Item 1. Business
General
AmerInst Insurance Group, Inc. ("AIIG" or the "Company") was incorporated under the laws of Delaware on September 9, 1987. AIIG's principal offices are located at P.O. Box 1330, Montpelier, Vermont 05601 (RR No. 3, Airport Road, Berlin, Vermont 05602).
The primary purpose for the formation and operation of AIIG and its wholly owned subsidiary, AmerInst Insurance Company ("AIIC"), was to establish, for the benefit of accounting firms which are stockholders of AIIG, an insurance company which over time can exert a stabilizing influence, primarily through the reinsurance capacity of AIIC, on the design, pricing and availability of accountants' professional liability insurance. AIIC's sole current business activity is to act as a reinsurer of professional liability insurance policies which are issued under the AICPA Professional Liability Insurance Plan ("AICPA Plan" or "Plan"). The AICPA Plan offers professional liability coverage to accounting firms in all 50 states. Currently, approximately 17,000 accounting firms are insured under the Plan. In the future, AIIC may want to expand its business, subject to obtaining any required regulatory approvals, to include the reinsurance of other lines of coverage.
The reinsurance activity of AIIC depends upon agreements entered into with outside parties. From the inception of AIIC through mid-1993, Crum and Forster Managers Corporation, through its affiliates (collectively "CFMC"), was the primary insurer for the AICPA Plan. Virginia Surety Company, Inc. ("VSC"), was a reinsurer for the AICPA Plan. AIIC was a reinsurer of VSC for the years 1989- 1993. In 1988, AIIC reinsured CFMC directly. In August 1993, the AICPA Plan endorsed the CNA insurance group as its insurance carrier, replacing CFMC as the primary insurer. AIIC then began a reinsurance relationship with CNA, taking a 10% participation of the first million dollars of liability of each policy written under the plan. Since its inception, AIIC's participation has ranged from 10% to 12.5% of the first million dollars of underlying coverage.
Third-party Managers and Service Providers
USA Risk Group, through Vermont Insurance Management, Inc., provides the day to day services necessary in the administration of AIIG's and AIIC's business.
The Country Club Bank of Kansas City, Missouri, has been engaged by AIIG for portfolio management and directs AIIG's investments pursuant to guidelines approved by AIIG's board of directors. Harris Associates L.P. has been engaged by AIIC to provide discretionary investment advice with respect to AIIC's equity investments.
Liscord, Ward & Roy, Inc., an independent casualty actuarial consulting firm, has been retained by AIIC to render advice regarding actuarial matters.
The law firms of Lord, Bissell & Brook and Altheimer & Gray have been retained to render advice on legal matters.
Johnson Lambert & Co. has been retained by AIIG as its independent auditor to audit its financial statements.
Professional Liability Coverage
The professional liability policy issued by CFMC or CNA and ultimately reinsured by AIIC (the "Policy") is a Professional Liability Company Indemnity Policy form.
The coverage provided under the Policy is on a "claims made" basis, which means the Policy covers only those losses resulting from claims asserted against the insured during the policy period. The insuring clause of the Policy, which indemnifies for losses caused by acts, errors or omissions in the insured's performance of professional accounting services for others, is in three parts:
Clause A indemnifies the accounting firm insured and any predecessor firms;
Clause B indemnifies any accountant or accounting firm while performing professional accounting services under contract with the insured;
Clause C indemnifies any former or new partner, officer, director or employee of the firm or predecessor firms.
In almost every state, the Policy provides that costs of defense and related expenses incurred in defending a claim are included within the Policy limits of liability, and payment of such items by the insurer reduces the insurer's remaining limit of liability for payment of damage awards or settlements. There are a few states in which defense costs may not be included within the Policy limit. The Plan carrier often charges additional premium to cover this exposure. Settlements are made only with the written consent of the insured. However, if the insured contests the settlement recommended by the insurer, the Policy will only cover costs that do not exceed the amount for which the claim could have been settled or the applicable limit of liability (whichever is less).
Competition
The AICPA Plan's current major competition comes from three large, established insurance companies, including the Plan's former carrier, CFMC. A number of smaller companies compete in the field, but none have significant nationwide market share. Many of these companies charge lower premiums than the Plan and may provide less coverage. The Plan's principal competitive strength is its commitment to the use of large, financially strong and experienced primary insurers which enhance the Plan's capacity to continue to be a stable and dependable source of coverage and to pay losses as they arise.
