,402      

Gross IBNR reserves

    124,351            123,358            120,186      
 

 

 

    

 

 

    

 

 

 

Gross unpaid loss, DCC and AO reserves

    614,557            570,450            538,214      

Reinsurance recoverables on unpaid loss and LAE

    (48,699)           (55,190)           (60,937)     
 

 

 

    

 

 

    

 

 

 

Net unpaid loss, DCC and AO reserves

   $     565,858           $     515,260           $     477,277      
 

 

 

    

 

 

    

 

 

 

We performed sensitivity analyses to show how our net loss and DCC expense reserve, including IBNR, would be impacted by changes in certain critical assumptions. For our paid and incurred development methods, we varied both the cumulative paid and incurred loss development factors (LDFs) by plus and minus 30%, both individually and in combination with one another. The results of this sensitivity analysis, using December 31, 2013 data, are summarized below.

 

Change in

Paid LDFs

 

Change in

            Incurred LDFs             

 

Resultant Change in

Net Loss and DCC Reserve

   

            Amount ($)            

 

            Percentage             

        (In thousands)    

+30%

  +30%   35,152    6.6%

+30%

      0%   27,585    5.1%

+30%

  –30%   19,938    3.7%

    0%

  +30%     9,130    1.7%

    0%

  –30%       (8,574)     (1.6)%

–30%

  +30%   (14,648)   (2.7)%

–30%

      0%   (29,232)   (5.5)%

–30%

  –30%   (40,762)   (7.6)%

For our paid and incurred weighted severity methods, we varied our year-end selected trend factor (for medical costs, defense costs, wage inflation, etc.) by plus and minus 30%. The results of this sensitivity analysis, using December 31, 2013 data, are summarized below.

 

Change in

Severity Trend

  Resultant Change in
Net Loss and DCC Reserve
 
  Amount ($)     Percentage  
    (In thousands)        

+30%

                    6,560                        1.2

–30%

    (5,740     (1.1 )% 

 

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Reconciliation of Loss Reserves

The table below shows the reconciliation of loss reserves on a gross and net basis for the years ended December 31, 2013, 2012 and 2011, reflecting changes in losses incurred and paid losses.

 

    Year Ended December 31,  
    2013     2012     2011  
    (In thousands)  

Balance, beginning of period

   $ 570,450        $ 538,214        $ 532,204     

Less amounts recoverable from reinsurers on unpaid loss and loss adjustment expenses

    55,190         60,937         65,536     
 

 

 

   

 

 

   

 

 

 

Net balance, beginning of period

     515,260         477,277         466,668     
 

 

 

   

 

 

   

 

 

 

Add incurred related to:

     

Current year

    241,584         222,393         196,269     

Prior years

    (12,611)        (2,490)        (6,563)    
 

 

 

   

 

 

   

 

 

 

Total incurred

    228,973         219,903         189,706     
 

 

 

   

 

 

   

 

 

 

Less paid related to:

     

Current year

    44,474         50,423         53,213     

Prior years

    133,901         131,497         125,884     
 

 

 

   

 

 

   

 

 

 

Total paid

    178,375         181,920         179,097     
 

 

 

   

 

 

   

 

 

 

Net balance, end of period

    565,858         515,260         477,277     
 

 

 

   

 

 

   

 

 

 

Add amounts recoverable from reinsurers on unpaid loss and loss adjustment expenses

    48,699         55,190         60,937     
 

 

 

   

 

 

   

 

 

 

Balance, end of period

   $     614,557        $     570,450        $     538,214     
 

 

 

   

 

 

   

 

 

 

Our gross reserves for loss and loss adjustment expenses of $614.6 million as of December 31, 2013 are expected to cover all unpaid loss and loss adjustment expenses as of that date. As of December 31, 2013, we had 5,297 open claims, with an average of $116,020 in unpaid loss and loss adjustment expenses per open claim. During the year ended December 31, 2013, 5,620 new claims were reported, and 5,287 claims were closed.

In 2013, our gross reserves increased to $614.6 million from $570.5 million at December 31, 2012. The increase in reserves was attributable to both the 2013 accident year and prior accident years. We also recognized $12.6 million of favorable development for prior accident years. As of December 31, 2012, we had 4,964 open claims, with an average of $114,917 in unpaid loss and loss adjustment expenses per open claim. During the year ended December 31, 2012, 5,721 new claims were reported, and 5,941 claims were closed.

In 2012, our gross reserves increased to $570.5 million from $538.2 million at December 31, 2011. The increase in reserves was attributable to both the 2012 accident year and prior accident years. There was also $2.5 million of favorable development for prior accident years. As of December 31, 2011, we had 5,184 open claims, with an average of $103,822 in unpaid loss and loss adjustment expenses per open claim. During the year ended December 31, 2011, 5,986 new claims were reported, and 5,931 claims were closed.

Loss Development

The table below shows the net loss development for business written each year from 2003 through 2013. The table reflects the changes in our loss and loss adjustment expense reserves in subsequent years from the prior loss estimates based on experience as of the end of each succeeding year on a GAAP basis.

The first line of the table shows, for the years indicated, our liability including the incurred but not reported loss and loss adjustment expenses as originally estimated, net of amounts recoverable from reinsurers. For example, as of December 31, 2003, it was estimated that $183.0 million would be sufficient to settle all claims not already settled that had occurred on or prior to December 31, 2003, whether reported or unreported. The next

 

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section of the table sets forth the re-estimates in later years of incurred losses, including payments, for the years indicated. The next section of the table shows, by year, the cumulative amounts of loss and loss adjustment expense payments, net of amounts recoverable from reinsurers, as of the end of each succeeding year. For example, with respect to the net loss reserves of $183.0 million as of December 31, 2003, by December 31, 2013 (ten years later) $153.2 million had actually been paid in settlement of the claims that relate to liabilities as of December 31, 2003.

The “cumulative redundancy/(deficiency)” represents, as of December 31, 2013, the difference between the latest re-estimated liability and the amounts as originally estimated. A redundancy means that the original estimate was higher than the current estimate. A deficiency means that the current estimate is higher than the original estimate.

Analysis of Loss and Loss Adjustment Expense Reserve Development

 

                                
    Year Ended December 31,  
    2003     2004     2005     2006     2007     2008     2009     2010     2011     2012     2013  
    (In thousands)  

Reserve for loss and loss adjustment expenses, net of reinsurance recoverables

   $ 183,001        $ 243,256        $ 364,253        $ 412,366        $ 462,478        $ 474,697        $ 474,220        $ 466,668        $ 477,277        $ 515,260        $ 565,858    

Net reserve estimated as of:

                     

One year later

    196,955         265,138         362,026         402,876         442,091         452,812         452,587         460,105         474,787         502,648      

Two years later

    217,836         262,601         361,181         372,520         416,758         427,794         422,697         454,479         462,650        

Three years later

    218,217         262,427         346,914         359,590         396,492         398,187         411,516         442,700          

Four years later

    219,114         256,790         339,849         348,596         371,599         387,525         402,003            

Five years later

    214,304         250,586         335,158         335,252         364,147         381,950              

Six years later

    209,819         247,798         325,714         331,390         361,720                

Seven years later

    208,549         239,886         323,695         330,367                  

Eight years later

    200,717         238,650         322,620                    

Nine years later

    199,801         239,268                      

Ten years later

    200,758                        

Net cumulative redundancy (deficiency)

   $ (17,757)       $ 3,988        $ 41,633        $ 81,999        $ 100,758        $ 92,747       $ 72,217       $ 23,968       $ 14,627       $ 12,613      

Cumulative amount of reserve paid, net of reserve recoveries, through:

                     

One year later

    73,783         40,514         110,369         105,408         116,631         121,619         117,555         125,884         131,497         133,900      

Two years later

    65,752         97,091         164,354         167,852         182,879         185,334         182,242         199,682         201,814        

Three years later

    99,829         124,785         201,393         203,502         217,137         222,249         223,726         240,196          

Four years later

    114,594         154,799         222,867         224,419         239,189         245,012         248,294            

Five years later

    136,497         167,092         237,699         235,931         251,941         261,323              

Six years later

    143,642         175,639         245,466         242,761         261,707                

Seven years later

    149,349         180,743         249,037         247,681                  

Eight years later

    152,523         181,018         253,008                    

Nine years later

    151,556         183,672                      

Ten years later

    153,185                        

Net reserve— December 31

   $ 183,001        $ 243,256        $ 364,253        $ 412,366        $ 462,478        $ 474,697        $ 474,220        $ 466,668        $ 477,277        $ 515,260        $ 565,858    

Reinsurance recoverables

    194,558         189,624         120,232         106,810         74,925         56,596         60,435         65,536         60,937         55,190         48,699    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross reserve—December 31

   $ 377,559        $ 432,880        $ 484,485        $ 519,176        $ 537,403        $ 531,293        $ 534,655        $ 532,204        $ 538,214        $ 570,450        $   614,557    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net re-estimated reserve

   $ 200,758        $ 239,268        $ 322,620        $ 330,367        $ 361,720        $ 381,950        $ 402,003        $ 442,700        $ 462,650        $ 502,648      

Re-estimated reinsurance recoverables

    226,638         186,619         122,921         116,337         86,132         70,544         53,410         51,044         48,210         43,540      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Gross re-estimated reserve

   $   427,396        $   425,887        $   445,541        $   446,704        $   447,852        $   452,494        $   455,413        $   493,744        $   510,860        $   546,188      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Gross cumulative redundancy (deficiency)

   $ (49,837)       $ 6,993        $ 38,944        $ 72,472        $ 89,551        $ 78,799        $ 79,242        $ 38,460        $ 27,354        $ 24,263      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

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Investments

We derive net investment income from our invested assets. As of December 31, 2013, the carrying value of our investment portfolio, including cash and cash equivalents, was $1.0 billion and the fair value of the portfolio was $1.0 billion.

Our board of directors has established an investment policy governing our investments, which is reviewed at least annually. The principal objectives of our investment portfolio are to preserve capital and surplus and to maintain appropriate liquidity for corporate requirements. Additional objectives are to support our A.M. Best rating and to maximize after-tax income and total return. Our investment policy establishes limitations and guidelines relating to, for example, asset allocation, diversification, credit ratings and duration. We periodically review our investment portfolio with the risk committee of our board of directors for compliance with the policy. Our investment portfolio is managed internally.

We classify the majority of our fixed maturity securities as “held-to-maturity”. We do not reflect any changes in fair value for these securities in our financial statements, unless such changes are deemed to be “other than temporary impairments,” in which case such impairments flow through our income statement within the category, “Net realized gains (losses) on investments.” The remainder of our fixed maturity securities and all of our equity securities are classified as “available-for-sale.” These investments are valued at fair market value each period, with changes in fair value flowing through other comprehensive income. We generally seek to limit our holdings in equity securities to the lesser of 10% of the investment portfolio or 30% of shareholders’ equity, on a fair value basis.

See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Investments” for further information on the composition and results of our investment portfolio.

The table below shows the carrying values of various categories of securities held in our investment portfolio, the percentage of the total carrying value of our investment portfolio represented by each category and the effective interest rate for the year ended December 31, 2013 based on the carrying value of each category as of December 31, 2013:

 

      Carrying Value       Percentage
   of Portfolio   
    Effective
       Interest Rate       
 
    (In thousands)              

Fixed maturity securities—held-to-maturity:

     

State and political subdivisions

   $ 381,674         38.1%          3.7%     

Corporate bonds

    67,423         6.7%          2.2%     

Commercial mortgage-backed securities

    50,813         5.1%          5.5%     

U.S. agency-based mortgage-backed securities

    21,775         2.2%          5.2%     

U.S. Treasury securities and obligations of U.S. Government agencies

    11,514         1.2%          3.3%     

Asset-backed securities

    3,384         0.3%          3.7%     
 

 

 

   

 

 

   

Total fixed maturity securities—held-to-maturity

    536,583         53.6%          3.7%     
 

 

 

   

 

 

   

Fixed maturity securities—available-for-sale:

     

State and political subdivisions

    150,375         15.0%          3.4%     

Corporate bonds

    80,428         8.0%          2.0%     

U.S. agency-based mortgage-backed securities

    7,074         0.7%          3.3%     
 

 

 

   

 

 

   

Total fixed maturity securities—available-for-sale

    237,877         23.7%          2.9%     
 

 

 

   

 

 

   

Equity securities

    9,302         0.9%          5.1%     

Other investments

    10,591         1.1%          0.0%     

Cash and cash equivalents

    123,077         12.3%          0.3%     

Short-term investments

    84,422         8.4%          0.7%     
 

 

 

   

 

 

   

Total investments, including cash and cash equivalents

   $ 1,001,852         100.0%          2.8%     
 

 

 

   

 

 

   

 

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As of December 31, 2013, our fixed maturity securities had a carrying value of $774.5 million, which represented 77.3% of the carrying value of our investments, including cash and cash equivalents. For the twelve months ended December 31, 2013, the pre-tax accounting investment yield of our investment portfolio was 2.8% per annum.

The gross unrealized gains and losses on, and the cost and fair value of, our investment portfolio as of December 31, 2013 are summarized as follows:

 

           
    Cost or
      Amortized      
Cost
    Gross
      Unrealized      
Gains
    Gross
      Unrealized      
Losses
          Fair Value        
    (In thousands)  

Fixed maturity securities, held-to-maturity

   $ 536,583         $ 25,934         $ (1,338)         $ 561,179     

Fixed maturity securities, available-for-sale

    244,409          1,936          (8,468)          237,877     

Equity securities, available-for-sale

    9,482          387          (567)          9,302     

Other investments, available-for-sale

    10,000          591          —            10,591     
 

 

 

   

 

 

   

 

 

   

 

 

 

Totals

   $ 800,474         $ 28,848         $ (10,373)         $ 818,949     
 

 

 

   

 

 

   

 

 

   

 

 

 

As of December 31, 2013, the municipal bond component was 53.2% of the investment portfolio, including cash and short-term investments. The table below summarizes the top five geographic exposures as of December 31, 2013.

 

     Carrying Value      Percentage
of Municipal
Portfolio
     Percentage
of Total
Portfolio
 
     (In thousands)                

Louisiana

     $ 103,655           19.5%             10.4%        

Texas

     92,055           17.3%             9.2%        

Florida

     48,948           9.2%             4.9%        

Washington

     36,390           6.8%             3.6%        

Illinois

     23,002           4.3%             2.3%        

Other

     228,776           42.9%             22.8%        
  

 

 

    

 

 

    

 

 

 
     $       532,826               100.0%                 53.2%        
  

 

 

    

 

 

    

 

 

 

Companies are allowed an investment credit against Louisiana premium taxes for varying levels of Louisiana assets.

The table below summarizes the credit quality of our investment portfolio, excluding our equity holdings, as of December 31, 2013, as determined by the middle rating of Moody’s, Standard and Poor’s, and Fitch.

 

Credit Rating

   Percentage
of Total
Carrying Value
 

“AAA”

     36.2%   

“AA”

     27.3%   

“A”

     16.4%   

“BBB”

     19.2%   

“BB and below”

     0.7%   

“Unrated Securities”

     0.2%   
  

 

 

 

Total

     100.0%   
  

 

 

 

As of December 31, 2013, the average composite rating of our investment portfolio, excluding our equity holdings, was “AA-.”

 

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The table below shows the composition of our fixed maturity securities by remaining time to maturity as of December 31, 2013.

 

Remaining Time to Maturity

   As of December 31, 2013  
   Carrying Value      Percentage  
     (In thousands)         

Less than one year

     $ 91,955         11.9%     

One to five years

     174,376         22.5%     

Five to ten years

     155,762         20.1%     

More than ten years

     269,321         34.8%     

U.S. agency-based mortgage-backed securities

     28,849         3.7%     

Commercial mortgage-backed securities

     50,813         6.6%     

Asset-backed securities

     3,384         0.4%     
  

 

 

    

 

 

 

Total

     $       774,460             100.0%     
  

 

 

    

 

 

 

Reinsurance

We purchase reinsurance to reduce our net liability on individual risks and claims and to protect against catastrophic losses. Reinsurance involves an insurance company transferring to, or ceding, a portion of the exposure on a risk to a reinsurer. The reinsurer assumes the exposure in return for a portion of our premium. The cost and limits of reinsurance we purchase can vary from year to year based upon the availability of quality reinsurance at an acceptable price and our desired level of retention. Retention refers to the amount of risk that we retain for our own account. Under excess of loss reinsurance, covered losses in excess of the retention level up to the limit of the program are paid by the reinsurer. Our excess of loss reinsurance is written in layers, in which our reinsurers accept a band of coverage up to a specified amount. Any liability exceeding the limit of the program reverts to us as the ceding company. Reinsurance does not legally discharge us from primary liability for the full amount due under our policies. However, our reinsurers are obligated to indemnify us to the extent of the coverage provided in our reinsurance agreements.

We believe reinsurance is critical to our business. Our reinsurance purchasing strategy is to protect against unforeseen and/or catastrophic loss activity that would adversely impact our income and capital base. We generally select financially strong reinsurers with an A.M. Best rating of “A–” (Excellent) or better at the time we enter into a reinsurance contract. In addition, to minimize our exposure to significant losses from reinsurer insolvencies, we evaluate the financial condition of our reinsurers and monitor concentrations of credit risk on a continual basis.

In January 2013, the Company commuted reinsurance agreements with Clearwater Insurance Company, covering portions of accident years 1990 through 1995. The Company received cash of $0.3 million in exchange for releasing these reinsurers from their reinsurance obligations under the commuted agreements. Clearwater Insurance Company remains obligated to the Company’s insurance subsidiaries under other reinsurance agreements. As a result of the commutation, the effect on the Company’s net income in the year ended December 31, 2013 was immaterial.

On September 15, 2013, we commuted certain reinsurance agreements with Hannover Reinsurance (Ireland) Limited (“Hannover Re”) and Aspen Insurance Limited (“Aspen”) covering portions of the 2008 through 2010 accident years. Hannover Re and Aspen remain obligated to subsidiaries of the Company under other reinsurance agreements. We received cash of $14.9 million and an additional $17.6 million payment effectuated solely through offset against the balance of the funds withheld account under the reinsurance agreement in exchange for releasing Hannover Re and Aspen from their reinsurance obligations under the commuted agreements. As a result of the commutation, there was no effect on the Company’s net income in the year ended December 31, 2013.

 

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2014 Excess of Loss Reinsurance Treaty Program

Effective January 1, 2014, we entered into a new excess of loss reinsurance treaty program related to our voluntary and assigned risk business that applies to losses incurred between January 1, 2014 and the date on which our reinsurance agreements are terminated. Our reinsurance treaty program provides us with reinsurance coverage for each loss occurrence up to $70.0 million, subject to applicable deductibles, retentions and aggregate limits. This is an increase over the 2013 contract which provided reinsurance coverage for each loss occurrence up to $50.0 million.

The maximum loss occurrence involving a single claimant remains limited to a maximum of $10.0 million for that claimant, subject to applicable deductibles, retentions and aggregate limits. In 2014, we also added coverage for terrorism involving the use and/or dispersal of nuclear, biological, chemical and radiological agents.

We have 14 reinsurers participating in our 2014 reinsurance treaty program. Under certain circumstances, including a downgrade of a reinsurer’s A.M. Best rating to “B++” (Very Good) or below, such reinsurer may be required to provide us with security for amounts due under the terms of our reinsurance program. This security may take the form of, among other things, cash advances or letters of credit. If security is required because of a ratings downgrade, the form of security must be mutually agreed to between the reinsurer and us.

First Layer: Effective January 1, 2014, the Company entered into a new working layer. For 2014, we have raised our retention from $1.0 million to $2.0 million for each loss occurrence. Losses in the layer between $2.0 million and $5.0 million are ceded to a new multi-year reinsurance cover with an aggregate annual deductible of approximately $5.0 million and an aggregate limit of coverage of approximately $11.5 million for 2014. This cover is 75% placed, with Amerisafe retaining a 25% co-participation. Beginning on January 1, 2015, the treaty provides coverage up to $8 million for each loss occurrence in excess of $2 million. The treaty will expire on January 1, 2017.

Second Layer: This is a three-year treaty covering losses incurred between January 1, 2012 and January 1, 2015. The treaty affords coverage up to $5.0 million for each loss occurrence in excess of $5.0 million. The aggregate limit for all claims, including terrorism, under this layer is $10.0 million in any one year and $20.0 million in the aggregate for all three years covered by this layer. Our 2011 program included a similar layer effective between January 1, 2009 and January 1, 2012.

Catastrophe Layer: Affords coverage up to $60.0 million for each loss occurrence in excess of $10.0 million. The aggregate limit for all claims, including terrorism, under this layer is $120.0 million.

