AFSI 09.30.2012 10Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
 
S
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012
 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ___________________ to ___________________
 
Commission file no. 001-33143
 
AmTrust Financial Services, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
04-3106389
(State or other jurisdiction of
 
(IRS Employer Identification No.)
incorporation or organization)
 
 
 
 
 
59 Maiden Lane, 6th  Floor, New York, New York
 
10038
(Address of principal executive offices)
 
(Zip Code)
 
(212) 220-7120
(Registrant’s telephone number, including area code)
 
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes       x No      ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company" in Rule 12b-2 of the Exchange Act:
 
Large accelerated filer       ¨
 
Accelerated filer       x
 
 
 
Non-accelerated filer         ¨
 
Smaller reporting company      ¨
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).
Yes      ¨ No      x
 
As of November 1, 2012, the Registrant had one class of Common Stock ($.01 par value), of which 66,918,040 shares were issued and outstanding. 



INDEX

 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
AMTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In Thousands, Except Par Value)
 
September 30,
2012
 
December 31,
2011
 
(Unaudited)
 
(Audited)
ASSETS
 
 
 
Investments:
 
 
 
Fixed maturities, available-for-sale, at market value (amortized cost $1,749,699; $1,382,863)
$
1,847,623

 
$
1,394,243

Equity securities, available-for-sale, at market value (cost $20,202; $34,041)
18,318

 
35,600

Short-term investments
485

 
128,565

Equity investment in unconsolidated subsidiaries – related parties
94,889

 
83,691

Other investments
14,324

 
14,588

Total investments
1,975,639

 
1,656,687

Cash and cash equivalents
557,989

 
406,847

Restricted cash and cash equivalents
46,795

 
23,104

Accrued interest and dividends
15,220

 
12,644

Premiums receivable, net
1,038,495

 
932,992

Reinsurance recoverable (related party $721,406; $597,525)
1,218,180

 
1,098,569

Prepaid reinsurance premium (related party $492,214; $429,124)
687,171

 
584,871

Prepaid expenses and other assets (recorded at fair value $171,476; $131,387)
358,028

 
292,849

Federal income tax receivable
29,046

 
13,024

Deferred policy acquisition costs
349,647

 
280,991

Property and equipment, net
72,711

 
61,553

Goodwill
190,725

 
147,654

Intangible assets
226,388

 
166,962

 
$
6,766,034

 
$
5,678,747

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities:
 
 
 
Loss and loss expense reserves
$
2,247,118


$
1,879,175

Unearned premiums
1,709,185


1,366,170

Ceded reinsurance premiums payable (related party $232,466; $222,408)
324,272


337,508

Reinsurance payable on paid losses
11,088


14,731

Funds held under reinsurance treaties
38,318


49,249

Note payable on collateral loan – related party
167,975


167,975

Securities sold but not yet purchased, at market
57,198


55,942

Securities sold under agreements to repurchase, at contract value
226,098


191,718

Accrued expenses and other current liabilities (recorded at fair value $9,550; $12,022)
353,021


267,643

Deferred income taxes
173,440


108,775

Debt
301,510


279,600

Total liabilities
5,609,223

 
4,718,486

Commitments and contingencies


 


Redeemable non-controlling interest
600

 
600

Stockholders’ equity:
 
 
 
Common stock, $.01 par value; 100,000 shares authorized, 91,637 and 84,906 issued in 2012 and 2011, respectively; 67,085 and 60,106 outstanding in 2012 and 2011, respectively
912

 
849

Preferred stock, $.01 par value; 10,000 shares authorized
—

 
—

Additional paid-in capital
756,814

 
582,321

Treasury stock at cost; 24,552 and 24,800 shares in 2012 and 2011, respectively
(296,415
)
 
(300,365
)
Accumulated other comprehensive income (loss)
49,938

 
(9,999
)
Retained earnings
563,061

 
617,757

Total AmTrust Financial Services, Inc. equity
1,074,310

 
890,563

Non-controlling interest
81,901

 
69,098

Total stockholders’ equity
1,156,211

 
959,661

 
$
6,766,034

 
$
5,678,747

See accompanying notes to unaudited condensed consolidated statements.

3


AmTrust Financial Services, Inc.
Condensed Consolidated Statements of Income
(Unaudited)
(In Thousands, Except Per Share Data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 

 
 

 
 

 
 

Premium income:
 

 
 

 
 

 
 

Net written premium
$
483,659

 
$
321,903

 
$
1,235,025

 
$
931,603

Change in unearned premium
(96,212
)
 
(33,055
)
 
(199,560
)
 
(194,135
)
Net earned premium
387,447

 
288,848

 
1,035,465

 
737,468

Ceding commission – primarily related party
49,860

 
40,732

 
140,684

 
111,830

Service and fee income (related parties – three months $7,171; $4,189 and nine months $20,195; $12,089)
44,561

 
28,815

 
118,110

 
78,546

Net investment income
18,429

 
14,456

 
49,291

 
41,815

Net realized gain on investments
2,213

 
550

 
3,768

 
1,581

Total revenues
502,510

 
373,401

 
1,347,318

 
971,240

Expenses:
 

 
 

 
 

 
 

Loss and loss adjustment expense
255,646

 
185,352

 
667,362

 
484,056

Acquisition costs and other underwriting expenses
143,736

 
113,270

 
397,474

 
284,084

Other
42,337

 
24,045

 
110,296

 
62,805

Total expenses
441,719

 
322,667

 
1,175,132

 
830,945

Income before other income (expense), income taxes and equity in earnings of unconsolidated subsidiary
60,791

 
50,734

 
172,186

 
140,295

Other income (expense):
 

 
 

 
 

 
 

Interest expense
(7,218
)
 
(3,946
)
 
(21,303
)
 
(12,034
)
Foreign currency gain (loss)
(951
)
 
(4,063
)
 
(2,985
)
 
(1,827
)
Acquisition gain on purchase
—

 
5,850

 
—

 
5,850

Gain on investment in life settlement contracts net of profit commission
3,251

 
6,822

 
5,302

 
48,346

Total other income (expense)
(4,918
)
 
4,663

 
(18,986
)
 
40,335

Income before income taxes and equity in earnings of unconsolidated subsidiary
55,873

 
55,397

 
153,200

 
180,630

Provision for income taxes
13,187

 
14,297

 
36,106

 
30,623

Income before equity in earnings of unconsolidated subsidiary
42,686

 
41,100


117,094

 
150,007

Equity in earnings (loss) of unconsolidated subsidiary – related party
3,207

 
(918
)
 
8,659

 
3,415

Net income
45,893

 
40,182

 
125,753

 
153,422

Net income attributable to non-controlling interest of subsidiaries
(2,663
)
 
(3,016
)
 
(3,079
)
 
(20,911
)
Net income attributable to AmTrust Financial Services, Inc.
$
43,230

 
$
37,166

 
$
122,674

 
$
132,511

Earnings per common share:
 

 
 

 
 

 
 

Basic earnings per share
$
0.69

 
$
0.60

 
$
2.01

 
$
2.19

Diluted earnings per share
$
0.66

 
$
0.58

 
$
1.93

 
$
2.13

Dividends declared per common share
$
0.10

 
$
0.09

 
$
0.29

 
$
0.25

Net realized gain on investments:
 

 
 

 
 

 
 

Total other-than-temporary impairment loss
$
—

 
$
—

 
$
(1,208
)
 
$
(345
)
Portion of loss recognized in other comprehensive income
—

 
—

 
—

 
—

Net impairment losses recognized in earnings
—

 
—

 
(1,208
)
 
(345
)
Other net realized gain (loss) on investments
2,213

 
550

 
4,976

 
1,926

Net realized investment gain
$
2,213

 
$
550

 
$
3,768

 
$
1,581

 See accompanying notes to unaudited condensed consolidated financial statements.