Licensing and Regulation
The rates and terms of reinsurance agreements generally are not subject to regulation by any governmental authority. This is in contrast to primary insurance policies, the rates and terms of which are regulated by various state insurance departments. As a practical matter, however, the rates charged by primary insurers place a limit upon the rates that can be charged by reinsurers.
AIIG and AIIC are subject to regulation under the insurance laws, including the insurance holding company law of Illinois, where AIIC is domiciled. If AIIC becomes licensed as an insurer in other states, AIIG and AIIC would become subject to the insurance laws in such other states as well. Insurance laws vary from state to state, but generally require insurance holding companies and their insurance subsidiaries to register and file certain reports, including information concerning their capital structure, ownership, financial condition and general business operations, and require prior approval of changes in control, payments of dividends and other intercompany transfers of assets, and transactions between insurance companies, their parents and affiliates.
State insurance holding company statutes also impose standards on certain transactions with related companies, which stipulate, among other requirements, that all transactions be fair and reasonable and that transactions exceeding specified limits receive prior regulatory approval. AIIC is required to file annual statutory statements and is subject to statutory restrictions concerning the types and quality of investments and the size of risks that it may reinsure. Additionally, AIIC is subject to financial examinations by the Illinois Department of Insurance.
AIIC's ability to pay dividends to AIIG is subject to the provisions of the Illinois insurance laws. Such laws provide that insurance companies may not pay a dividend except out of cumulative earned surplus determined in accordance with statutory insurance accounting principles. In addition, insurance companies may not pay an "extraordinary" dividend or make an "extraordinary" distribution unless thirty days' prior written notice is given to the Illinois Director of Insurance and the Director does not disapprove the proposed dividend or distribution. An "extraordinary" dividend or distribution is a dividend or distribution of cash or other property having a fair market value, which together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of: (1) 10% of the insurer's surplus as regards policyholders as of the December 31 immediately preceding the date of the dividend or distribution, or (2) 100% of its net income for the annual period ending on such preceding December 31.
Customers
AIIC's only source of income, other than its investment portfolio, is its reinsurance treaties. Without such reinsurance treaties, investment income would provide enough revenue to continue operations while the Company evaluated other reinsurance and insurance opportunities.
Employees
AIIG and AIIC have no employees. See Note D, Notes to the Consolidated Financial Statements.
Loss Reserves
For information concerning AIIC's loss reserves, changes in aggregate reserves for the last three years, and loss reserve development as of the end of each of the last ten years, see Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operation, Note A to the Consolidated Financial Statements, and Note B to the Consolidated Financial Statements.
Item 2.
Item 2. Properties
Neither AIIG nor AIIC owns or leases material properties. Substantially all of the business of AIIG and AIIC is conducted from the offices of USA Risk Group.
Item 3.
Item 3. Legal Proceedings
There are no legal proceedings to which AIIG or AIIC is a party.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
There is no established public trading market for the common stock of AIIG. AIIG's Certificate of Incorporation provides that all transfers of shares of AIIG common stock must be approved by AIIG's Board of Directors or a committee thereof. AIIG's Board of Directors has appointed a Stockholder Relations Committee for purposes of reviewing and approving applications for transfer. All transferees must meet the qualifications for Stock Ownership contained in AIIG's Stock Ownership Policy.
As of March 18, 1998, AIIG had 2,585 holders of record of its common stock. On August 28, 1995, the Board adopted a dividend policy for AIIG to pay a quarterly dividend of $0.65 per share subject to legally available funds and specific Board approval for each quarter. During 1997 and 1996, AIIG paid cash dividends of $867,735 and $869,661, respectively, representing four quarterly payments of $0.65 per share in each year. During 1995, AIIG paid two quarterly dividends of $0.65 totaling $435,412. The declaration of dividends by AIIG's Board of Directors is dependent upon AIIG's and AIIC's capacity to insure or reinsure business, profitability, financial condition, and other factors which the Board of Directors may deem appropriate. For a description of the restrictions which Illinois law imposes on AIIC's ability to pay dividends, see Item 1 above.
Item 6.
Item 6. Selected Financial Data
The following summary sets forth selected financial data with respect to AIIG for the five fiscal years ended December 31, 1997. The balance sheet and income statement data have been derived from AIIG's consolidated financial statements, which have been audited by Johnson Lambert & Co. (1994-1997) and Altschuler, Melvoin and Glasser (1993), AIIG's independent auditors. The data set forth below should be read in conjunction with the audited financial statements and notes thereto included elsewhere herein.
