UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For Fiscal Year Ended December 31, 2005 | Commission File Number 0-11773 |
ALFA CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 63-0838024 | |
(State or other jurisdiction incorporation or organization) |
(I.R.S Employer Identification No.) | |
2108 East South Boulevard P.O. Box 11000, Montgomery, Alabama |
36191-0001 | |
(Address of principal executive offices) | (Zip-Code) |
Registrants Telephone Number including Area Code (334) 288-3900
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act: Common Stock, par value $1.00 per share |
The NASDAQ Stock Market (EXCHANGE) |
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 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 registrants 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. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ |
Accelerated filer x | Non-accelerated filer ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
As of June 30, 2005, the aggregate market value of the registrants common stock held by non-affiliates of the registrant was $528,638,203 based on the closing sale price as reported on the National Association of Securities Dealers Automated Quotation System National Market System.
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class |
Outstanding at February 28, 2006 | |
Common Stock, $1.00 par value per share | 80,290,551 shares |
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrants Proxy Statement relating to the Annual Meeting of Stockholders to be held April 25, 2006 are incorporated by reference into Parts II and III of this Form 10-K Report.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
INDEX
Page | ||||
PART I | ||||
Item 1. | 1 | |||
Item 1A. | 9 | |||
Item 1B. | 13 | |||
Item 2. | 13 | |||
Item 3. | 13 | |||
Item 4. | 13 | |||
PART II | ||||
Item 5. |
14 | |||
Item 6. |
16 | |||
Item 7. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
17 | ||
Item 7A. |
40 | |||
Item 8. |
43 | |||
Item 9. |
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure |
96 | ||
Item 9A. |
96 | |||
Item 9B. |
96 | |||
PART III | ||||
Item 10. |
97 | |||
Item 11. |
98 | |||
Item 12. |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
98 | ||
Item 13. |
98 | |||
Item 14. |
98 | |||
PART IV | ||||
Item 15. |
Exhibits, Financial Statement Schedules | 99 |
Description of the Corporation. Alfa Corporation is a financial services holding company that offers property casualty insurance, life insurance and financial services products through its wholly-owned subsidiaries:
| Alfa Insurance Corporation (AIC) |
| Alfa General Insurance Corporation (AGI) |
| Alfa Vision Insurance Corporation (AVIC) |
| Alfa Life Insurance Corporation (Life) |
| Alfa Financial Corporation (Financial) |
| The Vision Insurance Group, LLC (Vision) |
| Alfa Agency Mississippi, Inc. (AAM) |
| Alfa Agency Georgia, Inc. (AAG) |
| Alfa Benefits Corporation (ABC) |
Alfa Corporation is affiliated with Alfa Mutual Insurance Company, Alfa Mutual Fire Insurance Company, and Alfa Mutual General Insurance Company (collectively, the Mutual Group). The Mutual Group owns 54.9% of Alfa Corporations common stock, their largest single investment. Alfa Corporation and its subsidiaries (the Company) together with the Mutual Group comprise the Alfa Group (Alfa). Alfa Virginia Mutual Insurance Company (Virginia Mutual) currently cedes 80% of its direct business to Alfa Mutual Fire Insurance Company (Fire) under an affiliate agreement signed in August 2001.
The Companys common stock is traded on the NASDAQ Stock Markets National Market under the symbol ALFA.
Recent Developments. Effective January 1, 2005, the Pooling Agreement was amended and restated, commuting certain pools from August 1, 1987 through December 31, 2001. In addition, AVIC was added as a participant in the Pooling Agreement with other companies in the Alfa Group and Fire began retroceding the quota share business it receives from Virginia Mutual to the pool. AVIC, a new subsidiary formed by the Company in the third quarter of 2004, writes nonstandard automobile business through Vision and currently operates in Texas, Missouri, Indiana, Ohio, Virginia, Tennessee, Arkansas, Kentucky, and Florida. AVIC cedes 100% of its direct business to the intercompany pool and receives in return 5% of the business included in the Alfa Group intercompany pool. AIC and AGI, both wholly-owned subsidiaries of the Company, reduced their respective pooling participations from 32.5% to 30.0% to allow for the Vision addition.
On January 3, 2005, the Company completed its acquisition of Vision, a full-service managing general agency. Prior to the execution of the purchase agreement, no material relationship existed between the Company and the sellers. The Company purchased Vision for $20 million in cash and stock with an additional purchase consideration of up to $14 million based on future performance.
During the fourth quarter of 2005, the Company completed the sale of Financials leasing division, OFC Capital, to OFC Servicing Corporation, a subsidiary of MidCountry Financial Corporation (MidCountry). No gain or loss was recognized and no amounts of revenue and pretax profit or loss have been reported in discontinued operations due to the Companys significant continuing involvement through its equity-method investment in MidCountry.
1
Effective January 1, 2006, the Pooling Agreement was amended to reallocate the Alfa Specialty Insurance Corporation (Specialty) coinsurance allocation of catastrophes to Mutual. Specialty is a wholly-owned subsidiary of Mutual.
Nature of Operations. Alfa Corporations insurance subsidiaries are direct writers of life insurance in Alabama, Georgia and Mississippi and property casualty insurance in Georgia, Mississippi, Missouri, Indiana, Ohio, Virginia, Tennessee, Arkansas, Kentucky, and Florida. In addition, AVIC assumes business in Texas. The Companys property casualty business is pooled with that of the Mutual Group, which writes property casualty business in Alabama. Approximately 75.6% of the Companys property casualty premium income and 66.5% of its total premium income for 2005 was derived from the Companys participation with the Mutual Group in the Pooling Agreement.
Effective August 1, 1987, the Company entered into a property casualty insurance Pooling Agreement (the Pooling Agreement) with Alfa Mutual Insurance Company (Mutual), and other members of the Mutual Group (refer to Note 2Pooling Agreement in the Notes to Consolidated Financial Statements of this Form 10-K).
The Company reports operating segments based on the Companys legal entities, which are organized by line of business:
| Property casualty insurance |
| Life insurance |
| Noninsurance |
| Consumer financing |
| Commercial leasing |
| Agency operations |
| Employee benefits administration |
| Corporate and eliminations |
Presented below is summarized financial information for the Companys four business segments for the years ended December 31, 2005, 2004 and 2003:
Years Ended December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
(in thousands) | ||||||||||||
Revenues by Segment |
||||||||||||
Property casualty insurance |
$ | 606,445 | $ | 521,371 | $ | 486,569 | ||||||
Life insurance |
133,498 | 132,466 | 119,491 | |||||||||
Noninsurance operations |
33,266 | 9,851 | 15,456 | |||||||||
Corporate |
45,973 | 27,150 | 25,680 | |||||||||
Revenues before eliminations |
$ | 819,182 | $ | 690,838 | $ | 647,196 | ||||||
Eliminations |
(62,277 | ) | (29,546 | ) | (27,379 | ) | ||||||
Total revenues |
$ | 756,905 | $ | 661,292 | $ | 619,817 | ||||||
Operating Income (Loss)1 by Segment |
||||||||||||
Property casualty insurance operating income |
$ | 80,195 | $ | 68,699 | $ | 53,112 | ||||||
Life insurance operating income |
21,736 | 18,763 | 19,058 | |||||||||
Noninsurance operating income (loss) |
(38 | ) | 2,138 | 4,031 | ||||||||
Corporate operating loss |
(6,792 | ) | (4,737 | ) | (1,803 | ) | ||||||
Total operating income |
$ | 95,101 | $ | 84,863 | $ | 74,398 | ||||||
Realized investment gains, net of tax |
3,933 | 4,582 | 4,071 | |||||||||
Net income |
$ | 99,034 | $ | 89,445 | $ | 78,469 | ||||||
2
1 | Operating income (loss), a non-GAAP financial measure, is defined as net income (loss) excluding realized investment gains and losses, net of applicable taxes. Management uses operating income as a measure of the Companys ongoing profitability since it eliminates the effect of securities market volatility from earnings. |
Property Casualty Insurance:
Alfas primary business is personal lines property casualty insurance, which accounts for approximately 78% of total premiums and approximately 69% of total revenues. Automobile and homeowners insurance account for approximately 86% of property casualty premiums. In Alabama, Alfa enjoys approximately a 20% share of the personal automobile and homeowners markets, second only to State Farm.
The Company is a direct writer and distributes its products utilizing a combination of exclusive, independent and independent exclusive sales agents in its core states of operation. The following table shows the Companys pooled share of direct premium distribution by product for property casualty insurance for 2005:
Automobile |
61.5 | % | |
Homeowner |
24.7 | % | |
Farmowner |
4.8 | % | |
Commercial |
4.3 | % | |
Manufactured Home |
2.9 | % | |
Other |
1.8 | % | |
100.0 | % | ||
A discussion of the Companys property casualty insurance results of operations is included in Managements Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K.
Segment disclosures required under Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of an Enterprise and Related Information, are included in Note 14Segment Information in the Notes to Consolidated Financial Statements.
The Companys strategy in property casualty business has been to operate primarily in its niche, personal lines insurance, and to strive to be the low-cost producer, thereby marketing and underwriting to achieve a preferred, profitable book of business. The Companys objective is to operate with an underwriting profit. Historically, this objective has been met except for five separate years, each of which was primarily impacted by catastrophic weather. In the wake of Hurricanes Opal and Erin, Alfa initiated intense studies of its catastrophe management strategy. Effective November 1, 1996, Alfa restructured the catastrophe program and amended the intercompany pooling agreement to allocate catastrophe losses among the members of the pool in a fashion that more equitably reflects the realities of catastrophe finance. As a result, the Companys share of Alfas storm-related losses has been substantially reduced, providing greater earnings stability. The lower exposure also means a substantial reduction in reinsurance costs. Alfas pooled catastrophe losses for 2005, 2004 and 2003 totaled approximately $293.9 million, $347.5 million and $69 million, respectively. The Companys share of such losses totaled $11.6 million, $9.2 million and $7.9 million in 2005, 2004 and 2003, respectively.
There are inherent uncertainties in reserving for unpaid losses. Managements philosophy has been to establish reserves at a high level of confidence. The Company experienced no materially significant large losses or gains in its loss payments during 2003, 2004 or 2005 which led to changes in estimates.
3
The Companys pooled business is concentrated geographically in Alabama, Georgia and Mississippi. Accordingly, unusually severe storms or other disasters in these contiguous states might have a more significant effect on the Companys financial condition and operating results than on a more geographically diversified insurance company. However, the Companys catastrophe protection program, which began November 1, 1996, reduced the potential adverse impact and earnings volatility caused by such catastrophe exposures.
Life Insurance:
Life directly writes individual life insurance policies consisting primarily of ordinary whole life, term life, interest sensitive whole life and universal life products in Alabama, Georgia and Mississippi and distributes these products utilizing an exclusive and independent exclusive agent sales force. In the highly fragmented life insurance market in Alabama, Alfa ranks among the leaders in market share.
Life offers several different types of whole life and term insurance products. The following table shows the Companys distribution by product for life insurance premiums and policy charges for 2005:
Traditional life insurance premiums |
53.0 | % | |
Universal life policy charges |
27.1 | % | |
Interest sensitive life policy charges |
14.2 | % | |
Universal life policy chargesCOLI |
5.0 | % | |
Group life insurance premiums |
0.7 | % | |
100.0 | % | ||
As of December 31, for each year indicated, the Company had insurance inforce as follows:
2005 | 2004 | 2003 | |||||||
(in thousands) | |||||||||
Ordinary life |
$ | 21,148,519 | $ | 19,719,825 | $ | 18,206,689 | |||
Credit life |
$ | 13,446 | $ | 12,526 | $ | 10,554 | |||
Group life |
$ | 47,269 | $ | 47,152 | $ | 45,505 |
A discussion of the Companys life insurance results of operations is included in Managements Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K.
Segment disclosures required under SFAS No. 131 are included in Note 14Segment Information in the Notes to Consolidated Financial Statements.
While the amount retained on an individual life will vary depending upon age and mortality prospects of the risk, Life generally will not retain more than $500,000 of individual life insurance on a single risk with the exception of company-owned life insurance (COLI) and group policies where the retention is limited to $100,000 per individual. These retention limits are set for the purpose of limiting the liability of Life with respect to any one risk and providing greater diversification of its exposure. When Life reinsures a portion of its risk it must cede the premium income to the reinsurer who reinsures the risk, thereby decreasing the income of Life. Life performs various underwriting procedures and blood testing for AIDS and other diseases before issuance of insurance.
Noninsurance:
The Company operates five subsidiaries which are not considered to be significant by the Securities and Exchange Commission (SEC) Regulations for purposes of separate disclosure: Financial, a lending
4
and leasing institution; AAM, AAG, Vision (collectively, Agency operations); and ABC, a provider of benefit services for Alfa.
| Financial is an institution engaged principally in making consumer loans. Loans are available through all customer service centers. Automobiles and other property collateralize these loans. Financial is also engaged in operating and capital leasing activities. |
| AAM and AAG, headquartered in Montgomery, Alabama, provide agents with the opportunity to offer customers a broader portfolio of products by placing insurance risks with third party insurers for a commission. Vision is a full-service managing general agency that currently writes nonstandard automobile insurance policies in nine states. In addition, during 2005, Vision wrote a limited amount of nonstandard homeowner business through non-affiliated carriers as a general agency. Vision is headquartered in Brentwood, Tennessee and provides all underwriting, claims, actuarial and financial services on behalf of its contracted carriers. |
| ABC serves as a record keeper by handling nonqualified employee benefits. |
A discussion of the Companys noninsurance results of operations is included in Managements Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K.
Segment disclosures required under SFAS No. 131 are included in Note 14Segment Information in the Notes to Consolidated Financial Statements.
Investments:
The Companys income is directly affected by its investment income and realized gains and losses from its investment portfolio. The capital and reserves of the Company are invested in assets comprising its investment portfolio. In its insurance subsidiaries, insurance regulations prescribe the nature and quality of investments that may be made and included in the insurance subsidiaries investment portfolios. Such investments include qualified state, municipal and federal obligations, high quality corporate bonds and stocks, mortgage-backed securities and certain other assets. The Companys noninsurance segment also holds investments in collateral loans, commercial leases, notes receivable and equity method investments.
The Companys investment philosophy is long-term and value oriented with focus on total return for both yield and growth potential. During the past ten years, invested assets have grown from approximately $841 million to over $2.0 billion at the end of 2005, a compound annual growth rate of 9.1%. During that same period, net investment income has almost doubled, growing from $50.9 million to over $94.9 million. At year-end, the value of unrealized gains in the Companys portfolio was $22.1 million, net of tax. The portfolio was invested 70.9% in fixed maturities, 5.4% in equities, 4.2% in short-term investments and 19.5% in other investments which include policy loans, collateral loans, commercial leases, partnerships, notes receivable and equity method investments.
The rating of the Companys portfolio of fixed maturities using the Standard & Poors rating categories is as follows at December 31, 2005 and 2004:
December 31, | ||||||
2005 | 2004 | |||||
AAA to A- |
90.8 | % | 92.8 | % | ||
BBB+ to BBB- |
7.3 | 6.8 | ||||
BB+ and below (below investment grade) |
1.9 | 0.4 | ||||
100.0 | % | 100.0 | % | |||
5
A discussion of the Companys investments is included in Managements Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K.
Reserves:
The Companys property casualty insurance subsidiaries are required to maintain reserves to cover their estimated ultimate liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred. The Companys life insurance subsidiary is required to maintain reserves for future policy benefits. To the extent that reserves prove to be inadequate or excessive in the future, the Company would have to modify such reserves and incur a charge or credit to earnings in the period such reserves are modified which could have a material effect on the Companys results of operations and financial condition. Establishing appropriate reserves is an inherently uncertain process and there can be no assurance that ultimate losses will not materially differ from the Companys established loss reserves. Reserves are estimates involving actuarial and statistical projections at a given time of what the Company expects to be the cost of the ultimate settlement and administration of claims based on facts and circumstances then known, estimates of future trends in claims severity and other variable factors.
Property Casualty Reserves. With respect to reported claims, reserves are established on a case-by-case basis. The reserve amounts on each reported claim are determined by taking into account the circumstances surrounding each claim and policy provision relating to the type of loss. Loss reserves are reviewed on a regular basis and, as new data becomes available, appropriate adjustments are made to reserves.
For incurred but not reported (IBNR) losses, a variety of methods have been developed in the insurance industry for determining estimates of loss reserves. One common method of actuarial evaluation, which is used by the Company, is the loss development method. This method uses the pattern by which losses have been reported over time and assumes that each accident years experience will develop in the same pattern as the historical loss development.
Reserves are computed by the Company based upon actuarial principles and procedures applicable to the lines of business written by the Company. Management reviews these reserve calculations regularly and as required by state law, the Company annually engages an independent actuary to render an opinion as to the adequacy of reserves established by management, whose opinions are filed with the various jurisdictions in which the Company is licensed. Based upon practice and procedures employed by the Company, without regard to independent actuarial opinions, management believes that the Companys reserves are adequate.
The liability for estimated unpaid losses and loss adjustment expenses is based on a detailed evaluation of reported losses and of estimates of incurred but not reported losses. Adjustments to the liability based on subsequent developments are included in current operations. The Company is primarily an insurer of private passenger motor vehicles and of single-family homes and has limited exposure for difficult-to-estimate claims such as environmental, product and general liability claims. The Company does not believe that any such claims will have a material impact on the Companys liquidity, results of operations, cash flows or financial condition.
Life Reserves. The life insurance policy reserves reflected in the Companys financial statements as future policy benefits are calculated based on accounting principles generally accepted in the United States of America. These reserves, with the addition of premiums to be received and the interest thereon compounded annually at assumed rates, must be sufficient to cover policy and contract obligations as they mature. Generally, the mortality and persistency assumptions used in the calculation of reserves are based on company experience. The assumptions used in the calculation of Lifes reserves are shown in Note 6Policy Liabilities and Accruals in the Notes to Consolidated Financial Statements of this Form 10-K.
6
Relationship with Mutual Group:
The Companys business and operations are substantially integrated with and dependent upon the management, personnel and facilities of Mutual. Under a Management and Operating Agreement with Mutual, all management personnel are provided by Mutual and the Company reimburses Mutual for field office expenses and operations services rendered by Mutual.
Mutual periodically conducts time usage and related expense allocation studies. Mutual charges the Company for its allocable and directly attributable salaries and other expenses, including office facilities.
The Board of Directors of the Company consisted, at December 31, 2005, of eleven members, six of whom serve on the Executive Committee of the Boards of the Mutual Group and two of whom are Executive Officers of the Company.
At December 31, 2005, Mutual owned 34,296,747 shares, or 42.7%, Fire owned 9,187,970 shares, or 11.4%, and Alfa Mutual General Insurance Company owned 631,166 shares, or 0.8%, of the Companys outstanding common stock.
Competition:
Both the life and property casualty insurance businesses are highly competitive. There are numerous insurance companies in the Companys area of operation and throughout the United States. Many of the companies in direct competition with the Company have been in business for a much longer period of time, have a larger volume of business, offer a more diversified line of insurance coverage, and have greater financial resources than the Company. In its life and property casualty insurance businesses, the Company competes with other insurers in the sale of insurance products to consumers and the recruitment and retention of qualified agents. The Company believes the main competitive factors in its business are price, name recognition and service. The Company believes it competes effectively in these areas in Alabama. In other states, however, the Companys name is not as well recognized, but such recognition is improving.
Regulation:
The Mutual Group and the Companys insurance subsidiaries are subject to the Alabama Insurance Holding Company Systems Regulatory Act and are subject to reporting to the Alabama Insurance Department and to periodic examination of their transactions and regulation under the Act with Mutual being considered the controlling party.
Additionally, the Companys insurance subsidiaries are subject to licensing and supervision by the governmental agencies in the jurisdictions in which they do business. The nature and extent of such regulation varies, but generally has its source in state statutes which delegate regulatory, supervisory and administrative powers to State Insurance Commissioners. Such regulation, supervision and administration relate, among other things, to standards of solvency which must be met and maintained, licensing of the companies, periodic examination of the affairs and financial condition of the Company, annual and other reports required to be filed on the financial condition and operation of the Company. Rates of property casualty insurance are subject to regulation and approval of regulatory authorities. Life insurance rates are generally not subject to prior regulatory approval.
The Mutual Group, the Company and its subsidiary, Alfa Financial Corporation, are regulated by, report to and are subject to examination by the Office of Thrift Supervision (OTS), pursuant to the Federal Home Owners Loan Act (HOLA) and its Control Regulations. The scope of this authority includes the savings association, its holding company and other affiliates, and subsidiaries of the
7
savings association. In accordance with its responsibilities, OTS has issued regulations and developed examination procedures for savings and loan holding companies.
Restrictions on Dividends to Stockholders: The Companys insurance subsidiaries are subject to various state statutory and regulatory restrictions, generally applicable to each insurance company in its state of domicile, which limit the amount of dividends or distributions by an insurance company to its stockholders. The restrictions are generally based on certain levels of surplus, investment income and operating income, as determined under statutory accounting practices. Alabama law permits dividends in any year which, together with other dividends or distributions made within the preceding 12 months that do not exceed the greater of (i) 10% of statutory surplus as of the end of the preceding year or (ii) for property casualty companiesthe statutory net income for the preceding year, or for life companiesthe statutory net gain from operations. Larger dividends are payable only after receipt of regulatory approval. Future dividends from the Companys subsidiaries may be limited by business and regulatory considerations. However, based upon restrictions presently in effect, the maximum amount available for payment of dividends to the Company by its insurance subsidiaries in 2006 without prior approval of regulatory authorities is approximately $84.4 million based on December 31, 2005 financial condition and results of operations.
Risk-Based Capital Requirements: The National Association of Insurance Commissions (NAIC) adopted risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula which attempts to measure statutory capital and surplus needs based on the risks in a companys mix of products and investment portfolio. The formula is designed to allow state insurance regulators to identify potential weakly capitalized companies. Under the formula, a company determines risk-based capital (RBC) by taking into account certain risks related to the insurers assets (including risks related to its investment portfolio and ceded reinsurance) and the insurers liabilities (including underwriting risks related to the nature and experience of its insurance business). Risk-based capital rules provide for different levels of regulatory attention depending on the ratio of a companys total adjusted capital to its authorized control level of RBC. Based on calculations made by the Company, the risk-based capital levels for each of the Companys insurance subsidiaries significantly exceed that which would require regulatory attention.
Personnel:
The Company has no management or operational employees. The Company and its subsidiaries have a Management and Operating Agreement with Mutual whereby it reimburses Mutual for salaries and expenses of employees provided to the Company under the Agreement. Involved are employees in the areas of Life Underwriting, Life Processing, Accounting, Sales, Administration, Legal, Files, Data Processing, Programming, Research, Policy Issuing, Claims, Investments and Management. At December 31, 2005, the Company was represented by 491 agents in Alabama who are employees of Mutual. The Companys subsidiaries had 132 independent exclusive agents in Georgia and Mississippi and 2,438 independent agents in Georgia, Texas, Missouri, Indiana, Ohio, Virginia, Tennessee, Arkansas, Kentucky, and Florida at December 31, 2005. The Company believes its employee relations are good.
Available Information:
The Companys annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act), as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC are made available free of charge on its website at www.alfains.com by first selecting Invest in Alfa and then selecting Financial Reports.
8
Also available on the website is the Companys Code of Ethics titled Principles of Business Conduct which can be accessed under such title.
A free copy of the Companys Form 10-K, as filed with the SEC, may also be obtained by writing: Al Scott, Senior Vice President, Secretary and General Counsel, Alfa Corporation, P.O. Box 11000, Montgomery, Alabama 36191-0001.
Any of the materials the Company files with the SEC may also be read and copied at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. Information on the operation of the SECs Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.
Risk factors are uncertainties and events over which the Company has limited or no control and which can have a materially adverse effect on the business, the results of operations or the financial condition of the Company and its subsidiaries. The Company and its business segments are subject to a variety of risk factors. The following sections set forth managements evaluation of the most prevalent material risk factors for the Company and its subsidiaries. There may be risks which management does not presently consider material or which are not presently known to management that may later prove to be material risk factors as well.
Regulatory Environment
The Companys insurance subsidiaries are subject to extensive governmental regulation in all of the state and similar jurisdictions in which they operate. These regulations relate to licensing requirements, types of insurance products that may be sold, premium rates, marketing practices, capital and surplus requirements, investment limitations, underwriting limitations, dividend payment limitations, transactions with affiliates, accounting practices, taxation and other matters. While most of the regulation is at the state level, the federal government has increasingly expressed an interest in regulating the insurance industry through the Graham-Leach-Bliley Act, the Patriot Act, financial services regulation, changes in the Internal Revenue Code and other legislation. All of these regulations increase the cost of conducting insurance business through increased compliance expenses. Furthermore, as existing regulations evolve through administrative and court interpretations, and as new regulations are adopted, there can be no way of predicting what impact these changes will have on the Company in the future. Such impact could adversely affect the Companys profitability and limit its growth.
Geographic Concentration Risk
The Companys property casualty insurance business is generated in 13 southeastern states and its life insurance business is generated in 3 states. For the year ended December 31, 2005, approximately $514 million of premiums and policy charges representing 81% of such amounts were from policies written in Alabama. Accordingly, unusually severe storms or other disasters in this state might have a more significant effect on the Company than a more geographically diversified company and could have an adverse impact on the Companys financial condition and operating results.
In addition, the revenues and profitability of the Company are subject to prevailing regulatory, legal, economic, demographic, competitive and other conditions in these states. Changes in any of these conditions could make it less attractive for the Company to do business in these states and could have an adverse effect on the Companys financial results.
9
Catastrophic Loss Risk
The insurance operations expose the Company to claims arising out of catastrophic events. Catastrophes can be caused by various unpredictable events, including hurricanes, hailstorms, tornadoes, severe winter weather, earthquakes, and other natural or man-made disasters.
Property Casualty: While the Company limits the property exposures it writes in coastal exposure areas, the Companys critical catastrophic risk is hurricanes because of the proximity of southeastern markets to the Gulf of Mexico. The Company also limits its catastrophic loss risk by participating in a catastrophe protection program through an intercompany pooling arrangement (more fully discussed in Note 2Pooling Agreement in the Notes to Consolidated Financial Statements). A catastrophic event in excess of the Companys upper catastrophe pool limit could adversely affect the Companys business, results of operations and financial condition.
Reserves
Reserves are the amounts that an insurance company sets aside for its anticipated policy liabilities.
Property Casualty: Claim reserves are an estimate of liability for unpaid claims and claims defense and adjustment expenses, and cover reported as well as incurred, but not yet reported claims. It is not possible to calculate precisely what these liabilities will amount to in advance and, therefore, the reserves represent a best estimate at any point in time. Such estimates are based upon known historical loss data and trending using actuarial techniques and modeling. Reserve estimates are periodically reviewed in consideration of known developments and, where necessary, adjusted as circumstances may warrant. Nevertheless, the reserving process is inherently uncertain. If for any of these reasons, reserve estimates prove to be inadequate, the Companys subsidiaries will increase their reported liabilities. Such an occurrence could result in a materially adverse impact on the Companys results of operations and financial condition.
Life: Reserve for life-contingent contract benefits is computed on the basis of long-term actuarial assumptions of future investment yields, mortality, morbidity, policy terminations and expenses. The Company reviews the adequacy of these reserves on an aggregate basis and, if future experience differs significantly from assumptions, adjustments to reserves may be required, which could have a material adverse impact on the Companys results of operations and financial condition.
Excessive Losses and Loss Expenses
The greatest risk factor common to all insurance coverages is excessive losses due to unanticipated claims frequency, severity or a combination of both. Many of the factors affecting the frequency and severity of claims depend upon the type of insurance coverage. Severity and frequency can be affected by unexpectedly adverse outcomes in claims litigation, often as a result of unanticipated jury verdicts, changes in court-made law and adverse court interpretations of insurance policy provisions resulting in increased liability or new judicial theories of liability, together with unexpectedly high costs of defending claims.
Investment Risks (Interest and Equity)
The invested assets of the Companys subsidiaries are centrally managed by the Company. The majority of these invested assets consist of fixed maturity securities. Changes in interest rates directly affect the income from, and the market value of fixed maturity investments and could reduce the value of the Companys investment portfolio and adversely affect the Companys, and its subsidiaries results of operations and financial condition. A smaller percentage of total investments are in equity securities. A change in general economic conditions, the stock market, or many other external factors could
10
adversely affect the value of those investments and, in turn, the Companys, or its subsidiaries results and financial condition. Further, the Company manages its fixed maturity investments by taking into account the maturities of such securities and the anticipated liquidity needs of the Company and its subsidiaries. Should the Company suddenly experience greater than anticipated liquidity needs for any reason, it could face a liquidity risk that may adversely affect the Companys financial condition or results of operations.
Reinsurance
Reinsurance is a contractual arrangement whereby one insurer (the reinsurer) assumes some or all of the risk exposure written by another insurer (the reinsured). The Company uses reinsurance to manage its risks both in terms of the amount of coverage it is able to write, the amount it is able to retain for its own account, and the price at which it is able to write it. The availability of reinsurance and its price, however, are determined in the reinsurance market by conditions beyond the Companys control.
Reinsurance does not relieve the reinsured company of its primary liability to its insureds in the event of a loss. It merely reimburses the reinsured company. The ability and willingness of reinsurers to honor their obligations represent credit risks inherent in reinsurance transactions. The Company addresses this risk by limiting its reinsurance to those reinsurers it considers the best credit risks with limited duration contracts.
There can be no assurance that the Company will be able to find the desired or even adequate amounts of reinsurance at favorable rates from acceptable reinsurers in the future. If unable to do so, the Company would be forced to reduce the volume of business it writes or retain increased amounts of liability exposure. This could adversely affect the Companys results of operations and financial condition.
Litigation
The Company and its subsidiaries are named defendants in a number of lawsuits. These lawsuits are described more fully in Note 9Commitments and Contingencies in the Notes to Consolidated Financial Statements. Litigation, by its nature, is unpredictable and the outcome of these cases is uncertain. The precise nature of the relief that may be sought or granted in any lawsuits is uncertain and may, if these lawsuits are determined adversely to the Company, negatively impact results of operations.
Pricing
Property casualty premium rates are generally determined on the basis of historical data for claims frequency and severity as well as related production and other expense patterns. In the event ultimate claims and expenses exceed historically projected levels, premium rates are likely to prove insufficient. Premium rate inadequacy may not become evident quickly and may require time to correct.
For currently issued life products, initial premiums are guaranteed for a short period and may be increased thereafter, subject to contractual maximums, if insured mortality experience deteriorates. The Company does not assume mortality improvement when setting the initial premium scale.
Inadequate premiums, much like excessive losses, if material, can adversely affect the Companys results of operations and financial condition.
11
Liquidity Risk
As indicated above, the Company manages its fixed maturity investments with a view toward matching the maturities of those investments with the anticipated liquidity needs of its subsidiaries for the payment of claims and expenses. If a subsidiary suddenly experienced greater than anticipated liquidity needs for any reason, an injection of funds might be required that may not necessarily be available to the Company at that point in time.
Dividend Dependence and Liquidity
The Parent Company is a financial services holding company with no significant operations. Its principal asset is the stock and interests of its subsidiaries. The Parent Company relies upon dividends from the insurance subsidiaries in order to pay the interest on debt obligations, dividends to its shareholders and corporate expenses. The ability of the insurance subsidiaries to declare and pay dividends is subject to regulations under state laws that limit dividends based on the amount of adjusted unassigned surplus and earnings and require the subsidiaries to maintain minimum amounts of capital, surplus and reserves. Dividends in excess of the ordinary limitations can only be declared and paid with prior regulatory approval, of which there can be no assurance. The inability of the insurance subsidiaries to pay dividends in an amount sufficient to meet debt service and cash dividends on stock, as well as other cash requirements of the Company could result in liquidity issues for the Company.
Competition
Each of the Companys lines of insurance is highly competitive and is likely to remain so for the foreseeable future. Moreover, existing competitors and the capital markets have brought an influx of capital and newly organized entrants into the industry in recent years, and changes in laws have allowed financial institutions, like banks and savings and loans, to sell insurance products. Increases in competition threaten to reduce demand for the Companys insurance products, reduce its market share, reduce its growth, reduce its profitability and generally adversely affect its results of operations and financial condition.
Rating Downgrades
The competitive positions of insurance companies, in general, have come to depend increasingly on independent ratings of their financial strength and claims-paying ability. The rating agencies base their ratings on criteria they establish regarding an insurers financial strength, operating performance, strategic position and ability to meet its obligations to policyholders. A significant downgrade in the ratings of any of the Companys insurance subsidiaries could negatively impact their ability to compete for new business and retain existing business and, as a result, adversely affect the Companys results of operations and financial condition.
Guaranty Funds and Residual Markets
In nearly all states, licensed insurers are required to participate in guaranty funds through assessments covering a portion of insurance claims against impaired or insolvent insurers. Any increase in the number or size of impaired companies would likely result in an increase in the Companys share of such assessments.
Residual market or pooling arrangements exist in many states to provide various types of insurance coverage to those that are otherwise unable to find private insurers willing to insure them. All licensed property casualty insurers writing such coverage voluntarily are required to participate in these residual markets or pooling mechanisms.
12
A material increase in any of these assessments or charges could adversely affect the Companys results of operations and financial condition.
Prior Approval of Rates
Most of the lines of property casualty insurance underwritten by the Company are subject to prior regulatory approval of premium rates in a majority of the states in which it operates. The process of securing regulatory approval can be time consuming and can impair the Companys ability to effect necessary rate increases in an expeditious manner.
For most types of life business, initial premium rates are not subject to regulatory approval. However, if mortality experience deteriorates on a block of business, the process of securing regulatory approval for a necessary rate increase can be time consuming and impair the Companys ability to remedy the premium insufficiency in an expeditious manner.
There is a risk that regulators will not approve a requested increase. To the extent that rate increases are not approved on an adequate and timely basis, the Companys results of operations and financial condition may be adversely impacted.
Item 1B. Unresolved Staff Comments.
None
Physical Properties of the Company and Its Subsidiaries. The Company leases buildings that are used in the normal course of business. The principal executive office is owned by Mutual and is located at 2108 East South Boulevard, Montgomery, Alabama, in a 342,000 square foot building. The Company leases other offices and facilities in Georgia, Mississippi, and Tennessee. The executive office is a component of all segments. Other offices are components of the insurance segments and noninsurance segment.
The Company and its subsidiaries are defendants in legal proceedings arising in the normal course of business. Management believes adequate accruals have been established in these known cases. However, it should be noted that in Mississippi and Alabama, where the Company has substantial business, the likelihood of a judgment in any given suit, including a large mental anguish and/or punitive damage award by a jury, bearing little or no relation to actual damages, continues to exist, creating the potential for unpredictable material adverse financial results.
Based upon information presently available, management is unaware of any contingent liabilities arising from other threatened litigation that should be reserved or disclosed.
For a more detailed discussion of legal proceedings of the Company, refer to Note 9Commitments and Contingencies in the Notes to Consolidated Financial Statements of this Form 10-K.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of stockholders during the fourth quarter of 2005.
