AAME

Business Context and Reporting Period

Company: Atlantic American Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2006
Business Overview: Atlantic American is an insurance holding company operating through four principal subsidiaries: American Southern, Association Casualty, Georgia Casualty, and Bankers Fidelity. The company focuses on regional property and casualty insurance as well as life and health insurance products.

Key Financial Metrics

Material Changes vs. Prior Period

• Premium Decline: Insurance premiums decreased 13.8% to $79.0 million for the six months ended June 30, 2006, compared to $91.6 million in 2005. This was driven by increased competition, non-renewal of targeted property classes, reassessment of coastal exposures, and lower sales in the Medicare supplement market.
• Profitability Improvement: Despite lower premiums, net income applicable to common stock improved from a loss of $0.2 million in 2005 to $2.6 million in 2006. This was primarily due to a significant increase in realized investment gains ($4.0 million in 2006 vs. $0.03 million in 2005) and the absence of the severe claim frequency/severity experienced in the first half of 2005.
• Unusual Items: The second quarter of 2006 included a $1.8 million expense related to a subsequent windstorm assessment from the Mississippi Windstorm Underwriting Association (Hurricane Katrina) that exceeded reinsurance coverage. Additionally, a $1.0 million increase in the second injury trust fund assessment was recorded.
• Cash Position: Cash and cash equivalents dropped significantly from $41.8 million at year-end 2005 to $4.0 million at June 30, 2006. Management attributes this to a strategic shift from short-term investments to higher-yielding fixed maturity securities.

Guidance, Outlook, and Risks

• Management Commentary: Management is consolidating information systems and operations between Association Casualty and Georgia Casualty to create a more efficient regional property and casualty operation. New programs implemented at Bankers Fidelity to boost life insurance sales are not expected to impact financial results until the second half of 2006.
• Debt and Liquidity: The company holds $12.8 million in bank debt (term loans with Wachovia) and $41.2 million in junior subordinated debentures. Interest rates on bank debt are variable (LIBOR + margin). The company believes dividends from subsidiaries and potential refinancing will meet liquidity needs.
• Preferred Stock: The company has accrued but unpaid dividends on Series B Preferred Stock totaling $12.7 million as of June 30, 2006.
• Risks and Contingencies:
  • Reserving Risk: Unpaid loss and loss adjustment expenses comprise 46% of liabilities. Estimates involve significant judgment and could vary materially.
  • Investment Risk: Investments (71% of assets) are subject to market fluctuations. The company carries investments at fair value.
  • Reinsurance Risk: Failure of reinsurers to meet obligations could result in uncollectible amounts.

Investor Verification Checklist

• Reinsurance Recoveries: Verify the status of the $1.8 million Hurricane Katrina assessment expense and the adequacy of reinsurance coverage for future windstorm events.
• Premium Trends: Monitor the sustainability of the premium decline, particularly in the property and Medicare supplement lines, and the effectiveness of new sales programs at Bankers Fidelity.
• Investment Portfolio: Review the composition of the fixed maturity portfolio and the impact of the shift from short-term to long-term assets on liquidity and yield.
• Debt Covenants: Confirm compliance with debt covenants regarding funded debt to capitalization ratios and tangible net worth, especially given the reduction in cash reserves.
• Preferred Dividends: Assess the company's ability to pay the $12.7 million in accrued preferred dividends and the impact on common shareholder distributions.