SELECTED FINANCIAL STATEMENT DATA
Balance Sheet Data
The accompanying 1993 financial statements have been reclassified to conform with the 1994-1997 presentation.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation
Results of Operation
Net income decreased by 36% in 1997 to $1,331,171 from $2,086,778 in 1996. Net income for 1996 decreased by 33% from $3,096,985 reported in 1995.
Premiums earned increased by 9% in 1997 to $5,852,286 from $5,386,388 in 1996. Premiums earned for 1996 decreased by 2% from $5,494,413 reported in 1995. In 1997, 1996, and 1995 premiums earned includes $720,298, $693,976 and $611,916, respectively resulting from reductions in the ultimate estimated premium ceded pursuant to retrocession agreements in effect during 1989 through mid-1993. Ultimate premiums are dependent on loss experience under the agreements and are reevaluated as ultimate losses are reevaluated. Excluding the effect of the reduction of estimated ultimate premiums ceded, 1997 premiums earned increased by 9% as compared to 1996 premiums earned, and 1995 premiums earned decreased by 4% from 1994. The increase in earned premiums in 1997 resulted from an increase in the number of insureds, attracted through a "step plan" in which new insureds are offered premium discounts for favorable loss history. The step plan was initiated during 1995, but has only recently had significant impact. The reduction in earned premiums in 1996, excluding the effect of the reduction of estimated ultimate premiums ceded, primarily reflects the increased competition in the accountants professional liability market which has placed downward pressure on premiums.
Net investment income, including realized capital gains and losses, includes amounts earned on the Company's investment portfolio, cash on deposit and funds held pursuant to reinsurance agreements. During 1995, the investments comprising funds held were released to the Company and were then placed by the Company into a trust account for the benefit of Virginia Surety Company. Net investment income increased by $178,162 or 7% in 1997 to $2,572,539 from $2,394,377 in 1996. 1996 net investment income increased by $198,926 or 9% from the $2,195,451 reported in 1995. Net investment income in 1997 includes net realized capital gains of $305,252 as compared to net realized capital gains in 1996 of $1,765, a net change of $303,487. Net realized capital losses in 1995 were $312,657. Capital losses are used to offset capital gains of prior and future years and recover related income taxes. Average invested assets including cash equivalents increased by $1,297,437 or 3% to $41,374,745 in 1997 compared to $40,077,308 in 1996. 1996 average
invested assets decreased by 2% from $40,842,132 in 1995. Investment yield including realized capital gains and losses in 1997 was 6.2% as compared to 6.0% in 1996 and 5.4% in 1995. Excluding realized gains and losses, the yield is computed at 5.50% in 1997, 6.0% in 1996 and 6.1% in 1995. The changes in the yields excluding realized gains and losses reflect the relatively stable interest rates during the last three years, combined with the effects of an increase in the portion of invested assets in equity and tax exempt securities.
Unrealized gain on investments net of tax is $1,016,956 at December 31, 1997 as compared to $424,621 at December 31, 1996. AIIG considers all of its investment portfolio to be available for sale and accordingly all investments are reported at market value, with changes in net unrealized gains and losses reflected as an adjustment to stockholders' equity. The increase in net unrealized gain as of December 31, 1997 as compared to 1996 is primarily attributable to the increase in the proportion of invested assets in equity securities which experienced significant market value increases during 1997.
The composition of the investment portfolio at December 31, 1997 and 1996 is as follows:
AIIG continues to invest in high grade debt and equity securities.
Losses and loss adjustment expenses incurred increased by 75% to $4,748,833 in 1997 from $2,717,884 in 1996. 1996 losses and loss adjustment expense increased by 83% from $1,489,667 in 1995. These amounts include favorable development of prior years' estimates of losses and loss adjustment expense of approximately $1,411,000 in 1997, $2,917,000 in 1996 and $3,307,000 in 1995. As adjustments to prior estimates of losses and loss adjustment expenses become known, such adjustments are included in current operations. AIIG's loss ratio, calculated as the ratio of losses and loss adjustment expense to premiums earned, is 81% in 1997, 50% in 1996 and 27% in 1995. The ratio calculated using only losses and loss adjustment expenses incurred for the current year (excluding the effects of favorable development and excluding reductions to retrocession premiums) is 105% in 1997, 105% in 1996, 87% in 1995.