13
Item 5. Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
MARKET INFORMATION
The primary market for Alfa Corporation common stock is the National Association of Securities Dealers, Inc. Automated Quotation National Market System (the NASDAQ). The Companys common stock is quoted under the symbol of ALFA. Newspaper listings of NASDAQ stocks list Alfa Corporation as AlfaCp.
The following table sets forth, for each of the fiscal periods indicated, the range of the high and low sale prices per share as reported by the NASDAQ. These prices do not include adjustments for retail markups, markdowns or commissions.
2005 |
High | Low | Dividends Per Share | ||||||
First Quarter |
$ | 15.47 | $ | 13.92 | $ | 0.0875 | |||
Second Quarter |
15.81 | 12.80 | 0.1000 | ||||||
Third Quarter |
16.79 | 14.40 | 0.1000 | ||||||
Fourth Quarter |
18.00 | 15.60 | 0.1000 | ||||||
2004 |
High | Low | Dividends Per Share | ||||||
First Quarter |
$ | 14.02 | $ | 13.03 | $ | 0.0800 | |||
Second Quarter |
14.04 | 12.86 | 0.0875 | ||||||
Third Quarter |
14.79 | 12.93 | 0.0875 | ||||||
Fourth Quarter |
15.60 | 13.24 | 0.0875 |
HOLDERS
As of January 31, 2006, Alfa Corporation has approximately 2,600 stockholders of record.
DIVIDENDS
The Company pays dividends on its common stock upon declaration by the Board of Directors. There are no restrictions on the Companys present or future ability to pay dividends other than the usual statutory restrictions.
Dividends have been paid annually since 1974 and quarterly since September 1977. There is a present expectation that dividends will continue to be paid in the future. Future dividends depend upon future earnings, the Companys financial condition and other factors.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The table Securities Authorized for Issuance Under Equity Compensation Plans contained in the Proxy Statement for the annual meeting of stockholders to be held April 25, 2006 is incorporated herein by reference.
14
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASES
Period |
Total Number of Shares Purchased |
Average Price Paid per Share |
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs |
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs 1 | |||||
January 1, 2005 - January 31, 2005 |
| $ | | | 3,952,377 | ||||
February 1, 2005 - February 28, 2005 |
| $ | | | 3,952,377 | ||||
March 1, 2005 - March 31, 2005 |
| $ | | | 3,952,377 | ||||
April 1, 2005 - April 30, 2005 |
131,600 | $ | 13.44 | 131,600 | 3,820,777 | ||||
May 1, 2005 - May 31, 2005 |
87,400 | $ | 13.64 | 87,400 | 3,733,377 | ||||
June 1, 2005 - June 30, 2005 |
| $ | | | 3,733,377 | ||||
July 1, 2005 - July 31, 2005 |
| $ | | | 3,733,377 | ||||
August 1, 2005 - August 31, 2005 |
| $ | | | 3,733,377 | ||||
September 1, 2005 - September 30, 2005 |
| $ | | | 3,733,377 | ||||
October 1, 2005 - October 31, 2005 |
| $ | | | 3,733,377 | ||||
November 1, 2005 - November 30, 2005 |
| $ | | | 3,733,377 | ||||
December 1, 2005 - December 31, 2005 |
| $ | | | 3,733,377 | ||||
Total |
219,000 | $ | 13.52 | 219,000 | |||||
1 | In October 1989, the Companys Board of Directors approved a stock repurchase program authorizing the repurchase of up to 4,000,000 shares of its outstanding common stock in the open market or in negotiated transactions in such quantities and at such times and prices as management may decide. The Board increased the number of shares authorized for repurchase by 4,000,000 in both March 1999 and September 2001, bringing the total number of shares authorized for repurchase to 12,000,000. |
RECENT SALES OF UNREGISTERED SECURITIES; USE OF PROCEEDS FROM REGISTERED SECURITIES
On January 1, 2005, the Company issued 325,035 non-registered shares of common stock to Mr. John C. Russell, President and one of the owners of Vision. The shares were issued as part of the Companys acquisition of Vision on January 1, 2005. The shares were issued pursuant to the exemption found in section 4(2) of the Securities Act of 1933 for non-public offerings.
15
Item 6. Selected Financial Data.
Years Ended December 31, | ||||||||||||||||||||
(dollars in thousands except per share amounts and number of agents) |
2005 | 2004 | 2003 | 2002 | 2001 | |||||||||||||||
PremiumsProperty Casualty Insurance |
$ | 556,439 | $ | 485,534 | $ | 454,453 | $ | 423,593 | $ | 392,589 | ||||||||||
Premiums and policy chargesLife Insurance |
76,633 | 71,224 | 66,172 | 63,005 | 56,007 | |||||||||||||||
Net investment income |
94,932 | 89,361 | 83,096 | 88,113 | 84,533 | |||||||||||||||
Realized investment gains |
6,051 | 7,049 | 6,264 | 5,160 | 6,448 | |||||||||||||||
Other income |
22,850 | 8,124 | 9,832 | 9,225 | 8,368 | |||||||||||||||
Total Revenues |
756,905 | 661,292 | 619,817 | 589,096 | 547,945 | |||||||||||||||
Benefits, Losses and Expenses |
619,043 | 540,663 | 513,220 | 489,751 | 449,851 | |||||||||||||||
Income before provision for income taxes |
137,862 | 120,629 | 106,597 | 99,345 | 98,094 | |||||||||||||||
Provision for income taxes |
38,828 | 31,184 | 28,128 | 27,637 | 28,132 | |||||||||||||||
Cumulative effect of changes in accounting principles |
| | | | (456 | ) | ||||||||||||||
Net income |
$ | 99,034 | $ | 89,445 | $ | 78,469 | $ | 71,708 | $ | 69,506 | ||||||||||
Balance sheet data at December 31: |
||||||||||||||||||||
Invested assets |
$ | 2,001,380 | $ | 1,854,212 | $ | 1,760,160 | $ | 1,618,033 | $ | 1,449,492 | ||||||||||
Total assets |
$ | 2,381,874 | $ | 2,222,664 | $ | 2,031,008 | $ | 1,862,207 | $ | 1,670,993 | ||||||||||
Future policy benefits, losses and claims, unearned premiums |
$ | 1,178,230 | $ | 1,076,108 | $ | 988,769 | $ | 908,178 | $ | 828,844 | ||||||||||
Long-term obligations |
$ | 70,000 | $ | 70,000 | $ | 70,000 | $ | 70,000 | $ | | ||||||||||
Total liabilities |
$ | 1,625,882 | $ | 1,531,211 | $ | 1,392,495 | $ | 1,296,109 | $ | 1,161,881 | ||||||||||
Stockholders equity |
$ | 755,992 | $ | 691,453 | $ | 638,513 | $ | 566,098 | $ | 509,112 | ||||||||||
Per share data1: |
||||||||||||||||||||
Net incomeBasic |
$ | 1.24 | $ | 1.12 | $ | 0.98 | $ | 0.91 | $ | 0.89 | ||||||||||
Net incomeDiluted |
$ | 1.23 | $ | 1.11 | $ | 0.98 | $ | 0.90 | $ | 0.88 | ||||||||||
Cash dividends paid |
$ | 0.3875 | $ | 0.3425 | $ | 0.315 | $ | 0.2975 | $ | 0.2825 | ||||||||||
Annual dividend rate |
$ | 0.40 | $ | 0.35 | $ | 0.32 | $ | 0.30 | $ | 0.29 | ||||||||||
Stockholders equity |
$ | 9.42 | $ | 8.66 | $ | 7.96 | $ | 7.14 | $ | 6.50 | ||||||||||
Closing sales price at December 31 |
$ | 16.10 | $ | 15.19 | $ | 12.86 | $ | 12.01 | $ | 11.22 | ||||||||||
Price/earnings ratio |
13.1 | X | 13.7 | X | 13.1 | X | 13.3 | X | 12.8 | X | ||||||||||
Weighted average shares outstandingBasic |
80,141 | 79,985 | 79,809 | 78,804 | 78,316 | |||||||||||||||
Weighted average shares outstandingDiluted |
80,713 | 80,490 | 80,390 | 79,547 | 78,963 | |||||||||||||||
Other data: |
||||||||||||||||||||
Life insurance inforce |
$ | 21,209,234 | $ | 19,779,503 | $ | 18,262,749 | $ | 16,736,418 | $ | 15,167,308 | ||||||||||
Number of agents |
3,061 | 616 | 615 | 618 | 613 |
1 | Per share amounts have been restated where appropriate to reflect 2-for-1 stock split in June 2002. |
16
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
Managements Discussion and Analysis of Financial Condition and Results of Operations addresses the financial condition of Alfa Corporation and its subsidiaries (the Company) as of December 31, 2005, compared with December 31, 2004 and the results of operations for each of the three years ended December 31, 2005. The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements that are included in Item 8 of this Form 10-K.
Any statement contained in this report which is not a historical fact, or which might otherwise be considered an opinion or projection concerning the Company or its business, whether expressed or implied, is meant as and should be considered a forward-looking statement as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and opinions concerning a variety of known and unknown risks, including but not necessarily limited to changes in market conditions, natural disasters and other catastrophic events, increased competition, changes in availability and cost of reinsurance, changes in governmental regulations, technological changes, political and legal contingencies and general economic conditions, as well as other risks and uncertainties more completely described in the Companys filings with the Securities and Exchange Commission, including this report on Form 10-K. If any of these assumptions or opinions proves incorrect, any forward-looking statements made on the basis of such assumptions or opinions may also prove materially incorrect in one or more respects and may cause actual future results to differ materially from those contemplated, projected, estimated or budgeted in such forward-looking statements.
OVERVIEW
Alfa Corporation is a financial services holding company headquartered in Alabama that offers primarily personal lines of property casualty insurance, life insurance and financial services products through its wholly-owned subsidiaries:
| Alfa Insurance Corporation (AIC) |
| Alfa General Insurance Corporation (AGI) |
| Alfa Vision Insurance Corporation (AVIC) |
| Alfa Life Insurance Corporation (Life) |
| Alfa Financial Corporation (Financial) |
| The Vision Insurance Group, LLC (Vision) |
| Alfa Agency Mississippi, Inc. (AAM) |
| Alfa Agency Georgia, Inc. (AAG) |
| Alfa Benefits Corporation (ABC) |
Alfa Corporation is affiliated with Alfa Mutual Insurance Company, Alfa Mutual Fire Insurance Company, and Alfa Mutual General Insurance Company (collectively, the Mutual Group). The Mutual Group owns 54.9% of Alfa Corporations common stock, their largest single investment. Alfa Corporation and its subsidiaries (the Company) together with the Mutual Group comprise the Alfa Group (Alfa). Alfa Virginia Mutual Insurance Company (Virginia Mutual) currently cedes 80% of its direct business to Alfa Mutual Fire Insurance Company (Fire) under an affiliate agreement signed in August 2001.
The Companys revenue consists mainly of premiums earned, policy charges, net investment income and fee income. Benefit and settlement expenses consist primarily of claims paid and claims in
17
process and pending and include an estimate of amounts incurred but not yet reported along with loss adjustment expenses. Other operating expenses consist primarily of compensation expenses, and other overhead business expenses, net of deferred policy acquisition costs.
The Company reports operating segments based on the Companys legal entities, which are organized by line of business:
| Property casualty insurance |
| Life insurance |
| Noninsurance |
| Consumer financing |
| Commercial leasing |
| Agency operations |
| Employee benefits administration |
| Corporate and eliminations |
Property casualty insurance operations accounted for 80.1% of revenues and 81.1% of net income in 2005. Life insurance operations generated 17.6% of revenues and 25.8% of net income during the same period. Noninsurance net income, combined with corporate expenses for 2005, resulted in a net loss of $6.9 million or 6.9% of net income.
Future results of operations will depend in part on the Companys ability to predict and control benefit and settlement expenses through underwriting criteria, product design and negotiation of favorable vendor contracts. The Company must also seek timely and accurate rate changes from insurance regulators in order to meet strategic business objectives. Selection of insurable risks, proper collateralization of loans and leases and continued staff development also impact the operating results of the Company. The Companys inability to mitigate any or all risks mentioned above or other factors may adversely affect its profitability.
In evaluating the performance of the Companys segments, management believes operating income serves as a meaningful tool for assessing the profitability of the Companys ongoing operations. Operating income, a non-GAAP financial measure, is defined by the Company as net income excluding net realized investment gains and losses, net of applicable taxes. Realized investment gains and losses are somewhat controllable by the Company through the timing of decisions to sell securities. Therefore, realized investment gains and losses are not indicative of future operating performance.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires the Companys management to make significant estimates and assumptions based on information available at the time the financial statements are prepared. In addition, management must ascertain the appropriateness and timing of any changes in these estimates and assumptions. Certain accounting estimates are particularly sensitive because of their significance to the Companys financial statements and because of the possibility that subsequent events and available information may differ markedly from managements judgments at the time financial statements are prepared. For the Company, the areas most subject to significant management judgments include reserves for property casualty losses and loss adjustment expenses, reserves for future policy benefits, deferred policy acquisition costs, valuation of investments, and reserves for pending litigation. The application of these critical accounting estimates impacts the values at which
18
73% of the Companys assets and 59% of the Companys liabilities are reported at December 31, 2005 and therefore have a direct effect on net earnings and stockholders equity. The Companys Summary of Significant Accounting Policies is presented in Note 1 of the Notes to Consolidated Financial Statements.
Management has discussed the Companys critical accounting policies and estimates, together with any changes therein, with the Audit Committee of the Companys Board of Directors. The Companys Audit Committee has also reviewed the disclosures contained herein.
Reserves For Property Casualty Losses And Loss Adjustment Expenses
The estimated liabilities for losses and loss adjustment expenses include the accumulation of estimates of losses for claims reported prior to the balance sheet dates, estimates of losses for claims incurred but not reported and the development of case reserves to ultimate values, and estimates of expenses for investigating, adjusting and settling all incurred claims. Amounts reported are estimates of the ultimate costs of settlement, net of estimated salvage and subrogation. The estimates are necessarily subject to the outcome of future events, such as changes in medical and repair costs as well as economic, political and social conditions that impact the settlement of claims. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. Due to the Companys current mix of exposures, the majority of claims are settled within twelve months of the date of loss.
The amount of loss reserves for reported claims is based primarily upon a case-by-case evaluation of the risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions related to the type of loss. The amounts of loss reserves for unreported claims and loss adjustment expenses are determined using historical information by line of business as adjusted to current conditions. Inflation is implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results. Organized by accident year and evaluation dates, historical data on paid losses, loss adjustment expenses, case reserves, earned premium, catastrophe losses and carried reserves is provided to the Companys actuaries who apply standard actuarial techniques to estimate a range of reasonable reserves. The carried reserve is then compared to these estimates to determine whether it is reasonable and whether any adjustments need to be recorded. The Companys appointed actuary conducts his own analysis and renders an opinion as to the adequacy of the reserves. Reserve estimates are closely monitored and are rolled forward quarterly using the most recent information on reported claims. Each quarter, after the rolled forward analysis has been completed, a meeting is held to discuss the actuarial data. Management evaluates reserve level estimates across various segments and adjustments are made as deemed necessary. It is expected that such estimates will be more or less than the amounts ultimately paid when the claims are settled. Changes in these estimates are reflected in current operating results. An increase in the ending reserve for incurred but not reported losses of 1% would have negatively impacted income before income taxes by $453,358 at December 31, 2005. Similarly, increases of 1% in the reserves for unpaid losses and loss adjustment expenses would have reduced pretax earnings by $882,892 and $239,113, respectively.
Due to the Companys geographically concentrated operations, it is possible that changes in assumptions based on regional data could cause fluctuations in reported results. However, the Companys exposure to large adjustments in these reserves created by these assumption changes is partially limited by its participation in Alfas catastrophe protection program. Historically, the Companys reserves, in the aggregate, have been adequate when compared to actual results. Given the inherent variability in the estimates, management believes the aggregate reserves are within a reasonable and acceptable range of adequacy.
19
Reserves For Policyholder Benefits
Benefit reserves for traditional life products are determined according to the provisions of Statement of Financial Accounting Standard (SFAS) No. 60, Accounting and Reporting by Insurance Enterprises. The methodology used requires that the present value of future benefits to be paid to or on behalf of policyholders less the present value of future net premiums (that portion of the gross premium required to provide for all future benefits and expenses) be determined. Such determination uses assumptions, including provision for adverse deviation, for expected investment yields, mortality, terminations and maintenance expenses applicable at the time the insurance contracts are issued. These assumptions determine the level and the sufficiency of reserves. The Company annually tests the validity of these assumptions.
Benefit reserves for universal life products are determined according to the provisions of SFAS No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. This standard directs that, for policies with an explicit account balance, the benefit reserve is the account balance without reduction for any applicable surrender charge. Benefit reserves for the Companys annuity products, like those for universal life products, are determined using the requirements of SFAS No. 97.
In accordance with the provisions of SFAS No. 60 and the AICPA Audit and Accounting Guide, credit insurance reserves are held as unearned premium reserves calculated using the rule of 78 method. Reserves for supplementary contracts with life contingencies are determined using the 1971 Individual Annuity Mortality Table and an interest rate of 7.5%. Likewise, reserves for accidental death benefits are determined predominately by using the 1959 Accidental Death Benefit Mortality Table and an interest rate of 3%. Reserves for disability benefits, both active and disabled lives, are calculated primarily from the 1952 Disability Study and a rate of 2.5%. A small portion of the Companys disabled life reserves are calculated based on the 1970 Intercompany Group Disability Study and a rate of 3%.
Reserves for all other benefits are computed in accordance with presently accepted actuarial standards. Management believes that reserve amounts reflected in the Companys balance sheet related to life products:
| are consistently applied and fairly stated in accordance with sound actuarial principles; |
| are based on actuarial assumptions which are in accordance with contract provisions; |
| make a good and sufficient provision for all unmatured obligations of the Company guaranteed under the terms of its contracts; |
| are computed on the basis of assumptions consistent with those used in computing the corresponding items of the preceding year end; and |
| include provision for all actuarial reserves and related items that ought to be established. |
Valuation Of Investments
Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in stockholders equity as a component of accumulated other comprehensive income (loss) and, accordingly, have no effect on net income. Fair values for fixed maturities are based on quoted market prices. The cost of investment securities sold is determined by using the first-in, first-out methodology. In some instances, the Company may use the specific identification method. The Company monitors its investment portfolio and conducts quarterly reviews of investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. Such evaluations involve judgment and consider the magnitude and reasons for a decline and the prospects for the fair value to recover in the near term. Declines resulting from broad market conditions
20
or industry related events, and for which the Company has the intent to hold the investment for a period of time believed to be sufficient to allow a market recovery or to maturity, are considered to be temporary. Future adverse investment market conditions, or poor operating results of underlying investments, could result in an impairment charge in the future. Where a decline in fair value of an investment below its cost is deemed to be other than temporary, a charge is reflected in income for the difference between the cost or amortized cost and the estimated net realizable value. As a result, writedowns of approximately $1.0 million and $1.0 million were recorded in 2005 on equity securities and fixed maturities, respectively. During 2004, writedowns of approximately $111,000 were recorded on fixed maturities with no writedowns on equity securities.
Policy Acquisition Costs
Policy acquisition costs, such as commissions, premium taxes and certain other underwriting and marketing expenses that vary with and are directly related to the production of business have been deferred. Traditional life insurance acquisition costs are being amortized over the premium payment period of the related policies using assumptions consistent with those used in computing policy benefit reserves. Acquisition costs for universal life type policies are being amortized over a thirty-year period in relation to the present value of estimated gross profits that are determined based upon surrender charges and investment, mortality and expense margins. Investment income is considered, if necessary, in the determination of the recoverability of deferred policy acquisition costs. Acquisition costs for property casualty insurance are amortized over the period in which the related premiums are earned. Future changes in estimates, such as the relative time certain employees spend in initial policy bookings, may require adjustment to the amounts deferred. Changes in underwriting and policy issuance processes may also give rise to changes in these deferred costs.
Reserves For Litigation
The Company is subject to lawsuits in the normal course of business related to its insurance and noninsurance products. At the time a lawsuit becomes known, management evaluates the merits of the case and determines the need for establishing estimated reserves for potential settlements or judgments as well as reserves for potential costs of defending the Company against the allegations of the complaint. These reserves may be adjusted as the case develops. Periodically, and at least quarterly, management assesses all pending cases as a basis for evaluating reserve levels. At that point, any necessary adjustments are made to applicable reserves as determined by management and are included in current operating results. Reserves may be adjusted based upon outside counsels advice regarding the law and facts of the case, any revisions in the law applicable to the case, the results of depositions and/or other forms of discovery, general developments as the case progresses such as a favorable or an adverse trial court ruling, whether a verdict is rendered for or against the Company, whether management believes an appeal will be successful, or other factors that may affect the anticipated outcome of the case. Management believes adequate reserves have been established in known cases. However, due to the uncertainty of future events, there can be no assurance that actual outcomes will not differ from the assessments made by management.
21
RESULTS OF OPERATIONS
The following table sets forth consolidated summarized income statement information for the years ended December 31, 2005, 2004 and 2003:
Years Ended December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
(in thousands, except share and per share data) | ||||||||||||
Revenues |
||||||||||||
Property casualty insurance premium |
$ | 556,439 | $ | 485,534 | $ | 454,453 | ||||||
Life insurance premiums and policy charges |
76,633 | 71,224 | 66,172 | |||||||||
Total premiums and policy charges |
$ | 633,072 | $ | 556,758 | $ | 520,625 | ||||||
Net investment income |
$ | 94,932 | $ | 89,361 | $ | 83,096 | ||||||
Other income |
$ | 22,850 | $ | 8,124 | $ | 9,832 | ||||||
Total revenues |
$ | 756,905 | $ | 661,292 | $ | 619,817 | ||||||
Net income |
||||||||||||
Insurance operations |
||||||||||||
Property casualty insurance |
$ | 80,195 | $ | 68,699 | $ | 53,112 | ||||||
Life insurance |
21,736 | 18,763 | 19,058 | |||||||||
Total insurance operations |
$ | 101,931 | $ | 87,462 | $ | 72,170 | ||||||
Noninsurance operations |
(38 | ) | 2,138 | 4,031 | ||||||||
Realized investment gains, net of tax |
3,933 | 4,582 | 4,071 | |||||||||
Corporate |
(6,792 | ) | (4,737 | ) | (1,803 | ) | ||||||
Net income |
$ | 99,034 | $ | 89,445 | $ | 78,469 | ||||||
Net income per share |
||||||||||||
Basic |
$ | 1.24 | $ | 1.12 | $ | 0.98 | ||||||
Diluted |
$ | 1.23 | $ | 1.11 | $ | 0.98 | ||||||
Weighted average shares outstanding |
||||||||||||
Basic |
80,141,068 | 79,984,651 | 79,808,669 | |||||||||
Diluted |
80,712,923 | 80,489,502 | 80,390,001 | |||||||||
Consolidated results of operations have been impacted by the following events in 2005:
| Effective January 1, 2005, the property casualty insurance Pooling Agreement (refer to Note 2Pooling Agreement in the Notes to Consolidated Financial Statements) was modified as follows: |
| AVIC, which writes nonstandard automobile business in nine states, was added as a participant to the pool. |
| Fires quota share reinsurance agreement with Virginia Mutual was retroceded to the pool. |
| On January 3, 2005, the Company completed the purchase of Vision, a full-service managing general agency that writes nonstandard automobile insurance policies in nine states, and provides all underwriting, claims, actuarial and financial services on behalf of its contracted carriers, which includes AVIC. |
| During the fourth quarter, a new property casualty policy administration system was implemented for the automobile line of business. |
| On December 31, 2005, the Company completed the sale of a substantial portion of its commercial lease portfolio and other assets, net of related liabilities, to OFC Servicing Corporation, a wholly-owned subsidiary of MidCountry Financial Corporation (MidCountry). |
22
Total premiums and policy charges increased $76.3 million, or 14% in 2005 and $36.1 million, or 7%, in 2004. For 2005, AVIC contributed $20.8 million and Virginia Mutual contributed $21.8 million, for a combined amount of $42.6 million of the increase. The persistency ratio for life business was 91.2% at December 31, 2005 and 2004. Persistency, a non-GAAP financial measure, represents the ratio of the annualized premium of policies inforce at December 31, 2005 and 2004 as a percentage of the annualized premium paid at December 31, 2005 and 2004, respectively.
Net investment income increased 6% in 2005 due to increased partnership earnings and a slightly lower yield on increased balances of fixed income securities, while net investment income grew 8% in 2004 due to increased earnings from fixed income securities and partnerships. Positive cash flows resulted in an increase in invested assets of 8% and 5% in the twelve months since December 31, 2005 and 2004, respectively.
Other income increased $14.7 million in 2005 after decreasing $1.7 million in 2004. In 2005, AVIC contributed $3.5 million of the increase and Vision contributed $22.9 million, which was offset by intercompany eliminations of $12.0 million.
Operating income for the property casualty subsidiaries increased by approximately $11.5 million, or 17%, in 2005 and $15.6 million, or 29%, in 2004. In 2005, AVIC and Virginia Mutual contributed $2.9 million in operating income. AIC and AGI operating income increased $8.6 million as the non-storm loss ratio, declined from 59.4% in 2004 to 58.2% in 2005. During the first quarter of 2005, $11.6 million in pretax storm losses were incurred which was the limit under the Companys catastrophe program. Storm losses of $9.2 million were incurred during 2004. The expense ratio was impacted with the introduction of the new policy administration system by $2.4 million, or 0.5% of the expense ratio. The return on average equity for 2005 was 18.6%, compared to 16.7% for 2004. Return on average equity, a non-GAAP financial measure, is defined as net income divided by the simple average of beginning and ending stockholders equity.
Life insurance operating income increased $3.0 million or 16% in 2005 as a result of a lower mortality ratio of 96% compared to 104% during 2004, premiums and policy charges growth of 8%, and net investment income growth of 4% due to increased investments in fixed maturities at a slightly lower yield. Mortality, a non-GAAP financial measure, represents the ratio of actual to expected death claims. Therefore, in 2005, the Company experienced more favorable financial results when compared to 2004 due to the lower mortality ratio.
Noninsurance operating income decreased $2.2 million or 102% in 2005 after declining 47% in 2004. Starting in 2005, this segment contains all agency operations, which include Vision, AAG and AAM. Due to unanticipated delays in licensing for AVIC, Vision experienced lower revenues than expected. By the end of the fourth quarter of 2005, all licenses were in place. Also impacting this segment was the reduction in commercial leasing activities as a result of managements decision to hold this division for sale as of December 31, 2004 and which was subsequently sold on December 31, 2005. Rising interest rates also contributed to reduced margins within Financials portfolio. ABCs operations resulted in an operating loss for 2005 as the result of recognition of a deferred tax asset and subsequent charge to earnings for the change in the deferred tax asset arising from the formation of the entity in 1999.
Corporate expenses increased by $2.1 million in 2005 and $2.9 million in 2004. Current year results were impacted by increased costs on the Companys short-term borrowings and the elimination of profits generated by transactions between the property casualty segment and Vision, which was acquired in January 2005. In 2004, corporate expenses were negatively influenced by increased professional fees related to the compliance requirements of the Sarbanes-Oxley Act of 2002 and rising interest rates.
23
Net income improved 10.4% on a per diluted share basis in 2005 compared to 2004 and increased 13.8% on a similar basis in 2004 compared to 2003.
PROPERTY CASUALTY INSURANCE OPERATIONS
The following table sets forth summarized financial information for the Companys property casualty insurance subsidiaries, AIC, AGI and AVIC, for the years ended December 31, 2005, 2004 and 2003:
Years Ended December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
(in thousands) | ||||||||||||
Earned premiums |
||||||||||||
Personal lines |
$ | 519,874 | $ | 473,931 | $ | 441,668 | ||||||
Commercial lines |
16,862 | 16,135 | 15,325 | |||||||||
Reinsurance ceded |
(3,063 | ) | (4,706 | ) | (2,668 | ) | ||||||
Reinsurance assumed |
22,766 | 174 | 128 | |||||||||
Total earned premiums |
$ | 556,439 | $ | 485,534 | $ | 454,453 | ||||||
Net underwriting income |
$ | 55,871 | $ | 50,158 | $ | 35,224 | ||||||
Loss ratio |
60.1 | % | 61.3 | % | 62.4 | % | ||||||
LAE ratio |
4.3 | % | 4.2 | % | 3.9 | % | ||||||
Expense ratio |
25.5 | % | 24.1 | % | 25.9 | % | ||||||
GAAP basis combined ratio |
90.0 | % | 89.7 | % | 92.2 | % | ||||||
Underwriting margin |
10.0 | % | 10.3 | % | 7.8 | % | ||||||
Net investment income |
$ | 40,200 | $ | 34,746 | $ | 28,503 | ||||||
Other income and fees |
$ | 9,621 | $ | 5,905 | $ | 5,899 | ||||||
Pretax operating income |
$ | 105,692 | $ | 90,809 | $ | 69,626 | ||||||
Operating income, net of tax |
$ | 80,195 | $ | 68,699 | $ | 53,112 | ||||||
Realized investment gains (losses), net of tax |
$ | 121 | $ | (3,129 | ) | $ | (1,486 | ) | ||||
Net income |
$ | 80,316 | $ | 65,570 | $ | 51,626 | ||||||
2005 Compared to 2004
Results of operations for this segment have been impacted by the following events in 2005:
| Effective January 1, 2005, the property casualty insurance Pooling Agreement (refer to Note 2Pooling Agreement in the Notes to Consolidated Financial Statements) was modified as follows: |
| AVIC, which writes nonstandard automobile business in nine states, was added as a participant to the pool. |
| Fires quota share reinsurance agreement with Virginia Mutual was retroceded to the pool. |
| On January 3, 2005, the Company completed the purchase of Vision, a full-service managing general agency that writes nonstandard automobile insurance policies in nine states, and provides all underwriting, claims, actuarial and financial services on behalf of its contracted carriers, which includes AVIC. |
| During the fourth quarter, a new property casualty policy administration system was implemented for the automobile line of business. |
24
AVIC, a direct writer of nonstandard risk automobile business in Missouri, Indiana, Ohio, Virginia, Tennessee, Arkansas, Kentucky and Florida, and assumes business in Texas, contributed $53 million of written premium and $32 million of earned premium to the pool during 2005. Virginia Mutual, a direct writer of personal and commercial automobile business, homeowners, and other personal and commercial business in Virginia and North Carolina, through the quota share agreement, contributed $50.2 million of written premium, of which $16.9 million was related to unearned premium existing at December 31, 2004 with $33.3 written during 2005. In addition, Virginia Mutual contributed $33.5 million of earned premium to the pool during 2005. The Companys pooled share of AVIC and Virginia Mutual premium is reported as $20.0 million of personal lines earned premiums and $22.6 million of reinsurance assumed earned premiums in the table above.
The loss ratio for the year related to the AVIC business was 61.4% and Virginia Mutual was 49.6%, which represents 4.2% of the overall loss ratio of 60.1%. Also included in the loss ratio are 2.1% of catastrophe losses. Alfa had eight events totaling $293.9 million in gross catastrophe losses during 2005 and five events totaling $347.5 million in 2004 due to the impact of hurricanes, tornadoes and other severe weather. The effect of claims from these events impacted underwriting results by $0.09 and $0.07 per share in 2005 and 2004, respectively, after taxes, based upon the pooling agreement and the catastrophe protection program. For additional information on the pooling agreement, refer to Note 2Pooling Agreement in the Notes to Consolidated Financial Statements.
The loss adjustment expense (LAE) ratio has been impacted by the addition of AVIC, which has a different expense structure than AIC and AGI. AVIC pays Vision a fee based on earned premiums to provide loss adjustment activities. This fee structure contributed 0.4% to the LAE ratio.
The expense ratio has been impacted by the different expense structure of AVIC. AVIC pays a commission to Vision, which is based on written premium, for underwriting and servicing the business written. In addition, the policy fees collected by AVIC, net of related premium taxes, are paid to Vision. These amounts, net of deferral and amortization, represent 1.5% of the expense ratio. The commission paid to Virginia Mutual under the quota share agreement represents 1.4% of the expense ratio. Also included in the expense ratio for 2005 is the 0.5% effect of the new policy administration system that went into production in the fourth quarter.
The overall higher expense structures of AVIC and Virginia Mutual, along with the impact of technology costs has produced a slightly lower underwriting margin of 10.0% in 2005, compared with 10.3% in 2004. Underwriting margin, a non-GAAP financial measure, represents the percentage of each premium dollar earned which remains after losses, loss adjustment expenses and other operating expenses.
Included in other income and fees in 2005 is the addition of $3.5 million of policy fees collected by AVIC.
Net investment income increased 15.7% for 2005, compared to 21.9% for 2004. The slowdown in growth is the result of slightly lower fixed income securities yields with only a 0.5% increase in fixed income balances, offset by increases in partnership income.
Pretax operating income increased $4.5 million and operating income, net of tax, increased $2.9 million as a result of the addition of AVIC and Virginia Mutual business.
Net income increased 22.5% for 2005, compared to 27.0% in 2004, with AVIC and Virginia Mutual contributing $2.9 million in 2005. Return on equity was 18.6% for 2005 compared to 16.7% in 2004.
25
At December 31, 2005, the Companys property casualty subsidiaries Adjusted Capital calculated in accordance with National Association of Insurance Commissioners (NAIC) Risk-Based Capital (RBC) guidelines was $407.5 million compared to the Authorized Control Level (Required) RBC of $30.3 million. These statutory measures serve as a benchmark for the regulation of an organizations solvency by state insurance regulators.
2004 Compared to 2003
Earned premiums increased $31.1 million, or 6.8% in 2004, due to an increase in sales production of new business and the positive impact of homeowner rate increases offset by increases in ceded catastrophe premium of approximately $1.8 million. These factors contributed to the growth in personal lines earned premiums of 7.3% and 7.5% in 2004 and 2003, respectively.
Operating income increased by approximately $15.6 million despite $9.2 million in pretax catastrophic storm losses in 2004. Approximately $7.9 million in similar losses were incurred in 2003. The underwriting margin of 10.3% in 2004 was the result of a 61.3% loss ratio (59.4% excluding storm losses), a 4.2% LAE ratio and a 24.1% expense ratio compared to a loss ratio of 62.4%, a LAE ratio of 3.9% and an expense ratio of 25.9% in 2003.
The non-storm loss ratio decrease was due primarily to a lower loss ratio in the automobile line of business. As the largest line of business within the Company, automobile comprised 60.7% of property casualty written premiums in 2004 and generated another strong loss ratio of 62.2%.
The Alfa Group had approximately $347.5 million in gross catastrophe losses during 2004 due to the impact of hurricanes and other severe weather occurring in the second and third quarters. The effect of claims from these events impacted underwriting results by $0.07 per share, based upon the pooling agreement and catastrophe protection program. Another factor in the improved underwriting margin was a decrease in the expense ratio from 2003 levels primarily attributable to the favorable comparison created by adjustments recorded during 2003 to reserves established to cover the cost of purchasing books of business from independent exclusive agents upon their separation from the Company.
Invested assets grew 16.4% in 2004 while investment income increased by $6.2 million primarily due to an increase in partnership earnings. At December 31, 2004, the Companys property casualty subsidiaries Adjusted Capital calculated in accordance with NAIC RBC guidelines was $369.8 million compared to the Authorized Control Level (Required) RBC of $21.5 million.