The agreement for the second layer will terminate on January 1, 2015 and the Catastrophe layer of coverage will terminate on January 1, 2015 as well. In addition, we may terminate the participation of one or more of our reinsurers under certain circumstances as permitted by the terms of our reinsurance agreements.

At our option, we have the right to commute the reinsurers’ obligations under the agreement for the first and second layers of coverage at any time after the end of the applicable terms of the agreements. If we commute the reinsurers’ obligations, we are entitled to receive a portion of the premiums that were paid to the reinsurers prior to the effective dates of the applicable commutations, subject to certain adjustments provided in the agreement.

 

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The table below sets forth the reinsurers participating in our 2014 reinsurance program:

 

Reinsurer

   A.M. Best
Rating

Hannover Reinsurance (Ireland) Limited

   A+

Tokio Millennium Re Ltd.

   A++

Munich Reinsurance America, Inc.

   A+

Arch Reinsurance Company

   A+

Alterra Reinsurance USA Inc

   A

Houston Casualty Company

   A+

Lloyd’s Syndicate 1400 CSL

   A

Lloyd’s Syndicate 1955 BAR

   A

Lloyd’s Syndicate 2003 SJC

   A

Lloyd’s Syndicate 2003 BRT

   A

Lloyd’s Syndicate 2003 MKL

   A

Lloyd’s Syndicate 4472 LIB

   A

Lloyd’s Syndicate 5151 MRE

   A

Minnesota Workers’ Compensation Reinsurance Association

   NR

Due to the nature of reinsurance, we have receivables from reinsurers that apply to accident years prior to 2013. The table below summarizes our amounts recoverable from reinsurers as of December 31, 2013.

 

Reinsurer

  A.M. Best
Rating
  Amounts Recoverable as
of December 31, 2013
 
        (In thousands)  

Hannover Reinsurance (Ireland) Limited (1)

  A+    $ 23,956    

Odyssey Reinsurance Company

  A     12,045    

Minnesota Workers’ Compensation Reinsurance Association (1)

  NR     6,784    

Tokio Millennium Re Ltd (1)

  A++     6,246    

Clearwater Insurance Company

  bbb     5,693    

Finial Reinsurance

  A-     4,681    

SCOR Reinsurance Company

  A     4,257    

St. Paul Fire and Marine Insurance Company

  A+     2,415    

Lloyd’s Syndicate #2000/Harrington

  A     1,211    

American National Insurance Company

  A     1,197    

Other

      6,841    
   

 

 

 

Total

     $ 75,326    
   

 

 

 

 

(1) Current participant in our 2014 reinsurance program.

Terrorism Reinsurance

The Terrorism Risk Insurance Act of 2002 (the “2002 Act”) was enacted in response to the events of September 11, 2001 and was extended by the Terrorism Risk Insurance Extension Act of 2005 (the “2005 Act”) and the Terrorism Risk Insurance Program Reauthorization Act of 2007 (the “2007 Act”). The 2002 Act, the 2005 Act and the 2007 Act were designed to ensure the availability of insurance coverage for losses resulting from certain acts of terrorism in the United States. The 2007 Act reauthorizes a federal program, established under the 2002 Act, extended by the 2005 Act, and further extended the program through the end of 2014. This program provides federal reimbursement to insurance companies for a portion of their losses arising from certain acts of terrorism and requires insurance companies to offer coverage for these acts. The program applies to insured losses arising out of acts that are certified as “acts of terrorism” by the Secretary of the Treasury in concurrence with the Secretary of State and the Attorney General of the United States. In addition, the program does not provide any reimbursement for any portion of aggregate industry-wide insured losses from certified acts of terrorism that exceed $100.0 billion in any one year and is subject to certain other limitations and restrictions.

 

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For insured losses in 2014, each insurance group is responsible for a statutory deductible under the 2007 Act that is equal to 20% of its direct earned property and casualty insurance premiums. For losses occurring in 2014, the U.S. Federal Government will reimburse 85% of an insurance group’s covered losses over the statutory deductible. In addition, no federal reimbursement is available unless the aggregate insurance industry-wide losses from a certified act of terrorism exceed $100.0 million for any act of terrorism occurring in 2014. However, there is no relief from the requirement under the 2007 Act that insurance companies offer coverage for certified acts of terrorism if those acts do not cause losses exceeding these threshold amounts and thus do not result in any federal reimbursement payments.

Under the 2007 Act, insurance companies must offer coverage for losses due to certified acts of terrorism in their workers’ compensation policies. Moreover, the workers’ compensation laws of the various states generally do not permit the exclusion of coverage for losses arising from acts of terrorism, including terrorism that involves the use of nuclear, biological, radioactive or chemical agents. In addition, state law prohibits us from limiting our workers’ compensation insurance losses arising from any one catastrophe or any one claimant. We have reinsurance protection in our 2014 reinsurance treaty program that affords coverage for up to $70 million for losses arising from terrorism. Amerisafe’s 2014 reinsurance program also added coverage for losses caused by nuclear, biological, chemical and radiological attacks, subject to the deductibles, retentions, definitions and aggregate limits.

Technology

We view our information systems as an integral part of our operations. We make substantial investments in improving our systems on an ongoing basis. We provide our field premium auditors, field safety professionals and field case managers with computer and communication equipment to efficiently complete services. We also deploy online solutions for our policyholders to enable timely and efficient premium payments and claims reporting, and for our agents to improve collaboration and exchange of data in the underwriting process. Our information technology employees perform end-user support, systems development, and infrastructure operation and maintenance with limited assistance from outside vendors.

Competition

The insurance industry, in general, is highly competitive and there is significant competition in the workers’ compensation segment of the industry. Competition in the insurance business is based on many factors, including premium rates, policy terms, coverage availability, claims management, safety services, payment terms, types of insurance offered, overall financial strength and financial ratings assigned by independent rating organizations, such as A.M. Best. Some of the insurers with which we compete have significantly greater financial, marketing and management resources than we do. We may also compete with new market entrants in the future.

We believe the workers’ compensation market for the hazardous industries we target is more fragmented and to some degree less competitive than other segments of the workers’ compensation market. Our competitors include other insurance companies, individual self-insured companies, state insurance pools and self-insurance funds. We estimate that more than 300 insurance companies participate in the workers’ compensation market. The insurance companies with which we compete vary by state and by the industries we target. These market conditions are also impacted by lower estimated loss costs adopted by a number of states in which we do business.

Our competitive advantages include our safety service and claims management practices, our A.M. Best rating and our ability to reduce claims through implementation of our work safety programs. In addition, we believe that our insurance is competitively priced and our premium rates are typically lower than those for policyholders assigned to the state insurance pools, allowing us to provide a viable alternative for policyholders in those pools.

 

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Employees

As of December 31, 2013, we had 437 full-time employees. None of our employees are subject to collective bargaining agreements. We believe that our employee relations are good.

Regulation

Holding Company Regulation

Nearly all states have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Under these laws, the respective state insurance departments may examine us at any time, require disclosure of material transactions and require prior notice of or approval for certain transactions. All transactions within a holding company system affecting an insurer must have fair and reasonable terms and are subject to other standards and requirements established by law and regulation.

Change of Control

The insurance holding company laws of nearly all states require advance approval by the respective state insurance departments of any change of control of an insurer. “Control” is generally presumed to exist through the direct or indirect ownership of 10% or more of the voting securities of a domestic insurance company or any entity that controls a domestic insurance company. In addition, insurance laws in many states contain provisions that require pre-notification to the insurance commissioners of a change of control of a non-domestic insurance company licensed in those states. Any future transactions that would constitute a change of control of American Interstate, Silver Oak Casualty or American Interstate of Texas, including a change of control of AMERISAFE, would generally require the party acquiring control to obtain the prior approval of the department of insurance in the state in which the insurance company being acquired is incorporated and may require pre-notification in the states where pre-notification provisions have been adopted. Obtaining these approvals may result in the material delay of, or deter, any such transaction.

These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of AMERISAFE, including through transactions, and in particular unsolicited transactions, that some or all of the shareholders of AMERISAFE might consider to be desirable.

State Insurance Regulation

Insurance companies are subject to regulation and supervision by the department of insurance in the state in which they are domiciled and, to a lesser extent, other states in which they conduct business. American Interstate and Silver Oak Casualty are primarily subject to regulation and supervision by the Nebraska Department of Insurance. American Interstate of Texas is primarily subject to regulation and supervision by the Texas Department of Insurance and Workers’ Compensation Commission. These state agencies have broad regulatory, supervisory and administrative powers, including among other things, the power to grant and revoke licenses to transact business, license agencies, set the standards of solvency to be met and maintained, determine the nature of, and limitations on, investments and dividends, approve policy forms and rates in some states, periodically examine financial statements, determine the form and content of required financial statements and periodically examine market conduct.

Detailed annual and quarterly financial statements and other reports are required to be filed with the state insurance departments in all states in which we are licensed to transact business. The financial statements of American Interstate, Silver Oak Casualty and American Interstate of Texas are subject to periodic examination by the department of insurance in each state in which they are licensed to do business.

In addition, many states have laws and regulations that limit an insurer’s ability to withdraw from a particular market. For example, states may limit an insurer’s ability to cancel or not renew policies. Furthermore, certain states prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant

 

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to a plan that is approved by the state insurance department. The state insurance department may disapprove a plan that may lead to market disruption. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict our ability to exit unprofitable markets.

Insurance agencies are also subject to regulation and supervision by the state insurance departments in the states in which they are licensed. Our wholly owned subsidiary, Amerisafe General Agency, Inc., is licensed as an insurance agent in 27 states and as a managing general insurance agency in 14 states. Amerisafe General Agency is domiciled in Louisiana and is primarily subject to regulation and supervision by the Louisiana Department of Insurance, which regulates the solicitation of insurance and the qualification and licensing of agents and agencies that may desire to conduct business in Louisiana.

State Insurance Department Examinations

We are subject to periodic examinations by state insurance departments in the states in which we operate. During 2013, American Interstate Insurance Company and Silver Oak Casualty, Inc. re-domesticated from Louisiana to Nebraska. The Nebraska insurance department generally examines its domiciliary insurance companies every five years. The Texas insurance department generally conducts examinations of its domiciliary insurance companies on a triennial basis.

American Interstate Insurance Company and Silver Oak Casualty, Inc. underwent a Louisiana insurance department examination in 2009 that covered calendar years 2006 through 2008. American Interstate Insurance Company of Texas underwent an examination in 2010 that covered calendar year 2009. American Interstate Insurance Company, Silver Oak Casualty, Inc., and American Interstate Insurance Company of Texas have been notified by the Nebraska Department of Insurance there will be an examination covering years 2009 through 2013. American Interstate Insurance Company of Texas has been notified by the Texas Department of Insurance there will be an examination covering calendar years 2010 through 2013.

Guaranty Fund Assessments

In most of the states where we are licensed to transact business, there is a requirement that property and casualty insurers doing business in that state participate in a guaranty association, which is organized to pay contractual benefits owed under insurance policies issued by impaired, insolvent or failed insurers. These associations levy assessments, up to prescribed limits, on all member insurers in a particular state on the basis of the proportionate share of the premium written by member insurers in the lines of business in which the impaired, insolvent or failed insurer is engaged. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets.

Property and casualty insurance company insolvencies or failures may result in additional security fund assessments to us at some future date. At this time, we are unable to determine the impact, if any, such assessments may have on our financial position or results of operations. We have established liabilities for guaranty fund assessments with respect to insurers that are currently subject to insolvency proceedings.

Residual Market Programs

Many of the states in which we conduct business or intend to conduct business require that all licensed insurers participate in a program to provide workers’ compensation insurance to those employers who have not or cannot obtain coverage from a carrier on a negotiated basis. The level of required participation in such programs is generally determined by calculating the volume of our voluntary business in that state as a percentage of all voluntary business in that state by all insurers. The resulting factor is the proportion of premium we must accept as a percentage of all of premiums in policies included in that state’s residual market program.

Companies generally can fulfill their residual market obligations by either issuing insurance policies to employers assigned to them, or participating in a reinsurance pool where the results of all policies provided through the pool are shared by the participating companies. We utilize both methods, depending on

 

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management’s evaluation of the most cost-efficient method to adopt in each state that allows a choice of assigned risk or participation in a pooling arrangement. In 2013, we had assigned risks in four states: Alabama, Alaska, North Carolina and Virginia.

Second Injury Funds

A number of states operate trust funds that reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. The state-managed trust funds are funded through assessments against insurers and self-insurers providing workers’ compensation coverage in the applicable state. Our recoveries from state-managed trust funds for the years ended December 31, 2013, 2012 and 2011 were $6.0 million, $3.9 million and $7.0 million, respectively. Our cash paid for assessments to state-managed trust funds for the years ended December 31, 2013, 2012 and 2011 was $2.3 million, $2.2 million and $2.2 million, respectively.

Dividend Limitations

Under Nebraska law, without the prior approval of the Nebraska Director of Insurance, American Interstate and Silver Oak Casualty cannot pay dividends to their shareholder that exceed the greater of (a) 10% of statutory surplus as of the previous year end or (b) or statutory net income, excluding realized investment gains, for the preceding 12-month period. However, net income from the previous two calendar years may be carried forward to the extent that it has not already been paid out as dividends. Further, under Texas law, without the prior approval of the Texas Commissioner of Insurance, American Interstate of Texas cannot pay dividends to its shareholder in excess of the greater of (x) 10% of statutory surplus, or (y) statutory net income, for the preceding 12-month period.

Federal Law and Regulations

For the year ended December 31, 2013, we derived 3.1% of our voluntary in-force premiums from employers engaged in the maritime industry. As a provider of workers’ compensation insurance for employers engaged in the maritime industry, we are subject to the United States Longshore and Harbor Workers’ Compensation Act, or the USL&H Act, and the Merchant Marine Act of 1920, or Jones Act. We are also subject to regulations related to the USL&H Act and the Jones Act.

The USL&H Act, which is administered by the U.S. Department of Labor, generally covers exposures on the navigable waters of the United States and in adjoining waterfront areas, including exposures resulting from stevedoring. The USL&H Act requires employers to provide medical benefits, compensation for lost wages, and rehabilitation services to longshoremen, harbor workers and other maritime workers who may suffer injury, disability or death during the course and scope of their employment. The Department of Labor has the authority to require us to make deposits to serve as collateral for losses incurred under the USL&H Act.

The Jones Act is a federal law, the maritime employer provisions of which provide injured offshore workers, or seamen, with a remedy against their employers for injuries arising from negligent acts of the employer or co-workers during the course of employment on a ship or vessel.

Privacy Regulations

In 1999, Congress enacted the Gramm-Leach-Bliley Act, which, among other things, protects consumers from the unauthorized dissemination of certain personal information. Subsequently, a majority of states have implemented additional regulations to address privacy issues. These laws and regulations apply to all financial institutions, including insurance companies, and require us to maintain appropriate policies and procedures for managing and protecting certain personal information of our policyholders and to fully disclose our privacy practices to our policyholders. We may also be exposed to future privacy laws and regulations, which could impose additional costs and impact our results of operations or financial condition. In 2000, the National Association of Insurance Commissioners, or the NAIC, adopted the Privacy of Consumer Financial and Health Information Model Regulation, which assisted states in promulgating regulations to comply with the Gramm-Leach-Bliley Act. In 2002, to further facilitate the implementation of the Gramm-Leach-Bliley Act, the NAIC

 

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adopted the Standards for Safeguarding Customer Information Model Regulation. Several states have now adopted similar provisions regarding the safeguarding of policyholder information. We have established policies and procedures intended to ensure that we are in compliance with the Gramm-Leach-Bliley related privacy requirements.

Federal and State Legislative and Regulatory Changes

From time to time, various regulatory and legislative changes have been proposed in the insurance industry. Among the proposals that have in the past been or are at present being considered are the possible introduction of federal regulation in addition to, or in lieu of, the current system of state regulation of insurers and proposals in various state legislatures (some of which proposals have been enacted) to conform portions of their insurance laws and regulations to various model acts adopted by the NAIC. We are unable to predict whether any of these laws and regulations will be adopted, the form in which any such laws and regulations would be adopted or the effect, if any, these developments would have on our operations and financial condition.

For information on the Terrorism Risk Act, see “—Reinsurance—Terrorism Reinsurance.”

The National Association of Insurance Commissioners

The NAIC is a group formed by state insurance commissioners to discuss issues and formulate policy with respect to regulation, reporting and accounting of insurance companies. Although the NAIC has no legislative authority and insurance companies are at all times subject to the laws of their respective domiciliary states and, to a lesser extent, other states in which they conduct business, the NAIC is influential in determining the form in which such laws are enacted. Model insurance laws, regulations and guidelines, which we refer to as the Model Laws, have been promulgated by the NAIC as a minimum standard by which state regulatory systems and regulations are measured. Adoption of state laws that provide for substantially similar regulations to those described in the Model Laws is a requirement for accreditation by the NAIC. The NAIC provides authoritative guidance to insurance regulators on statutory accounting issues by promulgating and updating a codified set of statutory accounting practices in its Accounting Practices and Procedures manual. The Nebraska and Texas legislatures have adopted these codified statutory accounting practices.

Under Nebraska law, American Interstate and Silver Oak Casualty are each required to maintain minimum capital and surplus of $2.0 million. Under Texas law, American Interstate of Texas is required to maintain minimum capital and surplus of $5.0 million. Property and casualty insurance companies are also subject to certain risk-based capital requirements by the NAIC. Under those requirements, the amount of capital and surplus maintained by a property and casualty insurance company is determined based on the various risk factors related to it. As of December 31, 2013, American Interstate, Silver Oak Casualty, and American Interstate of Texas exceeded the minimum risk-based capital requirements.

The key financial ratios of the NAIC’s Insurance Regulatory Information System, or IRIS, which ratios were developed to assist insurance departments in overseeing the financial condition of insurance companies, are reviewed by experienced financial examiners of the NAIC and state insurance departments to select those companies that merit highest priority in the allocation of the regulators’ resources. IRIS identifies 13 industry ratios and specifies “usual values” for each ratio. Departure from the usual values on four or more of the ratios can lead to inquiries from individual state insurance commissioners as to certain aspects of an insurer’s business.

The 2013 IRIS results for American Interstate Insurance Company, Silver Oak Casualty and American Interstate Insurance Company of Texas were within expected values for 12 of the 13 ratios. The investment yield ratios for American Interstate Insurance Company and American Interstate Insurance Company of Texas were outside the expected range by four tenths of one percent. Silver Oak Casualty was outside the expected range by two tenths of one percent. This occurred because current low interest rates affected the reinvestment rate for the portfolio.

 

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Statutory Accounting Principles

Statutory accounting principles, or SAP, are a basis of accounting developed to assist insurance regulators in monitoring and regulating the solvency of insurance companies. SAP is primarily concerned with measuring an insurer’s surplus as regards to policyholders. Accordingly, statutory accounting focuses on valuing assets and liabilities of insurers at financial reporting dates in accordance with appropriate insurance law and regulatory provisions applicable in each insurer’s domiciliary state.

Generally accepted accounting principles, or GAAP, are concerned with a company’s solvency, but are also concerned with other financial measurements, principally income and cash flows. Accordingly, GAAP gives more consideration to appropriate matching of revenue and expenses and accounting for management’s stewardship of assets than does SAP. As a direct result, different assets and liabilities and different amounts of assets and liabilities will be reflected in financial statements prepared in accordance with GAAP as compared to SAP.

Statutory accounting principles established by the NAIC and adopted in part by Nebraska and Texas insurance regulators, determine, among other things, the amount of statutory surplus and statutory net income of American Interstate, Silver Oak Casualty and American Interstate of Texas and thus determine, in part, the amount of funds that are available to pay dividends to AMERISAFE.

Website Information

Our corporate website is located at www.amerisafe.com. Our Annual Report on Form 10-K, annual proxy statement and related proxy card will be made available on our website at the same time they are mailed to shareholders. Our quarterly reports on Form 10-Q, periodic reports on Form 8-K and amendments to those reports that we file or furnish pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available through our website, free of charge, as soon as reasonably practicable after they have been electronically filed or furnished to the Securities and Exchange Commission, or the SEC. Our website also provides access to reports filed by our directors, executive officers and certain significant shareholders pursuant to Section 16 of the Securities Exchange Act of 1934. In addition, our Corporate Governance Guidelines, Code of Business Conduct and Ethics and charters for the standing committees of our board of directors are available on our website. The information on our website is not incorporated by reference into this report. In addition, the SEC maintains a website, www.sec.gov, which contains reports, proxy and information statements and other information that we file electronically with the SEC.

Executive Officers of the Registrant

The table below sets forth information about our executive officers and key employees as of March 1, 2014.