Policy acquisition costs of $1,462,733 were expensed in 1997 as compared to $1,302,327 in 1996, an increase of 12%. Policy acquisition costs expensed in 1996 reflect an increase of 20% from $1,084,577 in 1995. Such costs as a percentage of premiums earned are 25% in 1997, 24% in 1996 and 20% in 1995, and result primarily from ceding commissions paid to ceding companies determined contractually pursuant to reinsurance agreements.
Operating and management expenses decreased by 15% in 1997 to $619,684 from $727,780 in 1996. 1996 operating and management expenses decreased by 7% from $786,037 in 1995.
The effective tax rate was 16% in 1997, 31% in 1996 and 28% in 1995. These rates differ from the statutory federal rate primarily due to the effects of tax exempt income offset by state income taxes. Gross tax exempt investment income increased by 110% in 1997 to $527,600 from $250,913 in 1996. Gross 1996 tax exempt investment income increased by 10% from $227,407 in 1995.
AIIG and its subsidiary do not have any employees. All operations of AIIG are performed by service providers and business partners, including a management company, under the direction of AIIG's Board of Directors. AIIG has undertaken an ongoing effort to evaluate and monitor the year 2000 compliance and related remediation efforts of its significant service providers and business partners. AIIG has identified CNA, the sole current reinsured of AIIG, as the most critical of such entities to AIIG's ongoing operations. CNA performs underwriting and claims administration functions for all risks currently reinsured by AIIG. CNA has informed AIIG that its target for achieving Year 2000 compliance is December 1, 1998. AIIG will continue to monitor the year 2000 compliance efforts of its service providers and business partners. AIIG does not expect to incur significant costs associated with year 2000 remediation efforts.
Liquidity and Capital Resources
The Company's cash needs consist of settlement of losses and expenses under its reinsurance treaties and funding day-to-day operations. Management expects to be able to meet these cash needs from cash flows arising from its investment portfolio. Because substantially all of the Company's assets are marketable securities, the Company has sufficient flexibility to provide for unbudgeted cash needs which may arise, without resorting to borrowing.
During 1997 and 1996, the Board of Directors declared quarterly dividends of $0.65 per share totaling $867,735 and $869,661 during 1997 and 1996 respectively. During 1995, the Board of Directors declared two quarterly dividends of $.65 per share totaling $435,412. Continuation of quarterly dividend payments is subject to the Board of Directors' continuing evaluation of the Company's level of surplus vis a vis its capacity to accept more business. It is an objective of the Company to build surplus in anticipation of the next "hard market", that is to say, the next period in which accountants' professional liability insurance becomes difficult or impossible to obtain at reasonable prices, and to retain flexibility for any future business expansions.
Due to regulatory restrictions on the payment of dividends, $18,200,893 of AIIC's separately determined GAAP basis stockholders' equity of $19,940,953 is unavailable for distribution as dividends in 1998 without prior regulatory approval.
Property/Casualty Losses and Loss Adjustment Expenses
The consolidated financial statements include the established liability for unpaid losses and loss adjustment expenses (LAE) of the Company's property/casualty (P/C) insurance operations. The liabilities for losses and loss adjustment expenses are determined using case-basis evaluations and statistical projections and represent estimates of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates are subject to the effect of trends in future claim severity and frequency. The estimates are continually reviewed, and as experience develops and new information becomes known, the liability is adjusted as necessary. Such adjustments are reflected in current operations.
The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and LAE. Future average severities are projected based on historical trends adjusted for anticipated changes in underwriting standards, policy provisions, and general economic trends. These anticipated trends are monitored based on actual development, and are modified if necessary.
The following table shows the development of the estimated liability for the previous nine years of the Company's P/C operations:
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSES DEVELOPMENT (Thousands of Dollars) Amounts prior to 1993 restated to conform with SFAS 113
The above table presents the development of balance sheet liabilities for 1988 through 1997 as of year end 1997. The top line of the table shows the original recorded unpaid liability for losses and LAE recorded at the balance sheet date for each of the indicated years.
This liability represents the estimated amount of losses and LAE for claims arising in all prior years, both paid and unpaid at the balance sheet date, including losses that had been incurred, but not yet reported, to the Company. The upper portion of the table shows the experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims.
The "cumulative redundancy (deficiency)" represents the aggregate change in the estimates over all prior years. For example, the 1994 liability has developed a $7,629,000 redundancy which has been reflected in income in subsequent years as the reserves were reestimated.