26
LIFE INSURANCE OPERATIONS
The following table sets forth summarized financial information for the Companys life insurance subsidiary, Life, for the years ended December 31, 2005, 2004 and 2003:
Years Ended December 31, | |||||||||
2005 | 2004 | 2003 | |||||||
(in thousands) | |||||||||
Premiums and policy charges |
|||||||||
Universal life policy charges |
$ | 20,803 | $ | 19,863 | $ | 18,823 | |||
Universal life policy chargesCOLI |
3,812 | 3,473 | 3,245 | ||||||
Interest sensitive life policy charges |
10,884 | 10,754 | 10,475 | ||||||
Traditional life insurance premiums |
40,617 | 36,642 | 33,087 | ||||||
Group life insurance premiums |
517 | 492 | 542 | ||||||
Total premiums and policy charges |
$ | 76,633 | $ | 71,224 | $ | 66,172 | |||
Net investment income |
$ | 50,963 | $ | 49,129 | $ | 44,735 | |||
Benefits and expenses |
$ | 87,841 | $ | 86,864 | $ | 76,368 | |||
Amortization of deferred policy acquisition costs |
$ | 9,277 | $ | 8,024 | $ | 8,788 | |||
Pretax operating income |
$ | 30,478 | $ | 25,465 | $ | 25,751 | |||
Operating income, net of tax |
$ | 21,736 | $ | 18,763 | $ | 19,058 | |||
Realized investment gains, net of tax |
$ | 3,837 | $ | 7,873 | $ | 5,580 | |||
Net income |
$ | 25,573 | $ | 26,636 | $ | 24,638 | |||
2005 Compared to 2004
Lifes premiums and policy charges increased $5.4 million, or 7.6%, for 2005, compared to an increase of $5.1 million, or 7.6% in 2004. Issued annualized new business premium increased by 1.9% to $13.6 million with a total volume of $2.9 billion of insurance being issued.
Total life insurance inforce for 2005 increased $1.4 billion, with term insurance increasing $1.2 billion, or 12.4%. Annualized premiums for inforce business increased 6%, or $7.2 million, for the year, with term insurance increasing 11.6% or $3.4 million. The persistency ratio remained steady at 91.2%.
The mortality ratio declined to 96% of expected in 2005 from 104% of expected in 2004. The result was an increase of only $1.3 million in benefits and claims expense for the year, which is offset by a decline of $918 thousand in legal costs and relatively low growth in operating expenses. Amortization of deferred policy acquisition costs have increased as a result of growth in deferred costs related to new business production increases.
Invested assets increased 7.2%, with an increase of amortized value in fixed income securities of 12.5%, while net investment income increased 3.7%, with income from fixed maturities up $1.1 million, reflecting a slightly lower yield. Writedowns accounted for $1.1 million of the reduction in realized investment gains, net of tax.
Operating income increased 15.9% during 2005 after declining 1.5% in 2004. With a decrease in realized investment gains, net income declined 4.0% in 2005 compared to an increase in net income of 8.1% in 2004, which was the result of an increase in realized investment gains in 2004.
27
At December 31, 2005, the life subsidiarys Adjusted Capital calculation in accordance with NAIC RBC guidelines was $189.9 million compared to the Authorized Control Level (Required) RBC amount of $12.9 million.
2004 Compared to 2003
The Companys life insurance premiums and policy charges increased $5.1 million, or 7.6% in 2004. Universal life policy charges and traditional premiums increased by $1.3 million and $3.6 million, respectively. The increase in traditional premiums was due to continued increases in term product production and a decline in termination rates. In addition, interest sensitive life policy charges grew by $279,000 or 2.7% as a result of re-pricing the product and adding a preferred underwriting class. New business premium increased 1.4% while persistency declined from 92.9% to 91.2%.
Life insurance operating income, net of tax, decreased $295,000 or 1.5% in 2004. Death claims increased $2.6 million, or 10.5% in 2004, while mortality declined from 105% in 2003 to 104% in 2004. Investment income increased 9.8% while invested assets grew by 7.0% due to positive cash flows. General expenses increased by approximately $1.5 million or 16.2% primarily due to an increase in legal costs. Amortization of deferred policy acquisition costs declined by 8.7% as amortization factors were adjusted to properly reflect expected gross profits of universal life products.
At December 31, 2004, the life subsidiarys Adjusted Capital calculation in accordance with NAIC RBC guidelines was $173.6 million compared to the Authorized Control Level (Required) RBC amount of $11.6 million.
NONINSURANCE OPERATIONS
The following discussion relates to the Companys noninsurance subsidiaries, Financial, Vision, AAM, AAG and ABC.
2005 Compared to 2004
Results of operations for this segment have been impacted by the following events in 2005:
| On January 3, 2005, the Company completed the purchase of Vision, a full-service managing general agency that currently writes nonstandard automobile insurance policies in nine states. In addition, during 2005, Vision wrote a limited amount of homeowner business through other carriers as a general agency. Vision is headquartered in Brentwood, Tennessee and provides all underwriting, claims, actuarial and financial services on behalf of its contracted carriers, which includes AVIC. |
| On December 31, 2005, the Company completed the sale of a substantial portion of its commercial lease portfolio and other assets, net of related liabilities, to OFC Servicing Corporation, a wholly-owned subsidiary of MidCountry Financial Corporation (MidCountry). |
| All agency operations, Vision, AAM and AAG, are included in this segment. |
Noninsurance operating income decreased $2.2 million, or 102%, in 2005. Net loss for the year was $64 thousand.
Agency operations for the year produced a net loss of $14 thousand. During 2005, AAM and AAG produced $72 thousand in operating income. Vision generated an operating loss of $86 thousand due to infrastructure costs and lower than anticipated premium volume attributable to delays in licensing.
OFC Capital, the commercial leasing division of Financial, was sold on December 31, 2005. As a result of managements decision in the fourth quarter of 2004 to sell OFC Capital, a significant portion
28
of the portfolio was syndicated in 2004, and new lease production was limited in 2005, creating a significant reduction in leasing income for 2005 of 46.9%. In addition, the change in interest rates during the year increased interest expense 12.9%. Results were also negatively impacted by additional bad debt reserves established in the commercial lease portfolio. The net loss for OFC Capital for the year was $2.2 million. No gain or loss was recognized on the sale and all revenue and expenses are included in continuing operations instead of discontinued operations due to the Companys significant continuing involvement with MidCountry. The Company retained a small portion of the commercial lease portfolio which OFC Servicing Corporation will service. All of the results of operations relating to the retained portfolio activities will continue to be reported in this segment.
Loan operations in Financial continue to grow with a 12.3% increase in the loan portfolio, an increase in the loan portfolio yield to 7.41% from 6.89%, and a delinquency ratio of only 1.44%. Interest rate increases during the year reduced margins slightly. Equity in net earnings (after internal capital charge) of MidCountry increased 113.7% for the year while the carrying value increased 3.6%. These components of Financial produced net income of $3.1 million for the year.
ABC had an operating loss of $931 thousand for 2005 as a result of recognition of a deferred tax asset and subsequent charge to earnings for the change in the deferred tax asset.
2004 Compared to 2003
Noninsurance operations were down 47% due primarily to unfavorable results in the finance subsidiary. Collateral loans grew by 10.4% to $110.8 million at December 31, 2004 while the yield on the portfolio increased 59 basis points in 2004. The commercial lease portfolio decreased by 31.0% to $81.3 million at December 31, 2004 as the commercial leasing division sold portions of its portfolio. Commercial lease operations experienced a decrease in earnings of approximately $2.5 million after reserves were established related to the Chapter 7 bankruptcy filing of NorVergence, a telecommunications provider who previously supplied essential services to approximately 340 of the Companys leasing customers. In addition, the finance subsidiarys investment in MidCountry yielded pretax income of approximately $540,000 during 2004 compared to $965,000 in 2003. This decline is attributable to acquisition activity and stock offering expenses incurred in 2004 by MidCountry as well as interest costs associated with the additional investment of $36.1 million by the finance subsidiary. Operating income from the Companys subsidiary covering certain employee benefits increased by approximately $1.1 million to $1.25 million in 2004. The sales of the Companys real estate and construction subsidiaries in February 2004 created unfavorable earnings comparisons since these business units incurred losses of approximately $47,000 prior to their dispositions in 2004 compared to earnings of approximately $364,000 during 2003.
CORPORATE
The following discussion relates to the Companys corporate operations and intercompany profit eliminations between the Company and its subsidiaries.
2005 Compared to 2004
Corporate expenses, including the impact of eliminations, increased $2.0 million in 2005 due primarily to an increase in borrowing costs and the elimination of profits generated by transactions between the property casualty segment and Vision. Unfavorable increases in short-term interest rates and an increase in the commercial paper borrowings attributable to corporate functions and the purchase of Vision led the Companys interest expense to rise by approximately $1.9 million from levels experienced in 2004. The weighted average rate increased from 2.3% to 4.3% with corporate debt increasing from $58.1 million at the end of 2004 to $77.6 million on December 31, 2005.
29
2004 Compared to 2003
Corporate expense increased approximately $2.9 million, or 162.7% in 2004 primarily due to higher auditing and legal expenses compounded by negative comparisons created by a favorable adjustment made to reserves for employee benefit costs of $1.7 million in 2003. In addition, interest expense on short-term borrowings increased by $265,000 as interest rates climbed during 2004. The weighted average rate increased from 1.2% to 2.3% with corporate debt increasing from $52.6 million at the end of 2003 to $58.1 million on December 31, 2004.
INVESTMENTS
The Company has historically produced positive cash flow from operations which has resulted in increasing amounts of funds available for investment and, consequently, higher investment income. Investment income is also affected by investment yields. Information about cash flows, invested assets and yields are presented below for the years ended December 31, 2005, 2004 and 2003:
Years Ended December 31, | |||||||||
2005 | 2004 | 2003 | |||||||
Increase (decrease) in cash flow from operations |
(8.6 | )% | 31.6 | % | 7.0 | % | |||
Increase in invested assets since January 1, 2005 and 2004 |
7.9 | % | 5.3 | % | 8.8 | % | |||
Investment yield rate |
6.0 | % | 6.0 | % | 6.0 | % | |||
Increase in net investment income |
6.2 | % | 7.5 | % | (5.7 | )% |
As a result of the overall positive cash flows from operations, invested assets grew 7.9% since December 31, 2004 while net investment income increased 6.2%. The decrease in cash flow from operations in 2005 was due primarily to the increase in liabilities from higher partnership commitments in 2004 offset by increases in policy liabilities impacted by catastrophes during 2005. Property casualty underwriting income of $55.9 million in 2005, $50.2 million in 2004 and $35.2 million in 2003 positively impacted cash flow from operations. In addition, the COLI plan in the life insurance subsidiary provided approximately $15 million in additional cash flow in 2005, $15 million in 2004 and $16 million in 2003. Net increases in cash resulting from increased borrowings were primarily used to support growth in the loan portfolio of the finance subsidiary and to fund a portion of the acquisition costs of Vision. During 2005, the Company also increased its investment in fixed maturity securities by approximately $89.5 million. The Companys increase in net investment income resulted primarily from earnings on fixed maturities, equity-method investments and partnerships offset by increased borrowing costs and lower lease revenues.
The overall yield rate, calculated using amortized cost, remained unchanged during 2005 at 6.0%. The Company had net realized investment gains before income taxes of approximately $6.1 million in 2005 compared to realized investment gains of approximately $7.0 million during 2004. These gains are primarily from sales of equity securities. Such realized gains on sales of equity securities are the result of market conditions and therefore can fluctuate from period to period.
30
The composition of the Companys investment portfolio is as follows at December 31, 2005 and 2004:
December 31, | ||||||
2005 | 2004 | |||||
Fixed maturities |
||||||
Taxable |
||||||
Mortgage-backed (CMOs) |
31.3 | % | 34.0 | % | ||
Corporate bonds |
23.5 | 21.7 | ||||
Total taxable |
54.8 | 55.7 | ||||
Tax exempts |
16.1 | 17.3 | ||||
Total fixed maturities |
70.9 | 73.0 | ||||
Equity securities |
5.4 | 5.4 | ||||
Policy loans |
3.1 | 3.1 | ||||
Collateral loans |
6.2 | 6.0 | ||||
Commercial leases |
0.1 | 0.3 | ||||
Other long-term investments |
3.1 | 3.6 | ||||
Other long-term investments in affiliates |
7.0 | 4.2 | ||||
Short-term investments |
4.2 | 4.4 | ||||
Total |
100.0 | % | 100.0 | % | ||
The majority of the Companys investment portfolio consists of fixed maturities that are diverse as to both industry and geographic concentration. In 2005, the overall mix of investments shifted with rising interest rates reducing unrealized gains within the fixed maturity portfolio and the Company increasing other long-term investments in affiliates by $55.5 million as a result of the sale of OFC Capital.
The rating of the Companys portfolio of fixed maturities using the Standard & Poors rating categories is as follows at December 31, 2005 and 2004:
December 31, | ||||||
2005 | 2004 | |||||
AAA to A- |
90.8 | % | 92.8 | % | ||
BBB+ to BBB- |
7.3 | 6.8 | ||||
BB+ and below (below investment grade) |
1.9 | 0.4 | ||||
100.0 | % | 100.0 | % | |||
At December 31, 2005, all securities in the fixed maturity portfolio were rated by an outside rating service. The Company considers bonds with a quality rating of BB+ and below to be below investment grade or high yield bonds (also called junk bonds).
At December 31, 2005, approximately 44.1% of fixed maturities were mortgage-backed securities. Such securities are comprised of Collateral Mortgage Obligations (CMOs) and pass through securities. Based on reviews of the Companys portfolio of mortgage-backed securities, the impact of prepayment risk on the Companys financial position and results from operation is not believed to be significant. These risks are discussed in more detail in Item 7A of this Form 10-K. At December 31, 2005, the Companys total portfolio of fixed maturities had gross unrealized gains of $38.3 million and gross unrealized losses of $13.4 million. All securities are priced by nationally recognized pricing services or by broker/dealers securities firms. During 2005, the Company sold approximately $108.4 million in fixed maturities available for sale. These sales resulted in gross realized gains of $426,899 and gross
31
realized losses of $2,231,672. During 2004, the Company sold approximately $61.4 million in fixed maturities available for sale. These sales resulted in gross realized gains of $391,408 and gross realized losses of $952,108.
The Company monitors its level of investments in high yield fixed maturities and its level of equity investments in companies that issue high yield debt securities. Management believes the level of such investments is not significant to the Companys financial condition. At December 31, 2005, the Company had unrealized gains in such investments of approximately $134,000 compared to approximately $3.5 million at December 31, 2004. The Company recognized a net gain of $80,256 on the disposal of high yield debt securities in 2005 after recognizing a net loss of $151,375 on similar disposals in 2004.
It is the Companys policy to write down securities for which declines in value have been deemed to be other than temporary. The amount written down represents the difference between the cost or amortized cost and the fair value at the time of determining the security was impaired. Quarterly reviews are conducted by the Company to ascertain which securities, if any, have become impaired in value. Investments in securities entail general market risk as well as company specific risk. During 2005, the Company wrote down three bond issues totaling $1,046,867 and five equity securities totaling $1,004,197 for which declines in value were deemed to be other than temporary. During 2004, the Company wrote down one bond issue totaling $111,279 for which its decline in value was deemed to be other than temporary. There were no non-performing bonds included in the portfolio at either December 31, 2005 or December 31, 2004.
Of the Companys approximately $13.4 million in gross unrealized losses on fixed maturities available for sale, $10.2 million or 75.9% are related to mortgage-backed securities, $2.1 million or 15.6% to obligations of United States government corporations and agencies, $583,000 or 4.4% to corporate securities, $461,000 or 3.4% to obligations of states and political subdivisions and $96,000 or 0.7% to United States treasury securities. At December 31, 2005, unrealized losses of approximately $3.2 million existed on equity securities directly owned by the Company. Of this amount, the greatest concentrations of gross unrealized losses were in the healthcare, information technology and consumer discretionary sectors where the Company had losses of approximately $1.1 million, $563,000 and $481,000, respectively. In assessing each security, the Company analyzes the industry and earnings trends of the underlying issuer, the length of time the security has continuously been in a loss position, and the magnitude of the loss in comparison to its cost. Generally, the Company writes down securities that have been continuously in a loss position of at least 20% for six consecutive months. In addition, management reviews the underlying causes for any significant loss position within the debt securities to determine if the item is impaired. Due to the subjectivity of the writedown process, there are risks and uncertainties that could impact the Companys future earnings and financial position. If recoveries in the price of securities fail to materialize, the Companys earnings and financial position will be negatively impacted. The Companys investment philosophy is one that generally looks for long-range growth based on the Companys willingness and ability to hold investments for extended periods of time.
Six equity securities had experienced a reduction in value of at least 20% in value at the end of 2005. Of these equity securities in loss positions, $413,849 of the losses had been in loss positions for less than three months and $468,715 of the losses had been in loss positions for longer than three months but less than six months. No fixed maturity had experienced a reduction in value of at least 20% at the end of 2005. The Companys general practice is to re-evaluate any security written down on a periodic basis in order to determine whether additional impairment has occurred.
At December 31, 2005, the Company held below investment grade fixed maturities with a cost of $27,806,121 and a fair value of $27,878,697. While these securities represent 2.0% of both the cost and fair value of the Companys total fixed maturity portfolio, only three of these investments were in an unrealized loss position. Additionally, at December 31, 2005, the Company owned equity securities
32
that have issued junk bonds with a cost of $7,202,891 and a fair value of $7,264,420. These securities had gross unrealized gains of $562,639 and gross unrealized losses of $501,110 at the end of the year. These unrealized losses comprised less than 0.5% of the total fair value and 13.9% of the total gross unrealized losses from equity securities for the Company at December 31, 2005.
The table below shows a breakdown of the unrealized losses on fixed maturities at December 31, 2005 based on the maturity date of each.
Gross Unrealized Loss | |||
Less than 1 year |
$ | 637 | |
Between 1 and 3 years |
225,850 | ||
Between 3 and 5 years |
726,713 | ||
Between 5 and 10 years |
1,655,434 | ||
Between 10 and 20 years |
2,266,242 | ||
Over 20 years |
8,528,316 | ||
$ | 13,403,192 | ||
Of the fixed maturities experiencing declines in value at December 31, 2005, none was in a loss position of over $500,000. Of the equity securities directly owned by the Company with unrealized losses at December 31, 2005, eleven were in a loss position of over $100,000. Of these securities, three securities are part of the healthcare sector, three securities are part of the consumer discretionary sector, two securities are part of the industrials sector, one security is part of the energy sector, one security is part of the materials sector and one security is part of the technology sector. These securities cumulatively represented 14.6% of the fair value of equity securities at December 31, 2005 and a 12.4% decline from cost.
The Companys investment in collateral loans and commercial leases consists primarily of consumer loans and commercial leases originated by the finance subsidiary. The majority of the commercial lease portfolio was reclassified to Assets Classified as Held for Sale at December 31, 2004 and subsequently sold in the fourth quarter of 2005. Automobiles, equipment and other property collateralize the Companys loans and leases. At December 31, 2005, the delinquency ratio on the loan portfolio was 1.44%, or $1.8 million. Loans charged off in 2005 totaled $422,288. At December 31, 2005, the Company maintained an allowance for loan losses of $1,406,871 or approximately 1.1% of the outstanding loan balance. In addition, at December 31, the Company maintained an allowance for lease losses of $8,083,758 or approximately 83.2% of the outstanding lease balance. Leases charged off in the same period were $1,415,578. Other significant long-term investments include assets leased under operating leases, partnership investments and other equity-method investments.
The Company periodically invests in affordable housing tax credit partnerships. At December 31, 2005, the Company had legal and binding commitments to fund partnerships of this type in the amount of approximately $23.5 million. The Companys carrying value of such investments was $43.0 million at December 31, 2005.
During the third quarter of 2002, the Companys finance subsidiary invested $13.5 million in MidCountry, a financial services holding company. Financial invested an additional $36.1 million in MidCountry during the fourth quarter of 2004 to maintain its approximate original ownership in the entity. Financial accounts for earnings from MidCountry using the equity method of accounting. Pretax operating income was approximately $1.2 million in 2005 compared to approximately $540,000 in 2004.
INCOME TAXES
The effective tax rate was 28.2% in 2005, 25.9% in 2004 and 26.4% in 2003. The increase in the effective tax rate in 2005 from 2004 is due to increases in income before the provision for income
33
taxes as compared to the relative mix of taxable income versus tax-exempt income. In addition, 1.2% of the increase is related to the recognition of a deferred tax asset and the subsequent charge to income tax expense for the change in this deferred tax asset arising from the formation of Alfa Benefits Corporation in 1999. The slight decrease in effective tax rate in 2004 when compared to 2003 is due primarily to an increase in investments generating affordable housing tax credits.
IMPACT OF INFLATION
Inflation increases consumers needs for both life and property casualty insurance coverage. Inflation increases claims incurred by property casualty insurers as property repairs, replacements and medical expenses increase. Such cost increases reduce profit margins to the extent that rate increases are not maintained on an adequate and timely basis. Since inflation has remained relatively low in recent years, financial results have not been significantly impacted by inflation.
LIQUIDITY AND CAPITAL RESOURCES
The Company receives funds from its subsidiaries consisting of dividends, payments for funding federal income taxes, and reimbursement of expenses incurred at the corporate level for the subsidiaries. These funds are used for paying dividends to stockholders, corporate interest and expenses, federal income taxes, and for funding additional investments in its subsidiaries operations.
The Companys subsidiaries require cash in order to fund policy acquisition costs, claims, other policy benefits, interest expense, general operating expenses, and dividends to the Company. The major sources of the subsidiaries liquidity are operations and cash provided by maturing or liquidated investments. A significant portion of the Companys investment portfolio consists of readily marketable securities that can be sold for cash. Based on a review of the Companys matching of asset and liability maturities and on the interest sensitivity of the majority of policies inforce, management believes the ultimate exposure to loss from interest rate fluctuations is not significant.
In evaluating current and potential financial performance of any corporation, investors often wish to view the contractual obligations and commitments of the entity. The Company has a limited number of contractual obligations in the form of long-term debt and leases. These leases have primarily been originated by its insurance subsidiaries and Vision. Operating leases supporting the corporate operations are the responsibility of Mutual. In turn, the Company reimburses Mutual monthly for a portion of these and other expenses based on a management and operating agreement. There are currently no plans to change the structure of this agreement.
The Companys contractual obligations at December 31, 2005 are summarized below:
Payments Due by Period | |||||||||||||||
Total | Less than 1 year | 1-3 years | 4-5 years | After 5 years | |||||||||||
Operating leases |
$ | 3,999,378 | $ | 1,172,572 | $ | 1,795,471 | $ | 1,031,335 | $ | | |||||
Capital lease obligations |
146,216 | 124,858 | 21,358 | | | ||||||||||
Unconditional purchase obligations |
| | | | | ||||||||||
Notes payable to affiliates |
20,887,635 | 20,887,635 | | | | ||||||||||
Long-term debt |
70,000,000 | | | | 70,000,000 | ||||||||||
Other long-term obligations |
| | | | | ||||||||||
Total contractual obligations |
$ | 95,033,229 | $ | 22,185,065 | $ | 1,816,829 | $ | 1,031,335 | $ | 70,000,000 | |||||
34
The Company maintains a variety of funding agreements in the form of lines of credit with affiliated entities. The chart below depicts, at December 31, 2005, the cash outlay by the Company representing the potential full repayment of lines of credit it has outstanding with others. Also included with the amounts shown as lines of credit are the potential amounts the Company would have to supply to other affiliated entities if they made full use of their existing lines of credit during 2006 with the Companys finance subsidiary. Other commercial commitments of the Company shown below include commercial paper outstanding, scheduled fundings of partnerships, potential performance payouts related to Vision and funding of a policy administration system project of the life subsidiary.
Amount of Commitment Expiration Per Period | |||||||||||||||
Total Amounts Committed |
Less than 1 year | 1-3 years | 4-5 years | After 5 years | |||||||||||
Lines of credit |
$ | 43,137,635 | $ | 22,250,000 | $ | | $ | 20,887,635 | $ | | |||||
Standby letters of credit |
75,000 | 75,000 | | | | ||||||||||
Guarantees |
2,229,248 | 200,000 | | 636,016 | 1,393,232 | ||||||||||
Standby repurchase obligations |
| | | | | ||||||||||
Other commercial commitments |
266,325,626 | 245,259,699 | 14,888,259 | 3,426,734 | 2,750,934 | ||||||||||
Total commercial commitments |
$ | 311,767,509 | $ | 267,784,699 | $ | 14,888,259 | $ | 24,950,385 | $ | 4,144,166 | |||||
Certain commercial commitments in the table above include items that may, in the future, require recognition within the financial statements of the Company. Events leading to the call of a guarantee, the failure of the policy administration system being developed for use by the life insurance operations to perform properly and achievement of specific metrics by Vision are examples of situations that would impact the financial position and results of the Company.
Net cash provided by operating activities approximated $132 million, $144 million, and $110 million in 2005, 2004 and 2003, respectively. Such net positive cash flows provide the foundation of the Companys assets/liability management program and are the primary drivers of the Companys liquidity. As previously discussed, the Company also maintains a diversified portfolio of fixed maturity and equity securities that provide a secondary source of liquidity should net cash flows from operating activities prove inadequate to fund current operating needs. Management believes that such an eventuality is unlikely given the Companys product mix (primarily short-duration personal lines property casualty products), its ability to adjust premium rates (subject to regulatory oversight) to reflect emerging loss and expense trends and its catastrophe reinsurance program, amongst other factors.
Assessment of credit risk is a critical factor in the Companys consumer loan and commercial leasing subsidiary. All credit decisions are made by personnel trained to limit loss exposure from unfavorable risks. In attempting to manage risk, the Company regularly reviews delinquent accounts and adjusts reserves for potential loan losses and potential lease losses. To the extent these reserves are inadequate at the time an account is written off, income would be negatively impacted. In addition, the Company monitors interest rates relative to the portfolio duration. Rising interest rates on commercial paper issued, the primary source of funding portfolio growth, could reduce the interest rate spread if the Company failed to adequately adjust interest rates charged to customers.
Total borrowings increased approximately $14.5 million in 2005 to $304.7 million. The majority of the short-term debt is commercial paper issued by the Company. At December 31, 2005, the Company had approximately $213.8 million in commercial paper at rates ranging from 4.24% to 4.33% with maturities ranging from January 9, 2006 to January 23, 2006. The Company intends to continue to use the commercial paper program as a major source to fund the consumer loan portfolio and other corporate short-term needs. Backup lines of credit are in place up to $300 million. The backup lines
35
agreements contain usual and customary covenants requiring the Company to meet certain operating levels. The Company has maintained full compliance with all such covenants. The Company has A-1+ and P-1 commercial paper ratings from Standard & Poors and Moodys Investors Service, respectively. The commercial paper is guaranteed by two affiliates, Mutual and Fire. In addition, the Company had $20.9 million in short-term debt outstanding to affiliates at December 31, 2005 with interest payable monthly at rates established using the existing commercial paper rate and renewable for multiples of 30-day periods at the commercial paper rate then applicable.
Included in total borrowings is a variable rate note issued by the Company during the second quarter of 2002 in the amount of $70 million. This note is payable in its entirety on June 1, 2017 with interest payments due monthly. The Company is using the proceeds of this note to partially fund the consumer loan and commercial lease portfolios of its finance subsidiary. The Company has entered into an interest rate swap contract in order to achieve its objective of hedging 100 percent of its variable-rate long-term interest payments over the first five years of the note. Under the interest rate swap, the Company receives variable interest payments and makes fixed interest rate payments, thereby fixing the rate on such debt at 4.945%.
On October 25, 1993, the Company established a Stock Option Plan (the 1993 Plan), pursuant to which a maximum aggregate of 4,000,000 shares of common stock have been reserved for grant to key personnel. On April 26, 2001, the 1993 Plan was amended to increase the maximum aggregate number of shares available for grant to 6,400,000 shares. Under the 1993 Plan, options ratably become exercisable annually over three years and may not be exercised after ten years from the date of the award. At December 31, 2005, there had been 2,850,815 options exercised, 2,027,410 options were exercisable and 366,331 had been forfeited or expired. During February 2005, the Company issued 427,000 nonqualified options under this plan. The authority to grant the remaining 442,531 shares under the 1993 Plan was terminated on April 28, 2005 by the stockholder approval of the Alfa Corporation 2005 Amended and Restated Stock Incentive Plan (the Plan).
On February 28, 2005, the Company granted 52,000 awards of restricted stock to certain officers, subject to the approval of the Plan by the stockholders at the Companys annual meeting. On June 1, 2005, the Company granted 24,500 awards of restricted stock to certain officers based on specific target levels of ownership at May 31, 2005 of Company common stock by those officers. During July 2005, the Company issued 2,000 nonqualified options under the Plan.
In October 1989, the Companys Board of Directors approved a stock repurchase program authorizing the repurchase of up to 4,000,000 shares of its outstanding common stock in the open market or in negotiated transactions in such quantities and at such times and prices as management may decide. The Board increased the number of shares authorized for repurchase by 4,000,000 in both March 1999 and September 2001, bringing the total number of shares authorized for repurchase to 12,000,000. During 2005, the Company repurchased 219,000 shares at a cost of $2,960,751 (refer to Part II, Item 5Purchases of Equity Securities by the Issuer and Affiliated Purchases). At December 31, 2005, the total repurchased was 8,266,623 shares at a cost of $65,383,384. The Company has reissued 2,850,815 treasury shares as a result of option exercises and sold 1,607,767 shares through funding its dividend reinvestment plan. In January 2005, the Company issued 325,035 non-registered shares to fund a portion of the acquisition of Vision.
All share information presented in this section has been adjusted to reflect the impact of the two-for-one stock split effected in the form of a 100% stock dividend that was paid on June 17, 2002.
Due to the sensitivity of the products offered by the life subsidiary to interest rates fluctuations, the Company must assess the risk of surrenders exceeding expectations factored into its pricing program. Internal actuaries are used to determine the need for modifying the Companys policies on surrender charges and assessing the Companys competitiveness with regard to rates offered. Cash surrenders paid
36
to policyholders on a statutory basis totaled $17.1 million in both 2005 and 2004. This level of surrenders is within the Companys pricing expectations. Historical persistency rates indicate a normal pattern of surrender activity in 2005, 2004 and 2003. The structure of the surrender charges is such that persistency is encouraged. The majority of the policies inforce have surrender charges which grade downward over a 12 to 15 year period. At December 31, 2005, the total amount of cash that would be required to fund all amounts subject to surrender was approximately $649.8 million.
The Companys business is concentrated geographically in Alabama, Georgia and Mississippi. Accordingly, unusually severe storms or other disasters in these contiguous states might have a more significant effect on the Companys financial condition and operating results than on a more geographically diversified insurance company. However, the Companys catastrophe protection program, which began November 1, 1996, reduced the potential adverse impact and earnings volatility caused by such catastrophe exposures.
The Companys management uses estimates in determining loss reserves for inclusion in its financial statements. Internal actuaries conduct periodic reviews to determine a range of reasonable loss reserves. In addition, the Companys catastrophe protection program, which began November 1, 1996, was established to address the economics of catastrophe finance. This plan limits the Companys exposure to catastrophes, which might otherwise deplete the Companys surplus, through the sharing of catastrophe losses within the Alfa Group (refer to Note 2Pooling Agreement in the Notes to Consolidated Financial Statements). In addition, the Company supplements this plan with the purchases of reinsurance coverage from external reinsurers.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; therefore, allowances are established if amounts are determined to be uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurance to minimize exposure to significant losses from reinsurer insolvencies. At December 31, 2005, the Company does not believe there to be a significant concentration of credit risk related to its reinsurance program.
Lawsuits brought by policyholders or third-party claimants can create volatility in the Companys earnings. The Company maintains in-house legal staff and, as needed, secures the services of external legal firms to present and protect its position. Certain legal proceedings are in process at December 31, 2005. These proceedings involve alleged breaches of contract, torts, including bad faith and fraud claims, and miscellaneous other causes of action. These lawsuits involve claims for unspecified amounts of compensatory damages, mental anguish damages and punitive damages. Costs for these and similar proceedings, including accruals for outstanding cases, are included in the financial statements of the Company. Management periodically reviews reserves established to cover potential costs of litigation including legal fees and potential damage assessments and adjusts them based on their best estimates. It should be noted that in Mississippi and Alabama, where the Company has substantial business, the likelihood of a judgment in any given suit, including a large mental anguish and/or punitive damage award by a jury, bearing little or no relation to actual damages, continues to exist, creating the potential for unpredictable material adverse financial results.
Increased public interest in the availability and affordability of insurance has prompted legislative, regulatory and judicial activity in several states. This includes efforts to contain insurance prices, restrict underwriting practices and risk classifications, mandate rate reductions and refunds, eliminate or reduce exemptions from antitrust laws and generally expand regulation. Because of Alabamas low automobile rates as compared to rates in most other states, the Company does not expect the type of punitive legislation and initiatives found in some states to be a factor in its primary market in the immediate future. In 1999, the Alabama legislature passed a tort reform package that has helped to curb some of the excessive litigation experienced in the late 1990s.
37
FINANCIAL ACCOUNTING DEVELOPMENTS
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-based Compensation. SFAS 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees and non-employees, including grants of stock options, to be recognized in the income statement based on fair value at grant date. Pro forma disclosure will no longer be an alternative.
SFAS 123(R) originally required adoption no later than July 1, 2005. In April 2005, the Securities and Exchange Commission (SEC) issued a release that amends the compliance dates for SFAS 123(R). Under the SECs new rule, the Company will be required to apply SFAS 123(R) as of January 1, 2006.
SFAS 123(R) permits public companies to adopt its requirement using one of two methods:
| A modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date. |
| A modified retrospective method which includes the requirements of the modified prospective method described above, but also permits entities to restate, based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures, either (a) all prior periods presented or (b) prior interim periods of the year of adoption. |
The Company will adopt SFAS 123(R) using the modified prospective method.
As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using the intrinsic value method described in APB Opinion No. 25 and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123(R)s fair value method will impact the Companys results of operations, although it will have no impact on the Companys overall financial position. The Company will share compensation cost with Mutual based on the Management and Operating Agreement (refer to Note 3Related Party Transactions in the Notes to Consolidated Financial Statements). The total impact of SFAS 123(R) on 2006 results of operations for Alfa is expected to be $2.5 million, with $1.6 million allocated to the Company, based on historical levels of activity.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions. This statement requires that exchanges of nonmonetary assets be measured based on fair value and eliminates the exception for exchanges of nonmonetary, similar productive assets, and adds an exemption for nonmonetary exchanges that do not have commercial substance. SFAS No. 153 was effective for nonmonetary asset exchanges in periods beginning after June 15, 2005. This statement has not had a significant impact on the Companys financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement for APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. This statement changes the requirements for the accounting for and reporting of a change in accounting principle. It applies to all voluntary changes in accounting principle as well as to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires voluntary
38
changes in accounting principles be recognized retrospectively to financial statements for prior periods, rather than recognition in the net income of the current period. Retrospective application requires restatements of prior period financial statements as if that accounting principle had always been used. This statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. The provisions of SFAS No. 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
In June 2005, the FASB issued a final FASB Staff Position (FSP) EITF 03-1-a (retitled FSP FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments) which will replace the guidance set forth in paragraphs 10-18 of EITF Issue No. 03-1 and clarifies when an investor should recognize an impairment loss. The provisions of FSP FAS 115-1 are effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. This staff position has not had a significant impact on the Companys financial position or results of operations.
