ATLANTIC AMERICAN CORP annual report, FY2013

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Atlantic American Corporation — 2013 Form 10-K

Business context and reporting period. This is an annual report for the fiscal year ended December 31, 2013, with comparisons to 2012—not a standalone fourth-quarter report. The insurance holding company operates through property-and-casualty insurer American Southern and life-and-health insurer Bankers Fidelity, focused particularly on Medicare supplement and senior-market products.

Financial performance and condition

  • Revenue: $165.4 million, up 18.3% from $139.8 million. Premium revenue rose to $145.6 million from $126.7 million, led by Medicare supplement growth and a new state commercial-auto contract.
  • Earnings: Net income was $11.0 million ($0.48 diluted EPS), versus $4.4 million ($0.18) in 2012. The increase chiefly reflects net realized investment gains of $8.7 million, compared with $1.4 million. Management’s non-GAAP operating income, excluding realized investment gains and income taxes, declined to $2.5 million from $3.6 million.
  • Insurance results and margins: American Southern’s combined ratio improved to 101.0% from 105.7%, though underwriting remained loss-making ($0.5 million loss). Bankers Fidelity’s combined ratio worsened to 101.0% from 98.9%, moving from $1.0 million underwriting income to a $1.0 million loss. Consolidated benefits and losses plus commissions and underwriting expenses were 96.8% of premiums, versus 96.5%.
  • Investment income and cash flow: Net investment income fell to $10.3 million from $11.3 million; reported average portfolio yield fell to 4.3% from 4.9%. Operating cash flow increased to $13.0 million from $6.1 million. Cash and cash equivalents were $33.1 million at year-end, up from $19.0 million.
  • Balance sheet and liquidity: Total assets were $319.4 million, liabilities $218.5 million, and shareholders’ equity $100.9 million. Investments totaled $229.0 million. Parent-only unrestricted cash and investments were approximately $32.0 million; this is distinct from consolidated cash of $33.1 million. Insurance-subsidiary dividends to the Parent are subject to regulatory limits.
  • Debt and capital: Debt payable was $41.2 million, comprising junior subordinated debentures bearing three-month LIBOR plus 4.00%–4.10% (4.30% effective at year-end), with maturities in 2032 and 2033. The insurance subsidiaries exceeded regulatory risk-based-capital thresholds; aggregate statutory surplus was $73.6 million.

Material changes versus 2012

  • American Southern gross written premiums grew 33.2%, primarily from a new state contract awarded in the second quarter; $13.7 million of the increase was attributed to that contract. Its loss ratio improved, but its expense ratio rose.
  • Bankers Fidelity premiums increased 11.8%, principally from Medicare supplement business. Benefits and expenses grew faster than premiums, resulting in an underwriting loss.
  • Realized investment gains rose substantially as the company sold longer-duration fixed maturities. Fixed maturities due after ten years fell to $76.9 million from $181.6 million; the shift contributed to lower investment income and yield.
  • Other comprehensive income turned to a $13.4 million loss from $7.3 million income, largely reflecting lower unrealized gains on available-for-sale securities. Equity declined to $100.9 million from $105.7 million.
  • The company acquired Direct Life Insurance Company on December 18, 2013, renamed Bankers Fidelity Assurance Company, for $3.9 million. The acquired company had no significant recent operations.
  • Cash used for share repurchases was $1.4 million in 2013. The company paid a $0.02-per-share annual common dividend and declared the same annual dividend for 2014.

Outlook, risks and unusual items

  • No numerical earnings or revenue guidance is provided. Management said existing cash, subsidiary distributions and, if needed, additional borrowing were expected to meet liquidity needs for the foreseeable future.
  • Management cited higher advertising and agency costs, worksite-product development expenses, and actuarial consulting costs as pressures on operating income. It also noted that reinvestment of proceeds from longer-term bond sales was at lower yields.
  • Reserve estimates are material and judgment-dependent. Management’s consolidated reserve range indicated recorded reserves could be 11.6% lower or 9.3% higher; revisions could materially affect future results. Prior-year favorable development was $2.5 million in property-and-casualty operations in 2013.
  • Investment and operating risks include interest-rate and market-value changes, claims frequency and severity, catastrophe losses, reserve uncertainty, competition, regulatory changes, and reinsurer performance. Approximately 99% of reinsurance receivables were due from two reinsurers; the filing identifies them as highly rated.
  • Other matters to note: ordinary-course litigation was not expected to materially affect financial condition, though a period’s results could be affected; Series D preferred stock is held by an affiliate of the controlling shareholder and may become convertible under specified circumstances; and the main office lease is with an entity controlled by an affiliate.
  • The independent auditor issued an unqualified opinion on the consolidated financial statements. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not attest to internal-control effectiveness under the scaled rules for smaller reporting companies.

Important facts for investors to verify

  1. How much of 2013 earnings growth is repeatable, given the $8.7 million realized investment gain and the decline in operating income?
  2. Whether the new state contract remains profitable after its separate reinsurance terms, and how concentration in that contract affects premiums and loss exposure.
  3. Whether Medicare supplement growth can produce underwriting profitability as benefit costs, rates, and acquisition expenses change.
  4. Reserve adequacy and subsequent claims development, particularly for long-tail general liability and current accident years.
  5. Investment portfolio exposure to interest rates, credit concentration, unrealized losses and the lower reinvestment yields described by management.
  6. Parent liquidity and debt-service capacity, including limits on subsidiary dividends and the variable-rate debenture obligations.
  7. Potential dilution and related-party considerations associated with Series D preferred stock, affiliate transactions, and the company’s Gray Television investment.