 

Name

      Age      

Position

Executive Officers

   

C. Allen Bradley, Jr.

  62   Chairman and Chief Executive Officer

Geoffrey R. Banta

  64   Executive Vice President, Corporate Development

G. Janelle Frost

  43   President and Chief Operating Officer

Vincent J. Gagliano

  41   Executive Vice President and Chief Technology Officer

Brendan D. Gau

  39   Executive Vice President and Chief Investment Officer

Michael F. Grasher

  49   Executive Vice President and Chief Financial Officer

Craig P. Leach

  64   Executive Vice President, Sales and Marketing

Key Employees

   

Kelly R. Goins

  48   Senior Vice President, Underwriting Operations

Cynthia P. Harris

  60   Senior Vice President, Human Resources/Client Services

Leon J. Lagneaux

  62   Senior Vice President, Safety Operations

Henry O. Lestage, IV

  53   Senior Vice President, Claims Operations

Kathryn H. Rowan

  48   Senior Vice President, General Counsel and Secretary

 

 

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C. Allen Bradley, Jr. has served as Chairman of our board of directors since October 2005, our Chief Executive Officer since December 2003 and as a Director since June 2003. From November 2002 to August 2010 he served as President and from November 2002 until December 2003 he served as our Chief Operating Officer. Since joining our company in 1994, Mr. Bradley has had principal responsibility for the management of our underwriting operations (December 2000 through June 2005) and safety services (September 2000 through November 2002) and has served as our General Counsel (September 1997 through December 2003) and Secretary (September 1997 through November 2002). Prior to joining our company, he was engaged in the private practice of law.

Geoffrey R. Banta has served as our Executive Vice President Corporate Development since September 2013. He served as President from November 2008 to August 2013. He served as our Chief Operating Officer from November 2008 to May 2013. From December 2003 to October 2008, he served as Executive Vice President and Chief Financial Officer. Prior to joining our company in 2003, he held the positions of President and Chief Executive Officer from 2001 until November 2003, and Chief Operating Officer from 1996 until 2001, at Scruggs Consulting, an actuarial and management consulting firm. From 1994 to 1996, Mr. Banta was Chief Financial Officer of the Atlanta Casualty Companies, an issuer of non-standard auto insurance.

G. Janelle Frost has served as our President since September 2013 and our Chief Operating Officer since May 2013. From November 2008 to April 2013 she served as our Executive Vice President and Chief Financial Officer. Prior to becoming Chief Financial Officer, Ms. Frost served as Controller from May 2004 to November 2008 and Vice President from May 2006 to November 2008. She has been employed with our company since 1992 and served as Assistant Vice President from May 2004 to May 2006 and Deputy Controller from 1998 to April 2004.

Vincent J. Gagliano has served as our Executive Vice President and Chief Technology Officer since January 2013. He has been employed with our company since 2001. He previously served as Senior Vice President of Information Technology, Senior Business Analyst, Director of Business Intelligence, Assistant Vice President of Business Intelligence, and Vice President, Operations Analysis.

Brendan D. Gau has served as our Executive Vice President and Chief Investment Officer since June 2009. Prior to joining our company, Mr. Gau was employed by AIM Capital Management, where he held the positions of Financial Analyst, Portfolio Analyst and Senior Portfolio Manager from 1996 until 2009.

Michael F. Grasher has served as Executive Vice President and Chief Financial Officer since May 2013 when he joined our Company. From February 2012 to April 2013 he was employed by Fortegra Financial Corporation, a NYSE listed insurance services company, as Senior Vice President in charge of Capital Markets and Investor Relations. From 2004 through January 2012 he was a Managing Director, Senior Equity Research Analyst for Piper Jaffray, Inc. covering the property-casualty industry.

Craig P. Leach has served as our Executive Vice President, Sales and Marketing since November 2002. He has served in a variety of sales and key marketing positions within our company since beginning his insurance career with a predecessor to our company in 1980, including Senior Vice President, Sales and Marketing from 1997 until November 2002.

Kelly R. Goins has served as our Senior Vice President, Underwriting Operations since March 2005. She has been employed with our company since 1986. She previously served as Vice President, Underwriting Operations from 2000 until March 2005.

Cynthia P. Harris has served as our Senior Vice President, Human Resources/Client Services since January 2003. She has been employed with our company since 1977. She previously served as Vice President, Policyholder Services and Administration from 1992 until December 2002.

Leon J. Lagneaux has served as our Senior Vice President, Safety Operations since March 2005. He has been employed with our company since 1994. He previously served as Vice President, Safety Operations from 1999 until March 2005.

 

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Henry O. Lestage, IV has served as our Senior Vice President, Claims Operations since September 2000. He has been employed with our company since 1987. He previously served as Vice President, Claims Operations from 1998 until 2000.

Kathryn H. Rowan has served as Senior Vice President, General Counsel and Secretary since May 2012 when she joined our company. From 2009 through May 2012 she practiced law at Christian & Small LLP. From 2000 until 2008 she was employed as an Insurance Regulatory Compliance Manager with United Investors Life Insurance Company and Liberty National Life Insurance Company, subsidiaries of Torchmark Corporation.

 

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Item 1A.    Risk Factors.

In evaluating our company, the factors described below should be considered carefully. The occurrence of one or more of these events could significantly and adversely affect our business, prospects, financial condition, results of operations and cash flows.

Risks Related to Our Business

If we do not appropriately establish our premium rates, our results of operations will be adversely affected.

In general, the premium rates for our insurance policies are established when coverage is initiated and, therefore, before all of the underlying costs are known. Like other workers’ compensation insurance companies, we rely on estimates and assumptions in setting our premium rates. Establishing adequate rates is necessary to generate sufficient revenue to offset losses, loss adjustment expenses and other underwriting expenses, and to earn an underwriting profit. If we fail to accurately assess the risks that we assume, we may fail to charge adequate premium rates to cover our losses and expenses, which could reduce our net income and cause us to become unprofitable. For example, when initiating coverage on a policyholder, we estimate future claims expense based, in part, on prior claims information provided by the policyholder’s previous insurance carriers. If this prior claims information is not accurate, we may underprice our policy by using claims estimates that are too low. As a result, our actual costs for providing insurance coverage to our policyholders may be significantly higher than our premiums. In order to set premium rates appropriately, we must:

 

    collect and properly analyze a substantial volume of data;

 

    develop, test and apply appropriate rating formulae;

 

    closely monitor and timely recognize changes in trends; and

 

    project both frequency and severity of losses with reasonable accuracy.

We must also implement our pricing accurately in accordance with our assumptions. Our ability to undertake these efforts successfully, and as a result set premium rates accurately, is subject to a number of risks and uncertainties, principally:

 

    insufficient reliable data;

 

    incorrect or incomplete analysis of available data;

 

    uncertainties generally inherent in estimates and assumptions;

 

    the complexity inherent in implementing appropriate rating formulae or other pricing methodologies;

 

    costs of ongoing medical treatment;

 

    uncertainties inherent in accurately estimating retention, investment yields, and the duration of our liability for loss and loss adjustment expenses; and

 

    unanticipated court decisions, legislation or regulatory action.

Consequently, we could set our premium rates too low, which would negatively affect our results of operations and our profitability, or we could set our premium rates too high, which could reduce our competitiveness and lead to lower revenues.

We operate in a highly competitive industry and may lack the financial resources to compete effectively.

There is significant competition in the workers’ compensation insurance industry. We believe that our competition in the hazardous industries we target is fragmented and not dominated by one or more competitors. We compete with other insurance companies, state insurance pools and self-insurance funds. Many of our existing and potential competitors are significantly larger and possess greater financial, marketing and management resources than we do. Moreover, a number of these competitors offer other types of insurance in addition to workers’ compensation and can provide insurance nationwide.

 

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We offer workers’ compensation insurance. We have no current plans to focus our efforts on offering other types of insurance. As a result, negative developments in the economic, competitive or regulatory conditions affecting the workers’ compensation insurance industry could have an adverse effect on our financial condition and results of operations. Negative developments in the workers’ compensation insurance industry could have a greater effect on insurance companies that do not sell multiple types of insurance.

We compete on the basis of many factors, including coverage availability, claims management, safety services, payment terms, premium rates, policy terms, types of insurance offered, overall financial strength, financial ratings and reputation. If any of our competitors offer premium rates, policy terms or types of insurance that are more competitive than ours, we could lose market share. No assurance can be given that we will maintain our current competitive position in the markets in which we currently operate or that we will establish a competitive position in new markets into which we may expand.

Our loss reserves are based on estimates and may be inadequate to cover our actual losses.

We record reserves for estimated losses under insurance policies we write and for loss adjustment expenses related to the investigation and settlement of claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain.

Our pre-tax income for any period is impacted by establishing reserves for new claims as well as changes in estimates for previously reported losses. Our focus on writing workers’ compensation insurance for employers engaged in hazardous industries results in our experiencing fewer, but more severe, claims. The ultimate cost of resolving severe claims is difficult to predict, particularly in the period shortly after the injury occurs. Substantial judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical data can be impacted by external forces, principally frequency and severity of unreported claims, length of time to achieve ultimate settlement of claims, inflation in medical costs and wages, insurance policy coverage interpretations, jury determinations, and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If there are unfavorable changes affecting our assumptions, our reserves may need to be increased. When a reserve estimate is increased, the change decreases pre-tax income by a corresponding amount.

The effects of emerging claims and coverage issues on our business are uncertain.

As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until after we have issued insurance policies that are affected by the changes. As a result, the full extent of our liability under an insurance policy may not be known until many years after the policy is issued. For example, medical costs associated with permanent and partial disabilities may increase more rapidly or be higher than we currently expect. Changes of this nature may expose us to higher claims than we anticipated when we wrote the underlying policy.

Current economic conditions could adversely affect our financial condition and results of operations.

The economic recovery from the recession of 2008-2010 has been sluggish. We anticipate continued modest growth in the economy during 2014. Negative trends in business investment, consumer confidence and spending, the significant declines and volatility of the capital markets, the availability of credit and the rate of unemployment can adversely affect our business. A continuation of the current economic environment could further adversely impact our growth and profitability. Although we continue to closely monitor market conditions, we cannot predict future conditions or their impact on our premium volume, the value of our investment portfolio and our financial performance. As a result of these existing economic conditions, we could

 

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experience future decreases in business activity and incur additional realized and unrealized losses in our investment portfolio, both of which could adversely affect our financial condition and results of operations.

In addition, certain actions taken by the U.S. government to stimulate the economy and stabilize the financial markets have directly impacted the property and casualty insurance industry and our competitors. Additional measures in this regard could negatively impact our financial condition and the competitive landscape.

The workers’ compensation insurance industry is cyclical in nature, which may affect our overall financial performance.

The financial performance of the workers’ compensation insurance industry has historically fluctuated with periods of lower premium rates and excess underwriting capacity resulting from increased competition followed by periods of higher premium rates and reduced underwriting capacity resulting from decreased competition. Although the financial performance of an individual insurance company is dependent on its own specific business characteristics, the profitability of most workers’ compensation insurance companies generally tends to follow this cyclical market pattern. Following a number of years of decreasing loss costs and excessive competition, the market transitioned into a period of higher premium rates and a less competitive marketplace. Because this market cyclicality is due in large part to the actions of our competitors and general economic factors, we cannot predict the timing or duration of changes in the market cycle. We expect these cyclical patterns will cause our revenues and net income to fluctuate, which may cause the price of our common stock to be more volatile.

Our business is dependent on the efforts of our executive officers because of their industry expertise, knowledge of our markets and relationships with the independent agencies that sell our insurance.

Our success is dependent on the efforts of our executive officers because of their industry expertise, knowledge of our markets and relationships with our independent agencies. We have entered into employment agreements with each of our executive officers. Those agreements expire in March 2014 except for Mr. Gau’s agreement which expires June 2014 and Mr. Gagliano’s agreement which expires January 2016, in each case, unless extended. Should any of our executive officers cease working for us, we may be unable to find acceptable replacements with comparable skills and experience in the workers’ compensation insurance industry and the hazardous industries that we target. As a result, our operations may be disrupted and our business may be adversely affected. We do not currently maintain life insurance policies with respect to our executive officers.

A decline in the level of business activity of our policyholders, particularly those engaged in the construction, trucking, manufacturing and agricultural industries, could negatively affect our earnings and profitability.

In 2013, 77.3% of our gross premiums written were derived from policyholders in the construction, trucking, manufacturing, oil and gas and agriculture industries. Because premium rates are calculated, in general, as a percentage of a policyholder’s payroll expense, premiums fluctuate depending upon the level of business activity and number of employees of our policyholders. As a result, our gross premiums written are primarily dependent upon economic conditions in the construction, trucking, manufacturing and agricultural industries and upon economic conditions generally.

An inability to effectively manage our operations could make it difficult for us to compete and could affect our ability to operate profitably.

Our continuing strategy includes expanding in our existing markets, entering new geographic markets and further developing our agency relationships. Our strategy is subject to various risks, including risks associated with our ability to:

 

    profitably increase our business in existing markets;

 

    identify profitable new geographic markets for entry;

 

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    attract and retain qualified personnel for expanded operations;

 

    identify, recruit and integrate new independent agencies; and

 

    augment our internal operations and systems as we expand our business.

Because we are subject to extensive state and federal regulation, legislative changes may negatively impact our business.

We are subject to extensive regulation by the Nebraska Department of Insurance and the insurance regulatory agencies of other states in which we are licensed and, to a lesser extent, federal regulation. State agencies have broad regulatory powers designed primarily to protect policyholders and their employees, and not our shareholders. Regulations vary from state to state, but typically address:

 

    standards of solvency, including risk-based capital measurements;

 

    restrictions on the nature, quality and concentration of our investments;

 

    restrictions on the terms of the insurance policies we offer;

 

    restrictions on the way our premium rates are established and the premium rates we may charge;

 

    required reserves for unearned premiums and loss and loss adjustment expenses;

 

    standards for appointing general agencies;

 

    limitations on transactions with affiliates;

 

    restrictions on mergers and acquisitions;

 

    restrictions on the ability of our insurance company subsidiaries to pay dividends to AMERISAFE;

 

    certain required methods of accounting; and

 

    potential assessments for state guaranty funds, second injury funds and other mandatory pooling arrangements.

We may be unable to comply fully with the wide variety of applicable laws and regulations that are continually undergoing revision. In addition, we follow practices based on our interpretations of laws and regulations that we believe are generally followed by our industry. These practices may be different from interpretations of insurance regulatory agencies. As a result, insurance regulatory agencies could preclude us from conducting some or all of our activities or otherwise penalize us. For example, in order to enforce applicable laws and regulations or to protect policyholders, insurance regulatory agencies have relatively broad discretion to impose a variety of sanctions, including examinations, corrective orders, suspension, revocation or denial of licenses, and the takeover of one or more of our insurance subsidiaries. The extensive regulation of our business may increase the cost of our insurance and may limit our ability to obtain premium rate increases or to take other actions to increase our profitability.

If we cannot sustain our relationships with independent agencies, we may be unable to operate profitably.

We market a substantial portion of our workers’ compensation insurance through independent agencies. As of December 31, 2013, independent agencies produced 95.2% of our voluntary in-force premiums. No independent agency accounted for more than 1.2% of our voluntary in-force premiums at that date. Independent agencies are not obligated to promote our insurance and may sell insurance offered by our competitors. As a result, our continued profitability depends, in part, on the marketing efforts of our independent agencies and on our ability to offer workers’ compensation insurance and maintain financial strength ratings that meet the requirements of our independent agencies and their policyholders.

 

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As an insurance holding company, AMERISAFE is dependent on the results of operations of its insurance subsidiaries, and our Company’s ability to pay dividends depends on the regulatory and financial capacity of its subsidiaries to pay dividends to AMERISAFE.

AMERISAFE is a holding company that transacts business through its operating subsidiaries, including American Interstate Insurance Company. AMERISAFE’s primary assets are the capital stock of these operating subsidiaries. The ability of AMERISAFE to pay dividends to our shareholders depends upon the surplus and earnings of our subsidiaries and their ability to pay dividends to AMERISAFE. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds, and could be subject to contractual restrictions in the future, including those imposed by indebtedness we may incur in the future. As a result, AMERISAFE may not be able to receive dividends from its insurance subsidiaries and may not receive dividends in amounts necessary to pay dividends on our capital stock.

Assessments and premium surcharges for state guaranty funds, second injury funds and other mandatory pooling arrangements may reduce our profitability.

Most states require insurance companies licensed to do business in their state to participate in guaranty funds, which require the insurance companies to bear a portion of the unfunded obligations of impaired, insolvent or failed insurance companies. These obligations are funded by assessments, most of which are expected to continue in the future. State guaranty associations levy assessments, up to prescribed limits, on all member insurance companies in the state based on their proportionate share of premiums written in the lines of business in which the impaired, insolvent or failed insurance companies are engaged. See “Business—Regulation” in Item 1 of this report. Accordingly, the assessments levied on us may increase as we increase our written premium. Some states also have laws that establish second injury funds to reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. These funds are supported by either assessments or premium surcharges based on case incurred losses.

In addition, as a condition to conducting business in some states, insurance companies are required to participate in residual market programs to provide insurance to those employers who cannot procure coverage from an insurance carrier on a negotiated basis. Insurance companies generally can fulfill their residual market obligations by, among other things, participating in a reinsurance pool where the results of all policies provided through the pool are shared by the participating insurance companies. Although we price our insurance to account for obligations we may have under these pooling arrangements, we may not be successful in estimating our liability for these obligations. Accordingly, mandatory pooling arrangements may cause a decrease in our profits.

At December 31, 2013, we participated in mandatory pooling arrangements in 21 states and the District of Columbia. As we write policies in new states that have mandatory pooling arrangements, we will be required to participate in additional pooling arrangements. Further, the impairment, insolvency or failure of other insurance companies in these pooling arrangements would likely increase the liability for other members in the pool. The effect of assessments and premium surcharges or changes in them could reduce our profitability in any given period or limit our ability to grow our business.

A downgrade in our A.M. Best rating would likely reduce the amount of business we are able to write.

Rating agencies evaluate insurance companies based on their ability to pay claims. We are currently assigned a group letter rating of “A” (Excellent) from A.M. Best, which is the rating agency that we believe has the most influence on our business. This rating is assigned to companies that, in the opinion of A.M. Best, have demonstrated an excellent overall performance when compared to industry standards. A.M. Best considers “A” rated companies to have an excellent ability to meet their ongoing obligations to policyholders. The ratings of A.M. Best are subject to periodic review using, among other things, proprietary capital adequacy models, and are subject to revision or withdrawal at any time. A.M. Best ratings are directed toward the concerns of policyholders and insurance agencies and are not intended for the protection of investors or as a recommendation to buy, hold

 

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or sell securities. Our competitive position relative to other companies is determined in part by our A.M. Best rating. Any downgrade in our rating would likely adversely affect our business through the loss of certain existing and potential policyholders and the loss of relationships with certain independent agencies.

A downgrade in the A.M. Best rating of one or more of our significant reinsurers could adversely affect our financial condition.

Our financial condition could be adversely affected if the A.M. Best rating of one or more of our significant reinsurers is downgraded. For example, our A.M. Best rating may be downgraded if our amounts recoverable from a reinsurer are significant and the A.M. Best rating of that reinsurer is downgraded. If one of our reinsurers suffers a rating downgrade, we may consider various options to lessen the impact on our financial condition, including commutation, novation and the use of letters of credit to secure amounts recoverable from reinsurers. However, these options may result in losses to our company, and there can be no assurance that we could implement any of these options.

We may not be able to recover amounts due from our reinsurers, which would adversely affect our financial condition.

Reinsurance does not discharge our obligations under the insurance policies we write. We remain liable to our policyholders even if we are unable to make recoveries that we are entitled to receive under our reinsurance contracts. As a result, we are subject to credit risk with respect to our reinsurers. Losses are recovered from our reinsurers as claims are paid. In long-term workers’ compensation claims, the creditworthiness of our reinsurers may change before we recover amounts to which we are entitled. Therefore, if a reinsurer is unable to meet any of its obligations to us, we would be responsible for all claims and claim settlement expenses for which we would have otherwise received payment from the reinsurer.

As of December 31, 2013, we had $75.3 million of recoverables from reinsurers. Of this amount, $36.0 million was unsecured. As of December 31, 2013, our largest recoverable from reinsurers included $24.0 million from Hannover Reinsurance (Ireland) Limited, $12.0 million from Odyssey America Reinsurance and and $6.8 million from Minnesota Workers’ Compensation Reinsurance Association. No reinsurance recoverable due at December 31, 2013 was over ninety days old. If we are unable to collect amounts recoverable from our reinsurers, our financial condition would be adversely impacted.

If we are unable to obtain reinsurance on favorable terms, our ability to write policies could be adversely affected.