In June 2005, the FASB ratified the consensus on EITF Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights. This Issue affects accounting by general partners evaluating whether to consolidate limited partnerships. The EITF agreed on a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate. The presumption of general-partner control would be overcome only when the limited partners have either kick-out rights or participating rights. This guidance was effective after June 29, 2005 for all new limited partnerships formed and for existing limited partnership agreements for which the partnership agreements are modified. For general partners in all other limited partnerships, the guidance in this Issue is effective no later than the beginning of the first reporting period in fiscal years beginning after December 31, 2005, and application of either one of two transition methods described in the Issue would be acceptable. During the fourth quarter of 2005, two limited partnerships in which the Companys life subsidiary has been a general partner with one percent ownership interests were modified to become general partnerships. Consequently, the Company expects EITF Issue No. 04-5 to continue to have no significant impact on the Companys financial position and results of operations.
In addition, the FASB issued FASB Staff Position (FSP) SOP 78-9-1, Interaction of AICPA Statement of Position 78-9 and EITF Issue No. 04-5 in June 2005. The guidance in this FSP was effective after June 29, 2005 for general partners of all new partnerships formed and for existing partnerships for which the partnership agreements are modified. For general partners in all other partnerships, the guidance in this FSP is effective no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005, and the application of either transition method as described in the FSP is permitted.
In August 2005, the FASB issued FSP Financial Accounting Standard (FAS) 123(R)-1, Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R). This staff position defers the requirement under SFAS No. 123(R) that a freestanding financial instrument become subject to the recognition and measurement requirements of other applicable generally accepted accounting principles when the rights conveyed by the instrument to the holder are no longer dependent on the holder being an employee of the entity. The Company does not anticipate that this staff position will have a significant impact on its financial position or results of operations at the time SFAS No. 123(R) is adopted.
During the fourth quarter of 2005, the FASB also issued three other staff positions applicable at the time the Company adopts SFAS No. 123(R). They are FSP FAS 123(R)-2, Practical Accommodation to the Application of Grant Date As Defined in FASB Statement No. 123(R); FSP FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards; and FSP
39
FAS 123(R)-4, Classification of Options and Similar Instruments Issued As Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event. The Company does not anticipate that these staff positions will have a significant impact on its financial position or results of operations at the time SFAS No. 123(R) is adopted.
In September 2005, the American Institute of Certified Public Accountants issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. This statement provides guidance on accounting for deferred acquisition costs on an internal replacement, defined as a modification in product benefits, rights, coverages, or features that occurs by the exchange of an existing contract for a new contract, or by amendment, endorsement, or rider to an existing contract, or by the election of a benefit, right, coverage, or feature within an existing contract. The guidance in this pronouncement is effective for fiscal years beginning after December 15, 2006. The Company plans to adopt this statement for internal replacements beginning January 1, 2007. Due to its recent issuance, the Company is still assessing the impact this statement will have on its financial position or results of operations.
In November 2005, the FASB issued FSP Nos. FAS 115-1 and 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment. The FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in the FSP amends SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. The Company has reviewed the guidance of FSP Nos. FAS 115-1 and 124-1 and has determined that the adoption of the FSP on January 1, 2006 will not have a significant impact on the Companys financial position or results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Companys objectives in managing its investment portfolio are to maximize investment income and investment returns while minimizing overall credit risk. Investment strategies are developed based on many factors including underwriting results, overall tax position, regulatory requirements, and fluctuations in interest rates. Investment decisions are made by management and approved by the Board of Directors. Market risk represents the potential for loss due to adverse changes in the fair value of securities. The market risk related to the Companys fixed maturity portfolio is primarily interest rate risk and prepayment risk. The market risk related to the Companys equity portfolio is equity price risk.
Interest Rate Risk
The Companys fixed maturity investments and borrowings are subject to interest rate risk. Increases and decreases in interest rates typically result in decreases and increases in the fair value of these financial instruments.
The Companys fixed maturity portfolio is invested predominantly in high quality corporate, mortgage-backed, government agency and municipal bonds. The portfolio has an average effective duration of 4.74 years and an average quality rating of AA1. The changes in the fair value of the fixed maturity available for sale portfolio are presented as a component of stockholders equity in accumulated other comprehensive income, net of taxes.
The Company works to manage the impact of interest rate fluctuations on its fixed maturity portfolio. The effective duration of the portfolio is managed to diversify its distribution. This duration distribution, as well as the portfolios moderate duration, serves to curb the impact of large swings in interest rates on the fixed maturity portfolio.
40
The estimated fair value of the Companys investment portfolio at December 31, 2005 was $2.0 billion, 70.8% of which was invested in fixed maturities, 5.3% in equity securities, 6.5% in collateral loans, 0.1% in commercial leases, 4.2% in short-term investments and 13.1% in other long-term investments.
The table below summarizes the Companys interest rate risk and shows the effect of a hypothetical change in interest rates as of December 31, 2005. The selected hypothetical changes do not indicate what would be the potential best or worst-case scenarios.
(dollars in thousands) | Estimated Fair Value at December 31, 2005 |
Estimated Change in Interest Rate (bp=basis points) |
Estimated Fair Value After Hypothetical Change in Interest Rate |
Hypothetical Percentage Increase (Decrease) in Stockholders Equity |
|||||||
FIXED MATURITY INVESTMENTS |
|||||||||||
U.S. Treasury Securities |
$ | 182,687 | 200 bp decrease | $ | 192,124 | 0.6 | % | ||||
and obligations of U.S. |
100 bp decrease | 188,152 | 0.4 | ||||||||
government corporations |
100 bp increase | 174,106 | (0.6 | ) | |||||||
and agencies |
200 bp increase | 164,713 | (1.2 | ) | |||||||
Tax-exempt obligations of |
$ | 322,431 | 200 bp decrease | $ | 360,266 | 3.8 | % | ||||
states, municipalities and |
100 bp decrease | 341,266 | 1.9 | ||||||||
political subdivisions |
100 bp increase | 302,367 | (2.0 | ) | |||||||
200 bp increase | 281,313 | (4.1 | ) | ||||||||
Mortgage-backed securities |
$ | 626,295 | 200 bp decrease | $ | 652,171 | 1.7 | % | ||||
100 bp decrease | 644,313 | 1.2 | |||||||||
100 bp increase | 589,693 | (2.4 | ) | ||||||||
200 bp increase | 542,802 | (5.4 | ) | ||||||||
Corporate, taxable municipal |
$ | 288,389 | 200 bp decrease | $ | 318,947 | 2.0 | % | ||||
and other debt securities |
100 bp decrease | 303,020 | 1.0 | ||||||||
100 bp increase | 274,607 | (0.9 | ) | ||||||||
200 bp increase | 261,509 | (1.7 | ) | ||||||||
TOTAL FIXED MATURITY |
$ | 1,419,802 | 200 bp decrease | $ | 1,523,508 | 6.7 | % | ||||
INVESTMENTS |
100 bp decrease | 1,476,751 | 3.7 | ||||||||
100 bp increase | 1,340,773 | (5.1 | ) | ||||||||
200 bp increase | 1,250,337 | (11.0 | ) | ||||||||
COLLATERAL LOANS |
$ | 130,284 | 200 bp decrease | $ | 135,667 | * | |||||
100 bp decrease | 134,032 | * | |||||||||
100 bp increase | 122,670 | * | |||||||||
200 bp increase | 112,915 | * | |||||||||
SHORT-TERM INVESTMENTS |
$ | 84,862 | 200 bp decrease | $ | 89,246 | * | |||||
100 bp decrease | 87,401 | * | |||||||||
100 bp increase | 80,876 | * | |||||||||
200 bp increase | 76,513 | * | |||||||||
LIABILITIES |
|||||||||||
4.24% to 4.33% Commercial Paper |
$ | 213,790 | 200 bp decrease | $ | 224,835 | * | |||||
100 bp decrease | 220,186 | * | |||||||||
100 bp increase | 203,749 | * | |||||||||
200 bp increase | 192,756 | * | |||||||||
Short-term Notes Payable |
$ | 20,888 | 200 bp decrease | $ | 21,967 | * | |||||
100 bp decrease | 21,512 | * | |||||||||
100 bp increase | 19,907 | * | |||||||||
200 bp increase | 18,833 | * |
* | Changes in estimated fair value have no impact on stockholders equity. |
41
Equity Price Risk
The Company invests in equity securities that have historically, over long periods of time, produced higher returns relative to fixed maturity investments. The Company seeks to invest at reasonable prices in companies with solid business plans and capable management. The Company intends to hold these investments over the long-term. This focus on long-term total investment returns may result in variability in the level of unrealized investment gains and losses from one period to the next. The changes in the estimated fair value of the equity portfolio are presented as a component of stockholders equity in accumulated other comprehensive income, net of taxes.
At December 31, 2005, the Companys equity portfolio was concentrated in terms of the number of issuers and industries. The Companys top ten equity holdings represented $28.0 million or 26.2% of the equity portfolio. Investments in the healthcare sector represented 19.4% while the combined financial holdings, energy, materials and consumer discretionary sectors represented 13.6%, 12.6%, 11.4% and 10.5%, respectively, of the equity portfolio. No other sector represented over 10% of the equity portfolio. Such concentration can lead to higher levels of short-term price volatility. Due to its long-term investment focus, the Company is not as concerned with short-term volatility as long as its subsidiaries ability to write business is not impaired.
The table below summarizes the Companys equity price risk and shows the effect of a hypothetical 20% increase and a 20% decrease in market prices as of December 31, 2005. The selected hypothetical changes do not indicate what could be the potential best or worst-case scenarios.
Estimated Fair Value of Equity Securities at December 31, 2005 |
Hypothetical Price Change |
Estimated Fair Value After Hypothetical Change in Prices |
Hypothetical Percentage Increase (Decrease) in Stockholders Equity |
|||||
(dollars in thousands) | ||||||||
$107,020 |
20% increase | $ | 128,424 | 2.8 | % | |||
20% decrease | $ | 85,616 | (2.8 | )% |
42
Item 8. Financial Statements and Supplementary Data.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
43
Report of Independent Registered Public Accounting Firm
on Consolidated Financial Statements
To the Stockholders and Board of Directors
Alfa Corporation:
We have audited the accompanying consolidated balance sheets of Alfa Corporation and subsidiaries (the Company) as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Companys internal control over financial reporting as of December 31, 2005, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 7, 2006, expressed an unqualified opinion on managements assessment of, and the effective operation of, internal control over financial reporting.
KPMG LLP
Birmingham, Alabama
March 7, 2006
44
Report of Independent Registered Public Accounting Firm
on Internal Control over Financial Reporting
The Stockholders and Board of Directors
Alfa Corporation:
We have audited managements assessment, included in the accompanying Report on Internal Control Over Financial Reporting, that Alfa Corporation and Subsidiaries (the Company) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A Companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alfa Corporation and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 7, 2006, expressed an unqualified opinion on those consolidated financial statements.
KPMG LLP
Birmingham, Alabama
March 7, 2006
45
CONSOLIDATED BALANCE SHEETS
December 31, | ||||||||
2005 | 2004 | |||||||
Assets |
||||||||
Investments: |
||||||||
Fixed Maturities Held for Investment, at amortized cost (fair value $93,578 in 2005 and $123,935 in 2004) |
$ | 88,330 | $ | 114,708 | ||||
Fixed Maturities Available for Sale, at fair value (amortized cost $1,394,823,078 in 2005 and $1,305,288,027 in 2004) |
1,419,708,095 | 1,354,507,490 | ||||||
Equity Securities Available for Sale, at fair value (cost $96,668,040 in 2005 and $83,445,562 in 2004) |
107,020,104 | 99,701,250 | ||||||
Policy Loans |
62,101,204 | 58,476,569 | ||||||
Collateral Loans |
124,667,449 | 110,792,974 | ||||||
Commercial Leases |
2,515,084 | 4,831,363 | ||||||
Other Long-Term Investments |
61,961,072 | 66,855,805 | ||||||
Other Long-Term Investments in Affiliates |
138,457,224 | 77,942,989 | ||||||
Short-Term Investments |
84,861,880 | 80,988,969 | ||||||
Total Investments |
2,001,380,442 | 1,854,212,117 | ||||||
Cash |
37,228,639 | 20,052,493 | ||||||
Accrued Investment Income |
16,912,488 | 16,726,050 | ||||||
Accounts Receivable |
72,622,465 | 50,447,800 | ||||||
Reinsurance Balances Receivable |
6,648,204 | 5,279,560 | ||||||
Deferred Policy Acquisition Costs |
204,253,919 | 183,258,224 | ||||||
Assets Classified as Held for Sale |
| 77,450,278 | ||||||
Goodwill |
13,924,306 | | ||||||
Other Intangible Assets (net of accumulated amortization of $683,400 in 2005) |
8,424,600 | | ||||||
Other Assets |
20,478,836 | 15,237,024 | ||||||
Total Assets |
$ | 2,381,873,899 | $ | 2,222,663,546 | ||||
Liabilities and Stockholders Equity |
||||||||
Policy Liabilities and AccrualsProperty Casualty Insurance |
$ | 159,639,886 | $ | 154,107,730 | ||||
Policy Liabilities and AccrualsLife Insurance Interest-Sensitive Products |
600,994,074 | 555,733,736 | ||||||
Policy Liabilities and AccrualsLife Insurance Other Products |
197,140,294 | 180,410,535 | ||||||
Unearned Premiums |
220,456,047 | 185,856,467 | ||||||
Dividends to Policyholders |
11,662,085 | 11,262,132 | ||||||
Premium Deposit and Retirement Deposit Funds |
5,741,071 | 6,369,125 | ||||||
Deferred Income Taxes |
29,118,958 | 43,070,818 | ||||||
Liabilities Associated with Assets Classified as Held for Sale |
| 340,876 | ||||||
Other Liabilities |
74,201,255 | 73,872,992 | ||||||
Due to Affiliates |
22,249,975 | 29,995,986 | ||||||
Commercial Paper |
213,790,443 | 204,303,206 | ||||||
Notes Payable |
70,000,000 | 70,000,000 | ||||||
Notes Payable to Affiliates |
20,887,635 | 15,887,635 | ||||||
Total Liabilities |
1,625,881,723 | 1,531,211,238 | ||||||
Commitments and Contingencies |
||||||||
Stockholders Equity : |
||||||||
Preferred Stock, $1 par value Shares authorized: 1,000,000 Issued: None |
| | ||||||
Common Stock, $1 par value Shares authorized: 110,000,000 Issued: 83,783,024 Outstanding: 80,284,018 in 2005 and 79,833,467 in 2004 |
83,783,024 | 83,783,024 | ||||||
Capital in Excess of Par Value |
21,171,462 | 10,961,782 | ||||||
Accumulated Other Comprehensive Income (unrealized gains on securities available for sale, net of tax, of $22,105,684 in 2005 and $39,450,553 in 2004; unrealized (losses) on interest rate swap contract, net of tax, of ($11,265) in 2005 and ($1,406,747) in 2004; unrealized gains/(losses) on other long-term investments, net of tax, of ($394,560) in 2005 and $16,565 in 2004) |
21,699,859 | 38,060,371 | ||||||
Retained Earnings |
667,535,056 | 599,609,509 | ||||||
Treasury Stock, at cost (shares, 3,499,006 in 2005 and 3,949,557 in 2004) |
(38,197,225 | ) | (40,962,378 | ) | ||||
Total Stockholders Equity |
755,992,176 | 691,452,308 | ||||||
Total Liabilities and Stockholders Equity |
$ | 2,381,873,899 | $ | 2,222,663,546 | ||||
See accompanying Notes to Consolidated Financial Statements.
46
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, | |||||||||
2005 | 2004 | 2003 | |||||||
Revenues |
|||||||||
PremiumsProperty Casualty Insurance |
$ | 556,438,727 | $ | 485,534,231 | $ | 454,453,266 | |||
PremiumsLife Insurance |
41,134,144 | 37,134,465 | 33,628,724 | ||||||
Policy ChargesLife Insurance |
35,499,178 | 34,089,930 | 32,543,328 | ||||||
Net Investment Income |
94,931,739 | 89,361,003 | 83,096,319 | ||||||
Realized Investment Gains |
6,050,873 | 7,048,654 | 6,263,619 | ||||||
Other Income |
22,849,897 | 8,123,307 | 9,831,374 | ||||||
Total Revenues |
756,904,558 | 661,291,590 | 619,816,630 | ||||||
Benefits, Losses and Expenses |
|||||||||
Benefits, Claims, Losses and Settlement Expenses |
432,856,310 | 390,061,548 | 364,599,459 | ||||||
Dividends to Policyholders |
4,009,119 | 3,873,932 | 3,761,720 | ||||||
Amortization of Deferred Policy Acquisition Costs |
108,723,470 | 90,454,509 | 86,475,442 | ||||||
Other Operating Expenses |
73,453,925 | 56,272,154 | 58,383,192 | ||||||
Total Benefits, Losses and Expenses |
619,042,824 | 540,662,143 | 513,219,813 | ||||||
Income Before Provision for Income Taxes |
137,861,734 | 120,629,447 | 106,596,817 | ||||||
Provision for Income Taxes |
38,827,981 | 31,184,488 | 28,127,869 | ||||||
Net Income |
$ | 99,033,753 | $ | 89,444,959 | $ | 78,468,948 | |||
Net Income Per Share |
|||||||||
Basic |
$ | 1.24 | $ | 1.12 | $ | 0.98 | |||
Diluted |
$ | 1.23 | $ | 1.11 | $ | 0.98 | |||
Weighted Average Shares Outstanding |
|||||||||
Basic |
80,141,068 | 79,984,651 | 79,808,669 | ||||||
Diluted |
80,712,923 | 80,489,502 | 80,390,001 | ||||||
See accompanying Notes to Consolidated Financial Statements.
47
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
Common Stock |
Capital in Excess of Par Value |
Accumulated Other Comprehensive Income (Loss) |
Retained Earnings |
Treasury Stock |
Total | ||||||||||||||||||
Balance, December 31, 2002 |
$ | 83,783,024 | $ | 5,531,384 | $ | 32,832,254 | $ | 484,454,615 | $ | (40,503,573 | ) | $ | 566,097,704 | ||||||||||
Net Income |
78,468,948 | 78,468,948 | |||||||||||||||||||||
Other Comprehensive Income, net of tax: |
|||||||||||||||||||||||
Change in Net Unrealized Investment Gains, net of reclassification adjustment |
7,561,180 | 7,561,180 | |||||||||||||||||||||
Change in Unrealized Gain on Interest Rate Swap Contract |
1,058,174 | 1,058,174 | |||||||||||||||||||||
Change in Unrealized (Loss) on Other Long-Term Investments |
(100,204 | ) | (100,204 | ) | |||||||||||||||||||
Total Other Comprehensive Income |
8,519,150 | ||||||||||||||||||||||
Comprehensive Income |
86,988,098 | ||||||||||||||||||||||
Dividends to Stockholders ($.315 per share) |
(25,176,932 | ) | (25,176,932 | ) | |||||||||||||||||||
Issuance of Treasury Shares for Dividend Reinvestment Plan (841,321 shares) |
3,333,612 | 7,462,200 | 10,795,812 | ||||||||||||||||||||
Purchase of Treasury Stock (299,183 shares) |
(3,684,667 | ) | (3,684,667 | ) | |||||||||||||||||||
Exercise of Stock Options (396,833 shares) |
(932 | ) | 3,493,355 | 3,492,423 | |||||||||||||||||||
Balance, December 31, 2003 |
83,783,024 | 8,864,064 | 41,351,404 | 537,746,631 | (33,232,685 | ) | 638,512,438 | ||||||||||||||||
Net Income |
89,444,959 | 89,444,959 | |||||||||||||||||||||
Other Comprehensive Income, net of tax: |
|||||||||||||||||||||||
Change in Net Unrealized Investment (Losses), net of reclassification adjustment |
(6,541,611 | ) | (6,541,611 | ) | |||||||||||||||||||
Change in Unrealized Gain on Interest Rate Swap Contract |
2,949,238 | 2,949,238 | |||||||||||||||||||||
Change in Unrealized Gain on Other Long-Term Investments |
301,340 | 301,340 | |||||||||||||||||||||
Total Other Comprehensive (Loss) |
(3,291,033 | ) | |||||||||||||||||||||
Comprehensive Income |
86,153,926 | ||||||||||||||||||||||
Sale of Subsidiaries |
1,682,982 | 1,682,982 | |||||||||||||||||||||
Dividends to Stockholders ($.3425 per share) |
(27,582,081 | ) | (27,582,081 | ) | |||||||||||||||||||
Issuance of Treasury Shares for Dividend Reinvestment Plan (12,158 shares) |
(103,871 | ) | 103,871 | | |||||||||||||||||||
Purchase of Treasury Stock (899,843 shares) |
(12,152,909 | ) | (12,152,909 | ) | |||||||||||||||||||
Exercise of Stock Options (503,836 shares) |
518,607 | 4,319,345 | 4,837,952 | ||||||||||||||||||||
Balance, December 31, 2004 |
83,783,024 | 10,961,782 | 38,060,371 | 599,609,509 | (40,962,378 | ) | 691,452,308 | ||||||||||||||||
Net Income |
99,033,753 | 99,033,753 | |||||||||||||||||||||
Other Comprehensive Income, net of tax: |
|||||||||||||||||||||||
Change in Net Unrealized Investment (Losses), net of reclassification adjustment |
(17,344,869 | ) | (17,344,869 | ) | |||||||||||||||||||
Change in Unrealized Gain on Interest Rate Swap Contract |
1,395,482 | 1,395,482 | |||||||||||||||||||||
Change in Unrealized (Loss) on Other Long-Term Investments |
(411,125 | ) | (411,125 | ) | |||||||||||||||||||
Total Other Comprehensive (Loss) |
(16,360,512 | ) | |||||||||||||||||||||
Comprehensive Income |
82,673,241 | ||||||||||||||||||||||
Additional Contribution |
4,836,140 | 4,836,140 | |||||||||||||||||||||
Issuance of Treasury Shares for Acquisition (325,035 shares) |
2,218,848 | 2,781,152 | 5,000,000 | ||||||||||||||||||||
Dividends to Stockholders ($.3875 per share) |
(31,108,206 | ) | (31,108,206 | ) | |||||||||||||||||||
Purchase of Treasury Stock (219,000 shares) |
(2,960,751 | ) | (2,960,751 | ) | |||||||||||||||||||
Restricted Share AwardsNonvested (77,765 shares) |
282,812 | 282,812 | |||||||||||||||||||||
Exercise of Stock Options (344,516 shares) and reclassification |
2,871,880 | 2,944,752 | 5,816,632 | ||||||||||||||||||||
Balance, December 31, 2005 |
$ | 83,783,024 | $ | 21,171,462 | $ | 21,699,859 | $ | 667,535,056 | $ | (38,197,225 | ) | $ | 755,992,176 | ||||||||||
See accompanying Notes to Consolidated Financial Statements.
48
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
Cash Flows From Operating Activities: |
||||||||||||
Net Income |
$ | 99,033,753 | $ | 89,444,959 | $ | 78,468,948 | ||||||
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: |
||||||||||||
Policy Acquisition Costs Deferred |
(126,165,508 | ) | (103,065,322 | ) | (98,787,583 | ) | ||||||
Amortization of Deferred Policy Acquisition Costs |
108,723,470 | 90,454,509 | 86,475,442 | |||||||||
Depreciation and Amortization |
3,920,991 | 2,925,306 | 2,708,669 | |||||||||
Stock-based Compensation |
415,817 | 146,888 | 167,510 | |||||||||
Provision for Deferred Taxes |
(306,215 | ) | (3,012,541 | ) | 5,342,706 | |||||||
Interest Credited on Policyholders Funds |
28,281,912 | 27,609,884 | 26,954,469 | |||||||||
Net Realized Investment Gains |
(6,050,873 | ) | (7,048,654 | ) | (6,263,619 | ) | ||||||
(Earnings) Losses in Equity Method Investments |
(8,583,398 | ) | (3,801,774 | ) | 318,223 | |||||||
Other |
(2,163,332 | ) | 8,832,456 | 4,229,712 | ||||||||
Changes in Operating Assets and Liabilities: |
||||||||||||
Accrued Investment Income |
(186,438 | ) | (1,156,955 | ) | 134,909 | |||||||
Accounts Receivable |
(18,317,051 | ) | (3,471,131 | ) | (7,553,528 | ) | ||||||
Reinsurance Balances Receivable |
(1,368,644 | ) | 536,122 | (2,398,561 | ) | |||||||
Other Assets |
(5,173,117 | ) | 3,005,585 | (957,014 | ) | |||||||
Liability for Policy Reserves |
20,807,581 | 25,599,547 | 14,812,239 | |||||||||
Liability for Unearned Premiums |
34,599,580 | 15,563,692 | 16,946,943 | |||||||||
Amounts Held for Others |
(228,101 | ) | 394,729 | 324,427 | ||||||||
Other Liabilities |
13,815,543 | 2,909,786 | (13,411,462 | ) | ||||||||
Due to/from Affiliates |
(9,255,456 | ) | (1,625,045 | ) | 2,105,973 | |||||||
Net Cash Provided by Operating Activities |
131,800,514 | 144,242,041 | 109,618,403 | |||||||||
Cash Flows from Investing Activities: |
||||||||||||
Maturities and Redemptions of Fixed Maturities Held for Investment |
26,211 | 43,072 | 116,133 | |||||||||
Maturities and Redemptions of Fixed Maturities Available for Sale |
393,899,269 | 328,912,867 | 635,219,130 | |||||||||
Maturities and Redemptions of Other Investments |
3,577,276 | 3,867,840 | 4,548,307 | |||||||||
Sales of Fixed Maturities Available for Sale |
108,372,196 | 61,425,800 | 68,916,066 | |||||||||
Sales of Equity Securities |
137,282,425 | 167,267,526 | 126,036,887 | |||||||||
Sales of Commercial Leases |
6,082,177 | 64,218,420 | 4,980,629 | |||||||||
Sales of Other Investments |
6,349,904 | 5,482,372 | 5,143,110 | |||||||||
Purchases of Fixed Maturities Available for Sale |
(591,177,592 | ) | (583,668,788 | ) | (745,426,493 | ) | ||||||
Purchases of Equity Securities |
(139,811,006 | ) | (119,154,022 | ) | (173,725,650 | ) | ||||||
Purchases of Other Investments |
(26,392,547 | ) | (57,112,951 | ) | (12,632,523 | ) | ||||||
Origination of Consumer Loans Receivable |
(73,540,434 | ) | (60,409,849 | ) | (59,061,709 | ) | ||||||
Principal Payments on Consumer Loans Receivable |
59,453,752 | 49,721,101 | 53,873,695 | |||||||||
Origination of Commercial Leases Receivable |
(21,665,208 | ) | (83,521,356 | ) | (76,828,007 | ) | ||||||
Principal Payments on Commercial Leases Receivable |
37,085,467 | 48,965,475 | 46,324,434 | |||||||||
Net Change in Short-term Investments |
(3,872,911 | ) | 28,472,140 | (9,555,341 | ) | |||||||
Net Change in Receivable/Payable on Securities |
(1,755,909 | ) | 2,917,338 | (7,323,609 | ) | |||||||
Net Proceeds from Sales of Subsidiaries |
2,252,520 | 7,495,925 | | |||||||||
Purchase of Subsidiary, Net of Cash Acquired |
(12,702,438 | ) | | | ||||||||
Net Cash Used in Investing Activities |
(116,536,848 | ) | (135,077,090 | ) | (139,394,941 | ) | ||||||
Cash Flows From Financing Activities: |
||||||||||||
Change in Commercial Paper |
9,487,237 | 39,859,437 | 31,020,844 | |||||||||
Change in Notes Payable to Affiliates |
5,000,000 | (21,206,141 | ) | (5,395,011 | ) | |||||||
Stockholder Dividends Paid |
(31,108,206 | ) | (27,582,081 | ) | (25,176,932 | ) | ||||||
Purchases of Treasury Stock |
(2,960,751 | ) | (12,152,909 | ) | (3,684,667 | ) | ||||||
Proceeds from Exercise of Stock Options |
3,028,748 | 3,263,270 | 2,112,838 | |||||||||
Proceeds from Dividend Reinvestment Plan |
| | 10,795,812 | |||||||||
Deposits of Policyholders Funds |
72,109,506 | 69,738,185 | 69,379,831 | |||||||||
Withdrawal of Policyholders Funds |
(53,644,054 | ) | (51,924,735 | ) | (48,145,481 | ) | ||||||
Net Cash Provided by (Used in) Financing Activities |
1,912,480 | (4,974 | ) | 30,907,234 | ||||||||
Net Change in Cash |
17,176,146 | 9,159,977 | 1,130,696 | |||||||||
CashBeginning of Period |
20,052,493 | 10,892,516 | 9,761,820 | |||||||||
CashEnd of Period |
$ | 37,228,639 | $ | 20,052,493 | $ | 10,892,516 | ||||||
See accompanying Notes to Consolidated Financial Statements.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
In the opinion of the Company, the accompanying consolidated financial statements contain all adjustments (consisting primarily of normal recurring accruals, except as explained in Note 2Pooling Agreement) necessary to present fairly its financial position, results of operations and cash flows. The accompanying financial statements are prepared on the basis of accounting principles generally accepted in the United States of America. Generally accepted accounting principles differ in certain respects from the statutory accounting practices prescribed or permitted by insurance regulatory authorities. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Permitted statutory accounting practices encompass all accounting practices that are not prescribed. Such practices differ from state-to-state, may differ from company-to-company within a state, and may change in the future. Currently, the Companys statutory net income and surplus are the same under the State of Alabama and NAIC accounting practices.
Consolidation
The accompanying consolidated financial statements include, after intercompany eliminations, Alfa Corporation and its wholly-owned subsidiaries
| Alfa Insurance Corporation (AIC) |
| Alfa General Insurance Corporation (AGI) |
| Alfa Vision Insurance Corporation (AVIC) |
| Alfa Life Insurance Corporation (Life) |
| Alfa Financial Corporation (Financial) |
| The Vision Insurance Group, LLC (Vision) |
| Alfa Agency Mississippi, Inc. (AAM) |
| Alfa Agency Georgia, Inc. (AAG) |
| Alfa Benefits Corporation (ABC) |
During 2003, one of Financials investments, MidCountry Financial Corporation (MidCountry), pursued the opportunity to purchase Bayside Financial Corp. In order for this purchase to take place, approval had to be secured from the Office of Thrift Supervision. Consequently, due to ownership levels, this transaction qualified Financial and the Company as unitary thrift holding companies. As a condition of approval, the Company agreed to sell its residential and commercial construction subsidiary, Alfa Builders, Inc. (Builders) and its real estate sales subsidiary Alfa Realty, Inc. (Realty) to Southern Boulevard Corporation (Southern), a wholly-owned subsidiary of Alfa Mutual Insurance Company (Mutual) for their independently-determined fair values of approximately $5.5 million and $2.6 million, respectively. Southern subsequently became Alfa Properties, Inc. (Alfa Properties) during the first quarter of 2004. No gain or loss was recorded on these transactions. The financial statements and notes to the financial statements contained within this report include the results of these subsidiaries for the first two months of 2004 as well as the year 2003.
Nature of Operations
Alfa Corporation operates predominantly in the insurance industry. At December 31, 2005, its insurance subsidiaries write life insurance in Alabama, Georgia and Mississippi and property casualty
50
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
insurance in Georgia, Mississippi, Missouri, Indiana, Ohio, Virginia, Tennessee, Arkansas, Kentucky, and Florida. In addition, AVIC assumes business in Texas.
Alfa Corporation is affiliated with Mutual, Alfa Mutual Fire Insurance Company (Fire), and Alfa Mutual General Insurance Company (General). These companies are known collectively as the Mutual Group. The Mutual Group owns 54.9% of Alfa Corporations common stock, their largest single investment. Alfa Corporation and its subsidiaries (the Company) together with the Mutual Group comprise the Alfa Group (Alfa). Alfa Virginia Mutual Insurance Company (Virginia Mutual) currently cedes 80% of its direct business to Fire under an affiliate agreement signed in August 2001.
As more fully discussed in Note 2Pooling Agreement, the Companys property casualty insurance business is pooled with that of the Mutual Group which writes property casualty business in Alabama. The Companys pooled business is concentrated geographically in Alabama, Georgia and Mississippi. Approximately $514 million of premiums and policy charges representing 81% of such amounts in 2005 were from policies written in Alabama. Accordingly, unusually severe storms or other disasters in this state might have a more significant effect on the Company than on a more geographically diversified insurance company and could have an adverse impact on the Companys financial condition and operating results. Increasing public interest in the availability and affordability of insurance has prompted legislative, regulatory and judicial activity in several states. This includes efforts to contain insurance prices, restrict underwriting practices and risk classifications, mandate rate reductions and refunds, eliminate or reduce exemptions from antitrust laws and generally expand regulation. Because of Alabamas low automobile rates as compared to rates in most other states, the Company does not expect the type of punitive legislation and initiatives found in some states to be a factor in its primary market in the immediate future.
The Companys noninsurance subsidiaries are engaged in consumer financing, commercial leasing, agency operations and benefits administration.
Use of Estimates in the Preparation of the Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect 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 reporting period. Estimates and assumptions are particularly important in determining the reserves for future policy benefits, losses and loss adjustment expenses and deferred policy acquisition costs. Actual results could differ from those estimates.
Revenues, Benefits, Claims and Expenses
Traditional Life Insurance Products: Traditional life insurance products include those products with fixed and guaranteed premiums and benefits and consist principally of whole life insurance policies, term life insurance policies and certain annuities with life contingencies. Premiums are recognized as revenue over the premium-paying period of the policy when due. The liability for future policy benefits is computed using a net level method including assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the Companys experience, modified as necessary, to reflect anticipated trends and to include provisions for possible unfavorable deviations. Policy benefit claims are charged to expense in the period that the claims are incurred.
51
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Universal Life Products: Universal life products include universal life insurance and other interest-sensitive life insurance policies. Universal life revenues, which are considered operating cash flows, consist of policy charges for the cost of insurance, policy administration, and surrender charges that have been assessed against policy account balances during the period. The timing of revenue recognition is determined by the nature of the charge. Cost of insurance and policy administrative charges are assessed on a monthly basis and recognized as revenue when remittances are processed. Percent of premium charges are assessed at the time of payment by the policyholder and recognized as revenue when processed. Surrender charges are recognized as revenue upon surrender of a contract by the policyholder in accordance with contractual terms. Benefit reserves for universal life represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include interest credited to policy account balances on a monthly basis and death claims reported in the period in excess of related policy account balances.