4


AmTrust Financial Services, Inc.
Condensed Consolidated Statement of Comprehensive Income
(Unaudited)
(In Thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
45,893


$
40,182

 
$
125,753


$
153,422

Other comprehensive income, net of tax:
 

 
 

 
 

 
 

Foreign currency translation adjustments
7,484

 
(5,027
)
 
4,624

 
(508
)
Change in fair value of interest rate swap
(325
)
 
—

 
(952
)
 
—

Unrealized gains on securities:
 

 
 

 
 

 
 

Unrealized holding gains arising during period
27,382

 
(7,917
)
 
60,499

 
2,483

Reclassification adjustment for gains included in net income
442

 
(5,667
)
 
(4,234
)
 
(3,916
)
Other comprehensive income, net of tax
$
34,983

 
$
(18,611
)
 
$
59,937

 
$
(1,941
)
Comprehensive income
80,876

 
21,571

 
185,690

 
151,481

Less: Comprehensive income attributable to non-controlling interest
2,663

 
3,016

 
3,079

 
20,911

Comprehensive income attributable to AmTrust Financial Services, Inc.
$
78,213

 
$
18,555

 
$
182,611

 
$
130,570

 
See accompanying notes to unaudited condensed consolidated financial statements.

5


AmTrust Financial Services, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In Thousands)
 
Nine Months Ended September 30,
 
2012
 
2011
Cash flows from operating activities:
 

 
 

Net income
$
125,753


$
153,422

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
27,848

 
40,151

Equity earnings and gain on investment in unconsolidated subsidiaries
(8,659
)
 
(3,415
)
Gain on investment in life settlement contracts
(5,302
)
 
(48,346
)
Realized gain on marketable securities
(4,976
)
 
(1,926
)
Acquisition gain on purchase
—

 
(5,850
)
Non-cash write-down of marketable securities
1,208

 
345

Discount on notes payable
2,225

 
379

Stock based compensation
4,954

 
4,182

Bad debt expense
5,697

 
4,717

Foreign currency loss
2,985

 
1,827

Changes in assets - (increase) decrease:
 

 
 

Premiums and note receivables
(111,200
)
 
(98,569
)
Reinsurance recoverable
(119,611
)
 
(120,897
)
Deferred policy acquisition costs, net
(68,656
)
 
(52,849
)
Prepaid reinsurance premiums
(100,074
)
 
(56,165
)
Prepaid expenses and other assets
(44,998
)
 
(72,828
)
Changes in liabilities - increase (decrease):
 

 
 

Reinsurance premium payable
(13,236
)
 
30,279

Loss and loss expense reserve
367,943

 
204,265

Unearned premiums
316,330

 
223,600

Funds held under reinsurance treaties
(10,931
)
 
(4,783
)
Accrued expenses and other current liabilities
23,704

 
67,770

Deferred tax liability
8,559

 
(41,092
)
Net cash provided by operating activities
399,563

 
224,217

Cash flows from investing activities:
 

 
 

Net purchases of securities with fixed maturities
(237,174
)
 
(88,449
)
Net sales (purchases) of equity securities
19,068

 
(18,852
)
Net purchases of other investments
1,938

 
(544
)
Acquisition of Majestic, net of cash obtained
—

 
27,314

Acquisition of and capitalized premiums for life settlement contracts
(42,225
)
 
(43,847
)
Receipt of life settlement contract proceeds
10,074

 
10,530

Acquisition of intangible assets and subsidiaries, net of cash obtained
(19,764
)
 
(4,535
)
Increase in restricted cash and cash equivalents
(23,691
)
 
(19,369
)
Purchase of property and equipment
(19,955
)
 
(33,055
)
Net cash used in investing activities
(311,729
)
 
(170,807
)
Cash flows from financing activities:
 

 
 

Repurchase agreements, net
34,380

 
(3,712
)
Revolving credit facility borrowing
—

 
123,200

Revolving credit facility payment
—

 
(90,000
)
Convertible senior notes proceeds
25,000

 
—

Secured loan agreement borrowings
—

 
10,800


6


Secured loan agreements payments
(729
)
 
(544
)
Promissory notes, net
500

 
(7,500
)
Term loan payment
—

 
(6,667
)
Debt financing fees
(1,670
)
 
(1,368
)
Capital contribution to subsidiaries
16,624

 
23,764

Stock option exercise and other
4,176

 
3,680

Dividends distributed on common stock
(16,866
)
 
(14,327
)
Net cash used in financing activities
61,415

 
37,326

Effect of exchange rate changes on cash
1,893

 
703

Net increase in cash and cash equivalents
151,142

 
91,439

Cash and cash equivalents, beginning of the period
406,847

 
192,925

Cash and cash equivalents, end of the period
$
557,989

 
$
284,364

Supplemental Cash Flow Information
 

 
 

Income tax payments
$
7,893

 
$
13,792

Interest payments on debt
12,555

 
10,098

 
See accompanying notes to unaudited condensed consolidated financial statements.

7


Notes to Unaudited Condensed Consolidated Financial Statements
(Unaudited)
(Dollars In Thousands, Except Per Share Data)
1.
 Basis of Reporting
  
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include all of the information and footnotes required by GAAP for complete financial statements. These interim statements should be read in conjunction with the financial statements and notes thereto included in the AmTrust Financial Services, Inc. (“AmTrust” or the “Company”) Annual Report on Form 10-K for the year ended December 31, 2011, previously filed with the Securities and Exchange Commission (“SEC”) on March 15, 2012. The balance sheet at December 31, 2011 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.
 
These interim consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim period and all such adjustments are of a normal recurring nature. The results of operations for the interim period are not necessarily indicative, if annualized, of those to be expected for the full year.   The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
 
A detailed description of the Company’s significant accounting policies and management judgments is located in the audited consolidated financial statements for the year ended December 31, 2011, included in the Company’s Form 10-K filed with the SEC.
 
All significant inter-company transactions and accounts have been eliminated in the consolidated financial statements.
 
To facilitate period-to-period comparisons, certain reclassifications have been made to prior period consolidated financial statement amounts to conform to current period presentation. A description of the major items include:

The three and nine months ended September 30, 2011 have been restated to include a retrospective gain of $3,185 on a pre-tax basis and $2,070 on an after tax basis related to the renewal rights transaction with Majestic Insurance Company during the three months ended September 30, 2011. The impact on diluted earnings per share in both periods was $0.03.

The Company paid a 10% stock dividend during the three months ended September 30, 2012. As such, the weighted average number of shares used for basic and diluted earnings per share have been adjusted in prior periods. The impact on basic and diluted earnings per share was $(0.02) for the three and nine months ended September 30, 2011.
 
The Company and American Capital Acquisition Corporation (“ACAC”) currently each have a 50% ownership interest in Tiger Capital LLC (“Tiger”) and AMT Capital Alpha, LLC (“AMT Alpha”). The Company also has a 21.25% ownership share of ACAC. As a result, the Company ultimately receives 60.625% of the income and losses related to Tiger and AMT Alpha and therefore consolidates Tiger and AMT Alpha. Prior to January 1, 2012, the Company reported Tiger’s and AMT Alpha’s income and losses attributable to its 10.625% indirect ownership as a component of Equity in Earnings of Unconsolidated Subsidiaries. This amount was offset by reporting an equal amount as a component of Non-controlling interest. Effective January 1, 2012, the Company presents the impact of the 10.625% indirect ownership of Tiger and AMT Alpha on a net basis and excludes this amount from both Equity in Earnings of Unconsolidated Subsidiaries and Non-controlling Interest. All prior periods presented have been reclassed to conform to the current presentation. There was no impact on prior period Net Income Attributable to AmTrust Financial Services, Inc. The Company’s equity investment in ACAC and non-controlling interest were reduced by $3,807 as of December 31, 2011. Additionally, the non-controlling interest related to income on life settlement contracts is now presented on a pre-tax basis and the provision for income taxes has been reduced by an equivalent amount.

