Report of the Examination of United National Specialty Insurance Company Bala Cynwyd, Pennsylvania As of December 31, 2007
TABLE OF CONTENTS
Page I. INTRODUCTION .............................................................................................................. 2 II. HISTORY AND PLAN OF OPERATION .......................................................................... 4 III. MANAGEMENT AND CONTROL .................................................................................... 9 IV. AFFILIATED COMPANIES ............................................................................................ 11 V. REINSURANCE ............................................................................................................. 18 VI. FINANCIAL DATA .......................................................................................................... 27 VII. SUMMARY OF EXAMINATION RESULTS ................................................................... 36 VIII. CONCLUSION................................................................................................................ 39 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS.......................................... 40 X. ACKNOWLEDGMENT ................................................................................................... 41 XI. APPENDIX – SUBSEQUENT EVENTS .......................................................................... 42
State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE
Jim Doyle, Governor Sean Dilweg, Commissioner Wisconsin.gov
March 31, 2009
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 D. Scheiber Secretary, Midwestern Zone, NAIC Director of Insurance State of South Dakota 445 East Capitol Avenue Pierre, South Dakota 57501-3185
Honorable Joel Ario Secretary, Northeastern Zone, NAIC Commissioner of Insurance Commonwealth of Pennsylvania 1326 Strawberry Square, 13th Floor Harrisburg, Pennsylvania 17120
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: UNITED NATIONAL SPECIALTY INSURANCE COMPANY Bala Cynwyd, Pennsylvania and this report is respectfully submitted.
I. INTRODUCTION The previous examination of United National Specialty Insurance Company (the company or UNSIC) was conducted in 2003 as of December 31, 2002. The current examination covered the intervening period ending December 31, 2007, and included a review of subsequent 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 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 recommendation and comment made in the previous examination report.
2
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 Since 1985, the company has been a participant in a comprehensive reinsurance pooling agreement with United National Insurance Company and Diamond State Insurance Company. In consequence, while the company’s annual Statement of Actuarial Opinion has been rendered on an independent basis, the company’s net loss and loss adjustment expense reserves are the product of the reserves of the United National Group Pool and the company’s participation percentage in the pool. An independent actuarial firm was engaged under a contract with Pennsylvania’s Department of Insurance in connection with the Commonwealth of Pennsylvania’s examination of United National Insurance Company. This independent actuarial firm reviewed the adequacy of the company’s loss reserves and loss adjustment expense reserves. The results of the independent actuarial firm’s work were reported to the examiner-in-charge. As deemed appropriate, reference is made in this report to the actuarial firm’s conclusion.
3
II. HISTORY AND PLAN OF OPERATION The company was organized as Hallmark Insurance Company, Inc., (Hallmark) and was the successor to a corporation of the same name organized on February 2, 1961, and having commenced business on December 16, 1961. The original Hallmark was based in Madison, Wisconsin, and later, in Middleton, Wisconsin. It wrote short-term insurance for hunters, sportsmen, athletes, and travelers, including accidental medical expense, short-term disability, accidental death and dismemberment, and legal liability. The common shares of Hallmark were publicly traded. Effective January 1, 1967, Hallmark assumed all of the outstanding property and casualty business of the Wisconsin Insurance Corporation of America, of Madison, Wisconsin, thereby diversifying its book of business while actively continuing its former activities. CIC Financial Corporation (CIC), an insurance holding company based in Chicago, Illinois, acquired financial control of Hallmark on August 31, 1977, through a tender offer of $2 per common share. Eventually, CIC acquired approximately 96% of the outstanding common shares of Hallmark. After the acquisition, Hallmark was restructured to write commercial property policies in Illinois and Wisconsin, with the home office remaining in Middleton, Wisconsin. The corporation’s plan of operation was to complement the lines of Casualty Insurance Company, a wholly owned insurance subsidiary of CIC domiciled in Illinois. In September 1982, The Continental Corporation of New York, New York, acquired CIC under an Agreement and Plan of Merger dated June 28, 1982. On April 29, 1983, through a complex series of mergers and corporate reorganizations, Hallmark Insurance Company, Inc., was merged into a newly created Wisconsin insurer, CI-Wisconsin Insurance Corporation, with the latter company surviving. CI-Wisconsin Insurance Corporation, a wholly owned subsidiary of The Continental Corporation, was incorporated on August 9, 1982, under Chapter 611 of the Wisconsin Statutes. It commenced business on April 29, 1983, effective with the final merger transaction with the original Hallmark. This final merger transaction dissolved the existence of the original Hallmark as an independent entity and cancelled all of its issued and outstanding common stock. Outstanding common shares of Hallmark then owned by the public, representing approximately
4
4% of the total shares outstanding, were converted into the right to receive $3 in cash per share (without interest) from the surviving corporation. The surviving CI-Wisconsin Insurance Corporation changed its name to Hallmark Insurance Company, Inc., concurrent to the final merger transaction. The management and office location of Hallmark did not change initially after the acquisition of ultimate control by The Continental Corporation. However, efforts to achieve profitability in its commercial property business were unsuccessful. Hallmark had experienced underwriting losses since its acquisition by CIC in 1977. Pursuant to s. 611.78, Wis. Stat., Hallmark reinsured all outstanding liabilities for policies and contracts of insurance with the Continental Insurance Company effective July 1, 1983. All of Hallmark’s employees, with a few exceptions, were terminated and the Middleton, Wisconsin, home office was closed. Sufficient assets were retained in Hallmark to maintain the insurer’s licenses in good standing and to meet obligations to general creditors. Diamond State Insurance Company (Diamond State) purchased Hallmark as a shell from The Continental Corporation on March 7, 1985. In this way, Hallmark became a fifth-tier subsidiary of American Manufacturing Corporation (Pennsylvania), and ultimately under the effective control of the various trusts that control American Manufacturing Corporation. On June 30, 1997, the holding company system was restructured to remove American Manufacturing Corporation (Pennsylvania) and American Manufacturing Corporation (Delaware) from the succession of control. This was accomplished through a dividend of the outstanding shares of American Insurance Service, Inc., to the private related family trusts that own American Manufacturing Corporation (Pennsylvania). The ultimate control of the various trusts continued to be exercised through American Insurance Service, Inc. The company changed its statutory home office address effective June 9, 2000. Pursuant to discussions with the Wisconsin Insurance Department, this change did not warrant an amendment to the company’s articles of incorporation or bylaws. The company changed its statutory home office address again on March 31, 2002. The statutory home office address is now 411 E. Wisconsin Avenue, Suite 700, Milwaukee, WI 53202.