Property Casualty Products: Premiums written are earned ratably over the periods of the related insurance and reinsurance contracts or policies. Unearned premium reserves are established to cover the remainder of the unexpired contract period. Premiums reported are net of ceded premiums. The liability for estimated unpaid property casualty losses and loss adjustment expenses is based upon an evaluation of reported losses and on estimates of incurred but not reported losses. Adjustments to the liability based upon subsequent developments are included in current operations.
Stock-Based Employee Compensation
At December 31, 2005, the Company has a stock-based employee compensation plan, which is described more fully in Note 15Stock-Based Compensation. The Company accounts for this plan under Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, using the recognition and measurement principles of the intrinsic value method. Compensation cost on fixed awards with prorata vesting is recognized using the straight-line method. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
Years Ended December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
Net income as reported |
$ | 99,033,753 | $ | 89,444,959 | $ | 78,468,948 | ||||||
Add: Total stock-based compensation expense included in reported net income, net of tax effect |
270,281 | 95,478 | 108,882 | |||||||||
Less: Total stock-based compensation expense determined under fair value based method for all awards, net of tax effect |
(2,222,017 | ) | (2,078,716 | ) | (1,571,820 | ) | ||||||
Pro forma net income |
$ | 97,082,017 | $ | 87,461,721 | $ | 77,006,010 | ||||||
Earnings per share, as reported |
||||||||||||
Basic |
$ | 1.24 | $ | 1.12 | $ | 0.98 | ||||||
Diluted |
$ | 1.23 | $ | 1.11 | $ | 0.98 | ||||||
Pro forma earnings per share |
||||||||||||
Basic |
$ | 1.21 | $ | 1.09 | $ | 0.96 | ||||||
Diluted |
$ | 1.20 | $ | 1.09 | $ | 0.96 |
52
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Income Taxes
The Companys method of accounting for income taxes is the liability method. Under the liability method, deferred tax assets and liabilities are adjusted to reflect changes in statutory tax rates resulting in income adjustments in the period such changes are enacted. Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities, based on enacted tax laws and statutory tax rates applicable to the periods in which the temporary difference is expected to reverse. The method of allocation between subsidiaries is subject to a written agreement, approved by the Board of Directors. Current taxes are allocated to each subsidiary within the consolidated group based upon the ratio of the subsidiarys taxable income to the consolidated taxable income with no credit to subsidiaries with a taxable loss.
Earnings Per Share
Basic EPS is computed by dividing net income by the weighted average number of shares outstanding. Diluted EPS is computed similarly except that the shares outstanding are increased to give effect to all potentially dilutive shares that would have been outstanding if such shares had been issued. The weighted average diluted shares outstanding include, on a post-split basis, potentially dilutive shares which total 571,855 shares in 2005, 504,851 in 2004 and 581,332 shares in 2003. All dilutive shares are the result of stock options outstanding with the exception of 9,149 dilutive shares resulting from restricted stock awards in 2005 (refer to Note 15Stock-Based Compensation).
Investments
Fixed Maturities: Fixed maturities held for investment include investments that the Company has both the ability and positive intent to hold until maturity; such securities are reported at amortized cost. Securities available for sale include bonds and redeemable preferred stocks that the Company may elect to sell prior to maturity and are reported at their current fair value. The unrealized gains or losses on these securities are reflected as accumulated other comprehensive income within stockholders equity, net of taxes. Furthermore, deferred policy acquisition costs for universal and other interest sensitive life insurance products are adjusted to reflect the effect that would have been recognized had the unrealized holding gains and losses been realized. This adjustment to deferred acquisition costs results in a corresponding adjustment to comprehensive income. During 2005, the amount of this adjustment before taxes was $3,553,657. Amortization of premium or discount is calculated using the scientific (constant yield) interest method and is recorded as an adjustment to investment income. The interest method results in a constant effective yield equal to the prevailing rate at the time of purchase or at the time of subsequent adjustments to book value. Fixed maturities containing call provisions (where the issue can be called away from the Company at the issuers discretion) are amortized to the call or maturity value/date that produces the lowest asset value (yield to worst). For mortgage-backed securities, the amortization period reflects estimates of the period over which repayment of principal is expected to occur, not the stated maturity period.
Equity Securities: Equity securities (common and non-redeemable preferred stocks) are carried at fair value. The unrealized gains or losses on these securities are reflected as accumulated other comprehensive income within stockholders equity, net of taxes.
Declines in fair values of fixed maturities and equity securities deemed to be other than temporary are recognized in the determination of net income. Generally, realized gains and losses on sales of investments are recognized in net income using the first-in, first-out methodology. In some instances, the Company may use the specific identification method if so directed by the investment portfolio
53
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
manager. Realized investment gains and losses are reported on a pretax basis as a component of revenues. Income taxes applicable to net realized investment gains and losses are included in the provision for income tax.
Collateral Loans and Commercial Leases: Collateral loans and lease financings including commercial leases classified as held for sale are reported in the balance sheet at outstanding principal balance adjusted for charge-offs and the allowance for losses in accordance with Statement of Position (SOP) 01-6, Accounting by Certain Entities That Lend to or Finance the Activities of Others. The allowance for losses on collateral loans and commercial leases represents the Companys best estimate of probable losses inherent in the portfolios based on relevant observable data that include, but are not limited to, historical experience, collateral type, account balance and delinquency. Credit losses are deducted from the allowance and charged off in the period in which the loans or leases are deemed uncollectible. Recoveries previously charged off are recorded when received. The Company considers an account to be delinquent if it is thirty or more days late in its scheduled payments. If the account is over 90 days late, the Company considers repossession of the collateral. If collateral is repossessed, the loan or lease is written down against the allowance for losses and the asset is transferred to other assets and carried at the lower of cost or estimated fair value less the cost to dispose. Loans are placed on a nonaccrual status when a bankruptcy is reported or the collateralized assets are repossessed. The Company uses the effective interest method to recognize income on loans and leases. Deferred fees are amortized over the term of the commercial lease.
Other Long-term Investments: Partnerships, joint ventures and unconsolidated investee companies accounted for using the equity method are a component of other long-term investments and other long-term investments in affiliates. Investments in partnerships, joint ventures and unconsolidated investee companies are stated at the underlying audited equity value based on accounting principles generally accepted in the United States of America. Investments are reviewed annually for impairments and adjusted accordingly. It is the Companys policy to review investments for applicability of Financial Accounting Standards Board Interpretation (FIN) 46(R), Consolidation of Variable Interest Entities. At December 31, 2005, the Company determined that no investment required consolidation based on FIN 46(R) criteria.
Short-term Investments: Short-term investments with maturities of three months or less are considered to be investments and are not considered to be cash or cash equivalents. The Companys short-term investments are predominately money market funds. Money market mutual funds seek to maintain a stable net asset value of $1.00 per share. There is no assurance that funds will be able to maintain a stable asset value of $1.00 per share. However, our policy is to invest in money market funds that are rated AAAm and/or Aaa by Standard & Poors and/or Moodys Investor Service, Inc., respectively, or are rated by the NAIC Securities Valuation Office as Class 1. These funds are diversified money market funds investing in Tier 1 commercial paper and bank obligations, U.S. Treasury, U.S. government obligations, certificates of deposits and repurchase agreements.
Cash
Cash consists of demand deposits at banks. Fair value equals the carrying value of such assets.
At December 31, 2005, Vision (refer to Note 17Business Combinations and Divestitures) had a carrier contract requiring them to fund a collateral trust based on a percentage of written premiums. The primary purpose was to provide collateral for the payment of all obligations and performance of all duties set forth in the contract. The amount in the trust is reviewed on an annual basis and adjusted accordingly. The amount of cash restricted at December 31, 2005 was $957,368.
54
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Accounts Receivable
Accounts receivable are primarily comprised of premium installment plan receivables from policyholders and insurance carrier receivables.
Reinsurance
Amounts recoverable from property casualty reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts.
The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.
Deferred Policy Acquisition Costs and Premium Deficiencies
Life Insurance Products: Commissions and other costs of acquiring insurance that vary with and are primarily related to the production of new and renewal business have been deferred. Traditional life insurance acquisition costs are being amortized over the premium payment period of the related policies using assumptions consistent with those used in computing policy benefit reserves. Acquisition costs for universal life type policies are being amortized over a thirty-year period in relation to the present value of estimated gross profits that are determined based upon surrender charges and investment, mortality and expense margins. The life insurance segment deferred $18,815,613 and recorded amortization expense of $9,277,108 related to acquisition costs leaving a balance of $171,107,909 at December 31, 2005. Included in this balance is a reduction of $1,529,460 which represents an offset to unrealized holding gains that is required as an adjustment to deferred policy acquisition costs under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, when amortization expense is determined under the gross profits method described in SFAS No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.
Property Casualty Products: Acquisition costs for property casualty insurance are amortized over the period in which the related premiums are earned. Investment income is considered, if necessary, in the determination of the recoverability of deferred policy acquisition costs. During 2005, the property casualty insurance segment deferred $109,342,742 and recorded amortization expense of $100,652,027 related to acquisition costs, leaving a balance of $33,933,193 in the property casualty segment at December 31, 2005. Due to the elimination of intercompany profits, property casualty deferrals were reduced by $1,992,848 and amortization expense was reduced by $1,205,665 within the corporate and eliminations segment.
A premium deficiency reserve is recognized by recording an additional liability for the deficiency, with a corresponding charge to operations when anticipated losses, loss adjustment expenses, commissions and other acquisition costs, and maintenance costs exceed the recorded unearned premium reserve, and any future installment premiums on existing policies. The Company had no liability related to premium deficiency reserves at December 31, 2005 or December 31, 2004. The Company utilizes anticipated investment income as a factor in the premium deficiency calculation.
55
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Goodwill and Other Intangible Assets
Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. The Company performs an annual review in the fourth quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the carrying value of the recorded goodwill is impaired. If the fair value of the subsidiary were less than its carrying value at the valuation date, an impairment loss would be recorded to the extent that the implied value of the goodwill is less than the recorded amount of goodwill. Fair value is estimated based on various valuation metrics.
Intangible assets include agent relationships, information technology, and restrictive covenants, and are amortized on a straight-line basis over periods ranging from 5 to 20 years. The Company performs an annual review of its intangible assets in the fourth quarter of each year, or more frequently if indicators of potential impairment exist. This review is to determine if facts and circumstances exist which indicate that the useful life is shorter than originally estimated or that the carrying amount of assets may not be recoverable.
Other Assets
Included in other assets, furniture, equipment, capital leases, software and leasehold improvements are stated at cost less accumulated depreciation or amortization. Depreciation is computed principally using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized on a straight-line basis over the lesser of the lease terms or the estimated useful lives of the improvements.
Derivative Instruments and Hedging Activities
The Company accounts for derivative instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging ActivitiesAn Amendment of FASB Statement No. 133, and SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The statements require that the Company recognize all derivatives as either assets or liabilities in the consolidated balance sheet at fair value. Changes in the fair value of derivatives are recorded currently in earnings unless special hedge accounting criteria are met. For derivatives designated as fair value hedges, the changes in the fair value of both the derivative instrument and the hedged item are recorded in earnings. For derivatives designated as cash flow hedges, the effective portions of changes in fair value of the derivative are reported in other comprehensive income. Any ineffective portions of hedges would be recognized in earnings.
Cash Flow Hedges: The Company uses variable-rate debt to partially fund its consumer loan and commercial lease portfolios. In particular, it has issued variable-rate long-term debt and commercial paper. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense also decreases.
As part of its funding efforts, the Company issued a $70 million long-term obligation maturing on June 1, 2017 in the second quarter of 2002 that is included in total borrowings. Management believes it is prudent to limit the variability of a portion of its interest payments. It is the Companys objective to hedge 100 percent of its variable-rate long-term interest payments over the first five years of the life of the debt obligation.
56
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
To meet this objective, management entered into an interest rate swap to manage fluctuations in cash flows resulting from interest rate risk. The interest rate swap changes the variable-rate cash flow exposure of the variable-rate long term debt obligation to fixed-rate cash flows by entering into a receive-variable, pay-fixed interest rate swap. Under the interest rate swap, the Company receives variable interest payments and makes fixed interest rate payments, thereby creating long-term debt with a fixed rate of 4.945%. During 2005, interest received ranged from 2.358% to 4.361%.
The Company assesses interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities.
The Company maintains risk management control systems to monitor interest rate cash flow risk attributable to both the Companys outstanding or forecasted debt obligations as well as the Companys offsetting hedge position. The risk management control systems involve the use of analytical techniques, including cash flow sensitivity analysis, to estimate the expected impact of changes in interest rates on the Companys future cash flows.
Changes in fair value of the interest rate swap designated as a hedging instrument of the variability of cash flows associated with floating-rate, long-term debt obligation are reported in accumulated other comprehensive income, net of taxes. The Company accounts for the hedging instrument using the short-cut method and has not reclassified any of the gains or losses to interest expense in the subsequent periods. The fair value of the interest rate swap contract decreased by $2,146,896 in 2005 prior to a tax benefit of $751,414.
If it is determined that the swap has ceased to be a highly effective hedge, is sold, or is terminated, the Company will discontinue hedge accounting prospectively. The change in fair value of the hedged item attributable to hedged risk, as has been reported in accumulated other comprehensive income, would be amortized to interest expense over the remaining life of the hedged item.
Other Derivative Instruments: Covered call options are contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to purchase a financial instrument at a specified price within a specified period of time. The Company writes (sells) call options on certain common stocks it already owns to enhance returns to the extent of the premium received. The premium received for a written call option is recorded in other liabilities until the option is exercised, expires, or is otherwise terminated. On disposition, gains (losses) are recognized immediately, with gains (losses) on exercise combined with gains (losses) on the covering asset. The liability is marked to market at each statement date with the changes in the market value of the open options recognized as realized gains (losses) and recorded in the statement of income. The Company had $49,700 and $169,450 in options outstanding at December 31, 2005 and 2004, respectively.
Reserve for Litigation
The Company is subject to lawsuits in the normal course of business related to its insurance and noninsurance products. In accordance with SFAS No. 5, Accounting for Contingencies, management evaluates the merits of each case and determines the need for establishing estimated reserves for potential settlements or judgments as well as reserves for potential costs of defending the Company against the allegations of the complaint at the time a lawsuit becomes known. These reserves may be adjusted as the case develops. Periodically, and at least quarterly, management assesses all pending cases as a basis for evaluating reserve levels. At that point, any necessary adjustments are made to
57
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
applicable reserves as determined by management and are included in current operating results. Reserves may be adjusted based upon outside counsels advice regarding the law and facts of the case, any revisions in the law applicable to the case, the results of depositions and/or other forms of discovery, general developments as the case progresses such as a favorable or an adverse trial court ruling, whether a verdict is rendered for or against the Company, whether management believes an appeal will be successful, or other factors that may affect the anticipated outcome of the case. Management believes adequate reserves have been established in known cases. However, due to the uncertainty of future events, there can be no assurance that actual outcomes will not differ from the assessments made by management.
Reclassifications
Certain amounts in prior periods have been reclassified to conform to the presentation adopted in the current fiscal year. Such reclassification did not impact earnings.
2. POOLING AGREEMENT
Parties to the Pool
Effective August 1, 1987, the Companys property casualty insurance subsidiaries entered into a reinsurance Pooling Agreement (the Pooling Agreement) with the Mutual Group.
| Effective October 1, 1994, participation percentages were amended. |
| Effective October 1, 1996, Fire withdrew from participation in the Pooling Agreement. |
| Effective January 1, 2001, Fire and Alfa Specialty Insurance Corporation (Specialty), a subsidiary of Mutual, became participants in the Pooling Agreement. |
| Effective January 1, 2005, the Pooling Agreement was amended and restated, commuting certain pools from August 1, 1987 through December 31, 2001. In addition, AVIC was added as a participant in the Pooling Agreement with other companies in the Alfa Group and Fire began retroceding the quota share business it receives from Virginia Mutual to the pool. |
| Effective January 1, 2006, the Pooling Agreement was amended to reallocate Specialtys coinsurance allocation of catastrophes to Mutual. |
The Mutual Group is a direct writer primarily of personal lines property casualty insurance in Alabama. The Companys subsidiaries similarly are direct writers in: Georgia, Mississippi, Missouri, Indiana, Ohio, Virginia, Tennessee, Arkansas, Kentucky, and Florida; and assume business from Texas. Specialty is a direct writer in Alabama, Georgia, Mississippi, and Virginia. Virginia Mutual is a direct writer in Virginia and North Carolina.
The Mutual Group, Virginia Mutual and the Company write preferred risk automobile and homeowner insurance, manufactured home insurance, fire and allied lines, standard risk automobile and homeowner insurance, and a limited amount of commercial insurance, including auto, church and businessowner insurance. Mutual is also a direct writer of farmowner insurance. Specialty and AVIC are direct writers of nonstandard risk automobile insurance.
Under the Pooling Agreement, each participant cedes premiums, losses, and underwriting expenses on all of their direct property casualty business to Mutual, and Mutual in turn retrocedes to each participant a specified portion of premiums, losses, and underwriting expenses based on each participants pooling percentage. The Mutual Groups direct property casualty business (together with the property casualty business ceded by the Company) is included in the pool.
58
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The pooling participants and their percentage participation in the pool since inception are as follows:
8/1/87 to 9/30/94 |
10/1/94 to 09/30/96 |
10/1/96 to 12/31/00 |
1/1/01 to 12/31/04 |
1/1/05 to current |
|||||||||||
Mutual2 |
32 | % | 24 | % | 32 | % | 18 | % | 18 | % | |||||
Fire2 |
15 | % | 8 | % | 0 | % | 13 | % | 13 | % | |||||
General2 |
3 | % | 3 | % | 3 | % | 3 | % | 3 | % | |||||
AIC1 |
25 | % | 32.5 | % | 32.5 | % | 32.5 | % | 30 | % | |||||
AGI1 |
25 | % | 32.5 | % | 32.5 | % | 32.5 | % | 30 | % | |||||
Specialty3 |
| | | 1 | % | 1 | % | ||||||||
AVIC1 |
| | | | 5 | % |
1 | Subsidiary of the Company |
2 | Member of Mutual Group |
3 | Subsidiary of Mutual |
Approximately 72.9%, 80.5% and 80.7% of the Companys property casualty premium income and 66.5%, 70.3% and 70.6% of its total premium income were derived from the Companys participation in the Pooling Agreement in 2005, 2004 and 2003, respectively.
As a result of the Pooling Agreement, the Company had a receivable of $9,321,639 from and a payable of $714,555 to the Mutual Group at December 31, 2005 and 2004, respectively, for transactions originating in December and settled the following month.
Catastrophe Protection Program
On October 1, 1996, the Pooling Agreement was amended in conjunction with the restructuring of the Alfa Insurance Groups catastrophe protection program. Effective November 1, 1996, the allocation of catastrophe costs among the members of the pool was changed to better reflect the economics of catastrophe finance. The amendment limited the Companys participation in any single catastrophic event or series of disasters to its pool share (65%) of a lower catastrophe pool limit unless the loss exceeded an upper catastrophe pool limit. In cases where the upper catastrophe limit is exceeded on a 100% basis, the Companys share in the loss would be based upon its amount of surplus relative to other members of the group. Lower and upper catastrophe pool limits are adjusted periodically due to increases in insured property risks. The limits and participation levels since inception of the program are summarized below:
Lower Catastrophe Pool Limit (millions) |
Upper Catastrophe Pool Limit (millions) |
Estimated Coinsurance Allocation of Catastrophes Exceeding Upper Catastrophe Pool Limit |
|||||||
November 1, 1996 |
$ | 10.0 | $ | 249.0 | 13 | % | |||
July 1, 1999 |
11.0 | 284.0 | 13 | % | |||||
January 1, 2001 |
11.4 | 284.0 | 14 | % | |||||
January 1, 2002 |
11.6 | 289.0 | 16 | % | |||||
January 1, 2003 |
12.1 | 301.5 | 18 | % | |||||
January 1, 2004 |
14.2 | 352.0 | 18 | % | |||||
January 1, 2005 |
17.9 | 443.7 | 19 | % | |||||
January 1, 2006 |
21.2 | 525.5 | 21 | % |
59
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The Company incurred catastrophe losses of $11.6 million, $9.2 million, and $7.9 million in 2005, 2004, and 2003, respectively. These losses resulted in reductions to the Companys net income of approximately $0.09, $0.07, and $0.06 per diluted share, after reinsurance and taxes in the respective years.
Management
The Boards of Directors of the Mutual Group and of the Companys property casualty insurance subsidiaries have established the pool participation percentages and must approve any changes in such participation. The Alabama Insurance Department reviewed the Pooling Agreement and the Department determined that the implementation of the Pooling Agreement did not require the Departments approval.
A committee consisting of two members of the Boards of Directors of the Mutual Group, two members of the Board of Directors of Specialty, two members of the Board of Directors of the Company and Jerry A. Newby, as chairman of each such Board, has been established to review and approve any changes in the Pooling Agreement. The committee is responsible for matters involving actual or potential conflicts of interest between the Company, Specialty and the Mutual Group and for attempting to ensure that, in operation, the Pooling Agreement is equitable to all parties. Conflicts in geographic markets are currently minimal because the Mutual Group writes property casualty insurance only in Alabama and at present all of such insurance written by the Company is outside of Alabama. The Pooling Agreement is intended to reduce conflicts that could arise in the selection of risks to be insured by the participants by making the results of each participants operations dependent on the results of all of the pooled business. Accordingly, the participants should have substantially similar loss ratios for the pooled business excluding catastrophes as long as the Pooling Agreement remains in effect.
Should any member of the affiliated group be unable to meet its obligation on a claim for a policy written by the Companys property casualty subsidiaries, the obligation to pay the claim would remain with the Companys subsidiaries. The participation of the Company in the Pooling Agreement may be changed or terminated without the consent or approval of the stockholders, and the Pooling Agreement may be terminated only by mutual agreement of the parties in writing. Any such termination, or a change in the Companys allocated share of the pooled business, inclusion of riskier business or certain types of reinsurance assumed in the pool, or other changes to the Pooling Agreement, could have a material adverse impact on the Companys earnings. Participants respective abilities to share in the pooled business are subject to regulatory capital requirements.
3. RELATED PARTY TRANSACTIONS
Ownership
Mutual owns 42.7%, Fire owns 11.4% and General owns 0.8% of the Companys common stock. The Board of Directors of the Company consists of eleven members, six of whom serve as Directors of Mutual, Fire and General and two of whom at December 31, 2005 were executive officers of the Company. One of the Companys directors and most of the Companys executive officers, including the Companys President, also hold the same positions with Mutual, Fire, General and Specialty. The Company paid stockholder dividends to the Mutual Group totaling $17,159,686 in 2005, $15,109,690 in 2004 and $13,741,391 in 2003.
The Mutual Group and the Companys insurance subsidiaries are considered an insurance company holding system with Mutual being the controlling party under the Alabama Insurance Holding Company Systems Regulatory Act and their activities and transactions are subject to reporting, examination and regulation thereunder.
60
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Management and Operating Agreement
Under a Management and Operating Agreement, Mutual provides substantially all facilities, management and other operational services to the Company and its subsidiaries and to other companies associated with Mutual. Most of the personnel providing management services to the Company are full-time employees of, and are directly compensated by, Mutual. The Companys business is substantially integrated with that of Mutual, Fire and General. Mutual periodically conducts time usage and other special expense allocation studies. Mutual charges the Company for its allocated and direct salaries, employee benefits and other expenses, including those for the use of office facilities. The amounts paid by the Company to Mutual under the Management and Operating Agreement were approximately $61.8 million in 2005, $50.7 million in 2004 and $46.9 million in 2003. The Company reimburses Mutual for the full amount of all its agents commissions paid by Mutual for the sale of the Companys insurance products.
Debt and Guarantees
The Mutual Group is a partner in a real estate partnership, which in 2000 established a revolving line of credit with Financial of $4.0 million at a rate of interest equal to the prime lending rate less 1.0%. During 2002, this line of credit was increased to $5.0 million. At December 31, 2005 and 2004, the amount loaned to the partnership under the line of credit was $4,000,000 and $4,535,000, respectively. Interest paid by the partnership was $230,589, $154,331 and $140,850 in 2005, 2004, and 2003, respectively.
The Companys property casualty subsidiaries have agreed to guarantee payment on debt owed by three real estate partnerships affiliated with Fire. These guarantees expire between 2006 and 2035 and, in the unlikely circumstance of a guarantee call, could negatively impact the Company by up to $2.2 million (refer to Note 9Commitments and Contingencies).
In 1997, Mutual established a revolving line of credit with Financial of $20 million at a rate of interest equal to the one-month London Interbank Offered Rate (LIBOR) plus .75%. No balance was outstanding at either December 31, 2005 or 2004. No interest was paid to Financial related to this line of credit in 2005, 2004 or 2003.
In 1999, Realty secured a line of credit with Financial of $250,000 with interest payable monthly at the Companys commercial paper rate then applicable plus ..35%. No balance was outstanding at either December 31, 2005 or 2004. No interest was paid to Financial related to this line of credit in 2005, 2004 or 2003.
Also, during 1999, Builders established a line of credit with Financial of $5 million with interest payable monthly at the Companys commercial paper rate then applicable plus 1.00%. The unpaid balance on this line of credit was $4,020,917 and $2,506,774 at December 31, 2005 and 2004, respectively. Interest paid to Financial in 2005 and in 2004 subsequent to the sale of Builders to Southern was $162,461 and $41,334, respectively.
The Companys commercial paper is guaranteed by Mutual and Fire. The Company paid fees of $50,000 and $25,000 to Mutual and Fire, respectively, for their guarantees in 2005 and 2004.
Insurance Products
On February 1, 1997, Mutual began covering its employees with a Corporate Owned Life Insurance (COLI) plan utilizing Lifes universal life product. Premiums paid to Life totaled approximately
61
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
$17.9 million in 2005, $17.9 million in 2004 and $18.7 million in 2003. Policy charges recorded from such premiums totaled approximately $3.8 million in 2005, $3.5 million in 2004 and $3.2 million in 2003. Policy reserves and insurance in force on the COLI plan at December 31, 2005 were approximately $149.0 million and $709.9 million, respectively. Certain of Mutuals employees and those of the Mutual Groups sponsoring organization, the Alabama Farmers Federation (Federation), not covered by the COLI plan are covered by group life insurance provided by Life. During 2002, certain retired employees of Virginia Mutual, also began being covered by group life insurance provided by Life. Contingency reserves held for this group as of December 31, 2005 and 2004 were $165,739 and $220,226, respectively. Group life insurance premiums paid to Life totaled $516,752 in 2005, $492,449 in 2004 and $542,167 in 2003. Insurance inforce under this plan at December 31, 2005 was approximately $47.3 million. Reserves for group life insurance represent the excess present value of future guaranteed benefits over future premiums plus any unearned premium. Since this one-year term contract renews on January 1 of each year at the discretion of each party, there is no future excess present value of future guaranteed benefits over future premiums at December 31. Since all of the certificates have a renewal date of January 1, the premium for each certificate is fully earned on the following December 31 and no unearned premium liability is present. This reserving method has been used since the Companys inception. The only change in resulting reserves in recent years occurred when the plan year was adjusted to coincide with the calendar year.
Periodically, certain of the Companys subsidiaries have purchased property insurance and general liability insurance protection from Mutual and Fire. The annual premium paid for such policies totaled approximately $19,300 in 2004 and $19,600 in 2003. No premiums were paid to Mutual or Fire for policies of these types in 2005.
Other Related-Party Transactions
During 1999, the Company formed a subsidiary, ABC, in an effort to improve the controls over employee benefits and related payments, to simplify and consolidate the accounting and recordkeeping function, and to improve operating efficiencies. As a result, the accrued benefit liabilities held by the various Alfa property casualty entities and their related assets were transferred to ABC at that time. The amounts of net transfers from ABC to Mutual in 2005 and 2004 for payments of benefits totaled approximately $763,000 and $554,000, respectively.
Financial leases equipment, automobiles, furniture and other property to the Mutual Group and its affiliates. The Mutual Group and its affiliates paid $3,367,415 in 2005, $3,367,326 in 2004 and $3,460,011 in 2003 under these leases. Periodically, the Mutual Group invests in automobile and other installment loans issued and serviced by Financial. However, the Mutual Group held no such investment in these loans at either December 31, 2005 or December 31, 2004. Interest paid by Financial to the Mutual Group on these loans was $199,897 in 2005, $320,900 in 2004 and $434,304 in 2003. The Alabama Farmers Federation (Federation) and Alfa Services, Inc. (Services), a Federation subsidiary, invest in short-term lines of credit with the Company and Financial. The balance outstanding on these lines of credit included in notes payable to affiliates was $20,887,635 and $15,887,635 at December 31, 2005 and 2004, respectively. Interest paid by the Company and Financial to the Federation and its subsidiary was $502,302 in 2005, $166,398 in 2004 and $99,104 in 2003.
In 2004 prior to its being sold, the Companys real estate construction subsidiary, Builders, purchased 6 residential lots at fair value for $292,207 and 11 residential lots in 2003 at fair value for $542,796 from a partnership in which the Mutual Group is a partner. Builders also purchased one lot
62
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
during the first two months of 2004 at fair value for $20,750 from a partnership in which Alfa Properties is a member. Alfa Properties paid $21,199 in other commissions to Realty in 2003. Builders purchased 4 residential lots in 2003 at fair value for $213,000 from Alfa Properties.
Alfa Properties has a partnership interest in Marshall Creek, Ltd., a real estate development. Financial established capital leases with this entity during 2002 and received payments of $183,900 and $157,646 under these leases in 2005 and 2004, respectively.
Builders contracts with the Mutual Group for the construction of certain commercial facilities. The Mutual Group paid $6,240 in the first two months of 2004 and $299,471 in 2003 to Builders under such contracts. Builders also received $1,429 in rental income from the Mutual Group during 2004.
The Company periodically has investment transactions with the Mutual Group. In 2004, the Company bought one security at fair value of $3,094. In addition, during 2003, the Company sold seven securities to the Mutual Group at fair value for a loss of $1,128,328. No such transactions occurred during 2005. The Company is also a partner in Alfa Investors Partnership with the Mutual Group. The amount contributed to the partnership was $36.3 million and $33.1 million at December 31, 2005 and 2004, respectively. The Company had committed to fund up to $3.2 million additional investment in the partnership at December 31, 2005. The Company received distributions from the partnership of $1.2 million and $3.5 million in 2005 and 2004, respectively. In 2000, the Company became a member in Alfa Ventures II, LLC with the Mutual Group. The amount contributed to the limited liability company was approximately $1.9 million at both December 31, 2005 and 2004, respectively. The Company received distributions from this partnership of $3,002,218 in 2005 and $479,974 in 2004.
The Companys life subsidiary is a general partner in two investment partnerships with a trust created by Mutual and Fire. The carrying value of the partnerships was $986,658 and $931,384 at December 31, 2005 and 2004, respectively.
On December 31, 2005, the Company completed the sale of Financials leasing division, OFC Capital, to OFC Servicing Corporation, a subsidiary of MidCountry. Included in other long-term investments in affiliates is a note receivable of $55.5 million related to this transaction.
63
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
4. INVESTMENTS
Net investment income by source is summarized as follows:
2005 | 2004 | 2003 | ||||||||||
Fixed maturities: |
||||||||||||
Held for investment |
$ | 7,799 | $ | 10,800 | $ | 15,929 | ||||||
Available for sale |
76,742,477 | 73,679,602 | 68,422,691 | |||||||||
Total fixed maturities |
76,750,276 | 73,690,402 | 68,438,620 | |||||||||
Equity securities |
2,911,867 | 2,931,221 | 2,429,561 | |||||||||
Mortgage loans on real estate |
| 88 | 2,211 | |||||||||
Investment real estate |
| 8,926 | 376,863 | |||||||||
Policy loans |
4,514,618 | 4,326,939 | 4,145,985 | |||||||||
Collateral loans |
8,502,108 | 7,346,929 | 7,170,102 | |||||||||
Commercial leases |
6,219,519 | 11,721,507 | 9,183,383 | |||||||||
Other long-term investments |
13,194,809 | 8,267,706 | 4,547,351 | |||||||||
Short-term investments |
2,571,982 | 1,268,755 | 2,637,195 | |||||||||
Total investment income |
114,665,179 | 109,562,473 | 98,931,271 | |||||||||
Interest expense |
(11,531,361 | ) | (6,691,180 | ) | (5,705,598 | ) | ||||||
Investment expenses |
(8,202,079 | ) | (13,510,290 | ) | (10,129,354 | ) | ||||||
Net investment income |
$ | 94,931,739 | $ | 89,361,003 | $ | 83,096,319 | ||||||
Net realized investment gains (losses) are summarized as follows:
2005 | 2004 | 2003 | ||||||||||
Fixed maturities available for sale |
$ | (1,768,154 | ) | $ | (1,077,337 | ) | $ | (2,345 | ) | |||
Equity securities |
10,693,897 | 17,440,120 | 5,337,076 | |||||||||
Other investments |
(2,874,870 | ) | (9,314,129 | ) | 928,888 | |||||||
Net realized investment gains, before taxes |
6,050,873 | 7,048,654 | 6,263,619 | |||||||||
Less: Tax effect on realized investment gains |
2,117,806 | 2,467,029 | 2,192,268 | |||||||||
Net realized investment gains, net of tax |
$ | 3,933,067 | $ | 4,581,625 | $ | 4,071,351 | ||||||
Valuation of Investments
Changes in net unrealized investment gains and losses on fixed maturities and equity securities are as follows:
Increase (Decrease) | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
Fixed maturities: |
||||||||||||
Held for investment |
$ | (3,979 | ) | $ | (5,364 | ) | $ | (10,921 | ) | |||
Available for sale, net of tax |
$ | (13,507,513 | ) | $ | (4,765,233 | ) | $ | (3,319,155 | ) | |||
Equity securities, net of tax |
$ | (3,837,356 | ) | $ | (1,776,378 | ) | $ | 10,880,335 | ||||
64
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Unrealized investment gains and losses are based on fair values that were determined using nationally recognized pricing services, broker/dealers securities firms and market makers.
The cost and estimated fair value of investments in equity securities are as follows:
December 31, 2005 | |||||||||||||
Cost | Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | ||||||||||
Equity securities |
$ | 96,668,040 | $ | 13,966,406 | $ | (3,614,342 | ) | $ | 107,020,104 | ||||
December 31, 2004 | |||||||||||||
Cost | Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | ||||||||||
Equity securities |
$ | 83,445,562 | $ | 17,888,444 | $ | (1,632,756 | ) | $ | 99,701,250 | ||||
Applicable deferred income taxes on net unrealized gains for equity securities aggregated $3,639,602 and $5,705,870 at December 31, 2005 and 2004, respectively.