2.
Recent Accounting Pronouncements
 
With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2012, as compared to those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, that are of significance, or potential significance, to the Company.





8


In July 2012, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") No. 2012-02, Intangibles - Goodwill and Other (Topic 350) Testing Indefinite Lived Intangible Assets for Impairment. This updated guidance regarding the impairment test applicable to indefinite-lived intangible assets that is similar to the impairment guidance applicable to goodwill. Under the updated guidance, an entity may assess qualitative factors (such as changes in management, strategy, technology or customers) that may impact the fair value of the indefinite-lived intangible asset and lead to the determination that it is more likely than not that the fair value of the asset is less than its carrying value. If an entity determines that it is more likely than not that the fair value of the intangible asset is less than its carrying value, an impairment test must be performed. The impairment test requires an entity to calculate the estimated fair value of the indefinite-lived intangible asset. If the carrying value of the indefinite-lived intangible asset exceeds its estimated fair value, an impairment loss is recognized in an amount equal to the excess. The updated guidance is effective for the quarter ending March 31, 2013 with early adoption permitted. The adoption of this guidance is not expected to have any effect on the Company's results of operations, financial position or liquidity.
 
In December 2011, the FASB issued a new standard which indefinitely defers certain provisions of a previously issued standard, ASU No. 2011-5 Comprehensive Income (Topic 220) that revised the manner in which companies present comprehensive income in financial statements. One of the ASU provisions required companies to present, by component, reclassification adjustments out of accumulated other comprehensive income in both the statement in which net income is presented and the statement in which other comprehensive income is presented. This requirement has been indefinitely deferred and will be further deliberated by the FASB at a future date. The new standard is effective for fiscal years and interim periods within those years that begin after December 15, 2011. The Company adopted this standard on January 1, 2012. The adoption of the new standard did not have a material impact on the Company’s results of operations, financial position or liquidity.
 
In June 2011, the FASB issued ASU No. 2011-5, Comprehensive Income (Topic 220). This update required that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-step approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. The updated guidance was effective for fiscal years and interim periods beginning on or after December 15, 2011 and was to be applied on a retrospective basis to the beginning of the annual period of adoption. The new standard does not change the items that must be reported in other comprehensive income and was effective for fiscal years and interim periods within those years that begin after December 15, 2011. The Company adopted this standard on January 1, 2012. The adoption of the new standard did not have a material impact on the Company’s results of operations, financial position or liquidity.
 
In September 2011, the FASB issued ASU No. 2011-8, Intangibles-Goodwill and Other (Topic 350). The updated guidance is intended to reduce complexity and costs by allowing an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment, using factors such as changes in management, key personnel, business strategy, technology or customers, to determine whether it should calculate the fair value of a reporting unit. Previous accounting literature required an entity to test goodwill for impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit was less than its carrying amount, then the second step of the test had to be performed to measure the amount of the impairment loss, if any. In the second step, the implied fair value of the reporting unit’s goodwill was determined in the same manner as goodwill is measured in a business combination (by measuring the fair value of the reporting unit’s assets, liabilities and unrecognized intangible assets and determining the remaining amount ascribed to goodwill) and comparing the amount of the implied goodwill to the carrying amount of the goodwill. Under the updated guidance, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that is more likely than not that its fair value is less than its carrying amount. This update is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 31, 2011. The Company adopted this standard January 1, 2012 and it did not have any material impact on its results of operations, financial position or liquidity.
 
In May 2011, the FASB issued ASU No. 2011-4, Fair Value Measurement (Topic 820). The ASU generally aligns the principles for fair value measurements and the related disclosure requirements under GAAP and International Financial Reporting Standards (“IFRS”). ASU 2011-4 changes certain fair value measurement principles and enhances the disclosure requirements, particularly for Level 3 fair value measurements. The amendment is effective on a prospective basis for interim and annual reporting periods beginning after December 15, 2011. The Company adopted this standard on January 1, 2012 and adoption of the standard did not have a material impact on the Company’s consolidated financial statements.
 






9


In April 2011, the FASB amended its guidance on accounting for repurchase agreements. The amendments eliminate as a criteria for demonstrating effective control over the transferred asset whether a transferor has the ability to repurchase or redeem the financial assets. Under the amended guidance, a transferor maintains effective control over transferred financial assets (and thus accounts for the transfer as a secured borrowing) if there is an agreement that both entitles and obligates the transferor to repurchase the financial assets before maturity and if all of the following conditions previously required are met: (i) financial assets to be repurchased or redeemed are the same or substantially the same as those transferred; (ii) repurchase or redemption date before maturity at a fixed or determinable price; and (iii) the agreement is entered into contemporaneously with, or in contemplation of, the transfer. As a result, more arrangements could be accounted for as secured borrowings rather than sales. The updated guidance is effective on a prospective basis for interim and annual reporting periods beginning on or after December 15, 2011. The Company adopted this standard January 1, 2012 and it did not have a material impact on the Company’s results of operations, financial position or liquidity.
 
In October 2010, the FASB issued ASU No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (“ASU 2010-26”). ASU 2010-26 modifies the types of costs that may be deferred, allowing insurance companies to only defer costs directly related to a successful contract acquisition or renewal. These costs include incremental direct costs of successful contracts, the portion of employees’ salaries and benefits related to time spent on acquisition activities for successful contracts and other costs incurred in the acquisition of a contract. Additional disclosure of the type of acquisition costs capitalized is also required.
 
The Company adopted ASU 2010-26 prospectively. During 2012, the Company estimates that pre-tax expenses will increase by approximately $8,000 to $10,000 as a lower amount of acquisition costs will be capitalized and existing costs that no longer meet the criteria for deferral under ASU 2010-26 will be recognized in expense over the original amortization periods. For the three and nine months ended September 30, 2012, the Company recognized approximately $2,000 and $5,600, respectively, of expense related to such previously deferrable costs. If the Company had adopted ASU 2010-26 retrospectively, approximately $1,300 and $7,600, respectively, of acquisition costs that were deferred would have been recognized in expense for the three and nine month period ended September 30, 2011.
 
3.
Investments
 
(a) Available-for-Sale Securities
 
The amortized cost, estimated market value and gross unrealized appreciation and depreciation of available-for-sale securities as of September 30, 2012, are presented in the table below:
 
(Amounts in Thousands)
Original or amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
 Market value
Preferred stock
$
5,091

 
$
107

 
$
(211
)
 
$
4,987

Common stock
15,111

 
1,085

 
(2,865
)
 
13,331

U.S. treasury securities
45,442

 
2,905

 
(6
)
 
48,341

U.S. government agencies
45,341

 
964

 
—

 
46,305

Municipal bonds
251,610

 
13,487

 
(86
)
 
265,011

Corporate bonds:
 

 
 

 
 

 
 

Finance
729,724

 
50,337

 
(6,587
)
 
773,474

Industrial
314,663

 
17,726

 
(2,120
)
 
330,269

Utilities
32,773

 
2,455

 
—

 
35,228

Commercial mortgage backed securities
10,057

 
152

 
—

 
10,209

Residential mortgage backed securities:
 

 
 

 
 

 
 

Agency backed
312,258

 
20,211

 
(442
)
 
332,027

Non-agency backed
7,831

 
—

 
(1,072
)
 
6,759

 
$
1,769,901

 
$
109,429


$
(13,389
)
 
$
1,865,941

 
Proceeds from the sale of investments in available-for-sale securities during the nine months ended September 30, 2012 and 2011 were approximately $761,757 and $1,827,485, respectively.
 


10


A summary of the Company’s available-for-sale fixed securities as of September 30, 2012, by contractual maturity, is 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.
 