We purchase reinsurance to protect us from the impact of large losses. Reinsurance is an arrangement in which an insurance company, called the ceding company, transfers insurance risk by sharing premiums with another insurance company, called the reinsurer. Conversely, the reinsurer receives or assumes reinsurance from the ceding company. Our 2014 reinsurance program provides us with reinsurance coverage for each loss occurrence up to $70.0 million, subject to applicable deductibles, retentions and aggregate limits. However, for any loss occurrence involving only one claimant, our reinsurance coverage is limited to $10.0 million, subject to applicable deductibles, retentions and aggregate limits. For 2014, we have raised our retention from $1.0 million to $2.0 million for each loss occurrence. Losses in the layer between $2.0 million and $5.0 million are ceded to a new multi-year reinsurance cover with an aggregate annual deductible of approximately $5.0 million and an aggregate limit of coverage of approximately $11.6 million for 2014. This cover is 75% placed with Amerisafe retaining a 25% co-participation. Losses in the layer between $5.0 million and $10.0 million are 100% ceded to an existing three year reinsurance cover which provides up to $10.0 million of aggregate limit for 2014. See “Business—Reinsurance.”

The availability, amount, and cost of reinsurance are subject to market conditions and our experience with insured losses. As a result, any material changes in market conditions or our loss experience could adversely affect our financial performance.

 

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If any of our current reinsurers were to terminate participation in our reinsurance treaty program, we could be exposed to an increased risk of loss.

When our reinsurance treaty program is terminated and we enter into a new program, any decrease in the amount of reinsurance at the time we enter into a new program, whether caused by the existence of more restrictive terms and conditions or decreased availability, will also increase our risk of loss and, as a result, could adversely affect our business, financial condition and results of operations. We currently have 14 reinsurers participating in our reinsurance treaty program, and we believe that this is a sufficient number of reinsurers to provide us with the reinsurance coverage we require. However, it is possible that one or more of our current reinsurers could terminate participation in our program. Regarding the first casualty excess of loss treaty, it is possible that one or more of our current reinsurers could terminate continued participation in this loss layer. In addition, we may terminate the participation of one or more of our reinsurers under certain circumstances as permitted by the terms of our reinsurance agreements. In any of these events, if our reinsurance broker is unable to reallocate the terminated reinsurance among the remaining reinsurers in the program, it could take a significant period of time to identify and negotiate agreements with one or more replacement reinsurers. During this period, we would be exposed to an increased risk of loss, the extent of which would depend on the coverage previously provided by the terminated reinsurance.

If we are unable to realize our investment objectives, our financial condition and results of operations may be adversely affected.

Investment income is an important component of our net income. As of December 31, 2013, our investment portfolio, including cash and cash equivalents, had a carrying value of $1.0 billion. For the year ended December 31, 2013 we had $27.0 million of net investment income. Our investment portfolio is managed under investment guidelines approved by our board of directors, and is made up predominately of fixed maturity securities and cash and cash equivalents. Although our investment guidelines emphasize capital preservation and liquidity, our investments are subject to a variety of risks, including risks related to general economic conditions, interest rate fluctuations, market illiquidity and market volatility. General economic conditions may be adversely affected by U.S. involvement in hostilities with other countries and large-scale acts of terrorism, or the threat of hostilities or terrorist acts.

Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. Changes in interest rates could have an adverse effect on the value of our investment portfolio and future investment income. The unprecedented low interest rates will continue to have an adverse effect on our investment income. Additionally, changes in interest rates can expose us to prepayment risks on mortgage-backed securities included in our investment portfolio.

Similarly, during periods of market disruption, including periods of rapidly widening credit spreads or illiquidity, the fair values of certain of our fixed maturity securities, such as asset-backed and commercial mortgage-backed securities, could be deemed to be other-than-temporarily impaired, even though we have the intent not to sell these securities and it is not more likely than not that we will be required to sell these securities. Further, rapidly changing and unprecedented equity market conditions could materially impact the valuation of the equity securities as reported within our consolidated financial statements and the period-to-period changes in value could vary significantly.

These and other factors affect the capital markets and, consequently, the value of our investment portfolio and our future investment income. Any significant decline in our investment income would adversely affect our revenues and net income.

We may require additional capital in the future, which may not be available to us or may be available only on unfavorable terms.

Our future capital requirements will depend on many factors, including state regulatory requirements, the financial stability of our reinsurers and our ability to write new business and establish premium rates sufficient to cover our estimated claims. We may need to raise additional capital or curtail our growth if the capital of our

 

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insurance subsidiaries is insufficient to support future operating requirements and/or cover claims. If we had to raise additional capital, equity or debt financing might not be available to us or might be available only on terms that are not favorable. Future equity offerings could be dilutive to our shareholders and the equity securities issued in any offering may have rights, preferences and privileges senior to our common stock.

If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition or results of operations could be adversely affected.

We may have exposure to losses from terrorism for which we are required by law to provide coverage.

When writing workers’ compensation insurance policies, we are required by law to provide workers’ compensation benefits for losses arising from acts of terrorism. The impact of any terrorist act is unpredictable, and the ultimate impact on us would depend upon the nature, extent, location and timing of such an act. Our 2014 reinsurance treaty program affords limited coverage for up to $70.0 million for losses arising from terrorism, subject to applicable deductibles, retentions and aggregate limits.

Notwithstanding the protection provided by reinsurance and the Terrorism Risk Insurance Extension Act of 2007, the risk of severe losses to us from acts of terrorism has not been eliminated because our reinsurance treaty program includes various sub-limits and exclusions limiting our reinsurers’ obligation to cover losses caused by acts of terrorism. Accordingly, events constituting acts of terrorism may not be covered by, or may exceed the capacity of, our reinsurance and could adversely affect our business and financial condition. In addition, the Terrorism Risk Insurance Extension Act of 2007 is set to expire on December 31, 2014. If this law is not extended or replaced by legislation affording a similar level of protection to the insurance industry against insured losses arising out of acts of terrorism, reinsurance for losses arising from terrorism may be unavailable or prohibitively expensive, and we may be further exposed to losses arising from acts of terrorism.

Technology breaches or failures, including those resulting from a malicious cyber attack on us or our policyholders and medical providers, could disrupt or otherwise negatively impact our business.

We rely on information technology systems to process, transmit, store and protect the electronic information, financial data and proprietary models that are critical to our business. Furthermore, a significant portion of the communications between our employees, our policyholders and medical providers depend on information technology and electronic information exchange. Like all companies, our information technology systems are vulnerable to data breaches, interruptions or failures due to events that may be beyond our control, including natural disasters, theft, terrorist attacks, computer viruses, hackers and general technology failures.

We have established and implemented security measures, controls and procedures in an effort to safeguard our information technology systems and to prevent unauthorized access to these systems and any data processed and/or stored in these systems. Despite these safeguards, disruptions to and breaches of our information technology systems are possible and may negatively impact our business.

Although we have experienced no known or threatened cases involving unauthorized access to our information technology systems and data or unauthorized appropriation of such data to date, we have no assurance that such technology breaches will not occur in the future.

Risks Related to Our Common Stock

Our revenues and results of operations may fluctuate as a result of factors beyond our control, which fluctuation may cause the price of our common stock to be volatile.

The revenues and results of operations of our insurance subsidiaries historically have been subject to significant fluctuations and uncertainties. Our profitability can be affected significantly by:

 

    rising levels of claims costs, including medical and prescription drug costs, that we cannot anticipate at the time we establish our premium rates;

 

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    fluctuations in interest rates, inflationary or deflationary pressures and other changes in the investment environment that affect returns on our invested assets;

 

    changes in the frequency or severity of claims;

 

    the financial stability of our reinsurers and changes in the level of reinsurance capacity and our capital capacity;

 

    new types of claims and new or changing judicial interpretations relating to the scope of liabilities of insurance companies;

 

    volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes or terrorist attacks; and

 

    price competition.

If our revenues and results of operations fluctuate as a result of one or more of these factors, the price of our common stock may become more volatile.

Provisions of our articles of incorporation and bylaws and the laws of the states of Texas and Nebraska could impede an attempt to replace or remove our directors or otherwise effect a change of control of our company, which could diminish the value of our common stock.

Our articles of incorporation and bylaws contain provisions that may make it more difficult for shareholders to replace or remove directors even if the shareholders consider it beneficial to do so. In addition, these provisions could delay or prevent a change of control of our company that shareholders might consider favorable. Our articles of incorporation and bylaws contain the following provisions that could have an anti-takeover effect:

 

    election of our directors is classified, meaning that the members of only one of three classes of our directors are elected each year;

 

    shareholders have limited ability to call shareholder meetings and to bring business before a meeting of shareholders;

 

    shareholders may not act by written consent, unless the consent is unanimous; and

 

    our board of directors may authorize the issuance of preferred stock with such rights, preferences and privileges as the board deems appropriate.

These provisions may make it difficult for shareholders to replace management and could have the effect of discouraging a future takeover attempt that is not approved by our board of directors, but which individual shareholders might consider favorable.

We are incorporated in Texas. Under the Texas Business Organizations Code, our ability to enter into a business combination with an affiliated shareholder is limited.

In addition, two of our three insurance company subsidiaries, American Interstate and Silver Oak Casualty, are incorporated in Nebraska and the other, American Interstate of Texas, is incorporated in Texas. Under Nebraska and Texas insurance law, advance approval by the state insurance department is required for any change of control of an insurer. “Control” is presumed to exist through the direct or indirect ownership of 10% or more of the voting securities of a domestic insurance company or any entity that controls a domestic insurance company. Obtaining these approvals may result in the material delay of, or deter, any transaction that would result in a change of control.

The trading price of our common stock may decline.

The trading price of our common stock may decline for many reasons, some of which are beyond our control, including, among others:

 

    our results of operations;

 

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    changes in expectations as to our future results of operations, including financial estimates and projections by securities analysts and investors;

 

    results of operations that vary from those expected by securities analysts and investors;

 

    developments in the healthcare or insurance industries;

 

    current and expected economic conditions;

 

    changes in laws and regulations;

 

    announcements of claims against us by third parties; and

 

    future issuances or sales of our common stock.

In addition, the stock market experiences significant volatility from time to time that is often unrelated to the operating performance of companies whose shares are traded. These market fluctuations could adversely affect the trading price of our common stock, regardless of our actual operating performance.

Securities analysts may discontinue coverage of our common stock or may issue negative reports, which may adversely affect the trading price of our common stock.

There is no assurance that securities analysts will continue to cover our company. If securities analysts do not cover our company, this lack of coverage may adversely affect the trading price of our common stock. The trading market for our common stock relies in part on the research and reports that securities analysts publish about us or our business. If one or more of the analysts who cover our company downgrades our common stock, the trading price of our common stock may decline rapidly. If one or more of these analysts ceases to cover our company, we could lose visibility in the market, which, in turn, could also cause the trading price of our common stock to decline.

Future sales of our common stock may affect the trading price of our common stock and the future exercise of options may lower our stock price.

We cannot predict what effect, if any, future sales of our common stock, or the availability of shares for future sale, will have on the trading price of our common stock. Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, may adversely affect the trading price of our common stock and may make it more difficult for you to sell your shares at a time and price that you determine appropriate. As of February 14, 2014, there were 18,619,680 shares of our common stock outstanding. As of that date, there were also outstanding options exercisable to purchase 553,748 shares of our common stock.

 

Item 1B. Unresolved Staff Comments.

None.

 

Item 2. Properties.

We own our principal business office which has approximately 60,000 square foot of office space together with a warehouse facility with 3,200 square foot located in DeRidder, Louisiana. AIIC and SOCI lease their corporate headquarters which has approximately 3,500 square foot of office space located in Omaha, Nebraska. The Company leases space at other locations for certain of our service and claims representatives, none of which are material.

 

Item 3. Legal Proceedings.

In the ordinary course of our business, we are involved in the adjudication of claims resulting from workplace injuries. We are not involved presently in any legal or administrative proceedings that we believe are likely to have a materially adverse effect on our business, financial condition or results of operations.

 

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Item 4. Mine Safety Disclosures

None.

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.

Market Information and Holders

Our common stock is traded on the NASDAQ Global Select Market under the symbol “AMSF.” As of February 14, 2014, there were 28 holders of record of our common stock.

The table below sets forth the reported high and low sales prices of our common stock as quoted on the NASDAQ during each quarter for the last two fiscal years.

 

    High     Low  

2012

   

First Quarter

   $     25.27           $     21.56       

Second Quarter

   $     28.40           $ 24.54       

Third Quarter

   $     28.07           $ 23.96       

Fourth Quarter

   $     27.91           $ 22.00       

2013

   

First Quarter

   $     36.15           $ 27.62       

Second Quarter

   $     35.70           $ 31.34       

Third Quarter

   $     38.86           $ 32.28       

Fourth Quarter

   $     44.47           $ 34.04       

Dividend Policy

On February 25, 2014, the Company declared a special cash dividend of $0.50 per share payable March 28, 2014 to shareholders of record on March 14, 2014.

Also on February 25, 2014 the Company declared a regular quarterly cash dividend of $0.12 per share payable on March 28, 2014 to shareholders of record on March 14, 2014. In 2013, the Company paid a quarterly cash dividend of $0.08 per share.

The Board intends to continue to consider the payment of a regular cash dividend each calendar quarter. On an annualized basis, the cash dividend is expected to be $0.48 per share.

AMERISAFE is a holding company and has no direct operations. Our ability to pay dividends in the future depends on the ability of our operating subsidiaries to pay dividends to us. Our insurance company subsidiaries are regulated insurance companies and therefore are subject to significant regulatory restrictions limiting their ability to declare and pay dividends. See “Business—Regulation—Dividend Limitations.” in Item 1 of this report.

Our existing revolving credit agreement contains covenants that restrict our ability to pay dividends on our common stock. See “Liquidity and Capital Resources.” in Item 7 of this report.

Description of Capital Stock

AMERISAFE is authorized to issue 60,000,000 shares of capital stock, consisting of:

 

    10,000,000 shares of preferred stock, par value $0.01 per share; and

 

    50,000,000 shares of common stock, par value $0.01 per share.

As of February 14, 2014, 18,619,680 shares of common stock were outstanding. As of that date, there were no other shares of our capital stock outstanding.

 

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Share Repurchases

The Board of Directors initially authorized the Company’s share repurchase program in February 2010. In October 2011, 2012 and 2013 the Board reauthorized this program. Unless reauthorized, the program will expire on December 31, 2014. Since inception we have repurchased a total of 1,258,250 shares of our outstanding common stock for $22.4 million. The Company had $25.0 million available for future purchases at December 31, 2013 under this program. There were no share repurchases in 2013. The purchases will continue to be affected from time to time depending upon market conditions and subject to applicable regulatory considerations. It is anticipated that future purchases will be funded from available capital.

 

Item 6. Selected Financial Data.

The following tables summarize certain selected financial data that should be read in conjunction with our audited financial statements and accompanying notes thereto for the year ended December 31, 2013 included in this report and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

                             
    Year Ended December 31,  
    2013     2012     2011     2010     2009  
    (In thousands, except share and per share data)  

Income Statement Data

     

Gross premiums written

   $     372,177         $ 328,823         $ 272,101         $ 228,424         $ 256,454      

Ceded premiums written

    (18,425)          (16,305)          (13,881)          (20,549)          (20,158)     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 353,752         $ 312,518         $ 258,220         $ 207,875         $ 236,296      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 329,983         $ 290,689         $ 251,015         $ 218,881         $ 250,896      

Net investment income

    27,029           27,018           26,340           26,242           28,014      

Net realized gains (losses) on investments

    (1,211)          2,979           2,228           2,449           2,033      

Fee and other income

    534           562           1,080           584           1,268      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    356,335           321,248           280,663           248,156           282,211      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss and loss adjustment expenses incurred

    228,973           219,903           189,706           157,388           163,316      

Underwriting and certain other operating costs (1)

    18,951           18,450           22,404           6,409           12,393      

Commissions

    25,303           22,144           18,507           16,350           18,418      

Salaries and benefits

    22,862           20,839           19,914           21,405           21,447      

Interest expense

    —            566           1,311           1,548           1,810      

Policyholder dividends

    1,042           2,203           1,464           834           770      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

    297,131           284,105           253,306           203,934           218,154      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes

    59,204           37,143           27,357           44,222           64,057      

Income tax expense

    15,567           7,790           3,176           9,702           16,522      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    43,637           29,353           24,181           34,520           47,535      

Redemption premium

    —            —            —            —            (875)     

Less allocated income to participating securities

    142           22           14           17           7      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) available to common shareholders

   $ 43,495         $ 29,331         $ 24,167         $ 34,503         $ 46,653      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Portion allocable to common shareholders (2)

    100.0%        100.0%        100.0%        100.0%        94.0%   

Net income (loss) allocable to common shareholders

   $ 43,495         $ 29,331         $ 24,167         $ 34,503         $ 43,854      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share equivalent

   $ 2.32         $ 1.58         $ 1.29         $ 1.81         $ 2.28      

Weighted average common shares

    18,373,033           18,166,261           18,249,583           18,635,634           18,860,197      

Stock Options and Performance Shares

    375,776           408,930           443,128           467,364           396,254      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted weighted average of common share equivalents outstanding

    18,748,809           18,575,191           18,692,711           19,102,998           19,256,451      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Selected Insurance Ratios

     

Current accident year loss ratio (3)

    73.2%         76.5%         78.2%         81.8%         73.8%    

Prior accident year loss ratio (4)

    (3.8)%        (0.9)%        (2.6)%        (9.9)%        (8.7)%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss ratio

    69.4%         75.6%         75.6%         71.9%         65.1%    

Net underwriting expense ratio (5)

    20.3%         21.1%         24.2%         20.2%         20.8%    

Net dividend ratio (6)

    0.3%         0.8%         0.6%         0.4%         0.3%    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net combined ratio (7)

    90.0%         97.5%         100.4%         92.5%         86.2%    

 

                             
    As of December 31,  
    2013     2012     2011     2010     2009  
    (In thousands)  

Balance Sheet Data

         

Cash and cash equivalents

  $ 123,077      $ 92,676      $ 45,536      $ 60,966      $ 63,188   

Investments

    878,775        808,116        805,974        765,537        737,297   

Amounts recoverable from reinsurers

    75,326        101,352        96,212        95,133        81,878   

Premiums receivable, net

    171,579        141,950        121,223        122,618        151,570   

Deferred income taxes

    33,645        29,521        30,048        29,629        27,234   

Deferred policy acquisition costs

    19,171        18,419        16,578        15,137        15,997   

Total assets

    1,329,001        1,220,946        1,143,973        1,113,516        1,106,084   

Reserves for loss and loss adjustment expenses

    614,557        570,450        538,214        532,204        534,655   

Unearned premiums

    164,296        140,528        118,699        111,494        122,500   

Insurance-related assessments

    25,428        22,244        19,071        16,464        25,406   

Debt

    —          —          25,780        36,090        36,090   

Shareholders’ equity

    416,814        381,222        349,437        328,721        304,748   

 

(1) Includes policy acquisition expenses and other general and administrative expenses, excluding commissions and salaries and benefits, related to insurance operations and corporate operating expenses.
(2) Reflects the participation rights of our redeemable preferred stock, which was redeemed on December 31, 2009. See Note 12 to our audited financial statements.
(3) The current accident year loss ratio is calculated by dividing loss and loss adjustment expenses incurred for the current accident year by the current year’s net premiums earned.
(4) The prior accident year loss ratio is calculated by dividing the change in loss and loss adjustment expenses incurred for prior accident years by the current year’s net premiums earned.
(5) The net underwriting expense ratio is calculated by dividing underwriting and certain other operating costs, commissions and salaries, and benefits by the current year’s net premiums earned.
(6) The net dividend ratio is calculated by dividing policyholder dividends by the current year’s net premiums earned.
(7) The net combined ratio is the sum of the net loss ratio, the net underwriting expense ratio and the net dividend ratio.

 

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Item  7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto included in Item 8 of this report. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described in Item 1A of this report. These factors could cause our actual results in 2014 and beyond to differ materially from those expressed in, or implied by, those forward-looking statements.