The amortized cost and estimated fair value of investments in fixed maturity securities are as follows:
December 31, 2005 | |||||||||||||
Amortized Cost | Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | ||||||||||
Held for investment: |
|||||||||||||
Mortgage-backed securities |
$ | 88,330 | $ | 5,248 | $ | | $ | 93,578 | |||||
Available for Sale: |
|||||||||||||
U.S. Treasury securities |
$ | 8,453,587 | $ | 1,533,984 | $ | (95,774 | ) | $ | 9,891,797 | ||||
Obligations of U.S. Government corporations and agencies |
173,859,067 | 1,032,316 | (2,096,645 | ) | 172,794,738 | ||||||||
Obligations of states and political subdivisions |
380,733,250 | 17,631,560 | (461,293 | ) | 397,903,517 | ||||||||
Corporate securities |
196,569,148 | 14,900,108 | (583,434 | ) | 210,885,822 | ||||||||
Mortgage-backed securities |
633,188,826 | 3,178,241 | (10,166,046 | ) | 626,201,021 | ||||||||
Other debt securities |
2,019,200 | 12,000 | | 2,031,200 | |||||||||
Total |
$ | 1,394,823,078 | $ | 38,288,209 | $ | (13,403,192 | ) | $ | 1,419,708,095 | ||||
65
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2004 | |||||||||||||
Amortized Cost | Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | ||||||||||
Held for investment: |
|||||||||||||
Mortgage-backed securities |
$ | 114,708 | $ | 9,227 | $ | | $ | 123,935 | |||||
Available for Sale: |
|||||||||||||
U.S. Treasury securities |
$ | 12,170,755 | $ | 1,640,699 | $ | (85,252 | ) | $ | 13,726,202 | ||||
Obligations of U.S. Government corporations and agencies |
69,552,353 | 1,841,239 | (317,542 | ) | 71,076,050 | ||||||||
Obligations of states and political subdivisions |
372,575,346 | 22,839,750 | (329,295 | ) | 395,085,801 | ||||||||
Corporate securities |
217,747,375 | 23,234,132 | (53,302 | ) | 240,928,205 | ||||||||
Mortgage-backed securities |
631,069,998 | 5,687,654 | (5,552,470 | ) | 631,205,182 | ||||||||
Other debt securities |
2,172,200 | 313,850 | | 2,486,050 | |||||||||
Total |
$ | 1,305,288,027 | $ | 55,557,324 | $ | (6,337,861 | ) | $ | 1,354,507,490 | ||||
Management analyzes net unrealized losses on investments for impairment. The following table shows the Companys net unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005:
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses | |||||||||||||
U.S. Treasury securities |
$ | | $ | | $ | 2,711,625 | $ | 95,774 | $ | 2,711,625 | $ | 95,774 | ||||||
Obligations of U.S. Government corporations and agencies |
122,617,873 | 1,585,228 | 12,293,110 | 511,417 | 134,910,983 | 2,096,645 | ||||||||||||
Obligations of states and political subdivisions |
25,858,343 | 125,937 | 7,705,864 | 335,356 | 33,564,207 | 461,293 | ||||||||||||
Corporate securities |
28,610,474 | 574,184 | 1,994,056 | 9,250 | 30,604,530 | 583,434 | ||||||||||||
Mortgage-backed securities |
341,436,969 | 7,703,819 | 104,664,491 | 2,462,227 | 446,101,460 | 10,166,046 | ||||||||||||
Total fixed maturities |
518,523,659 | 9,989,168 | 129,369,146 | 3,414,024 | 647,892,805 | 13,403,192 | ||||||||||||
Equity securities |
38,830,001 | 3,347,259 | 3,528,551 | 267,083 | 42,358,552 | 3,614,342 | ||||||||||||
Total temporarily impaired securities |
$ | 557,353,660 | $ | 13,336,427 | $ | 132,897,697 | $ | 3,681,107 | $ | 690,251,357 | $ | 17,017,534 | ||||||
Of the 166 fixed maturities in an unrealized loss position at December 31, 2005, the majority are mortgage-backed securities. Of the $10.2 million in unrealized losses on mortgage-backed securities, the majority was issued by governmental agencies. Therefore, return of principal is not currently an issue. Similarly, the interest rate environment has been the primary cause of the other fixed maturity loss positions in the portfolio. While unrealized gains and losses will fluctuate with interest rate changes, receipt of principal is highly probable if these securities are held to maturity. The Company reviews
66
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
securities for impairment each quarter and considers its intent and ability to hold any debt securities in a loss position until the fair value recovers. Information used in the assessment for impairment includes industry analyst reports, credit ratings, and the volatility of the securitys market price.
There were 53 equity positions with unrealized losses at December 31, 2005. No single position comprised over 12% of the gross unrealized losses at that date.
The Company did not consider any decline in value to be an other than temporary impairment at December 31, 2005.
Fixed Maturities
The amortized cost and estimated fair value of fixed maturities available for sale at December 31, 2005 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
December 31, 2005 | ||||||
Amortized Cost | Estimated Fair Value | |||||
Available for Sale: |
||||||
Due in one year or less |
$ | 32,826,029 | $ | 33,187,675 | ||
Due after one year through five years |
115,719,586 | 118,990,036 | ||||
Due after five years through ten years |
248,075,301 | 256,598,074 | ||||
Due after ten years |
365,013,336 | 384,731,289 | ||||
761,634,252 | 793,507,074 | |||||
Mortgage-backed securities |
633,188,826 | 626,201,021 | ||||
Total |
$ | 1,394,823,078 | $ | 1,419,708,095 | ||
Proceeds from sales of fixed maturities available for sale were $108,372,196 in 2005, $61,425,800 in 2004 and $68,916,066 in 2003. Gross gains of $426,899 in 2005, $391,408 in 2004 and $1,644,188 in 2003 and gross losses of $2,231,672 in 2005, $952,108 in 2004 and $2,519,043 in 2003 were realized on those sales. In addition, the Company recorded a loss of $1,046,867 in 2005 and $111,279 in 2004 for fixed maturities available for sale whose valuation was deemed to be an other than temporary decline. No fixed maturities available for sale were written down during 2003. At December 31, 2005, the Companys mortgage-backed securities were comprised of CMOs and pass through securities. The valuation of such securities is subject to significant fluctuations due to changes in interest rates. The Company has a history of positive cash flow and has the ability to hold such investments to maturity. Management performs periodic assessments of the portfolio to monitor interest rate fluctuations. At December 31, 2005, the Company had $5,501,747 in fixed maturities available for sale on deposit with regulatory agencies in order to meet statutory requirements.
The Companys fixed maturity portfolio is predominantly comprised of investment grade securities. At December 31, 2005, approximately $26.3 million in fixed maturities (1.9% of the total fixed maturity portfolio) are considered below investment grade. The Company considers bonds with a quality rating of BB+ and below, based on Standard & Poors rating scale, to be below investment grade.
Equity Securities
Proceeds from sales of equity securities were $137,282,425 in 2005, $167,267,526 in 2004 and $126,036,887 in 2003. Gross gains of $14,545,779 in 2005, $20,503,986 in 2004 and
67
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
$10,785,331 in 2003 and gross losses of $2,847,685 in 2005, $3,063,865 in 2004 and $4,488,106 in 2003 were realized on those sales. The Company also recorded a loss of approximately $1,004,197 in 2005 and $953,349 in 2003 for equity securities whose valuation was deemed to be an other than temporary decline. The Company recorded no such writedowns during 2004.
Policy Loans
The Companys policy loans are carried at the outstanding balance and earn interest predominately at 8.0% but range from 5.0% to 8.0%. Policy loans have no stated maturity and are often repaid by reductions to benefits and surrenders. Therefore, the carrying amount approximates the fair value of the policy loan portfolio.
Collateral Loans
The Companys collateral loan portfolio totaled approximately $124.7 million and $110.8 million at December 31, 2005 and 2004, respectively. These portfolios consisted of mortgage and consumer loans in the Companys primary market area of Alabama, Georgia and Mississippi. Management evaluates the creditworthiness of customers on a case-by-case basis and obtains collateral as deemed necessary based on this evaluation. The Company had charged off loans totaling $422,288, $432,099 and $364,317 in 2005, 2004 and 2003, respectively. At December 31, 2005 and 2004, respectively, the Company maintained an allowance for losses of $1,406,871 and $1,244,280. The Company has estimated the fair value of the collateral loan portfolio to be approximately $130.3 million and $113.9 million at December 31, 2005 and 2004, respectively. The estimated fair value was determined by discounting the estimated future cash flows from the loan portfolio at 5.89% for 2005 and 5.74% for 2004, the current interest rates offered for similar loans, and after allowing for estimated loan losses. The Company had impaired loans of $633,532 and $35,079 subject to individual valuation at December 31, 2005 and 2004, respectively. Loans in nonaccrual status at December 31, 2005 and 2004 were $441,215 and $354,196 respectively. Repossessed assets, net of allowance for losses on disposal, included in other assets were $75,757 and $59,434 at December 31, 2005 and 2004, respectively.
Commercial Leases
The Companys commercial lease portfolio totaled approximately $2.5 million and $4.8 million at December 31, 2005 and 2004, respectively. The majority of the commercial lease portfolio was reclassified to Assets Classified as Held for Sale at December 31, 2004 and subsequently sold in the fourth quarter of 2005 (refer to Note 17Business Combinations and Divestitures). During 2005, 2004 and 2003, the Company charged off leases totaling $1,415,578, $8,303,396 and $2,265,023, respectively. At December 31, 2005, the Company had an allowance for losses of $8,083,758 on the lease portfolio. At December 31, 2004, the allowance for losses on the lease portfolio was $9,727,546 including $3,553,763 on assets classified as held for sale. The Company has estimated the fair value of the commercial lease portfolio to be approximately $2.5 million and $5.0 million at December 31, 2005 and 2004, respectively. The estimated fair value of the lease portfolio at December 31, 2005 approximates carrying value after allowing for estimated lease losses. At December 31, 2004, the estimated fair value of the lease portfolio was determined by discounting the estimated future cash flows from the lease portfolio at 8.5%, the current interest rate offered for similar leases, and after allowing for estimated lease losses. Assets leased to affiliated companies are expected to be held until the lease terminates and, therefore, fair value is assumed to equal net cost. The Company had impaired leases of $1,101,050 and $1,173,593 subject to individual valuation at December 31, 2005 and
68
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
2004, respectively. Leases that are more than 90 days late are placed in a nonaccrual status and totaled $9,881,175 and $8,571,638 at December 31, 2005 and 2004, respectively. Repossessed assets, net of allowances for losses on disposal, included in other assets were $350,156 and $897,118 at December 31, 2005 and 2004, respectively.
Other Long-term Investments
Partnerships and Equity Method Investments: Investments in partnerships, joint ventures and unconsolidated investee companies are stated at the underlying audited equity value based on accounting principles generally accepted in the United States of America. Income is recognized based on reported earnings by the partnerships, joint ventures and companies. Partnership interests represent 77.5%, or approximately $48.0 million, of other long-term investments at December 31, 2005 and 78.6%, or approximately $52.5 million at December 31, 2004. Similarly, partnership interests represent 15.6%, or approximately $21.6 million, of other long-term investments in affiliates at December 31, 2005 and 24.9%, or approximately $19.4 million at December 31, 2004.
Ownership in partnership interests range from less than 1% to 62.5%. The Companys investment in MidCountry is also accounted for using the equity method. In addition to earnings reflected within the statements of income, this investment has generated gross accumulated other comprehensive loss of $607,015 before a tax benefit of $212,455 since the investment was made in 2002. The table below summarizes the companys primary long-term investment interests at December 31, 2005 and related operating results for 2005.
Segment Holding |
Ownership | Carrying Value | Unpaid in Other Liabilities |
Equity in Net Earnings |
Realized Losses |
||||||||||||
Non-affiliates: |
|||||||||||||||||
Low Income Housing Tax Credit Partnerships
|
Property Casualty Insurance | Various | $ | 36,853,272 | $ | 23,515,546 | $ | | $ | (3,391,784 | ) | ||||||
Life Insurance | Various | $ | 6,177,375 | $ | | $ | | $ | (714,790 | ) | |||||||
Other Partnerships |
Life Insurance | Various | $ | 5,013,643 | $ | | $ | 342,909 | $ | | |||||||
Affiliates: |
|||||||||||||||||
Alfa Investors |
Property Casualty Insurance | 27% | $ | 19,893,941 | $ | | $ | 4,097,010 | $ | | |||||||
Alfa Ventures II, LLC
|
Property Casualty Insurance | 20% | $ | 703,391 | $ | | $ | 2,240,193 | $ | | |||||||
East South Boulevard Investors I, LLP |
Life Insurance | 1% | $ | 805,500 | $ | | $ | 45,686 | $ | | |||||||
East South Boulevard Investors II, LLP |
Life Insurance | 1% | $ | 181,159 | $ | | $ | 9,588 | $ | | |||||||
MidCountry Financial Corporation |
Noninsurance | 43% | $ | 53,329,870 | $ | | $ | 1,153,811 | $ | |
The Company had net investment income from partnerships and other equity method investments of approximately $7.9 million in 2005 and $4.1 million in 2004 after net investment losses of approximately $2.5 million in 2003. At December 31, 2005 and 2004, partnerships yielding tax credits from investments in low-income housing of approximately $43.0 million and $47.1 million are included in the Companys other long-term investments. The Company realized losses from its
69
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
investments in low-income housing partnerships of $4.1 million in 2005 and $10.9 million in 2004. In addition, the Companys investment in MidCountry was approximately $53.3 million, $51.5 million and $14.4 million at December 31, 2005, 2004 and 2003, respectively. Net investment income from MidCountry was $1,153,811, $540,189 and $965,229, respectively in 2005, 2004 and 2003.
Other Investments: Included in the Companys other long-term investments is its leased asset portfolio (refer to Note 11Operating Leases) and a position in Waveland NCO Alabama Ventures, LLC, a certified capital company that is an investment premium tax credit program sanctioned by the State of Alabama. This investment is carried at its unpaid principal balance of $2.9 million at December 31, 2005. Principal and interest are received in accordance with a contractual agreement and repayment of principal is protected by strict guidelines imposed by the governing agency. Also included within other long-term investments to affiliates is a note receivable from OFC Servicing Corporation, a wholly-owned subsidiary of MidCountry, for $55,543,362 resulting from the sale of OFC Capital (refer to Note 18Business Combinations and Divestitures). The leased asset portfolio and the note receivable are carried at the net book value.
Short-term Investments
Short-term investments are reflected at fair value and are comprised almost exclusively of money market funds and are not discounted due to their liquidity and short-term nature. Therefore, the Company considers the fair value of its short-term investments to be equal to cost.
5. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosures of fair value information of financial instruments. Information about specific valuation techniques and related fair value detail is provided in Note 1Summary of Significant Accounting Policies, Note 4Investments and Note 8Commercial Paper and Notes Payable. The cost and estimated fair value of financial instruments as of December 31 are as follows:
December 31, | ||||||||||||
2005 | 2004 | |||||||||||
Cost | Estimated Fair Value |
Cost | Estimated Fair Value | |||||||||
Assets: |
||||||||||||
Fixed maturities held for investment |
$ | 88,330 | $ | 93,578 | $ | 114,708 | $ | 123,935 | ||||
Fixed maturities available for sale |
$ | 1,394,823,078 | $ | 1,419,708,095 | $ | 1,305,288,027 | $ | 1,354,507,490 | ||||
Equity securities |
$ | 96,668,040 | $ | 107,020,104 | $ | 83,445,562 | $ | 99,701,250 | ||||
Policy Loans |
$ | 62,101,204 | $ | 62,101,204 | $ | 58,476,569 | $ | 58,476,569 | ||||
Collateral loans |
$ | 124,667,449 | $ | 130,283,798 | $ | 110,792,974 | $ | 113,917,064 | ||||
Commercial leases |
$ | 2,515,084 | $ | 2,515,084 | $ | 4,831,363 | $ | 5,013,646 | ||||
Other long-term investments |
$ | 62,957,416 | $ | 61,961,072 | $ | 75,310,735 | $ | 66,855,805 | ||||
Other long-term investments in affiliates |
$ | 130,839,787 | $ | 138,457,224 | $ | 74,943,872 | $ | 77,942,989 | ||||
Short-term investments |
$ | 84,861,880 | $ | 84,861,880 | $ | 80,988,969 | $ | 80,988,969 | ||||
Cash |
$ | 37,228,639 | $ | 37,228,639 | $ | 20,052,493 | $ | 20,052,493 | ||||
Liabilities: |
||||||||||||
Commercial paper |
$ | 213,790,443 | $ | 213,790,443 | $ | 204,303,206 | $ | 204,303,206 | ||||
Notes payable |
$ | 90,887,635 | $ | 90,887,635 | $ | 85,887,635 | $ | 85,887,635 | ||||
Derivative-related liabilities |
$ | 103,780 | $ | 67,031 | $ | 137,512 | $ | 2,333,677 |
70
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
6. POLICY LIABILITIES AND ACCRUALS
The composition of the liability for future policy benefits and life and health claim reserves and the more significant assumptions used in its calculation are as follows:
Liability | Basis of Assumption | ||||||||||||||||
Insurance Inforce | December 31, | Years of Issue | Interest Rate |
Mortality and |
Withdrawals | ||||||||||||
2005 | 2004 | ||||||||||||||||
Ordinary life |
$ | 12,379,235,907 | $ | 187,849,874 | $ | 174,193,395 | 1955 to 1978 | 5% | 1955-60 Basic Select and Ultimate Mortality Tables | Company experience | |||||||
1979 to 1980 | 7% graded to 5% |
Modified 1965-70 Basic Select and Ultimate Mortality Tables | Company experience | ||||||||||||||
1981 to 1993 | 9% graded to 7% |
Modified 1965-70 Basic Select and Ultimate Mortality Tables | Company experience | ||||||||||||||
1994 to 2005 | 6% | Modified 1965-70 Basic Select and Ultimate Mortality Tables | Company experience | ||||||||||||||
Interest sensitive life |
2,492,011,968 | 246,586,176 | 235,582,918 | 1984 to 2005 | 4.75% to 5%* |
Modified 1965-70 Basic Select and Ultimate Mortality Tables | Company experience | ||||||||||
Universal life |
6,277,271,493 | 341,764,173 | 307,112,029 | 1987 to 2005 | 4.75% to 5%* |
Modified 1965-70 Basic Select and Ultimate Mortality Tables | Company experience | ||||||||||
Annuities w/o life contingencies |
12,842,589 | 12,442,351 | 1974 to 2005 | 4.5%* | |||||||||||||
Group credit life |
13,445,549 | 389,197 | 368,381 | 1992 to 2005 | 3.0% | 1958 CET | |||||||||||
Group life |
47,269,368 | 165,739 | 220,226 | 2005 | 4.5% | 1960 CSG | |||||||||||
$ | 21,209,234,285 | $ | 789,597,748 | $ | 729,919,300 | ||||||||||||
Accident and health |
248,182 | 270,889 | 4.5% to 5% | 1972 intercompany reports | 200% N&W III | ||||||||||||
Life and health claim reserves |
8,288,438 | 5,954,082 | |||||||||||||||
$ | 798,134,368 | $ | 736,144,271 | ||||||||||||||
* | Rates are adjustable annually on policyholders anniversary dates. |
71
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
For the year ended December 31, 2005, premiums under individual ordinary life insurance participating policies were $5,176,439, or 4% of total premiums collected. The Company accounts for its policyholder dividends based upon dividends apportioned for payment for the next year plus any adjustments for dividends paid differently from those apportioned in the prior year. Total policyholder dividends incurred for 2005 were $4,009,119. The Company paid dividends in the amount of $3,963,044 during 2005 to policyholders and did not allocate any additional income to such policyholders. The Company did not issue any participating policies during 2005. The amount of insurance inforce on participating policies represents 1% of ordinary life insurance inforce or approximately $236 million.
Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:
2005 | 2004 | 2003 | ||||||||||||||||||||||
Property Casualty |
Life | Property Casualty |
Life | Property Casualty |
Life | |||||||||||||||||||
Balance at January 1, |
$ | 154,107,730 | $ | 5,954,082 | $ | 144,723,003 | $ | 4,567,589 | $ | 140,019,766 | $ | 4,372,433 | ||||||||||||
less reinsurance recoverables on unpaid losses |
(3,251,046 | ) | (1,677,427 | ) | (5,133,250 | ) | (543,978 | ) | (2,648,790 | ) | (690,672 | ) | ||||||||||||
Net balance on January 1, |
150,856,684 | 4,276,655 | 139,589,753 | 4,023,611 | 137,370,976 | 3,681,761 | ||||||||||||||||||
Incurred related to: |
||||||||||||||||||||||||
Current year |
353,497,743 | 27,921,285 | 325,446,874 | 27,089,443 | 312,309,956 | 24,427,420 | ||||||||||||||||||
Prior years |
4,598,363 | 192,211 | (7,280,159 | ) | 28,369 | (10,761,807 | ) | 115,329 | ||||||||||||||||
Total incurred |
358,096,106 | 28,113,496 | 318,166,715 | 27,117,812 | 301,548,149 | 24,542,749 | ||||||||||||||||||
Paid related to: |
||||||||||||||||||||||||
Current year |
252,333,889 | 25,178,694 | 232,589,448 | 24,905,841 | 229,234,630 | 22,327,532 | ||||||||||||||||||
Prior years |
99,082,555 | 2,179,475 | 74,310,336 | 1,958,927 | 70,094,742 | 1,873,367 | ||||||||||||||||||
Total paid |
351,416,444 | 27,358,169 | 306,899,784 | 26,864,768 | 299,329,372 | 24,200,899 | ||||||||||||||||||
Net balance at December 31, |
157,536,346 | 5,031,982 | 150,856,684 | 4,276,655 | 139,589,753 | 4,023,611 | ||||||||||||||||||
plus reinsurance recoverables on unpaid losses |
2,103,540 | 3,256,456 | 3,251,046 | 1,677,427 | 5,133,250 | 543,978 | ||||||||||||||||||
Balance at December 31, |
$ | 159,639,886 | $ | 8,288,438 | $ | 154,107,730 | $ | 5,954,082 | $ | 144,723,003 | $ | 4,567,589 | ||||||||||||
There are inherent uncertainties in reserving for unpaid losses. Managements philosophy has been to establish reserves at a high level of confidence. The liability for estimated unpaid losses and loss adjustment expenses is based on a detailed evaluation of reported losses and of estimates of incurred but not reported losses. Adjustments to the liability based on subsequent developments are included in current operations. The estimated cost of loss and loss adjustment expenses attributable to insured events of prior years increased by approximately $4.1 million during 2005 as a result of re-estimation of unpaid losses and loss adjustment expenses. Increases or decreases of this nature occur as the result of claim settlements during the current year, and as additional information is received regarding individual claims, causing changes from the original estimates of the cost of these claims. Recent loss development trends are also taken into account in evaluating the overall adequacy of unpaid losses and loss adjustment expenses. The Company is primarily an insurer of private passenger motor vehicles and of single-family homes and has limited exposure for difficult-to-estimate claims such as environmental, product and general liability claims. The Company does not believe that any such claims will have a material impact on the Companys liquidity, results of operations, cash flows or financial condition. Deducted from the liability for estimated unpaid losses and loss adjustment expenses are the Companys estimates of salvage and subrogation recoverable of approximately $9.8 million and $10.1 million at December 31, 2005 and 2004, respectively. The table below summarizes the 2005 changes in estimated loss reserves by component and period in thousands of dollars.
72
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Reserves at January 1, 2005 |
Loss Development |
Paid Loss | Reserves at December 31, 2005 | ||||||||||
(in thousands) | |||||||||||||
Prior to 1996 |
$ | 5,488 | $ | (133 | ) | $ | 4,955 | $ | 400 | ||||
1996 |
886 | 23 | 841 | 68 | |||||||||
1997 |
700 | (1 | ) | 639 | 60 | ||||||||
1998 |
1,970 | (382 | ) | 1,188 | 400 | ||||||||
1999 |
2,076 | 252 | 1,996 | 332 | |||||||||
2000 |
3,358 | 383 | 2,901 | 840 | |||||||||
2001 |
7,228 | (1,563 | ) | 2,185 | 3,480 | ||||||||
2002 |
10,883 | (272 | ) | 3,190 | 7,421 | ||||||||
2003 |
25,410 | 2,624 | 14,336 | 13,698 | |||||||||
2004 |
92,858 | 3,667 | 66,852 | 29,673 | |||||||||
2005 |
| 353,498 | 252,334 | 101,164 | |||||||||
Totals |
$ | 150,857 | $ | 358,096 | $ | 351,417 | $ | 157,536 | |||||
7. INCOME TAXES
The provision for income taxes consists of the following:
2005 | 2004 | 2003 | |||||||||
Current |
$ | 39,134,196 | $ | 34,197,029 | $ | 22,785,163 | |||||
Deferred |
(306,215 | ) | (3,012,541 | ) | 5,342,706 | ||||||
Provision for income taxes |
$ | 38,827,981 | $ | 31,184,488 | $ | 28,127,869 | |||||
A reconciliation of the tax provision at the U.S. Federal statutory rate to the provision for income taxes is as follows:
2005 | 2004 | 2003 | ||||||||||
Tax provision at U.S. Federal statutory tax rate |
$ | 48,251,607 | $ | 42,220,307 | $ | 37,308,886 | ||||||
Dividends received deduction, tax exempt interest and proration |
(4,591,123 | ) | (4,755,627 | ) | (4,430,741 | ) | ||||||
Tax credits |
(5,841,081 | ) | (5,388,287 | ) | (4,005,681 | ) | ||||||
Other, net |
1,008,578 | (891,905 | ) | (744,595 | ) | |||||||
Provision for income taxes |
$ | 38,827,981 | $ | 31,184,488 | $ | 28,127,869 | ||||||
Total income tax expense (benefit) for the years ended December 31 was recorded in the financial statements as follows:
2005 | 2004 | 2003 | ||||||||||
Statements of Income: |
||||||||||||
Provision for income taxes |
$ | 38,827,981 | $ | 31,184,488 | $ | 28,127,869 | ||||||
Statements of Stockholders Equity: |
||||||||||||
Capital in excess of par: |
||||||||||||
Tax (benefit) from stock option exercises |
(846,334 | ) | (1,339,659 | ) | (1,055,685 | ) | ||||||
Accumulated other comprehensive income: |
||||||||||||
Tax expense (benefit) from net unrealized gains (losses) |
(8,809,505 | ) | (4,270,966 | ) | 4,071,306 | |||||||
Total |
$ | 29,172,142 | $ | 25,573,863 | $ | 31,143,490 | ||||||
73
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Deferred tax assets (liabilities) include the following as of December 31:
2005 | 2004 | |||||||
Deferred tax assets: |
||||||||
Reserve computational method differences |
$ | 34,448,779 | $ | 32,378,821 | ||||
Unearned premium reserve |
15,431,900 | 13,009,954 | ||||||
Other |
4,599,064 | 1,061,154 | ||||||
Total deferred tax asset |
54,479,743 | 46,449,929 | ||||||
Deferred tax liabilities: |
||||||||
Net unrealized holding gain on investments |
11,579,146 | 20,388,653 | ||||||
Deferral of policy acquisition cost |
64,501,948 | 58,017,879 | ||||||
Other |
7,517,607 | 11,114,215 | ||||||
Total deferred tax liability |
83,598,701 | 89,520,747 | ||||||
Net deferred tax (liability) |
$ | (29,118,958 | ) | $ | (43,070,818 | ) | ||
At December 31, 2005, the Company established a deferred tax asset for $3.2 million related to future tax benefits in ABC resulting from the transfer of liabilities to ABC when it was formed in 1999. The provision for deferred income taxes was increased by $1.6 million as a result of previously recognized tax benefits in ABC.
The Company has not recognized any deferred taxes for differences between its financial statement carrying amount and its adjusted tax basis of investments in subsidiaries. The amount is not determinable at this time. In the event the Company disposes of one or more of its subsidiaries, it has the ability and intent to liquidate these subsidiaries in a tax-free manner. Therefore, the tax effects of such differences are not required to be recognized. Deferred taxes will be recognized when the Company expects that it will liquidate these subsidiaries in a taxable manner, such as a taxable sale of the investments.
The Company did not establish a valuation allowance related to the deferred tax assets due to the existence of sufficient taxable income related to future reversals of existing temporary differences.
At December 31, 2005 and 2004, the Company had an income tax payable of $1.1 million and an income tax receivable of $2.6 million, respectively.
8. COMMERCIAL PAPER AND NOTES PAYABLE
The Company uses variable-rate debt to partially fund its consumer loan and commercial lease portfolios. In particular, it has issued variable-rate long-term debt and commercial paper. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense also decreases. Short-term debt was $234.7 million and $220.2 million at December 31, 2005 and 2004, respectively, and long-term debt was $70 million at both December 31, 2005 and 2004.
Commercial Paper
The Company had $213.8 million in commercial paper outstanding at a weighted average rate of 4.30% at December 31, 2005. Rates ranged from 4.24% to 4.33% with maturities from January 9,
74
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
2006 to January 23, 2006. At December 31, 2004, the Company had $204.3 million in commercial paper outstanding at a weighted average rate of 2.32%. Rates ranged from 1.83% to 2.38% with maturities from January 4, 2005 to February 2, 2005. The Company intends to continue to use the commercial paper program to fund its short-term needs. However, backup lines of credit are in place up to $300 million to cover up to $230 million in commercial paper and the $70 million variable-rate demand note described below. Commitment fees related to the backup lines were $304,167 in 2005 and $305,000 in 2004. The backup lines agreements contain usual and customary covenants requiring the Company to meet certain operating levels. Included in the financial covenants are requirements that the Company maintain minimum levels of stockholders equity and perform at a level that produces acceptable ratios of credit losses to reserves and indebtedness to capitalization. The Company has maintained full compliance with all such covenants. The Company has A-1+ and P-1 commercial paper ratings from Standard & Poors and Moodys Investors Service, respectively. The commercial paper is guaranteed by two affiliates, Mutual and Fire. Due to the short-term nature of the Companys commercial paper borrowings, the fair value approximates the carrying value.
Notes Payable
The Company issued a variable-rate $70 million long-term obligation maturing on June 1, 2017 in the second quarter of 2002 as a means of funding the collateral loan and commercial lease portfolios. Refer to Note 1Summary of Significant Accounting Policies for discussions about the Companys cash flow hedge.
In addition, the Company had $20.9 million and $15.9 million in short-term debt outstanding to affiliates at December 31, 2005 and 2004, respectively, with interest payable monthly at rates established using the existing commercial paper rate and renewable for multiples of 30-day periods at the commercial paper rate then applicable. Due to the short-term nature of the Companys outstanding debt to affiliates, the fair value approximates the carrying value.
9. COMMITMENTS AND CONTINGENCIES
Contingencies
Certain legal proceedings are in process at December 31, 2005. Costs for these and similar legal proceedings, including accruals for outstanding cases, totaled approximately $2.2 million in 2005, $2.2 million in 2004, and $1.1 million in 2003. These proceedings involve alleged breaches of contract, torts, including bad faith and fraud claims, and miscellaneous other causes of action. These lawsuits involve claims for unspecified amounts of compensatory damages, mental anguish damages, and punitive damages.
Approximately 17 legal proceedings against the Companys life subsidiary were in process at December 31, 2005. Of the 17 proceedings, seven were filed in 2004, five were filed in 2003, four were filed in 1999, and one was filed in 1996.
In addition, one purported class action lawsuit is pending against both Alfa Builders, Inc. and Fire. Additionally, three purported class action lawsuits are pending against the property casualty companies involving a number of issues and allegations which could affect the Company because of a pooling agreement between the companies. No class has been certified in any of these four purported class action cases. In the event a class is certified in any of these purported class actions, reserves may need to be adjusted.
75
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Management believes adequate accruals have been established in these known cases. However, it should be noted that in Mississippi and Alabama, where the Company has substantial business, the likelihood of a judgment in any given suit, including a large mental anguish and/or punitive damage award by a jury, bearing little or no relation to actual damages, continues to exist, creating the potential for unpredictable material adverse financial results.
Based upon information presently available, management is unaware of any contingent liabilities arising from other threatened litigation that should be reserved or disclosed.
Commitments
Guarantees: The Companys property casualty subsidiaries entered into an agreement with Fire in 2000 with respect to a loan guarantee on Fires part, on behalf of EastChase Land Company, LLC to Whitney Bank. Fires guarantee amount to Whitney Bank is $1,000,000. In the unlikely event of a guarantee call, the Companys property casualty subsidiaries would be liable to reimburse Fire a maximum of $200,000. Similarly, in 2003, the Companys property casualty subsidiaries entered into a second agreement with Fire which agreed to guarantee, on behalf of Alfa Ventures II, LLC, the lesser of $25,000,000 or 50% of the total obligations of The Shoppes at EastChase, LLC and EastChase Plaza, LLC with Columbus Bank & Trust Company (CB&T). This second guarantee is known as the bucket guarantee, and supercedes all previous CB&T guarantees for each of these EastChase entities. In the unlikely event of a guarantee call, the Companys property casualty subsidiaries would be liable to reimburse Fire a maximum of $1,393,232. During 2004, the Companys property casualty subsidiaries entered into a third agreement with Fire in which Fire agreed to guarantee, on behalf of EastChase Office, LLC, an amount of $3,180,077 to CB&T. In the unlikely event of a guarantee call, the property casualty subsidiaries would be liable to reimburse Fire a maximum of $636,016.
Unfunded Commitments: The Company periodically invests in affordable housing tax credit partnerships. At December 31, 2005, the Company had legal and binding commitments to fund partnerships of this type in the amount of approximately $23.5 million. These commitments are included in other liabilities in the consolidated balance sheet.
The Company maintains a variety of funding agreements in the form of lines of credit with affiliated entities. The chart below depicts, at December 31, 2005, the cash outlay by the Company representing the potential full repayment of lines of credit it has outstanding with others. Also included with the amounts shown as lines of credit are the potential amounts the Company would have to supply to other affiliated entities if they made full use of their existing lines of credit during 2006 with the Companys finance subsidiary. Other commercial commitments of the Company shown below include commercial paper outstanding, scheduled fundings of partnerships, potential performance payouts related to Vision and funding of a policy administration system project of the life subsidiary.
Amount of Commitment Expiration Per Period | |||||||||||||||
Total Amounts Committed |
Less than 1 year | 1-3 years | 4-5 years | After 5 years | |||||||||||
Lines of credit |
$ | 43,137,635 | $ | 22,250,000 | $ | | $ | 20,887,635 | $ | | |||||
Standby letters of credit |
75,000 | 75,000 | | | | ||||||||||
Guarantees |
2,229,248 | 200,000 | | 636,016 | 1,393,232 | ||||||||||
Standby repurchase obligations |
| | | | | ||||||||||
Other commercial commitments |
266,325,626 | 245,259,699 | 14,888,259 | 3,426,734 | 2,750,934 | ||||||||||
Total commercial commitments |
$ | 311,767,509 | $ | 267,784,699 | $ | 14,888,259 | $ | 24,950,385 | $ | 4,144,166 | |||||
76
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Certain commercial commitments in the table above include items that may, in the future, require recognition within the financial statements of the Company. Events leading to the call of a guarantee, the failure of the policy administration system being developed for use by the life insurance operations to perform properly and achievement of specific metrics by Vision are examples of situations that would impact the financial position and results of the Company
Contractual Obligations: The Company has a limited number of contractual obligations in the form of long-term debt and leases. These leases have primarily been originated by its insurance subsidiaries and Vision. Operating leases supporting the corporate operations are the responsibility of Mutual, an affiliate. In turn, the Company reimburses Mutual monthly for a portion of these and other expenses based on a management and operating agreement. There are currently no plans to change the structure of this agreement. The Companys contractual obligations at December 31, 2005 are summarized below:
Payments Due by Period | |||||||||||||||
Total | Less than 1 year | 1-3 years | 4-5 years | After 5 years | |||||||||||
Operating leases |
$ | 3,999,378 | $ | 1,172,572 | $ | 1,795,471 | $ | 1,031,335 | $ | | |||||
Capital lease obligations |
146,216 | 124,858 | 21,358 | | | ||||||||||
Unconditional purchase obligations |
| | | | | ||||||||||
Notes payable to affiliates |
20,887,635 | 20,887,635 | | | | ||||||||||
Long-term debt |
70,000,000 | | | | 70,000,000 | ||||||||||
Other long-term obligations |
| | | | | ||||||||||
Total contractual obligations |
$ | 95,033,229 | $ | 22,185,065 | $ | 1,816,829 | $ | 1,031,335 | $ | 70,000,000 | |||||
10. STOCKHOLDERS EQUITY
Accumulated Other Comprehensive Income
Components of comprehensive income are depicted in the Consolidated Statements of Stockholders Equity. The tax expense or (benefit) allocated to each component of accumulated other comprehensive income in 2005 was ($8,465,520) for change in fair value of securities available for sale, $1,243,779 for change in deferred acquisition cost adjustment, $751,414 for change in unrealized gain on interest rate swap contract, ($221,375) for change in unrealized loss on other long-term investments and $2,117,805 for reclassification adjustment for realized investment gains.