The lower section of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. For example, the 1994 year end liability was originally $21,264,000. As of December 31, 1997, the Company had paid $7,721,000 of the currently estimated $13,635,000 of losses and LAE that had been incurred for 1994 and prior years through the end of 1997; thus an estimated $5,914,000 in losses incurred through 1994 remain unpaid as of the current financial statement date.
In evaluating this information, it should be noted that each amount includes the effects of all changes in amounts for prior periods. This table does not present accident or policy year development data, which readers may be more accustomed to analyzing. Conditions and trends that have affected development of liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.
NAIC Codification of Statutory Accounting Practices
See Note F to the Consolidated Financial Statements regarding an anticipated codification of statutory accounting practices by the National Association of Insurance Commissioners.
Proposed Redomestication and Restructuring
The Board of Directors of the Company has approved a redomestication and restructuring of the Company, which is subject to shareholders approval, regulatory approvals and the approval of certain other third parties. See Note G to the Consolidated Financial Statements for a further description of the proposed transaction.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements required by this Item are listed below:
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Schedules I, III, IV, V, and VI are omitted as they are inapplicable, immaterial, or because the required information may be found in the audited consolidated financial statements and notes thereto.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information regarding the officers and directors of the Registrant is included under the caption "Election of Directors" in the Registrant's proxy statement for the Registrant's 1998 Annual Meeting* and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The Registrant does not have any employees. Information regarding compensation of directors is included under the caption "Executive and Director Compensation" in the Registrant's proxy statement for the Registrant's 1998 Annual Meeting* and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding the above is included under the caption "Security Ownership of Certain Beneficial Owners" in the Registrant's proxy statement for the Registrant's 1998 Annual Meeting* and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information regarding the above is included under the caption "Certain Transactions and Relationships" in the Registrant's proxy statement for the Registrant's 1998 Annual Meeting* and is incorporated herein by reference.
- --------------- * To be filed within 120 days after the end of the fiscal year.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) See Index to Financial Statements on page 9.
(a)(2) See Index to Financial Statement Schedules on page 9.
(a)(3) See Index to Exhibits set forth on page 33.
(b) No reports on Form 8-K were filed during the fourth quarter of 1997.
(c) See Index to Exhibits set forth on page 33.
(d) See Index to Financial Statement Schedules on page 9.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors AmerInst Insurance Group, Inc.
We have audited the accompanying consolidated balance sheets of AmerInst Insurance Group, Inc. as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the three years ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and the disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of AmerInst Insurance Group, Inc. as of December 31, 1997 and 1996, and the results of its operations and its cash flows for the three years ended December 31, 1997 in conformity with generally accepted accounting principles.
JOHNSON LAMBERT & CO.
Burlington, Vermont February 13, 1998
AMERINST INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
See notes to the consolidated financial statements.
AMERINST INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
See notes to the consolidated financial statements.
AMERINST INSURANCE GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
See notes to the consolidated financial statements.
AMERINST INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to the consolidated financial statements.
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization: AmerInst Insurance Group, Inc. (AIIG) was incorporated under the laws of the State of Delaware on September 9, 1987. On February 29, 1988, AIIG sold 343,357 shares of its common stock at a price of $25 per share in a public offering to accounting firms that were members of the American Institute of Certified Public Accountants (AICPA) or a state CPA society. Proceeds of the public offering (net of selling agent's commission and expenses, management fees and other offering costs totaling $1,151,850) amounted to $7,432,075, which consisted of $3,434 of paid-in share capital and $7,428,641 of additional paid- in capital.
Basis of Presentation: The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) and include the accounts of AIIG and its wholly owned subsidiary, AmerInst Insurance Company (AIIC). All material intercompany accounts and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recognition of Premium Revenue: Premiums assumed are earned ratably over the terms of the underlying policies to which they relate. Premiums assumed relating to the unexpired portion of underlying policies in force at the balance sheet date are recorded as unearned premiums. Premiums ceded pursuant to excess of loss retrocession agreements are expensed over the calendar year term of the treaty and are netted against earned premiums. Charges or credits resulting from adjustments to provisional retrocession premiums ceded pursuant to the excess of loss retrocession agreements are reflected as adjustments to ceded premiums based upon estimated ultimate premiums. Management believes that recorded retrocession premiums ceded represent its best estimates of such amounts; however, as changes in the estimated ultimate losses and loss adjustment expenses applicable to the first excess of loss retrocession agreements are determined, the estimated ultimate ceded premiums will also change. As adjustments to these estimates become necessary, such adjustments are reflected in current operations.