Overview

AMERISAFE is a holding company that markets and underwrites workers’ compensation insurance through its insurance subsidiaries. Workers’ compensation insurance covers statutorily prescribed benefits that employers are obligated to provide to their employees who are injured in the course and scope of their employment. Our business strategy is focused on providing this coverage to small to mid-sized employers engaged in hazardous industries, principally construction, trucking, manufacturing, oil and gas and agriculture. Employers engaged in hazardous industries pay substantially higher than average rates for workers’ compensation insurance compared to employers in other industries, as measured per payroll dollar. The higher premium rates are due to the nature of the work performed and the inherent workplace danger of our target employers. Hazardous industry employers also tend to have less frequent but more severe claims as compared to employers in other industries due to the nature of their businesses. We provide proactive safety reviews of employers’ workplaces. These safety reviews are a vital component of our underwriting process and also promote safer workplaces. We utilize intensive claims management practices that we believe permit us to reduce the overall cost of our claims. In addition, our audit services ensure that our policyholders pay the appropriate premiums required under the terms of their policies and enable us to monitor payroll patterns that cause underwriting, safety or fraud concerns. We believe that the higher premiums typically paid by our policyholders, together with our disciplined underwriting and safety, claims and audit services, provide us with the opportunity to earn attractive returns for our shareholders.

We actively market our insurance in 30 states and the District of Columbia through independent agencies, as well as through our wholly owned insurance agency subsidiary. We are also licensed in an additional 17 states and the U.S. Virgin Islands.

Two of the key financial measures that we use to evaluate our performance are return on average equity and growth in book value per share. We calculate return on average equity by dividing annual net income by the average of annual shareholders’ equity. Our return on average equity was 10.9% in 2013, 8.0% in 2012 and 7.1% in 2011. We calculate book value per share by dividing ending shareholder’s equity by number of common shares outstanding. Our book value per share was $22.41 at December 31, 2013, $20.88 at December 31, 2012 and $19.25 at December 31, 2011.

Investment income is an important element of our net income. Because the period of time between our receipt of premiums and the ultimate settlement of claims is often several years or longer, we are able to invest cash from premiums for significant periods of time. As a result, we are able to generate more investment income from our premiums as compared to insurance companies that operate in other lines of business that pay claims more quickly. From December 31, 2008 to December 31, 2013, our investment portfolio, including cash and cash equivalents, increased from $800.0 million to $1.0 billion and produced net investment income of $27.0 million in 2013, $27.0 million in 2012 and $26.3 million in 2011.

The use of reinsurance is an important component of our business strategy. We purchase reinsurance to protect us from the impact of large losses. Our reinsurance program for 2014 includes 14 reinsurers that provide coverage to us in excess of a certain specified loss amount, or retention level. Our 2014 reinsurance program provides us with reinsurance coverage for each loss occurrence up to $70.0 million, subject to applicable deductibles, retentions and aggregate limits. However, for any loss occurrence involving only one claimant, our reinsurance coverage is limited to $10.0 million for any single claimant, subject to applicable deductibles, retentions and aggregate limits. For 2014, we raised our retention from $1.0 million to $2.0 million for each loss

 

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occurrence. Losses in the layer between $2.0 million and $5.0 million are ceded to a new multi-year reinsurance cover with an aggregate annual deductible of approximately $5.0 million and an aggregate limit of coverage of approximately $11.5 million for 2014. This cover is 75% placed, with Amerisafe retaining a 25% co-participation. For losses between $5.0 million and $10.0 million, we are subject to an annual aggregate deductible of 6.5% of subject earned premium before our reinsurers are obligated to reimburse us. For losses between $5.0 million and $10.0 million, the three year aggregate limit is $20.0 million. As losses are incurred and recorded, we record amounts recoverable from reinsurers for the portion of the losses ceded to our reinsurers.

Our most significant balance sheet liability is our reserve for loss and loss adjustment expenses. We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain. In addition, there are no policy limits on the liability for workers’ compensation claims as there are for other forms of insurance. Therefore, estimating reserves for workers’ compensation claims may be more uncertain than estimating reserves for other types of insurance claims with shorter or more definite periods between occurrence of the claim and final determination of the loss and with policy limits on liability for claim amounts.

Our focus on providing workers’ compensation insurance to employers engaged in hazardous industries results in our receiving relatively fewer but more severe claims than many other workers’ compensation insurance companies. Severe claims, which we define as claims having an estimated ultimate cost of more than $1.0 million, usually have a material effect on each accident year’s loss reserves (and our reported results of operations) as a result of both the number of severe claims reported in any year and the timing of claims in the year. As a result of our focus on higher severity, lower frequency business, our reserve for loss and loss adjustment expenses may have greater volatility than other workers’ compensation insurance companies.

For example, for the five-year period ended December 31, 2013 we had recorded 49 severe claims, or an average of 10 severe claims per year for accident years 2009 through 2013. The number of severe claims reported in any one accident year as of December 31, 2013 ranged from a low of 6 in 2011 to a high of 13 in 2010. The average reported severity for these claims ranged from $1.5 million for the 2010 accident year to $2.2 million for the 2013 accident year. For the five accident years, these severe claims accounted for an average of 6.7 percentage points of our overall loss and loss adjustment expense, or LAE, ratio, measured at December 31, 2013.

Further, the ultimate cost of severe claims is more difficult to estimate, principally due to uncertainties as to medical treatment and outcome and the length and degree of disability. Because of these uncertainties, the estimate of the ultimate cost of severe claims can vary significantly as more information becomes available. As a result, at year end, the case reserve for a severe claim reported early in the year may be more accurate than the case reserve established for a severe claim reported late in the year.

A key assumption used by management in establishing loss reserves is that average per claim case incurred loss and loss adjustment expenses will increase year over year. We believe this increase primarily reflects medical and wage inflation and utilization. However, changes in per average claim case incurred loss and loss adjustment expenses can also be affected by frequency of severe claims in the applicable accident years.

As more fully described in “Business—Loss Reserves” in Item 1 of this report, the estimate for loss and loss adjustment expenses is established based upon management’s analysis of historical data, and factors and trends derived from that data, including claims reported, average claim amount incurred, case development, duration, severity and payment patterns, as well as subjective assumptions. This analysis includes reviews of case reserves for individual open severe claims in the current and prior years. Management reviews the outcomes from actuarial analyses to confirm the reasonableness of its reserve estimate.

Substantial judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical and industry data can be

 

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impacted by external forces, principally frequency and severity of unreported claims, length of time to achieve ultimate settlement of claims, utilization, inflation in medical costs and wages, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings.

Our gross reserves for loss and loss adjustment expenses at December 31, 2013, 2012 and 2011 were $614.6 million, $570.5 million and $538.2 million, respectively. As a percentage of gross reserves at year end, IBNR represented 20.2% in 2013, 21.6% in 2012 and 22.3% in 2011.

In 2013, we decreased our estimates for prior year loss reserves by $12.6 million. In 2012, we decreased our estimates for prior year loss reserves by $2.5 million. In 2011, we decreased our estimates for prior year loss reserves by $6.6 million.

The workers’ compensation insurance industry is cyclical in nature and influenced by many factors, including price competition, medical cost increases, natural and man-made disasters, changes in interest rates, changes in state laws and regulations, and general economic conditions. A hard market in our industry is characterized by decreased competition that results in higher premium rates, more restrictive policy coverage terms, and lower commissions paid to agencies. In contrast, a soft market is characterized by increased competition that results in lower premium rates, expanded policy coverage terms, and higher commissions paid to agencies. We believe that the workers’ compensation insurance industry is transitioning to a hard market cycle. Our strategy is to focus on maintaining underwriting profitability.

For additional information regarding our loss reserves and the analyses and methodologies used by management to establish these reserves, see the information under the caption “Business—Loss Reserves” in Item 1 of this report.

Principal Revenue and Expense Items

Our revenues consist primarily of the following:

Net Premiums Earned. Net premiums earned is the earned portion of our net premiums written. Net premiums written is equal to gross premiums written less premiums ceded to reinsurers. Gross premiums written includes the estimated annual premiums from each insurance policy we write in our voluntary and assigned risk businesses during a reporting period based on the policy effective date or the date the policy is bound, whichever is later.

Premiums are earned on a daily 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 and are earned in subsequent periods over the remaining term of the policy. Our insurance policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2013 for an employer with constant payroll during the term of the policy, we would earn half of the premiums in 2013 and the other half in 2014. On a monthly basis, we also recognize net premiums earned from mandatory pooling arrangements.

We estimate the annual premiums to be paid by our policyholders when we issue the policies and record those amounts on our balance sheet as premiums receivable. We conduct premium audits on all of our voluntary business policyholders annually, upon the expiration of each policy, including when the policy is renewed. The purpose of these audits is to verify that policyholders have accurately reported their payroll expenses and employee job classifications, and therefore have paid us the premium required under the terms of the policies. The difference between the estimated premium and the ultimate premium is referred to as “earned but unbilled” premium, or EBUB premium. EBUB premium can be higher or lower than the estimated premium. EBUB premium is subject to significant variability and can either increase or decrease earned premium based upon several factors, including changes in premium growth, industry mix and economic conditions. Due to the timing of audits and other adjustments, the ultimate premium earned is generally not determined for several months after the expiration of the policy.

 

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We review the estimate of EBUB premiums on a quarterly basis using historical data and applying various assumptions based on the current market, and we record an adjustment to premium, related losses, and expenses as warranted.

Net Investment Income and Net Realized Gains and Losses on Investments. We invest our statutory surplus funds and the funds supporting our insurance liabilities in fixed maturity, equity securities and alternative investments. In addition, a portion of these funds are held in cash and cash equivalents to pay current claims. Our net investment income includes interest and dividends earned on our invested assets, amortization of premiums and discounts on our fixed-maturity securities and returns on our other investments. We assess the performance of our investment portfolio using a standard tax equivalent yield metric. Investment income that is tax-exempt is increased by our marginal federal tax rate of 35% to express yield on tax-exempt securities on the same basis as taxable securities. Net realized gains and losses on our investments are reported separately from our net investment income. Net realized gains occur when our investment securities are sold for more than their costs or amortized costs, as applicable. Net realized losses occur when our investment securities are sold for less than their costs or amortized costs, as applicable, or are written down as a result of other-than-temporary impairment. We classify the majority of our fixed maturity securities as held-to-maturity. We also have some fixed-maturity securities classified as available-for-sale, as are our equity securities and other investments. Net unrealized gains or losses on our securities classified as available-for-sale are reported separately within accumulated other comprehensive income on our balance sheet.

Fee and Other Income. We recognize commission income earned on policies issued by other carriers that are sold by our wholly owned insurance agency subsidiary as the related services are performed. We also recognize a small portion of interest income from mandatory pooling arrangements in which we participate.

Our expenses consist primarily of the following:

Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses incurred represents our largest expense item and, for any given reporting period, includes estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending, and administering 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 claims to take several years to settle and we revise our estimates as we receive additional information about the condition of the injured employees. 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.

Underwriting and Certain Other Operating Costs. Underwriting and certain other operating costs are those expenses that we incur to underwrite and maintain the insurance policies we issue. These expenses include state and local premium taxes and fees and other operating costs, offset by commissions we receive from reinsurers under our reinsurance treaty programs. We pay state and local taxes, licenses and fees, assessments, and contributions to state workers’ compensation security funds based on premiums. In addition, other operating costs include general and administrative expenses, excluding commissions and salaries and benefits, incurred at both the insurance company and corporate level.

Commissions. We pay commissions to our subsidiary insurance agency and to the independent agencies that sell our insurance based on premiums collected from policyholders.

Salaries and Benefits. We pay salaries and provide benefits to our employees.

Policyholder Dividends. In limited circumstances, we pay dividends to policyholders in particular states as an underwriting incentive. Additionally, Florida law requires payment of dividends to Florida policyholders pursuant to a formula based on underwriting results from policies written in Florida over a consecutive three-year period.

 

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Interest Expense. Interest expense represents amounts we incur on our outstanding indebtedness at the then-applicable interest rate.

Income Tax Expense. We incur federal, state, and local income tax expense.

Critical Accounting Policies

Understanding our accounting policies is key to understanding our financial statements. Management considers some of these policies to be very important to the presentation of our financial results because they require us to make significant estimates and assumptions. These estimates and assumptions affect the reported amounts of our assets, liabilities, revenues and expenses and related disclosures. Some of the estimates result from judgments that can be subjective and complex and, consequently, actual results in future periods might differ from these estimates.

Management believes that the most critical accounting policies relate to the reporting of reserves for loss and loss adjustment expenses, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from reinsurers, assessments, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities and share-based compensation.

The following is a description of our critical accounting policies.

Reserves for Loss and Loss Adjustment Expenses. We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses, which include defense and cost containment, or DCC, and adjusting and other, or AO expenses, related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances.

Our reserves for loss and DCC expenses are estimated using case-by-case valuations based on our estimate of the most likely outcome of the claim at that time. In addition to these case reserves, we establish reserves on an aggregate basis that have been incurred but not reported, or IBNR. Our IBNR reserves are also intended to provide for aggregate changes in case incurred amounts as well as for recently reported claims which an initial case reserve has not been established. The third component of our reserves for loss and loss adjustment expenses is our AO reserve. Our AO reserve is established for those future claims administration costs that cannot be allocated directly to individual claims. The final component of our reserves for loss and loss adjustment expenses is the reserve for mandatory pooling arrangements.

In establishing our reserves, we review the results of analyses using actuarial methods that utilize historical loss data from our more than 28 years of underwriting workers’ compensation insurance. The actuarial analysis of our historical data provides the factors we use in estimating our loss reserves. These factors are primarily measures over time of the number of claims paid and reported, average paid and incurred claim amounts, claim closure rates and claim payment patterns. In evaluating the results of our analyses, management also uses substantial judgment in considering other factors that are not considered in these actuarial analyses, including changes in business mix, claims management, regulatory issues, medical trends, employment and wage patterns, insurance policy coverage interpretations, judicial determinations and other subjective factors. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may vary significantly from our original estimates.

On a quarterly basis, we review our reserves for loss and loss adjustment expenses to determine whether adjustments are required. Any resulting adjustments are included in the results for the current period. In establishing our reserves, we do not use loss discounting, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income. Additional information regarding our reserves for loss and loss adjustment expenses and the actuarial method and other factors used in establishing these reserves can be found under the caption “Business—Loss Reserves” in Item 1 of this report.

 

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Amounts Recoverable from Reinsurers. Amounts recoverable from reinsurers represent the portion of our paid and unpaid loss and loss adjustment expenses that are assumed by reinsurers and related commissions due from reinsurers. These amounts are separately reported on our balance sheet as assets and do not reduce our reserves for loss and loss adjustment expenses because reinsurance does not relieve us of liability to our policyholders. We are required to pay claims even if a reinsurer fails to pay us under the terms of a reinsurance contract. We calculate amounts recoverable from reinsurers based on our estimates of the underlying loss and loss adjustment expenses, as well as the terms and conditions of our reinsurance contracts, which could be subject to interpretation. In addition, we bear credit risk with respect to our reinsurers, which can be significant because some of the unpaid loss and loss adjustment expenses for which we have reinsurance coverage remain outstanding for extended periods of time.

Premiums Receivable. Premiums receivable represents premium-related balances due from our policyholders based on annual premiums for policies written, including surcharges and deposits and it is adjusted for premium audits, endorsements, cancellations, cash transactions and charge offs. The balance is shown net of the allowance for doubtful accounts and it includes an estimate for EBUB. The EBUB estimate is subject to significant variability and can either increase or decrease premiums receivable and earned premiums based upon several factors, including changes in premium growth, industry mix and economic conditions.

Assessments. We are subject to various assessments and premium surcharges related to our insurance activities, including assessments and premium surcharges for state guaranty funds and second injury funds. Assessments based on premiums are recorded as an expense as premiums are earned and generally paid one year after the calendar year in which the policies are written. Assessments based on losses are recorded as an expense as losses are incurred and are generally paid within one year of when claims are paid by us. State guaranty fund assessments are used by state insurance oversight agencies to pay claims of policyholders of impaired, insolvent or failed insurance companies and the operating expenses of those agencies. Second injury funds are used by states to reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. In some states, these assessments and premium surcharges may be partially recovered through a reduction in future premium taxes.

Deferred Policy Acquisition Costs. We defer commission expenses, premium taxes and certain marketing, sales, underwriting and safety costs that vary with and are primarily related to the acquisition of insurance policies. These acquisition costs are capitalized and charged to expense ratably as premiums are earned. In calculating deferred policy acquisition costs, these costs are limited to their estimated realizable value, which gives effect to the premiums to be earned, anticipated losses and settlement expenses and certain other costs we expect to incur as the premiums are earned, less related net investment income. Judgments as to the ultimate recoverability of these deferred policy acquisition costs are highly dependent upon estimated future profitability of unearned premiums. If the unearned premiums were less than our expected claims and expenses after considering investment income, we would reduce the deferred costs.

Deferred Income Taxes. We use the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities resulting from a tax rate change impacts our net income or loss in the reporting period that includes the enactment date of the tax rate change.

In assessing whether our deferred tax assets will be realized, management considers whether it is more likely than not that we will generate future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, tax planning strategies and projected future taxable income in making this assessment. If necessary, we establish a valuation allowance to reduce the deferred tax assets to the amounts that are more likely than not to be realized.

 

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Impairment of Investment Securities. Impairment of an investment security results in a reduction of the carrying value of the security and the realization of a loss when the fair value of the security declines below our cost or amortized cost, as applicable, for the security, and the impairment is deemed to be other-than-temporary. We regularly review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of specific investments. We consider various factors in determining if a decline in the fair value of an individual security is other-than-temporary. Some of the factors we consider include:

 

    any reduction or elimination of preferred stock dividends, or nonpayment of scheduled principal or interest payments;

 

    the financial condition and near-term prospects of the issuer of the applicable security, including any specific events that may affect its operations or earnings;

 

    how long and by how much the fair value of the security has been below its cost or amortized cost;

 

    any downgrades of the security by a rating agency;

 

    our intent not to sell the security for a sufficient time period for it to recover its value;

 

    the likelihood of being forced to sell the security before the recovery of its value; and

 

    an evaluation as to whether there are any credit losses on debt securities.

Share-Based Compensation. In accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718, Compensation-Stock Compensation, we recognize compensation costs for stock option awards over the applicable vesting periods.

 

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Results of Operations

The table below summarizes certain operating results and key measures we use in monitoring and evaluating our operations.

 

    Year Ended December 31,  
    2013     2012     2011  
    (In thousands)  

Income Statement Data

     

Gross premiums written

   $ 372,177           $ 328,823           $ 272,101       

Ceded premiums written

    (18,425)           (16,305)           (13,881)      
 

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 353,752           $ 312,518           $ 258,220       
 

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 329,983           $ 290,689           $ 251,015       

Net investment income

    27,029            27,018            26,340       

Net realized gains (losses) on investments

    (1,211)           2,979            2,228       

Fee and other income

    534            562            1,080       
 

 

 

   

 

 

   

 

 

 

Total revenues

    356,335            321,248            280,663       
 

 

 

   

 

 

   

 

 

 

Loss and loss adjustment expenses incurred

    228,973            219,903            189,706       

Underwriting and certain other operating costs (1)

    18,951            18,450            22,404       

Commissions

    25,303            22,144            18,507       

Salaries and benefits

    22,862            20,839            19,914       

Interest expense

    —           566            1,311       

Policyholder dividends

    1,042            2,203            1,464       
 

 

 

   

 

 

   

 

 

 

Total expenses

       297,131               284,105               253,306       
 

 

 

   

 

 

   

 

 

 

Income before taxes

    59,204            37,143            27,357       

Income tax expense

    15,567            7,790            3,176       
 

 

 

   

 

 

   

 

 

 

Net income

   $ 43,637           $ 29,353           $ 24,181       
 

 

 

   

 

 

   

 

 

 

Selected Insurance Ratios

     

Current accident year loss ratio (2)

    73.2%         76.5%         78.2%    

Prior accident year loss ratio (3)

    (3.8)%        (0.9)%        (2.6)%   
 

 

 

   

 

 

   

 

 

 

Net loss ratio

    69.4%         75.6%         75.6%    
 

 

 

   

 

 

   

 

 

 

Net underwriting expense ratio (4)

    20.3%         21.1%         24.2%    

Net dividend ratio (5)

    0.3%         0.8%         0.6%    

Net combined ratio (6)

    90.0%         97.5%         100.4%    

 

    As of December 31,  
    2013     2012     2011  
    (In thousands)  

Balance Sheet Data

     

Cash and cash equivalents

   $ 123,077           $ 92,676           $ 45,536       

Investments

    878,775            808,116            805,974       

Amounts recoverable from reinsurers

    75,326            101,352            96,212       

Premiums receivable, net

    171,579            141,950            121,223       

Deferred income taxes

    33,645            29,521            30,048       

Deferred policy acquisition costs

    19,171            18,419            16,578       

Total assets

    1,329,001            1,220,946            1,143,973       

Reserves for loss and loss adjustment expenses

    614,557            570,450            538,214       

Unearned premiums

    164,296            140,528            118,699       

Insurance-related assessments

    25,428            22,244            19,071       

Debt

    —           —           25,780       

Shareholders’ equity

    416,814            381,222            349,437       

 

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(1) Includes policy acquisition expenses, and other general and administrative expenses, excluding commissions and salaries and benefits, related to insurance operations and corporate operating expenses.
(2) The current accident year loss ratio is calculated by dividing loss and loss adjustment expenses incurred for the current accident year by the current year’s net premiums earned.
(3) The prior accident year loss ratio is calculated by dividing the change in loss and loss adjustment expenses incurred for prior accident years by the current year’s net premiums earned.
(4) The net underwriting expense ratio is calculated by dividing underwriting and certain other operating costs, commissions and salaries, and benefits by the current year’s net premiums earned.
(5) The net dividend ratio is calculated by dividing policyholder dividends by the current year’s net premiums earned.
(6) The net combined ratio is the sum of the net loss ratio, the net underwriting expense ratio and the net dividend ratio.

