Atlantic American Corporation — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; balance-sheet comparisons are with December 31, 2013. The insurance holding company operates property and casualty businesses through American Southern and life and health businesses through Bankers Fidelity. Financial amounts below are in millions unless otherwise stated.
Financial performance and position
- Third quarter: Revenue was $42.7 million, down 1.4% year over year. Net income was $1.45 million versus $2.68 million; diluted EPS was $0.06 versus $0.12. Non-GAAP operating income was a loss of $0.01 million, compared with income of $0.41 million.
- Nine months: Revenue was $125.4 million, up 0.7%. Net income fell to $3.15 million from $9.56 million; diluted EPS was $0.13 versus $0.42. Non-GAAP operating income increased slightly to $1.38 million from $1.35 million. The company defines operating income by excluding income taxes, realized investment gains and the gain on its debt purchase.
- Revenue mix and costs: Nine-month insurance premiums rose 6.9% to $115.2 million; investment income declined 4.1% to $7.9 million, and realized investment gains fell to $1.4 million from $8.4 million. Benefits and losses increased to $81.0 million from $75.1 million; total benefits and expenses rose to $121.8 million from $114.8 million.
- Segments: Nine-month pretax income was $3.7 million at American Southern (down from $6.5 million) and $3.8 million at Bankers Fidelity (down from $7.2 million); Corporate and Other posted a $4.0 million loss. American Southern’s nine-month combined ratio was 100.8%, with a 74.6% loss ratio. Bankers Fidelity’s combined ratio was 101.5%, with a 68.1% loss ratio.
- Cash flow and liquidity: Operating cash flow was negative $1.8 million for the nine months, versus positive $7.6 million a year earlier. Cash and cash equivalents declined to $16.5 million from $33.1 million. At the parent, unrestricted cash and investments were approximately $19.5 million. Total investments were $235.4 million.
- Debt and capital: Junior subordinated debentures, net, were $33.7 million, down from $41.2 million. Total liabilities were $214.7 million and shareholders’ equity was $102.2 million at September 30. The company repurchased $7.5 million principal amount of its debentures for $6.75 million, recording a $0.75 million gain.
Material changes and management commentary
- Management attributed the sharp year-over-year decline in net income mainly to lower realized investment gains, following sales of higher-yielding, longer-term investments in 2013 to shorten portfolio maturity. Nine-month investment income also declined for this reason.
- American Southern’s premiums benefited from a state contract that began in 2013, but higher expected commercial-auto losses and other claims raised its loss ratio. The company also cancelled an agency because of unfavorable loss experience, reducing written premiums.
- Bankers Fidelity’s nine-month premiums increased, primarily due to Medicare supplement renewal rate increases; more favorable Medicare supplement loss experience improved its loss ratio. Higher agency, underwriting and hiring costs partly offset that benefit.
- Investment securities had $2.3 million of gross unrealized losses at September 30, compared with $5.8 million at year-end. The company recorded $0.2 million of other-than-temporary impairment losses on certain non-redeemable preferred stocks. Third-quarter other comprehensive loss was $5.2 million, primarily reflecting available-for-sale securities valuation changes.
- Cash declined in part because of the debenture purchase, $3.8 million of property and equipment additions, $2.4 million of common-stock repurchases and dividends. The company’s board had authorized repurchases of up to 750,000 shares; 230,626 shares were repurchased in Q3 for an average $4.02 per share.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management said it believes existing cash, subsidiary dividends, fees and tax-sharing payments, and potential additional borrowing will meet liquidity needs for the foreseeable future. It also stated that subsidiary invested assets and expected inflows should support policy liabilities and claims, subject to insurance-regulatory limits on asset use and dividends.
- Outstanding debentures bear interest at three-month LIBOR plus 4.00%–4.10%; the reported effective rate was 4.3%. The company may defer interest under specified terms, but had not elected to do so. Debentures are unsecured and subordinated; subsidiary liabilities effectively rank ahead of parent obligations.
- Insurance results remain exposed to claims frequency and severity, reinsurance recoveries, investment valuations and interest rates. Management classified securities in unrealized-loss positions as temporarily impaired and said it did not intend, or expect to be required, to sell them before recovery.
- Ordinary-course claims and lawsuits were not expected by management to materially affect financial condition or results. Forward-looking statements are subject to risks described in prior SEC filings; the company undertook no obligation to update them.
- Subsequent event: On October 28, 2014, the board declared a special dividend of $0.02 per share, payable on or about December 5 to holders of record November 14.
Important facts for investors to verify
- Whether American Southern’s elevated commercial-auto and other claims costs persist, and how the state contract affects future loss ratios.
- Whether lower investment income and realized gains continue to weigh on earnings after the portfolio repositioning.
- The sustainability of operating cash flow and parent liquidity, including the timing and regulatory availability of subsidiary dividends.
- The valuation and credit quality of investment securities, including the impaired preferred stocks and Level 3 fixed maturities.
- The impact of continued share repurchases, the special dividend, and the remaining subordinated-debt obligations on capital and liquidity.