5
The company changed its name from Hallmark Insurance Company, Inc., to United National Specialty Insurance Company effective July 1, 2001. On September 5, 2003, Fox Paine & Company, LLC, (Fox Paine) made a capital contribution of $240.0 million to United National Group, Ltd., (UNGL) a company formed to facilitate the acquisition, in exchange for 10.0 million Class B common shares and 14.0 million Series A preferred shares, and UNGL acquired Wind River Investment Corporation, the holding company for UNSIC, from a group of family trusts affiliated with the Ball family of Philadelphia, Pennsylvania. Additional information concerning the holding company system is contained in the section of this report titled “Affiliated Companies.” Effective as of December 15, 2003, UNGL, an intermediate parent of the company, completed its initial public offering (IPO). The shares are quoted on the NASDAQ National Market under the symbol “INDM.” In January 2004, the company’s non-U.S. affiliate reinsurer, Wind River Reinsurance Company, Ltd, (WRRC) started to assume business from UNSIC on a quota share basis. This agreement resulted in 60% of all business written by UNSIC being ceded to WRRC along with WRRC establishing a reinsurance credit trust. They were again reviewed and restructured in January 2007 reducing the ceded percentage to 50% of written business. Additional information concerning reinsurance is contained in the section of this report titled “Reinsurance.” On January 24, 2005, United American Indemnity, Ltd., (formerly United National Group Ltd.) completed a merger with Penn-America Group Inc. (PAGI) as well as the acquisition of Penn Independent Corp. Subsequent to the merger, UNIC directly owns 100% of Penn Independent Corp. and directly or indirectly owns 32.7% of PAGI. PAGI owns 100% of PennAmerica Insurance Company. The company writes direct premium in the following states: New York Pennsylvania Illinois Wisconsin All others Total $15,344,898 5,121,756 3,590,904 1,209,546 80,025 $25,347,129 60.5% 20.2 14.2 4.8 0.3 100.0%
6
The company is licensed in the District of Columbia and all states except Pennsylvania and Wyoming. The company is an eligible surplus lines insurer in Pennsylvania. 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 (c) Disability (d) Liability and Incidental Medical Expense (e) Automobile and Aircraft (f) Fidelity (g) Surety (j) Credit (k) Worker’s Compensation (l) Legal Expense (m) Credit Unemployment (n) Miscellaneous The company’s operations are coordinated from the home office of United National Insurance Company in Bala Cynwyd, Pennsylvania. The company has no employees of its own. All operations of the company are conducted with staff provided by United National Insurance Company, numbering 387 employees at year-end 2007. United National Insurance Company initially pays nearly all expenses on the company's behalf, except for claims, premium refunds, custodial fees, and bank charges. Accordingly, intercompany balances are created in the ordinary course of business, with settlements made monthly. Salaries, payroll taxes, travel and related items, office rent, and meals and entertainment not otherwise allocated to travel and related items are allocated among the three insurers of the United National Group. Such expenses are allocated under the Pool Reinsurance Agreement based on the company’s participation. All other expenses are allocated on the basis of specific identification. 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.
7
Line of Business Fire Allied lines Farmowners multiple peril Homeowners multiple peril Commercial multiple peril Inland marine Other liability - occurrence Other liability - claims made Products liability - occurrence Auto physical damage Surety Burglary and theft Total All Lines $
Direct Premium 659,819 143,087 148,834 753,260 13,110,491 1,035,296 8,069,745 1,302,390 124,207
Reinsurance Assumed $ 539,492 254,519 59,271 20,919 1,979,150 618,950 1,939,002 1,348,471 177,940 8 (567) 55 $6,937,210
Reinsurance Ceded $ 659,818 143,087 148,833 753,259 13,110,493 1,035,296 8,069,744 1,302,391 124,206
Net Premium $ 539,493 254,519 59,272 20,920 1,979,148 618,950 1,939,003 1,348,470 177,941 8 (567) 55 $6,937,212
$25,347,129
$25,347,127
8
III. MANAGEMENT AND CONTROL Board of Directors The board of directors consists of seven members. All of the directors are elected annually to serve a one-year term. Officers are elected at the shareholder's annual meeting and from time to time vacancies may be filled via unanimous shareholder consent as needed. Members of the company's board of directors may also be members of other boards of directors in the holding company group. The board members do not receive any compensation specific to their service on the board. Currently the board of directors consists of the following persons:
Name and Residence Stephen A. Cozen Villanova, Pennsylvania Charles F. Barr Ridgefield, Connecticut
Principal Occupation Attorney, Partner of Cozen & O’Conner Law Firm Senior Vice President, General Counsel and Secretary of United America Indemnity Ltd. President & CEO of United America Indemnity Ltd. Senior Vice President, General Counsel and Secretary of United America Indemnity Ltd. President of Penn America Group
Term Expires 2009
2010*
Larry A. Frakes West Chester, :Pennsylvania Richard S. March Voorhees, New Jersey
2009
2008*
Raymond H. McDowell Medford, New Jersey Thomas M. McGeehan King of Prussia, Pennsylvania David J. Myers West Chester , Pennsylvania Jeffery S. Reynolds Cornelius, North Carolina
2009
Interim CFO of United America Indemnity Ltd. President of Diamond State Insurance Co.
2009
2009
President of United National Group
2009
* Mr. March resigned at the end of 2008 and Mr. Barr was appointed effective February 2, 2009, to replace him.
9
Officers of the Company The primary officers who were elected by the board of directors and serving at the time of this examination are listed below. These officers are compensated by an upstream affiliate and their compensation is allocated among affiliates. The amount listed is their total gross salary before allocation. 2007 Compensation $275,000* 585,208 219,063 351,856 354,205
Name David J. Myers Richard S. March Linda C. Hohn** Joseph M. Boyle Thomas M. McGeehan**
Office President Secretary before January 1, 2009 Secretary after January 1, 2009 Treasurer before January 1, 2009 Interim Treasurer after January 1, 2009
* Mr. Myers was hired in November 2007and this is his annual base salary as of December 31, 2007. ** In January 2009, Ms. Hohn replaced Mr. March as Secretary and Mr. McGeehan replaced Mr. Boyle as Interim Treasurer. Committees of the Board The company's bylaws allow for the formation of certain committees by the board of directors. The committees at the time of the examination are listed below:
Executive Committee Larry A. Frakes David J. Meyers Jeffery S. Reynolds
Finance Committee Larry A. Frakes David J. Meyers Thomas M. McGeehan
10
IV. AFFILIATED COMPANIES United National Specialty Insurance Company is a member of a holding company system. United America Indemnity, Ltd., (UAI) is domiciled in the Cayman Islands and was organized by Fox Paine & Company (Fox Paine) for the purpose of acquiring its U.S. operations, which include Wind River Investment Corporation (WRIC) and its subsidiaries. On September 5, 2003, Fox Paine made a capital contribution of $240 million to United National Group, Ltd., in exchange for 10.0 million Class B common shares and 14.0 million Series A preferred shares. Of this capital contribution, $100 million was used to purchase a portion of the common stock of WRIC from a group of family trusts affiliated with the Ball family of Philadelphia, Pennsylvania. Subsequent to September 5, 2003, Wind River Reinsurance Company, Ltd. (WRRC), United America Indemnity Group, Inc. (UAIG), American Insurance Service, Inc. (AIS), and United National Insurance Company (UNIC), an insurance company domiciled in Pennsylvania, are 100% directly or indirectly owned by UAI. UNIC owns 100% of the common stock of Diamond State Insurance Company (DSIC), an insurance company domiciled in Indiana, who in turn owns 100% of the common stock of United National Specialty Insurance Company and United National Casualty Insurance Company, an insurance company domiciled in Indiana. The organizational chart below depicts the relationships among the affiliates in the group. A brief description of the significant affiliates follows the organizational chart.