(Amounts in Thousands)
Amortized Cost
 
 Fair Value
Due in one year or less
$
7,296

 
$
7,359

Due after one through five years
388,443

 
393,753

Due after five through ten years
785,711

 
848,460

Due after ten years
238,103

 
249,056

Mortgage backed securities
330,146

 
348,995

Total fixed maturities
$
1,749,699

 
$
1,847,623

 
(b) Investment Income
 
Net investment income for the three and nine months ended September 30, 2012 and 2011 was derived from the following sources:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands)
2012
 
2011
 
2012
 
2011
Fixed maturity securities
$
18,185

 
$
13,601

 
$
47,908

 
$
39,577

Equity maturities
325

 
141

 
823

 
427

Cash and short term investments
120

 
1,075

 
1,096

 
2,647

 
18,630

 
14,817

 
49,827

 
42,651

Less:
 

 
 

 
 

 
 

Investment expenses and interest expense on securities sold under agreement to repurchase
201

 
361

 
536

 
836

 
$
18,429

 
$
14,456

 
$
49,291

 
$
41,815

 
(c) Other-Than-Temporary Impairment
 
The table below summarizes the gross unrealized losses of our fixed maturity and equity securities by length of time the security has continuously been in an unrealized position as of September 30, 2012:
 
 
Less Than 12 Months
 
12 Months or More
 
Total
(Amounts in Thousands)
Fair Market Value
 
Unrealized Losses
 
No. of Positions Held
 
Fair Market Value
 
Unrealized Losses
 
No. of Positions Held
 
Fair Market Value
 
Unrealized Losses
Common and preferred stock
$
7,015

 
$
(1,446
)
 
30

 
$
2,453

 
$
(1,630
)
 
9

 
$
9,468

 
$
(3,076
)
U.S. treasury securities
994

 
(6
)
 
1

 
—

 
—

 
—

 
994

 
(6
)
Municipal bonds
24,177

 
(82
)
 
6

 
8,071

 
(4
)
 
1

 
32,248

 
(86
)
Corporate bonds:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Finance
40,776

 
(1,223
)
 
12

 
94,994

 
(5,364
)
 
15

 
135,770

 
(6,587
)
Industrial
39,595

 
(1,795
)
 
17

 
5,760

 
(325
)
 
1

 
45,355

 
(2,120
)
Residential mortgage backed securities:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Agency backed
4,674

 
(1
)
 
1

 
25,429

 
(441
)
 
1

 
30,103

 
(442
)
Non-agency backed
6,734

 
(1,069
)
 
1

 
25

 
(3
)
 
1

 
6,759

 
(1,072
)
Total temporarily impaired securities
$
123,965

 
$
(5,622
)
 
68

 
$
136,732

 
$
(7,767
)
 
28

 
$
260,697

 
$
(13,389
)
  




11


There are 96 securities at September 30, 2012 that account for the gross unrealized loss, none of which is deemed by the Company to be OTTI. Significant factors influencing the Company’s determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent not to sell these securities and it being not more likely than not that the Company will be required to sell these investments before anticipated recovery of fair value to the Company’s cost basis.

(d) Derivatives
 
The Company from time to time invests in a limited amount of derivatives and other financial instruments as part of its investment portfolio to manage interest rate changes or other exposures to a particular financial market. The Company records changes in valuation on its derivative positions not designated as a hedge as a component of net realized gains and losses.
 
The Company records changes in valuation on its hedge positions as a component of other comprehensive income. As of September 30, 2012, the Company had two interest rate swaps designated as hedges that were recorded as a liability in the total amount of $4,973 and were included as a component of accrued expenses and other liabilities.
 
The following table presents the notional amounts by remaining maturity of the Company’s interest rate swaps as of September 30, 2012: 
 
 
 
Remaining Life of Notional Amount (1)
 
(Amounts in Thousands)
 
One Year
 
Two Through Five Years
 
Six Through Ten Years
 
After Ten years
 
Total
Interest rate swaps
 
$
—

 
$
70,000

 
$
—

 
$
—

 
$
70,000

 
(1)
Notional amount is not representative of either market risk or credit risk and is not recorded in the consolidated balance sheet.

(e) Restricted Cash and Investments
 
The Company, in order to conduct business in certain states, is required to maintain letters of credit or assets on deposit to support state mandated regulatory requirements and certain third party agreements. The Company also utilizes trust accounts to collateralize business with its reinsurance counterparties. These assets are primarily in the form of cash and certain high grade securities. The fair values of our restricted assets as of September 30, 2012 and December 31, 2011 are as follows:
 
(Amounts in Thousands)
2012
 
2011
Restricted cash
$
46,795

 
$
23,104

Restricted investments
292,941

 
187,227

Total restricted cash and investments
$
339,736

 
$
210,331

 
(f) Other
 
Securities sold but not yet purchased represent obligations of the Company to deliver the specified security at the contracted price and, thereby, create a liability to purchase the security in the market at prevailing prices. The Company’s liability for securities to be delivered is measured at their fair value and as of September 30, 2012 was $57,155 for U.S treasury bonds and $43 for equity securities. These transactions result in off-balance sheet risk, as the Company’s ultimate cost to satisfy the delivery of securities sold but not yet purchased may exceed the amount reflected at September 30, 2012. Subject to certain limitations, all securities owned, to the extent required to cover the Company’s obligations to sell or repledge the securities to others, are pledged to the clearing broker.
 

12


The Company enters into repurchase agreements, which are accounted for as collateralized borrowing transactions and are recorded at contract amounts. The Company receives cash or securities that it invests or holds in short term or fixed income securities. As of September 30, 2012, there were $226,098 principal amount outstanding at interest rates between .40% and .45%. Interest expense associated with these repurchase agreements for the three months ended September 30, 2012 and 2011 was $341 and $361, respectively, and interest expense associated with these repurchase agreements for the nine months ended September 30, 2012 and 2011 was $676 and $836, respectively, of which $0 was accrued as of September 30, 2012. The Company has approximately $244,064 of collateral pledged in support of these agreements. Additionally, during the three and nine months ended September 30, 2012, the Company entered into a reverse repurchase agreement in the amount of $57,000 that is included in cash and cash equivalents as of September 30, 2012. The Company retains collateral of $57,000 related to this agreement.
 
4.
Fair Value of Financial Instruments

The following table presents the level within the fair value hierarchy at which the Company’s financial assets and financial liabilities are measured on a recurring basis as of September 30, 2012:
 
(Amounts in Thousands)
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 

 
 

 
 

 
 

U.S. treasury securities
$
48,341

 
$
48,341

 
$
—

 
$
—

U.S. government agencies
46,305

 
—

 
46,305

 
—

Municipal bonds
265,011

 
—

 
265,011

 
—

Corporate bonds and other bonds:
 

 
 

 
 

 
 

Finance
773,474

 
—

 
773,474

 
—

Industrial
330,269

 
—

 
330,269

 
—

Utilities
35,228

 
—

 
35,228

 
—

Commercial mortgage backed securities
10,209

 
—

 
10,209

 
—

Residential mortgage backed securities:
 

 
 

 
 

 
 

Agency backed
332,027

 
—

 
332,027

 
—

Non-agency backed
6,759

 
—

 
6,759

 
—

Equity securities
18,318

 
18,318

 
—

 
—

Short term investments
485

 
485

 
—

 
—

Other investments
14,324

 
—

 
—

 
14,324

Life settlement contracts
171,476

 
—

 
—

 
171,476

 
$
2,052,226

 
$
67,144

 
$
1,799,282

 
$
185,800

Liabilities:
 

 
 

 
 

 
 

Equity securities sold but not yet purchased, market
$
43

 
$
43

 
$
—

 
$
—

Fixed maturity securities sold but not yet purchased, market
57,155

 
57,155

 
—

 
—

Securities sold under agreements to repurchase, at contract value
226,098

 
—

 
226,098

 
—

Life settlement contract profit commission
9,550

 
—

 
—

 
9,550

Derivatives
4,973

 
—

 
4,973

 
—

 
$
297,819

 
$
57,198

 
$
231,071

 
$
9,550

 
The Company classifies its financial assets and liabilities in the fair value hierarchy based on the lowest level input that is significant to the fair value measurement.  This classification requires judgment in assessing the market and pricing methodologies for a particular security.  The fair value hierarchy includes the following three levels:
 
•
Level 1 – Valuations are based on unadjusted quoted market prices in active markets for identical financial assets or liabilities.
Examples of instruments utilizing Level 1 inputs include: exchange-traded securities and U.S. Treasury bonds.
 