Overview of Operating Results

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Gross Premiums Written. Gross premiums written for 2013 were $372.2 million, compared to $328.8 million for 2012, an increase of 13.2%. The increase was attributable to a $46.9 million increase in annual premiums on voluntary policies written during the period, a $2.8 million increase in premiums from mandatory pooling arrangements, and a $0.9 million increase in direct assigned risk premiums offset by a $7.4 million decrease in premiums resulting from payroll audits and related premium adjustments. Related premium adjustments in 2013 include a $1.3 million increase in “earned but unbilled”, or EBUB, premium.

Net Premiums Written. Net premiums written for 2013 were $353.8 million, compared to $312.5 million for 2012, an increase of 13.2%. The increase was primarily attributable to the increase in gross premiums written. As a percentage of gross premiums earned, ceded premiums were 5.3% for 2013 and 2012.

Net Premiums Earned. Net premiums earned for 2013 were $330.0 million, compared to $290.7 million for 2012, an increase of 13.5%. The increase was attributable to the increase in net premiums written, offset by an increase in unearned premiums.

Net Investment Income. Net investment income in 2013 was $27.0 million, in-line with the $27.0 million reported in 2012. The pre-tax investment yield on our investment portfolio was 2.8% per annum for 2013 and 3.1% for 2012. The tax-equivalent yield on our investment portfolio was 3.9% per annum for 2013, compared to 4.3% per annum for 2012. The tax-equivalent yield is calculated using the effective interest rate and a 35% marginal tax rate. Average invested assets, including cash and cash equivalents, increased 7.6%, from an average of $877.6 million for 2012 to an average of $944.4 million for 2013. During 2013, we invested $10 million in a limited partnership, which we account for under the equity method. The carrying value of this investment is $10.6 million at December 31, 2013.

Net Realized Gains (Losses) on Investments. Net realized losses on investments in 2013 totaled $1.2 million, compared to a gain of $3.0 million in 2012. Net realized losses of $2.2 million resulted from other-than-temporary impairments on four equity securities. These losses were offset by realized gains of $1.0 million in 2013 resulting from gains from called fixed maturity securities, the sale of equity securities and the sale of fixed maturity securities from the available-for-sale portfolio. Net realized gains in 2012 primarily resulted from $2.4 million in gains from called fixed-maturity securities and the sale of certain equity and fixed-maturity securities from the available-for-sale portfolio. These gains in 2012 were offset by an other-than-temporary impairment of $0.2 million on one asset-backed security from our held-to-maturity portfolio.

Loss and Loss Adjustment Expenses Incurred. Loss and LAE incurred totaled $229.0 million for 2013, compared to $219.9 million for 2012, an increase of $9.1 million, or 4.1%. The current accident year losses and LAE incurred were $241.6 million, or 73.2% of net premiums earned, compared to $222.4 million, or 76.5% of

 

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net premiums earned for 2012. We recorded favorable prior accident year development of $12.6 million in 2013, compared to $2.5 million in 2012. This is further discussed below in “Prior Year Development.” Our net loss ratio was 69.4% for 2013 and 75.6% for 2012.

Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for 2013 were $67.1 million, compared to $61.4 million for 2012, an increase of 9.3%. This increase was primarily due to a $3.2 million increase in commission expense, a $0.6 million increase in insurance related assessments, and a $0.8 million increase in mandatory pooling arrangement fees. Offsetting these increases were a $2.0 million decrease in bad debt expense, a $0.3 million decrease in taxes and fees, a $1.8 million increase in experience-rated commissions and a $0.5 million increase in ceding commission which serve to decrease the cost of our reinsurance. Our underwriting expense ratio decreased to 20.3% in 2013 from 21.1% in 2012.

Interest expense. There was no interest expense for 2013 compared with $0.6 million in 2012. The Company retired all of its debt in August 2012.

Income tax expense. Income tax expense for 2013 was $15.6 million, compared to $7.8 million for 2012. The increase was primarily attributable to an increase in pre-tax income, from $37.1 million for 2012 to $59.2 million for 2013. The effective tax rate also increased to 26.3% for 2013, compared to 21.0% for 2012. This increase is due to a higher level of underwriting income relative to our pre-tax income.

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Gross Premiums Written. Gross premiums written for 2012 were $328.8 million, compared to $272.1 million for 2011, an increase of 20.8%. The increase was attributable to a $38.9 million increase in annual premiums on voluntary policies written during the period, a $15.0 million increase in premiums resulting from payroll audits and related premium adjustments, a $2.4 million increase in premiums from mandatory pooling arrangements, and a $0.4 million increase in direct assigned risk premiums. Related premium adjustments in 2012 include a $0.9 million increase in “earned but unbilled”, or EBUB, premium. Premium adjustments for the same period in 2011 included a $0.3 million increase in EBUB premium.

Net Premiums Written. Net premiums written for 2012 were $312.5 million, compared to $258.2 million for 2011, an increase of 21.0%. The increase was primarily attributable to the increase in gross premiums written. As a percentage of gross premiums earned, ceded premiums were 5.3% for 2012, compared to 5.2% for 2011.

Net Premiums Earned. Net premiums earned for 2012 were $290.7 million, compared to $251.0 million for 2011, an increase of 15.8%. The increase was attributable to the increase in net premiums written, offset by an increase in unearned premiums.

Net Investment Income. Net investment income in 2012 was $27.0 million, compared to $26.3 million in 2011, an increase of 2.6%. The pre-tax investment yield on our investment portfolio was 3.1% per annum for 2012 and 2011. The tax-equivalent yield on our investment portfolio was 4.3% per annum for 2012, compared to 4.6% per annum for 2011. The tax-equivalent yield is calculated using the effective interest rate and a 35% marginal tax rate. Average invested assets, including cash and cash equivalents, increased 5.3%, from an average of $833.4 million for 2011 to an average of $877.6 million for 2012.

Net Realized Gains (Losses) on Investments. Net realized gains on investments in 2012 totaled $3.0 million, compared to $2.2 million in 2011. Net realized gains in 2012 resulted from gains from called fixed maturity securities, the sale of equity securities and the sale of fixed maturity securities from the available-for-sale portfolio. Net realized gains in 2011 primarily resulted from $2.4 million in gains from called fixed-maturity securities and the sale of certain equity and fixed-maturity securities from the available-for-sale portfolio. These gains in 2011 were offset by an other-than-temporary impairment of $0.2 million on one asset-backed security from our held-to-maturity portfolio.

 

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Loss and Loss Adjustment Expenses Incurred. Loss and LAE incurred totaled $219.9 million for 2012, compared to $189.7 million for 2011, an increase of $30.2 million, or 15.9%. The current accident year losses and LAE incurred were $222.4 million, or 76.5% of net premiums earned, compared to $196.3 million, or 78.2% of net premiums earned for 2011. We recorded favorable prior accident year development of $2.5 million in 2012, compared to $6.6 million in 2011. This is further discussed below in “Prior Year Development.” Our net loss ratio was 75.6% for 2012 and 2011.

Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for 2012 were $61.4 million, compared to $60.8 million for 2011, an increase of 1.0%. This increase was primarily due to a $3.6 million increase in commission expense, a $0.8 million increase in insurance related assessments, a $0.8 million increase in accounts receivable write-offs, and a $0.7 million increase in mandatory pooling arrangement fees. Offsetting these increases were a $5.4 million increase in experience-rated commissions, a $0.5 million decrease in taxes and fees and a $0.5 million decrease in ceding commission related to our 2012 reinsurance agreement. Our underwriting expense ratio decreased to 21.1% in 2012 from 24.2% in 2011.

Interest expense. Interest expense for 2012 was $0.6 million, compared to $1.3 million for 2011. Weighted average borrowings for 2012 were $12.9 million, compared to $31.1 million for 2011. The weighted average interest rate increased to 4.3% per annum for 2012 from 4.2% per annum for 2011. The Company retired all of its debt by August 2012.

Income tax expense. Income tax expense for 2012 was $7.8 million, compared to $3.1 million for 2011. The increase was primarily attributable to an increase in pre-tax income, from $27.4 million for 2011 to $37.1 million for 2012. The effective tax rate also increased to 21.0% for 2012, compared to 11.6% for 2011. This increase is due to the higher level of tax-exempt investment income relative to our higher pre-tax income. In 2011, the effective rate included a $1.4 million expense reduction for deferred tax assets related to unrealized losses on our investment portfolio.

Prior Year Development

The Company recorded favorable prior accident year loss and loss adjustment expense development of $12.6 million in calendar year 2013, $2.5 million in calendar year 2012 and $6.6 million in calendar year 2011. The table below sets forth the favorable or unfavorable development for accident years 2008 through 2012 and, collectively, all accident years prior to 2008.

 

    Favorable/(Unfavorable)
Development for Year
Ended December 31,
 
    2013      2012     2011  
    (in millions)  

2012

    $      0.5             $     —           $      —      

2011

    0.4             (3.1)          —      

2010

    2.3             (5.6)          (23.3)     

2009

    3.9             0.5           0.3      

2008

    3.1             3.2           4.7      

Prior to 2008

    2.4             7.5           24.9      
 

 

 

    

 

 

   

 

 

 

Total net development

     $    12.6            $     2.5            $    6.6      
 

 

 

    

 

 

   

 

 

 

 

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The table below sets forth the number of open claims as of December 31, 2013, 2012 and 2011, and the numbers of claims reported and closed during the years then ended.

 

    Twelve Months
Ended December 31,
 
    2013     2012     2011  

Open claims at beginning of period

    4,964           5,184           5,129      

Claims reported

    5,620           5,721           5,986      

Claims closed

    (5,287)         (5,941)         (5,931)    
 

 

 

   

 

 

   

 

 

 

Open claims at end of period

          5,297                 4,964                 5,184      
 

 

 

   

 

 

   

 

 

 

At December 31, 2013, our incurred amounts for certain accident years, particularly 2008, 2009 and 2010, developed more favorably than management previously expected. The assumptions we used in establishing our reserves for these accident years were based on our historical claims data. However, as of December 31, 2013, actual results for these accident years have been better than our assumptions would have predicted. We do not presently intend to modify our assumptions for establishing reserves in light of recent results. However, if actual results for current and future accident years are consistent with, or different than, our results in these recent accident years, our historical claims data will reflect this change and, over time, will impact the reserves we establish for future claims.

Our reserves for loss and loss adjustment expenses are inherently uncertain and our focus on providing workers’ compensation insurance to employers engaged in hazardous industries results in our receiving relatively fewer but more severe claims than many other workers’ compensation insurance companies. As a result of this focus on higher severity, lower frequency business, our reserve for loss and loss adjustment expenses may have greater volatility than other workers’ compensation insurance companies. For additional information, see “Business—Loss Reserves.”

Liquidity and Capital Resources

Our principal sources of operating funds are premiums, investment income, and proceeds from maturities of investments. Our primary uses of operating funds include payments for claims and operating expenses. We pay claims and operating expenses using cash flow from operations and invest our excess cash in fixed maturity, equity securities and other investments. We presently expect that our projected cash flow from operations will provide us sufficient liquidity to fund future operations, including payment of claims and operating expenses and other holding company expenses, for at least the next 18 months.

We forecast claim payments based on our historical trends. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on a short- and long-term basis. Cash payments, net of reinsurance, for claims were $178.4 million in 2013, $181.9 million in 2012 and $179.1 million in 2011. We fund claim payments out of cash flow from operations, principally premiums, net of amounts ceded to our reinsurers, and net investment income. Our investment portfolio has increased from $759.1 million at December 31, 2007 to $1.0 billion at December 31, 2013.

As discussed above under “—Overview,” we purchase reinsurance to protect us against severe claims and catastrophic events. Based on our estimates of future claims, we believe we are sufficiently capitalized to satisfy the deductibles and retentions in our 2014 reinsurance program. We reevaluate our reinsurance program at least annually, taking into consideration a number of factors, including cost of reinsurance, our liquidity requirements, operating leverage and coverage terms.

Even if we maintain our existing retention levels, if the cost of reinsurance increases, our cash flow from operations would decrease as we would cede a greater portion of our written premiums to our reinsurers. Conversely, our cash flow from operations would increase if the cost of reinsurance declined relative to our retention.

In January 2013, the Company commuted reinsurance agreements with Clearwater Insurance Company, covering portions of accident years 1990 through 1995. The Company received cash of $0.3 million in exchange

 

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for releasing these reinsurers from their reinsurance obligations under the commuted agreements. Clearwater Insurance Company remains obligated to the Company’s insurance subsidiaries under other reinsurance agreements. As a result of the commutation, the effect on the Company’s net income in the year ended December 31, 2013 was immaterial.

On September 15, 2013, we commuted certain reinsurance agreements with Hannover Reinsurance (Ireland) Limited (“Hannover Re”) and Aspen Insurance Limited (“Aspen”) covering portions of the 2008 through 2010 accident years. Hannover Re and Aspen remain obligated to subsidiaries of the Company under other reinsurance agreements. We received cash of $14.9 million and an additional $17.6 million payment effectuated solely through offset against the balance of the funds withheld account under the reinsurance agreement in exchange for releasing Hannover Re and Aspen from their reinsurance obligations under the commuted agreements. As a result of the commutation, there was no effect on the Company’s net income in the year ended December 31, 2013.

Net cash provided by operating activities was $128.9 million in 2013, as compared to $81.0 million in 2012, and $43.7 million in 2011. Major components of cash provided by operating activities in 2013 were net premiums collected of $325.0 million and investment income collected of $39.5 million, offset in-part by claim payments of $177.7 million, $46.4 million of operating expenditures, federal taxes paid of $14.5 million and dividends to policyholders paid of $1.6 million.

Major components of cash provided by operating activities in 2012 were net premiums collected of $290.6 million and investment income collected of $36.3 million, offset in-part by claim payments of $183.6 million, $56.1 million of operating expenditures, federal taxes paid of $7.4 million and dividends to policyholders paid of $1.6 million.

Major components of cash provided by operating activities in 2011 were net premiums collected of $260.1 million and investment income collected of $31.2 million, offset in-part by claim payments of $178.8 million, $65.0 million of operating expenditures, federal taxes paid of $2.0 million and dividends to policyholder paid of $1.6 million.

Net cash used in investing activities was $97.0 million in 2013, as compared to $9.3 million in 2012 and $42.9 million in 2011. In 2013, major components of net cash used in investing activities included investment purchases of $355.6 million and net purchases of furniture, fixtures and equipment of $1.1 million, offset by proceeds from sales and maturities of investment of investments of $259.8 million. In 2012, major components of net cash used in investing activities included investment purchases of $267.7 million and net purchases of furniture, fixtures and equipment of $1.2 million, offset by proceeds from sales and maturities of investments of $259.6 million. In 2011, major components of net cash used in investing activities included investment purchases of $294.8 million and net purchases of furniture, fixtures and equipment of $1.1 million, offset by proceeds from sales and maturities of investments of $252.9 million.

Net cash used in financing activities was $1.5 million in 2013, as compared to net cash used in financing activities of $24.6 million in 2012 and net cash used in financing activities of $16.2 million in 2011. Major components of cash provided in financing activities in 2013 included $2.3 million of proceeds from the exercise of stock options and $2.0 million of tax benefit from share-based compensation, offset by cash used for dividends paid to shareholders of $5.9 million. Major components of cash used in financing activities in 2012 included $25.8 million for the redemption of subordinated debt securities, $0.8 million of proceeds from the exercise of stock options and $0.4 million of tax benefit from share-based compensation. Major components of cash used in financing activities in 2011 included $10.3 million for the purchase of our common stock, 10.3 million for the redemption of subordinated debt securities, $3.3 million of proceeds from the exercise of stock options and $1.0 million of tax benefit from share-based compensation.

In 2012, the Company redeemed all $25.8 million of subordinated notes from the Amerisafe Capital Trust II (“ACT II”) and the related trust was canceled.

In 2011, the Company redeemed all $10.3 million of subordinated notes from the Amerisafe Capital Trust I (“ACT I”) and the related trust was canceled.

 

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In October 2007, the Company entered into an agreement providing for a line of credit in the maximum amount of $20.0 million with Frost Bank, NA. The agreement expired in October 2010. The Company renewed this agreement in the fourth quarter 2010 for an additional three years to mature in December of 2013. Under the agreement, advances may be made either in the form of loans or letters of credit. Borrowings under the agreement accrue at interest rates based upon prime rate or LIBOR. The Company paid a fee of 0.375% on the unused portion of the loan in arrears quarterly for a fee of $75,000 annually, assuming the line of credit remains unused during the calendar year. The line of credit is unsecured. At December 31, 2013, there were no outstanding borrowings. In December of 2013, the Company renewed the agreement providing for a line of credit up to $20.0 million, expiring in December 2016. Under the new agreement, the Company will pay a fee of 0.25% on the unused portion of the loan in arrears quarterly for a fee of $50,000 annually.

The Board of Directors initially authorized the Company’s share repurchase program in February 2010. In October 2011, 2012 and 2013 the Board reauthorized this program. As of December 31, 2013, we had repurchased a total of 1,258,250 shares of our outstanding common stock for $22.4 million. The Company had $25.0 million available for future purchases at December 31, 2013 under this program. There were no share repurchases in 2013. The purchases will continue to be affected from time to time depending upon market conditions and subject to applicable regulatory considerations. It is anticipated that future purchases will be funded from available capital.

AMERISAFE is a holding company that transacts business through its operating subsidiaries, including American Interstate, Silver Oak Casualty and American Interstate of Texas. AMERISAFE’s primary assets are the capital stock of these insurance subsidiaries. The ability of AMERISAFE to fund its operations depends upon the surplus and earnings of its subsidiaries and their ability to pay dividends to AMERISAFE. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds. Based upon the prescribed calculation, the insurance subsidiaries could pay to AMERISAFE dividends of up to $35.4 million after September 2014 without seeking regulatory approval. See “Business—Regulation—Dividend Limitations” in Item 1 of this report.

On February 25, 2014, the Company declared a special cash dividend of $0.50 per share payable March 28, 2014 to shareholders of record on March 14, 2014.

Also on February 25, 2014 the Company declared a regular quarterly cash dividend of $0.12 per share payable on March 28, 2014 to shareholders of record on March 14, 2014. In 2013, the Company paid a quarterly cash dividend of $0.08 per share.

The Board intends to continue to consider the payment of a regular cash dividend each calendar quarter. On an annualized basis, the cash dividend is expected to be $0.48 per share.

Investment Portfolio

The principal objectives of our investment portfolio are to preserve capital and surplus and to maintain appropriate liquidity for corporate requirements. Additional objectives are to support our A.M. Best rating and to maximize after-tax income and total return. We presently expect to maintain sufficient liquidity from funds generated by operations to meet our anticipated insurance obligations and operating and capital expenditure needs. Excess funds from operations will be invested in accordance with our investment policy and statutory requirements.

We allocate our portfolio into four categories: cash and cash equivalents, short term investments, fixed maturity securities and equity securities. Cash and cash equivalents include cash on deposit, money market funds and municipal securities, corporate securities and certificates of deposit with an original maturity of less than 90 days. Short-term investments include municipal securities, corporate securities and certificates of deposit with an original maturity greater than 90 days but less than one year. Our fixed maturity securities include obligations of the U.S. Treasury or U.S. agencies, obligations of states and their subdivisions, U.S. Dollar-denominated obligations of the U.S. or Canadian corporations, U.S. agency-based mortgage-backed securities, commercial mortgage-backed securities and asset-backed securities.

 

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Under Nebraska and Texas law, as applicable, each of American Interstate, Silver Oak Casualty and American Interstate of Texas is required to invest only in securities that are either interest-bearing, interest-accruing or eligible for dividends, and must limit its investment in the securities of any single issuer, other than direct obligations of the United States, to five percent of the insurance company’s assets. As of December 31, 2013, we were in compliance with these requirements.

We employ diversification policies and balance investment credit risk and related underwriting risks to minimize our total potential exposure to any one business sector or security.