11
Organizational Chart As of December 31, 2008
Fox Paine International GP, Ltd. (Cayman Exempted Company) (1)
Fox Paine Capital International GP, L.P. (Cayman Exempted Limited Partnership) (GPLP) (2) (3) Fox Paine Capital Fund II International, L.P. (Cayman Exempted Limited Partnership) (“Fund II”) (3) (4) U.N. Holdings (Cayman), Ltd. (5) United America Indemnity, Ltd. (Cayman Islands) EIN 98-0417107 (6) Wind River Reinsurance Company, Ltd (Bermuda)" EIN 98-0417111 U. A. I. (Luxembourg) I-IV and Investment Companies S.a.r.l. (7) United America Indemnity Group Inc. (DE) EIN 20-0184863 American Insurance Service, Inc. (PA) EIN 23-1892331 United National Insurance Company (PA) EIN 23-1581485 Diamond State Insurance Company (IN) EIN 51-0257823
American Insurance Adjustment Agency, Inc. (PA) EIN 23-2119460
United National Specialty Insurance Company (WI) EIN 39-0992335
United National Casualty Insurance Company (IN) EIN 75-3031380 J.H. Ferguson and Associates, LLC (IL) EIN 43-1995656
12
Footnotes (1) Fox Paine International GP, Ltd., is the general partner of GPLP. Management and control of GPLP is vested exclusively in the general partner. Limited partners have no voting rights with respect to, and do not exercise control over, GPLP. (2) GPLP is the general partner of Fund II. Management and control of Fund II is vested exclusively in the general partner. Limited partners have no voting rights with respect to, and do not exercise control over, Fund II. (3) GPLP, Fund II and Fox Paine & Company, LLC, a Delaware limited liability company (Fox Paine LLC), are parties to a Management Agreement. Fox Paine LLC has no direct or indirect ownership of GPLP, Fund II or any other entity shown on this chart. (4) Approximately 2.3% of U.N. Holdings (Cayman), Ltd., is held through various private investment funds controlled by GPLP in its capacity as the sole shareholder of the general partner of such investment funds. (5) Approximately 32.69% of common shares of United America Indemnity, Ltd., are held directly by U.N. Holdings (Cayman), Ltd. Approximately 6.39% of the issued and outstanding common shares in United America Indemnity, Ltd., are held through various private investment funds controlled by GPLP in its capacity as the sole shareholder of the general partner of such investment funds. (6) United National Group, Ltd., is a publicly traded company. There are no shareholders that directly or indirectly own 10% or more of its shares other than as shown. (7) U.A.I (Luxembourg) I-IV & Investment Sarl consists of U.A.I. (Luxembourg) Investment Sarl & Wind River (Luxembourg) Sarl, both of which are owned by U.A.I. (Luxembourg) IV Sarl which is owned by U.A.I. (Luxembourg) III Sarl which is owned by U.A.I. (Luxembourg) II Sarl which is owned by U.A.I (Luxembourg) I Sarl which is owned by Wind River Reinsurance Company Ltd.
Due to the number and variety of interests controlled by Fox Paine International GP, Ltd., this report will confine its narrative of specific entities to parents in the direct succession of control of United National Specialty Insurance Company. With the exception of certain members of its reinsurance pool, UNSIC does not have significant reinsurance, investment, or service relationships with any affiliate that is not in its succession of control. United America Indemnity Group, Inc. United America Indemnity Group, Inc., (UAIG) was incorporated under the laws of Delaware on June 2, 1972. It functions as a holding company. UAIG’s insurance subsidiaries write property and casualty insurance lines, on both a surplus lines and admitted basis. As of December 31, 2007, UAI, the indirect 100% owner of UAIG, had consolidated audited financial statement reported assets of $2,775,172,000, liabilities of $1,938,896,000, and stockholder’s equity of $836,276,000. Operations for 2007 produced a net income of $98,917,000.
13
American Insurance Services, Inc. American Insurance Service, Inc., (AIS) was incorporated under the laws of Pennsylvania on June 2, 1972. It functions as a holding company. AIS’s insurance subsidiaries write property and casualty insurance lines on both a surplus lines and admitted basis. As of December 31, 2007, the company's audited financial statement reported assets of $2, 526,545,000, liabilities of $1, 849,623,000, and stockholder’s equity of $676,922,000. Operations for 2007 produced a net income of $43,869,000. United National Insurance Company United National Insurance Company (UNIC) was incorporated under the laws of Pennsylvania on May 27, 1960, and commenced business on December 31, 1960. UNIC writes property and casualty insurance, primarily on a surplus lines basis. UNIC is licensed only in Pennsylvania, but is an eligible surplus lines insurer in every other state, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. As of December 31, 2007, the company's audited financial statement reported assets of $773,995,700, liabilities of $321,450,912, and capital and surplus of $452,544,788. Operations for 2007 produced a net income of $46,922,622. Diamond State Insurance Company Diamond State Insurance Company (DSIC) was incorporated under the laws of Delaware on February 20, 1981, and commenced business on April 1, 1982. On July 13, 1992, DSIC redomesticated from Delaware to Indiana. DSIC is authorized to write property and casualty insurance on an admitted basis in all 50 states and the District of Columbia. As of December 31, 2007, the company's audited financial statement reported assets of $184,591,152, liabilities of $63,899,323, and capital and surplus of $120,691,829. Operations for 2007 produced a net income of $6,178,975 United National Casualty Insurance Company United National Casualty Insurance Company (UNCIC) was incorporated under the laws of Indiana on August 24, 2001, and commenced business on June 6, 2002. UNCIC is
14
authorized to write property and casualty insurance on an admitted basis in 33 states. In addition, UNCIC is an eligible surplus lines insurer in Pennsylvania. As of December 31, 2007, the company's audited financial statement reported assets of $38,026,317, liabilities of $12,572,861 and capital and surplus of $25,453,456. Operations for 2007 produced net income of $2,186,881. Agreements with Affiliates UNSIC’s operations are coordinated from the home office of UNIC, in Bala Cynwyd, Pennsylvania. The company has no employees of its own. All day-to-day operations are conducted with staff provided by UNIC in accordance with the business practices and internal controls it maintains with respect to its employees. In addition to common staffing and management control by UNIC, UNSIC’s relationship to its affiliates is affected by the following written agreements. Reinsurance agreements are described in the reinsurance section of this report. A brief summary of the other agreements follows. Cost Allocation Agreement A cost allocation agreement, dated January 25, 2005, by and among the affiliates of UAIG covers facilities, operational services, cost allocation, billing and settlement. Each month each party provides supporting documentation of the charges to its affiliate to be paid within 30 days of the end of each month. The business and affairs of all affiliates are to each be managed by their respective boards of directors and by their respective designated officers. In the event of any disagreement, the determination of the Group’s independent certified public accountants shall be final and binding. This agreement may be terminated at any time by any party giving 30 days’ written notice, provided that each affiliate will have the right to continue to receive data processing services or to utilize data processing facilities and related software for up to one year from the date of notice. This agreement shall be subject to negotiation at least once every three years. Upon termination, each party will deliver to the others all books and records deemed to be the property of the others.