•
Level 2 – Valuations of financial assets and liabilities are based on quoted prices for similar assets or liabilities in active

13


markets, quoted prices for identical assets or liabilities in inactive markets obtained from third party pricing services or valuations based on models where the significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
 
Examples of instruments utilizing Level 2 inputs include: U.S. government-sponsored agency securities; non-U.S. government obligations; corporate and municipal bonds; mortgage-backed bonds, asset-backed securities and listed derivatives that are not actively traded.

•
Level 3 – Valuations are based on unobservable inputs for assets and liabilities where there is little or no market activity.  Management’s assumptions are used in internal valuation pricing models to determine the fair value of financial assets or liabilities, which may include projected cash flows, collateral performance or liquidity circumstances in the security or similar securities that may have occurred since the prior pricing period.

Examples of instruments utilizing Level 3 inputs include: hedge and credit funds with partial transparency.

For additional discussion regarding techniques used to value the Company’s investment portfolio, refer to Note 2. “Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data” in its 2011 Form 10-K.
 
The following table provides a summary of changes in fair value of the Company’s Level 3 financial assets and liabilities for the three and nine months ended September 30, 2012 and 2011:
 
(Amounts in Thousands)
 
Balance as of June 30, 2012
 
Net income
 
Other comprehensive income
 
Purchases and issuances
 
Sales and settlements
 
Net transfers into (out of) Level 3
 
Balance as of September 30,
2012
Other investments
 
$
15,103

 
$
1,491

 
$
—

 
$
315

 
$
(2,585
)
 
$
—

 
$
14,324

Life settlement contracts
 
151,092

 
10,758

 
—

 
9,626

 
—

 
—

 
171,476

Life settlement contract profit commission
 
(11,465
)
 
1,915

 
—

 
—

 
—

 
—

 
(9,550
)
Derivatives
 
(4,472
)
 
—

 
(501
)
 
—

 
—

 
4,973

 
—

Total
 
$
150,258

 
$
14,164

 
$
(501
)
 
$
9,941

 
$
(2,585
)
 
$
4,973

 
$
176,250

  
(Amounts in Thousands)
 
Balance as of December 31,
2011
 
Net income
 
Other comprehensive income
 
Purchases and issuances
 
Sales and settlements
 
Net transfers into (out of) Level 3
 
Balance as of September 30,
2012
Other investments
 
$
14,588

 
$
(2,861
)
 
$
4,535

 
$
1,062

 
$
(3,000
)
 
$
—

 
$
14,324

Life settlement contracts
 
131,387

 
26,174

 
—

 
23,989

 
(10,074
)
 
—

 
171,476

Life settlement contract profit commission
 
(12,022
)
 
2,472

 
—

 
—

 
—

 
—

 
(9,550
)
Derivatives
 
(3,508
)
 
—

 
(1,465
)
 
—

 
—

 
4,973

 
—

Total
 
$
130,445

 
$
25,785


$
3,070

 
$
25,051

 
$
(13,074
)
 
$
4,973

 
$
176,250

 
(Amounts in Thousands)
 
Balance as of June 30,
2011
 
Net income
 
Other comprehensive income
 
Purchases and issuances
 
Sales and settlements
 
Net transfers into (out of) Level 3
 
Balance as of September 30,
2011
Other investments
 
$
22,008

 
$
—

 
$
(1,348
)
 
$
5,672

 
$
(5,128
)
 
$
—

 
$
21,204

Life settlement contracts
 
108,710

 
17,188

 
—

 
6,298

 
(10,530
)
 
—

 
121,666

Life settlement contract profit commission
 
(9,267
)
 
(3,369
)
 
—

 
—

 
—

 
—

 
(12,636
)
Total
 
$
121,451

 
$
13,819

 
$
(1,348
)
 
$
11,970

 
$
(15,658
)
 
$
—

 
$
130,234

 
(Amounts in Thousands)
 
Balance as of December 31,
2010
 
Net income
 
Other comprehensive income
 
Purchases and issuances
 
Sales and settlements
 
Net transfers into (out of) Level 3
 
Balance as of September 30,
2011
Other investments
 
$
21,514

 
$
661

 
$
(1,725
)
 
$
6,538

 
$
(5,784
)
 
$
—

 
$
21,204

Life settlement contracts
 
22,155

 
75,209

 
—

 
34,832

 
(10,530
)
 
—

 
121,666

Life settlement contract profit commission
 
(4,711
)
 
(7,925
)
 
—

 
—

 
—

 
—

 
(12,636
)
Total
 
$
38,958

 
$
67,945

 
$
(1,725
)
 
$
41,370

 
$
(16,314
)
 
$
—

 
$
130,234

 

14


The Company transferred its derivatives from Level 3 to Level 2 during the three and nine months ended September 30, 2012. The Company had no transfers between levels during 2011.
 
The Company uses the following methods and assumptions in estimating its fair value disclosures for financial instruments:
 
—
Equity and Fixed Income Investments:   Fair value disclosures for these investments are disclosed above in this note. The carrying values of cash, short term investments and investment income accrued approximate their fair values.
—
Premiums Receivable:   The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair values due to the short term nature of the asset.
—
Subordinated Debentures and Debt:   The current fair value of the Company's convertible senior notes and subordinated debentures was $230,000 and $55,600 as of September 30, 2012, respectively. The remaining carrying values reported in the accompanying balance sheets for these financial instruments approximate fair value. Fair value was estimated using projected cash flows, discounted at rates currently being offered for similar notes.
—
Other investments: The Company has less than one percent of its investment portfolio in limited partnerships or hedge funds where the fair value estimate is determined by a fund manager based on recent filings, operating results, balance sheet stability, growth and other business and market sector fundamentals. Due to the significant unobservable inputs in these valuations, the Company includes the estimate in the amount disclosed in Level 3 hierarchy. The Company has determined that its investments in these securities are not material to its financial position or results of operations.
—
Derivatives: The Company classifies interest rate swaps as Level 2 hierarchy.  The Company uses these interest rate swaps to hedge floating interest rates on its debt, thereby changing the variable rate exposure to a fixed rate exposure for interest on these obligations.  The estimated fair value of the interest rate swaps, which is obtained from a third party pricing service is measured using discounted cash flow analysis that incorporates significant observable inputs, including the LIBOR forward curve and a measurement of volatility.
 
The fair value of life settlement contracts as well as life settlement profit commission is based on information available to the Company at the end of the reporting period. The Company considers the following factors in its fair value estimates: cost at date of purchase, recent purchases and sales of similar investments, financial standing of the issuer, and changes in economic conditions affecting the issuer, maintenance cost, premiums, benefits, standard actuarially developed mortality tables and industry life expectancy reports. The fair value of a life insurance policy is estimated using present value calculations based on the data specific to each individual life insurance policy. The following summarizes data utilized in estimating the fair value of the portfolio of life insurance policies as of September 30, 2012 and December 31, 2011 and, as described in Note 5, only includes data for policies to which the Company assigned value at those dates:
 
 
September 30,
2012
 
December 31,
2011
Average age of insured
79 years

 
77 years

Average life expectancy, months (1)
143 months

 
155 months

Average face amount per policy (Amounts in Thousands)
$
6,818

 
$
6,703

Fair value discount rate
7.5
%
 
7.5
%
Internal rate of return (2)
15.9
%
 
14.1
%
  
(1)
Standard life expectancy as adjusted for insured’s specific circumstances.
(2)
Internal rate of return includes a risk premium which represents risk adjustments applied to the estimated present value of cash flows based on the following factors: (i) the volatility in life expectancy of insureds and the associated level of future premium payments and (ii) the projected risk of non-payment, including the financial health of the insurance carrier, the possibility of legal challenges from the insurance carrier or others and the possibility of regulatory changes that may affect payment.