As of December 31, 2013, our investment portfolio, including cash and cash equivalents, totaled $1.0 billion, an increase of 11.2% from December 31, 2012. The majority of our fixed maturity securities are classified as held-to-maturity, as defined by FASB ASC Topic 320, Investments-Debt and Equity Securities. As such, the reported value of those securities is equal to their amortized cost, and is not impacted by changing interest rates. The remainder of our fixed maturity securities and all of equity securities are classified as available-for-sale and reported at fair value.

On January 1, 2008, we adopted FASB ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a fair value hierarchy and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. As disclosed in Note 19 of the financial statements, our securities available-for-sale are classified using Level 1, 2 and 3 inputs. We did not elect the fair value option prescribed under FASB ASC Topic 825, Financial Instruments, for any financial assets or financial liabilities in 2012 or 2013.

The composition of our investment portfolio, including cash and cash equivalents, as of December 31, 2013 is shown in the following table.

 

        Carrying Value        Percentage
    of Portfolio    
    Effective
      Interest Rate      
 
    (In thousands)              

Fixed maturity securities—held-to-maturity:

     

State and political subdivisions

   $ 381,674         38.1%          3.7%     

Corporate bonds

    67,423         6.7%          2.2%     

Commercial mortgage-backed securities

    50,813         5.1%          5.5%     

U.S. agency-based mortgage-backed securities

    21,775         2.2%          5.2%     

U.S. Treasury securities and obligations of U.S. Government agencies

    11,514         1.2%          3.3%     

Asset-backed securities

    3,384         0.3%          3.7%     
 

 

 

   

 

 

   

Total fixed maturity securities—held-to-maturity

    536,583         53.6%          3.7%     
 

 

 

   

 

 

   

Fixed maturity securities—available-for-sale:

     

State and political subdivisions

    150,375         15.0%          3.4%     

Corporate bonds

    80,428         8.0%          2.0%     

U.S. agency-based mortgage-backed securities

    7,074         0.7%          3.3%     
 

 

 

   

 

 

   

Total fixed maturity securities—available-for-sale

    237,877         23.7%          2.9%     
 

 

 

   

 

 

   

Equity securities

    9,302         0.9%          5.1%     

Other investments

    10,591         1.1%          0.0%     

Cash and cash equivalents

    123,077         12.3%          0.3%     

Short-term investments

    84,422         8.4%          0.7%     
 

 

 

   

 

 

   

Total Investments, including cash and cash equivalents

   $ 1,001,852         100.0%          2.8%     
 

 

 

   

 

 

   

 

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For our securities classified as available-for-sale, the securities are “marked to market” as of the end of each calendar quarter. As of that date, unrealized gains and losses are recorded against Accumulated Other Comprehensive Income (Loss), except when such securities are deemed to be other-than-temporarily impaired. For our securities classified as held-to-maturity, unrealized gains and losses are not recorded in the financial statements until realized or until a decline in fair value, below amortized cost, is deemed to be other-than-temporary.

We regularly review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. We consider various factors in determining if a decline in the fair value of an individual security is other-than-temporary. The key factors we consider are:

 

    any reduction or elimination of preferred stock dividends, or nonpayment of scheduled principal or interest payments;

 

    the financial condition and near-term prospects of the issuer of the applicable security, including any specific events that may affect its operations or earnings;

 

    how long and by how much the fair value of the security has been below its cost or amortized cost;

 

    any downgrades of the security by a rating agency;

 

    our intent not to sell the security for a sufficient time period for it to recover its value;

 

    the likelihood of being forced to sell the security before the recovery of its value; and

 

    an evaluation as to whether there are any credit losses on debt securities.

The following table summarizes the fair value of, and the amount of, unrealized losses on our investment securities, segregated by the time period each security has been in a continuous unrealized loss position as of December 31, 2013 and 2012:

 

    Less Than
Twelve Months
    Twelve Months
or Longer
 
  Fair
        Value        
          Unrealized      
Losses
    Fair
        Value        
          Unrealized      
Losses
 
    (In thousands)  

December 31, 2013:

       

Fixed maturity securities

   $ 201,887         $ (6,812)         $ 9,752         $ (2,994)     

Equity securities

    5,205          (567)          —           —      

December 31, 2012:

       

Fixed maturity securities

   $ 46,375         $ (1,143)         $ 2,345         $ (181)     

Equity securities

    4,186          (685)          —           —      

We reviewed all securities with unrealized losses in accordance with the impairment policy described above. With the exception of four equity securities deemed to be other-than-temporarily impaired, the Company expects to hold these investments in equity securities for a reasonable period of time sufficient for a recovery of fair value. We determined that the unrealized losses in the fixed maturity securities portfolio related primarily to changes in market interest rates since the date of purchase, current conditions in the capital markets and the impact of those conditions on market liquidity and prices generally, and the transfer of the investments from the available-for-sale classification to the held-to-maturity classification in January 2004. We expect to recover the carrying value of these securities as it is not more likely than not that we will be required to sell the security before the recovery of its amortized cost basis. In addition, none of the unrealized losses on debt securities are considered credit losses.

During 2013, the Company impaired securities totaling $2.2 million related to four equity securities. The impairment charge is included in “Net realized gains (losses) on investments” for 2013. We impaired the securities due to the amount of the accumulated unrealized loss positions, the amount of time in those loss positions and the management’s revised outlook on those securities.

There were no impairment charges in 2012.

 

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In 2011, we recorded an impairment charge of $0.2 million related to one asset-backed security in our held-to-maturity investment portfolio. We impaired this security because, among other things, a loss of principal was anticipated based upon estimated future cash flows. The impairment charge is included in “Net realized gains (losses) on investments” for 2011.

The pre-tax investment yield on our investment portfolio was 2.8% per annum during the twelve months ended December 31, 2013, compared to 3.1% per annum during the same period in 2012.

Contractual Obligations and Commitments

We manage risk on certain long-duration claims by settling these claims through the purchase of annuities from unaffiliated life insurance companies. In the event these companies are unable to meet their obligations under these annuity contracts, we could be liable to the claimants, but our reinsurers remain obligated to indemnify us for all or part of these obligations in accordance with the terms of our reinsurance contracts. As of December 31, 2013, the present value of these annuities was $92.4 million, as estimated by our annuity providers. Substantially all of the annuities are issued or guaranteed by life insurance companies that have an A.M. Best rating of “A” (Excellent) or better. For additional information, see Note 17 to our consolidated financial statements in Item 8 of this report.

We lease equipment and office space under noncancelable operating leases. Future minimum lease payments at December 31, 2013, were as follows:

 

Year

        Future Minimum      
Lease Payments
 
    (In thousands)  

2014

   $ 144       

2015

    111       

2016

    101       

2017

    90       

2018

    67       

2019

    6       
 

 

 

 
   $ 519       
 

 

 

 

Rental expense was $0.2 million in 2013, $0.2 million in 2012 and $0.3 million in 2011.

The table below provides information with respect to our contractual obligations as of December 31, 2013.

 

Contractual Obligations

 

 

    Payment Due By Period  
  Total     Less Than
1 Year
    1-3 Years     4-5 Years     More Than
5 Years
 
    (In thousands)  

Loss and loss adjustment expenses (1)

  $ 614,557       $ 206,491      $ 272,863      $ 63,914       $ 71,289    

Loss-based insurance assessments (2)

    11,396         3,829         5,060         1,185         1,322    

Operating lease obligations

    519         144         302         73         —     

Purchase obligations

    493         224         269         —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $     626,965        $     210,688        $     278,494        $     65,172        $     72,611   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of December 31, 2013 and actuarial estimates of expected payout patterns and are not contractual liabilities as to a time certain. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and loss adjustment expense payments due by period is subject to the same uncertainties associated with determining the level of loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and loss adjustment expense process, see “Business—Loss Reserves” in Item 1 of this report. Actual payments of

 

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  loss and loss adjustment expenses by period will vary, perhaps materially, from the amounts shown in the table above to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors— Risks Related to Our Business—Our loss reserves are based on estimates and may be inadequate to cover our actual losses” in Item 1A of this report for a discussion of the uncertainties associated with estimating loss and loss adjustment expenses.
(2) We are subject to various annual assessments imposed by certain of the states in which we write insurance policies. These assessments are generally based upon the amount of premiums written or losses paid during the applicable year. Assessments based on premiums are generally paid within one year after the calendar year in which the policies are written, while assessments based on losses are generally paid within one year after the loss is paid. When we establish a reserve for loss and loss adjustment expenses for a reported claim, we accrue our obligation to pay any applicable assessments. If settlement of the claim is to be paid out over more than one year, our obligation to pay any related loss-based assessments extends for the same period of time. Because our reserves for loss and loss adjustment expenses are based on estimates, our accruals for loss-based insurance assessments are also based on estimates. Actual payments of loss and loss adjustment expenses may differ, perhaps materially, from our reserves. Accordingly, our actual loss-based insurance assessments may vary, perhaps materially, from our accruals.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Market risk is the risk of potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are credit risk, interest rate risk, and equity price risk. We currently have no exposure to foreign currency risk.

Credit Risk

Credit risk is the potential loss arising principally from adverse changes in the financial condition of the issuers of our fixed maturity securities and the financial condition of our reinsurers.

We address the credit risk related to the issuers of our fixed maturity securities by primarily investing in fixed maturity securities that are rated as investment grade by one or more of Moody’s, Standard & Poor’s or Fitch. We also independently monitor the financial condition of all issuers of our fixed maturity securities. To limit our risk exposure, we employ diversification policies that limit our credit exposure to any single issuer or business sector.

We are also subject to credit risk with respect to our reinsurers. Although our reinsurers are obligated to reimburse us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks we have reinsured. As a result, reinsurance contracts do not limit our ultimate obligations to pay claims and, in some cases, we might not be able to collect amounts recoverable from our reinsurers. We address this credit risk by initially selecting reinsurers with an A.M. Best rating of “A-” (Excellent) or better and by performing, along with our reinsurance broker, periodic credit reviews of our reinsurers. If one of our reinsurers suffers a credit downgrade, we may consider various options to lessen the risk of asset impairment, including commutation, novation or letters of credit. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in Item 7 of this report.

Interest Rate Risk

Interest rate risk is the risk that we may incur losses due to adverse changes in interest rates. As of December 31, 2013, we had fixed maturity securities with a fair value of $799.1 million and a carrying value of $774.5 million. These securities are all subject to interest rate risk, but because we classify the majority of our

 

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fixed maturity securities as held-to-maturity, changes in fair values have a small effect on the carrying value of our portfolio. We manage our exposure to interest rate risk with respect to these securities by investing in a portfolio of securities with moderate effective duration. At December 31, 2013, the effective duration of the total investment portfolio, including cash and short term investments, was 4.3 years. Given the current low interest rate environment, the risk to the portfolio from higher rates exceeds the potential benefit to the portfolio from lower rates. Should we experience a large rise in interest rates, the effect on the carrying value of our portfolio could be substantial.

The table below summarizes the interest rate risk associated with our fixed maturity securities by illustrating the sensitivity of the fair value and carrying value of our fixed maturity securities as of December 31, 2013 to selected hypothetical changes in interest rates, and the associated impact on our shareholders’ equity.

 

Hypothetical Change in

Interest Rates

  Fair Value     Estimated
Change in
Fair Value
    Carrying
Value
    Estimated
Change in
Carrying
Value
    Hypothetical
Percentage
Increase
(Decrease) in
Shareholders’
Equity
 

200 basis point increase

   $     724,588        $     (74,468)        $     741,229        $     (33,230)         (8.0)%       

100 basis point increase

    761,562         (37,493)         757,359         (17,101)         (4.1)%       

No change

    799,056         —           774,460         —                           —        

100 basis point decrease

    830,712         31,656          789,934         15,474          3.7%       

200 basis point decrease

    849,881         50,826          801,537         27,077          6.5%       

Equity Price Risk

Equity price risk is the risk that we may incur losses due to adverse changes in the market prices of the equity securities we hold in our investment portfolio. We classify our portfolio of equity securities as available-for-sale and carry these securities on our balance sheet at fair value. Accordingly, adverse changes in the market prices of our equity securities result in a decrease in the value of our total assets and shareholders’ equity. In order to minimize our exposure to equity price risk, we independently monitor the financial condition of our equity securities, and diversify our investments. In addition, we limit the percentage of equity securities held in our investment portfolio to the lesser of 10% of the investment portfolio or 30% of shareholders’ equity. As of December 31, 2013, the equity securities in our investment portfolio had a fair value of $9.3 million, representing 2.2% of shareholders’ equity on that date. See “Business—Investments” in Item 1 of this report.

 

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Item 8. Financial Statements and Supplementary Data.

 

        Page      

Audited Financial Statements as of December 31, 2013 and 2012 and for the three years in the period ended December 31, 2013:

 

Report of Independent Registered Public Accounting Firm

            61   

Consolidated Balance Sheets

    62   

Consolidated Statements of Income

    63   

Consolidated Statements of Comprehensive Income

    64   

Consolidated Statements of Changes in Shareholders’ Equity

    65   

Consolidated Statements of Cash Flows

    66   

Notes to Consolidated Financial Statements

    67   

Financial Statement Schedules:

 

Schedule II. Condensed Financial Information of Registrant

    102   

Schedule VI. Supplemental Information Concerning Property-Casualty Insurance Operations

    105   

Schedules I, III, IV and V are not applicable and have been omitted.

 

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and shareholders of AMERISAFE, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of AMERISAFE, Inc. and Subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits also include the financial statement schedules listed in the Index at Item 15. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AMERISAFE, Inc. and Subsidiaries at December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), AMERISAFE, Inc. and Subsidiaries’ internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated February 28, 2014, expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

New Orleans, Louisiana

February 28, 2014

 

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AMERISAFE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

    December 31,  
    2013     2012  

Assets

   

Investments:

   

Fixed maturity securities—held-to-maturity, at amortized cost (fair value $561,179 and $627,349 in 2013 and 2012, respectively)

   $ 536,583         $ 583,287     

Fixed maturity securities—available-for-sale, at fair value (cost $244,409 and $144,514 in 2013 and 2012, respectively)

   $ 237,877         $ 149,139     

Equity securities—available-for-sale, at fair value (cost $9,482 and $7,000 in 2013 and 2012, respectively)

    9,302          6,766     

Short-term investments

    84,422          68,924     

Other investments

    10,591          —      
 

 

 

   

 

 

 

Total investments

    878,775          808,116     

Cash and cash equivalents

    123,077          92,676     

Amounts recoverable from reinsurers

    75,326          101,352     

Premiums receivable, net of allowance

    171,579          141,950     

Deferred income taxes

    33,645          29,521     

Accrued interest receivable

    11,242          10,392     

Property and equipment, net

    7,549          7,711     

Deferred policy acquisition costs

    19,171          18,419     

Other assets

    8,637          10,809     
 

 

 

   

 

 

 
   $ 1,329,001         $ 1,220,946     
 

 

 

   

 

 

 

Liabilities and shareholders’ equity

   

Liabilities:

   

Reserves for loss and loss adjustment expenses

   $ 614,557         $ 570,450     

Unearned premiums

    164,296          140,528     

Reinsurance premiums payable

    607          456     

Amounts held for others

    35,739          41,033     

Policyholder deposits

    44,620          39,088     

Insurance-related assessments

    25,428          22,244     

Accounts payable and other liabilities

    26,940          25,649     

Payable for investments purchased

    —           276     
 

 

 

   

 

 

 
    912,187          839,724     

Shareholders’ equity:

   

Common stock:

   

Voting—$0.01 par value authorized shares—50,000,000 in 2013 and 2012; 19,855,430 and 19,513,476 shares issued and 18,597,180 and 18,255,226 shares outstanding in 2013 and 2012, respectively

    198          195     

Additional paid-in capital

    192,537          187,401     

Treasury stock at cost (1,258,250 shares in 2013 and 2012)

    (22,370)         (22,370)    

Accumulated earnings

    250,744          213,017     

Accumulated other comprehensive income (loss)

    (4,295)         2,979     
 

 

 

   

 

 

 
    416,814          381,222     
 

 

 

   

 

 

 
   $     1,329,001         $     1,220,946     
 

 

 

   

 

 

 

See accompanying notes.

 

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AMERISAFE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except share data)

 

     Year Ended December 31,  
   2013      2012      2011  

Revenues

        

Premiums earned

    $ 329,983           $ 290,689           $ 251,015      

Net investment income

     27,029            27,018            26,340      

Net realized gains (losses) on investments

     (1,211)           2,979            2,228      

Fee and other income

     534            562            1,080      
  

 

 

    

 

 

    

 

 

 

Total revenues

     356,335            321,248            280,663      

Expenses

        

Loss and loss adjustment expenses incurred

     228,973            219,903            189,706      

Underwriting and certain other operating costs

     18,951            18,450            22,404      

Commissions

     25,303            22,144            18,507      

Salaries and benefits

     22,862            20,839            19,914      

Interest expense

     —             566            1,311      

Policyholder dividends

     1,042            2,203            1,464      
  

 

 

    

 

 

    

 

 

 

Total expenses

     297,131            284,105            253,306      
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     59,204            37,143            27,357      

Income tax expense

     15,567            7,790            3,176      
  

 

 

    

 

 

    

 

 

 

Net income

     43,637            29,353            24,181      
  

 

 

    

 

 

    

 

 

 

Net income available to common shareholders

    $ 43,495           $ 29,331           $ 24,167      
  

 

 

    

 

 

    

 

 

 

Earnings per share

        

Basic

    $ 2.37           $ 1.62           $ 1.32      
  

 

 

    

 

 

    

 

 

 

Diluted

    $ 2.32           $ 1.58           $ 1.29      
  

 

 

    

 

 

    

 

 

 

Shares used in computing earnings per share

        

Basic

     18,373,033            18,166,261            18,249,583      
  

 

 

    

 

 

    

 

 

 

Diluted

       18,748,809              18,575,191              18,692,711      
  

 

 

    

 

 

    

 

 

 

Cash dividends declared per common share

    $ 0.32           $ —            $ —       
  

 

 

    

 

 

    

 

 

 

See accompanying notes.