15
Reinsurance Trust Agreement On January 1, 2004, Wind River Reinsurance Company (WRRC) [f/k/a Wind River Insurance Company (WRIC)], as grantor, United National Specialty Insurance Company (UNSIC), as beneficiary, and Wachovia Bank, N.A., as trustee, entered into a reinsurance trust agreement. Under the terms of the reinsurance trust agreement, WRRC is to maintain, in trust, securities or cash, as permitted investments by the state of Wisconsin, with a valuation equal to the total of the unearned premium reserve, loss and loss adjustment expense reserve, and the reserve for incurred but not reported losses carried on UNSIC’s books as constituting the accounts reinsured by WRRC. UNSIC has the right to withdraw assets from the trust account at any time, without notice to the grantor, upon presentation of written notice to the trustee. UNSIC is under a contractual obligation to apply any assets withdrawn from the account only for the following purposes: a. To pay or reimburse UNSIC for WRRC’s share under the reinsurance agreement regarding any losses and allocated loss expenses paid or payable by UNSIC, but not recovered from WRRC, or for unearned premiums due to UNSIC, if not otherwise paid by WRRC. b. To make payment to WRRC of any amounts held in the trust account that exceed 104% of the actual amount required to fund WRRC’s obligations as provided by the reinsurance trust agreement. c. When UNSIC has received notice of termination of the trust account, and when WRRC’s entire obligations remain unliquidated and undischarged ten days prior to such termination date, to withdraw amounts equal to such obligations and deposit such amounts in a separate account, in UNSIC’s own name, in any United States bank or trust company, apart from its general assets, in trust for such uses and purposes specified in a. and b. above to the extent not theretofore satisfied.
The purpose of the reinsurance trust agreement is to forestall the need for UNSIC to establish provisions for reinsurance as required by statutory accounting principles in the absence of such collateral. Various state laws penalize reinsurance credits due from reinsurers not licensed or otherwise approved in their jurisdiction, regardless of the specific reinsurer’s financial integrity. Tax Allocation Agreement UNSIC has participated in a tax-sharing agreement since July 1, 1997. The company currently participates in a January 25, 2005, tax-sharing agreement with UAIG (fka U.N. Holdings
16
II, Inc.), and its subsidiaries whereby the federal tax liability determined at the end of the taxable year of any individual insurer member of the affiliated group shall not be more than it would have paid if it had filed on a separate return basis. Intercompany tax balances are settled with payments made within 30 days of the filing of the affiliated groups return and refunds paid within 30 days after receipt of tax refund. Current participating companies include: AIS, UNIC, DSIC, UNSIC, UNCIC, American Insurance Adjustment Agency, Inc., International Underwriters, Inc., J.H. Ferguson and Associates, LLC, Penn-America Group, Inc., Penn-America Insurance Company, Penn-Star Insurance Company, Penn-Patriot Insurance Company, and Penn Independent Corporation.
17
V. REINSURANCE All voluntary contracts reviewed by examiners contained proper insolvency provisions. Involuntary arrangements, such as mine subsidence funds have provisions deemed appropriate by the governmental authorities that establish and administer them. Significant treaties and arrangements are summarized as follows. Affiliated Pooling Agreement United National Specialty Insurance Company participates in a pooling arrangement with certain of its affiliates. After external and affiliate quota share reinsurance, the pool participants cede 100% of their net premiums written, losses, loss adjustment expenses, underwriting expenses and related balance sheet categories to United National Insurance Company. UNIC, as the lead company and pool manager, administers all aspects of the pooled business. UNIC distributes the net pooled business according to the participations listed below. Income and expenses related to investment operations and corporate taxes, including federal income taxes, are not included in pooling. Participations: 12/31/2007 United National Insurance Company Diamond State Insurance Company United National Specialty Insurance Company United National Casualty Insurance Company Total Lines covered: Items included: 80.0% 10.0 5.0 5.0 100.0% 4/1/2008 80.0% 10.0 5.0 5.0 100.0%
All the net retained business on policies written. Net premiums written and earned, losses, loss adjustment expenses, underwriting expenses, salvage and subrogation recoveries, assessments, taxes, and policyholder dividends April 1, 2008, continuous to present At any time with 90 days’ written notice by any party. Each participant shall remain liable with respect to all cessions in force on the effective date of termination. Any dispute arising out of this agreement shall be settled through arbitration. No amendments at this time
Effective: Termination:
Additional comments:
18
Pre-Pool Reinsurance Program Affiliated Ceding Contracts 1. Type: Reinsurer: Scope: 50% Quota Share Wind River Reinsurance Company, Ltd All net retained liability as respects losses occurring and/or claims made under policies in force at the inception of this contract or renewed during the term of this contract. 50% of the losses occurring and/or claims made under policies in force at the inception of this contract or renewed during the term of this contract 50% of the losses occurring and/or claims made under policies in force at the inception of this contract or renewed during the term of this contract. The company will cede to the reinsurer its proportionate share of the net subject premium and unearned premium on all policies in force at the inception of this contract. 37% provisional ceding commission offset with a final calculated adjusted ceding commission equal to the company’s acquisition costs on business plus 4.5% within 90 days following the end of each calendar year. January 1, 2007, continuous to present Either party may terminate this contract with not less than 90 days’ prior written notice. Upon termination the reinsurer will remain liable for all policies in force at the termination date until the first anniversary date, date of cancellation or natural expiration date, whichever occurs first, plus odd time, if any, not to exceed 24 months, plus the period of discovery allowed.
Retention:
Coverage:
Premium:
Commissions:
Effective: Termination:
Non-Affiliated Ceding Contracts 2. Type: Reinsurers: Casualty Clash Excess of Loss As of January 1, 2008, participation was as follows: Percentage Munich Reinsurance America, Inc Transatlantic Reinsurance Company Total Scope: 65.0% 35.0 100.0%
Casualty, professional liability, umbrella and following form excess liability business. The first $3,000,000 of ultimate net loss per occurrence
Retention:
19
Coverage:
Ultimate net loss up to $10,000,000 in excess of $3,000,000 per loss occurrence, with an annual aggregate limit of $20,000,000. Loss occurrences relating to acts of terrorism are limited to a $10,000,000 annual aggregate. Annual deposit premium of $1,750,000 paid in quarterly installments; annual minimum premium of $1,500,000, subject to adjustment at the rate of 0.4973% of subject gross earned premium None January 1, 2008 The contract is scheduled to expire on January 1, 2009. Either party may terminate this contract with not less than 90 days’ prior written notice. Upon termination the reinsurer will remain liable for all policies in force at the termination date until the first anniversary date, date of cancellation or natural expiration date, whichever occurs first, plus odd time, if any, not to exceed 24 months, plus the period of discovery allowed. Guy Carpenter & Company is recognized as the intermediary. Payments by the company to the intermediary shall be deemed to constitute payment to the reinsurer. Payments by the reinsurer to the intermediary shall be deemed to constitute payment to the company only to the extent that such payments are actually received by the company. Other reinsurance coverage’s required. Casualty Excess of Loss As of May 1, 2008, participation was as follows: Percentage Munich Reinsurance America, Inc Transatlantic Reinsurance Company Total 50.0% 50.0 100.0%
Premium:
Commissions: Effective date: Termination:
Additional comment:
3.
