Atlantic American Corporation — Q3 2011 Form 10-Q
Business context and period: Insurance holding company with property and casualty operations (American Southern) and life and health operations (Bankers Fidelity). This unaudited report covers the three and nine months ended September 30, 2011; comparisons are with the corresponding 2010 periods unless noted. Dollar amounts below are in millions unless otherwise stated.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $30.8 | $27.1 | $87.9 | $80.2 |
| Insurance premiums | $27.2 | $24.6 | $78.8 | $72.3 |
| Investment income | $2.7 | $2.3 | $7.9 | $7.4 |
| Realized investment gains | $0.9 | $0.2 | $1.0 | $0.2 |
| Net income | $1.7 | $0.5 | $2.4 | $1.0 |
| Net income applicable to common | $1.6 | $0.4 | $2.0 | $0.6 |
| Diluted earnings per common share | $0.07 | $0.02 | $0.09 | $0.03 |
| Operating cash flow | Not presented by quarter | $(0.02) | $0.32 |
Revenue increased 13.5% in Q3 and 9.6% year to date; net income improved substantially in both periods. Management attributed the improvement primarily to higher premiums, investment income and realized gains, alongside relatively consistent fixed expenses. Q3 income before tax was $1.8 million versus $0.6 million; nine-month income before tax was $2.7 million versus $1.2 million.
Premium growth was led by Medicare supplement and commercial automobile business. Bankers Fidelity’s Medicare supplement premiums rose 20.0% in Q3 and 12.5% year to date, helped by new business and renewal rate increases. American Southern’s earned premiums increased 2.8% in Q3 and 10.0% year to date. Its nine-month written premiums were lower, partly because of a state-contract policy-term change and continued weakness in general liability.
Margins, balance sheet and liquidity
- Underwriting: American Southern’s combined ratio was 105.0% in Q3 2011 versus 97.6% a year earlier, and 100.9% for nine months versus 100.7%. The Q3 loss ratio rose to 72.8% from 56.6%, reflecting several large commercial auto losses and higher surety contract-bond losses. Bankers Fidelity’s benefits-and-losses ratio improved to 70.0% in Q3 from 72.7%, and to 72.1% for nine months from 73.3%.
- Assets and equity: At September 30, total assets were $292.9 million, total liabilities $197.7 million and shareholders’ equity $95.1 million, compared with $277.6 million, $194.9 million and $82.7 million at year-end 2010. Investments were $218.8 million, including $206.7 million of fixed maturities; cash and cash equivalents were $22.4 million.
- Cash flow: Nine-month operating cash flow was nearly breakeven at $(0.02) million, versus $0.32 million provided in 2010. Investing activities used $5.4 million; financing activities used $0.5 million, including $0.4 million of common dividends. Cash declined $5.9 million from year-end 2010, primarily because investment purchases exceeded sales and maturities, and because of the dividend payment.
- Debt: Junior subordinated debentures totaled $41.2 million, with maturities in 2032 and 2033 and floating LIBOR-based coupons. No balance was outstanding under the $5.0 million revolving credit facility; the facility was extended to August 31, 2012, and the company reported covenant compliance. Nine-month interest expense was $1.9 million.
- Liquidity: Management reported $27.1 million of unrestricted cash and investments at the parent and said available resources and expected subsidiary dividends, fees and tax-sharing payments should meet foreseeable needs. Insurance-subsidiary assets are subject to regulatory limits on use and dividends; payments above $6.8 million in 2011 would require prior approval.
- Investment valuation: Net unrealized investment gains were $14.7 million at September 30, versus net unrealized losses of $1.7 million at year-end 2010. The change helped raise equity and included deferred taxes; it is distinct from realized gains in earnings. The interest-rate collar was a $1.1 million liability.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year or future results.
- Key estimates and risks include property-and-casualty loss reserves, future policy-benefit assumptions, deferred acquisition-cost recoverability, reinsurer collectability and investment fair values. Management noted that adverse loss development not covered by reinsurance could materially affect results.
- The investment portfolio includes securities with unrealized losses of $5.6 million, including $2.6 million on related-party Gray Television investments. Management considered the securities temporarily impaired and said it did not intend, and did not expect to be required, to sell them before recovery. Some fair values rely on significant unobservable inputs.
- The company continued making payments under its interest-rate collar because LIBOR remained below the 4.77% floor; the contract runs through March 2013. Management described counterparty exposure as minimal.
- Reported nine-month realized gains included a $0.3 million gain on sale of a land outparcel. The 2011 tax expense also reflected a $0.36 million reduction in the deferred-tax valuation allowance, primarily related to use of capital-loss carryforwards. The prior-year comparison included a $0.3 million nonrecurring defined-benefit-plan termination charge.
- Management said ordinary-course claims and lawsuits were not expected to materially affect financial condition or results. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.
Important facts for investors to verify
- Whether American Southern’s elevated Q3 loss ratio and large auto and surety losses persist, and whether its combined ratio improves.
- How much of earnings growth is repeatable versus attributable to realized investment gains and the tax valuation-allowance change.
- Investment portfolio credit quality, duration and concentration, including Gray Television exposure, unrealized losses and Level 3 valuation assumptions.
- Cash generation and parent-company liquidity, considering restricted insurance-subsidiary assets, permitted dividends and the $41.2 million of subordinated debentures.
- Development of claims reserves, policy-benefit assumptions and reinsurance recoverables, which depend on management estimates and actuarial assumptions.