AFSI 03.31.2013 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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| |
S | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the quarterly period ended March 31, 2013 |
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| |
£ | 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)
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| | |
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:
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| | |
Large accelerated filer x | | Accelerated filer ¨ |
| | |
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 May 1, 2013, the Registrant had one class of Common Stock ($.01 par value), of which 67,405,910 shares were issued and outstanding.
INDEX
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
AMTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In Thousands, Except Par Value)
|
| | | | | | | |
| March 31, 2013 | | December 31, 2012 |
| (Unaudited) | | (Audited) |
ASSETS | | | |
Investments: | | | |
Fixed maturities, available-for-sale, at market value (amortized cost $2,131,002; $1,947,644) | $ | 2,227,384 |
| | $ | 2,065,226 |
|
Equity securities, available-for-sale, at market value (cost $19,283; $20,943) | 21,555 |
| | 20,465 |
|
Short-term investments | 30,027 |
| | 10,282 |
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Equity investment in unconsolidated subsidiaries – related party | 97,741 |
| | 96,153 |
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Other investments | 16,052 |
| | 11,144 |
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Total investments | 2,392,759 |
| | 2,203,270 |
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Cash and cash equivalents | 450,724 |
| | 414,370 |
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Restricted cash and cash equivalents | 115,687 |
| | 78,762 |
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Accrued interest and dividends | 22,222 |
| | 18,536 |
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Premiums receivable, net | 1,311,530 |
| | 1,251,262 |
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Reinsurance recoverable (related party $872,540; $789,519) | 1,414,396 |
| | 1,318,395 |
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Prepaid reinsurance premium (related party $625,686; $547,128) | 869,327 |
| | 754,844 |
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Prepaid expenses and other assets (recorded at fair value $199,824; $193,927) | 427,523 |
| | 421,163 |
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Federal income tax receivable | 8,106 |
| | 16,609 |
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Deferred policy acquisition costs | 388,803 |
| | 349,126 |
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Property and equipment, net | 84,459 |
| | 75,933 |
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Goodwill | 237,394 |
| | 229,780 |
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Intangible assets | 307,073 |
| | 285,187 |
|
| $ | 8,030,003 |
| | $ | 7,417,237 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
Liabilities: | | | |
Loss and loss expense reserves | $ | 2,577,026 |
| | $ | 2,426,400 |
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Unearned premiums | 2,147,986 |
| | 1,773,593 |
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Ceded reinsurance premiums payable (related party $419,532; $333,962) | 535,110 |
| | 528,322 |
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Reinsurance payable on paid losses | 12,553 |
| | 13,410 |
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Funds held under reinsurance treaties | 33,434 |
| | 33,946 |
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Note payable on collateral loan – related party | 167,975 |
| | 167,975 |
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Securities sold but not yet purchased, at market | 56,317 |
| | 56,711 |
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Securities sold under agreements to repurchase, at contract value | 135,216 |
| | 234,911 |
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Accrued expenses and other current liabilities (recorded at fair value $12,237; $11,750) | 572,761 |
| | 406,447 |
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Deferred income taxes | 209,172 |
| | 225,484 |
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Debt | 302,445 |
| | 301,973 |
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Total liabilities | 6,749,995 |
| | 6,169,172 |
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Commitments and contingencies |
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| |
|
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Redeemable non-controlling interest | 600 |
| | 600 |
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Stockholders’ equity: | | | |
Common stock, $.01 par value; 100,000 shares authorized, 91,216 issued in 2013 and 2012, respectively; 67,329 and 67,192 outstanding in 2013 and 2012, respectively | 912 |
| | 912 |
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Preferred stock, $.01 par value; 10,000 shares authorized | — |
| | — |
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Additional paid-in capital | 762,899 |
| | 761,105 |
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Treasury stock at cost; 23,887 and 24,024 shares in 2013 and 2012, respectively | (292,502 | ) | | (293,791 | ) |
Accumulated other comprehensive income | 36,970 |
| | 64,231 |
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Retained earnings | 666,452 |
| | 611,664 |
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Total AmTrust Financial Services, Inc. equity | 1,174,731 |
| | 1,144,121 |
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Non-controlling interest | 104,677 |
| | 103,344 |
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Total stockholders’ equity | 1,279,408 |
| | 1,247,465 |
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| $ | 8,030,003 |
| | $ | 7,417,237 |
|
See accompanying notes to unaudited condensed consolidated statements.
AmTrust Financial Services, Inc.
Condensed Consolidated Statements of Income
(Unaudited)
(In Thousands, Except Per Share Data)
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| | | | | | | | |
| | Three Months Ended March 31, |
| | 2013 | | 2012 |
Revenues: | | |
| | |
|
Premium income: | | |
| | |
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Net written premium | | $ | 532,106 |
| | $ | 359,777 |
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Change in unearned premium | | (124,112 | ) | | (45,753 | ) |
Net earned premium | | 407,994 |
| | 314,024 |
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Ceding commission – primarily related party | | 63,958 |
| | 46,274 |
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Service and fee income (related parties – $10,507; $6,092) | | 60,513 |
| | 40,538 |
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Net investment income | | 18,095 |
| | 14,518 |
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Net realized gain (loss) on investments | | 17,284 |
| | (1,148 | ) |
Total revenues | | 567,844 |
| | 414,206 |
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Expenses: | | |
| | |
|
Loss and loss adjustment expense | | 272,256 |
| | 199,929 |
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Acquisition costs and other underwriting expenses | | 156,820 |
| | 124,025 |
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Other | | 52,152 |
| | 35,639 |
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Total expenses | | 481,228 |
| | 359,593 |
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Income before other income (expense), income taxes and equity in earnings of unconsolidated subsidiary | | 86,616 |
| | 54,613 |
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Other income (expense): | | |
| | |
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Interest expense | | (7,361 | ) | | (7,091 | ) |
(Loss) gain on investment in life settlement contracts net of profit commission | | (1,076 | ) | | 90 |
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Foreign currency gain | | 1,272 |
| | 421 |
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Total other income (expense) | | (7,165 | ) | | (6,580 | ) |
Income before income taxes and equity in earnings of unconsolidated subsidiary | | 79,451 |
| | 48,033 |
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Provision for income taxes | | 17,660 |
| | 11,177 |
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Income before equity in earnings of unconsolidated subsidiary |
| 61,791 |
| | 36,856 |
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Equity in earnings of unconsolidated subsidiary – related party | | 1,551 |
| | 2,364 |
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Net income | | 63,342 |
| | 39,220 |
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Net loss (income) attributable to non-controlling interest of subsidiaries | | 876 |
| | (134 | ) |
Net income attributable to AmTrust Financial Services, Inc. | | $ | 64,218 |
| | $ | 39,086 |
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Earnings per common share: | | |
| | |
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Basic earnings per share | | $ | 0.95 |
| | $ | 0.59 |
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Diluted earnings per share | | $ | 0.91 |
| | $ | 0.57 |
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Dividends declared per common share | | $ | 0.14 |
| | $ | 0.09 |
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Net realized gain on investments: | | |
| | |
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Total other-than-temporary impairment loss | | $ | — |
| | $ | — |
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Portion of loss recognized in other comprehensive income | | — |
| | — |
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Net impairment losses recognized in earnings | | — |
| | — |
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Other net realized gain (loss) on investments | | 17,284 |
| | (1,148 | ) |
Net realized investment gain | | $ | 17,284 |
| | $ | (1,148 | ) |
See accompanying notes to unaudited condensed consolidated financial statements.
AmTrust Financial Services, Inc.
Condensed Consolidated Statement of Comprehensive Income
(Unaudited)
(In Thousands)
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| | | | | | | | |
| | Three Months Ended March 31, |
| | 2013 | | 2012 |
Net income | | $ | 63,342 |
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| $ | 39,220 |
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Other comprehensive income, net of tax: | | |
| | |
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Foreign currency translation adjustments | | (15,731 | ) | | 4,197 |
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Change in fair value of interest rate swap | | 220 |
| | (57 | ) |
Unrealized gains on securities: | | |
| | |
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Unrealized holding (loss) gain arising during period | | (15,286 | ) | | 30,759 |
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Reclassification adjustment for gains (losses) included in net income | | 3,536 |
| | (2,444 | ) |
Other comprehensive (loss) income, net of tax | | $ | (27,261 | ) | | $ | 32,455 |
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Comprehensive income | | 36,081 |
| | 71,675 |
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Less: Comprehensive (loss) income attributable to non-controlling interest | | (876 | ) |
| 134 |
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Comprehensive income attributable to AmTrust Financial Services, Inc. | | $ | 36,957 |
| | $ | 71,541 |
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See accompanying notes to unaudited condensed consolidated financial statements.
AmTrust Financial Services, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In Thousands)
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| | | | | | | |
| Three Months Ended March 31, |
| 2013 | | 2012 |
Cash flows from operating activities: | |
| | |
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Net income | $ | 63,342 |
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| $ | 39,220 |
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Adjustments to reconcile net income to net cash provided by operating activities: | |
| | |
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Depreciation and amortization | 13,185 |
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| 8,746 |
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Equity earnings on investment in unconsolidated subsidiaries | (1,551 | ) |
| (2,364 | ) |
Loss (gain) on investment in life settlement contracts, net | 1,076 |
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| (90 | ) |
Realized (gain) loss on marketable securities | (17,284 | ) |
| 1,148 |
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Discount on notes payable | 723 |
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| 968 |
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Stock based compensation | 2,108 |
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| 1,180 |
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Bad debt expense | 2,996 |
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| 1,994 |
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Foreign currency gain | (1,272 | ) |
| (421 | ) |
Changes in assets - (increase) decrease: | |
| | |
|
Premiums and note receivables | (63,120 | ) |
| (73,953 | ) |
Reinsurance recoverable | (80,551 | ) |
| (43,578 | ) |
Deferred policy acquisition costs, net | (39,677 | ) |
| (14,406 | ) |
Prepaid reinsurance premiums | (114,483 | ) |
| (36,118 | ) |
Prepaid expenses and other assets | 24,092 |
|
| (34,589 | ) |
Changes in liabilities - increase (decrease): | |
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| |
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Reinsurance premium payable | 2,133 |
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| 37,681 |
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Loss and loss expense reserve | 138,007 |
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| 89,144 |
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Unearned premiums | 235,716 |
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| 86,838 |
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Funds held under reinsurance treaties | (512 | ) |
| (6,625 | ) |
Accrued expenses and other current liabilities | 57,403 |
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| 29,084 |
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Deferred tax liability | (24,064 | ) |
| 4,575 |
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Net cash provided by operating activities | 198,267 |
| | 88,434 |
|
Cash flows from investing activities: | |
| | |
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Net (purchases) sales of securities with fixed maturities | (8,089 | ) |
| (212,243 | ) |
Net (purchases) sales of equity securities | 7,240 |
|
| 7,509 |
|
Net (purchases) sales of other investments | (4,214 | ) |
| (309 | ) |
Acquisition of and capitalized premiums for life settlement contracts | (9,427 | ) |
| (7,961 | ) |
Receipt of life settlement contract proceeds | 4,028 |
|
| — |
|
Acquisition of subsidiaries and intangible assets, net of cash obtained | (3,516 | ) |
| (2,222 | ) |
Increase in restricted cash and cash equivalents | (36,925 | ) |
| (36,132 | ) |
Purchase of property and equipment | (8,383 | ) |
| (5,014 | ) |
Net cash used in investing activities | (59,286 | ) | | (256,372 | ) |
Cash flows from financing activities: | |
| | |
|
Repurchase agreements, net | (99,695 | ) |
| 9,197 |
|
Convertible senior notes proceeds | — |
|
| 25,000 |
|
Secured loan agreements payments | (251 | ) |
| (240 | ) |
Promissory notes borrowings | — |
|
| 2,500 |
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Financing fees | — |
|
| (750 | ) |
Capital contribution to subsidiaries | 2,209 |
|
| 4,928 |
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Stock option exercise and other | 975 |
|
| 922 |
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Dividends distributed on common stock | — |
|
| (5,533 | ) |
|
| | | | | | | |
Net cash (used in) provided by financing activities | (96,762 | ) | | 36,024 |
|
Effect of exchange rate changes on cash | (5,865 | ) | | 2,250 |
|
Net increase (decrease) in cash and cash equivalents | 36,354 |
| | (129,664 | ) |
Cash and cash equivalents, beginning of the period | 414,370 |
| | 406,847 |
|
Cash and cash equivalents, end of the period | $ | 450,724 |
| | $ | 277,183 |
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Supplemental Cash Flow Information | |
| | |
|
Income tax payments | $ | 273 |
| | $ | 46 |
|
Interest payments on debt | 2,452 |
| | 2,880 |
|
See accompanying notes to unaudited condensed consolidated financial statements.
Notes to Unaudited Condensed Consolidated Financial Statements
(Unaudited)
(Dollars In Thousands, Except Per Share Data)
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, 2012, previously filed with the Securities and Exchange Commission (“SEC”) on March 1, 2013. The balance sheet at December 31, 2012 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, 2012, 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.
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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 three months ended March 31, 2013, as compared to those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, that are of significance, or potential significance, to the Company.
In March 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-05, Parent’s Accounting for the Cumulative Translation Adjustment Upon Derecognition of Certain Subsidiaries or Groups of Assets Within a Foreign Entity or of an Investment in a Foreign Entity to standardize the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary. ASU 2013-05 will be applied prospectively and is effective for annual reporting periods beginning after December 15, 2013, and interim periods within those years. The standard is not expected to have a material impact on the Company’s results of operations, financial position or liquidity.
In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income ("ASU 2013-02"). ASU 2013-02 supersedes and replaces the presentation requirements for the reclassifications out of accumulated other comprehensive income. None of the other requirements of previously issued ASUs related to comprehensive income are affected by ASU 2013-02. The Company adopted ASU 2013-02 on January 1, 2013 and the implementation of the standard did not have a material impact on the Company's results of operations, financial position or liquidity.
In January 2013, the FASB issued ASU No. 2013-01, Clarifying the Scope of Disclosure about Offsetting Assets and Liabilities ("ASU 2013-01"). ASU 2013-01 relates to derivatives, repurchase agreements and reverse repurchase agreements, and secured borrowings and lending transactions that are either offset or subject to a master netting arrangement. The amendment provides a user of financial statements with comparable information as it relates to certain reconciling differences between financial statements prepared in accordance with U.S. GAAP and those financial statements prepared in accordance with International Financial Reporting Standards ("IFRS"). The Company adopted ASU 2013-02 on January 1, 2013 and the implementation of the standard did not have a material impact on the Company's results of operations, financial position or liquidity.
In July 2012, the FASB issued ASU No. 2012-02, Intangibles - Goodwill and Other (Topic 350) Testing Indefinite Lived Intangible Assets for Impairment ("ASU 2012-02"). ASU 2012-02 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 Company adopted this guidance on January 1, 2013 and it did not have any effect on the Company's results of operations, financial position or liquidity.
(a) Available-for-Sale Securities
The amortized cost, estimated market value and gross unrealized appreciation and depreciation of available-for-sale securities as of March 31, 2013 and December 31, 2012, are presented in the table below:
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| | | | | | | | | | | | | | | | |
(Amounts in Thousands) As of March 31, 2013 | | Original or amortized cost | | Gross unrealized gains | | Gross unrealized losses | | Market value |
Preferred stock | | $ | 1,488 |
| | $ | 119 |
| | $ | (64 | ) | | $ | 1,543 |
|
Common stock | | 17,795 |
| | 2,642 |
| | (425 | ) | | 20,012 |
|
U.S. treasury securities | | 33,481 |
| | 2,505 |
| | — |
| | 35,986 |
|
U.S. government agencies | | 12,785 |
| | 379 |
| | — |
| | 13,164 |
|
Municipal bonds | | 326,026 |
| | 12,820 |
| | (1,636 | ) | | 337,210 |
|
Foreign government | | 196,386 |
| | 1,771 |
| | (361 | ) | | 197,796 |
|
Corporate bonds: | | |
| | |
| | |
| | |
|
Finance | | 750,278 |
| | 49,030 |
| | (4,004 | ) | | 795,304 |
|
Industrial | | 438,885 |
| | 20,694 |
| | (1,195 | ) | | 458,384 |
|
Utilities | | 49,449 |
| | 2,492 |
| | (141 | ) | | 51,800 |
|
Commercial mortgage backed securities | | 9,739 |
| | 102 |
| | — |
| | 9,841 |
|
Residential mortgage backed securities: | | |
| | |
| | |
| | |
|
Agency backed | | 306,137 |
| | 15,083 |
| | (372 | ) | | 320,848 |
|
Non-agency backed | | 7,836 |
| | — |
| | (785 | ) | | 7,051 |
|
| | $ | 2,150,285 |
| | $ | 107,637 |
|
| $ | (8,983 | ) | | $ | 2,248,939 |
|
Investments in foreign government securities include securities issued by national entities as well as instruments that are unconditionally guaranteed by such entities. As of March 31, 2013, the Company's foreign government securities were issued or guaranteed primarily by Germany, Norway and the United Kingdom.
|
| | | | | | | | | | | | |
(Amounts in Thousands) As of December 31, 2012 | | Original or amortized cost | | Gross unrealized gains | | Gross unrealized losses | | Market value |
Preferred stock | | 5,092 |
| | 112 |
| | (20 | ) | | 5,184 |
|
Common stock | | 15,851 |
| | 596 |
| | (1,166 | ) | | 15,281 |
|
U.S. treasury securities | | 62,502 |
| | 3,694 |
| | (4 | ) | | 66,192 |
|
U.S. government agencies | | 39,594 |
| | 707 |
| | — |
| | 40,301 |
|
Municipal bonds | | 287,361 |
| | 12,833 |
| | (752 | ) | | 299,442 |
|
Corporate bonds: | | | | | | | | |
Finance | | 830,101 |
| | 68,190 |
| | (4,603 | ) | | 893,688 |
|
Industrial | | 387,980 |
| | 20,914 |
| | (1,094 | ) | | 407,800 |
|
Utilities | | 45,320 |
| | 2,611 |
| | (5 | ) | | 47,926 |
|
Commercial mortgage backed securities | | 10,065 |
| | 135 |
| | — |
| | 10,200 |
|
Residential mortgage backed securities: | | | | | | | | |
Agency backed | | 276,895 |
| | 16,373 |
| | (654 | ) | | 292,614 |
|
Non-agency backed | | 7,826 |
| | — |
| | (763 | ) | | 7,063 |
|
| | 1,968,587 |
| | 126,165 |
| | (9,061 | ) | | 2,085,691 |
|
A summary of the Company’s available-for-sale fixed securities as of March 31, 2013 and December 31, 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.
|
| | | | | | | | | | | | | | | |
| March 31, 2013 | | December 31, 2012 |
(Amounts in Thousands) | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
Due in one year or less | $ | 72,879 |
| | $ | 73,587 |
| | $ | 20,786 |
| | $ | 21,945 |
|
Due after one through five years | 459,422 |
| | 470,992 |
| | 400,865 |
| | 414,016 |
|
Due after five through ten years | 1,000,418 |
| | 1,062,766 |
| | 966,158 |
| | 1,044,510 |
|
Due after ten years | 274,571 |
| | 282,299 |
| | 265,049 |
| | 274,878 |
|
Mortgage backed securities | 323,712 |
| | 337,740 |
| | 294,786 |
| | 309,877 |
|
Total fixed maturities | $ | 2,131,002 |
| | $ | 2,227,384 |
| | $ | 1,947,644 |
| | $ | 2,065,226 |
|
Proceeds from the sale of investments in available-for-sale securities during the three months ended March 31, 2013 and 2012 were approximately $472,076 and $203,183, respectively.
(b) Investment Income
Net investment income for the three months ended March 31, 2013 and 2012 was derived from the following sources:
|
| | | | | | | |
| Three Months Ended March 31, |
(Amounts in Thousands) | 2013 | | 2012 |
Fixed maturity securities | $ | 17,272 |
| | $ | 13,529 |
|
Equity maturities | 402 |
| | 398 |
|
Cash and short term investments | 1,044 |
| | 591 |
|
| 18,718 |
| | 14,518 |
|
Less: | |
| | |
|
Investment expenses and interest expense on securities sold under agreement to repurchase | (623 | ) | | — |
|
| $ | 18,095 |
| | $ | 14,518 |
|
(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 March 31, 2013 and December 31, 2012:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months |
| 12 Months or More |
| Total |
(Amounts in Thousands) March 31, 2013 | | 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 | | $ | 4,126 |
|
| $ | (489 | ) |
| 41 |
|
| $ | — |
|
| $ | — |
|
| — |
|
| $ | 4,126 |
|
| $ | (489 | ) |
Municipal bonds | | 94,516 |
|
| (1,595 | ) |
| 40 |
|
| 2,312 |
|
| (41 | ) |
| 1 |
|
| 96,828 |
|
| (1,636 | ) |
Foreign government | | 17,822 |
| | (361 | ) | | 8 |
| | — |
| | — |
| | — |
| | 17,822 |
| | (361 | ) |
Corporate bonds: | | |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Finance | | 150,850 |
|
| (2,706 | ) |
| 37 |
|
| 57,029 |
|
| (1,298 | ) |
| 7 |
|
| 207,879 |
|
| (4,004 | ) |
Industrial | | 119,203 |
|
| (1,195 | ) |
| 55 |
|
| — |
|
| — |
|
| — |
|
| 119,203 |
|
| (1,195 | ) |
Utilities | | 18,120 |
| | (141 | ) | | 3 |
| | — |
| | — |
| | — |
| | 18,120 |
| | (141 | ) |
Residential mortgage backed securities: | | |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Agency backed | | 13,082 |
|
| (372 | ) |
| 1 |
|
| — |
|
| — |
|
| — |
|
| 13,082 |
|
| (372 | ) |
Non-agency backed | | — |
|
| — |
|
| — |
|
| 7,051 |
|
| (785 | ) |
| 2 |
|
| 7,051 |
|
| (785 | ) |
Total temporarily impaired securities | | $ | 417,719 |
|
| $ | (6,859 | ) |
| 185 |
|
| $ | 66,392 |
|
| $ | (2,124 | ) |
| 10 |
|
| $ | 484,111 |
|
| $ | (8,983 | ) |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months | | 12 Months or More | | Total |
(Amounts in Thousands) December 31, 2012 | | 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 | | $ | 7,643 |
| | $ | (1,138 | ) | | 25 |
| | $ | 1,978 |
| | $ | (48 | ) | | 1 |
| | $ | 9,621 |
| | $ | (1,186 | ) |
U.S. treasury securities | | 997 |
| | (4 | ) | | 1 |
| | — |
| | — |
| | — |
| | 997 |
| | (4 | ) |
Municipal bonds | | 63,577 |
| | (752 | ) | | 19 |
| | — |
| | — |
| | — |
| | 63,577 |
| | (752 | ) |
Corporate bonds: | | | | | |
| |
| |
| |
| | | | |
Finance | | 52,398 |
| | (899 | ) | | 20 |
| | 95,992 |
| | (3,704 | ) | | 13 |
| | 148,390 |
| | (4,603 | ) |
Industrial | | 82,066 |
| | (881 | ) | | 28 |
| | 9,105 |
| | (213 | ) | | 4 |
| | 91,171 |
| | (1,094 | ) |
Utilities | | 5,860 |
| | (5 | ) | | 3 |
| | — |
| | — |
| | — |
| | 5,860 |
| | (5 | ) |
Residential mortgage backed securities: | | | | | | | | | | | | | | | | |
Agency backed | | 24,554 |
| | (654 | ) | | 2 |
| | — |
| | — |
| | — |
| | 24,554 |
| | (654 | ) |
Non-agency backed | | — |
| | — |
| | — |
| | 7,062 |
| | (763 | ) | | 2 |
| | 7,062 |
| | (763 | ) |
Total temporarily impaired securities | | $ | 237,095 |
| | $ | (4,333 | ) | | 98 |
| | $ | 114,137 |
| | $ | (4,728 | ) | | 20 |
| | $ | 351,232 |
| | $ | (9,061 | ) |
There are 195 and 118 securities at March 31, 2013 and December 31, 2012, respectively, 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 number 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 March 31, 2013 and December 31, 2012, the Company had two interest rate swaps designated as hedges that were recorded as a liability in the total amount of $4,298 and $4,636, respectively, 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 March 31, 2013:
|
| | | | | | | | | | | | | | | | | | | | |
| | 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 March 31, 2013 and December 31, 2012 are as follows:
|
| | | | | | | |
(Amounts in Thousands) | 2013 | | 2012 |
Restricted cash | $ | 115,687 |
| | $ | 78,762 |
|
Restricted investments | 271,178 |
| | 251,082 |
|
Total restricted cash and investments | $ | 386,865 |
| | $ | 329,844 |
|
(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 March 31, 2013 was $56,300 for U.S treasury bonds and $17 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 March 31, 2013. Substantially all securities owned under these arrangements are pledged to the clearing broker to sell or repledge the securities to others subject to certain limitations.
The Company entered into repurchase agreements that are subject to a master netting arrangement, 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 March 31, 2013, the Company had nine repurchase agreements with a market value of $135,216 principal amount outstanding at interest rates between .45% and .53%. The nine agreements are with one counter-party. Interest expense associated with these repurchase agreements for the three months ended March 31, 2013 and 2012 was $277 and $0, respectively, of which $0 was accrued as of March 31, 2013. The Company has approximately $144,336 of collateral pledged in support of these agreements. Interest expense related to repurchase agreements is recorded as a component of investment income. Additionally, during the three months ended March 31, 2013, the Company entered into a reverse repurchase agreement in the amount of $56,125 that is included in cash and cash equivalents as of March 31, 2013. The Company retains collateral of $56,300 related to this agreement.
| |
4. | Fair Value of Financial Instruments |
The following tables present 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 March 31, 2013 and December 31, 2012:
|
| | | | | | | | | | | | | | | | |
(Amounts in Thousands) As of March 31, 2013 | | Total |
| Level 1 |
| Level 2 |
| Level 3 |
Assets: | | |
|
| |
|
| |
|
| |
|
U.S. treasury securities | | $ | 35,986 |
|
| $ | 35,986 |
|
| $ | — |
|
| $ | — |
|
U.S. government agencies | | 13,164 |
|
| — |
|
| 13,164 |
|
| — |
|
Municipal bonds | | 337,210 |
|
| — |
|
| 337,210 |
|
| — |
|
Foreign government | | 197,796 |
| | — |
| | 197,796 |
| | — |
|
Corporate bonds and other bonds: | | |
|
| |
|
| |
|
| |
|
Finance | | 795,304 |
|
| — |
|
| 795,304 |
|
| — |
|
Industrial | | 458,384 |
|
| — |
|
| 458,384 |
|
| — |
|
Utilities | | 51,800 |
|
| — |
|
| 51,800 |
|
| — |
|
Commercial mortgage backed securities | | 9,841 |
|
| — |
|
| 9,841 |
|
| — |
|
Residential mortgage backed securities: | | |
|
| |
|
| |
|
| |
|
Agency backed | | 320,848 |
|
| — |
|
| 320,848 |
|
| — |
|
Non-agency backed | | 7,051 |
|
| — |
|
| 7,051 |
|
| — |
|
Equity securities | | 21,555 |
|
| 21,555 |
|
| — |
|
| — |
|
Short term investments | | 30,027 |
|
| 30,027 |
|
| — |
|
| — |
|
Other investments | | 16,052 |
|
| — |
|
| — |
|
| 16,052 |
|
Life settlement contracts | | 199,824 |
|
| — |
|
| — |
|
| 199,824 |
|
| | $ | 2,494,842 |
|
| $ | 87,568 |
|
| $ | 2,191,398 |
|
| $ | 215,876 |
|
Liabilities: | | |
|
| |
|
| |
|
| |
|
Equity securities sold but not yet purchased, market | | $ | 17 |
|
| $ | 17 |
|
| $ | — |
|
| $ | — |
|
Fixed maturity securities sold but not yet purchased, market | | 56,300 |
|
| 56,300 |
|
| — |
|
| — |
|
Securities sold under agreements to repurchase, at carrying value | | 135,216 |
|
| — |
|
| 135,216 |
|
| — |
|
Life settlement contract profit commission | | 12,237 |
|
| — |
|
| — |
|
| 12,237 |
|
Derivatives | | 4,298 |
|
| — |
|
| 4,298 |
|
| — |
|
| | $ | 208,068 |
|
| $ | 56,317 |
|
| $ | 139,514 |
|
| $ | 12,237 |
|
|
| | | | | | | | | | | | | | | | |
(Amounts in Thousands) As of December 31, 2012 | | Total | | Level 1 | | Level 2 | | Level 3 |
Assets: | | | | | | | | |
U.S. treasury securities | | $ | 66,192 |
| | $ | 66,192 |
| | $ | — |
| | $ | — |
|
U.S. government agencies | | 40,301 |
| | — |
| | 40,301 |
| | — |
|
Municipal bonds | | 299,442 |
| | — |
| | 299,442 |
| | — |
|
Corporate bonds and other bonds: | |
| |
| |
| |
|
Finance | | 893,688 |
| | — |
| | 893,688 |
| | — |
|
Industrial | | 407,800 |
| | — |
| | 407,800 |
| | — |
|
Utilities | | 47,926 |
| | — |
| | 47,926 |
| | — |
|
Commercial mortgage backed securities | | 10,200 |
| | — |
| | 10,200 |
| | — |
|
Residential mortgage backed securities: | | | | | |
| |
|
Agency backed | | 292,614 |
| | — |
| | 292,614 |
| | — |
|
Non-agency backed | | 7,063 |
| | — |
| | 7,063 |
| | — |
|
Equity securities | | 20,465 |
| | 20,465 |
| | — |
| | — |
|
Short term investments | | 10,282 |
| | 10,282 |
| | — |
| | — |
|
Other investments | | 11,144 |
| | — |
| | — |
| | 11,144 |
|
Life settlement contracts | | 193,927 |
| | — |
| | — |
| | 193,927 |
|
| | $ | 2,301,044 |
| | $ | 96,939 |
| | $ | 1,999,034 |
| | $ | 205,071 |
|
Liabilities: | | | | | | | | |
Equity securities sold but not yet purchased, market | | $ | 11 |
| | $ | 11 |
| | $ | — |
| | $ | — |
|
Fixed maturity securities sold but not yet purchased, market | | 56,700 |
| | 56,700 |
| | — |
| | — |
|
Securities sold under agreements to repurchase, at carrying value | | 234,911 |
| | — |
| | 234,911 |
| | — |
|
Life settlement contract profit commission | | 11,750 |
| | — |
| | — |
| | 11,750 |
|
Derivatives | | 4,636 |
| | — |
| | 4,636 |
| | — |
|
| | $ | 308,008 |
| | $ | 56,711 |
| | $ | 239,547 |
| | $ | 11,750 |
|
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 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 2012 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 months ended March 31, 2013 and 2012:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Amounts in Thousands) | | Balance as of December 31, 2012 | | Net income | | Other comprehensive income | | Purchases and issuances | | Sales and settlements | | Net transfers into (out of) Level 3 | | Balance as of March 31, 2013 |
Other investments | | $ | 11,144 |
| | $ | 694 |
| | $ | — |
| | $ | 5,111 |
| | $ | (897 | ) | | $ | — |
| | $ | 16,052 |
|
Life settlement contracts | | 193,927 |
| | 9,925 |
| | — |
| | — |
| | (4,028 | ) | | — |
| | 199,824 |
|
Life settlement contract profit commission | | (11,750 | ) | | (487 | ) | | — |
| | — |
| | — |
| | — |
| | (12,237 | ) |
Total | | $ | 193,321 |
| | $ | 10,132 |
| | $ | — |
| | $ | 5,111 |
| | $ | (4,925 | ) | | $ | — |
| | $ | 203,639 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(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 March 31, 2012 |
Other investments | | $ | 14,588 |
| | $ | (3,949 | ) | | $ | 4,535 |
| | $ | 70 |
| | $ | (379 | ) | | $ | — |
| | $ | 14,865 |
|
Life settlement contracts | | 131,387 |
| | 7,961 |
| | — |
| | 3,227 |
| | — |
| | — |
| | 142,575 |
|
Life settlement contract profit commission | | (12,022 | ) | | (28 | ) | | — |
| | — |
| | — |
| | — |
| | (12,050 | ) |
Derivatives | | (3,508 | ) | | — |
| | (87 | ) | | — |
| | — |
| | — |
| | (3,595 | ) |
Total | | $ | 130,445 |
| | $ | 3,984 |
|
| $ | 4,448 |
| | $ | 3,297 |
| | $ | (379 | ) | | $ | — |
| | $ | 141,795 |
|
The Company had no transfers between levels during the three months ended March 31, 2013 and 2012.
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 and are classified as Level 1 in the financial hierarchy. |
— | 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 and are classified as Level 1 in the financial hierarchy. |
— | Subordinated Debentures and Debt: The current fair value of the Company's convertible senior notes and subordinated debentures was $285,000 and $62,000 as of March 31, 2013, respectively. These financial liabilities are classified as Level 3 in the financial hierarchy. The fair value of the convertible senior notes was determined using a binomial lattice model. The fair value of the subordinated debentures was determined using the Black-Derman-Toy interest rate lattice model. |
— | Other investments: The Company has less than 1% 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. |
— | 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. |
— | Repurchase agreements: The carrying value of repurchase agreements in the accompanying balance sheets represents their fair values and are classified as Level 2 in the financial hierarchy. |
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 March 31, 2013 and December 31, 2012 and, as described in Note 5 "Investments in Life Settlements", only includes data for policies to which the Company assigned value at those dates:
|
| | | | | | | |
| March 31, 2013 | | December 31, 2012 |
Average age of insured | 79.0 years |
| | 78.8 years |
|
Average life expectancy, months (1) | 137.3 |
|
| 139 |
|
Average face amount per policy | $ | 6,776,000 |
| | $ | 6,770,000 |
|
Notional fair value discount rate | 7.5 | % | | 7.5 | % |
Implicit discount rate (2) | 17.4 | % | | 17.7 | % |
| |
(1) | Standard life expectancy as adjusted for specific circumstances. |
| |
(2) | The implicit discount rate is a discounted cash flow methodology that includes an additional discount for risk premium for the following factors: (i) the volatility in life expectancy of insureds (ii) mortality adjustment reserve, which assumes life expectancy exceeds the standard mortality tables, (iii) operational risk, which includes the possibility of legal challenges from the insurance carrier or others, premium increases and the financial health of the insurance carrier, and (iv) projected future expenses. The risk premium discount was 9.9% and 10.2% for the three months ended March 31, 2013 and 2012, respectively. The value of the life settlement contracts after adjustment for risk premium is then adjusted by the notional fair value discount rate. |
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 reasonably 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 were held constant, the carrying value of the investment in life insurance policies would increase or (decrease) by the unaudited amounts summarized below as of March 31, 2013 and December 31, 2012:
|
| | | | | | | |
| Change in life expectancy |
(Amounts in Thousands) | Plus 4 Months | | Minus 4 Months |
Investment in life policies: | |
| | |
|
March 31, 2013 | $ | (27,495 | ) | | $ | 29,401 |
|
December 31, 2012 | $ | (27,160 | ) | | $ | 29,285 |
|
|
| | | | | | | |
| Change in discount rate |
(Amounts in Thousands) | Plus 1% | | Minus 1% |
Investment in life policies: | |
| | |
|
March 31, 2013 | $ | (17,743 | ) | | $ | 20,088 |
|
December 31, 2012 | $ | (17,591 | ) | | $ | 19,926 |
|
| |
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 National General Holdings Corp. ("NGHC"), which changed its name from American Capital Acquisition Corporation, or ACAC, in April 2013, for the purposes of acquiring life settlement contracts. In 2011, the Company formed AMT Capital Alpha, LLC (“AMT Alpha”) with a subsidiary of NGHC and AMT Capital Holdings, S.A. (“AMTCH”) with ACP Re, Ltd., an entity controlled by the Michael Karfunkel 2005 Grantor Retained Annuity Trust, for the purposes of acquiring additional life settlement contracts. The Company has a 50% 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. The third party administrator is eligible to receive a percentage of profits after certain time and performance thresholds have been met. The Company provides certain actuarial and finance functions related to the LSC entities. Additionally, in conjunction with the Company’s 21.25% ownership percentage of NGHC, 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, the Company has been deemed the primary beneficiary and, therefore, consolidates the LSC entities. On March 28, 2013, ACP Re, Ltd. sold its interest in AMTCH to NGHC.
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 $4,397 and $9,855 were made to the LSC entities during the three months ended March 31, 2013 and 2012, respectively, for which the Company contributed approximately $2,188 and $4,927 in those same periods. The LSC entities used the contributed capital to pay premiums on existing policies and premium finance loans. The Company’s investments in life settlements and cash value loans were approximately $199,824 and $193,927 as of March 31, 2013 and December 31, 2012, respectively and are included in Prepaid expenses and other assets on the Consolidated Balance Sheet. The Company recorded a loss on investment in life settlement contracts net of profit commission for the three months ended March 31, 2013 of approximately $1,076 and a gain on investment in life settlement contracts net of profit commission for the three months ended March 31, 2012 of $90, respectively, related to the life settlement contracts.
In addition to the 260 policies disclosed in the table below as of March 31, 2013, Tiger owned 5 premium finance loans as of the three months ended March 31, 2013, which were secured by life insurance policies and were carried at a value of $0. As of March 31, 2013, the face value amount of the related 260 life insurance policies and 5 premium finance loans were approximately $1,683,909 and $0 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 March 31, 2013:
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| | | | | | | | | | |
(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 | 6 |
| | 31,299 |
| | 58,000 |
|
2-3 | 3 |
| | 8,137 |
| | 15,000 |
|
3-4 | 2 |
| | 8,513 |
| | 20,000 |
|
4-5 | 3 |
| | 5,919 |
| | 20,000 |
|
Thereafter | 246 |
| | 145,956 |
| | 1,570,909 |
|
Total | 260 |
| | $ | 199,824 |
| | $ | 1,683,909 |
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(1) | The Company determined the fair value as of March 31, 2013 based on 175 policies out of 260 policies, as the Company assigned no value to 85 of the policies as of March 31, 2013. The Company estimated the fair value of a policy using present value calculations. If the estimate fair value is determined to be less than zero, then no value is assigned to that policy. |
Premiums to be paid for each of the five succeeding fiscal years to keep the life insurance policies in force as of March 31, 2013, are as follows:
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| | | | | | | | | | | |
(Amounts in Thousands) | Premiums Due on Life Settlement Contracts | | Premiums Due on Premium Finance Loans | | Total |
2013 | $ | 28,581 |
| | $ | 500 |
| | $ | 29,081 |
|
2014 | 31,309 |
| | 647 |
| | 31,956 |
|
2015 | 32,472 |
| | 685 |
| | 33,157 |
|
2016 | 50,719 |
| | 793 |
| | 51,512 |
|
2017 | 31,606 |
| | 642 |
| | 32,248 |
|
Thereafter | 520,882 |
| | 8,024 |
| | 528,906 |
|
Total | $ | 695,569 |
| | $ | 11,291 |
| | $ | 706,860 |
|
The Company’s borrowings consisted of the following at March 31, 2013 and December 31, 2012:
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| | | | | | | |
(Amounts in Thousands) | 2013 | | 2012 |
Revolving credit facility | $ | — |
|
| $ | — |
|
Subordinated debentures | 123,714 |
| | 123,714 |
|
Convertible senior notes | 161,941 |
| | 161,218 |
|
Secured loan agreements | 8,790 |
| | 9,041 |
|
Promissory notes | 8,000 |
| | 8,000 |
|
| $ | 302,445 |
| | $ | 301,973 |
|
Aggregate scheduled maturities of the Company’s borrowings at March 31, 2013 are:
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| | | | |
(Amounts in Thousands) | | |
2013 | $ | 770 |
| |
2014 | 1,068 |
| |
2015 | 1,116 |
| |
2016 | 1,167 |
| |
2017 | 1,220 |
| |
Thereafter | 297,104 | (1) |
| |
(1) | Amount reflected in balance sheet for convertible senior notes is net of unamortized original issue discount of $38,059. |
Revolving Credit Agreement
In August 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. Fees associated with the Credit Agreement were approximately $989. 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 March 31, 2013.
As of March 31, 2013, the Company had no outstanding borrowings under this Credit Agreement. The Company had outstanding letters of credit in place under this Credit Agreement at March 31, 2013 for $95,807, which reduced the availability for letters of credit to $4,193 as of March 31, 2013, and the availability under the facility to $104,193 as of March 31, 2013.
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 March 31, 2013 was 2.50%. The Company recorded total interest expense of approximately $560 and $510 for the three months ended March 31, 2013 and 2012, respectively, under revolving credit agreements.
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 March 31, 2013), a letter of credit fronting fee with respect to each letter of credit (.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 March 31, 2013).
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 March 31, 2013 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 $1,999 and $2,191 of interest expense for the three months ended March 31, 2013 and 2012, respectively, related to these trust preferred securities.
The table below summarizes the Company’s trust preferred securities as of March 31, 2013:
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(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 | | 3.580 | (2) |
AmTrust Capital Financing Trust IV | | 40,000 |
| | 1,238 |
| | 41,238 |
| | 3/15/2037 | | 3.280 | (3) |
Total trust preferred securities | | $ | 120,000 |
| | $ | 3,714 |
| | $ | 123,714 |
| | | | |
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(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%. |
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(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.
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 March 31, 2013 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.
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 $3,592 and $3,544 for the three month periods ended March 31, 2013 and 2012, respectively.
The following table shows the amounts recorded for the Notes as of March 31, 2013 and December 31, 2012:
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| | | | | | | |
(Amounts in Thousands) | March 31, 2013 | | December 31, 2012 |
Liability component | |
| | |
|
Outstanding principal | $ | 200,000 |
| | $ | 200,000 |
|
Unamortized OID | (38,059 | ) | | (38,782 | ) |
Liability component | 161,941 |
| | 161,218 |
|
Equity component, net of tax | 27,092 |
| | 27,092 |
|
Secured Loan Agreement
During 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 $101 and $112 for the three months ended March 31, 2013 and 2012, respectively, related to this agreement. The loan is secured by the aircraft.
The agreement contains certain covenants that are similar to the Company’s revolving credit facility. Additionally, subsequent to February 25, 2011, 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 September 2012, as part of its participation in the 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 $97 for the three months ended March 31, 2013 related to the notes. Additionally, the Company recorded approximately $1,430 of deferred financing fees.
Other Letters of Credit
The Company, through one of its subsidiaries, has a secured letter of credit facility with Comerica Bank. 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 $49,634 as of March 31, 2013. The Company is required to pay a letter of credit participation fee for each letter of credit in the amount of 0.40%.
The Company, through certain subsidiaries, has additional existing stand-by letters of credit with various lenders in the amount of $50,132 as of March 31, 2013.
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7. | Acquisition Costs and Other Underwriting Expenses |
The following table summarizes the components of acquisition costs and other underwriting expenses for the three months ended March 31, 2013 and 2012:
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| | | | | | | |
| Three Months Ended March 31, |
(Amounts in Thousands) | 2013 | | 2012 |
Policy acquisition expenses | $ | 101,688 |
| | $ | 85,192 |
|
Salaries and benefits | 45,129 |
| | 35,785 |
|
Other insurance general and administrative expenses | 10,003 |
| | 3,048 |
|
| $ | 156,820 |
| | $ | 124,025 |
|
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.
The Company paid a 10% stock dividend on September 20, 2012. As such, the weighted average number of shares used for basic and diluted earnings per share have been adjusted retroactively in the prior period. The impact on basic and diluted earnings per share was a decrease of $0.06 for the three months ended March 31, 2012.
The following table is a summary of the elements used in calculating basic and diluted earnings per share for the three months ended March 31, 2013 and 2012:
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| | | | | | | |
| Three Months Ended March 31, |
(Amounts in Thousands, except for earnings per share) | 2013 | | 2012 |
Basic earnings per share: | | | |
Net income attributable to AmTrust Financial Services, Inc. shareholders | $ | 64,218 |
|
| $ | 39,086 |
|
Less: Net income allocated to participating securities and redeemable non-controlling interest | 244 |
| | 58 |
|
Net income allocated to AmTrust Financial Services, Inc. common shareholders | $ | 63,974 |
| | $ | 39,028 |
|
| | | |
Weighted average common shares outstanding – basic | 67,297 |
| | 66,455 |
|
Less: Weighted average participating shares outstanding | 256 |
| | 89 |
|
Weighted average common shares outstanding - basic | 67,041 |
| | 66,366 |
|
Net income per AmTrust Financial Services, Inc. common share - basic | $ | 0.95 |
|
| $ | 0.59 |
|
| | | |
Diluted earnings per share: | |
| | |
|
Net income attributable to AmTrust Financial Services, Inc. shareholders | $ | 64,218 |
| | $ | 39,086 |
|
Less: Net income allocated to participating securities and redeemable non-controlling interest | 244 |
| | 58 |
|
Net income allocated to AmTrust Financial Services, Inc. common shareholders | $ | 63,974 |
| | $ | 39,028 |
|
| | | |
Weighted average common shares outstanding – basic | 67,041 |
| | 66,366 |
|
Plus: Dilutive effect of stock options, convertible debt, other | 3,514 |
| | 2,027 |
|
Weighted average common shares outstanding – dilutive | 70,555 |
| | 68,393 |
|
Net income per AmTrust Financial Services, Inc. common shares – diluted | $ | 0.91 |
|
| $ | 0.57 |
|
As of March 31, 2013, there were less than 10,000 anti-dilutive securities excluded from diluted earnings per share.
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9. | Share Based Compensation |
The Company’s 2010 Omnibus Incentive Plan (the “Plan”), which 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, authorizes up to an aggregate of 6,650,062 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 units ("PSU") 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 6,650,062 shares, subject to the autho