Type: Reinsurers:
Scope:
Small business including liquor liability and hired and non-hired auto, specialty products, monoline liquor liability and general casualty business of the company. Maximum policy limits are Small Business and Bike Dealers & Manufacturers - $3,000,000, Health Clubs & Day Spas and Home Medical Equipment $2,000,000. The first $750,000 of losses and LAE per occurrence Losses occurring on small business up to $2,250,000 in excess of $750,000 per loss occurrence. Loss occurrences relating to acts of terrorism are limited to a $6,750,000 annual aggregate. Annual deposit premium of $11,574,429 less ceding commission paid in quarterly installments; annual minimum premium of
Retention: Coverage:
Premium:
20
$8,925,943 subject to adjustment at the rate of 5.11% of subject gross net earned premium less ceding commission Commission: Effective date: Termination: 32.5% ceding commission May 1, 2008, continuous to present Either party may terminate this contract with not less than 90 days’ prior written notice. Upon termination the reinsurer will remain liable for all policies in force at the termination date until the first anniversary date, date of cancellation or natural expiration date, whichever occurs first, plus odd time, if any, not to exceed 12 months, plus the period of discovery allowed. Towers Perrin Forester & Crosby, Inc., is recognized as the intermediary. Payments by the company to the intermediary shall be deemed to constitute payment to the reinsurer. Payments by the reinsurer to the intermediary shall be deemed to constitute payment to the company only to the extent that such payments are actually received by the company. Identity Recovery Coverage Quota Share The Hartford Steam Boiler and Inspection Insurance Company All business classified by the company as identity recovery coverage. No retention Coverage is 100% quota share, with the cession limited to a $15,000,000 annual aggregate $9.25 per each identity recovery insured less ceding commissions 35.0% of each policy’s reinsurance premium June 1, 2007, continuous to present The company may terminate the participation of any reinsurer with 120 days’ prior written notice provided that the reinsurer shall continue to be bound for the balance of the term of all policies which remain in force. Property Per Risk Excess of Loss (multiple layer) As of January 1, 2008, participation was as follows: Percentage Munich Reinsurance America, Inc Transatlantic Reinsurance Company Total 65.0% 35.0 100.0%
Additional comments:
4.
Type: Reinsurer: Scope:
Retention: Coverage:
Premium:
Commissions: Effective date: Termination:
5. Type: Reinsurers:
21
Scope:
Business classified by the company as the following property business – small business (includes garage keepers’ legal liability coverage), class specific products, property brokerage and dealers open lot First Excess Layer - Ultimate losses occurring up to $1,000,000 of each and every risk. Second Excess Layer - Ultimate losses occurring up to $5,000,000 of each and every risk.
Retention:
Coverage:
First Excess Layer - 100% of $4,000,000 ultimate net loss each and every risk, each and every loss in excess of $1,000,000, subject to a limit of liability to the reinsurer of $4,000,000 ultimate net loss in the aggregate on all risks involved in one occurrence. Second Excess Layer - 100% of $10,000,000 ultimate net loss each and every risk, each and every loss in excess of $5,000,000, subject to a limit of liability to the reinsurer of $10,000,000 in the aggregate on all risks involved in one occurrence.
Premium:
First Excess Layer - Annual deposit premium of $8,416,210 less ceding commission paid in quarterly installments. Second Excess Layer - Annual deposit premium of $1,577,448 less ceding commission paid in quarterly installments; annual minimum premium of $8,000,000, subject to adjustment at the rate of 1.63%,15.83%, or 0.81% of subject net earned premium depending of business type.
Commissions: Effective: Termination:
32.5% ceding commission January 1, 2008, continuous to present The company may terminate the participation of any reinsurer with 90 days’ prior written notice provided that the reinsurer shall continue to be bound for the balance of the term of all policies which remain in force. Amended April 15, 2008, to include excess business and dealer open lot business Professional Liability Excess of Loss (multiple layers) As of January 1, 2008, participation was as follows: Participation Second Layer 7.5% 57.5 35.0 100.0%
Additional comment:
6. Type: Reinsurers:
Reinsurer Ace Property & Casualty Insurance Company Munich Reinsurance America, Inc. Transatlantic Reinsurance Company Total
First Layer 7.5% 57.5 35.0 100.0%
Third Layer 7.5% 57.5 35.0 100.0%
22
Scope:
All business classified as professional liability and/or errors and omissions and/or directors and officers business and/or general liability and/or automobile liability written by the company’s Public Entity, Social Services, Real Estate Errors and Omissions, Allied Health Care, Standard and Non-Standard Lawyers, Insurance Agents Errors and Omissions, Chiropractors, Miscellaneous Errors and Omissions and Non-Public Directors and Officers units. First Excess Layer - $500,000 of ultimate net loss each and every policy, each and every coverage part, each and every occurrence or each and every claim or each and every wrongful or negligent act. Second Excess Layer - $1,000,000 of ultimate net loss each and every policy, each and every coverage part, each and every occurrence or each and every claim or each and every wrongful or negligent act. As respects Public Entity business emanating from the state of New Mexico the retention is $1,050,000 of ultimate net loss each and every policy, each and every coverage part, each and every occurrence or each and every claim or each and every wrongful or negligent act. Third Excess Layer - $5,000,000 of ultimate net loss each and every policy, each and every coverage part, each and every occurrence or each and every claim or each and every wrongful or negligent act.
Retention:
Coverage:
First Layer - $500,000 of ultimate net loss each and every policy, each and every coverage part, each and every occurrence or each and every claim or each and every wrongful or negligent act in excess of the company’s $500,000 retention, except for Public Entity business emanating from the state of New Mexico where coverage is $550,000 ultimate net loss each and every policy, each and every coverage part, each and every occurrence or each and every claim or each and every wrongful or negligent act in excess of the company’s retention of $500,000 Second Layer - $4,000,000 of ultimate net loss each and every policy, each and every coverage part, each and every occurrence or each and every claim or each and every wrongful or negligent act in excess of the company’s $1,000,000 retention, except for Public Entity business emanating from the state of New Mexico where coverage is $4,000,000 ultimate net loss each and every policy, each and every coverage part, each and every occurrence or each and every claim or each and every wrongful or negligent act in excess of the company’s retention of $1,050,000. Third Layer - $5,000,000 of ultimate net loss each and every policy, each and every coverage part, each and every occurrence or each and every claim or each and every wrongful or negligent act in excess of the company’s $5,000,000 retention. The company shall have a 10% share in the interests and liabilities under this third excess layer only.
23
Premium:
First Layer - Annual deposit premium of $6,640,432 paid in quarterly installments; annual minimum premium of $5,150,000, subject to adjustment at the rate of 9.95% of subject net written premium. Second Layer - Quarterly calculation and payment of an adjusted reinsurance premium per cession factors listed in the contract multiplied by the company’s net written premium. Third Layer - Quarterly calculation and payment of an adjusted reinsurance premium per cession factors listed in the contract multiplied by the company’s net written premium
Commissions: Effective: Termination:
None January 1, 2008, continuous to present The company may terminate the participation of any reinsurer with 120 days’ prior written notice Guy Carpenter & Company is recognized as the intermediary. Payments by the company to the intermediary shall be deemed to constitute payment to the reinsurer. Payments by the reinsurer to the intermediary shall be deemed to constitute payment to the company only to the extent that such payments are actually received by the company. Property Catastrophe Excess of Loss (Multiple Layers) As of June 1, 2008, participation was as follows: Participation Second Layer 0.00% 0.00 7.50 0.00 12.50 1.00 8.50 20.00 12.00 15.00 7.00 0.00 5.00 11.50 0.00 100.00%
Additional comment:
7. Type: Reinsurers:
Reinsurer Allied World Assurance Company Ariel Reinsurance Company Ltd. Catlin Insurance Company DaVinci Reinsurance Ltd. Flagstone Re Hannover Re IPCRe Limited Underwriters at Lloyds Syndicates Montpelier Reinsurance Limited Munich Reinsurance America, Inc Odyssey America Reinsurance Corporation Renaissance Reinsurance Ltd. Transatlantic Reinsurance Company Validus Reinsurance, Ltd. XL Re Total
First Layer 0.00% 3.50 9.00 0.00 12.50 1.00 5.50 20.00 11.00 15.00 7.00 0.00 5.00 10.50 0.00 100.00%
Third Layer 5.00% 8.25 4.00 1.00 9.00 1.75 6.50 12.50 12.00 15.00 7.00 1.00 7.00 5.00 5.00 100.00%
24
Scope:
All business classified by the company as property business including, but not limited to, fire, allied lines, inland marine, commercial multiple peril, business owners, commercial and private passenger automobile physical damage. First Layer - The first $10,000,000 of ultimate net losses per occurrence. Second Layer - The first $15,000,000 of ultimate net losses per occurrence. Third Layer - The first $30,000,000 of ultimate net losses per occurrence.