Deferred Policy Acquisition Costs: Ceding commissions related to assumed reinsurance agreements are deferred and amortized over the terms of the underlying policies to which they relate.
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
NOTE A--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES(Continued)
Unpaid Losses and Loss Adjustment Expenses: The liability for unpaid losses and loss adjustment expenses includes case basis estimates of reported losses plus supplemental amounts calculated based upon projections of AIIC's historical loss experience supplemented with industry data. In establishing its liability for unpaid losses and loss adjustment expenses, AIIC utilizes the findings of an independent consulting actuary. Management believes that its aggregate liability for unpaid losses and loss adjustment expenses at year end represents its best estimate, based upon the available data, of the amount necessary to cover the ultimate cost of losses. However, because of the volatility inherent in professional liability coverage, actual loss experience may not conform to the assumptions used in determining the estimated amounts for such liability at the balance sheet dates. Accordingly, the ultimate liability could vary significantly from the amounts shown in the financial statements. As adjustments to these estimates become necessary, such adjustments are reflected in current operations.
The anticipated effect of inflation is implicitly considered when estimating liabilities for unpaid losses and loss adjustment expenses. Future average severities are projected based on historical trends adjusted for anticipated changes in underwriting standards, policy provisions, and general economic trends. These anticipated trends are monitored based on actual development, and are modified if necessary.
Reinsurance Recoveries Receivable: Reinsurance recoveries receivable is comprised of estimated amounts of losses and loss adjustment expenses paid and unpaid which are expected to be recoverable from reinsurers. Amounts recoverable from the reinsurers pursuant to retrocession agreements have been estimated using actuarial assumptions consistent with those used in establishing the liability for unpaid losses and loss adjustment expenses. Management believes that reinsurance recoveries receivable as recorded represents its best estimate of such amounts; however, as changes in the estimated ultimate liability for unpaid losses and loss adjustment expenses are determined, the estimated ultimate amount recoverable from the reinsurers will also change. Accordingly, the ultimate recoverable could be significantly in excess of or less than the amount indicated in the financial statements. Further, management has determined that no provision for uncollectible reinsurance recoveries is necessary. As adjustments to these estimates become necessary, such adjustments are reflected in current operations.
Investments: All investments are considered to be available for sale and are reported at their estimated market values at December 31, 1997 and 1996. Net changes in these estimated market values are reported as unrealized gains or losses directly in stockholders' equity, net of tax effects. Net realized gains and losses are determined using the specific identification method and are reflected in the income statement in the period of sale. Short-term investments include fixed maturity securities with a maturity date within one year of acquisition. As more fully described in Note B, certain investments held are used to collateralize obligations to previous and current ceding companies.
Cash and Cash Equivalents: Cash equivalents consist of money market mutual funds.
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
NOTE B--INSURANCE ACTIVITY
AIIG, through its wholly-owned subsidiary AIIC, has been engaged since April 1988 in the reinsurance of claims-made insurance policies of participants in an AICPA-endorsed insurance program that provides accountants' professional liability insurance coverage (AICPA Plan). From the inception of AIIC through mid-1993, Crum and Forster Managers Corporation through a group of affiliated insurance companies (collectively CFMC), was the primary insurer for the AICPA Plan. In 1988, AIIC provided reinsurance to CFMC, assuming 10% of the risks related to the first $1,000,000 of coverage for each policy issued under the program. For the period 1989 through mid-1993, an unaffiliated company, Virginia Surety Company, Inc. (VSC) provided reinsurance to CFMC and retroceded a portion to AIIC such that AIIC assumed 10% to 12.5% of the risk related to the first $1,000,000 of coverage limits for each policy issued under the program. In August 1993, the AICPA Plan endorsed the CNA Insurance Group (CNA) as its insurance carrier, replacing CFMC as the primary insurer. AIIC began a reinsurance relationship with CNA, taking a 10% participation of the first $1,000,000 of liability of each policy written under the plan. CFMC, VSC, and CNA are collectively referred to as the "ceding companies".