Undistributed Earnings of Equity Method Investments
The Companys investment in MidCountry has resulted in cumulative earnings of $2,787,667 that are included as a part of retained earnings.
Additional Contribution
The Company increased capital in excess of par value by $4.8 million for the establishment of future tax benefits in ABC resulting from the transfer of liabilities to ABC when it was formed in 1999 (refer to Note 7Income Taxes).
77
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Dividends, Dividend Restrictions and Statutory Financial Information
Alfa Corporation paid $31,054,206 in dividends to stockholders in 2005. ABC paid dividends of $54,000 in 2005 on preferred stock. Their minority interest of $600,000 is classified as other liabilities in the consolidated balance sheet.
The amounts of statutory net income and stockholders equity for the Companys life and property casualty insurance subsidiaries are as follows:
2005 | 2004 | 2003 | |||||||
Statutory net income: |
|||||||||
Life insurance subsidiary |
$ | 22,696,478 | $ | 24,577,418 | $ | 18,218,395 | |||
Property casualty insurance subsidiaries |
$ | 65,838,667 | $ | 59,981,567 | $ | 46,309,213 | |||
Statutory stockholders equity: |
|||||||||
Life insurance subsidiary |
$ | 177,189,239 | $ | 161,992,040 | $ | 144,834,065 | |||
Property casualty insurance subsidiaries |
$ | 407,475,147 | $ | 369,838,236 | $ | 323,362,343 | |||
Alfa Corporation is a holding company with no operations and, accordingly, any cash available for dividends or other distributions must be obtained by it from borrowings or in the form of distributions from its operating subsidiaries. Distributions to the Company from its insurance subsidiaries are subject to regulatory restrictions. Under applicable regulatory requirements, the Companys insurance subsidiaries can distribute to the Company an aggregate of approximately $84.4 million without prior regulatory approval.
At December 31, 2005, the life subsidiarys Adjusted Capital calculated in accordance with NAIC Risk-Based Capital guidelines was $189.9 million, compared to the Authorized Control Level amount of $12.9 million, and the property casualty subsidiaries Adjusted Capital was $407.5 million, compared to the Authorized Control Level amount of $30.3 million. The Risk-Based Capital analysis serves as the benchmark for the regulation of insurance enterprises solvency by state insurance regulators.
Treasury Stock
In October 1989, the Companys Board of Directors approved a stock repurchase program authorizing the repurchase of up to 4,000,000 shares of its outstanding common stock in the open market or in negotiated transactions in such quantities and at such times and prices as management may decide. In March 1999 and in September 2001, the Companys Board of Directors increased the number of shares authorized to be repurchased by 4,000,000 shares, bringing the total number of shares authorized to be repurchased to 12,000,000.
On January 1, 2005, the Company issued 325,035 non-registered shares of common stock to Mr. John C. Russell, President and one of the owners of Vision. The shares were issued as part of the Companys acquisition of Vision on January 1, 2005. The shares were issued pursuant to the exemption found in section 4(2) of the Securities Act of 1933 for non-public offerings.
At December 31, 2005, the Company had repurchased a total of 8,266,623 shares at a cost of $65,383,384 and due to the exercise of stock options had reissued 2,850,815 shares at a cost of $14,726,132 under this program. In addition, the Company began funding its dividend reinvestment plan through the sale of treasury stock during 2002 and therefore had reissued an additional 1,607,767 shares at a cost of $9,679,875 at December 31, 2005.
78
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
These transactions increased the total number of shares outstanding to 80,284,018 shares.
11. OPERATING LEASES
Lessor
Financial leases certain property and equipment to the Companys subsidiaries, Mutual and its affiliates (refer to Note 3Related Party Transactions) and to third parties under operating leases. Profits from related party leasing transactions are eliminated within the corporate segment. Total rental income for the years ended December 31, 2005, 2004 and 2003 was $3,905,441, $4,093,525 and $4,702,117, respectively. No contingent rentals have been included in income. Similarly, the Company recorded depreciation expense on leased assets within the Noninsurance segment of $2,853,390, $2,903,678 and $3,118,034 in 2005, 2004 and 2003, respectively. The cost, accumulated depreciation and net book value of major classes of leased property at December 31, 2005 were:
Cost | Accumulated Depreciation |
Net Book Value | |||||||
Transportation equipment |
$ | 15,921,476 | $ | 3,850,050 | $ | 12,071,426 | |||
Furniture and equipment |
4,749,364 | 2,904,308 | 1,845,056 | ||||||
Total |
$ | 20,670,840 | $ | 6,754,358 | $ | 13,916,482 | |||
At December 31, 2005, the aggregate minimum rental payments to be received under leases having initial or remaining lease terms in excess of one year are $2,855,609 in 2006, $1,409,879 in 2007, $166,867 in 2008, $14,507 in 2009 and $0 thereafter.
Lessee
The Company leases certain office facilities and equipment from Financial and third parties under various operating leases. Profits from related party leasing transactions are eliminated within the corporate segment. These leases expire at various dates through 2010. Visions office facility lease agreement contains scheduled rent increases over the term of the lease. At December 31, 2005, the aggregate minimum rental payments to be made under leases having initial or remaining lease terms in excess of one year are $1,172,572 in 2006, $964,669 in 2007, $830,802 in 2008, $698,729 in 2009, $332,606 in 2010 and $0 thereafter. Certain leases are subject to allocation under a Management and Operating Agreement (refer to Note 3Related Party Transactions) and the Pooling Agreement (refer to Note 2Pooling Agreement). Lease expense incurred for these leases, prior to allocation, was $1,535,480 in 2005, $549,922 in 2004 and $620,800 in 2003.
12. CAPITAL LEASES
Lessor
OFC Capital (OFC), a division of Financial, originated various leases to commercial businesses during its affiliation with the Company. At December 31, 2004, OFC was shown as assets classified as held for sale and was subsequently sold on December 31, 2005 (refer to Note 19Business Combinations and Divestitures). OFC offered various products to its customers that included capital leases, operating leases, sales leasebacks, TRAC leases, municipal leases and conditional sales contracts. Generally, the range of leases extended from 24 months to 60 months with the average being 45 months in length and containing a purchase option at the end of the lease term.
79
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The Companys finance subsidiary leases certain equipment to Marshall Creek, Ltd., a joint real estate venture with Mutual (refer to Note 3Related Party Transactions). These equipment leases have various expiration dates through 2009.
At December 31, 2005 and 2004, future minimum lease payments to be received on leases are $11,726,254 and $102,668,528, respectively; with separate deductions for allowance for uncollectible minimum lease payments receivable of $8,083,758 and $9,727,546, respectively. Unguaranteed residual values accruing to the benefit of the lessor total $895,277 and $1,241,083 at December 31, 2005 and 2004, respectively. Initial direct costs and unearned income at December 31, 2005 are $0 and $2,022,689, respectively. Initial direct costs and unearned income at December 31, 2004 are $578,174 and $12,522,740, respectively.
Future minimum lease payments to be received on capital leases including interest at December 31, 2005 are $1,498,783 in 2006, $1,135,883 in 2007, $796,275 in 2008, $211,555 in 2009, and $0 in 2010. Future minimum lease receivables do not include contingent rentals.
Lessee
The Company leases certain equipment under agreements that are classified as capital leases. The cost of equipment under capital leases included in other assets was $185,443 and $0 at December 31, 2005 and 2004, respectively. Accumulated amortization of the leased equipment at December 31, 2005 and 2004 was $60,715 and $0, respectively. Amortization of assets under capital leases is included in depreciation expense. At December 31, 2005, future minimum lease payments required under the capital leases are $124,858 in 2006, $21,358 in 2007 and $0 thereafter.
13. REINSURANCE
Life reinsures portions of its risks with other insurers. While the amount retained on an individual life will vary depending upon age and mortality prospects of the risk. Life generally will not retain more than $500,000 of individual life insurance on a single risk with the exception of COLI and group policies where the retention is limited to $100,000 per individual. Life has reinsured approximately $2,545,947,598 of its life insurance inforce with other insurance companies and has taken reserve credits for approximately $7,996,836 on account of such reinsurance at December 31, 2005. Amounts paid or deemed to have been paid for Lifes reinsured contracts are recorded as reinsurance receivables. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.
The Companys property casualty insurance subsidiaries, together with Mutual and its affiliates, participate in catastrophe and other reinsurance ceded arrangements to protect them from abnormal losses (refer to Note 2Pooling Agreement). The Companys subsidiaries and Mutual and its affiliates are also required to participate in certain assigned risk pools and associations by the states in which they operate.
80
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The following table summarizes the effects of reinsurance on premiums and losses for the years ended December 31, 2005, 2004 and 2003:
Years Ended December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
Property Casualty Operations: |
||||||||||||
Direct premiums written |
$ | 158,927,048 | $ | 99,434,495 | $ | 90,314,852 | ||||||
Premiums ceded to nonaffiliates/affiliates |
(830,173 | ) | (2,518,699 | ) | (635,515 | ) | ||||||
Premiums ceded to pooling agreement |
(159,964,502 | ) | (99,336,838 | ) | (90,215,982 | ) | ||||||
Premiums assumed from pooling agreement |
588,766,920 | 500,300,291 | 467,357,221 | |||||||||
Premiums assumed from nonaffiliates/affiliates |
1,481,038 | 284,551 | 241,152 | |||||||||
Net premiums written |
$ | 588,380,331 | $ | 498,163,800 | $ | 467,061,728 | ||||||
Total Insurance Operations: |
||||||||||||
Direct premiums earned |
$ | 217,755,714 | $ | 173,154,042 | $ | 158,739,713 | ||||||
Premiums ceded to nonaffiliates/affiliates |
(6,451,799 | ) | (7,870,990 | ) | (5,988,558 | ) | ||||||
Premiums ceded to pooling agreement |
(136,101,556 | ) | (96,431,375 | ) | (87,061,117 | ) | ||||||
Premiums assumed from pooling agreement |
556,825,316 | 487,670,722 | 454,748,760 | |||||||||
Premiums assumed from nonaffiliates/affiliates |
1,044,374 | 236,227 | 186,520 | |||||||||
Net premiums earned |
$ | 633,072,049 | $ | 556,758,626 | $ | 520,625,318 | ||||||
Direct losses |
$ | 242,309,401 | $ | 98,248,459 | $ | 94,132,012 | ||||||
Losses ceded to nonaffiliates |
(5,772,245 | ) | (4,553,343 | ) | (5,468,601 | ) | ||||||
Losses ceded to pooling agreement |
(217,525,550 | ) | (67,728,187 | ) | (64,884,220 | ) | ||||||
Losses assumed from pooling agreement |
334,621,906 | 298,731,435 | 284,289,312 | |||||||||
Losses assumed from nonaffiliates |
8,999,337 | 192,386 | 84,266 | |||||||||
Loss adjustment expenses, net |
25,131,897 | 20,393,777 | 17,935,187 | |||||||||
Net losses incurred |
387,764,746 | 345,284,527 | 326,087,956 | |||||||||
Surrender, maturities, interest and other benefits and settlement expenses |
45,091,564 | 44,777,021 | 38,511,503 | |||||||||
Total benefits and settlement expenses |
$ | 432,856,310 | $ | 390,061,548 | $ | 364,599,459 | ||||||
Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; therefore, allowances are established if amounts are believed to be uncollectible. At December 31, 2005 and 2004, there were no amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurance to minimize exposure to significant losses from reinsurer insolvencies. At December 31, 2005, the Company does not believe there to be a significant concentration of credit risk related to its reinsurance program.
81
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
14. SEGMENT INFORMATION
The Company reports operating segments based on the Companys legal entities, which are organized by line of business:
| Property casualty insurance |
| Life insurance |
| Noninsurance |
| Consumer financing |
| Commercial leasing |
| Agency operations |
| Employee benefits administration |
| Corporate and eliminations |
All investing activities are allocated to the segments based on the actual assets, investments, and cash flows of each segment.
82
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Summarized revenue data for each of the Companys business segments are as follows:
Years Ended December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
Revenues: |
||||||||||||
Property Casualty Insurance |
||||||||||||
Earned premiums |
||||||||||||
Automobile premiums |
$ | 344,193,353 | $ | 302,588,777 | $ | 288,494,920 | ||||||
Homeowner premiums |
196,456,993 | 171,129,997 | 153,374,668 | |||||||||
Other premiums |
15,788,381 | 11,815,457 | 12,583,678 | |||||||||
Total earned premiums |
556,438,727 | 485,534,231 | 454,453,266 | |||||||||
Net investment income |
40,199,673 | 34,746,264 | 28,503,408 | |||||||||
Other income |
9,620,944 | 5,905,213 | 5,898,497 | |||||||||
Realized investment gains (losses) |
185,275 | (4,814,462 | ) | (2,286,267 | ) | |||||||
Total Property Casualty Insurance |
606,444,619 | 521,371,246 | 486,568,904 | |||||||||
Life Insurance |
||||||||||||
Premiums and policy charges |
||||||||||||
Universal life policy charges |
20,803,386 | 19,863,023 | 18,823,152 | |||||||||
Universal life policy chargesCOLI |
3,811,935 | 3,473,319 | 3,244,736 | |||||||||
Interest sensitive life policy charges |
10,883,857 | 10,753,588 | 10,475,440 | |||||||||
Traditional life insurance premiums |
40,617,392 | 36,642,016 | 33,086,557 | |||||||||
Group life insurance premiums |
516,752 | 492,449 | 542,167 | |||||||||
Total premiums and policy charges |
76,633,322 | 71,224,395 | 66,172,052 | |||||||||
Net investment income |
50,962,584 | 49,128,633 | 44,734,610 | |||||||||
Realized investment gains |
5,901,883 | 12,112,573 | 8,584,062 | |||||||||
Total Life Insurance |
133,497,789 | 132,465,601 | 119,490,724 | |||||||||
Noninsurance |
||||||||||||
Net investment income |
||||||||||||
Equity interest in MidCountry Financial (net of expense) |
1,153,811 | 540,189 | 965,229 | |||||||||
Loan income (net of expense) |
4,349,633 | 4,258,133 | 4,200,623 | |||||||||
Other investment income |
2,521,962 | 2,976,049 | 6,313,686 | |||||||||
Total net investment income |
8,025,406 | 7,774,371 | 11,479,538 | |||||||||
Other income |
||||||||||||
Fee/commission income |
23,848,817 | 826,703 | 739,137 | |||||||||
Other income |
1,428,245 | 1,480,565 | 3,271,454 | |||||||||
Total other income |
25,277,062 | 2,307,268 | 4,010,591 | |||||||||
Realized investment gains (losses) |
(36,285 | ) | (230,187 | ) | (34,176 | ) | ||||||
Total Noninsurance |
33,266,183 | 9,851,452 | 15,455,953 | |||||||||
Corporate and Eliminations |
||||||||||||
Net investment income (loss) |
(4,255,924 | ) | (2,288,265 | ) | (1,621,237 | ) | ||||||
Other income (loss) |
(12,048,109 | ) | (89,174 | ) | (77,714 | ) | ||||||
Realized investment gains (losses) |
| (19,270 | ) | | ||||||||
Total Corporate and Eliminations |
(16,304,033 | ) | (2,396,709 | ) | (1,698,951 | ) | ||||||
Total revenues |
$ | 756,904,558 | $ | 661,291,590 | $ | 619,816,630 | ||||||
83
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Segment profit or loss for the property casualty segment is measured by underwriting profits and losses as well as by operating income. Segment profit or loss for the life insurance segment, the noninsurance segment and the corporate segment is measured by operating income. Management believes operating income serves as a meaningful tool for assessing the profitability of the Companys ongoing operations. Operating income, a non-GAAP financial measure, is defined by the Company as net income excluding net realized investment gains and losses, net of applicable taxes. Realized investment gains and losses are somewhat controllable by the Company through the timing of decisions to sell securities. Therefore, realized investment gains and losses are not indicative of future operating performance. Segment information for the previous periods has been restated to reflect the change in composition of reportable operating segments.
Summarized financial performance data for each of the Companys reportable segments are as follows:
Years Ended December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
Operating Income, net of tax: |
||||||||||||
Property Casualty Insurance |
||||||||||||
Net underwriting income |
$ | 55,871,824 | $ | 50,157,788 | $ | 35,224,085 | ||||||
Net investment income |
40,199,673 | 34,746,264 | 28,503,408 | |||||||||
Other income |
9,620,944 | 5,905,213 | 5,898,497 | |||||||||
Pretax operating income |
105,692,441 | 90,809,265 | 69,625,990 | |||||||||
Income tax expense |
25,496,999 | 22,109,813 | 16,513,835 | |||||||||
Operating income, net of tax |
80,195,442 | 68,699,452 | 53,112,155 | |||||||||
Realized investment gains (losses), net of tax |
120,429 | (3,129,401 | ) | (1,486,074 | ) | |||||||
Net income |
80,315,871 | 65,570,051 | 51,626,081 | |||||||||
Life Insurance |
||||||||||||
Pretax operating income |
30,477,610 | 25,465,457 | 25,750,719 | |||||||||
Income tax expense |
8,741,291 | 6,702,835 | 6,692,993 | |||||||||
Operating income, net of tax |
21,736,319 | 18,762,622 | 19,057,726 | |||||||||
Realized investment gains, net of tax |
3,836,224 | 7,873,174 | 5,579,640 | |||||||||
Net income |
25,572,543 | 26,635,796 | 24,637,366 | |||||||||
Noninsurance |
||||||||||||
Pretax operating income |
2,092,745 | 2,036,650 | 5,979,657 | |||||||||
Income tax expense (benefit) |
2,131,635 | (101,934 | ) | 1,948,680 | ||||||||
Operating income (loss), net of tax |
(38,890 | ) | 2,138,584 | 4,030,977 | ||||||||
Realized investment (losses), net of tax |
(23,585 | ) | (149,622 | ) | (22,214 | ) | ||||||
Net income (loss) |
(62,475 | ) | 1,988,962 | 4,008,763 | ||||||||
Corporate and Eliminations |
||||||||||||
Pretax operating (loss) |
(6,451,935 | ) | (4,730,579 | ) | (1,023,169 | ) | ||||||
Income tax expense |
340,251 | 6,745 | 780,093 | |||||||||
Operating (loss), net of tax |
(6,792,186 | ) | (4,737,324 | ) | (1,803,262 | ) | ||||||
Realized investment (losses), net of tax |
| (12,526 | ) | | ||||||||
Net (loss) |
(6,792,186 | ) | (4,749,850 | ) | (1,803,262 | ) | ||||||
Total net income |
$ | 99,033,753 | $ | 89,444,959 | $ | 78,468,948 | ||||||
84
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Segment assets and the segment asset reconciliation are as follows:
December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
Segment Assets: |
||||||||||||
Property Casualty Insurance |
$ | 883,472,822 | $ | 826,528,861 | $ | 718,975,557 | ||||||
Life Insurance |
1,172,546,200 | 1,095,896,131 | 1,013,682,716 | |||||||||
Noninsurance |
329,131,287 | 298,978,921 | 299,934,147 | |||||||||
Corporate and Eliminations |
(3,276,410 | ) | 1,259,633 | (1,584,894 | ) | |||||||
Total Assets |
$ | 2,381,873,899 | $ | 2,222,663,546 | $ | 2,031,007,526 | ||||||
Assets: |
||||||||||||
Allocated to segments |
$ | 3,402,821,045 | $ | 3,147,535,535 | $ | 2,858,440,010 | ||||||
Eliminations |
(1,020,947,146 | ) | (924,871,989 | ) | (827,432,484 | ) | ||||||
Total assets |
$ | 2,381,873,899 | $ | 2,222,663,546 | $ | 2,031,007,526 | ||||||
The following summary reconciles significant segment items to the Companys consolidated financial statements:
Years Ended December 31, | ||||||||||||
2005 | 2004 | 2003 | ||||||||||
Revenues: |
||||||||||||
PremiumsProperty Casualty Insurance |
$ | 556,438,727 | $ | 485,534,231 | $ | 454,453,266 | ||||||
PremiumsLife Insurance |
41,134,144 | 37,134,465 | 33,628,724 | |||||||||
Policy chargesLife Insurance |
35,499,178 | 34,089,930 | 32,543,328 | |||||||||
Net investment income |
94,931,739 | 89,361,003 | 83,096,319 | |||||||||
Net realized investment gains |
6,050,873 | 7,048,654 | 6,263,619 | |||||||||
Other income |
22,849,897 | 8,123,307 | 9,831,374 | |||||||||
Total revenues |
$ | 756,904,558 | $ | 661,291,590 | $ | 619,816,630 | ||||||
Income before income taxes: |
||||||||||||
Underwriting profit |
$ | 47,308,181 | $ | 27,156,195 | $ | 16,841,796 | ||||||
Other income |
22,849,897 | 8,123,307 | 9,831,374 | |||||||||
Other expense |
(33,278,956 | ) | (11,059,712 | ) | (9,436,291 | ) | ||||||
Net investment income |
94,931,739 | 89,361,003 | 83,096,319 | |||||||||
Net realized investment gains |
6,050,873 | 7,048,654 | 6,263,619 | |||||||||
Income before income taxes |
$ | 137,861,734 | $ | 120,629,447 | $ | 106,596,817 | ||||||
Income taxes: |
||||||||||||
Allocated to segments |
$ | 36,710,175 | $ | 28,717,459 | $ | 25,935,601 | ||||||
Allocated to realized gains |
2,117,806 | 2,467,029 | 2,192,268 | |||||||||
Total income tax |
$ | 38,827,981 | $ | 31,184,488 | $ | 28,127,869 | ||||||
15. ACCOUNTING FOR STOCK-BASED COMPENSATION
On October 25, 1993, the Company established a Stock Incentive Plan (the 1993 Plan), pursuant to which a maximum aggregate of 4,000,000 shares of common stock were reserved for grant
85
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
to key personnel. On April 26, 2001, the 1993 Plan was amended to increase the maximum aggregate number of shares available for grant to 6,400,000 shares. Consistent with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, the Company uses the intrinsic value based method to account for stock options issued under the 1993 Plan and provides pro forma disclosures as if the fair value based method had been applied (refer to Note 1Summary of Significant Accounting Policies).
On April 28, 2005, the Companys stockholders approved the 2005 Amended and Restated Stock Incentive Plan (the 2005 Plan). This Plan amends and restates the 1993 Plan. The 2005 Plan permits the grant of a variety of equity-based incentives based upon the Companys common stock, par value $1.00 per share. These include stock options, which may be either incentive stock options as that term is defined in Section 422 of the Internal Revenue Code of 1986, as amended or nonqualified options. The 2005 Plan also permits awards of Stock Appreciation Rights, Restricted Shares, Restricted Share Units and Performance Shares. A maximum of 3,800,000 shares of stock may be issued under the 2005 Plan. The Company accounts for the 2005 Plan under SFAS No. 123 using the recognition and measurement principles of the fair value method.
Stock Options
Under the 1993 and 2005 Plans, options ratably become exercisable annually over three years and expire ten years from the date of the award. Summarized information for stock option grants is as follows:
2005 | 2004 | 2003 | |||||||||||||||||||
Number of Options |
Weighted Average Exercise Price |
Number of Options |
Weighted Average Exercise Price |
Number of Options |
Weighted Average Exercise Price |
||||||||||||||||
Outstanding, beginning of year |
3,029,470 | $ | 10.90 | 2,782,605 | $ | 9.54 | 2,790,838 | $ | 8.67 | ||||||||||||
Add (deduct): |
|||||||||||||||||||||
Granted |
429,000 | $ | 14.44 | 781,000 | $ | 13.25 | 433,000 | $ | 11.65 | ||||||||||||
Exercised |
(344,516 | ) | $ | (9.16 | ) | (503,836 | ) | $ | (6.94 | ) | (396,833 | ) | $ | (6.15 | ) | ||||||
Forfeited/Expired |
(5,300 | ) | $ | (13.25 | ) | (30,299 | ) | $ | (12.25 | ) | (44,400 | ) | $ | (5.88 | ) | ||||||
Outstanding, end of year |
3,108,654 | $ | 11.58 | 3,029,470 | $ | 10.90 | 2,782,605 | $ | 9.54 | ||||||||||||
Exercisable, end of year |
2,027,410 | $ | 10.55 | 1,836,062 | $ | 9.57 | 1,940,621 | $ | 8.44 | ||||||||||||
The weighted-average grant-date fair value of options granted for the year was $6.09 in 2005, $5.69 in 2004 and $4.96 in 2003.
86
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The following table summarizes information about stock options outstanding and exercisable at December 31, 2005:
Options Outstanding | Options Exercisable | |||||||||||
Range of Exercise Prices |
Number of Options |
Weighted Average Remaining Contractual Life (in years) |
Weighted Average Exercise Price |
Number of Options |
Weighted Average Exercise Price | |||||||
$ 5.85 - $ 9.41 |
1,154,588 | 3.58 | $ | 8.66 | 1,154,588 | $ | 8.66 | |||||
$11.65 - $13.25 |
1,165,066 | 7.80 | $ | 12.70 | 512,822 | $ | 12.43 | |||||
$13.93 - $16.36 |
789,000 | 7.82 | $ | 14.21 | 360,000 | $ | 13.93 | |||||
$ 5.85 - $16.36 |
3,108,654 | 6.24 | $ | 11.58 | 2,027,410 | $ | 10.55 | |||||
The Company uses the intrinsic value based method to determine the value of options granted under the 1993 Plan. Under the intrinsic value based method, if options are granted at the market value of the common stock on the grant date, no compensation cost is recognized. The Company uses the fair value method to determine the value of options granted under the 2005 plan. The fair value method measures options at fair value on the grant date using an option-pricing model and compensation cost is recognized. Compensation cost for options with graded vesting is recognized using the straight-line method over the three year vesting period. The Company recognized compensation cost related to options of $234,542 in 2005, $146,888 in 2004 and $167,510 in 2003. Current and prior year expense includes costs related to dividend equivalents on options granted in prior years.
Restricted Shares
Beginning in 2005, the Company awarded two types of service-based nonvested restricted shares to certain officers: restricted shares and career shares. Restricted shares vest and are issuable on the third anniversary after the date of grant. Prior to issuance, the Company will vote the shares and dividends paid will be credited as additional shares of restricted stock that vest along with the original grant. Career shares are awards of restricted stock to certain officers based on specified target levels of ownership of Company common stock by those officers. These shares vest on the third anniversary after the date of grant, but are not negotiable by the recipients until the recipients terminate employment with the Company. The Company will vote these shares until they are issued to the recipients and dividends paid will be credited as additional shares of restricted stock and held by the Company until such shares are issued.
Summarized information for nonvested restricted shares awards is as follows:
2005 | |||||
Number of Shares |
Weighted- Average Grant-Date Fair Value | ||||
Outstanding, beginning of year |
| $ | | ||
Add (deduct): |
|||||
Granted |
77,765 | 15.95 | |||
Vested |
| | |||
Forfeited |
| | |||
Outstanding, end of year |
77,765 | $ | 15.95 | ||
87
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Nonvested restricted shares are measured at fair value on the date of grant. Compensation cost for restricted share awards with cliff vesting is recognized using the straight-line method over the three-year vesting period. Total compensation cost related to nonvested shares was $282,812 in 2005. Based on the Management and Operating Agreement (Refer to Note 3Related Party Transactions), the Companys share of compensation cost related to restricted shares was $181,275 in 2005.
Pro forma Information
The Company discloses the pro forma effect on net income and earnings per share in accordance with SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure, in Note 1, Summary of Significant Accounting Policies.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option-pricing model based on the following weighted-average (or range) assumptions:
2005 | 2004 | 2003 | |||||||
Risk-free interest rate |
4.38 | % | 4.04 | % | 3.95 | % | |||
Expected life (in years) |
7.5 | 7.5 | 7.5 | ||||||
Expected volatility |
46 | % | 47 | % | 49 | % | |||
Expected dividend yield |
2.4 | % | 2.4 | % | 2.7 | % |
| Risk-free interest rate for the expected term of the stock option is based on the U.S. Treasury note yield rate in effect on the date of the grant. |
| Expected life of the stock options granted is derived from historical analysis and represents the period of time that share options are expected to be outstanding. |
| Expected volatility is based on historical volatility of the Companys shares. |
| Expected dividend yield is the expected dividend to be paid on the underlying share. |
As discussed in Note 19Financial Accounting Developments, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R in December 2004, which changed the accounting for stock-based compensation, requiring companies to expense stock options and other equity awards based on their grant-date fair values.
16. GOODWILL AND OTHER INTANGIBLE ASSETS
The Company recorded goodwill related to the purchase of Vision in the amount of $13.9 million and other intangible assets in the amount of $9.1 million. Vision is reported in the noninsurance segment. Refer to Note 17Business Combinations and Divestitures for further discussions regarding the business combination.
Goodwill
The Companys tests of its goodwill for impairment in accordance with SFAS No. 142, Goodwill and Other Intangible Assets, resulted in no writedowns for the year ended December 31, 2005.
88
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Other Intangible Assets
Other intangible assets are classified into three categories:
| Agent Relationships intangible asset represents on-going contractual relationships between existing agents at acquisition date and the managing general agent. |
| Information Technology intangible asset is software enhancements. |
| Restrictive Covenants intangible asset is a covenant not to compete for one Vision executive. |
As of December 31, 2005, other intangible assets by asset class are as follows:
Agent Relationships |
Information Technology |
Restrictive Covenants |
Total | |||||||||||||
Gross carrying amount |
$ | 7,588,000 | $ | 400,000 | $ | 1,120,000 | $ | 9,108,000 | ||||||||
Accumulated amortization |
(379,400 | ) | (80,000 | ) | (224,000 | ) | (683,400 | ) | ||||||||
Net carrying amount |
$ | 7,208,600 | $ | 320,000 | $ | 896,000 | $ | 8,424,600 | ||||||||
The cost of other intangible assets is being amortized over a range of 5 to 20 years, with a weighted average original life of 17.5 years. Amortization expenses for 2005 were $683,400. Amortization expense for intangible assets is estimated to be $683,400 in 2006, $683,400 in 2007, $683,400 in 2008, $683,400 in 2009 and $379,400 in 2010.
17. BUSINESS COMBINATIONS AND DIVESTITURES
Business Combinations
On January 3, 2005, the Company completed the acquisition of Vision, a managing general agency, by acquiring all of the members equity of Vision for a total purchase price of $24.6 million. Visions results of operations have been included in the consolidated financial statements since the date of acquisition. The Company has deemed this acquisition to be immaterial to its overall financial position.
The aggregate purchase price of $24.6 million consisted of $15.3 million in cash, 325,035 non-registered shares of common stock of the Company valued at $5 million, and contingent consideration of $4.3 million.
Vision is a full-service managing general agency that currently writes nonstandard automobile insurance policies in nine states. The company is headquartered in Brentwood, Tennessee and provides all underwriting, claims, actuarial and financial services on behalf of its contracted carriers.
The Company views this acquisition as an opportunity to expand its personal lines business in new markets through Visions independent agent force. An insurance subsidiary, AVIC, was formed through which Vision will write its nonstandard automobile business. Vision operates in Texas, Missouri, Indiana, Ohio, Virginia, Tennessee, Arkansas, Kentucky, and Florida.
The Company has agreed to pay additional consideration in future periods, based upon the attainment of defined operating objectives by the acquired entity. At December 31, 2005, maximum potential future consideration pursuant to such arrangements, to be resolved over the four years ending December 31, 2009, is $11.2 million. The probable or expected contingency payout is recorded at $4.3 million and is included in other liabilities in the consolidated balance sheet.
89
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
On December 30, 2005, the Company amended the LLC Interest Purchase Agreement dated August 2004. The amendment changed the earnout target provisions for the four years beginning January 1, 2006 and ending December 31, 2009.
Internal funds, short-term borrowings, and common stock financed the acquisition.
Divestitures
On December 31, 2005, the Company completed the sale of a substantial portion of its commercial lease portfolio and other assets, net of related liabilities, to OFC Servicing Corporation, a wholly-owned subsidiary of MidCountry. The Companys commercial leasing division operated under the name OFC Capital. OFC Capitals results of operations have been included in the consolidated financial statements in the Noninsurance segment through divestiture. This transaction was subject to certain regulatory approvals, including from the Office of Thrift Supervision and the Federal Deposit Insurance Corporation, which were received during the fourth quarter of 2005.
The Company reported these net assets as held for sale under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets since the fourth quarter of 2004. No gain or loss has been recognized and no amounts of revenue and pretax profit or loss have been reported in discontinued operations during 2004 and 2005 due to the Companys significant continuing involvement through its equity-method investment in MidCountry.
Beginning in 2006, OFC Servicing Corporation will service the Companys retained commercial lease portfolio. The commercial leasing activities will continue to be reported in the Noninsurance segment.
18. SUPPLEMENTAL DISCLOSURE FOR STATEMENTS OF CASH FLOWS
The following table presents the Companys noncash investing and financing activities and required supplemental disclosures to the Statements of Cash Flows for the years ended December 31, 2005 2004, and 2003:
Years Ended December 31, | |||||||||
2005 | 2004 | 2003 | |||||||
Business combinations: |
|||||||||
Treasury stock issued |
$ | 5,000,000 | $ | | $ | | |||
Contingent consideration |
$ | 4,348,088 | $ | | $ | | |||
Divestitures: |
|||||||||
Note receivable issued |
$ | 55,543,362 | $ | | $ | | |||
Assets sold, net of liabilities |
$ | 56,795,882 | $ | | $ | | |||
Supplemental Disclosures of Cash Flow Information: |
|||||||||
Cash Paid During the Period for: |
|||||||||
Interest |
$ | 11,607,146 | $ | 6,859,095 | $ | 6,647,905 | |||
Income Taxes |
$ | 34,599,295 | $ | 32,093,395 | $ | 27,003,866 |
19. FINANCIAL ACCOUNTING DEVELOPMENTS
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-based Compensation. SFAS 123(R) supersedes
90
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees and non-employees, including grants of stock options, to be recognized in the income statement based on fair value at grant date. Pro forma disclosure will no longer be an alternative.