15


These assumptions are, by their nature, inherently uncertain and the effect of changes in estimates may be significant. The fair value measurements used in estimating the present value calculation are derived from valuation techniques generally used in the industry that include inputs for the asset that are not based on observable market data. The extent to which the fair value could reasonable vary in the near term has been quantified by evaluating the effect of changes in significant underlying assumptions used to estimate the fair value amount. If the life expectancies were increased or decreased by 4 months and the discount factors were increased or decreased by 1% while all other variables are held constant, the carrying value of the investment in life insurance policies would increase or (decrease) by the unaudited amounts summarized below as of September 30, 2012 and December 31, 2011:
 
 
Change in life expectancy
(Amounts in Thousands)
Plus 4 Months
 
Minus 4 Months
Investment in life policies:
 

 
 

September 30, 2012
$
(25,386
)
 
$
28,250

December 31, 2011
$
(18,778
)
 
$
20,785

 
 
Change in discount rate
(Amounts in Thousands)
Plus 1%
 
Minus 1%
Investment in life policies:
 

 
 

September 30, 2012
$
(17,167
)
 
$
20,030

December 31, 2011
$
(13,802
)
 
$
15,804

  
5.
Investment in Life Settlements
 
A life settlement contract is a contract between the owner of a life insurance policy and a third-party who obtains the ownership and beneficiary rights of the underlying life insurance policy. During 2010, the Company formed Tiger Capital LLC (“Tiger”) with a subsidiary of ACAC for the purposes of acquiring certain life settlement contracts. In 2011, the Company formed AMT Capital Alpha, LLC (“AMT Alpha”) with a subsidiary of ACAC and AMT Capital Holdings, S.A. (“AMTCH”) with ACP Re, Ltd., an entity controlled by the Michael Karfunkel Grantor Retained Annuity Trust, for the purposes of acquiring additional life settlement contracts. The Company has a fifty percent ownership interest in each of Tiger, AMT Alpha and AMTCH (collectively, the “LSC entities”). The LSC entities may also acquire premium finance loans made in connection with the borrowers’ purchase of life insurance policies that are secured by the policies, which are in default at the time of purchase. The LSC entities acquire the underlying policies through the borrowers’ voluntary surrender of the policy in satisfaction of the loan or foreclosure. A third party serves as the administrator of the Tiger life settlement contract portfolio, for which it receives an annual fee. Under the terms of an agreement for Tiger, the third party administrator is eligible to receive a percentage of profits after certain time and performance thresholds have been met. The Company provides for certain actuarial and finance functions related to the LSC entities. Additionally, in conjunction with the Company’s 21.25% ownership percentage of ACAC, the Company ultimately receives 60.625% of the profits and losses of Tiger and AMT Alpha. As such, in accordance with ASC 810-10, Consolidation, we have been deemed the primary beneficiary and, therefore, consolidate the LSC entities.
 
The Company accounts for investments in life settlements in accordance with ASC 325-30, Investments in Insurance Contracts, which states that an investor shall elect to account for its investments in life settlement contracts by using either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. The Company has elected to account for these policies using the fair value method. The Company determines fair value on a discounted cash flow basis of anticipated death benefits, incorporating current life expectancy assumptions, premium payments, the credit exposure to the insurance company that issued the life settlement contracts and the rate of return that a buyer would require on the contracts as no comparable market pricing is available.
 
Total capital contributions of approximately $28,042 and $39,930 were made to the LSC entities during the nine months ended September 30, 2012 and 2011, respectively, for which the Company contributed approximately $14,021 and $19,965 in those same periods. The Company’s investments in life settlements and cash value loans were approximately $173,298 and $136,800 as of September 30, 2012 and December 31, 2011, respectively and are included in Prepaid expenses and other assets on the Consolidated Balance Sheet. The Company recorded other income for the three months ended September 30, 2012 and 2011 of approximately $3,251 and $6,882, and approximately $5,302 and $48,346 for the nine months ended September 30, 2012 and 2011, respectively, related to the life settlement contracts.
 

16


In addition to the 256 policies disclosed in the table below as of September 30, 2012, Tiger owned 14 premium finance loans as of the nine months ended September 30, 2012, which were secured by life insurance policies and were carried at a value of $1,822. As of September 30, 2012, the face value amount of the related 256 life insurance policies and 14 premium finance loans were approximately $1,671,013 and $68,250 respectively. All of the premium finance loans are in default and Tiger is enforcing its rights in the collateral. Upon the voluntary surrender of the underlying life insurance policy in satisfaction of the loan or foreclosure, Tiger will become the owner of and beneficiary under the underlying life insurance policy and will have the option to continue to make premium payments on the policies or allow the policies to lapse. If a policyholder wishes to cure his or her default and repay the loan, Tiger will be repaid the total amount due under the premium finance loans, including all premium payments made by Tiger to maintain the policy in force since its acquisition of the loan.
 
The following table describes the Company’s investment in life settlements as of September 30, 2012:
 
(Amounts in Thousands, except number of Life Settlement Contracts) 
Expected Maturity Term in Years
Number of Life Settlement Contracts
 
Fair Value (1)
 
Face Value
0-1
—

 
$
—

 
$
—

1-2
—

 
—

 
—

2-3
3

 
12,266

 
20,000

3-4
1

 
2,932

 
5,000

4-5
3

 
13,133

 
30,000

Thereafter
249

 
143,145

 
1,616,013

Total
256

 
$
171,476

 
$
1,671,013

  
(1)
The Company determined this fair value based on 166 policies out of the 256 policies as of September 30, 2012, as the Company assigned no value to 90 of the policies as of September 30, 2012.

Premiums to be paid for each of the five succeeding fiscal years to keep the life insurance policies in force as of September 30, 2012, are as follows:
 
(Amounts in Thousands)
Premiums Due on Life  Settlement Contracts
 
Premiums Due on Premium Finance Loans
 
Total
2012
$
26,967

 
$
502

 
$
27,469

2013
28,316

 
478

 
28,794

2014
30,156

 
613

 
30,769

2015
33,015

 
1,131

 
34,146

2016
44,570

 
1,022

 
45,592

Thereafter
473,533

 
15,905

 
489,438

Total
$
636,557

 
$
19,651

 
$
656,208

   

17


6.
Debt
 
The Company’s borrowings consisted of the following at September 30, 2012 and December 31, 2011:
 
(Amounts in Thousands)
2012
 
2011
Subordinated debentures
123,714

 
123,714

Convertible senior notes
160,507

 
138,506

Secured loan agreements
9,289

 
10,018

Promissory notes
8,000

 
7,362

 
$
301,510

 
$
279,600

 

Aggregate scheduled maturities of the Company’s borrowings at September 30, 2012 are:
 
(Amounts in Thousands)
 
 
2012
$248
 
2013
1,021

 
2014
1,068

 
2015
1,116

 
2016
1,167

 
Thereafter
296,890
(1)
 
(1)
Amount reflected in balance sheet for convertible senior notes is net of unamortized original issue discount of $39,493.