Pursuant to the reinsurance agreements described above, AIIC is required to provide the ceding companies with collateral for AIIC's liabilities to them. At December 31, 1997 and 1996, investments with a carrying value of $499,707 and $1,498,311, respectively, are held in a trust account pursuant to the 1988 reinsurance agreement with CFMC. At December 31, 1997 and 1996, the carrying value of investments held in a trust account pursuant to reinsurance agreements with VSC in effect from 1989 to mid-1993 is $7,144,800 and $12,291,395, respectively. At December 31, 1997 and 1996, AIIC has provided CNA with a letter of credit issued by Harris Trust and Savings Bank in the amount of $4,500,000. At December 31, 1997 and 1996, investments with a carrying value of $7,225,790 and $7,170,612, respectively, are held in a trust account at Harris Trust and Savings Bank as security for the letter of credit.
AIIC entered into excess of loss retrocession agreements to limit its retained risk on any one claim underwritten by CFMC to $50,000 in 1989 and 1990 and $62,500 in 1991 through mid-1993, subject to specified maximum recoveries for each contract year. Retrocession premiums ceded by AIIC are adjustable within a specified range based on actual experience under each contract. Retrocession transactions do not relieve AIIC from its obligation to the ceding companies. Revisions to the estimates of ultimate premiums ceded pursuant to the retrocession agreements resulted in credits to retroceded premiums recorded of $720,298, $693,976 and $611,916 during 1997, 1996 and 1995, respectively.
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
NOTE B--INSURANCE ACTIVITY--(Continued)
A reconciliation of assumed to net premiums, on both a written and an earned basis is as follows:
The components of the liability for unpaid losses and loss adjustment expenses and related reinsurance recoveries receivable are as follows:
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
NOTE B--INSURANCE ACTIVITY--(Continued)
The changes in the liability for unpaid losses and loss adjustment expenses, net of related reinsurance recoveries receivable, are as follows:
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
NOTE C--INVESTMENTS
Major categories of net interest and dividend income, net realized gains (losses) on sales of investments and net change in unrealized gains (losses) are summarized as follows:
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
NOTE C--INVESTMENTS--(Continued)
The cost or amortized cost and estimated market values of investments are as follows:
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
NOTE C--INVESTMENTS--(Continued)
The amortized cost and estimated market value of fixed maturity investments at December 31, 1997, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities as borrowers may have the right to call or prepay obligations without penalties.
Included in fixed maturity investments at December 31, 1997 and 1996 are securities held in a trust fund deposit at a bank in accordance with the Illinois Insurance Code with a carrying value of approximately $1,750,000.
Information on sales and maturities of investments in fixed maturity investments are as follows:
NOTE D--OPERATING AND MANAGEMENT EXPENSES
AIIG and AIIC have no employees. Their operating activities, as well as certain management functions, are performed by contracted professional service providers. USA Risk Group (USARG) provides certain management, administrative and operational services under the direction of the Company's board of directors pursuant to an agreement. The agreement may be terminated by either party on July 1 of each year within a period not exceeding ninety days and no less than 60 days prior written notice.
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
NOTE D--OPERATING AND MANAGEMENT EXPENSES--(Continued)
Operating and management expenses include compensation paid to members of the board of directors and various committees of the board totaling $140,025 in 1997, $140,300 in 1996 and $129,183 in 1995.
NOTE E--FEDERAL INCOME TAXES
AIIG and AIIC file a consolidated federal income tax return. Deferred federal income taxes arise from temporary differences between the valuation of assets and liabilities as determined for financial reporting purposes and income tax purposes. Such temporary differences relate principally to unrealized gains and losses on investments, discounting of loss reserves, recognition of unearned premiums and deferred policy acquisition costs. Although realization is not assured, management believes it is more likely than not that the net deferred tax asset recorded at each balance sheet date is fully realizable. The amount of the deferred tax asset considered realizable could be reduced in the near term if estimates of future taxable income are reduced. Significant permanent differences between book and taxable income include tax exempt municipal bond income, and the deduction for dividends received.
The components of the provision for income tax are as follows:
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
NOTE EFEDERAL INCOME TAXES--(Continued)
A reconciliation of income tax at the federal statutory rate to the Company's provision for income tax is as follows:
The composition of the net deferred tax asset at December 31, 1997 is as follows:
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
NOTE E--FEDERAL INCOME TAXES--(Continued)
The composition of the net deferred tax asset at December 31, 1996 is as follows:
NOTE F--INSURANCE REGULATORY MATTERS
AIIC, domiciled in the State of Illinois, prepares statutory financial statements in accordance with accounting practices prescribed or permitted by the Insurance Department of the State of Illinois. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The NAIC currently is in the process of establishing a codified set of statutory accounting practices (the codification), the result of which is expected to change "prescribed" statutory accounting practices. The codification is expected to be effective in 1999. The impact of the codification on AIIC cannot be determined at this time. Significant differences between statutory accounting practices and generally accepted accounting principles as apply to AIIC are as follows:
. For statutory purposes, policy acquisition costs are charged to operations in the year the costs are incurred rather than being deferred and amortized as premiums are earned.
. Under statutory accounting practices, there is no provision made for deferred income taxes.
. Certain assets including prepaid expenses are not admitted for statutory purposes.
. Investments in fixed maturity securities are valued at amortized cost under statutory accounting practices, rather than at market value.
AMERINST INSURANCE GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
NOTE F--INSURANCE REGULATORY MATTERS--(Continued)
Statutory surplus (stockholder's equity determined on a statutory basis) as reflected in AIIC's Annual Statement filed with the Insurance Department of the State of Illinois was $17,400,602 and $16,478,241 at December 31, 1997 and 1996, respectively. Statutory net income was $1,248,255, $1,711,224 and $3,969,695 in 1997, 1996 and 1995, respectively.
The State of Illinois imposes a restriction on the amount of dividends that can be paid without prior regulatory approval. The maximum amount of dividends that may be paid without such approval is limited to the greater of 10% of statutory surplus or 100% of statutory basis net income for the preceding fiscal year. The amount of dividends that could be paid by AIIC in 1998 without prior regulatory approval is $1,740,060. Accordingly, $18,200,893 of AIIC's separately determined GAAP basis stockholder's equity of $19,940,953 is unavailable for distribution to AIIG in 1998 without prior regulatory approval.
NOTE G--PROPOSED REDOMESTICATION AND RESTRUCTURING
AIIG's Board of Directors has voted to submit a proposed "Exchange Agreement" and related matters to a vote of shareholders. Pursuant to this proposal, AIIG would transfer all of its assets and liabilities to a newly formed Bermuda company in exchange for newly issued shares of the Bermuda company. AIIG would then be liquidated and AIIG shareholders would receive on a share-for-share basis the newly issued shares of the Bermuda company.
The transaction contemplates the restructuring of AIIG's business, including the redomestication of AIIC's insurance operations to a Bermuda domiciled company.
The transactions contemplated in the Exchange Agreement, the redomestication and the restructuring will be consummated only if certain conditions are satisfied, including the approval of specified matters by the holders of at least a majority of the outstanding AIIG common stock, certain regulatory approvals and the agreement of certain other third parties.
REPORT OF INDEPENDENT ACCOUNTANTS ----------------------------------
ON FINANCIAL STATEMENT SCHEDULES --------------------------------
The Board of Directors AmerInst Insurance Group, Inc.
Our report on the 1997 consolidated financial statements of AmerInst Insurance Group, Inc. is included on page 11 of this Form 10-K. In connection with our audit of such financial statements, we also audited the related financial statement schedules listed in the index on page 9 of this Form 10-K.
In our opinion, the financial statement schedules referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
JOHNSON LAMBERT & CO.
Burlington, Vermont February 13, 1998
AMERINST INSURANCE GROUP, INC. (PARENT)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT-SCHEDULE II
Condensed Balance Sheets as of December 31, 1996 and 1997
AMERINST INSURANCE GROUP, INC. (PARENT)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT-SCHEDULE II
Condensed Statements of Income for the Years Ended December 31, 1995 through
AMERINST INSURANCE GROUP, INC. (PARENT)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT-SCHEDULE II
Condensed Statements of Cash Flows for the Years Ended December 31, 1995 through
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 27, 1998 AMERINST INSURANCE GROUP, INC. --------------------------------
By /S/ NORMAN BATCHELDER --------------------- Norman C. Batchelder, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and as of the dates indicated.
INDEX TO EXHIBITS
YEAR ENDED DECEMBER 31, 1997
(1) Filed with the Company's Registration Statement on Forms S-1, Registration No. 33-17421 and incorporated herein by reference.
(2) Filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference.
(3) Filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.
(4) Filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.
(5) Filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference.
(6) Filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference.
(7) Filed with the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference.
(8) Filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 and incorporated herein by reference.
(9) Filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference.