American Standard Insurance Company of Wisconsin

Report of the Examination of American Standard Insurance Company of Wisconsin Madison, Wisconsin As of December 31, 2006 TABLE OF CONTENTS Page I. INTRODUCTION .................................................................................................................. 2 II. HISTORY AND PLAN OF OPERATION .............................................................................. 4 III. MANAGEMENT AND CONTROL ........................................................................................ 6 IV. AFFILIATED COMPANIES .................................................................................................. 8 V. REINSURANCE ................................................................................................................. 14 VI. FINANCIAL DATA .............................................................................................................. 15 VII. SUMMARY OF EXAMINATION RESULTS ....................................................................... 23 VIII. CONCLUSION.................................................................................................................... 26 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS.............................................. 27 X. ACKNOWLEDGMENT ....................................................................................................... 28 State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE Jim Doyle, Governor Sean Dilweg, Commissioner Wisconsin.gov September 28, 2007 125 South Webster Street • P.O. Box 7873 Madison, Wisconsin 53707-7873 Phone: (608) 266-3585 • Fax: (608) 266-9935 E-Mail: information@oci.state.wi.us Web Address: oci.wi.gov Honorable Sean Dilweg Commissioner of Insurance State of Wisconsin 125 South Webster Street Madison, Wisconsin 53703 Honorable Alfred W. Gross Chair, Financial Condition (E) Committee, NAIC Commissioner of Insurance Commonwealth of Virginia 1300 East Main Street Richmond, Virginia 23219 Honorable Merle Scheiber Secretary, Midwestern Zone, NAIC Director of Insurance State of South Dakota 445 East Capitol Avenue Pierre, South Dakota 57501-3185 Honorable Morris J. Chavez Secretary, Western Zone, NAIC Superintendent of Insurance State of New Mexico 1120 Paseo de Paralta Santa Fe, New Mexico 87504 Commissioners: In accordance with the instructions of the Wisconsin Commissioner of Insurance, a compliance examination has been made of the affairs and financial condition of: AMERICAN STANDARD INSURANCE COMPANY OF WISCONSIN Madison, Wisconsin and this report is respectfully submitted. I. INTRODUCTION The previous examination of American Standard Insurance Company of Wisconsin (hereinafter also the company or ASIC) was conducted in 2002 as of December 31, 2001. The current examination covered the intervening period ending December 31, 2006, and included a review of such 2007 transactions as deemed necessary to complete the examination. The examination consisted of a review of all major phases of the company's operations and included the following areas: History Management and Control Corporate Records Conflict of Interest Fidelity Bonds and Other Insurance Employees' Welfare and Pension Plans Territory and Plan of Operations Affiliated Companies Growth of Company Reinsurance Financial Statements Accounts and Records Data Processing Emphasis was placed on the audit of those areas of the company's operations accorded a high priority by the examiner-in-charge when planning the examination. Special attention was given to the action taken by the company to satisfy the recommendations and comments made in the previous examination report. The company is annually audited by an independent public accounting firm as prescribed by s. Ins 50.05, Wis. Adm. Code. An integral part of this compliance examination was the review of the independent accountant's work papers. Based on the results of the review of these work papers, alternative or additional examination steps deemed necessary for the completion of this examination were performed. The examination work papers contain documentation with respect to the alternative or additional examination steps performed during the course of the examination. Independent Actuary's Review ASIC cedes 100% of its direct writings to American Family Mutual Insurance Company (hereinafter also AFMIC), which is described further in section V of this report titled 2 “Reinsurance.” Independent actuaries were engaged under a contract with the Office of the Commissioner of Insurance for the examination of AFMIC. Their review covered the adequacy of the company’s loss reserves and loss adjustment expense reserves of AFMIC, which includes the assumed loss reserves from ASIC. The results of their work were reported to the examiner-in-charge. As deemed appropriate, reference is made in this report to the actuaries' conclusion. 3 II. HISTORY AND PLAN OF OPERATION American Standard Insurance Company of Wisconsin is a stock property and casualty insurer, organized in 1961 under the provisions of ch. 611, Wis. Stat., as the American Standard Insurance Company. The company changed its name to that presently used effective in 1962. ASIC is a wholly owned subsidiary of American Family Mutual Insurance Company through its downstream holding company, AmFam, Incorporated. Collectively AFMIC and subsidiaries are known as the American Family Mutual Insurance Group. The company is currently licensed in twenty-three states. During the 5-year period under examination the company obtained a license to write business in Wyoming during 2005 and commenced writing business in Washington in 2006. In 2006, the company wrote business in 17 of the 23 jurisdictions in which it was licensed. The distribution of direct premiums written in 2006 by state was as follows: Wisconsin Missouri Arizona Colorado Kansas Indiana Illinois All others Total $ 92,385,916 84,509,422 63,290,278 61,389,691 43,181,420 37,042,659 35,230,584 118,983,707 $536,013,677 17.2% 15.8 11.8 11.5 8.1 6.9 6.5 22.2 100.0% The company is currently licensed in the following states: Arizona Illinois Kansas Montana New Mexico Ohio South Dakota Wisconsin Colorado Indiana Minnesota Nebraska North Carolina Oregon Utah Wyoming Idaho Iowa Missouri Nevada North Dakota South Carolina Washington In the state of Wisconsin, the company is licensed to transact the following lines of business as defined by s. Ins 6.75 (2), Wis. Adm. Code: (a) Fire, Inland Marine, and Other Property (b) Ocean Marine (d) Liability and Non Auto Incidental Medical Expense (e) Automobile and Aircraft (n) Miscellaneous 4 ASIC is limited to providing insurance for motorcycles and for nonstandard private passenger automobile risks. ASIC’s direct writings are 100% ceded to AFMIC, which is further described in section V of this report titled “Reinsurance.” Marketing of the company’s products is accomplished through AFMIC’s general agency network. The following table is a summary of the net insurance premiums written by the company in 2006. The growth of the company is discussed in the “Financial Data” section of this report. Direct Premium Reinsurance Assumed Reinsurance Ceded Net Premium Line of Business Private passenger auto liability Commercial auto liability Auto physical damage Total All Lines $344,638,278 756 191,374,643 $536,013,677 $0 0 0 $0 $344,638,278 756 191,374,643 $536,013,677 $0 0 0 $0 5 III. MANAGEMENT AND CONTROL Board of Directors The board of directors consists of eight members who are elected annually, each of whom is an officer of AFMIC. Officers are elected at the annual board meetings and are to hold those positions until the earlier of their resignation or removal by the board of directors. As inside directors, they receive no additional compensation for serving on the board. Currently the board of directors consists of the following persons: Name and Residence David Ralph Anderson Madison, WI Vicki Lee Chvala Madison, WI James Francis Eldridge Sun Prairie, WI Bradley James Gleason Deerfield, WI Alan Edward Meyer Verona, WI Darnell Moore Madison, WI Jack Charles Salzwedel Waunakee, WI Daniel Robert Schultz Monona, WI Principal Occupation Chairman and Chief Executive Officer of the American Family Mutual Insurance Group Executive Vice President of the American Family Mutual Insurance Group Secretary and Chief Legal Officer of the American Family Mutual Insurance Group Executive Vice President of the American Family Mutual Insurance Group Executive Vice President of the American Family Mutual Insurance Group Executive Vice President of the American Family Mutual Insurance Group President and Chief Operations Officer of the American Family Mutual Insurance Group Treasurer and Chief Financial Officer of the American Family Mutual Insurance Group Term Expires 2008 2008 2008 2008 2008 2008 2008 2008 6 Officers of the Company The officers appointed by the board of directors and serving at the time of this examination are listed below. Listed compensation is total gross earnings for services rendered to the American Family Mutual Insurance Group and includes amounts allocated to all affiliates. Name David Ralph Anderson Jack Charles Salzwedel James Francis Eldridge Daniel Robert Schultz Vicki Lee Chvala Bradley James Gleason Alan Edward Meyer Darnell Moore Kari Elizabeth Grasee Thomas Syme King James Walter Behrens Ann Marie Demerath Committees of the Board Office Chairman and Chief Executive Officer President and Chief Operations Officer Secretary and Chief Legal Officer Treasurer and Chief Financial Officer Executive Vice President Executive Vice President Executive Vice President Executive Vice President Vice President, Controller Vice President, Investments Assistant Secretary Assistant Treasurer 2006 Compensatio n $2,035,621 835,571 1,028,169 653,182 892,983 587,761 803,289 1,030,543 210,183 776,418 248,259 158,126 Article III, Section 7, of the company's bylaws allow for the formation of certain committees by the board of directors. There were no committees appointed by the board at the time of the examination. The committees of the ultimate controlling party, AFMIC, govern the company. 7 IV. AFFILIATED COMPANIES American Standard Insurance Company of Wisconsin is a member of a holding company system referred to as the “American Family Mutual Insurance Group.” The organizational chart below depicts the relationships among the affiliates in the group. A brief description of the affiliates follows the organizational chart. Organizational Chart As of December 31, 2006 American Family Mutual Insurance Company American Family Securities, LLC AmFam, Incorporated American Family Brokerage, Incorporated American Family Life Insurance Company American Standard Insurance Company of Wisconsin American Family Financial Services, Incorporated American Family Insurance Company American Standard Insurance Company of Ohio American Family Mutual Insurance Company American Family Mutual Insurance Company is the parent of the holding company system referenced above. AFMIC was organized in 1927 and writes primarily auto and homeowner’s coverage in 18 states. AFMIC assumes 100% of the business written by its downstream property and casualty subsidiaries including ASIC, which will be described in section V of this report titled “Reinsurance.” As of December 31, 2006, AFMIC reported assets of $11,009,904,394, liabilities of $6,818,334,833, and policyholders’ surplus of $4,191,569,561. Operations for 2006 produced a net loss of $103,568,663. AFMIC was examined concurrently with the ASIC examination. The results of that examination are described in a separate report. AmFam, Incorporated AmFam, Incorporated, was incorporated in 1981 to serve as a downstream holding company for the American Family Mutual Insurance Group. As of December 31, 2006, the company’s consolidated GAAP basis audited financial statement reported assets of 8 $5,569,851,000, liabilities of $4,417,535,000 and stockholder’s equity of $1,152,316,000. Of that amount, all but approximately $18,950,000 was derived from the value of its insurance subsidiaries. American Family Brokerage, Incorporated American Family Brokerage, Incorporated, was incorporated in 1985 as an insurance agency and operates within the same states as its parent, AFMIC. Its primary objective is to assist American Family agents in securing coverage for their clients when the coverage or limits are not available through the American Family Mutual Insurance Group. As of December 31, 2006, the company’s GAAP basis audited financial statement reported assets of $3,961,000, liabilities of $2,449,000, and stockholder’s equity of $1,512,000. Operations for 2006 produced a net income of $982,000. American Family Securities, LLC American Family Securities, LLC, (hereinafter also AFS) was incorporated on July 14, 2000, with a capital contribution of $250,000 from AFMIC, as a limited liability company whose sole member is AFMIC. AFS, a non-clearing, registered broker dealer, is the principal underwriter for American Family Life Insurance Company’s (hereinafter also AFLIC) variable life and annuity products. On March 23, 2001, AFS was admitted into the National Association of Securities Dealers (NASD) to sell AFLIC’s variable products. As of December 31, 2006, the company’s GAAP basis audited financial statement reported assets of $292,000, liabilities of $5,000 and member’s equity of $287,000. Operations for 2006 produced a net income of $9,000. American Family Financial Services, Incorporated American Family Financial Services, Incorporated, (hereinafter also AFFS) was acquired by American Family Mutual Insurance Group in 1969. Its original business purpose was to provide direct loans and leases, primarily to policyholders, through AFMIC's multi-line exclusive agency force. However, during the period under examination AFFS’s business environment has changed and so has its purpose. The company has been making fewer loans to policyholders. This was due to the fact that other lenders (banks, credit unions, etc.) could offer lower lending rates than AFFS because they have a lower cost of money. AFFS’s borrowing costs, derived 9 primarily from the issuance of commercial paper and a demand note, is considerably higher than banks which use checking, savings and certificate of deposit accounts to fund loans. At the same time AFFS expanded its lending to its exclusive agency force, since its agents found it hard to borrow money from other lenders due to their commission-based compensation. These trends are evident when comparing the commercial mortgage loan receivable balance as a ratio to total loans outstanding at year-end 2001 to year-end 2006, which was 7.9% and 35.7%, respectively. At year-end 2006 approximately 80% of AFFS’s commercial mortgage loans were to its agents. As noted above, AFFS finances its loan portfolio primarily through the sale of commercial paper. AFMIC has agreed to guarantee the debt of AFFS, in order to allow the company to receive the best possible interest rates. In 1998 the board of directors of AFMIC authorized an increase in the guarantee limit to $375 million, as approved by this office. As of December 31, 2006, AFFS outstanding guaranteed debt totaled $79,973,206. In addition, AFMIC, ASIC, and AFLIC may lend AFFS additional funds through the use of short-term notes not to exceed at any one time $100,000,000, $10,000,000 and $20,000,000, respectively, as approved by this office. At December 31, 2006, there were no outstanding short-term notes issued by AFFS owed to an affiliate. As of December 31, 2006, the company’s GAAP basis audited financial statement reported assets of $160,215,000, liabilities of $141,526,000, and stockholder’s equity of $18,689,000. Operations for 2006 produced net loss of $43,000. As of November 1, 2007, AFFS has discontinued writing new loans of any kind and is considering various options for the servicing and run-off of its existing loan portfolio. American Family Life Insurance Company American Family Life Insurance Company was incorporated in 1957. The company is currently licensed in 26 states and writes primarily ordinary life insurance products, including traditional, universal life and to a lesser extent variable universal life and annuities. As of December 31, 2006, AFLIC reported assets of $3,685,060,233, liabilities of $3,252,832,866 (both amounts include $179,738,716 from separate accounts), and surplus of $432,227,367. 10 Operations for 2006 produced net income of $61,131,953. AFLIC was examined concurrently with the AFMIC examination. The results of the examination are described within a separate report. American Family Insurance Company American Family Insurance Company (hereinafter also AFIC) was incorporated in Ohio in 1995 and writes business only in that state. AFIC was founded for the purposes of operating efficiencies and state tax savings. AFIC cedes 100% of its direct writings to AFMIC under a quota share agreement approved by this office. AFIC writes lines of business identical to American Family Mutual Insurance Company and markets its business through AFMIC’s agents. As of December 31, 2006, AFIC reported assets of $73,695,175, liabilities of $62,659,779 and surplus of $11,035,396. Operations for 2006 produced net income of $996,245. AFIC was examined concurrently with AFMIC as of December 31, 2006, and the results of that examination were expressed in a separate report issued by the Ohio Department of Insurance. American Standard Insurance Company of Ohio American Standard Insurance Company of Ohio (hereinafter also ASICO) was incorporated in 1995 and writes business only in Ohio. ASICO was founded for the purposes of operating efficiencies and state tax savings. ASICO writes lines of business identical to ASIC’s and cedes 100% of these direct writings to AFMIC under a quota share agreement approved by this office. Insurance is sold through AFMIC’s agents. As of December 31, 2006, ASICO reported assets of $17,113,493, liabilities of $11,373,899 and surplus of $5,739,594. Operations for 2006 produced a net income of $360,817. ASICO was examined concurrently with AFMIC as of December 31, 2006, and the results of that examination were expressed in a separate report issued by the Ohio Department of Insurance. Agreements with Affiliates ASIC has no employees of its own and all of its operations are conducted by employees of AFMIC, in accordance with the business practices and internal controls of that organization. In addition to ongoing common management and control by this upstream affiliate, various written agreements and undertakings affect the company’s relationship to its affiliates. 11 The affiliated reinsurance agreement between ASIC and AFMIC are described in section V of the report titled “Reinsurance.” A brief summary of the other agreements follows: Effective December 12, 1995, AFMIC developed an inter-company cost allocation agreement for the reimbursement of expenses paid by AFMIC on behalf of its affiliates. Allocated cost is based on the actual cost of providing the service multiplied by the affiliate’s proportionate share of the benefit conferred. All cost allocations are determined by the group’s Controller Division and are considered final. All parties to this agreement are allowed to express their opinion to the group’s Controller Division of the allocation affecting each of them and the Controller Division is to consider such opinions carefully in determining cost allocation. In connection with the affiliated quota share reinsurance agreements as described in section V of this report titled “Reinsurance,” AFMIC (hereinafter also Buyer) and ASIC (hereinafter also Seller) entered into an agreement for the sale of its premiums receivable. This contract was approved by this office and became effective on January 1, 2000. Under the terms of this agreement, the Buyer agrees to purchase the Seller’s premiums receivable at the end of the month, with no discount, beginning January 2000. Settlements are to be made within five days of the transfer. The motivation for the sale of premiums receivable by the Seller was that the routine intercompany balances were becoming so large that it could not settle them with AFMIC by using only its short-term investments, and ASIC did not want to liquidate its long-term investments to settle intercompany accounts. Effective April 29, 2002, AFMIC and its affiliates entered into a restated tax allocation agreement for the purpose of filing federal income tax returns on a consolidated basis. Under this agreement, AFMIC prepares and files a consolidated U.S. federal income tax return that includes all affiliates of the holding company group. The agreement sets forth the rights and obligations of the parties to the agreement with respect to the determination and settlement of federal income tax liabilities as well as the allocation of American Family Mutual Insurance Group’s consolidated U.S federal income tax liability and tax benefits in accordance with a rational, systematic formula. The agreement provides for computation of tax, settlement of balances between affiliates, tax sharing, filing the return, audits and other adjustments, and other administrative requirements. The 12 agreement calls for the settling of estimated U.S. federal tax payments within 30 days of filing of those payments. Final settlement is due within 30 days of the filing of the consolidated U.S. federal tax return. The agreement has a provision for members entering or departing the group and provides for successors. 13 V. REINSURANCE As noted in the “History and Plan of Operation” section, ASIC cedes 100% of its direct writings to AFMIC. This arrangement is represented by a signed contract, which includes all necessary provisions and a proper insolvency clause. Effective October 1, 1999, the contract was restated and signed by both parties due to changes made to its reporting, settlement and insolvency provisions. In 2006, this business represents approximately 9% of AFMIC’s gross written premium. ASIC’s business writings are primarily nonstandard personal lines automobile business. In connection with the affiliated reinsurance agreement, AFMIC and ASIC entered into an agreement for the sale of ASIC’s premium receivable, which was described in section IV of this report titled “Affiliated Companies.” 14 VI. FINANCIAL DATA The following financial statements reflect the financial condition of the company as reported to the Commissioner of Insurance in the December 31, 2006, annual statement. Also included in this section are schedules that reflect the growth of the company, NAIC Insurance Regulatory Information System (IRIS) ratio results for the period under examination, and the compulsory and security surplus calculation. Adjustments made as a result of the examination are noted at the end of this section in the area captioned "Reconciliation of Surplus per Examination." 15 American Standard Insurance Company of Wisconsin Assets As of December 31, 2006 Net Admitted Assets $263,978,691 31,789,288 31,903 3,982,321 Assets Bonds Cash, cash equivalents, and shortterm investments Receivables for securities Investment income due and accrued Premiums and considerations: Deferred premiums, agents' balances, and installments booked but deferred and not yet due Reinsurance: Amounts recoverable from reinsurers Guaranty funds receivable or on deposit Receivable from parent, subsidiaries, and affiliates Write-ins for other than invested assets: Miscellaneous receivables Total Assets $263,978,691 31,789,288 31,903 3,982,321 Nonadmitted Assets $0 0 0 0 (5,612,141) 0 (5,612,141) 25,355,113 10 35,686,808 0 0 0 25,355,113 10 35,686,808 5,401 $355,217,394 0 $0 5,401 $355,217,394 16 American Standard Insurance Company of Wisconsin Liabilities, Surplus, and Other Funds As of December 31, 2006 Other expenses (excluding taxes, licenses, and fees) Taxes, licenses, and fees (excluding federal and foreign income taxes) Net deferred tax liability Advance premium Ceded reinsurance premiums payable (net of ceding commissions) Amounts withheld or retained by company for account of others Remittances and items not allocated Drafts outstanding Payable to parent, subsidiaries, and affiliates Write-ins for liabilities: All other liabilities Total liabilities Common capital stock Gross paid in and contributed surplus Unassigned funds (surplus) Surplus as regards policyholders Total Liabilities and Surplus $ 3,000,000 3,000,000 232,598,476 238,598,476 $355,217,394 $ 173,474 799,831 251,368 1,132,966 22,064,633 10,809 (8,813) 57,919,252 32,112,970 2,162,428 116,618,918 17 American Standard Insurance Company of Wisconsin Summary of Operations For the Year 2006 Investment Income Net investment income earned Net realized capital gains (losses) Net investment gain (loss) Net income (loss) before federal and foreign income taxes Federal and foreign income taxes incurred Net Income $12,488,088 (40,017) $12,448,071 12,448,071 680,181 $11,767,890 American Standard Insurance Company of Wisconsin Cash Flow For the Year 2006 Premiums collected net of reinsurance Net investment income Total Benefit- and loss-related payments Commissions, expenses paid, and aggregate write-ins for deductions Federal and foreign income taxes paid (recovered) Total deductions Net cash from operations Proceeds from investments sold, matured, or repaid: Bonds Total investment proceeds Cost of investments acquired (long-term only): Bonds Miscellaneous applications Total investments acquired Net cash from investments Cash from financing and miscellaneous sources: Other cash provided (applied) Net cash from financing and miscellaneous sources Reconciliation: Net change in cash, cash equivalents, and short-term investments Cash, cash equivalents, and short-term investments: Beginning of year End of Year $(3,335,728) 13,248,265 9,912,537 $(1,402,385) (389,267) 680,181 (1,111,471) 11,024,008 $14,421,599 14,421,599 5,998,594 29,978 6,028,572 8,393,027 (1,715,714) (1,715,714) 17,701,321 14,087,965 $31,789,286 18 American Standard Insurance Company of Wisconsin Compulsory and Security Surplus Calculation December 31, 2006 Assets Less security surplus of insurance subsidiaries Less liabilities Adjusted surplus Annual premium: Lines other than accident and health Factor Compulsory surplus (subject to a minimum of $2 million) Compulsory Surplus Excess (or Deficit) $355,217,394 0 116,618,918 238,598,476 $ 0 20% 2,000,000 $236,598,476 Adjusted surplus (from above) Security surplus: (140% of compulsory surplus, factor reduced 1% for each $33 million in premium written in excess of $10 million, with a minimum factor of 110%) Security Surplus Excess (or Deficit) $238,598,476 2,800,000 $235,798,476 19 American Standard Insurance Company of Wisconsin Reconciliation and Analysis of Surplus For the Five-Year Period Ending December 31, 2006 The following schedule is a reconciliation of total surplus during the period under examination as reported by the company in its filed annual statements: 2006 Surplus, beginning of year Net income Change in net deferred income tax Change in nonadmitted assets Surplus, End of Year 2005 2004 2003 2002 $226,835,581 11,767,890 (4,995) 0 $238,598,476 $215,145,375 11,702,747 (12,541) 0 $226,835,581 $203,832,770 11,478,507 (362,518) 196,616 $215,145,375 $193,098,163 10,774,999 159,607 (200,000) $203,832,770 $182,702,844 10,126,371 255,837 13,111 $193,098,163 American Standard Insurance Company of Wisconsin Insurance Regulatory Information System For the Five-Year Period Ending December 31, 2006 The company’s NAIC Insurance Regulatory Information System (IRIS) results for the period under examination are summarized below. There were no unusual results. Ratio #1 #2 #3 #4 #5 #6 #7 #8 #9 #10 #11 #12 #13 Gross Premium to Surplus Net Premium to Surplus Change in Net Premiums Written Surplus Aid to Surplus Two-Year Overall Operating Ratio Investment Yield Gross Change in Surplus Net Change in Adjusted Surplus (established in 2005) Liabilities to Liquid Assets Agents’ Balances to Surplus One-Year Reserve Development to Surplus Two-Year Reserve Development to Surplus Estimated Current Reserve Deficiency to Surplus 2006 225% 0 0 0 0 4.3 5 5 41 0 0 0 0 2005 256% 0 0 0 0 4.4 5 5 45 0 0 0 0 2004 298% 0 0 0 0 4.5 6 0 52 0 0 0 0 2003 326% 0 0 0 0 4.9 6 0 56 0 0 0 0 2002 323% 0 0 0 0 5.0 6 0 58 0 0 0 0 20 Growth of American Standard Insurance Company of Wisconsin Surplus As Regards Policyholders $238,598,476 226,835,581 215,145,375 203,832,769 193,098,162 182,702,844 Year 2006 2005 2004 2003 2002 2001 Admitted Assets $355,217,394 354,031,844 353,211,962 333,402,455 328,509,934 274,546,561 Liabilities $116,618,918 127,196,263 138,066,587 129,569,686 135,411,773 91,843,717 Net Income $11,767,890 11,702,747 11,478,507 10,774,999 10,126,371 10,068,872 Year 2006 2005 2004 2003 2002 2001 Gross Liability Premium Written Gross Liability Losses Paid Gross Liability Loss Percentage 66.9% 67.9 64.5 62.1 61.7 64.0 Gross Property Premium Written Gross Property Losses Paid Gross Property Loss Percentage 61.8% 54.8 55.2 58.4 62.0 72.8 $344,639,034 $230,503,999 368,877,097 250,589,315 400,562,856 258,540,749 410,570,865 255,001,140 389,432,711 240,103,722 319,886,189 204,622,477 $191,374,643 $118,348,800 211,881,353 115,995,213 240,818,735 132,910,106 253,022,283 147,774,234 234,367,631 145,351,008 194,252,296 141,368,153 As previously discussed in section V of this report titled “Reinsurance,” ASIC cedes 100% of its writings to AFMIC and therefore doesn’t have a net underwriting gain or loss. The company has experienced surplus growth over the past five years of 30.6% and is primarily attributable to a steady increase in investment gains over this period. Gross premium growth was significant during 2002 and 2003; however in 2004, 2005 and 2006 premium writings have been in decline and is primarily due to fairly soft market conditions for personal line property casualty insurers, which caused competition to be strong and left very little room for companies to achieve market share growth. The table above shows above average gross loss percentages relating to the catastrophe wind and hail storms that hit the group’s main area of operation during 2001 and 2006. 21 Reconciliation of Surplus per Examination No adjustments were made to surplus as a result of the examination. The amount of surplus of $238,598,476 reported by the company as of December 31, 2006, is accepted. Examination Reclassifications Debit Deferred premiums agents’ balances and installments booked but deferred and not yet due Ceded reinsurance premiums payable Credit $5,612,141 $ 5,612,141 22 VII. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations There were six specific comments and recommendations in the previous examination report. Comments and recommendations contained in the last examination report and actions taken by the company are as follows: 1. Financial Reporting – Schedule Y—It is recommended that the company report in Schedule Y of its statutory annual statements all transactions among affiliates relating to the cost-sharing and income tax allocation agreements in compliance with s. Ins 40.03 (5), Wis. Adm. Code. Action—Compliance 2. Affiliated Balances—It is recommended that the company report all affiliated reinsurance transactions on Schedule F and the appropriate lines on the balance sheet as prescribed by the NAIC Annual Statement Instructions – Property and Casualty. Action—Compliance 3. Invested Assets—It is recommended that the company amend the custodial agreement to include the language recommended by the NAIC’s Financial Condition Examiners Handbook, to replace references to Midwest Securities with the current trust company, and to replace the custodian with the current one. Action—Compliance 4. Remittances and Items not Allocated—It is recommended that the company comply with the NAIC’s Accounting Practices and Procedures Manual SSAPs 53 and 67 and the NAIC’s Annual Statement Instructions – Property and Casualty for the reporting of Remittances and Items not Allocated. Action—Compliance 5. Amounts Withheld or Retained by Company for Account of Others—It is recommended that the company comply with the NAIC’s Accounting Practices and Procedures Manual SSAP 67 and the NAIC’s Annual Statement Instructions – Property and Casualty for the reporting of cash receipts that cannot be identified for a specific purpose. Action—Compliance 6. Advance Premium Accounting—It is recommended that the company record only the portion of the premium actually received as advance premium in compliance with the NAIC’s Accounting Practices and Procedures Manual SSAPs 6 and 53. Action—Compliance 23 Summary of Current Examination Results This section contains comments and elaboration on those areas where adverse findings were noted or where unusual situations existed. Comment on the remaining areas of the company's operations is contained in the examination work papers. Affiliated Agreements Each of AFMIC's subsidiary companies, including ASIC, do not have any employees; all day-to-day operations are performed by AFMIC's employees as described in section IV of this report titled “Affiliated Companies.” It was discovered during the review of the group's affiliated agreements that there were no service agreements executed by each of the affiliate’s boards allowing for or authorizing the delegation of duties to AFMIC in regards to their day-to-day operations in accordance with s. 611.67 (2), Wis. Stat. The group does establish a fair allocation of expenses between affiliates, including those expenses created by services provided by AFMIC on behalf of its affiliates, through an affiliated cost sharing agreement, which was not disapproved by this office. It is recommended that the company create and execute a service agreement with its ultimate parent company that describes the delegation of its board's management authority over day-to-day operations in accordance with s. 611.67 (2), Wis. Stat. Deferred Premiums, Agents’ Balances and Installments Booked but Deferred and Not Yet Due The company originally reported a negative deferred premium balance (credit balance) of $5,612,141 on line 13.2 “Deferred premiums, agents’ balances and installments booked but deferred and not yet due” of the asset side of the balance sheet, in its 2006 Annual Statement. The balance reported reflects the change in the amount of premiums receivable from the previous month that is to be sold to AFMIC under the premiums receivable sales agreement that was created in connection with the affiliated quota share reinsurance agreement as discussed in sections IV and V of this report titled “Affiliated Companies” and “Reinsurance,” respectively. According to the NAIC Annual Statement Instructions-Property & Casualty, line 13.2 of the asset side of the balance sheet is to exclude all ceded reinsurance balances payable. SSAP No. 62, paragraph 42, describes that ceded reinsurance premiums payable shall be $0 24 classified as a liability. According to the NAIC Annual Statement Instructions-Property & Casualty, Line 12 “Ceded reinsurance premiums payable” of the liability side of the balance sheet is to contain "Reinsurance premiums associated with those in course of payment, premium installments booked but deferred and not yet due and accrued retrospective ceded premiums." It is this office’s understanding that the balance in question more closely relates to being a premium ceded reinsurance liability and therefore the company is not in compliance with the Annual Statement Instructions. It is recommended that the company report its balance relating to the sale of its premiums receivable as ceded reinsurance premiums payable in accordance with NAIC Annual Statement Instructions-Property & Casualty. Ceded Reinsurance Premiums Payable $27,676,774 As a result of the examination, the above balance was increased from $22,064,633 to $27,676,774 as a result of the reclassification described above under the heading, “Deferred Premiums, Agents; Balances and Installments Booked but Deferred and Not Yet Due.” 25 VIII. CONCLUSION Reported policyholders’ surplus has increased from $182,702,844 as of year-end 2001 to $238,598,476 as of year-end 2006. This represents an increase of 30.6% during the period under examination. Gross premium growth was fairly significant in 2002 and 2003; however, in the last three years premium writings have declined due to soft market conditions for personal line property and casualty insurers. All of the company’s business writings are ceded to AFMIC, the ultimate controlling entity of the holding company structure, under a 100% Quota Share reinsurance agreement; therefore, no underwriting gain or loss is recorded by ASIC. Operating earnings were profitable for the period under examination due to steady investment income. The examination of American Standard Insurance Company of Wisconsin resulted in two recommendations, none of which were repeat recommendations, no adjustments to surplus, and one reclassification of account balances. The examination recommendations pertain to not having a formal written service agreement with its ultimate parent company for services provided and annual statement reporting guidelines in regard to ceded reinsurance premiums payable, which resulted in the reclassification of $5,612,141 from “Deferred premiums, agents’ balances and installments booked but deferred and not yet due” to the aforementioned balance sheet line. 26 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 24 - Affiliated Agreements—It is recommended that the company create and execute a service agreement with its ultimate parent company that describes the delegation of its board's management authority over day-to-day operations in accordance with s. 611.67 (2), Wis. Stat. Page 25 - Deferred Premiums, Agents; Balances and Installments Booked but Deferred and Not Yet Due—It is recommended that the company report its balance relating to the sale of its premiums receivable as ceded reinsurance premiums payable in accordance with NAIC Annual Statement InstructionsProperty & Casualty. 2. 27 X. ACKNOWLEDGMENT The courtesy and cooperation extended during the course of the examination by the officers and employees of the company are acknowledged. In addition to the undersigned, the following representatives of the Office of the Commissioner of Insurance, State of Wisconsin, participated in the examination: Name Rick H. Anderson Jerry C. DeArmond Andy M. Fell David A. Grinnell Thomas R. Houston Randy F. Milquet Frederick H. Thornton Title Insurance Financial Examiner Insurance Financial Examiner Advanced Loss Reserve Specialist Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner Advanced Data Processing Audit Specialist Insurance Financial Examiner Advanced Exam Planning & Quality Control Specialist Respectfully submitted, John E. Litweiler Examiner-in-Charge 28