SFAS 123(R) originally required adoption no later than July 1, 2005. In April 2005, the Securities and Exchange Commission (SEC) issued a release that amends the compliance dates for SFAS 123(R). Under the SECs new rule, the Company will be required to apply SFAS 123(R) as of January 1, 2006.
SFAS 123(R) permits public companies to adopt its requirement using one of two methods:
| A modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date. |
| A modified retrospective method which includes the requirements of the modified prospective method described above, but also permits entities to restate, based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures, either (a) all prior periods presented or (b) prior interim periods of the year of adoption. |
The Company will adopt SFAS 123(R) using the modified prospective method.
As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using the intrinsic value method described in APB Opinion No. 25 and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123(R)s fair value method will impact the Companys results of operations, although it will have no impact on the Companys overall financial position. The Company will share compensation cost with Mutual based on the Management and Operating Agreement (refer to Note 3Related Party Transactions). The total impact of SFAS 123(R) on 2006 results of operations for Alfa is expected to be $2.5 million, with $1.6 million allocated to the Company, based on historical levels of activity.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions. This statement requires that exchanges of nonmonetary assets be measured based on fair value and eliminates the exception for exchanges of nonmonetary, similar productive assets, and adds an exemption for nonmonetary exchanges that do not have commercial substance. SFAS No. 153 was effective for nonmonetary asset exchanges in periods beginning after June 15, 2005. This statement has not had a significant impact on the Companys financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement for APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. This statement changes the requirements for the accounting for and reporting of a change in accounting principle. It applies to all voluntary changes in accounting principle as well as to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires voluntary changes in accounting principles be recognized retrospectively to financial statements for prior periods,
91
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
rather than recognition in the net income of the current period. Retrospective application requires restatements of prior period financial statements as if that accounting principle had always been used. This statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. The provisions of SFAS No. 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
In June 2005, the FASB issued a final FASB Staff Position (FSP) EITF 03-1-a (retitled FSP FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments) which will replace the guidance set forth in paragraphs 10-18 of EITF Issue No. 03-1 and clarifies when an investor should recognize an impairment loss. The provisions of FSP FAS 115-1 are effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. This staff position has not had a significant impact on the Companys financial position or results of operations.
In June 2005, the FASB ratified the consensus on EITF Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights. This Issue affects accounting by general partners evaluating whether to consolidate limited partnerships. The EITF agreed on a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate. The presumption of general-partner control would be overcome only when the limited partners have either kick-out rights or participating rights. This guidance was effective after June 29, 2005 for all new limited partnerships formed and for existing limited partnership agreements for which the partnership agreements are modified. For general partners in all other limited partnerships, the guidance in this Issue is effective no later than the beginning of the first reporting period in fiscal years beginning after December 31, 2005, and application of either one of two transition methods described in the Issue would be acceptable. During the fourth quarter of 2005, two limited partnerships in which the Companys life subsidiary has been a general partner with one percent ownership interests were modified to become general partnerships. Consequently, the Company expects EITF Issue No. 04-5 to continue to have no significant impact on the Companys financial position and results of operations.
In addition, the FASB issued FASB Staff Position (FSP) SOP 78-9-1, Interaction of AICPA Statement of Position 78-9 and EITF Issue No. 04-5 in June 2005. The guidance in this FSP was effective after June 29, 2005 for general partners of all new partnerships formed and for existing partnerships for which the partnership agreements are modified. For general partners in all other partnerships, the guidance in this FSP is effective no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005, and the application of either transition method as described in the FSP is permitted.
In August 2005, the FASB issued FSP Financial Accounting Standard (FAS) 123(R)-1, Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R). This staff position defers the requirement under SFAS No. 123(R) that a freestanding financial instrument become subject to the recognition and measurement requirements of other applicable generally accepted accounting principles when the rights conveyed by the instrument to the holder are no longer dependent on the holder being an employee of the entity. The Company does not anticipate that this staff position will have a significant impact on its financial position or results of operations at the time SFAS No. 123(R) is adopted.
92
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
During the fourth quarter of 2005, the FASB also issued three other staff positions applicable at the time the Company adopts SFAS No. 123(R). They are FSP FAS 123(R)-2, Practical Accommodation to the Application of Grant Date As Defined in FASB Statement No. 123(R); FSP FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards; and FSP FAS 123(R)-4, Classification of Options and Similar Instruments Issued As Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event. The Company does not anticipate that these staff positions will have a significant impact on its financial position or results of operations at the time SFAS No. 123(R) is adopted.
In September 2005, the American Institute of Certified Public Accountants issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. This statement provides guidance on accounting for deferred acquisition costs on an internal replacement, defined as a modification in product benefits, rights, coverages, or features that occurs by the exchange of an existing contract for a new contract, or by amendment, endorsement, or rider to an existing contract, or by the election of a benefit, right, coverage, or feature within an existing contract. The guidance in this pronouncement is effective for fiscal years beginning after December 15, 2006. The Company plans to adopt this statement for internal replacements beginning January 1, 2007. Due to its recent issuance, the Company is still assessing the impact this statement will have on its financial position or results of operations.
In November 2005, the FASB issued FSP Nos. FAS 115-1 and 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment. The FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in the FSP amends SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. The Company has reviewed the guidance of FSP Nos. FAS 115-1 and 124-1 and has determined that the adoption of the FSP on January 1, 2006 will not have a significant impact on the Companys financial position or results of operations.
93
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
20. QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarter Ended | ||||||||||||||||||||||||
March 31 | June 30 | September 30 | December 31 | |||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||
Premiums and policy charges |
$ | 153,201,406 | $ | 137,966,592 | $ | 156,075,549 | $ | 138,027,894 | $ | 160,887,004 | $ | 139,956,442 | $ | 162,908,091 | $ | 140,807,698 | ||||||||
Underwriting profit |
$ | 5,028,462 | $ | 12,624,955 | $ | 18,727,468 | $ | 3,940,261 | $ | 12,444,877 | $ | 4,555,049 | $ | 11,107,372 | $ | 6,035,928 | ||||||||
Net investment income |
$ | 22,980,327 | $ | 21,903,138 | $ | 22,914,262 | $ | 22,542,826 | $ | 24,615,504 | $ | 22,442,254 | $ | 24,421,647 | $ | 22,472,784 | ||||||||
Net income |
$ | 21,570,344 | $ | 25,476,887 | $ | 28,555,160 | $ | 20,566,131 | $ | 25,102,903 | $ | 20,720,247 | $ | 23,805,346 | $ | 22,681,694 | ||||||||
Average shares outstanding |
||||||||||||||||||||||||
Basic |
80,165,952 | 80,097,071 | 80,082,617 | 80,039,000 | 80,099,751 | 79,938,616 | 80,215,641 | 79,829,520 | ||||||||||||||||
Diluted |
80,680,958 | 80,652,201 | 80,538,612 | 80,531,351 | 80,702,154 | 80,397,352 | 80,904,931 | 80,356,539 | ||||||||||||||||
Net income per share* |
||||||||||||||||||||||||
Basic |
$ | 0.27 | $ | 0.32 | $ | 0.36 | $ | 0.26 | $ | 0.31 | $ | 0.26 | $ | 0.30 | $ | 0.28 | ||||||||
Diluted |
$ | 0.27 | $ | 0.32 | $ | 0.35 | $ | 0.26 | $ | 0.31 | $ | 0.26 | $ | 0.29 | $ | 0.28 |
* | The sum of the quarters may not equal annual amounts due to the rounding effects on a quarterly basis. |
94
ALFA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
21. SUBSEQUENT EVENTS
Effective January 1, 2006, the Pooling Agreement was amended to remove Specialty from the coinsurance allocation and update the limits and participation levels. The Companys lower catastrophe pool limit increased $3.3 million to $21.2 million and the upper catastrophe pool limit increased $81.8 million to $525.5 million (refer to Note 2Pooling Agreement).
95
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify the Companys financial reports and to other members of senior management and the Board of Directors.
Based on their evaluation of the effectiveness of Alfa Corporations disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of December 31, 2005, the Chief Executive Officer and Chief Financial Officer of Alfa Corporation have concluded that such disclosure controls and procedures are effective to ensure that the information required to be disclosed by Alfa Corporation in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
The Company intends to review and evaluate the design and effectiveness of its disclosure controls and procedures on an ongoing basis, and to make all necessary improvements in controls and procedures and to correct any deficiencies that may be discovered in the future in order to ensure that senior management has timely access to all material financial and non-financial information concerning the Companys business. While the present design of the Companys disclosure controls and procedures is effective to achieve these results, future events affecting the Companys business may cause management to modify its disclosure controls and procedures.
Managements Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the evaluation under the framework in Internal ControlIntegrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2005.
Managements evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein.
Changes in Internal Controls Over Financial Reporting
There were no significant changes in the Companys internal controls over financial reporting that occurred during the fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, internal controls over financial reporting.
None.
96
Item 10. Directors and Executive Officers of the Registrant.
For information with respect to the Directors of the Company, refer to Election of Directors in the Proxy Statement for the annual meeting of stockholders to be held April 25, 2006, which is incorporated herein by reference.
Executive Officers of the Company:
The following is a list of names and ages of all of the executive officers of the Company indicating all positions and offices with the Company held by such person and each such persons principal occupation or employment during the past five years. No person other than those listed below has been chosen to become an executive officer of the Company.
Name |
Age | Position |
Since | |||
Jerry A. Newby |
58 | Chairman of the Board and President; President of its subsidiaries and associated companies; President Alabama Farmers Federation, and farmer | 1998 | |||
C. Lee Ellis |
54 | Executive Vice President, Operations and Treasurer of Alfa Corporation and its subsidiaries | 1999 | |||
Charles W. Hawkins |
68 | Executive Vice President, Marketing; Retired effective March 1, 2006 | 2000 | |||
Stephen G. Rutledge |
47 | Senior Vice President, CFO and Chief Investment Officer | 2000 | |||
Al Scott |
50 | Senior Vice President, Secretary and General Counsel | 1997 | |||
James R. Azar |
69 | Senior Vice President, Audit Services and Risk/Compliance | 1979 | |||
Thomas E. Bryant |
59 | Senior Vice President, Human Resources; Prior to 2001, Vice President, Human Resources, American General Life & Accident Insurance Company | 2001 | |||
Wyman Cabaniss |
54 | Senior Vice President, Underwriting | 1998 | |||
Bill Harper, Jr. |
61 | Senior Vice President, Life Operations of Alfa Life Insurance Corporation, Vice President of Alfa Financial Corporation since 1978. | 1986 | |||
John Jung |
59 | Senior Vice President, Chief Information Officer | 1999 | |||
Jerry Johnson |
50 | Senior Vice President, Claims Prior to 2006, Manager, Regional Claims | 2006 | |||
Ralph Forsythe |
51 | Vice President, Finance and Assistant CFO, Chief Accounting Officer; Prior to 2001, Chief Financial Officer, Haights Cross Communications, DBA The Coriolis Group | 2001 |
The information set forth under the caption Code of Ethics in the Proxy Statement for the annual meeting of stockholders to be held April 25, 2006 is incorporated herein by reference.
The Board of Directors has determined that B. Phil Richardson and Larry E. Newman qualify as independent financial experts on the Audit Committee within the meaning of Securities and Exchange Commission rules.
97
Item 11. Executive Compensation.
The information set forth under the caption Executive Compensation in the Proxy Statement for the annual meeting of stockholders to be held April 25, 2006, except for the Report of the Committee on Executive Compensation, is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information appearing on pages 3 through 10 of the Proxy Statement for the annual meeting of stockholders to be held April 25, 2006, relating to the security ownership of certain beneficial owners and management, is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
The information appearing on pages 5 through 21 of the Proxy Statement for the annual meeting of stockholders to be held April 25, 2006, is incorporated herein by reference.
Item 14. Principal Accounting Fees and Services.
The information set forth under the caption Fees in the Proxy Statement for the annual meeting of stockholders to be held April 25, 2006 is incorporated herein by reference.
98
Item 15. Exhibits, Financial Statement Schedules.
(a) The following documents are filed as part of this report:
1. Financial Statements.
Included in Item 8 of this report
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
Consolidated Balance Sheets as of December 31, 2005 and 2004.
Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003.
Consolidated Statements of Stockholders Equity for the years ended December 31, 2005, 2004 and 2003.
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003.
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules.
Schedules other than those listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not required or applicable.
99
3. Exhibits
Exhibit | (3) | Articles of Incorporation and By-Laws of the Company are incorporated by reference from the Companys Form 10-K for the year ended December 31, 1987. | |
Exhibit | (10(a)) | Asset Purchase Agreement | |
Exhibit | (10(b)) | Amendment No. 1 to Asset Purchase Agreement | |
Exhibit | (10(c)) | Amendment No. 2 to Asset Purchase Agreement | |
Exhibit | (10(d)) | Amendment No. 3 to Asset Purchase Agreement | |
Exhibit | (10(e)) | Amendment No. 4 to Asset Purchase Agreement | |
Exhibit | (10(f)) | Amendment No. 3 to LLC Interest Purchase Agreement | |
Exhibit | (10(g)) | Salary Adjustments for Named Executive Officers | |
Exhibit | (10(h)) | Insurance Pooling Agreement Amended and Restated effective January 1, 2006 | |
Exhibit | (10(i)) | Form of Stock Option Agreement under the 2005 Amended and Restated Stock Incentive Plan | |
Exhibit | (11) | Statement of Computation of Per Share Earnings | |
Exhibit | (19(a)) | The Alfa Corporation Employee Stock Purchase Plan is incorporated by reference from the Companys Form 10-K for the year ended December 31, 1993 and a subsequent amendment thereto is incorporated by referenced from the Companys Form S-8 Registration Statement filed May 2, 2000. | |
Exhibit | (19(b)) | The Alfa Corporation 2005 Amended and Restated Stock Incentive Plan is contained at Exhibit 10(g) in the Companys Form 10-K for the year ended December 31, 2004 and is incorporated herein by reference. | |
Exhibit | (19(c)) | The Form of Restricted Stock Agreement under the Alfa Corporation 2005 Amended and Restated Stock Incentive Plan is contained at Exhibit 10(h) in the Companys Form 10-K for the year ended December 31, 2004 and is incorporated herein by reference. | |
Exhibit | (21) | Subsidiaries of the Registrant | |
Exhibit | (23) | Consent of Independent Registered Public Accounting Firm | |
Exhibit | (31.1) | Certification of Alfa Corporations Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit | (31.2) | Certification of Alfa Corporations Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit | (32) | Certification of Alfa Corporations Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
100
Report on Financial Statement Schedules
of Independent Registered Public Accounting Firm
The Board of Directors
Alfa Corporation:
Under date of March 7, 2006, we reported on the consolidated balance sheets of Alfa Corporation and subsidiaries (the Company) as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders equity and comprehensive income (loss), and cash flows for each of the years in the three-year period December 31, 2005, as contained in the 2005 Annual Report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the Annual Report on Form 10-K for the year 2005. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, such financial statements schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth herein.
KPMG LLP
Birmingham, Alabama
March 7, 2006
101
SCHEDULE ISUMMARY OF INVESTMENTSOTHER THAN
INVESTMENTS IN RELATED PARTIES
December 31, 2005
Type Of Investment |
Cost Or Amortized Cost |
Fair Value |
Amount At Which Shown In Balance Sheet | ||||||
Fixed maturities: |
|||||||||
Bonds: |
|||||||||
United States Government and government agencies |
$ | 182,312,654 | $ | 182,686,534 | $ | 182,686,534 | |||
States, municipalities and political subdivisions |
380,733,250 | 397,903,518 | 397,903,518 | ||||||
Public utilities |
22,119,709 | 24,362,842 | 24,362,842 | ||||||
All other corporate bonds |
174,449,439 | 186,522,980 | 186,522,980 | ||||||
Mortgage-backed securities |
633,277,156 | 626,294,599 | 626,289,351 | ||||||
Redeemable preferred stocks |
2,019,200 | 2,031,200 | 2,031,200 | ||||||
Total fixed maturities |
1,394,911,408 | 1,419,801,673 | 1,419,796,425 | ||||||
Equity securities: |
|||||||||
Common stocks: |
|||||||||
Public utilities |
3,849,804 | 4,255,155 | 4,255,155 | ||||||
Banks, trusts and insurance companies |
4,634,933 | 5,061,836 | 5,061,836 | ||||||
Industrial, miscellaneous and all other |
82,410,321 | 90,948,812 | 90,948,812 | ||||||
Nonredeemable preferred stocks |
5,772,983 | 6,754,301 | 6,754,301 | ||||||
Total equity securities |
96,668,041 | 107,020,104 | 107,020,104 | ||||||
Policy loans |
62,101,204 | 62,101,204 | 62,101,204 | ||||||
Collateral loans |
124,667,449 | 130,283,798 | 124,667,449 | ||||||
Commercial leases |
2,515,084 | 2,515,084 | 2,515,084 | ||||||
Other long-term investments |
62,957,416 | 61,961,072 | 61,961,072 | ||||||
Short-term investments |
84,861,880 | 84,861,880 | 84,861,880 | ||||||
Total investments |
$ | 1,828,682,482 | $ | 1,868,544,815 | $ | 1,862,923,218 | |||
See accompanying report on financial statement schedules of independent registered public accounting firm.
102
ALFA CORPORATION (PARENT COMPANY)
SCHEDULE IICONDENSED FINANCIAL INFORMATION
BALANCE SHEETS
December 31, 2005 and 2004
2005 | 2004 | |||||||
ASSETS |
||||||||
Cash |
$ | 54,322 | $ | 66,106 | ||||
Short-term investments |
2,678,952 | 567,355 | ||||||
Investment in subsidiaries* |
846,482,975 | 764,129,907 | ||||||
Note receivable from subsidiaries* |
205,580,984 | 215,874,984 | ||||||
Accounts receivable and other assets |
1,193,835 | 693,718 | ||||||
Total assets |
$ | 1,055,991,068 | $ | 981,332,070 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Liabilities: |
||||||||
Commercial paper |
$ | 213,790,443 | $ | 204,303,206 | ||||
Notes payable |
81,600,000 | 81,600,000 | ||||||
Other liabilities |
4,607,449 | 3,975,556 | ||||||
Total liabilities |
299,997,892 | 289,878,762 | ||||||
Stockholders Equity: |
||||||||
Common stock, $1 par value, shares authorized110,000,000; issued83,783,024, outstanding200580,300,018; 200479,849,467 |
83,783,024 | 83,783,024 | ||||||
Capital in excess of par value |
21,171,462 | 10,961,782 | ||||||
Accumulated other comprehensive income |
21,699,859 | 38,060,371 | ||||||
Retained earnings |
667,535,056 | 599,609,509 | ||||||
Treasury stock, at cost (shares, 20053,483,006; 20043,933,557) |
(38,196,225 | ) | (40,961,378 | ) | ||||
Total stockholders equity |
755,993,176 | 691,453,308 | ||||||
Total liabilities and stockholders equity |
$ | 1,055,991,068 | $ | 981,332,070 | ||||
* | Eliminates in consolidation |
See accompanying report on financial statement schedules of independent registered public accounting firm.
103
ALFA CORPORATION (PARENT COMPANY)
SCHEDULE IICONDENSED FINANCIAL INFORMATION
STATEMENTS OF INCOME
For the years ended December 31, 2005, 2004 and 2003
2005 | 2004 | 2003 | ||||||||
Revenues: |
||||||||||
Dividends from subsidiaries* |
$ | 49,569,000 | $ | 28,884,000 | $ | 26,777,219 | ||||
Interest from subsidiaries* |
8,228,522 | 5,358,335 | 4,479,580 | |||||||
Gross realized investment losses |
| (19,270 | ) | | ||||||
Other interest |
29,391 | 9,389 | 16,049 | |||||||
Total revenues |
57,826,913 | 34,232,454 | 31,272,848 | |||||||
Expenses: |
||||||||||
Interest expense |
11,161,327 | 6,332,574 | 5,242,635 | |||||||
Other expenses |
3,377,103 | 3,765,730 | 3,473,244 | |||||||
Income before equity in undistributed income of subsidiaries |
43,288,483 | 24,134,150 | 22,556,969 | |||||||
Equity in undistributed income of subsidiaries |
55,745,270 | 65,310,809 | 55,911,979 | |||||||
Net income |
$ | 99,033,753 | $ | 89,444,959 | $ | 78,468,948 | ||||
* | Eliminates in consolidation |
See accompanying report on financial statement schedules of independent registered public accounting firm.
104
ALFA CORPORATION (PARENT COMPANY)
SCHEDULE IICONDENSED FINANCIAL INFORMATION
STATEMENTS OF CASH FLOWS
For the years ended December 31, 2005, 2004 and 2003
2005 | 2004 | 2003 | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net income |
$ | 99,033,753 | $ | 89,444,959 | $ | 78,468,948 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||||
Undistributed earnings of subsidiaries |
(55,745,270 | ) | (65,310,809 | ) | (55,911,979 | ) | ||||||
Stock-based compensation |
238,132 | 146,888 | 167,510 | |||||||||
Gross realized investment losses |
| 19,270 | | |||||||||
Change in other assets and accounts receivable |
(220,896 | ) | (241,673 | ) | (38,853 | ) | ||||||
Change in other liabilities |
232,630 | 583,902 | 1,852,511 | |||||||||
Net cash provided by operating activities |
43,538,349 | 24,642,537 | 24,538,137 | |||||||||
Cash flows from investing activities: |
||||||||||||
Net change in note receivable for subsidiaries |
10,294,000 | (34,145,160 | ) | (42,324,761 | ) | |||||||
Net change in short-term investments |
(2,111,597 | ) | (562,802 | ) | 2,554,037 | |||||||
Investment in subsidiaries |
(15,000,000 | ) | (8,417,500 | ) | | |||||||
Net proceeds from sales of subsidiaries |
| 8,055,609 | | |||||||||
Purchase of subsidiary |
(15,233,564 | ) | | | ||||||||
Dissolution of subsidiary |
| | 27,018 | |||||||||
Net cash used in investing activities |
(22,051,161 | ) | (35,069,853 | ) | (39,743,706 | ) | ||||||
Cash flows from financing activities: |
||||||||||||
Net change in commercial paper |
9,487,237 | 39,859,437 | 31,020,844 | |||||||||
Change in notes payable |
| 7,000,000 | | |||||||||
Purchases of treasury stock |
(2,960,751 | ) | (12,152,909 | ) | (3,684,667 | ) | ||||||
Proceeds from exercise of stock options |
3,028,748 | 3,263,270 | 2,112,838 | |||||||||
Proceeds from dividend reinvestment plan |
| | 10,795,812 | |||||||||
Stockholder dividends paid |
(31,054,206 | ) | (27,528,081 | ) | (25,122,932 | ) | ||||||
Net cash provided by financing activities |
(21,498,972 | ) | 10,441,717 | 15,121,895 | ||||||||
Net change in cash |
(11,784 | ) | 14,401 | (83,674 | ) | |||||||
Cash, beginning of year |
66,106 | 51,705 | 135,379 | |||||||||
Cash, end of year |
$ | 54,322 | $ | 66,106 | $ | 51,705 | ||||||
Supplemental disclosures of cash flow information: |
||||||||||||
Cash paid during the year for: |
||||||||||||
Interest |
$ | 10,882,499 | $ | 6,171,845 | $ | 5,176,877 | ||||||
Income taxes |
$ | 34,108,000 | $ | 31,420,000 | $ | 26,712,900 |
See accompanying report on financial statement schedules of independent registered public accounting firm.
105
SCHEDULE IIISUPPLEMENTAL INSURANCE INFORMATION
For the years ended December 31, 2005, 2004 and 2003
Segment |
Deferred Policy Acquisition Costs |
Future Policy Benefits, Losses, Claims And |
Unearned Premium |
Other Policy Claims And Benefits Payable |
Premiums And Policy Charges |
Net Investment Income |
Benefits Claims, Losses And Settlement Expenses |
Amortization Of Deferred Policy Acquisition Costs |
Other Operating Expenses |
Premiums Written | |||||||||||||||||||||||
2005 |
|||||||||||||||||||||||||||||||||
Life Insurance |
$ | 171,107,909 | $ | 798,134,368 | $ | | $ | | $ | 76,633,322 | $ | 50,962,584 | $ | 73,205,061 | $ | 9,277,108 | $ | 10,627,008 | $ | | |||||||||||||
Property casualty insurance |
33,933,193 | 160,092,101 | 220,456,047 | | 556,438,727 | 40,199,673 | 358,548,315 | 100,652,027 | 41,366,561 | 588,380,331 | |||||||||||||||||||||||
Noninsurance and corporate |
(787,183 | ) | (452,215 | ) | | | | 3,769,482 | 1,102,934 | (1,205,665 | ) | 21,460,356 | | ||||||||||||||||||||
Total |
$ | 204,253,919 | $ | 957,774,254 | $ | 220,456,047 | $ | | $ | 633,072,049 | $ | 94,931,739 | $ | 432,856,310 | $ | 108,723,470 | $ | 73,453,925 | $ | 588,380,331 | |||||||||||||
2004 |
|||||||||||||||||||||||||||||||||
Life Insurance |
$ | 158,015,747 | $ | 736,144,271 | $ | | $ | | $ | 71,224,395 | $ | 49,128,633 | $ | 71,894,833 | $ | 8,023,565 | $ | 11,095,240 | $ | | |||||||||||||
Property casualty insurance |
25,242,477 | 154,107,730 | 185,856,467 | | 485,534,231 | 34,746,264 | 318,166,715 | 82,430,944 | 34,778,783 | 498,163,800 | |||||||||||||||||||||||
Noninsurance and corporate |
| | | | | 5,486,106 | | | 10,398,131 | | |||||||||||||||||||||||
Total |
$ | 183,258,224 | $ | 890,252,001 | $ | 185,856,467 | $ | | $ | 556,758,626 | $ | 89,361,003 | $ | 390,061,548 | $ | 90,454,509 | $ | 56,272,154 | $ | 498,163,800 | |||||||||||||
2003 |
|||||||||||||||||||||||||||||||||
Life Insurance |
$ | 146,174,862 | $ | 673,753,655 | $ | | $ | | $ | 66,172,052 | $ | 44,734,610 | $ | 63,054,252 | $ | 8,788,424 | $ | 9,551,547 | $ | | |||||||||||||
Property casualty insurance |
23,457,958 | 144,723,003 | 170,292,775 | | 454,453,266 | 28,503,408 | 301,545,207 | 77,687,018 | 39,996,956 | 467,061,728 | |||||||||||||||||||||||
Noninsurance and corporate |
| | | | | 9,858,301 | | | 8,834,689 | | |||||||||||||||||||||||
Total |
$ | 169,632,820 | $ | 818,476,658 | $ | 170,292,775 | $ | | $ | 520,625,318 | $ | 83,096,319 | $ | 364,599,459 | $ | 86,475,442 | $ | 58,383,192 | $ | 467,061,728 | |||||||||||||
See accompanying report on financial statement schedules of independent registered public accounting firm.
106
SCHEDULE IVREINSURANCE
For years ended December 31, 2005, 2004 and 2003
Gross Amount | Ceded to Other Companies |
Amount Assumed from Other Companies |
Net Amount |
Percentage of Assumed From to Net |
|||||||||||||
2005 |
|||||||||||||||||
Life insurance inforce |
$ | 21,209,234,285 | $ | 2,545,947,598 | $ | 0 | $ | 18,663,286,687 | 0 | % | |||||||
Premiums and policy charges: |
|||||||||||||||||
Life insurance |
$ | 81,402,232 | $ | 5,280,806 | $ | 0 | $ | 76,121,426 | 0 | % | |||||||
Accident and health insurance |
944,559 | 432,663 | 0 | 511,896 | 0 | % | |||||||||||
Property and liability insurance |
135,408,923 | 136,839,886 | * | 557,869,690 | * | 556,438,727 | 100 | % | |||||||||
$ | 217,755,714 | $ | 142,553,355 | $ | 557,869,690 | $ | 633,072,049 | 88 | % | ||||||||
2004 |
|||||||||||||||||
Life insurance inforce |
$ | 19,779,502,871 | $ | 2,447,827,354 | $ | 0 | $ | 17,331,675,517 | 0 | % | |||||||
Premiums and policy charges: |
|||||||||||||||||
Life insurance |
$ | 75,565,924 | $ | 4,905,705 | $ | 0 | $ | 70,660,219 | 0 | % | |||||||
Accident and health insurance |
1,032,011 | 467,835 | 0 | 564,176 | 0 | % | |||||||||||
Property and liability insurance |
96,556,107 | 98,928,825 | * | 487,906,949 | * | 485,534,231 | 100 | % | |||||||||
$ | 173,154,042 | $ | 104,302,365 | $ | 487,906,949 | $ | 556,758,626 | 88 | % | ||||||||
2003 |
|||||||||||||||||
Life insurance inforce |
$ | 18,262,748,893 | $ | 2,421,536,699 | $ | 0 | $ | 15,841,212,194 | 0 | % | |||||||
Premiums and policy charges: |
|||||||||||||||||
Life insurance |
$ | 71,475,302 | $ | 5,372,826 | $ | 0 | $ | 66,102,476 | 0 | % | |||||||
Accident and health insurance |
69,576 | 0 | 0 | 69,576 | 0 | % | |||||||||||
Property and liability insurance |
87,194,835 | 87,676,849 | * | 454,935,280 | * | 454,453,266 | 100 | % | |||||||||
$ | 158,739,713 | $ | 93,049,675 | $ | 454,935,280 | $ | 520,625,318 | 87 | % | ||||||||
* | These amounts are subject to the pooling agreement. |
See accompanying report on financial statement schedules of independent registered public accounting firm.
107
SCHEDULE VVALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Balance at beginning of period |
Additions | Deductions | Balance at end of period | |||||||||||||
Description |
Charged to costs and expenses |
Charged to other accounts |
||||||||||||||
Loan Losses: |
||||||||||||||||
2005 Allowance for Loan Losses |
$ | 1,244,280 | $ | 495,905 | $ | 0 | $ | 333,314 | $ | 1,406,871 | ||||||
2004 Allowance for Loan Losses |
$ | 1,183,587 | $ | 524,820 | $ | 0 | $ | 464,127 | $ | 1,244,280 | ||||||
2003 Allowance for Loan Losses |
$ | 1,074,460 | $ | 473,444 | $ | 0 | $ | 364,317 | $ | 1,183,587 | ||||||
Lease Losses: |
||||||||||||||||
2005 Allowance for Lease Losses |
$ | 9,727,546 | $ | 1,415,578 | $ | 0 | $ | 3,059,366 | 1 | $ | 8,083,758 | |||||
2004 Allowance for Lease Losses |
$ | 3,487,123 | $ | 6,419,333 | $ | 0 | $ | 178,910 | $ | 9,727,546 | ||||||
2003 Allowance for Lease Losses |
$ | 2,125,035 | $ | 1,847,930 | $ | 0 | $ | 485,842 | $ | 3,487,123 | ||||||
Bad Debts: |
||||||||||||||||
2005 Allowance for Doubtful Accounts |
$ | 0 | $ | 682,469 | $ | 0 | $ | 97,222 | $ | 585,247 | ||||||
2004 Allowance for Doubtful Accounts |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||
2003 Allowance for Doubtful Accounts |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 |
1 | Includes impact of sale of OFC Capital |
See accompanying report on financial statement schedules of independent registered public accounting firm.
108
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ALFA CORPORATION | ||
Dated: March 7, 2006 |
/s/ JERRY A. NEWBY | |
Jerry A. Newby, President |
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature |
Title |
Date | ||
/s/ JERRY A. NEWBY (Jerry A. Newby) |
Chairman of the Board Director and Principal Executive Officer |
March 7, 2006 | ||
/s/ C. LEE ELLIS (C. Lee Ellis) |
Executive Vice President, Operations Treasurer, Director (Principal Operations Officer) |
March 7, 2006 | ||
/s/ STEPHEN G. RUTLEDGE (Stephen G. Rutledge) |
Senior Vice President, CFO and Chief Investment Officer, (Principal Financial Officer) |
March 7, 2006 | ||
/s/ HAL F. LEE (Hal F. Lee) |
Director |
March 7, 2006 | ||
/s/ JAKE HARPER, III (Jake Harper, III) |
Director |
March 7, 2006 | ||
/s/ STEVE DUNN (Steve Dunn) |
Director |
March 7, 2006 | ||
/s/ DEAN WYSNER (Dean Wysner) |
Director |
March 7, 2006 | ||
/s/ RUSSELL R. WIGGINS (Russell R. Wiggins) |
Director |
March 7, 2006 | ||
/s/ LARRY E. NEWMAN (Larry E. Newman) |
Director |
March 7, 2006 | ||
/s/ JOHN R. THOMAS (John R. Thomas) |
Director |
March 7, 2006 | ||
/s/ B. PHIL RICHARDSON (B. Phil Richardson) |
Director |
March 7, 2006 | ||
/s/ BOYD E. CHRISTENBERRY (Boyd E. Christenberry) |
Director |
March 7, 2006 |
EXHIBIT INDEX
Exhibit Number | Description of Exhibit | |
Exhibit (3) | Articles of Incorporation and By-Laws of the Company are incorporated by reference from the Companys Form 10-K for the year ended December 31, 1987. | |
Exhibit (10(a)) | Asset Purchase Agreement | |
Exhibit (10(b)) | Amendment No. 1 to Asset Purchase Agreement | |
Exhibit (10(c)) | Amendment No. 2 to Asset Purchase Agreement | |
Exhibit (10(d)) | Amendment No. 3 to Asset Purchase Agreement | |
Exhibit (10(e)) | Amendment No. 4 to Asset Purchase Agreement | |
Exhibit (10(f)) | Amendment No. 3 to LLC Interest Purchase Agreement | |
Exhibit (10(g)) | Salary Adjustments for Named Executive Officers | |
Exhibit (10(h)) | Insurance Pooling Agreement Amended and Restated effective January 1, 2006 | |
Exhibit (10(i)) | Form of Stock Option Agreement under the 2005 Amended and Restated Stock Incentive Plan | |
Exhibit (11) | Statement of Computation of Per Share Earnings | |
Exhibit (19(a)) | The Alfa Corporation Employee Stock Purchase Plan is incorporated by reference from the Companys Form 10-K for the year ended December 31, 1993 and a subsequent amendment thereto is incorporated by reference from the Companys Form S-8 Registration Statement filed May 2, 2000. | |
Exhibit (19(b)) | The Alfa Corporation 2005 Amended and Restated Stock Incentive Plan is contained at Exhibit 10(g) in the Companys Form 10-K for the year ended December 31, 2004 and is incorporated herein by reference. | |
Exhibit (19(c)) | The Form of Restricted Stock Agreement under the Alfa Corporation 2005 Amended and Restated Stock Incentive Plan is contained at Exhibit 10(h) in the Companys Form 10-K for the year ended December 31, 2004 and is incorporated herein by reference. | |
Exhibit (21) | Subsidiaries of the Registrant | |
Exhibit (23) | Consent of Independent Registered Public Accounting Firm | |
Exhibit (31.1) | Certification of Alfa Corporations Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit (31.2) | Certification of Alfa Corporations Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit (32) | Certification of Alfa Corporations Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |