Esurance Insurance Company

Report of the Examination of Esurance Insurance Company San Francisco, California As of December 31, 2007 TABLE OF CONTENTS Page I. INTRODUCTION ............................................................................................................... 2 II. HISTORY AND PLAN OF OPERATION ........................................................................... 4 III. MANAGEMENT AND CONTROL ..................................................................................... 7 IV. AFFILIATED COMPANIES ............................................................................................... 9 V. REINSURANCE .............................................................................................................. 21 VI. FINANCIAL DATA ........................................................................................................... 26 VII. SUMMARY OF EXAMINATION RESULTS .................................................................... 37 VIII. CONCLUSION................................................................................................................. 45 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS........................................... 46 X. ACKNOWLEDGMENT .................................................................................................... 47 State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE Jim Doyle, Governor Sean Dilweg, Commissioner Wisconsin.gov September 19, 2008 125 South Webster Street • P.O. Box 7873 Madison, Wisconsin 53707-7873 Phone: (608) 266-3585 • Fax: (608) 266-9935 E-Mail: ociinformation@wisconsin.gov 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 Thomas R. Sullivan Secretary, Northeastern Zone, NAIC Commissioner of Insurance State of Connecticut 153 Market Street Hartford, Connecticut 06103 Honorable Scott H. Richardson Secretary, Southeastern Zone, NAIC Director, Department of Insurance State of South Carolina 1201 Main Street, Suite 1000 Columbia, South Carolina 29201 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: ESURANCE INSURANCE COMPANY San Francisco, California and this report is respectfully submitted. I. INTRODUCTION The previous examination of Esurance Insurance Company (EIC or the company) was conducted in 2004 as of December 31, 2003, by the Oklahoma Department of Insurance. The current examination covered the intervening period ending December 31, 2007, and included a review of such 2008 transactions as deemed necessary to complete the examination. The examination was conducted in accordance with the NAIC Financial Condition Examiners Handbook, which sets forth guidance for planning and performing an examination to evaluate the financial condition and identify prospective risks of an insurer. This approach includes the obtaining of information about the company including corporate governance, the identification and assessment of inherent risks within the company, and the evaluation of system controls and procedures used by the company to mitigate those risks. The examination also included an assessment of the principles used and significant estimates made by management, as well as an evaluation of the overall financial statement presentation and management’s compliance with statutory accounting principles, annual statement instructions, and Wisconsin laws and regulations. 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 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. 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 2 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 An independent actuarial firm was engaged under a contract with the Office of the Commissioner of Insurance. The actuary reviewed the adequacy of the company’s loss and loss adjustment expense reserves. The actuary’s results were reported to the examiner-in-charge. As deemed appropriate, reference is made in this report to the actuary’s conclusion. 3 II. HISTORY AND PLAN OF OPERATION The company was incorporated under the laws of Oklahoma on December 1, 1933, as Tri-State Casualty Insurance Company and commenced business on December 5, 1933. Its initial operation consisted of writing accident liability and worker’s compensation coverages on behalf of zinc mine owners in Ottawa County, Oklahoma. Initial operations were abandoned in 1938. The name of the company was changed to Tri-State Insurance Company on June 9, 1949. The company was part of the CGU Insurance Group from 1990 until June 1, 2001. The company became a part of the insurance holding company system of White Mountains Insurance Group, Ltd., (WMIG) on June 1, 2001, upon the acquisition of the company’s then parent OneBeacon Insurance Group LLC (formerly the US property and casualty insurance operations of CGNU plc). As a result of the acquisition WMIG became the ultimate controlling parent of the company. On August 27, 2002, the company changed its name to the one currently used, Esurance Insurance Company. The company entered into a Stock Purchase Agreement with OneBeacon Insurance Company (OneBeacon), effective October 1, 2003, for the purchase of Esurance Property and Casualty Insurance Company (EPC), a California-domiciled company. In accordance with the Stock Purchase Agreement, EIC purchased all of the issued and outstanding shares of EPC’s common stock from OneBeacon. EPC is recorded on a statutory basis at surplus value. On December 3, 2003, EIC approved a dividend of 100% ownership of its subsidiary, Farmers and Merchants Insurance Company, to its direct parent, OneBeacon. On December 17, 2004, the company was acquired by White Mountains Holdings (Luxembourg) S.a.r.l. (WM Luxembourg) pursuant to a Stock Purchase Agreement by and between OneBeacon and WM Luxembourg. WM Luxembourg then immediately contributed its full stock ownership of the company to Esurance Holdings, Inc., (EHI) an affiliated Delaware holding company owned by WM Luxembourg. The company redomiciled from Oklahoma to Wisconsin on May 18, 2006. On July 31, 2006, Esurance Insurance Company of New Jersey (EICNJ) was purchased by EHI from OneBeacon, pursuant to the Stock Purchase Agreement by and between EHI and OneBeacon 4 dated July 18, 2006. EHI acquired EICNJ in order to gain a tax benefit on its New Jersey writings. Certain tax advantages were afforded companies that were licensed in New Jersey prior to 1984. On November 22, 2006, EICNJ was contributed from EHI to EIC and is recorded on a statutory basis at surplus value. At the same time EIC obtained approval for its redomestication to Wisconsin it agreed to the following Stipulation and Orders: 1. Compulsory surplus is to be the greater of: (a) $3,000,000; or (b) 12.5% of direct premium written plus nonaffiliated assumed premium during the previous 12 months; or (c) 33.3% of net premium written during the previous 12 months. 2. No reinsurance treaty shall be entered with Sirius International Insurance Corporation (PUBL) or any other affiliate domiciled in a jurisdiction outside the United States unless a reinsurance credit trust is established on the company’s behalf and approved by the Commissioner. Certain conditions are to be met for the company to recognize credit for reinsurance ceded. The company is also to obtain and file certain documents with the Commissioner with regard to Sirius International Insurance Corporation (PUBL) or any other affiliate domiciled in a jurisdiction outside the United States with whom the company enters a reinsurance treaty. Other restrictions also apply. In 2007, the company wrote direct premium in the following states: Florida New York Michigan Washington Pennsylvani a New Jersey Colorado Illinois Virginia Ohio All others Total $126,696,376 59,570,987 39,447,854 37,994,878 36,598,350 27,668,624 27,334,013 26,363,820 23,248,297 20,511,498 160,460,065 $585,894,762 21.6% 10.2 6.7 6.5 6.2 4.7 4.7 4.5 4.0 3.5 27.4 100.0% The company is licensed in the District of Columbia and all states except Delaware, Idaho, Massachusetts, Minnesota, New Hampshire, New Mexico, North Carolina and Wyoming. The company markets personal auto insurance through its affiliate, Esurance Insurance Services, Inc., (EISI) pursuant to an Agency Agreement. The Agency Agreement is further discussed in the report under the section titled, “Affiliated Companies.” The target market includes auto owners with a propensity to use the internet and other technology-enhanced 5 distribution channels to purchase insurance and manage their accounts. Coverage is sold to consumers through EISI’s website and over the phone. EIC also uses independent insurance agents that can distribute personal lines insurance products over the internet as well as through traditional insurance channels. Currently, EIC has appointed approximately 604 agents of whom 206 are employed by Esurance Inc. (EInc), a non-insurance affiliate, and 398 are independent agents. Of these agents, 520 are appointed to produce business in Wisconsin. Commissions are settled on a monthly basis. The following table is a summary of the net insurance premiums written by the company in 2007. 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 Auto physical damage Write-ins for other lines of business: Fees recorded as premium Total All Lines $383,593,021 196,448,254 $114,269,204 82,318,688 $423,782,017 236,951,900 $74,080,208 41,815,041 5,853,487 $585,894,762 $196,587,892 $660,733,917 5,853,487 $121,748,736 6 III. MANAGEMENT AND CONTROL Board of Directors The board of directors consists of seven members. Directors are elected at each annual meeting of shareholders to hold office until the next annual meeting. Officers are elected annually by the board of directors. Members of the company's board of directors may also be members of other boards of directors in the holding company group. Directors are also officers of the company, holding positions noted below, and do not receive additional compensation for their service as directors. Currently the board of directors consists of the following persons: Name and Residence Gary C. Tolman, Chairman Mill Valley, California Kerian Bunch Larkspur, California Jonathan D. Adkisson San Rafael, California Christopher M. Henn Corte Madera, California Philip J. Swift Novato, California John C. Swigart McLean, Virginia Wayne A. Sharrah Rocklin, California Principal Occupation President and Chief Executive Officer Term Expires 2009 Secretary and General Counsel 2009 Vice President and Chief Financial Officer 2009 Vice President and Chief Operating Officer 2009 Vice President and Chief Information Officer 2009 Vice President and Chief Marketing Officer 2009 Vice President 2009 7 Officers of the Company The officers serving at the time of this examination are as follows: 2007 Compensatio n $1,430,377 90,134 778,017 816,792 707,639 732,612 492,080 496,106 458,886 335,071 225,808 Name Gary C. Tolman *Kerian Bunch Jonathan D. Adkisson Christopher M. Henn Philip J. Swift John C. Swigart Wayne A. Sharrah Scott A. McCrae David M. Biewer Toby A. Grist Richard G. Warren Office President and Chief Executive Officer Secretary and General Counsel Vice President and Chief Financial Officer Vice President and Chief Operating Officer Vice President and Chief Information Officer Vice President and Chief Marketing Officer Vice President Vice President of Product Management Vice President of Actuarial Vice President and Managing Director of Claims Vice President and Controller * Kerian Bunch was employed July 30, 2007; compensation reflected is based on a partial year. EIC has no employees of its own. Employees providing services to the company and EISI are employed by EInc. EIC has entered an Insurance Management Services Agreement with EInc for services provided. The Insurance Management Services Agreement is further discussed in the report under the section titled, “Affiliated Companies.” The “2007 Compensation” reported above represents total gross compensation paid to each officer by EInc on behalf of the Esurance Group. Committees of the Board The company's bylaws allow for the formation of certain committees by the board of directors; however, the board had not designated any committees at the time of examination. 8 IV. AFFILIATED COMPANIES Esurance Insurance Company is a member of a holding company system in which the ultimate parent is White Mountains Insurance Group, Ltd. The principal businesses of the holding company system are conducted through its property and casualty insurance and reinsurance subsidiaries. The organizational chart below identifies the succession of control directly related to the company as well as other significant affiliates within the group. A brief description of these affiliates follows the organizational chart. Organizational Chart As of December 31, 2007 White Mountains Insurance Group, Ltd. White Mountains Holdings Bermuda Ltd. Lone Tree Insurance Group Ltd. Lone Tree Holdings Ltd. ONEBEACON ESURANCE WHITE MOUNTIANS RE OneBeacon Insurance Company Esurance Holdings (Bermuda) Ltd. White Mountains Reinsurance Company of America Sirius International Insurance Corporation AutoOne Insurance Company WM Alameda (Gibraltar) Limited The Camden Fire Insurance Association Pennsylvania General Insurance Company White Mountains Holdings (Luxembourg) S.a.r.l. White Mountains Inc. OTHER OPERATIONS Esurance Holdings, Inc. White Mountains Advisors LLC Esurance Inc. Esurance Insurance Company Esurance Insurance Services, Inc. Esurance Property and Casualty Insurance Company Esurance Insurance Company of New Jersey 9 White Mountains Insurance Group, Ltd. WMIG was originally formed as a Delaware corporation in 1980 and became a Bermuda company in October 1999. WMIG's corporate headquarters and its registered office are located in Hamilton, Bermuda, and its principal executive office is located in Hannover, New Hampshire. WMIG is a publicly held company and is listed on the New York Stock Exchange under the symbol "WTM." WMIG’s organizational chart refers to four primary segments: OneBeacon Group, Esurance Group, White Mountains Re Group and Other Operations. The following is a summary of operations of each segment: OneBeacon Group The OneBeacon Group consists of OneBeacon Insurance Group, Ltd., an exempted Bermuda limited liability company that owns a family of United States based property and casualty insurance companies, substantially all of which operate in a multi-company pool. This segment offers a wide range of specialty, commercial and personal products and services sold primarily through select independent agents and brokers. Esurance Group The Esurance Group consists of Esurance Holdings, Inc., and its subsidiaries. This segment sells personal auto insurance directly to customers online and through select independent agents. White Mountains Re Group The White Mountains Re Group consists of White Mountains Re Ltd., an exempted Bermuda limited liability company, and its subsidiaries. This segment offers reinsurance capacity for property, casualty, accident and health, agriculture, aviation and space, and certain other exposures on a worldwide basis. This segment also provides reinsurance advisory services, specializing primarily in property and other short-tailed lines of reinsurance. Other Operations Other Operations consists of WMIG and its intermediate holding companies, its wholly owned investment management subsidiary, White Mountains Advisors LLC, its weather risk management business (Galileo), its variable annuity reinsurance business, White Mountains Life Reinsurance (Bermuda) Ltd., as well as the International American Group, Inc., and other various entities not included in the other segments. As of December 31, 2007, the audited consolidated financial statements of WMIG reported assets of $19,105.6 million, liabilities of $13,524.8 million and minority interest of $867.4 million, and shareholders’ equity of $4,713.4 million. Operations for 2007 produced net income of $407.4 million on revenues of $4,733.8 million. 10 White Mountains Holdings Bermuda Ltd. White Mountains Holdings Bermuda Ltd. is a Bermuda-based intermediate holding company within a series of holding companies ultimately controlled by WMIG. Its existence and operations are primarily related to capital management strategies related to WMIG as a whole. As of December 31, 2007, the trial balance of White Mountains Holdings Bermuda Ltd. reported on a stand-alone GAAP basis, with investments in subsidiaries booked under the equity method, assets of $4,975,305,246, liabilities of $809,506 and shareholders’ equity of $4,974,495,739. Operations for 2007 produced stand-alone operating earnings of $15,199,973 on revenues of $16,140,122. Lone Tree Insurance Group Ltd. Lone Tree Insurance Group Ltd. is a Bermuda-based intermediate holding company. Its existence and operation are primarily related to capital management strategies related to WMIG as a whole. As of December 31, 2007, the trial balance of Lone Tree Insurance Group Ltd. reported on a stand-alone GAAP basis, with investments in subsidiaries booked under the equity method, assets of $4,730,015,815, liabilities of $20,000 and shareholders’ equity of $4,729,995,815. Operations for 2007 produced stand-alone operating earnings of $(7,442) on revenues of $731. Lone Tree Holdings Ltd. Lone Tree Holdings Ltd. is a Bermuda-based intermediate holding company that functions as the initial holding company of the reported operating segments within the WMIG series of companies. The top-level holding companies of the primary operational groups of WMIG roll up under Lone Tree Holdings Ltd. The operational groups under Lone Tree Holdings Ltd. include OneBeacon Group, Esurance Group, White Mountains Re Group, and Other Operations. As of December 31, 2007, the trial balance of Lone Tree Holdings Ltd. reported on a stand-alone GAAP basis, with investments in subsidiaries booked under the equity method, assets of $4,982,189,527, liabilities of $(264,981,229) and minority interest of $517,173,035 and shareholders’ equity of $4,729,997,722. Operations for 2007 produced stand-alone operating earnings of $26,195,292 on revenues of $17,445,264. 11 Esurance Holdings (Bermuda) Ltd., WM Alameda (Gibraltar) Limited and White Mountains Holdings (Luxembourg) S.a.r.l. Esurance Holdings (Bermuda) Ltd., WM Alameda (Gibraltar) Limited, and White Mountains Holdings (Luxembourg) S.a.r.l. are all intermediate holding companies within the succession of control of the Esurance Group. Their existence and operation are primarily related to capital management strategies for WMIG as a whole. As of December 31, 2007, the trial balances on a stand-alone GAAP basis, with investments in subsidiaries booked under the equity method were reported as follows: 2007 Financial Position StandAlone Operating Earnings Assets Esurance Holdings (Bermuda) Ltd. WM Alameda (Gibraltar) Limited White Mountains Holdings (Luxembourg) S.a.r.l. White Mountains Inc. $605,324,72 3 605,187,669 Liabilities Shareholders' Equity Revenue $(393,888) - $605,718,611 605,187,669 $196,892 423,743 $1,120,132 1,589,520 605,704,704 517,067 605,187,637 (2,942) (370,380) White Mountains Inc. is the first intermediate holding company above the Esurance Group. White Mountains Inc. has provided funding through capital contributions directly to its subsidiary EHI. As of December 31, 2007, the trial balance of White Mountains Inc. reported on a stand-alone GAAP basis, with investments in subsidiaries booked under the equity method, assets of $238,402,774, liabilities of $(4,878,296) and shareholders’ equity of $243,281,070. Operations for 2007 produced stand-alone operating earnings of $(2,056,363) on revenues of $388,346. Esurance Holdings, Inc. EHI is the parent company of the Esurance Group which is organized into two segments: non-insurance companies who provide services to insurance companies and the insurance companies. EHI is audited annually on a GAAP basis and has been issued a goingconcern qualification since 2004 due to losses from operations and an accumulated deficit which 12 raise substantial doubt as its ability to continue absent parental support. Further discussion of the EHI’s going-concern qualification issued by its CPA is included in the sections of the report titled “Financial Data” and “Summary of Examination Results.” As of December 31, 2007, consolidated audited financial statements of EHI reported assets of $851,137,298, liabilities of $775,561,504 and shareholders’ equity of $75,575,794. Operations for 2007 produced net losses of $72,660,739 on revenues of $182,252,410. Esurance Inc. and Esurance Insurance Services, Inc. EInc is the direct parent of EISI. EInc provides management services and EISI provides agency services for the Esurance Group. Expenses incurred in relation to the production of business including, but not limited to, sales and marketing expenses, personnel, and information technology are all the responsibility of EISI. As of December 31, 2007, management prepared consolidated financial statements on a GAAP basis of EInc reported assets of $82,065,586, liabilities of $49,189,583 and shareholders’ equity of $32,876,003. Operations for 2007 produced net losses of $53,113,011 on revenues of $179,677,007. Esurance Property and Casualty Insurance Company EPC markets personal auto insurance directly to customers online and through select independent agents and is licensed to write business in the District of Columbia and 39 states of the United States. EPC wrote all of its business in California and Minnesota during 2007 and 2006 and ceded 90% of risk written to EIC. As of December 31, 2007, the audited statutory financial statements of EPC reported assets of $88,930,000, liabilities of $63,775,000, and capital and surplus of $25,155,000. Operations for 2007 produced net income of $5,284,000 on premiums earned of $18,731,000. Esurance Insurance Company of New Jersey EICNJ markets personal auto insurance directly to customers online and through select independent agents and is licensed to write business in the District of Columbia and 25 states of the United States. EICNJ began writing business during 2007in New Jersey and ceded 100% of risk written to EIC. As of December 31, 2007, the audited statutory financial 13 statements of EICNJ reported assets of $11,303,000, liabilities of $2,321,000, and capital and surplus of $8,982,000. Operations for 2007 produced net income of $180,000. White Mountains Advisors LLC White Mountains Advisors LLC (WMA) provides investment advisory and management services to affiliates within WMIG. As of December 31, 2007, the trial balance on a stand-alone GAAP basis, with investments in subsidiaries booked under the equity method, WMA reported assets of $69,715,233, liabilities of $58,820,651 and shareholders’ equity of $10,894,582. Operations for 2007 produced net income of $9,041,026 on revenues of $31,780,305. White Mountains Reinsurance Company of America White Mountains Reinsurance Company of America (WMRCA) formerly known as Folksamerica Reinsurance Company is a reinsurance company that is domiciled in New York and mainly underwrites property, casualty, agriculture and accident and health reinsurance primarily in the United States, Canada, Continental Europe, Latin America, the Caribbean and Japan. EIC entered into a reinsurance agreement with WMRCA wherein WMRCA assumed 42.5% of the premiums and losses generated by EIC. Affiliated reinsurance agreements are further discussed in the section of the report titled “Reinsurance.” As of December 31, 2007, the audited statutory financial statements of WMRCA reported assets of $2,819.2 million, liabilities of $1,892.6 million and surplus of $926.6 million. Operations for 2007 produced net income of $62.9 million on net premiums earned of $858.0 million. Sirius International Insurance Corporation Sirius International Insurance Corporation (Sirius) is a Stockholm-based international reinsurer that focuses mainly on property and other short-tailed lines. EIC has entered into a reinsurance agreement with Sirius wherein Sirius assumes 42.5% of the premiums and losses generated by EIC. Sirius is the largest reinsurance company in Scandinavia and a leading reinsurer in Europe. Sirius is annually audited in accordance with generally accepted auditing standards in Sweden. Affiliated reinsurance agreements are further discussed in the section of the report titled “Reinsurance.” As of December 31, 2007, the consolidated audited financial 14 statements of Sirius reported assets of $3,023 million, provisions and liabilities of $1,810 million and shareholders’ equity of $1,213 million. Operations for 2007 produced net income of $89 million on total earned premiums, for own account of $932 million. An exchange rate of 0.154875 was used to convert one Swedish Krona to the United States dollar. OneBeacon Insurance Group OneBeacon Insurance Group consists of 19 property and casualty insurance companies, at year-end 2007, all of which are direct or indirect wholly owned subsidiaries of One Beacon Insurance Group LLC, an insurance holding company domiciled in the State of Delaware. OneBeacon Insurance Group provides a range of specialty insurance products as well as a variety of segmented commercial and personal insurance products primarily through independent agencies. OneBeacon Insurance Group are risk-sharing participants in the OneBeacon Amended and Restated Reinsurance [Pooling] Agreement (OneBeacon Pool), have entered into 100% reinsurance agreements with the OneBeacon Pool, have entered into a significant intercompany reinsurance agreement with the OneBeacon Pool or are wholly owned subsidiaries of one of the member companies. EIC has entered into Limited Assignment Distribution Program Agreements with the following companies which are part of the OneBeacon Insurance Group: AutoOne Insurance Company, The Camden Fire Insurance Association and Pennsylvania General Insurance Company. EIC has also entered a Sale of Excess Class Credits with AutoOne Insurance Company, and a Take-Out Credit Agreement with OneBeacon. The affiliated agreements are further discussed in this section under the heading “Agreements with Affiliates.” As of December 31, 2007, the audited combined statutory financial statements of OneBeacon Insurance Group reported assets of $5,057,200,000, liabilities of $3,149,231,000, and capital and surplus of $1,907,969,000. Operations for 2007 produced net income of $335,181,000 on premiums earned of $1,664,911,000. 15 Agreements with Affiliates Affiliated reinsurance and trust agreements are discussed in the section of the report titled “Reinsurance.” Sublease Agreements EIC has entered into property lease agreements with third parties across the nation. Properties are located in Sioux Falls, South Dakota; Rocklin, California; Tampa, Florida; Addison, Texas; Gilbert, Arizona; San Francisco, California; Madison, Wisconsin; and Hauppauge, New York. The properties provide office space for its headquarters, response centers and claim adjusters. In turn, EIC subleases the property to EInc. The sublease terms are the same lease terms as EIC has with the original lessor. Monthly rental obligations are paid by EIC to the lessor; EIC is then reimbursed by EInc. Each sublease agreement includes an indemnification clause requiring EInc to indemnify, defend and hold EIC harmless from and against any and all loss, cost, damage and expense arising out of or in any way related to a breach or default by EInc of EIC’s obligations under the original lease, or for which EIC would be liable to a third party under the terms of the original lease. Limited Assignment Distribution Program Agreements The following affiliates accept EIC’s assignments on private passenger non-fleet motor vehicle risk in accordance with Limited Assignment Distribution agreements the parties have entered. Each agreement includes proper indemnification clauses and automatically renews annually unless terminated. Financial transactions pursuant to these agreements are immaterial. • • • • Camden Fire Insurance Association accepts EIC’s assignments from the New Jersey Personal Automobile Insurance Plan AutoOne Insurance Company accepts EIC’s assignments from the New York Automobile Insurance Plan AutoOne Insurance Company accepts EIC’s assignments from the Pennsylvania Assigned Risk Plan Pennsylvania General Insurance Company accepts EIC’s assignments from the Connecticut Automobile Insurance Assigned Risk Plan Governing Committee 16 Sale of Excess Class Credits EIC has entered into a Letter of Understanding for Sale and Service of Esurance Excess Class Credits with AutoOne Insurance Company dated September 13, 2007, and revised October 26, 2007. EIC agreed to utilize the capabilities and contacts of AutoOne to effectuate a sale of EIC’s Excess Class Credits in New York to one or multiple clients as necessary to exhaust and monetize 100% of the credits. AutoOne agreed to charge clients a Credit Fee of at least $0.32 per $1.00 of Credits sold. As consideration to AutoOne, EIC agreed to pay a brokerage and servicing fee equal to 8% of the Credit Fee. The actual Esurance Excess Class Credits totaled $6,100,000 and were purchased by State Farm Mutual Automobile Insurance Company in November 2007 for $0.40 per $1.00 of Credits purchased. Settlement of balances occurred in March of 2008. Take-out Credit Agreement EIC has entered a Take-out Credit Agreement with OneBeacon, effective April 3, 2007. Pursuant to the agreement, OneBeacon shall purchase all take-out credits earned by EIC pursuant to Section 6.A.6.c. of the NYAIP Manual (Take-out Credit) for writing NYAIP policies. The Take-out Credit earned by and credited to EIC by the Automobile Insurance Plans Service Office (AIPSO) shall be an amount equal to a percentage set forth in the