 

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AMERISAFE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

 

    Year Ended December 31,  
  2013     2012     2011  

Net income

    $        43,637           $        29,353          $        24,181      

Other comprehensive income (loss):

     

Unrealized gain (loss) on securities, net of tax

    (7,274)          764          1,986      

Change in deferred tax valuation allowance

    —            —            (36)     
 

 

 

   

 

 

   

 

 

 

Comprehensive income

     $        36,363            $        30,117           $        26,131      
 

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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AMERISAFE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands, except share data)

 

    Common Stock     Treasury Stock     Additional
Paid-In
Capital
    Accumulated
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total  
    Shares     Amount     Shares     Amounts          

Balance at December 31, 2010

     19,060,649          $    191         (708,608)         $      (12,102)         $  180,884          $      159,483          $                265           $    328,721     

Comprehensive income:

               

Net income

    —          —         —          —          —           24,181         —          24,181     

Other comprehensive income:

               

Change in unrealized gains, net of tax

    —          —         —          —          —           —          1,986          1,986     

Change in deferred tax valuation allowance

    —          —         —          —          —           —          (36)         (36)    
               

 

 

 

Comprehensive income

    —          —         —          —          —           —          —          26,131     

Common stock issued upon exercise of options

    338,350                —          —          3,336         —          —          3,339     

Restricted common stock issued

    9,513         —         —          —          210         —          —          210     

Share-based compensation

    —          —         —          —          261         —          —          261     

Tax benefit of share-based compensation

    —          —         —          —          1,043         —          —          1,043     

Purchase of treasury stock

    —          —         (549,642)        (10,268)        —           —          —          (10,268)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

     19,408,512          $    194          (1,258,250)         $      (22,370)         $  185,734          $      183,664          $            2,215           $    349,437     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income:

               

Net income

    —          —         —          —          —           29,353          —          29,353     

Other comprehensive income:

               

Change in unrealized gains, net of tax

    —          —         —          —          —           —          764          764     
               

 

 

 

Comprehensive income

    —          —         —          —          —           —          —          30,117     

Common stock issued upon exercise of options

    86,800                —          —          780         —          —          781     

Restricted common stock issued

    18,164         —         —          —          240         —          —          240     

Share-based compensation

    —          —         —          —          226         —          —          226     

Tax benefit of share-based compensation

    —          —         —          —          421         —          —          421     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2012

     19,513,476          $    195          (1,258,250)         $      (22,370)         $  187,401          $      213,017          $            2,979           $    381,222     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income:

               

Net income

    —          —         —          —          —           43,637          —          43,637     

Other comprehensive income:

               

Change in unrealized losses, net of tax

    —          —         —          —          —           —          (7,274)         (7,274)    
               

 

 

 

Comprehensive income

    —          —         —          —          —           —          —          36,363     

Common stock issued upon exercise of options

    256,300                —          —          2,341         —          —          2,344     

Restricted common stock issued

    85,654         —         —          —          557         —          —          557     

Share-based compensation

    —          —         —          —          214         —          —          214     

Tax benefit of share-based compensation

    —          —         —          —          2,024         —          —          2,024     

Dividends to shareholders

    —          —         —          —          —           (5,910)        —          (5,910)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2013

     19,855,430          $    198          (1,258,250)         $      (22,370)         $  192,537          $      250,744          $            (4,295)          $    416,814     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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AMERISAFE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

    Year Ended December 31,  
  2013     2012     2011  

Operating activities

     

Net income

   $ 43,637          $ 29,353         $ 24,181      

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

     

Depreciation

    1,300           1,112          1,015      

Net amortization/accretion of investments

    13,350           10,151          6,660      

Deferred income taxes

    (207)          115          (1,525)     

Net realized (gains) losses on investments

    1,211           (2,979)         (2,228)     

Loss on sale of asset

    2           1          32      

Share-based compensation

    1,409           641          471      

Changes in operating assets and liabilities:

     

Premiums receivable, net

    (29,629)          (20,727)         1,395      

Accrued interest receivable

    (850)          (872)         (1,816)     

Deferred policy acquisition costs

    (752)          (1,841)         (1,441)     

Other assets

    1,581           445          (2,008)     

Reserve for loss and loss adjustment expenses

    44,107           32,236          6,010      

Unearned premiums

    23,768           21,829          7,205      

Reinsurance balances

    26,177           (5,910)         140      

Amounts held for others and policyholder deposits

    238           12,912          5,355      

Accounts payable and other liabilities

    3,561           4,582          263      
 

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

    128,903           81,048          43,709      

Investing activities

     

Purchases of investments held-to-maturity

    (77,868)          (79,042)         (86,669)     

Purchases of investments available-for-sale

    (135,798)          (92,751)         (120,637)     

Purchases of short-term investments

    (131,981)          (95,954)         (87,460)     

Purchases of other invested assets

    (10,000)          —            —       

Proceeds from maturities of investments held-to-maturity

    117,750           134,994          97,863      

Proceeds from sales and maturities of investments available-for-sale

    29,099           52,514          36,329      

Proceeds from sales and maturities of short-term investments

    112,978           72,105          118,759      

Purchases of property and equipment

    (1,140)          (1,196)         (1,128)     
 

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

    (96,960)          (9,330)         (42,943)     

Financing activities

     

Proceeds from stock option exercise

    2,344           781          3,339      

Tax benefit from share-based payments

    2,024           421          1,043      

Purchase of treasury stock

    —            —            (10,268)     

Redemption of subordinated debt securities

    —            (25,780)          (10,310)     

Dividends to shareholders

    (5,910)          —            —       
 

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

    (1,542)          (24,578)         (16,196)     
 

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

    30,401           47,140          (15,430)     

Cash and cash equivalents at beginning of year

    92,676           45,536          60,966      
 

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of year

   $ 123,077          $ 92,676         $ 45,536      
 

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow information

     

Interest paid

   $ —           $ 686         $ 1,412      
 

 

 

   

 

 

   

 

 

 

Income taxes paid

   $ 12,512          $ 7,004         $ 1,000      
 

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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AMERISAFE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013

 

1. Summary of Significant Accounting Policies

Organization

AMERISAFE, Inc. is an insurance holding company incorporated in the state of Texas. The accompanying consolidated financial statements include the accounts of AMERISAFE and its subsidiaries: American Interstate Insurance Company (“AIIC”) and its insurance subsidiaries, Silver Oak Casualty, Inc. (“SOCI”) and American Interstate Insurance Company of Texas (“AIIC-TX”), Amerisafe Risk Services, Inc. (“RISK”) and Amerisafe General Agency, Inc. (“AGAI”). AIIC and SOCI are property and casualty insurance companies organized under the laws of the state of Nebraska. In 2013, AIIC and SOCI were re-domesticated to Nebraska from Louisiana. AIIC-TX is a property and casualty insurance company organized under the laws of the state of Texas. RISK, a wholly owned subsidiary of the Company, is a claims and safety service company servicing only affiliated insurance companies. AGAI, a wholly owned subsidiary of the Company, is a general agent for the Company. AGAI sells insurance, which is underwritten by AIIC, SOCI and AIIC-TX, as well as by nonaffiliated insurance carriers. The assets and operations of AGAI are not significant to that of the consolidated entity.

The terms “AMERISAFE,” the “Company,” “we,” “us,” or “our” refer to AMERISAFE, Inc. and its consolidated subsidiaries, as the context requires.

The Company provides workers’ compensation for companies primarily in special trade groups, including construction, trucking, manufacturing, oil and gas and agriculture. Assets and revenues of AIIC represent at least 95% of comparable consolidated amounts of the Company for each of 2013, 2012 and 2011.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current year presentation.

Investments

The Company has the ability and positive intent to hold certain investments until maturity. Therefore, fixed maturity securities classified as held-to-maturity are recorded at amortized cost. Equity securities and fixed maturity securities classified as available-for-sale are recorded at fair value. Temporary changes in the fair value of these securities are reported in shareholders’ equity as a component of other comprehensive income, net of deferred income taxes.

Investment income is recognized as it is earned. The discount or premium on fixed maturity securities is amortized using the “constant yield” method. Anticipated prepayments, where applicable, are considered when determining the amortization of premiums or discounts. Realized investment gains and losses are determined using the specific identification method.

The Company regularly reviews the fair value of its investments. Impairment of an investment security results in a reduction of the carrying value of the security and the realization of a loss when the fair value of the

 

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AMERISAFE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013

 

security declines below the cost or amortized cost, as applicable, for the security and the impairment is deemed to be other-than-temporary. The Company regularly reviews its investment portfolio to evaluate the existence of other-than-temporary declines in the fair value of investments. The Company considers various factors in determining if a decline in the fair value of an individual security is other-than-temporary, including but not limited to a reduction or interruption in scheduled cash flows, the financial condition of the issuer, how long and by how much the fair value has been below amortized cost, losses due to credit concerns, downgrades and the Company’s intent to sell or ability to hold the security.

Other-than-temporary impairment losses on equity securities are recognized in net income and are measured as the difference between cost and fair value. Impairment losses on fixed maturities are recognized in the financial statements depending on the facts and circumstances related to the specific security. If we intend to sell a security or it is more likely than not that we would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, an other-than-temporary impairment would be recognized in net income for the difference between amortized cost and fair value. If we do not expect to recover the amortized cost basis, we do not plan to sell the security and if it is not more likely than not that we would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated. The credit loss portion would be recognized in net income and the noncredit loss portion in other comprehensive income.

Cash and Cash Equivalents

Cash equivalents include short-term money market funds and corporate bonds with an original maturity of three months or less.

Short-Term Investments

Short-term investments include municipal securities, corporate bonds and certificates of deposit with an original maturity greater than three months but less than one year.

Other Investments

Other investments consist of a limited partnership (“LP”) interest that is accounted for under the equity method valued using the net asset value provided by the general partner of the LP, which approximates the fair value of the interest. The LP’s objective is to generate absolute returns by investing long and short in publicly-traded global securities. Redemptions are allowed monthly following a sixty day notice with no lock up periods. The Company has no unfunded commitments related to the LP.

Premiums Receivable

Premiums receivable consist primarily of premium-related balances due from policyholders. The Company considers premiums receivable as past due based on the payment terms of the underlying policy. The balance is shown net of the allowance for doubtful accounts. Receivables due from insureds are charged off when a determination has been made by management that a specific balance will not be collected. An estimate of amounts that are likely to be charged off is established as an allowance for doubtful accounts as of the balance sheet date. The estimate is primarily comprised of specific balances that are considered probable to be charged off after all collection efforts have ceased, as well as historical trends and an analysis of the aging of the receivables.

Effective December 31, 2013, Amerisafe determined that to better reflect the collectability of accounts receivable balances, the Company decreased the allowance for doubtful accounts based on an analysis of

 

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December 31, 2013

 

historical write-offs. This change in estimate was accounted for prospectively and lowered underwriting and certain other operating costs by $1.7 million, increased income tax expense $0.6 million for a net income statement impact of $1.1 million or approximately $0.06 per share.

Property and Equipment

The Company’s property and equipment, including certain costs incurred to develop or obtain software for internal use, are stated at cost less accumulated depreciation. Depreciation is calculated primarily by the straight-line method over the estimated useful lives of the respective assets, generally 39 years for buildings and three to seven years for all other fixed assets.

Deferred Policy Acquisition Costs

The direct costs of successfully acquiring and renewing business are capitalized to the extent recoverable and are amortized over the effective period of the related insurance policies in proportion to premium revenue earned. These capitalized costs consist mainly of sales commissions, premium taxes and other underwriting costs. The Company evaluates deferred policy acquisition costs for recoverability by comparing the unearned premiums to the estimated total expected claim costs and related expenses, offset by anticipated investment income. The Company would reduce the deferred costs if the unearned premiums were less than expected claims and expenses after considering investment income, and report any adjustments in amortization of deferred policy acquisition costs. There were no adjustments necessary in 2013, 2012 or 2011.

Reserves for Loss and Loss Adjustment Expenses

Reserves for loss and loss adjustment expenses represent the estimated ultimate cost of all reported and unreported losses incurred through December 31. The Company does not discount loss and loss adjustment expense reserves. The reserves for loss and loss adjustment expenses are estimated using individual case-basis valuations, statistical analyses and estimates based upon experience for unreported claims and their associated loss and loss adjustment expenses. Such estimates may be more or less than the amounts ultimately paid when the claims are settled. The estimates are subject to the effects of trends in loss severity and frequency. Although considerable variability is inherent in these estimates, management believes that the reserves for loss and loss adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known. Any adjustments are included in current operations.

Subrogation recoverables, as well as deductible recoverables from policyholders, are estimated using individual case-basis valuations and aggregate estimates. Deductibles that are recoverable from policyholders and other recoverables from state funds decrease the liability for loss and loss adjustment expenses.

The Company funds its obligations under certain settled claims where the payment pattern and ultimate cost are fixed and determinable on an individual claim basis through the purchase of annuities. These annuities are purchased from unaffiliated carriers and name the claimant as payee. The cost of purchasing the annuity is recorded as paid loss and loss adjustment expenses. To the extent the annuity funds estimated future claims, reserves for loss and loss adjustment expense are reduced.

Premium Revenue

Premiums on workers’ compensation insurance are based on actual payroll costs or production during the policy term and are normally billed monthly in arrears or annually. However, the Company generally requires a deposit at the inception of a policy.

Premium revenue is earned on a pro rata basis over periods covered by the policies. The reserve for unearned premiums on these policies is computed on a daily pro rata basis.

 

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The Company estimates the annual premiums to be paid by its policyholders when the Company issues the policies and records those amounts on the balance sheet as premiums receivable. The Company conducts premium audits on all of its voluntary business policyholders annually, upon the expiration of each policy, including when the policy is renewed. The purpose of these audits is to verify that policyholders have accurately reported their payroll expenses and employee job classifications, and therefore have paid the Company the premium required under the terms of the policies. The difference between the estimated premium and the ultimate premium is referred to as “earned but unbilled” premium, or EBUB premium. EBUB premium can be higher or lower than the estimated premium. EBUB premium is subject to significant variability and can either increase or decrease earned premium based upon several factors, including changes in premium growth, industry mix and economic conditions. Due to the timing of audits and other adjustments, ultimate premium earned is generally not determined for several months after the expiration of the policy.

The Company estimates EBUB premiums on a quarterly basis using historical data and applying various assumptions based on the current market and records an adjustment to premium, related losses, and expenses as warranted.

Reinsurance

Reinsurance premiums, losses and allocated loss adjustment expenses are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts.

Amounts recoverable from reinsurers include balances currently owed to the Company for losses and allocated loss adjustment expenses that have been paid to policyholders, amounts that are currently reserved for and will be recoverable once the related expense has been paid and experience-rated commissions recoverable upon commutation.

Upon management’s determination that an amount due from a reinsurer is uncollectible due to the reinsurer’s insolvency or other matters, the amount is written off.

Ceding commissions are earned from certain reinsurance companies and are intended to reimburse the Company for policy acquisition costs related to those premiums ceded to the reinsurers. Ceding commission income is recognized over the effective period of the related insurance policies in proportion to premium revenue earned and is reflected as a reduction in underwriting and certain other operating costs.

Experience-rated commissions are earned from certain reinsurance companies based on the financial results of the applicable risks ceded to the reinsurers. These commission revenues on reinsurance contracts are recognized during the related reinsurance treaty period and are based on the same assumptions used for recording loss and allocated loss adjustment expenses. These commissions are reflected as a reduction in underwriting and certain other operating costs and are adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in current operations. Experience-rated commissions reduced underwriting and certain other operating costs by $9.3 million in 2013, $11.1million in 2012 and $5.7 million in 2011.

In January 2013, the Company commuted reinsurance agreements with Clearwater Insurance Company, covering portions of accident years 1990 through 1995. The Company received cash of $0.3 million in exchange for releasing these reinsurers from their reinsurance obligations under the commuted agreements. Clearwater Insurance Company remains obligated to the Company’s insurance subsidiaries under other reinsurance agreements. As a result of the commutation, the effect on the Company’s net income in the year ended December 31, 2013 was immaterial.

 

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On September 15, 2013, we commuted certain reinsurance agreements with Hannover Reinsurance (Ireland) Limited (“Hannover Re”) and Aspen Insurance Limited (“Aspen”) covering portions of the 2008 through 2010 accident years. Hannover Re and Aspen remain obligated to subsidiaries of the Company under other reinsurance agreements. We received cash of $14.9 million and an additional $17.6 million payment effectuated solely through offset against the balance of the funds withheld account under the reinsurance agreement in exchange for releasing Hannover Re and Aspen from their reinsurance obligations under the commuted agreements. As a result of the commutation, there was no effect on the Company’s net income in the year ended December 31, 2013.

Fee and Other Income

The Company recognizes income related to commissions earned by AGAI as the related services are performed.

Advertising

All advertising expenditures incurred by the Company are charged to expense in the period to which they relate and are included in underwriting and certain other operating costs in the consolidated statements of income. Total advertising expenses incurred were $491,000 in 2013, $444,000 in 2012 and $421,000 in 2011.

Income Taxes

The Company accounts for income taxes using the liability method. The provision for income taxes has two components, amounts currently payable or receivable and deferred amounts. Deferred income tax assets and liabilities are recognized for the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

The Company considers deferred tax assets to be recoverable if it is probable that the related tax losses can be offset by future taxable income. The Company includes reversal of existing temporary differences, tax planning strategies available and future operating income in this assessment. To the extent the deferred tax assets exceed the amount expected to be recovered in future years, the Company records a valuation allowance for the amount determined unrecoverable.

Insurance-Related Assessments

Insurance-related assessments are accrued in the period in which they have been incurred. The Company is subject to a variety of assessments related to insurance commerce, including those by state guaranty funds and workers’ compensation second-injury funds. State guaranty fund assessments are used by state insurance oversight agencies to cover losses of policyholders of insolvent or rehabilitated insurance companies and for the operating expenses of such agencies. The Company has a premium tax benefit accrued of $3.6 million and $3.4 million as of December 31, 2013 and 2012, respectively, for mandatory assessments that may be recovered through a reduction in future premium taxes in certain states. Assessments based on premiums are generally paid one year after the calendar year in which the premium is written, while assessments based on losses are generally paid within one year of when the loss is paid.

Policyholder Dividends

The Company writes certain policies for which the policyholder may participate in favorable claims experience through a dividend. An estimated provision for workers’ compensation policyholders’ dividends is

 

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December 31, 2013

 

accrued as the related premiums are earned. Dividends do not become a fixed liability unless and until declared by the respective Boards of Directors of AMERISAFE’s insurance subsidiaries. The dividend to which a policyholder may be entitled is set forth in the policy and is related to the amount of losses sustained under the policy. Dividends are calculated after the policy expiration. The Company is able to estimate the policyholder dividend liability because the Company has information regarding the underlying loss experience of the policies written with dividend provisions and can estimate future dividend payments from the policy terms.

Variable Interest Entities

In December 2003, the Company formed Amerisafe Capital Trust I (“ACT I”) for the sole purpose of issuing $10.0 million in trust preferred securities. ACT I used the proceeds from the sale of these securities and the Company’s initial capital contribution to purchase $10.3 million of subordinated debt securities from the Company. In July 2011, the Company redeemed all $10.3 million of subordinated debt securities from ACT I and the trust was canceled. The debt securities had been the sole assets of ACT I, and the payments under the debt securities were the sole revenues of ACT I.

In April 2004, the Company formed Amerisafe Capital Trust II (“ACT II”) for the sole purpose of issuing $25.0 million in trust preferred securities. ACT II used the proceeds from the sale of these securities and the Company’s initial capital contribution to purchase $25.8 million of subordinated debt securities from the Company. In May 2012, the Company redeemed $12.9 million of the $25.8 million aggregate principal amount of subordinated debt securities. The Company redeemed the remaining $12.9 million of subordinated debt securities from ACT II in August 2012 and the trust was canceled. The debt securities had been the sole assets of ACT II, and the payments under the debt securities were the sole revenues of ACT II.

Earnings Per Share

The Company computes earnings per share (EPS) in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 260, Earnings Per Share. Additionally, for periods after December 31, 2012, the Company applied the “two-class method” in computing basic and diluted earnings per share.

Under the two-class method, net income available to common and participating common shareholders is reduced by the amount of dividends declared in the current period and by the contractual amount of dividends that must be paid for the current period related to the Company’s common and participating common shares. Participating common shares include unvested share-based payment awards that contain nonforfeitable rights to dividends, whether paid or unpaid. Any remaining undistributed earnings are allocated to the common and participating common shareholders to the extent that each security shares in earnings as if all of the earnings for the period had been distributed. The amount of earnings allocable to each security is divided by the number of outstanding shares of the security to which the earnings are allocated to determine the EPS for the security. In a period of loss, no losses are allocated to the participating common shareholders. Instead, all such losses are allocated to the common shareholders.

Basic EPS is calculated by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. The diluted EPS calculation includes potential common shares assumed issued under the treasury stock method, which reflects the potential dilution that would occur if any outstanding options or warrants were exercised or restricted stock becomes vested, and includes the “if converted” method for participating securities if the effect is dilutive. We determine diluted EPS as the more dilutive result of either the treasury method or the two-class method.

 

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Stock-Based Compensation

The Company recognizes the impact of its share-based compensation in accordance with FASB ASC Topic 718, Compensation-Stock Compensation. All share-based grants are recognized as compensation expense over the vesting period. The target value of long-term incentive awards are recognized as compensation over the performance period.

Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (FASB) issued updated guidance to improve the reporting of reclassifications out of accumulated other comprehensive income. The guidance requires an entity to present, either on the face of the statement of income or in the notes, separately for each component of comprehensive income, the current period reclassifications out of accumulated other comprehensive income by the respective line items of net income affected by the reclassification.

The updated guidance is effective prospectively for reporting periods beginning after December 15, 2012. The Company adopted the updated guidance effective January 1, 2013. This adoption did not have any effect on the Company’s results of operations, financial position or liquidity.

 

2. Investments

Short-term investments held at December 31, 2013 include $82.7 million of corporate bonds, certificates of deposit of $0.9 million and $0.8 million of municipal securities. Short-term investments held at December 31, 2012 include $63.5 million of corporate bonds, certificates of deposits of $0.9 million and $4.5 million of municipal securities. All certificates of deposits are fully insured by the Federal Deposit Insurance Corporation.

Amerisafe holds investments in a LP, accounted for under the equity method. The carrying value of this investment is $10.6 million at December 31, 2013.

The gross unrealized gains and losses on, and the amortized cost and fair value of, those investments classified as held-to-maturity at December 31, 2013 are summarized as follows:

 

                                                                           
   
Amortized
Cost
    Gross
Unrealized
Gains
    Gross
Unrealized
Losses
    Fair Value  
    (In thousands)  

States and political subdivisions

   $ 381,674        $ 18,634        $ (1,153)        $ 399,155    

Corporate bonds

    67,423         861         (41)         68,243    

Commercial mortgage-backed securities

    50,813         3,431         —         54,244    

U.S. agency-based mortgage-backed securities

    21,775         1,790         —         23,565    

U.S. Treasury securities and obligations of U.S. Government agencies

    11,514         1,002         —         12,516    

Asset-backed securities

    3,384         216         (144)         3,456    
 

 

 

   

 

 

   

 

 

   

 

 

 

Totals

   $     536,583        $      25,934        $     (1,338)        $     561,179