Revolving Credit Agreement
 
On August 10, 2012, the Company entered into a four-year, $200,000 credit agreement (the “Credit Agreement”), among JPMorgan Chase Bank, N.A., as Administrative Agent, KeyBank National Association and SunTrust Bank, as Co-Syndication Agents, Associated Bank, National Association and Lloyds Securities Inc., as Co-Documentation Agents and the various lending institutions party thereto. The credit facility is a revolving credit facility with a letter of credit sublimit of $100,000 and an expansion feature not to exceed $100,000. In connection with entering into the Credit Agreement, the Company terminated its existing $150,000 credit agreement, dated as of January 28, 2011 with JPMorgan Chase Bank, NA. Fees associated with the Credit Agreement were approximately $968.  The Credit Agreement contains certain restrictive covenants customary for facilities of this type (subject to negotiated exceptions and baskets), including restrictions on indebtedness, liens, acquisitions and investments, restricted payments and dispositions. There are also financial covenants that require the Company to maintain a minimum consolidated net worth, a maximum consolidated leverage ratio, a minimum fixed charge coverage ratio, a minimum risk-based capital and a minimum statutory surplus. The Company was in compliance with all covenants as of September 30, 2012.
 
As of September 30, 2012, the Company had no outstanding borrowings under this Credit Agreement. The Company had outstanding letters of credit in place under this Credit Agreement at September 30, 2012 for $49,015, which reduced the availability for letters of credit to $50,985 as of September 30, 2012, and the availability under the facility to $150,985 as of September 30, 2012.
 
Borrowings under the Credit Agreement bear interest at (x) the greatest of (a) the Administrative Agent’s prime rate, (b) the federal funds effective rate plus 0.5 percent or (c) the adjusted LIBO rate for a one month interest period on such day plus 1 percent, plus (y) a margin that is adjusted on the basis of the Company’s consolidated leverage ratio. Eurodollar borrowings under the Credit Agreement will bear interest at the adjusted LIBO rate for the interest period in effect plus a margin that is adjusted on the basis of the Company’s consolidated leverage ratio. The interest rate on the credit facility as of September 30, 2012 and 2011 was 2.50%. The Company recorded total interest expense of approximately $450 and $595 for the three months ended September 30, 2012 and 2011, respectively, and $1,468 and $2,013 for the nine months ended September 30, 2012 and 2011, respectively, under the Credit Agreement and the terminated credit agreement.
 

18


Fees payable by the Company under the Credit Agreement include a letter of credit participation fee (which is the margin applicable to Eurodollar borrowings and was 1.50% at September 30, 2012), a letter of credit fronting fee with respect to each letter of credit of .125% and a commitment fee on the available commitments of the lenders (a range of .20% to .30% based on the Company’s consolidated leverage ratio and was .25% at September 30, 2012).

Junior Subordinated Debt
 
The Company has established four special purpose trusts for the purpose of issuing trust preferred securities. The proceeds from such issuances, together with the proceeds of the related issuances of common securities of the trusts, were invested by the trusts in junior subordinated debentures issued by the Company. In accordance with FASB ASC 810-10-25, the Company does not consolidate such special purpose trusts, as the Company is not considered to be the primary beneficiary. The equity investment, totaling $3,714 as of September 30, 2012 on the Company’s consolidated balance sheet, represents the Company’s ownership of common securities issued by the trusts. The debentures require interest-only payments to be made on a quarterly basis, with principal due at maturity. The debentures contain covenants that restrict declaration of dividends on the Company’s common stock under certain circumstances, including default of payment. The Company incurred $2,605 of placement fees in connection with these issuances which is being amortized over thirty years. The Company recorded $2,049 and $2,552 of interest expense for the three months ended September 30, 2012 and 2011, respectively, and $6,275 and $7,657 of interest expense for the nine months ended September 30, 2012 and 2011, respectively, related to these trust preferred securities.
 
The table below summarizes the Company’s trust preferred securities as of September 30, 2012:
 
(Amounts in Thousands)

Name of Trust
 
Aggregate Liquidation Amount of Trust Preferred Securities
 
Aggregate Liquidation Amount of Common Securities
 
Aggregate Principal Amount of Notes
 
Stated Maturity of Notes
 
Per Annum Interest Rate % of Notes
AmTrust Capital Financing Trust I
 
$
25,000

 
$
774

 
$
25,774

 
3/17/2035
 
8.275
 (1)
AmTrust Capital Financing Trust II
 
25,000

 
774

 
25,774

 
6/15/2035
 
7.710
 (1)
AmTrust Capital Financing Trust III
 
30,000

 
928

 
30,928

 
9/15/2036
 
3.689
 (2)
AmTrust Capital Financing Trust IV
 
40,000

 
1,238

 
41,238

 
3/15/2037
 
3.389
 (3)
Total trust preferred securities
 
$
120,000

 
$
3,714

 
$
123,714

 
 
 
 

 
(1)
The interest rate will change to three-month LIBOR plus 3.40% after the tenth anniversary in 2015.
(2)
The interest rate is LIBOR plus 3.30%.
(3)
The interest rate is LIBOR plus 3.00%.

The Company entered into two interest rate swap agreements related to these junior subordinated debentures, which effectively convert the interest rate on the trust preferred securities from a variable rate to a fixed rate. Each agreement is for a period of five years and commenced on September 15, 2011 for tranche III and March 15, 2012 for tranche IV.
 
Convertible Senior Notes
 
In December 2011, the Company issued $175,000 aggregate principal amount of its 5.5% convertible senior notes due 2021 (the “Notes”) to certain initial purchasers in a private placement. In January 2012, the Company issued an additional $25,000 of the Notes to cover the initial purchasers’ overallotment option. The Notes bear interest at a rate equal to 5.5% per year, payable semiannually in arrears on June 15th and December 15th of each year, beginning June 15, 2012.
 
The Notes will mature on December 15, 2021 (the “Maturity Date”), unless earlier purchased by the Company or converted into shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”). Prior to September 15, 2021, the Notes will be convertible only upon satisfaction of certain conditions, and thereafter, at any time prior to the close of business on the second scheduled trading day immediately preceding the Maturity Date. The conversion rate at September 30, 2012 is equal to 34.5759 shares of Common Stock per $1,000 principal amount of Notes, which corresponds to a conversion price of approximately $28.92 per share of Common Stock. The conversion rate is subject to adjustment upon the occurrence of certain events as set forth in the indenture governing the notes. Upon conversion of the Notes, the Company will, at its election, pay or deliver, as the case may be, cash, shares of Common Stock, or a combination of cash and shares of Common Stock.
 

19


Upon the occurrence of a fundamental change (as defined in the indenture governing the notes) involving the Company, holders of the Notes will have the right to require the Company to repurchase their Notes for cash, in whole or in part, at 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest, if any, to, but excluding, the fundamental change purchase date.
 
The Company separately allocated the proceeds for the issuance of the Notes to a liability component and an equity component, which is the embedded conversion option. The equity component was reported as an adjustment to paid-in-capital, net of tax, and is reflected as an original issue discount (“OID”). The OID of $41,679 and deferred origination costs relating to the liability component of $4,750 will be amortized into interest expense over the term of the loan of the Notes. After considering the contractual interest payments and amortization of the original discount, the Notes effective interest rate was 8.57%. Transaction costs of $1,250 associated with the equity component were netted in paid-in-capital. Interest expense, including amortization of deferred origination costs, recognized on the Notes was $3,578 and $10,451 for the three and nine month periods ended September 30, 2012.
  
The following table shows the amounts recorded for the Notes as of September 30, 2012 and December 31, 2011:
  
(Amounts in Thousands)
September 30,
2012
 
December 31,
2011
Liability component
 

 
 

Outstanding principal
$
200,000

 
$
175,000

Unamortized OID
(39,493
)
 
(36,494
)
Liability component
160,507

 
138,506

Equity component, net of tax
27,092

 
23,785

 
Secured Loan Agreement
 
During February 2011, the Company, through a wholly-owned subsidiary, entered into a seven-year secured loan agreement with Bank of America Leasing & Capital, LLC in the aggregate amount of $10,800 to finance the purchase of an aircraft. The loan bears interest at a fixed rate of 4.45%, requires monthly installment payments of approximately $117 commencing on March 25, 2011 and ending on February 25, 2018, and a balloon payment of $3,240 at the maturity date. The Company recorded interest expense of approximately $107 and $117 for the three months ended September 30, 2012 and 2011, respectively, and approximately $328 and $288 of interest expense for the nine months ended September 30, 2012 and 2011, respectively, related to this agreement. The loan is secured by an aircraft that the subsidiary acquired in February 2011.
 
