Assurant 10-K 2006
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
For the fiscal year ended December 31, 2005
For the transition period from to
Commission file number 001-31978
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
NoteChecking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes ¨ No x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check One):
x Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the Common Stock held by non-affiliates of the registrant was $4,078 million at June 30, 2005 based on the closing sale price of $36.10 per share for the common stock on such date as traded on the New York Stock Exchange.
The number of shares of the registrants Common Stock outstanding at March 1, 2006 was 129,959,069.
Documents Incorporated by Reference
Certain information contained in the definitive proxy statement for the annual meeting of stockholders to be held on May 18, 2006 (2006 Proxy Statement) is incorporated by reference into Part III hereof.
ANNUAL REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 2005
TABLE OF CONTENTS
Some of the statements under Business, Managements Discussion and Analysis of Financial Condition and Results of Operations, and elsewhere in this report may contain forward-looking statements which reflect our current views with respect to, among other things, future events and financial performance. You can identify these forward-looking statements by the use of forward-looking words such as outlook, believes, expects, potential, continues, may, will, should, seeks, approximately, predicts, intends, plans, estimates, anticipates or the negative version of those words or other comparable words. Any forward-looking statements contained in this report are based upon our historical performance and on current plans, estimates and expectations. The inclusion of this forward looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. Such forward-looking statements are subject to various risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in this report. We believe that these factors include but are not limited to those described under the subsection entitled Risk Factors in Managements Discussion and Analysis of Financial Condition and Results of Operations. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Any forward-looking statements you read in this report reflect our current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, financial condition, growth strategy and liquidity.
Item 1. Business
Assurant, Inc. (Assurant) is a Delaware corporation, formed in connection with the Initial Public Offering (IPO) of its common stock, which began trading on the New York Stock Exchange (NYSE) on February 5, 2004. Prior to that initial trading date, Fortis, Inc., a Nevada corporation, had formed Assurant and merged into it on February 4, 2004. The merger was executed in order to redomesticate Fortis, Inc. from Nevada to Delaware and to change its name. As a result of the merger, Assurant is the successor to the business operations and obligations of Fortis, Inc.
Prior to the IPO, 100% of the outstanding common stock of Fortis, Inc. was owned indirectly by Fortis N.V., a public company with limited liability incorporated as naamloze vennootschap under Dutch law, and Fortis SA/ NV, a public company with limited liability incorporated as société anonyme/naamloze vennootschap under Belgian law. Following the IPO, Fortis N.V. and Fortis SA/ NV, through a wholly owned subsidiary Fortis Insurance N.V., owned approximately 35% (50,199,130 shares) of the outstanding common stock of Assurant.
On January 21, 2005, Fortis N.V. and Fortis SA/ NV, through a wholly owned subsidiary Fortis Insurance N.V., owned approximately 36% (50,199,130 shares) of the outstanding common stock of Assurant based on the number of shares outstanding that day and sold 27,200,000 of those shares in a secondary offering to the public. Assurant did not receive any of the proceeds from the sale of shares of common stock. Fortis N.V. received all net proceeds from the sale and concurrently sold exchangeable bonds, due January 26, 2008, that are mandatorily exchangeable for their remaining 22,999,130 shares of Assurant. The exchangeable bonds and the shares of Assurants common stock into which they are exchangeable have not been and will not be registered under the Securities Act of 1933 (Securities Act) and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.
In this report, references to the Company, Assurant, we, us or our refer to (1) Fortis, Inc. and its subsidiaries, and (2) Assurant, Inc. and its subsidiaries after the consummation of the merger described above. References to Fortis refer collectively to Fortis N.V. and Fortis SA/ NV. References to our separation from Fortis refer to the fact that Fortis reduced its ownership of our common stock in connection with the secondary offering.
Dollar amounts are presented in U.S. dollars and all amounts are in thousands, except number of shares, per share amounts, registered holders, number of employees and beneficial owners.
We pursue a differentiated strategy of building leading positions in specialized market segments for insurance products and related services in North America and selected international markets. We provide creditor-placed homeowners insurance, manufactured housing homeowners insurance, debt protection administration, credit insurance, warranties and extended service contracts, individual health and small employer group health insurance, group dental insurance, group disability insurance, group life insurance and pre-funded funeral insurance.
The markets we target are generally complex, have a relatively limited number of competitors and, we believe, offer attractive profit opportunities. In these markets, we leverage the experience of our management team and apply our expertise in risk management, underwriting and business-to-business management, as well as our technological capabilities in complex administration and systems. Through these activities, we seek to generate above-average returns by building on specialized market knowledge, well-established distribution relationships and economies of scale.
As a result of our strategy, we are a leader in many of our chosen markets and products. In the Assurant Solutions business, we have leadership positions or are aligned with clients who are leaders in creditor-placed homeowners insurance based on servicing volume, manufactured housing homeowners insurance based on number of homes built and debt protection administration based on credit card balances outstanding. In the
Assurant Health business, we were among one of the first companies to offer Medical Savings Accounts (MSAs) and Health Savings Accounts (HSAs). In the Assurant Employee Benefits business, we are a leading writer of group dental, disability and life plans sponsored by employers based on the number of subscribers and based on the number of master contracts in force. A master contract refers to a single contract issued to an employer that provides coverage on a group basis; group members receive certificates, which summarize benefits provided and serve as evidence of membership. In the Assurant PreNeed business, we are the largest writer of pre-funded funeral insurance in Canada measured by face amounts of new policies sold and the sole provider of pre-funded funeral insurance to the largest funeral home firm in North America. We believe that our leadership positions give us a sustainable competitive advantage in our chosen markets.
We currently have four operating business segments to ensure focus on critical activities close to our target markets and customers, while simultaneously providing centralized support in key functions. Each operating business segment has its own experienced management team with the autonomy to make decisions on key operating matters. These managers are eligible to receive incentive-based compensation based in part on operating business segment performance and in part on company-wide performance, thereby encouraging strong business performance and cooperation across all our businesses. At the operating business segment level, we stress disciplined underwriting, careful analysis and constant improvement and product redesign. At the corporate level, we provide support services, including finance, legal, litigation compliance, regulatory relations, investment, asset/liability matching and capital management, mergers and acquisitions, treasury, leadership development, information technology support and other administrative functions, enabling the operating business segments to focus on their target markets and distribution relationships while enjoying the economies of scale realized by operating these businesses together. Also, our overall strategy and financial objectives are set and continuously monitored at the corporate level to ensure that our capital resources are being properly allocated.
We organize and manage our specialized businesses through four operating business segments:
We also have a Corporate and Other segment, which includes activities of the holding company, financing expenses, net realized gains (losses) on investments, interest income earned from short-term investments, interest income from excess surplus of insurance subsidiaries not allocated to other segments and additional costs associated with excess of loss reinsurance programs reinsured and ceded to certain subsidiaries in the London market between 1995 and 1997. The Corporate and Other segment also includes the amortization of deferred gains associated with the portions of the sales of Fortis Financial Group (FFG) and Long Term Care (LTC) sold through reinsurance agreements. See Item 7Managements Discussion and Analysis of Financial Condition and Results of OperationsCorporate and Other.
We face competition in each of our businesses; however, we believe that no single competitor competes against us in all of our business lines and the business lines in which we operate are generally characterized by a limited number of competitors. Competition in our operating business segments is based on a number of factors, including: quality of service, product features, price, scope of distribution, financial strength ratings and name recognition.
The relative importance of these factors depends on the particular product and market. We compete for customers and distributors with insurance companies and other financial services companies in our various businesses.
Assurant Solutions has several competitors in its product lines, but we believe no other company participates in all of the same lines or offers comparable comprehensive capabilities. Competitors include insurance companies and financial institutions. In Assurant Health, we believe the market is characterized by
many competitors, and our main competitors include health insurance companies, Health Management Organizations (HMOs) and the Blue Cross/Blue Shield plans in the states in which we write business. In Assurant Employee Benefits, commercial competitors include other benefit and life insurance companies as well as dental managed care entities and not-for-profit Delta Dental plans. In Assurant PreNeed, our main competitors are several small regional insurers. While we are among the largest competitors in terms of market share in many of our business lines, in some cases there are one or more major market players in a particular line of business.
We believe our competitive strengths include:
Leadership Positions in Specialized Markets. We are a market leader in many of our chosen markets. We seek to participate in markets in which there are a limited number of competitors and that allow us to achieve a market leading position by capitalizing on our market expertise and capabilities in complex administration and systems, as well as on our established distribution relationships. We believe that our leadership positions provide us with the opportunity to generate high returns in these niche markets.
Strong Relationships with Key Clients and Distributors. We have created strong relationships with our distributors and clients in each of the niche markets we serve. We believe that the strength of our distribution relationships enables us to market our products and services to our customers in an effective and efficient manner that would be difficult for our competitors to replicate.
History of Product Innovation and Ability to Adapt to Changing Market Conditions. We are able to adapt quickly to changing market conditions by tailoring our product and service offerings to the specific needs of our clients. This flexibility was developed, in part, as a result of our entrepreneurial focus and the encouragement of management autonomy at each business segment. By understanding the dynamics of our core markets, we design innovative products and services and seek to sustain profitable growth and market leading positions.
Disciplined Approach to Underwriting and Risk Management. Our businesses share best practices of disciplined underwriting and risk management. We focus on generating profitability through careful analysis of risks and by drawing on our experience in core specialized markets. We prioritize loss containment and we purchase reinsurance as a risk management tool to diversify risk and protect against unexpected events, such as catastrophes. We believe that our disciplined underwriting and risk management philosophy have enabled us to realize above average financial returns while executing our strategic objectives.
Prudent Capital Management. We seek to generate above-average returns on a risk-adjusted basis from our operating activities. We invest capital in our operating business segments when we identify attractive profit opportunities in our target markets. To the extent that we believe we can achieve, maintain or improve leadership positions in these markets by deploying our capital and leveraging our expertise and other competitive advantages, we have done so with the expectation of generating high returns. When expected returns have justified continued investment, we have reinvested cash from operations into enhancing and growing our operating business segments through the development of new products and services, additional distribution
relationships and other operational improvements. In addition, when we have identified external opportunities that are consistent with these objectives, we have acquired businesses, portfolios, distribution relationships, personnel or other resources. We believe we have benefited from having the discipline and flexibility to deploy capital opportunistically and prudently to maximize returns to our stockholders.
Diverse Business Mix and Excellent Financial Strength. We have four operating business segments across distinct areas of the insurance market. These businesses are generally not affected in the same way by economic and operating trends, which we believe allows us to maintain a greater level of financial stability than many of our competitors across business and economic cycles. Our domestic rated operating insurance subsidiaries have financial strength ratings of A (Excellent) or A- (Excellent) from A.M. Best, six of our domestic operating insurance subsidiaries have financial strength ratings of A2 (Good) from Moodys and seven of our domestic operating insurance subsidiaries have financial strength ratings of A (Strong) or A- (Strong) from Standard and Poors (S&P). We employ a conservative investment policy and our portfolio primarily consists of high grade fixed income securities. We believe our solid capital base and overall financial strength allow us to distinguish ourselves from our competitors and continue to enable us to attract clients that are seeking long-term financial stability. In addition to financial strength ratings, these ratings agencies also rate Assurant, Inc.s senior notes and commercial paper. See Item 7Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources.
Experienced Management Team with Proven Track Record and Entrepreneurial Culture. We have a talented and experienced management team both at the corporate level and at each of our business segments. Our management team is led by our Chief Executive Officer, J. Kerry Clayton, who has been with our Company or its predecessors for 35 years. Mr. Clayton plans to retire on March 17, 2006. He will continue to serve on the Companys Board of Directors until the end of 2006. Robert B. Pollock, who has been with our company for 25 years and is currently Assurants President and Chief Operating Officer, has been named President and Chief Executive Officer and has been appointed to the Board of Directors. Our executive officers have an average tenure of approximately 17 years with our Company and close to 20 years in the insurance and related risk management business. Our management team has successfully led our business and executed on our specialized niche strategy through numerous business cycles and political and regulatory challenges. Our management team also shares a set of corporate values and promotes a common corporate culture that we believe enables us to leverage business ideas, risk management expertise and focus on regulatory compliance across our businesses. At the same time, we reward and encourage entrepreneurship at each business segment, accomplished in part by our long history of utilizing performance-based compensation plans.
In March of 2005, we announced a strategic growth initiative, emphasizing certain lines of business within each business segment. We established performance goals and short-term incentive compensation for senior management based on the initiatives. The growth initiatives by segment are as follows:
Operating Business Segments
Our business is comprised of four operating business segments: Assurant Solutions; Assurant Health; Assurant Employee Benefits; and Assurant PreNeed. We also have a Corporate and Other segment. Our business segments and the related net earned premiums and other considerations and fees and other income and segment income before income tax generated by those segments are as follows for the periods indicated:
Net Earned Premiums and Other Considerations and
Fees and Other Income by Segment
Segment Income (Loss) Before Income Tax by Business Segment
The amount of our total revenues, segment income before and after income tax and total assets by segment and the amount of our revenues and long-lived assets by geographic region is set forth in Note 21 to our consolidated financial statements.
On June 21, 2005, we announced our intention to separate Assurant Solutions into two segments: Assurant Solutions and Assurant Specialty Property. We will begin reporting separate segment financial information sometime in 2006 upon completion of the separation of the underlying product lines. The majority of Assurant Solutions existing Specialty Property division will become the Assurant Specialty Property segment. The majority of Assurant Solutions existing Consumer Protection division combined with the existing Assurant PreNeed segment will become the new Assurant Solutions segment. Since these segment changes will not be made until some time in 2006, all discussions in this Form 10-K refer to the existing Assurant Solutions segment and its two divisions, Specialty Property and Consumer Protection.
On November 9, 2005, we signed an agreement with Forethought Life Insurance Company (Forethought) whereby we will discontinue writing new preneed insurance policies in the United States via independent funeral homes and non-SCI corporate funeral home chains for a period of 10 years. This agreement does not impact Assurant PreNeeds IndependentCanada or AMLICs relationship with SCI. In addition, concurrent with the creation of the new Assurant Solutions and Assurant Specialty Property segments, we will realign the Assurant PreNeed segment under the new Assurant Solutions segment.
Assurant Solutions, which includes American Security Group operations acquired in 1980 and American Bankers Insurance Group acquired in 1999, has leadership positions or is aligned with clients who are leaders in creditor placed homeowners insurance, manufactured housing homeowners, credit related insurance products, debt protection administration and warranty and extended service contracts. We develop, underwrite and market our specialty insurance products and services through collaborative relationships with our clients.
Assurant Solutions is organized into two divisions: Specialty Property and Consumer Protection. The Specialty Property division focuses on creditor placed homeowners and manufactured housing homeowners insurance products and related services, as well as other insurance related products such as renters insurance, watercraft and motorcycle property coverages. In our Consumer Protection division, we are a low-cost provider of credit and debt protection administration services. In addition, we offer a variety of warranties and extended service contracts on consumer electronics, cellular phones, personal computers, appliances and vehicles through clients domestically and internationally.
Assurant Solutions maintains a comprehensive client and transaction database, which we believe gives us a competitive advantage with respect to pricing, marketing and projected claims development. Additionally, our high level of integration with clients allows us to have current and accurate data on the performance of their underwriting, claims, fees earned and commissions. We leverage the data advantage with clients to determine their optimal pricing and marketing strategy.
Our principal business lines within our Assurant Solutions segment have experienced growth in varying degrees. We have benefited from growth in the creditor placed homeowners insurance market and from the acquisition of new clients. We also experienced growth in our warranty and extended service contract and
international businesses due to the acquisition of new clients as well as the expansion of relationships with our existing clients. The manufactured housing market has been more challenging because of a more restrictive lending environment and the decline in shipments and retail sales. The domestic consumer credit insurance market has been contracting due to an adverse regulatory environment and the growth of debt protection products. Fortunately, this decline has been partially offset by the growth in debt protection administration services.
Products and Services
The Specialty Property division underwrites a variety of creditor placed hazard and voluntary insurance products as well as property coverages on manufactured housing, specialty automobiles, recreational vehicles including motorcycles and watercraft, and other leased equipment. We also offer complementary programs such as flood insurance, renters insurance and other property coverages. Growth in premiums in the creditor placed hazard market has been driven by increased home loan activity, new accounts and a hardening in pricing and insurance availability in the standard insurance market. We also offer administration services for some of the largest mortgage lenders and servicers, manufactured housing lenders, dealers and vertically integrated builders and equipment leasing institutions in the United States. Many of our products and services are sold by our clients in conjunction with the sale or lease of the underlying property, vehicle or equipment and through portfolio solicitations. We believe that our clients can most effectively market and distribute our products and services directly to their large customer bases.