Retention:
Coverage:
First Layer - $5,000,000 ultimate net loss in excess of the company’s retention of $10,000,000 of ultimate loss. The reinsurer’s limit of liability will be no more that $10,000,000 of ultimate net loss for all occurrences during the term of the contract. Second Layer - $15,000,000 ultimate net loss in excess of the company’s retention of $15,000,000 of ultimate net loss. The reinsurer’s limit of liability will be no more that $30,000,000 of ultimate net loss for all occurrences during the term of the contract. Third Layer - $50,000,000 ultimate net loss in excess of the company’s retention of $30,000,000 of ultimate net loss. The reinsurer’s limit of liability will be no more that $100,000,000 of ultimate net loss for all occurrences during the term of the contract.
Premium:
First Layer - Annual deposit premium of $1,450,000 paid in quarterly installments; annual minimum premium of $1,160,000, subject to adjustment at the rate of 0.8698% of subject net written premium. Second Layer - Annual deposit premium of $2,512,500 paid in quarterly installments; annual minimum premium of $2,010,000, subject to adjustment at the rate of 1.5071% of subject net written premium. Third Layer - Annual deposit premium of $4,125,000 paid in quarterly installments; annual minimum premium of $3,300,000, subject to adjustment at the rate of 2.4744% of subject net written premium.
Commissions: Effective: Termination: Additional comment:
None June 1, 2008 The contract is scheduled to expire on June 1, 2009. Towers Perrin Forester & Crosby, Inc., is recognized as the intermediary. Payments by the company to the intermediary shall be deemed to constitute payment to the reinsurer. Payments by
25
the reinsurer to the intermediary shall be deemed to constitute payment to the company only to the extent that such payments are actually received by the company. 8. Type: Reinsurer: Scope: Statutory Mine Subsidence Insurance Coverage Illinois Mine Subsidence Insurance Fund Required by statue to be available in certain counties in Illinois for commercial and residential property insurance to cover damage by mine subsidence Deductibles determined by the fund Up to 100% of the statutory limits which currently are $750,000 for residential coverage, $350,000 for commercial coverage, and $15,000 for living unit coverage 100% of the premium for business written and classified by the company as mine subsidence insurance Ceding commissions determined by the fund July 1, 2008 July 1, 2010, or upon the repeal of the statute Boiler & Machinery Breakdown Reinsurance The Travelers Indemnity Company 100% of all business written and classified by the company as specialty products equipment breakdown insurance Minimum deductibles of $1,000 100% of the losses occurring and/or claims made under policies in force at the inception of this contract or renewed during the term of this contract with limits of liability for property damage up to $50,000,000 and business income/extra expense coverage up to $10,000,000. 100% of the premium for business written and classified by the company as specialty products equipment breakdown insurance 36% ceding commission January 1, 2008, continuous to present The company may terminate the participation of any reinsurer with 90 days’ prior written notice
Retention: Coverage:
Premium:
Commissions: Effective: Termination: 9. Type: Reinsurer: Scope:
Retention: Coverage:
Premium:
Commissions: Effective: Termination:
26
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."
27
United National Specialty Insurance Company Assets As of December 31, 2007 Net Admitted Assets $69,613,075 1,867,332 3,262,800 91,891 535,795 2,089,678 3,224,195 716,607 591,462 630,710 6,184 1,310,993 53,684 $1,306,086 298,614 $82,986,934
Assets Bonds Preferred stock Cash Write-ins for invested assets: Cash in trust Premiums and agents' balances in course of collection Reinsurance recoverable on loss and loss adjustment expense payments Federal and foreign income tax recoverable and interest thereon Interest, dividends, and real estate income due and accrued Guaranty funds receivable or on deposit Receivable from parent, subsidiaries, and affiliates Aggregate write-ins for other than invested assets Total Assets $69,613,075 1,867,332 3,262,800 91,891 2,625,473 3,224,195 1,308,069 630,710 6,184 1,310,993 352,298 $84,293,020
Nonadmitted Assets $
28
United National Specialty 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) Current federal and foreign income taxes Unearned premiums Ceded reinsurance premiums payable (net of ceding commissions) Remittances and items not allocated Provision for reinsurance Drafts outstanding Payable to parent, subsidiaries, and affiliates Total liabilities Common capital stock Gross paid in and contributed surplus Unassigned funds (surplus) Surplus as regards policyholders Total Liabilities and Surplus $ 4,200,000 28,631,583 26,732,103 59,563,686 $82,986,935 $12,315,713 382,376 5,303,126 47,292 48,152 400,310 2,408,902 770,394 862,557 10,288 677,191 196,948 23,423,249
29
United National Specialty 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 gain or (loss) Investment Income Net investment income earned Net realized capital gains or (losses) Net investment gain or (loss) Other Income Net gain or (loss) from agents' or premium balances charged off Write-ins for miscellaneous income: Miscellaneous income Total other income Net income (loss) after dividends to policyholders but before federal and foreign income taxes Federal and foreign income taxes incurred Net Income
$7,491,185
$2,957,125 2,918,797 303,151 6,179,073 1,312,112
3,660,100 98,693 3,758,793
887 47,132 48,019
5,118,924 1,501,546 $3,617,378
30
United National Specialty 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 (recovered) Total deductions Net cash from operations Proceeds from investments sold, matured, or repaid: Bonds Miscellaneous proceeds 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: Dividends to stockholders 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 $ 12,625,887 3,536,742 48,019 16,210,648 $ 3,954,022 2,665,780 772,906 7,392,708 8,817,940
$16,440,579 (48) 16,440,531
29,038,996 1,875,000 31,911 30,945,907 (14,505,376)
1,400,000 (906,859) (2,306,859)
(7,994,295)
11,257,095 $ 3,262,800
31
United National Specialty Insurance Company Compulsory and Security Surplus Calculation December 31, 2007 Assets Less liabilities Adjusted surplus Annual premium: Lines other than accident and health Factor Total Compulsory surplus (subject to a minimum of $2 million) Compulsory surplus excess (or deficit) $82,986,934 23,423,249 59,563,685
$6,937,212 20% $1,387,442
2,000,000 $57,563,685
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)
$59,563,685
2,800,000 $56,763,685
After reviewing the company’s Compulsory and Security Surplus Calculation submitted in accordance with s. Ins 51.80, Wis. Adm. Code, for the period ending December 31, 2007, it was determined that the company was computing the Compulsory and Security Surplus incorrectly. The error had no material effect on the outcome as the company has more than sufficient Total Compulsory Surplus Excess and Total Security Surplus Excess. After the error was pointed out, the company made the necessary correction during the on-site portion of the examination and reported the company’s Compulsory and Security Surplus correctly during their third quarter 2008 submission.
32
United National Specialty 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 Net unrealized capital gains or (losses) Change in net deferred income tax Change in nonadmitted assets Change in provision for reinsurance Dividends to stockholders Surplus, end of year $56,693,712 3,617,378 (4,984) (349,791) 979,400 27,972 (1,400,000) $59,563,687 49,736 (616,311) (27,381) (1,000,000) $56,693,712 (49,731) (205,993) 23,319 (1,000,000) $54,781,017 (249,682) 11,762 (34,199) 2006 $54,781,017 3,506,651 2005 $53,406,567 2,606,855 2004 $50,827,016 2,851,670 2003 $47,852,417 2,534,996 99,990 (141,466) 481,079
$53,406,567
$50,827,016
United National Specialty Insurance Company Insurance Regulatory Information System For the Five-Year Period Ending December 31, 2007 The company’s NAIC Insurance Regulatory Information System (IRIS) results for the period under examination are summarized below. 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 54% 12 5 0 29 5.2 5 5 31 4 1 (1) 6 2006 99% 12 9 1 36 5.1 3 3 40 15 (2) (3) 5 2005 108% 11 55* 2 46 3.8 3 3 45 14 (1) (1) 0 2004 126% 7 -62* 2 62 3.2* 5 43 14 0 3 (23) 2003 146% 20 -31 4 102* 3.6* 5 54 9 0 17 (20)
Ratio No. 3 measures the company’s change in net premiums written from the previous year period. Since the change in ownership in 2003, changes in the affiliate reinsurance pooling agreement coupled with the company entering into an affiliated 50% quota share
33
reinsurance agreement in 2004 have caused a significant decline in net premium written affecting the ratios for 2004 and 2005. Ratio No. 5 measures the company’s profitability over the previous two-year period. The exceptional results in 2003 for this ratio were impacted by the following: The 2002 conclusion of the arbitration with Riunione Adriatica Di Sicurta with a financial impact which exceeded the pool’s reserve by $10 million. The company received 10% of this charge. As of September 30, 2002, the pool also recorded reserve strengthening of $7.8 million resulting from more adverse than expected development on accident years 2001 and prior. The company received 10% of this charge. The company received a capital contribution of $20.0 million in 2002. Ratio No. 6 measures the company’s investment yield during the year. The exceptional results in 2003 and 2004 were due to the company’s portfolio consisting largely of tax exempt bonds and cash and the company’s receipt of a $20 million capital contribution during the second quarter of 2002. Tax exempt bonds typically have lower yields than taxable bonds; however, they yield a greater return on an after-tax basis. The capital contribution lowered computed yield due to the method of computing average investments.
Growth of United National Specialty Insurance Company Surplus as Regards Policyholders $59,563,687 56,693,712 54,781,017 53,406,567 50,827,016 47,852,417
Year 2007 2006 2005 2004 2003 2002
Admitted Assets $82,986,934 84,018,882 86,908,254 85,923,803 97,152,853 84,943,282
Liabilities $23,423,249 27,325,171 32,127,237 32,517,236 46,325,837 37,090,865
Net Income $ 3,617,378 3,506,651 2,606,855 2,851,670 2,534,996 (2,216,346)
Year 2007 2006 2005 2004 2003 2002
Gross Premium Written $32,284,339 56,325,331 58,947,972 67,276,106 74,317,240 66,771,760
Net Premium Written $ 6,937,212 6,626,641 6,087,324 3,921,994 10,357,673 15,042,792
Premium Earned $ 7,491,185 6,256,283 5,686,905 4,923,206 10,652,629 15,688,590
Loss and LAE Ratio 78.4% 51.2 65.2 71.8 79.5 113.9
Expense Ratio 4.1% 30.5 35.6 20.8 17.5 24.1
Combined Ratio 82.5% 81.7 100.8 92.6 97.0 138.0
34
Since the change in ownership in 2003, the company’s assets have decreased 14.5% while liabilities have decreased 49.5% primarily due to changes in the affiliate reinsurance pooling agreement in 2004. Since 2004, assets have decreased 3.4% and liabilities have decreased 28.0% while surplus increased 11.5% due to steadily increasing net income offset by several years of dividends paid. The company’s entry into an affiliated quota share reinsurance agreement in 2004 coupled with a decrease in their participation in the affiliated reinsurance pool caused the significant decline in gross premium written over the last five years while the company’s net premium written and premium earned have increased in the more recent years. The company’s loss and LAE ratio has been as high as 113.9% in 2002 and low as 51.2% in 2006 with an average over the last five years of 69.2%. Its expense ratio has been as high as 35.6% in 2005 and low as 4.0 % in 2007 but its average over the last five years is 21.7%. Its combined ratio has been as high as 138% in 2005 and low as 81.7% in 2006 but the average over the last five years is 90.9%. 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, is accepted.
35
VII. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations There was one specific comment and recommendation in the previous examination report. The comment and recommendation contained in the last examination report and actions taken by the company is as follows: 1. Custodial Agreement—It is recommended that the company amend its custodial agreement to comply with the guidelines contained in the NAIC Financial Condition Examiners Handbook with regard to segregation of securities and custodian indemnification. Action—Compliance.
36
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. Management and Control Since most of the company's directors and officers were changed since the last examination, the director and officer change notification letters sent to Wisconsin were reviewed comparing appointment dates to the notification dates. It was noted that in two instances the notifications took less than 15 days but in several instances it took approximately 22 to 25 days which is slightly more than the required 15 days. It was determined that the company had reasonable procedures in place to provide the notification within the time required; however, these procedures were not carried out on a timely basis. It is recommended that the company report biographical data relating to officers and directors in accordance with the provisions of s. Ins 6.52, Wis. Adm. Code. Investments – Custodial Agreements After reviewing the company’s investment custodian agreement, it was determined that the company had changed its agreement to conform to the language suggested by the NAIC Financial Condition Examiners Handbook. It was also noted that their custodian was purchased by another institution in 2007 but the agreement was never updated to reflect the current name of the new custodian. It is recommended that the company maintain its custodial agreement pursuant to the language suggested by the NAIC Financial Condition Examiners Handbook and update it when the custodian changes its ownership and name. Financial Reporting After reviewing and confirming the company’s assets and liabilities detail for the period ending December 31, 2007, it was determined that the company was classifying and reporting several balance sheet accounts incorrectly on the asset and liabilities pages of its annual statement. Some of the errors discovered during the examination included the following:
37
The company reported a liability of Drafts Outstanding which OCI determined should have been reported as an offset to the asset Cash, a TPA wire transfer suspense account was incorrectly reported in the Aggregate Write-In for Invested Assets account instead of the Aggregate Write-In for Other than Invested Assets account, not all subsidiary accounts were included when determining the nonadmitted portion of the reported Agent Balances account balance, a two year old tax refund was incorrectly admitted in the Aggregate Write-In for Other than Invested Assets account and an investment suspense account was incorrectly included in the Aggregate Write-In for Other Than Invested Assets account instead of the Aggregate Write-In for Invested Assets account. These errors had no material effect on the outcome of the company’s financial reporting and no reclassifications or adjustments to surplus have been made. Because the reclassifications were not material it was felt that a general recommendation would be appropriate so that the company would take a proactive aggressive approach to its review of the account mapping and classifications for its next annual statement filing. It is recommended that the company prepare the asset and liabilities pages of its annual statement, in accordance with the NAIC Annual Statement Instructions – Property and Casualty.
38
VIII. CONCLUSION The experience of the company relative to net premiums, liabilities, and net underwriting results will largely, though not precisely, follow the experience of the affiliated pool as a whole. Therefore, the practices and procedures of pool participants, especially UNIC, which manages the pool, are critical to the operating results of the company. During the years under examination, the company experienced significant decline in premium volume along with increased profitability. Since the prior examination, annual net premiums written decreased by 64% to $6.9 million in 2007, and annual net income increased by 163% from a loss of $(2.2M) in 2002 to an income of $3.6 million in 2007. During the same period, assets decreased by 2%, liabilities decreased by 37%, and surplus increased by 24%. The current examination made three recommendations. The company was in compliance with the previous exam recommendation. The examination determined that there were no material misstatements of account balances as reported by the company in its 2007 statutory financial statements and did not make any adjustments or reclassifications of reported account balances. The examination determined that as of December 31, 2007, the company had admitted assets of $82,986,934, liabilities of $23,423,249, and policyholders’ surplus of $59,563,686.
39
IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 37 - Management and Control—It is recommended that the company report biographical data relating to officers and directors in accordance with the provisions of s. Ins 6.52, Wis. Adm. Code. Page 37 - Custodial Agreement—It is recommended that the company maintain its custodial agreement pursuant to the language suggested by the NAIC Financial Condition Examiners Handbook and update it when the custodian changes its ownership and name. Page 38 - Financial Reporting—It is recommended that the company prepare the asset and liabilities pages of its annual statement, in accordance with the NAIC Annual Statement Instructions – Property and Casualty.
2.
3.
40
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 Jerry C. DeArmond Joe Hilgendorf Frederick H. Thornton Title Insurance Financial Examiner – Advanced, Data Processing Audit Specialist Insurance Financial Examiner – Advanced, Policy and Claim Reserve Specialist Insurance Financial Examiner Insurance Financial Examiner – Advanced, Exam Planning and Quality Control Specialist
Respectfully submitted,
Russell Lamb Examiner-in-Charge
41
XI. APPENDIX – SUBSEQUENT EVENTS Based on review of the annual statement Jurat pages for 2002-2007 it was noted that there had been significant turnover in the group’s directors and officers. It is important to note that the CEO presides over all insurance companies and their operations. During the period under examination the company had four Chief Executive Officers and based on the complexity and size of the United America Indemnity Group this is significant turnover which lends itself to instability and lack of leadership. As a result of CEO changes, there has also been significant turnover within the senior management team during the period under examination. Some of this turnover is attributable to the merger of Penn-America Group and UAI. Based on review of the Jurat page in the annual statements, it was noted that some of the company’s vice presidents have been retained during the exam period. The concentration of stability has previously been in legal, accounting and actuarial area. However, in 2008 the following changes have taken place: • • Mr. Kevin Tate, UAI’s Chief Financial Officer left the company after over 20 years of service and was replaced by Interim Chief Financial Officer, Mr. Thomas McGeehan. The company chose to nonrenew Mr. Boyle’s, UAI’s Senior Vice President & Treasurer, employment contract as of December 31, 2008. Mr. Boyle has been with the company since 2005 and was replaced by Interim Treasurer, Mr. Thomas McGeehan for UNSIC. The company chose to nonrenew Mr. Richard March’s, UAI’s General Counsel, employment contract as of December 31, 2008. Mr. March has been with the company since 1996 and was replaced by Mr. Charles Barr as Senior Vice President, General Counsel and Secretary of UAI and Ms. Linda Hohn as Secretary of UNSIC. Mr. Randy Lennon, Vice President of Information Technology, left UAI as of July 15, 2008, after many years of service, including his time serving Penn-America, and was immediately replaced by Ed Rafter as Chief Administrative Officer and Chief Information Officer of UAI. As of December 31, 2008, the company reported assets of $77,869,902, liabilities of $18,696,562, policyholders’ surplus of $59,173,340, and net income of $550,319. During 2008, annual direct premiums written decreased by 70.8% from $25,347,129 in 2007 to $7,406,888 in 2008. The decrease in direct premium written was primarily due to terminations of admitted New York business that did not meet the company’s profitability targets, a reduction in premiums from agents that write business in coastal catastrophe prone areas, as well as an overall increase in competition due to the current soft marketplace.
•
•
42
As of January 1, 2009, the company entered into a new reinsurance pooling agreement with the goal of: (i) combining the U.S.-domiciled insurance subsidiaries of United America Indemnity, Ltd., into one pooling arrangement from the previously existing two; and (ii) sharing proportionately among the members of the pool the results of insurance underwriting operations, reducing expenses, and broadening distribution of risk by line of insurance. After external and affiliate quota share reinsurance, the pool participants cede 100% of their net premiums written, losses, loss adjustment expenses, underwriting expenses and related balance sheet categories to United National Insurance Company. UNIC, as the lead company and pool manager, administers all aspects of the pooled business. UNIC distributes the net pooled business according to the participations listed below. Income and expenses related to investment operations and corporate taxes, including federal income taxes, are not included in pooling. Participations: 01/01/2009 United National Insurance Company Penn-America Insurance Company Diamond State Insurance Company Penn-Star Insurance Company Penn-Patriot Insurance Company United National Specialty Insurance Company United National Casualty Insurance Company Total Lines covered: Items included: 45.0% 25.0 10.0 5.0 5.0 5.0 5.0 100.0% All the net retained business on policies written Net premiums written and earned, losses, loss adjustment expenses, underwriting expenses, salvage and subrogation recoveries, assessments, taxes, and policyholder dividends January 1, 2009, continuous to present At any time with 90 days’ written notice by any party. Each participant shall remain liable with respect to all cessions in force on the effective date of termination. Any dispute arising out of this agreement shall be settled through arbitration.
Effective: Termination:
Additional comments:
43
On March 17, 2009, United America Indemnity, Inc., announced a Rights Offering and Backstop Plan. The rights issued by United America Indemnity, Inc., pursuant to the Rights Offering and Backstop Plan expired on April 6, 2009. The gross proceeds were approximately $100 million. Under the Rights Offering and Backup Plan, United America Indemnity, Inc., entered into an agreement with U.N. Holdings (Cayman) II, Ltd., whereby U.N. Holdings (Cayman) II, Ltd., purchased, subject to certain conditions, all of the Class A common shares and Class B common shares of United America Indemnity, Inc., offered and not subscribed for pursuant to the rights offering. In this way, U.N. Holdings (Cayman) II, Ltd., became an indirect intermediate controlling person of UNSIC. Within the succession of control of UNSIC, U.N. Holdings (Cayman) II, Ltd., is a direct subsidiary of Fox Paine Capital Fund II International, L.P., and is, together with U.N. Holdings (Cayman), Ltd., a parent of United America Indemnity, Inc. U.N. Holdings (Cayman) II, Ltd., was formed as an investment entity and its underlying shareholders are the same as U.N. Holdings (Cayman), Ltd. The two central reasons for the formation of U.N. Holdings (Cayman) II, Ltd., are ease of bookkeeping and tax considerations. The formation of U.N. Holdings (Cayman) II, Ltd., for the Rights Offering and Backup Plan allows for the segregation of the investment funds and acquired Class A and Class B common shares of United America Indemnity, Inc., relative to the backstop portion of the Rights Offering and Backup Plan. This segregation eases bookkeeping as the investment funds and acquired shares will not be commingled with the investment funds and Class A and Class B common shares of United America Indemnity, Inc., held by U.N. Holdings (Cayman), Ltd. The formation of U.N. Holdings (Cayman) II, Ltd., and the subsequent segregation of investment funds and shares makes it easier to establish holding periods and long- and short-term capital gains and losses.
44