NYAIP Manual of the premium amount of each NYAIP policy written by EIC. The purchase price for the Take-out Credit shall be an amount equal to (a) 27% of the total premiums credited to OneBeacon for each quarter, as set forth in the quarterly AIPSO NYAIP Take-out Credit Program Circular, for NYAIP policies originated in 2006, or (b) 32% of the total premiums credited to OneBeacon for each quarter, as set forth in the quarterly AIPSO NYAIP Take-out Credit Program Circular, for NYAIP policies originated in 2007. The company reported no transactions under this agreement during 2007. The agreement has indemnification clauses and terminated on June 30, 2008. Guarantees EIC has guaranteed EInc’s obligations to Paymentech, LP, a payment processor. Esurance Inc.'s payments to Paymentech, LP, were approximately $8.9 million and $9.0 million in 2006 and 2007. Expense generally relates to operations of EIC and its subsidiaries. If EInc 17 defaults, the amount payable under the Paymentech, LP, guarantee would be determined based on services rendered by the vendor through the date of default, but is limited to total costs incurred over the prior 6 months. EIC has guaranteed EInc's office lease payments to Holder/Royal 400 I, LLC. EInc's payments to Holder/Royal 400 I, LLC, were approximately $150,000 and $170,000 in 2006 and 2007. Payment would be triggered by EInc's default, for an amount up to the remaining contractual term of the lease, discounted at 8% per annum, plus any related costs and expenses (e.g., legal collection charges). EIC's maximum payment under this guarantee would be approximately $458,000 at December 31, 2007. Agency Agreement EIC has entered into an Agency Agreement with EISI effective January 1, 2003. In accordance with the agreement, EIC appoints EISI as its insurance services representative and agent. EISI is given the authority to solicit, receive, accept, bind, issue or endorse insurance contracts and to handle related claims. The agreement includes EIC’s maximum annual premium volume and limits of liability with respect to any one policy in which is not to be exceeded by EISI. EISI is to provide and maintain separate books, records, claim files and correspondence with policyholders on the business written. The agreement includes a listing of reports to be provided by EISI to EIC within 30 days after the calendar close of business each month. EISI is responsible for paying all expenses attributable to the producing and servicing of business. Any funds received by EISI relating to the business written under the agreement are to be kept in a fiduciary capacity and paid to EIC within 30 days following the end of each calendar month. The agreement includes indemnification clauses. According to the terms of the agreement EIC is to compensate EISI the following amounts within 30 days following the end of each calendar month: a. Agency commission of the lower of the actual cost or 13.5% of all net premiums written by the agent during the previous calendar month. Net premium is defined as gross premium charged on all original and renewal policies less return premium. 18 b. 100% of the actual loss adjustment expenses incurred by the agent in the prior calendar month. The agreement remains in force for a period of one year and automatically renews for subsequent one-year terms unless terminated. Commission and fees incurred under this agreement in 2007 and 2006 were $78.3 million and $72.1 million, respectively. Further discussion of the Agency Agreement is included in the section of the report titled “Summary of Examination Results.” Insurance Management Services Agreement EIC has entered into an Insurance Management Services Agreement with EInc effective January 1, 2003. In accordance with the agreement, EInc is to provide the following services: accounting, tax and auditing, functional support services and investment services. EIC is to reimburse EInc actual and reasonable expenses, not to exceed 6% of EIC’s direct and assumed earned premium. Within 30 days after the end of each calendar month, EInc will submit to EIC a detailed written statement of the charges due for services in the preceding calendar month. Any balance payable shall be paid within 30 days following receipt of the written statement. The agreement remains in effect until termination. Management service fees incurred under this agreement in 2007 and 2006 were $59.4 million and $41.7 million, respectively. Further discussion of the Insurance Management Services Agreement is included in the section of the report titled “Summary of Examination Results.” Investment Management Agreement EIC has entered into an Investment Management Agreement with WMA effective July 1, 2002. WMA provides EIC investment management services, including the investment and reinvestment of EIC’s investment assets. EIC provides WMA with investment guidelines, approved by the board of directors, which direct WMA with investment objectives, policies and restrictions. The assets in the investment account are being held in a custodial account. WMA is responsible for providing EIC reports containing a detailed listing of invested assets and transactions at least quarterly. EIC is to reimburse WMA a quarterly management fee for services rendered, as follows: 19 Assets Under Management Up to $100 million Next $400 million More than $500 million Quarterly Fee (basis points) 7.50 5.00 3.75 The investment management fee is billed and payable within 10 days after the last day of each calendar quarter based on the value of the investment account as of the last day of the calendar quarter. The agreement remains in effect until termination. EIC’s expense incurred under this agreement in 2007 and 2006 were $443,283 and $266,573, respectively. Tax Allocation Agreement EIC has entered into a Tax Allocation Agreement by and between Fund American Enterprises Holdings, Inc., and the following affiliates: Esurance Holdings Inc.; Esurance Inc.; Esurance Insurance Services, Inc.; Esurance Insurance Company of New Jersey; and Esurance Property and Casualty Insurance Company. The agreement was effective December 18, 2004, and amended December 21, 2007, to include EIC as a party to the agreement. Under this agreement, all of the parties subject to this agreement are to file a consolidated federal income tax return. Each member’s tax is calculated as if it filed a separate tax return. If a member has a net operating loss which does not generate a tax refund on a separate company basis, such loss is carried forward to subsequent periods and is taken in account in the separate computation of tax of the member. The agreement remains in effect until termination. 20 V. REINSURANCE The company's reinsurance portfolio and strategy is described below. The company has one ceding reinsurance agreement and three assuming agreements all containing proper insolvency provisions. The company also participates in the following mandatory pools: Michigan Catastrophic Claims Association, Missouri Joint Underwriting Association, and Florida Automobile Joint Underwriting Association. Affiliated Ceding Contracts 1. Type: Reinsurer: Quota Share Reinsurance Agreement Sirius International Insurance Corp (PUBL) White Mountain Reinsurance Company of America Total Scope: Retention: Personal lines automobile insurance coverage 15% of each net loss, ALAE and ULAE ALAE - loss adjustment expenses paid to third parties for investigation, appraisal, adjustment, legal services, transcriptions, review of medical bills or medical review of injuries, police and other reports, and other outside services that can be directly attributed to a claim ULAE - loss adjustment expenses incurred by the company as reflected in its books and records, including expenses incurred by claims departments and allocation of expenses from other departments The sum of ALAE and ULAE constitutes the total loss adjustment expenses (LAE) Coverage: Quota share percentage of each net loss, ALAE and ULAE LAE are subject to a maximum amount equal to 11.5% of premium earned during each annual period of this agreement Net loss also include 100% of losses in excess of policy limits, 100% of extra contractual obligations and 100% of any expense incurred by the company in bringing or defending a declaratory judgment action brought to determine the company’s obligations with respect to a specific claim under a policy Premium: Proportionate share of the difference of (A) the ceded premium earned for the month and (B) the sum of (i) ceding commission on the ceded premium earned for the month, (ii) ceded losses paid during the month, (iii) ceded ALAE paid during the month, and (iv) ceded ULAE paid during the month 42.5% 42.5% 85.0% 21 Commissions: 1. Ceding commission of 18% of ceded premiums written 2. If the ratio of losses incurred to premium earned is less than 77%, the reinsurer will pay the company a profit commission in an amount equal to the product of: (A) the ceded premium earned, and (B) an amount equal to the lesser of (i) 4% or (ii) the difference between 77% and the ratio of losses incurred to premium earned January 1, 2008 1. By either party effective the first day of any calendar year with 120 days’ prior written notice, on a run-off basis 2. By the company, if the reinsurer is found to be insolvent, or is placed in supervision, conservation, rehabilitation, or liquidation, or has a receiver or supervisor appointed 3. By the company if the rating of the AM Best rating of the reinsurer is lowered to B++ or below This agreement will cover run off of liabilities from policies in force at termination date to natural expiry Effective date: Termination: Trust requirement: This agreement contains a provision according to which all reinsurers shall establish a trust account for the benefit of the company. Such trust accounts shall be for an amount of 104% and 100% of reinsurance recoverable on paid losses and loss adjustment expenses and the reserves for premium unearned and outstanding losses and loss expenses including IBNR reserves, less ceded balances payable, for unauthorized reinsurers and authorized reinsurers, respectively. Trust Agreements Pursuant to s. Ins 52.05, Wis. Adm. Code, and the Stipulation and Order issued by the Office of the Commissioner of Insurance (OCI) on October 10, 2006, EIC has entered into a trust agreement with Sirius and The Bank of New York (the Trustee), dated as of November 7, 2006, as amended on February 26, 2007. Sirius secures payments of amounts due EIC, under the reinsurance agreement, by transferring assets to the Trustee for deposit into a trust account for the sole benefit of EIC. The amount held in the trust account should equal to 104% of Sirius’ obligations attributable to the reinsurance agreement. Sirius’ obligations are defined as the sum of losses and allocated loss expenses paid by EIC but not recovered from Sirius; reserves for loss reported and outstanding; reserves for losses incurred but not reported; reserves for allocated loss expenses; and reserves for unearned premium. The agreement may be terminated only after Sirius or EIC has given the Trustee a written notice of its intention to terminate the trust account. The agreement provides that written notification of termination should be delivered by 22 the Trustee to Sirius, EIC, and OCI at least 30 days, but not more that 45 days, prior to termination of the trust account. Sirius is responsible for reimbursing the Trustee for its expenses under the agreement. OCI approved a Standing Consent Letter dated November 12, 2007, according to which the company grants written approval for Sirius to direct the Trustee to substitute assets of comparable value for other assets held in the trust account established by the trust agreement. EIC has entered into a similar trust agreement with WMRCA and The Bank of New York, dated as of December 6, 2007, in connection to the reinsurance agreement entered into by EIC and WMRCA. The amount held in the trust account should equal to 100% of WMRCA’s obligations attributable to the reinsurance agreement. The definition of reinsurer’s obligations is similar to those defined in the trust agreement with Sirius with the exception of unearned premium which are excluded from the definition. Further discussion of the trust agreements is included in the section of the report titled “Summary of Examination Results.” Affiliated Assuming Contracts 1. Type: Reinsured: Scope: Retention: Coverage: Quota Share Reinsurance Agreement Esurance Insurance Company of New Jersey Private passenger automobile insurance coverage None 100% of each net loss and loss adjustment expenses; net loss also includes 100% of losses in excess of policy limits, 100% of extra contractual obligations and 100% of any expenses incurred by the company in bringing or defending a declaratory judgment action brought to determine the company’s obligations with respect to a specific claim under a policy Quota share percentage of the company’s net premium written Ceding commission which consists of the actual expenses paid for commissions, premium, and other tax liabilities, licenses and board and bureau fees as reflected in the books and records of the company. The company retains any and all policy or other fees collected on the policies reinsured under this agreement. August 9, 2007 Premium: Commissions: Effective date: 23 Termination: By either party upon 365 days’ prior written notice to the other party, on a run-off basis Quota Share Reinsurance Agreement Esurance Property and Casualty Insurance Company Private passenger automobile insurance coverage 10% of each net loss 90% of each net loss and loss adjustment expenses; net loss also includes 100% of losses in excess of policy limits, 100% of extra contractual obligations, and 100% of any expense incurred by the company in bringing or defending a declaratory judgment action brought to determine the company’s obligations with respect to a specific claim under a policy Quota share percentage of the company’s net premium written Ceding commission which consists of the actual expenses paid for commissions, premium, and other tax liabilities, licenses and board and bureau fees as reflected in the books and records of the company. The company retains any and all policy or other fees collected on the policies reinsured under this agreement. January 1, 2008 By either party upon 365 days’ prior written notice to the other party, on a run-off basis 2. Type: Reinsured: Scope: Retention: Coverage: Premium: Commissions: Effective date: Termination: Unaffiliated Assuming Agreements 1. Type: Reinsured: Scope: Retention: Coverage: Quota Share Reinsurance Agreement Home State County Mutual Insurance Company Private passenger automobile insurance coverage None 100% of all losses and loss adjustment expenses under the policies covering risks situated in Texas 100% of the net premium 1. An agency commission of 13.5% of all net premiums written, such commission to be payable to the company’s agent, EISI, pursuant to the Agency Agreement 2. A provisional loss adjustment expense commission of 10% of all net premiums written in the current calendar year and 3% for the prior calendar year to be payable to the company’s agent, EISI, pursuant to the Agency Agreement, provided that this commission will be reconciled to the actual loss adjustment expense costs Premium: Commissions: 24 3. A ceding commission based on net premium and policy fees, according to the following schedule: Net (Annual) Premium and Policy Fees $4,000,00 $0 to 0 $4,000,00 $5,000,00 0 to 0 $5,000,00 an 0 d above Effective date: Termination: January 1, 2004 By either party, by giving 120 days’ advance written notice to other party, on a run-off basis Ceding Commission 2.50% 2.25% 2.00% 25 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, 2007, 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." 26 Esurance Insurance Company Assets As of December 31, 2007 Net Admitted Assets $187,810,178 661,437 44,819,599 42,067,399 10,325,762 1,515,595 Assets Bonds Stocks: Preferred stocks Common stocks Cash, cash equivalents, and short-term investments Receivables for securities Investment income due and accrued Premiums and considerations: Uncollected premiums and agents' balances in course of collection Deferred premiums, agents' balances, and installments booked but deferred and not yet due Reinsurance: Amounts recoverable from reinsurers Current federal and foreign income tax recoverable and interest thereon Net deferred tax asset Write-ins for other than invested assets: Receivable from sale of assigned risk credits Total Assets $187,810,178 661,437 44,819,599 42,067,399 10,325,762 1,515,595 Nonadmitted Assets $ 19,756,288 15,396 19,740,892 93,903,320 33,181,328 59,177 3,796,045 93,903,320 33,181,328 59,177 3,796,045 2,244,800 $440,140,928 $15,396 2,244,800 $440,125,532 27 Esurance Insurance Company Liabilities, Surplus, and Other Funds As of December 31, 2007 Losses Reinsurance payable on paid loss and loss adjustment expenses Loss adjustment expenses Other expenses (excluding taxes, licenses, and fees) Taxes, licenses, and fees (excluding federal and foreign income taxes) Unearned premiums Advance premium Ceded reinsurance premiums payable (net of ceding commissions) Payable to parent, subsidiaries, and affiliates Payable for securities Write-ins for liabilities: Deferred excess ceding commission Claims administration Unapplied cash for securities JUA liabilities Total liabilities Common capital stock Preferred capital stock Gross paid in and contributed surplus Unassigned funds (surplus) Surplus as regards policyholders Total Liabilities and Surplus $ 3,000,000 500,000 88,252,377 30,263,549 122,015,926 $440,125,532 $ 36,199,045 8,315,399 22,990,300 413,378 6,511,028 29,934,144 8,476,700 156,683,140 9,888,740 94,219 23,203,676 12,802,666 2,575,796 21,374 318,109,605 28 Esurance Insurance Company Summary of Operations For the Year 2007 Underwriting Income Premiums earned Deductions: Losses incurred Loss expenses incurred Other underwriting expenses incurred Total underwriting deductions Net underwriting loss Investment Income Net investment income earned Net realized capital gains Net investment gain Other Income Finance and service charges not included in premiums Write-ins for miscellaneous income: Income on sale of assigned risk credits Miscellaneous income Total other income Net income before dividends to policyholders and before federal and foreign income taxes Dividends to policyholders Net income after dividends to policyholders but before federal and foreign income taxes Federal and foreign income taxes incurred Net Income $ $116,377,228 $78,655,396 64,396,482 (5,663,101) 137,388,776 (21,011,548) 10,594,198 224,895 10,819,093 12,915,900 2,440,000 1,559 15,357,459 5,165,003 0 5,165,003 2,459,056 2,705,947 29 Esurance Insurance Company Cash Flow For the Year 2007 Premiums collected net of reinsurance Net investment income Miscellaneous income Total Benefit- and loss-related payments Commissions, expenses paid, and aggregate write-ins for deductions Federal and foreign income taxes paid Total deductions Net cash from operations Proceeds from investments sold, matured, or repaid: Bonds Stocks Net gains on cash, cash equivalents, and short-term investments Total investment proceeds Cost of investments acquired (long-term only): Bonds Stocks Miscellaneous applications Total investments acquired Net cash from investments Cash from financing and miscellaneous sources: Capital and paid in surplus less treasury stock Other cash provided 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 $140,900,600 8,880,638 16,829,698 166,610,937 $ 84,837,152 48,020,162 821,279 133,678,593 32,932,344 $165,302,532 149,147 33,488 165,485,167 226,038,876 16,828,549 11,186,543 254,053,968 (88,568,801) 44,100,000 8,432,418 52,532,418 (3,104,039) 45,171,439 $ 42,067,400 30 Esurance Insurance Company Compulsory and Security Surplus Calculation December 31, 2007 At the same time EIC obtained approval for its redomestication to Wisconsin it agreed to a Stipulation and Order for calculation of its compulsory and security surplus in the following format: Assets Add security surplus excess of insurance subsidiaries Less investments in insurance subsidiaries Less liabilities Adjusted surplus Compulsory surplus is to be the greater of the following: $3,000,000; or 12.5% of direct premium written plus nonaffiliated assumed premium during the previous 12 months; or 33.3% of net premium written during the previous 12 months Compulsory surplus Compulsory Surplus Excess (or Deficit) $440,125,532 25,724,815 33,869,480 318,109,605 113,871,262 $ 3,000,000 76,866,629 40,582,912 76,866,629 $ 37,004,633 Adjusted surplus (from above) Security surplus: 122% (percentage based on resulting calculation of compulsory surplus; for 2007 140% of compulsory surplus, factor reduced 1% for each $33 million in direct premium plus nonaffiliated assumed premium in excess of $10 million) Security Surplus Excess (or Deficit) $113,871,262 93,777,287 $ 20,093,975 31 Esurance Insurance Company Reconciliation and Analysis of Surplus For the Five-Year Period Ending December 31, 2007 The following schedule is a reconciliation of total surplus during the period under examination as reported by the company in its filed annual statements: 2007 Surplus, beginning of year Net income Change in net unrealized capital gains/losses Change in net unrealized foreign exchange capital gains/losses Change in net deferred income tax Change in nonadmitted assets Change in provision for reinsurance Surplus adjustments: Paid in Surplus, End of Year 2006 2005 2004 2003 $68,809,120 2,705,947 5,712,034 $45,559,760 4,175,684 644,486 $34,747,568 (1,235,055) 629,552 $25,438,584 148,991 143,779 $25,932,246 (1,191,759) 144,601 (4,183) 682,409 10,599 1 1,110,446 328,848 (2,838) 1,190,862 65,555 164,116 158,394 21,936 (164,116) 9,000,000 $34,747,568 $25,438,584 995,830 (442,334) 44,100,000 $122,015,926 16,989,895 $68,809,120 10,000,000 $45,559,760 32 Esurance Insurance Company Insurance Regulatory Information System For the Five-Year Period Ending December 31, 2007 The company’s IRIS results for the period under examination are summarized below. Unusual IRIS results are denoted with asterisks and discussed below the table. 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 2007 641% 100 39* 0 95 4.5 77* 13 89 16 6 6 12 2006 854% 127 71* 0 94 3.4 51* 14 96 13 5 2 3 2005 755% 112 100* 0 97 2.3* 31 2 105* 7 (3) (4) (32) 2004 558% 74 (9) 0 96 1.3* 36 n/a 134* 1 (3) 0 (7) 2003 424% 111 999* 0 87 1.9* 1 n/a 141* 5 0 0 0 Ratio No. 3 reflects the percentage change in net premiums written from the prior year. Premium volume has increased substantially over the period through online marketing, online agency partners, and other marketing including television, radio and direct mail. EIC began to retain premium in 2003 and entered into a quota share reinsurance agreement with WMRCA, whereby EIC ceded 75% of its direct and assumed business. On January 1, 2004, the company amended this agreement with WMRCA to cede 85% of its direct and assumed business causing the slight decline in net premiums written during that year. Ratio No. 6 measures the average return on the company’s investments. The exceptional results for 2005, 2004 and 2003 were mainly due to the low interest rate environment of recent years. Another factor contributing to EIC’s low dividend yield is that EPC, comprising of approximately 13%, 35% and 33% of invested assets during 2005, 2004 and 2003, respectively, did not pay any dividends during that period. 33 Ratio No. 7 compares current-year surplus to the prior-year surplus. Exceptional results for 2007 and 2006 were due to capital contributions made to EIC by its parent, EHI, of $44.1 million and $17.0 million, respectively. Ratio No. 9 measures the company’s liabilities less unearned premium equal to deferred premium as a percentage of liquid assets. Exceptional ratios are primarily due to EIC’s investment in EPC which is not included as a liquid asset. The ratio was in normal range in 2007 and 2006 due to capital contributions made to EIC by its parent, EHI. Growth of Esurance Insurance Company Surplus as Regards Policyholders $122,015,926 68,809,121 45,559,760 34,747,568 25,438,584 25,932,245 Loss and LAE Ratio 122.9% 121.0 86.4 72.7 78.8 0.0 Year 2007 2006 2005 2004 2003 2002 Admitted Assets $440,125,532 328,929,140 199,153,022 102,706,212 91,607,057 36,511,996 Gross Premium Written Net Premium Written $121,748,736 87,649,782 51,204,604 25,663,158 28,261,455 0 Liabilities $318,109,605 260,120,018 153,593,262 67,958,644 66,168,473 10,579,750 Net Income $ 2,705,947 4,175,684 (1,235,055) 148,991 (1,191,759) 46,293,330 Year 2007 2006 2005 2004 2003 2002 Premium Earned $116,377,228 77,643,902 44,908,502 25,270,481 20,393,478 0 Expense Ratio (17.3)% (22.3) 15.2 27.3 20.4 0.0 Combined Ratio 105.6% 98.7 101.6 100.0 99.2 0.0 $782,482,653 587,905,324 344,073,333 193,840,441 107,941,238 9,842,951 As noted above, premium volume has increased substantially over the period. Loss and LAE ratios have been less favorable than its peers. The company has experienced underwriting losses since 2003. Underwriting losses have been offset by high levels of fee income and investment income to achieve net income in three of the past five years. Fee income includes installment and miscellaneous policyholder fees which are not subject to the quota share agreement held with reinsurers. Negative and lower expense ratios are due to subsidies provided through affiliated reinsurance ceding commissions and lower than actual cost for management and agency services provided by affiliates. Further discussion is included in the report under the section titled, “Summary of Examination Results.” 34 Surplus has increased by $96.6 million during the period under examination. During this period EIC has received $80.1 million in capital contributions. The following chart documents net capital contributions made by White Mountains Inc. during 2007: 2007 Net Capital Contributions (from)/to White Mountains Inc. $ (10,300,000) (6,500,000) (24,000,000) (4,300,000) (5,000,000) (25,500,000) (14,800,000) (7,500,000) (7,500,000) (7,400,000) (12,300,000) Date 1/26/2007 2/14/2007 2/23/2007 3/23/2007 3/26/2007 4/16/2007 5/16/2007 5/18/2007 5/23/2007 5/25/2007 6/25/2007 7/20/2007 8/17/2007 8/20/2007 9/14/2007 12/12/2007 12/19/2007 Esurance Holdings, Inc. $ 10,300,000 (10,000,000) 24,000,000 (24,000,000) 4,300,000 5,000,000 (4,000,000) 25,500,000 (30,800,000) Esurance Inc. $ 10,000,000 6,500,000 17,000,000 $ EIC $ EPC 7,000,000 4,000,000 7,800,000 7,500,000 7,500,000 7,300,000 7,300,000 4,250,000 $79,150,000 1,800,000 $39,100,000 5,000,000 $5,000,000 23,000,000 7,300,000 7,500,000 (7,300,000) 100,000 12,300,000 (11,050,000) $ 1,850,000 $(125,100,000) EHI, who holds a 100% direct interest in EIC, is annually audited by a CPA firm. The CPAs state that EHI's consolidated financial statements are prepared assuming it will continue as a going concern. EHI has had recurring losses and an accumulated deficit since its inception in October 2004, related primarily to the development of its website, marketing expenses, and other operations, which raises substantial doubt about EHI's ability to continue as a going concern. EHI partly finances its operations using a borrowing facility with WTM Reuler (Luxembourg) S.a.r.l. (WTM Reuler), a downstream subsidiary of White Mountains Holdings (Luxembourg) S.a.r.l., and capital contributions received from White Mountains, Inc. EHI has received total capital contributions of $130.6 million in 2007 and $22.2 million in 2006. Through April 15, 2008, EHI received $25.0 million of capital contributions from White Mountains Inc. There is no assurance that EHI will continue to receive financial support from WTM Reuler or 35 White Mountains Inc., or that it will be successful in its efforts to eventually achieve profitable operations. Reconciliation of Surplus per Examination No adjustments were made to surplus as a result of the examination. The amount of surplus reported by the company as of December 31, 2007, of $122,015,926 is accepted. Examination Reclassifications Debit Receivables from parent, subsidiaries and affiliates Aggregate write-ins for other than invested assets: Receivable from sale of assigned risk credits Aggregate write-ins for liabilities: Claims administration Payable to parent, subsidiaries and affiliates Uncollected premiums and agents’ balances in course of collection Payable to parent, subsidiaries and affiliates Total Reclassifications $ 2,244,800 $ 2,244,800 12,802,666 12,802,666 5,580,699 5,580,699 $20,628,165 $20,628,165 Credit 36 VII. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations There were no comments or recommendations in the previous examination report conducted by the Oklahoma Insurance Department that required follow-up by the Wisconsin Commissioner of Insurance. 37 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. Conflict of Interest Directors, officers and employees of the Esurance Group are required to sign, initially at the outset of employment and beginning in 2008 on an annual basis, the Employee Handbook, which includes an acknowledgement of the company's Conflict of Interest and Insider Trading Policy. The Employee Handbook contains a comprehensive listing of company policies in situations for which the interests of the company may become subordinated to the employee’s own personal interest. The company also requires directors, officers and employees to sign a Mutual Non-Disclosure Agreement and Proprietary Information Agreement at the outset of employment which also identifies company policies concerning potential conflict of interest situations. In addition, the company requires directors and officers to complete the NAIC’s standard form of biographical affidavit on an annual basis. The biographical affidavit requires the individual to respond to certain questions that would disclose whether or not the individual has been or is involved in a situation of conflict with the interests of the company. The following question appears in the General Interrogatories of the annual statement: Has the reporting entity an established procedure for disclosure to its Board of Directors or trustees of any material interest or affiliation on the part of any of its officers, directors, trustees or responsible employees that is in conflict or is likely to conflict with the official duties of such person? The Commissioner has issued a directive that each company adopt a procedure which would enable it to answer the question in the affirmative. This question contemplates that insurers will have formulated and adopted a standard of ethics and established procedures for the annual disclosure of any material interest or affiliation which is in or is likely to conflict with the official duties of its directors, officers, or key employees. The procedure should require the conveyance of the standard of ethics to the employee, the design of a suitable questionnaire to disclose any inconsistency with such standard, and a periodic system of 38 reinstruction, interrogatory, and reappraisal. Neither the Commissioner’s directive nor the annual statement instructions define what constitutes a key employee. It is the company’s responsibility under the directive to determine which employees have decision-making authority that could result in a potential conflict with the interests of the company. It is the practice of some insurers to have all of their employees complete a conflict of interest questionnaire on an annual basis. The company has not established a comprehensive questionnaire for annual disclosure of conflict of interests of its key employees. Although directors and officers may disclose certain situations on an annual basis that involve potential conflict with their responsibilities to the company in connection with their completion of a biographical affidavit, the disclosures required by these affidavits do not address all of the company’s policies regarding situations of conflict. The company should also be able to provide evidence of its review and follow-up regarding disclosures of potential situations of conflict made by directors, officers and employees in this comprehensive questionnaire. It is recommended that the company establish a conflict of interest procedure for its directors, officers and key employees to require them to complete a conflict of interest questionnaire upon appointment and on an annual basis for the duration of their service in compliance with the directive of the Commissioner. Affiliated Transactions EIC and its subsidiaries, EICNJ and EPC, have all entered into an Agency Agreement with EISI and an Insurance Management Services Agreement with EInc. EIC, EICNJ and EPC reimbursed EISI for services provided at the lower of actual cost or 13.5% of gross premium written less return premium and 100% of loss and LAE expenses. EIC, EICNJ and EPC reimbursed EInc for services provided at actual and reasonable expenses, not to exceed 6% of direct and assumed earned premium. The cost of services provided to EIC, EICNJ and EPC under the terms of these agreements exceeds what is being paid by the insurance companies to the non-insurance affiliates due to the contractual caps on compensation. During 2007, services provided cost approximately $80.8 million more than what was paid by the insurance companies, and in 2006 the cost of services exceeded payments by $55.9 million as noted below: 39 2007 Fees & Commission Paid Agency Fee $107,302,182 Management Fee 60,797,350 LAE Commission 71,578,562 Total $239,678,094 Cost of Services Acquisition Costs 154,700,805 General Expenses 178,522,592 Other Revenue* (12,723,564) Total Difference 320,499,836 $ (80,821,742) 2006 $ 92,183,987 42,490,555 48,488,189 $183,162,731 111,514,036 152,325,656 (24,759,815) 239,079,877 $ (55,917,146) * Includes partner revenue, fee income and investment income less rebates. The consolidated statutory net income for EIC, EPC and EICNJ was reported as $8,168,791 and $5,528,288 for 2007 and 2006, respectively. Had the insurance company’s been charged actual expenses for services, they would have incurred net losses of $72,652,951 and $50,388,858 in 2007 and 2006, respectively. The combined surplus of the insurance companies would have reduced from $156,151,184 to $75,329,442 for 2007 and $92,331,333 to $36,414,187 for 2006. The 2007 quota share reinsurance agreement between Sirius and WMRCA afforded the company a 30% ceding commission. A ceding commission is to approximate costs related to acquiring the business ceded and associated overhead. Direct acquisition costs for new and renewal business incurred by the company during 2007 was approximately $125.6 million. The overhead costs were determined to be approximately $52.5 million relating to unallocated loss adjustment expenses paid by the company during 2007. Given the 85% quota share cession under the reinsurance agreements with Sirius and WMRCA, the examiners calculated acquisition and overhead costs for which the reinsurers would be responsible at $151.3 million. The company received ceding commission of $197.0 million during 2007. Sirius and WMCRA may have reimbursed EIC actual cost related to acquiring the business ceded and associated overhead; however, EIC is not charged actual acquisition costs. Acquisition costs have been subsidized by EISI and EInc through the Agency Agreement and Insurance Management Services Agreement, as discussed above. The ceding commission received by the company represented a subsidy of approximately 7% of ceded premium written or $45.7 million. 40 The quota share reinsurance agreement between EIC, Sirius and WMRCA was amended effective January 1, 2008. Under the current agreement ceding commission was reduced to 18% and the reinsurers assume their quota share of all loss adjusting expense (allocated and unallocated) versus assuming only allocated loss adjusting expense. The agreement provides that the combined cession of allocated and unallocated loss adjusting expenses may not exceed 11.5% of premium earned. The amendments made to the 2008 reinsurance agreement would appear to reduce the subsidy provided by reinsurers during 2008. Under the existing contracts, EISI as the company’s agent is responsible for reimbursing the company for any premiums earned but unpaid by policyholders. In 2007, EISI reimbursed EIC $2.5 million and EICNJ a de minimis amount for this unpaid earned premium. At the time of approval of the Insurance Management Services Agreement and Agency Agreement, OCI suggested that the company perform periodic annual reviews to determine whether the compensation was fair and did not constitute a material subsidy to either party. Generally, contributions of capital should be made through purchase of additional shares of common or preferred stock, purchase of surplus notes, or direct addition of paid-in and contributed surplus. Contributions made in a direct manner keep the accuracy of the various schedules of the annual statement intact. Indirect subsidy, such as favorable allocation of expenses, distorts the financial statement and trends cannot be discerned. The consistent undercharging of the insurance subsidiaries that is created by these agreements materially distorts the reporting of costs necessary to support the insurance companies’ current operations. Accordingly, the financial stresses being placed on EHI that have resulted in a going-concern qualification issued by its CPA, as noted earlier in the section of this report titled “Financial Data,” is not readily apparent from the statutory financial statements as these losses are being reported at the intermediate holding company level. It is recommended that the company fully disclose the costs of services being provided by affiliates and the amount charged for services provided in its annual and quarterly financial statements in the notes to financial statements when a material subsidy has occurred. 41 There is no assurance that EHI will continue to receive financial support from affiliates or that it will be successful in its efforts to eventually achieve profitable operations. It is recommended that the company provide this office with a plan of action, pursuant to s. 601.42, Wis. Stat., identifying when it expects to be able to support its operations free of affiliated cost subsidies. This plan of action should include the company’s plans to secure capital in the form of cost subsidies, capital contributions and a guaranty of financial support during the period of time the company is unable to support its operations independent of these means. Trust Agreements The WMRCA trust agreement, as discussed in the section of the report titled, “Reinsurance,” was filed with OCI on December 28, 2007. On February 1, 2008, this office wrote to the company to suggest certain amendments that could be made to the trust agreement so that it would meet the standards of the NAIC Financial Condition Examiners’ Handbook with respect to indemnification of the company by the trustee in certain circumstances and notice to this office in the event that all account assets are withdrawn, among other matters. The company has earnestly endeavored to make these amendments, but, through no fault of its own, it has not obtained all of the regulatory approvals necessary to complete this process. It is recommended that the company amend its reinsurance trust agreement with WMRCA and the Bank of New York to meet the standards set forth for such agreements in the Financial Condition Examiners’ Handbook and that it file the amended agreement with this office in accordance with s. Ins 40.04 (2), Wis. Adm. Code. The quota share reinsurance agreement between EIC, Sirius and WMRCA was amended effective January 1, 2008. Under the current agreement, the reinsurers assume their quota share of all loss adjusting expense, allocated and unallocated, versus assuming only allocated loss adjusting expense. The correlating trust agreements have not been amended to include the changes to the reinsurers’ obligations in accordance with the 2008 reinsurance agreement. It is recommended that the trust agreements the company has entered with reinsurers be amended to reflect the current reinsurers’ obligations. 42 Annual Statement Reporting The company did not report total management and service fees incurred attributable to affiliates and non-affiliates in the footnote to the Underwriting and Investment Exhibit, Part 3, of the 2007 annual statement in accordance with the NAIC Annual Statement Instructions - Property and Casualty. It is recommended the company complete the footnote to the Underwriting and Investment Exhibit, Part 3, by reporting management and service fees in accordance with the NAIC Annual Statement Instructions - Property and Casualty. Affiliated Balances The company included a liability of $12,802,888 for claims administration as an aggregate write-in for liabilities on the 2007 annual statement. The claims administration balance represents claims funding provided by EISI, the company’s affiliate, to EIC. Any liability due to affiliates or expenditures incurred on behalf of the insurer by an affiliate should be classified and reported as part of payable to parent, subsidiaries and affiliates in accordance with the NAIC Annual Statement Instructions - Property and Casualty. The examination reclassified amounts due an affiliate for claims administration by decreasing aggregate write-ins for liabilities by $12,802,888 and increasing payable to parent, subsidiaries and affiliates by the same amount. The reclassifications of these balances are reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” It is recommended that the company properly report payables due to an affiliate as a payable to parent, subsidiaries and affiliates in accordance with the NAIC Annual Statement Instructions - Property and Casualty. The company included a liability for commission due to an affiliated agent, EISI, as an off-setting balance to its asset for uncollected premiums on the 2007 annual statement. EISI does not collect premium for the company. Premium is directly received by the company. Statements of Statutory Accounting Principles (SSAP) No. 6 (6) allows commissions due to agents to offset uncollected premium only when agents have collected premium which is owed to the company. The company should not offset uncollected premium due from policyholders with commission due an agent. 43 Commissions due to an affiliated agent would have been properly reported as a payable to parent, subsidiaries and affiliates in accordance with the NAIC Annual Statement Instructions - Property and Casualty. The examination reclassified amounts due an affiliated agent by increasing uncollected premium by $5,580,699 and increasing payable to parent, subsidiaries and affiliates by the same amount. The reclassifications of these balances are reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” It is recommended that the company properly report commissions due to an affiliated agent as a payable to parent, subsidiaries and affiliates in accordance with SSAP No. 6 (6) and the NAIC Annual Statement Instructions - Property and Casualty. The company included a receivable from the sale of assigned risk credits as an aggregate write-in for other than invested assets on the 2007 annual statement. The receivable due EIC results from the sale of EIC’s excess class credits in New York to one or multiple clients as necessary to exhaust and monetize 100% of the credits. EIC's affiliate, AutoOne Insurance Company, facilitated the sale for EIC to State Farm Insurance Company. Amounts due to EIC were from AutoOne Insurance Company. Unsecured current accounts receivable from affiliates are to be included as receivables from parent, subsidiaries and affiliates in accordance with the NAIC Annual Statement Instructions - Property and Casualty. Amounts were settled within 90 days after the 2007 annual statement report date. The examination reclassified the receivable due from an affiliate for the sale of excess class credits by decreasing aggregate write-ins for other than invested assets by $2,244,800 and increasing receivables from parent, subsidiaries and affiliates by the same amount. The reclassifications of these balances are reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” It is recommended that the company properly report receivables due from an affiliate as receivables from parent, subsidiaries and affiliates in accordance with the NAIC Annual Statement Instructions - Property and Casualty. 44 VIII. CONCLUSION The company is a property and casualty insurer that redomiciled from Oklahoma to Wisconsin on May 18, 2006. Upon redomestication the company agreed to two stipulations and orders: 1) concerning its calculation of compulsory and security surplus and 2) restrictions to enter into reinsurance transactions with offshore affiliates. The company is licensed in the District of Columbia and all states except Delaware, Idaho, Massachusetts, Minnesota, New Hampshire, New Mexico, North Carolina and Wyoming. The company markets personal auto insurance through its affiliate, EISI, pursuant to an Agency Agreement. EIC has no employees; employees providing services to the company and EISI are employed by EInc. EIC has entered an Insurance Management Services Agreement with EInc for services provided. EIC cedes 85% of risk to affiliates WMRCA and Sirius in accordance with a quota share reinsurance agreement. The examination resulted in nine recommendations related to annual conflict of interest disclosure, affiliated transactions, trust agreements, annual statement reporting and affiliated balances. The Esurance Group has not achieved profitable underwriting results during the period under review and has been dependent upon capital contributions and cost subsidies from affiliates within the holding company system. During 2007 capital contributions of $44.1 million were received by EIC, EPC and EICNJ and subsidies of $80.8 million for affiliated services provided and not charged, $45.7 million in excess reinsurance commissions and $2.5 million in reimbursement from EISI for premiums earned but unpaid. There were no adjustments to surplus as a result of the examination. However, three reclassifications were made to properly report affiliated balances. The amount of surplus reported by the company as of December 31, 2007, of $122,015,926, is accepted. 45 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 39 - Conflict of Interest—It is recommended that the company establish a conflict of interest procedure for its directors, officers and key employees to require them to complete a conflict of interest questionnaire upon appointment and on an annual basis for the duration of their service in compliance with the directive of the Commissioner. Page 41 - Affiliated Transactions—It is recommended that the company fully disclose the costs of services being provided by affiliates and the amount charged for services provided in its annual and quarterly financial statements in the notes to financial statements when a material subsidy has occurred. Page 42 - Affiliated Transactions—It is recommended that the company provide this office with a plan of action, pursuant to s. 601.42, Wis. Stat., identifying when it expects to be able to support its operations free of affiliated cost subsidies. This plan of action should include the company’s plans to secure capital in the form of cost subsidies, capital contributions and a guaranty of financial support during the period of time the company is unable to support its operations independent of these means. Page 42 - Trust Agreements—It is recommended that the company amend its reinsurance trust agreement with WMRCA and the Bank of New York to meet the standards set forth for such agreements in the Financial Condition Examiners’ Handbook and that it file the amended agreement with this office in accordance with s. Ins 40.04 (2), Wis. Adm. Code. Page 42 - Trust Agreements—It is recommended that the trust agreements the company has entered with reinsurers be amended to reflect the current reinsurers’ obligations. Page 43 - Annual Statement Reporting—It is recommended the company complete the footnote to the Underwriting and Investment Exhibit, Part 3, by reporting management and service fees in accordance with the NAIC Annual Statement Instructions - Property and Casualty. Page 43 - Affiliated Balances—It is recommended that the company properly report payables due to an affiliate as a payable to parent, subsidiaries and affiliates in accordance with the NAIC Annual Statement Instructions - Property and Casualty. Page 44 - Affiliated Balances—It is recommended that the company properly report commissions due to an affiliated agent as a payable to parent, subsidiaries and affiliates in accordance with SSAP No. 6 (6) and the NAIC Annual Statement Instructions - Property and Casualty. Page 44 - Affiliated Balances—It is recommended that the company properly report receivables due from an affiliate as receivables from parent, subsidiaries and affiliates in accordance with the NAIC Annual Statement Instructions Property and Casualty. 2. 3. 4. 5. 6. 7. 8. 9. 46 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 Victoria Chi Satinderjit Dhillon Stephen Elmer Yelena Vetrina Title Insurance Financial Examiner - Advanced Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner Respectfully submitted, Rebecca Easland Examiner-in-Charge 47