The agreement contains certain covenants that are similar to the Company’s revolving credit facility. Additionally, subsequent to February 25, 2012, but prior to payment in full, if the outstanding balance of this loan exceeds 90% of the fair value of the aircraft, the Company is required to pay the lender the entire amount necessary to reduce the outstanding principal balance to be equal to or less than 90% of the fair value of the aircraft.  The agreement allows the Company, under certain conditions, to repay the entire outstanding principal balance of this loan without penalty.
 
Promissory Notes

In 2012, 800 Superior, LLC entered into two promissory notes with ACP Re, Ltd. totaling $5,000. 800 Superior, LLC is an entity in which both the Company and ACAC have a 50% ownership interest. The notes bore an interest rate of 2.00% per annum , which resulted in $20 and $43 of interest expense for the three and nine months ended September 30, 2012. The notes were paid in full in September 2012. For more information regarding these promissory notes, see Note 11. “Related Party Transactions.”

In September 2012, as part of its participation in the new New Market Tax Credit Program discussed in Note 13. "New Market Tax Credit", the Company entered into two promissory notes totaling $8,000. The loans are for a period of 15 years and have an average interest rate of 1.7% per annum. The Company recorded interest expense of approximately $12 for the three and nine months ended September 30, 2012.
 
 

20


Comerica Letter of Credit Facility
 
In connection with the Majestic acquisition discussed in Note 12 “Acquisitions,” the Company, through one of its subsidiaries, entered into a secured letter of credit facility with Comerica Bank during the three months ended September 30, 2011. The Company utilizes this letter of credit facility to comply with the deposit requirements of the State of California and the U.S. Department of Labor as security for the Company’s obligations to workers’ compensation and Federal Longshore and Harbor Workers’ Compensation Act policyholders. The credit limit is for $75,000 and was utilized for $49,801 as of September 30, 2012. The Company is required to pay a letter of credit participation fee for each letter of credit in the amount of 0.40%.

Other Letters of Credit
 
As of September 30, 2012, the Company, through certain subsidiaries, has additional existing stand-by letters of credit in the amount of $7,393 outstanding, which reduced the availability on the letters of credit to $11 as of September 30, 2012.

7.
Acquisition Costs and Other Underwriting Expenses
 
The following table summarizes the components of acquisition costs and other underwriting expenses for the three and nine months ended September 30, 2012 and 2011:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands)
2012
 
2011
 
2012
 
2011
Policy acquisition expenses
$
108,427

 
$
76,944

 
$
279,476

 
$
180,260

Salaries and benefits
32,557

 
27,418

 
109,174

 
87,309

Other insurance general and administrative expenses
2,752

 
8,908

 
8,824

 
16,515

 
$
143,736

 
$
113,270

 
$
397,474

 
$
284,084

 
8.
Earnings Per Share
 
Effective January 1, 2009, the Company adopted ASC subtopic 260-10, Determining Whether Instruments Granted in Share-Based Payments Transactions Are Participating Securities. ASC 260-10 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities and are to be included in the computation of earnings per share under the two-class method. The Company’s unvested restricted shares contain rights to receive nonforfeitable dividends and are participating securities, requiring the two-class method of computing earnings per share.

In August 2012, the Company declared a ten percent stock dividend that was paid in September 2012. As a result, the Company's prior year's basic and diluted earnings per share have been retroactively adjusted for the three and nine months ended September 30, 2011. The adjustment negatively impacted basic and diluted shares by $0.02 per share in both periods.


21


The following table is a summary of the elements used in calculating basic and diluted earnings per share for the three and nine months ended September 30, 2012 and 2011:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands except per share)
2012
 
2011
 
2012
 
2011
Basic earnings per share:
 
 
 
 
 
 
 
Net income attributable to AmTrust Financial Services, Inc. shareholders
$
43,230


$
37,166

 
$
122,674


$
132,511

Less: Net income allocated to participating securities and redeemable non-controlling interest
206

 
16

 
513

 
80

Net income allocated to AmTrust Financial Services, Inc. common shareholders
$
43,024

 
$
37,150

 
$
122,161

 
$
132,431

 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
62,642

 
61,700

 
61,156

 
60,414

Less: Weighted average participating shares outstanding
297

 
32

 
255

 
40

Weighted average common shares outstanding - basic
62,345

 
61,668

 
60,901

 
60,374

Net income per AmTrust Financial Services, Inc. common share - basic
$
0.69


$
0.60

 
$
2.01


$
2.19

   
 

 
 

 
 

 
 

Net income attributable to AmTrust Financial Services, Inc. shareholders
$
43,230

 
$
37,166

 
$
122,674

 
$
132,511

Less: Net income allocated to participating securities and redeemable non-controlling interest
206

 
16

 
513

 
80

Net income allocated to AmTrust Financial Services, Inc. common shareholders
$
43,024

 
$
37,150

 
$
122,161

 
$
132,431

 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
62,345

 
61,668

 
60,901

 
60,374

Plus: Dilutive effect of stock options, other
2,779

 
1,984

 
2,515

 
1,719

Weighted average common shares outstanding – dilutive
65,124

 
63,652

 
63,416

 
62,093

Net income per AmTrust Financial Services, Inc. common shares – diluted
$
0.66


$
0.58

 
$
1.93


$
2.13

 
As of September 30, 2012, there were less than 10,000 anti-dilutive securities excluded from diluted earnings per share.




















 

22


9.
Share Based Compensation
 
The Company’s 2010 Omnibus Incentive Plan (the “Plan”) permits the Company to grant to its officers, employees and non-employee directors incentive compensation directly linked to the price of the Company’s stock. The Plan authorizes up to an aggregate of 6,045,511 shares of Company stock for awards of options to purchase shares of the Company’s common stock, restricted stock, restricted stock units (“RSU”), performance shares or appreciation rights. Shares used may be either newly issued shares or treasury shares or both. The aggregate number of shares of common stock for which awards may be issued may not exceed 6,045,511 shares, subject to the authority of the Company’s board of directors to adjust this amount in the event of a consolidation, reorganization, stock dividend, stock split, recapitalization or similar transaction affecting the Company’s common stock. As of September 30, 2012, approximately 5,000,000 shares of Company common stock remained available for grants under the Plan.
 
The Company recognizes compensation expense under FASB ASC 718-10-25 for its share-based payments based on the fair value of the awards. The Company grants stock options at prices equal to the closing stock price of the Company’s stock on the dates the options are granted. The options have a term of ten years from the date of grant and vest primarily in equal annual installments over the four years period following the date of grant for employee options. Employees have three months after the employment relationship ends to exercise all vested options. The fair value of each option grant is separately estimated for each vesting date. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the award and each vesting date. The Company has estimated the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes-Merton multiple-option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense. The Company grants restricted shares and RSUs with a grant date value equal to the closing stock price of the Company’s stock on the dates the shares or units are granted and they vest over a period of two to four years.
 
The following schedule shows all options granted, exercised, and expired under the Plan for the nine months ended September 30, 2012 and 2011:
 
 
2012
 
2011
 
 
 
Shares
 
Weighted Average Exercise Price
 
 
 
Shares
 
Weighted Average Exercise Price
Outstanding at beginning of period
4,136,466

 
$
9.96

 
4,572,557

 
$
9.48

Granted
41,800

 
25.99

 
258,500

 
15.30

Exercised
(430,399
)
 
8.23

 
(426,930
)
 
8.74

Cancelled or terminated
(86,966
)
 
12.98

 
(116,149
)
 
10.86

Outstanding end of period
3,660,901

 
$
10.27

 
4,287,978

 
$
9.87

 
The weighted average g