Hazard insurance is our largest product line in the Specialty Property division. Creditor placed insurance is the primary program within our hazard insurance product line. The Specialty Property division has successfully developed a creditor placed business model that leverages its clients portfolios and retail sales networks to generate premium and fee income. Creditor placed hazard insurance generally consists of fire and dwelling insurance that we provide to ensure collateral protection to a mortgage lender in the event that a homeowner fails to purchase or renew homeowners insurance on a mortgaged dwelling. We use a proprietary insurance tracking administration system to continuously monitor a clients mortgage portfolio to verify the existence of insurance on the mortgaged property. In the event that a mortgagee is not maintaining adequate insurance coverage, they will be notified and, if the situation continues, we issue a creditor placed insurance policy on the property. This process works through integration of Assurants proprietary loan tracking system to the back offices of our clients. We currently track approximately 23 million loans on behalf of our clients. We envision that this business model will allow us to continue our growth due to seamless integration with our clients and the inherent efficiencies of said integration. Additionally, there are excellent opportunities for expansion of this business model with the addition of new clients coupled with the introduction of new products for existing clients. Our Specialty Property division is continuously evaluating new products that have been specifically designed to leverage this sales and distribution model.
We also provide fee-based services to our mortgage lender and servicer clients in the creditor placed homeowners insurance administration area. As a result of our efficiency in handling their back-office functions, the vast majority of our mortgage lender and servicing clients outsource their insurance processing to us.
The second largest program within the Specialty Property division is manufactured home insurance. Manufactured housing insurance programs are marketed predominantly through three channels. Our primary channel is via collateral tracking and creditor placed mobile owners insurance placement and administration services for manufactured housing lenders. We also offer our voluntary products through the nations leading manufactured housing retailers. These retailers use our proprietary premium rating technology, which allows retailers the opportunity to sell property coverages at the point-of-sale. Lastly, independent specialty agents distribute our products to individuals subsequent to new home purchases. We have direct access to manufacturers, retailers, and financial institutions and consistently strive to provide a comprehensive solution that requires minimal client resources.
Our Specialty Property division acts as an administrator for the Federal Government under the National Flood Insurance program for which we earn a fee for collecting premiums and processing claims. This is a public
flood insurance program and is restricted as to rates, underwriting, coverages and claims management procedures. Specialty Property does not assume any underwriting risk with respect to this program. Additionally, there is a smaller separate flood insurance program that we underwrite.
Our Specialty Property division also offers other property coverages, which include physical damage insurance for dwelling fire for renters and owners, specialty automobile, personal watercraft and motorcycles. These products are marketed primarily through agents and operate in a competitive environment.
The Consumer Protection division offers a broad array of products including credit insurance programs, debt protection services, product warranties and extended service contracts. Our objective is to market these products through a top-tier network of financial and retailing partners. This division provides our clients customers with products that offer protection from the life events and uncertainties that arise in purchasing and borrowing transactions thereby providing the consumer peace of mind. Credit insurance and debt protection programs generally offer a consumer a convenient option to protect a credit card balance or installment loan in the event of death, involuntary unemployment or disability and are generally available to all consumers without the underwriting restrictions that apply to term life insurance. Debt protection products are offered by the client to their customers and are not insurance products. We provide administrative services such as marketing support, customer service and benefit activation. Warranties and extended service contracts give a customer extended coverage beyond the base warranties offered by the manufacturer. These products are offered domestically and in selected international markets.
We provide credit insurance programs for many financial institutions, consumer finance companies and other institutions that are involved in consumer lending transactions. Revenues are generated in the form of direct written premium. Credit insurance revenues are primarily generated through lenders who originate installment loans, credit cards, lines of credit and real estate secured loans.
Due to an increasingly restrictive domestic regulatory environment and the shift to debt deferment products by financial institutions, we have experienced a reduction in written premium generated in the credit insurance market. Consequently, the largest credit card issuing institutions have migrated from credit insurance towards debt protection programs. Therefore, we have worked with our clients to offer alternative products such as debt deferment and protection services.
Debt protection agreements protect consumers from the inability to meet their obligations due to events such as death, disability and involuntary unemployment. Debt protection is not an insurance product, but rather a service that is voluntarily added by retail customers as an addendum to a loan. These administrative services we perform on behalf of the lender generate fee income rather than the earned premiums that a credit insurance policy generates. Margins on debt protection administration business are lower than traditional credit insurance programs. However, because debt protection is not an insurance product, certain costs, such as regulatory costs and costs of capital, are reduced.
We also provide administrative services for warranties and extended service contracts and underwrite and offer service contracts. Typically, through partnerships with retail industry leaders, we market these contracts to consumers to provide coverage on appliances, consumer electronics, personal computers, cellular phones, automobiles and recreational vehicles. These contracts serve to protect consumers from losses incurred due to product failures. We pay the cost of repairing or replacing customers property in the event of damages due to mechanical breakdown, accidental damage, and casualty losses such as theft, fire, and water damage. Our strategy is to seamlessly provide our clients with all aspects of the warranty or extended service contract, including program design and marketing strategy. We provide technologically advanced administration, claims handling and customer service. We believe that we maintain a differentiated position in the marketplace as a provider of both the required administrative infrastructure and insurance underwriting capabilities.
We have extensive experience in risk management in the extended service contract and warranty areas and utilize an integrated model to address the complexities of pricing, marketing, training, risk retention and client
service. We have agreements with major manufacturing and distribution partners and have set up repair networks to assist clients in quickly getting their customers automobiles and equipment back in the field, thereby minimizing claim expense.
We currently operate in selected international markets as well. These markets include Canada, the United Kingdom, Denmark, Germany, Argentina, Brazil, Puerto Rico and Mexico. In these markets, we primarily sell extended service contracts and credit insurance products through agreements with financial institutions, retailers and cellular-phone companies. Although there has been shrinkage in the domestic credit insurance market, the international markets are experiencing growth in credit insurance business. Expertise gained in the domestic credit insurance market has helped us to leverage our administrative infrastructure as we expand internationally. Systems, training, computer hardware and the overall market development approach have been customized to fit the particular needs of the targeted international markets.
Marketing and Distribution
Our marketing strategy is to establish relationships with institutions that are leaders in their chosen markets. Assurant Solutions markets its insurance programs and administration services directly to large financial institutions, mortgage lenders and servicers, credit card issuers, finance companies, automobile and recreational vehicle dealers, consumer electronics retailers, manufactured housing lenders and dealers and vertically integrated builders and other institutions.
We enter into distribution agreements, most of which are exclusive. Typically, these agreements have terms of one to five years and permit the development of integrated systems through cooperation with clients. The high level of integration permits our information systems to interface with our clients systems in order to exchange information in an almost real-time environment. We have maintained long-standing relationships with clients, which allows us to access numerous potential policyholders. We tailor our products to directly meet the needs of our clients and targeted market segments. We maintain a dedicated sales force that implements a multiple step business development methodology for contacting, negotiating and consummating business relationships with new clients. Additionally, we maintain a specialized consumer acquisition marketing services group that manages direct marketing efforts on behalf of our clients.
Underwriting and Risk Management
Assurant Solutions and its predecessors have over 50 years of experience in providing specialty insurance programs. We maintain extensive proprietary actuarial databases and utilize catastrophe models that we believe enable us to better identify and quantify the expected loss experience of particular products. These models, together with continuous client interaction and market intelligence, are employed in the design of our innovative products and the establishment of rates.
We have a disciplined approach to the management of our Specialty Property product lines. We monitor pricing adequacy on a product by region, state, risk and producer. We proactively seek to make timely commission, premium and coverage modifications, subject to regulatory considerations, where we determine them to be appropriate. In addition, we maintain a segregated risk management area which concentrates on catastrophic exposure management, the adequacy and pricing of reinsurance coverage and continuous analytical review of risk retention and subsequent profitability in the property lines. Our creditor placed homeowners insurance line is unique in that it is not underwritten on an individual basis, as our contracts with our clients require that we automatically issue these policies, after notice, when a homeowners policy lapses or is terminated. These products are priced after factoring in this inherent underwriting risk. For the lines where there is exposure to catastrophes (e.g., homeowners policies), we monitor and manage our aggregate risk exposure by geographic area and, when appropriate, enter into reinsurance contracts to manage our exposure to catastrophic events. Additionally, in the event of a catastrophic loss, we have the mechanism in place to reinstate, as needed, reinsurance coverages for protection from potential subsequent catastrophic events within the policy year.
A significant portion of Assurant Solutions Consumer Protection contracts are written on a retrospective commission basis, which permits Assurant Solutions to adjust commissions based on claims experience. Under this commission arrangement, as permitted by law, compensation to the financial institutions and other clients is predicated upon the actual losses incurred compared to premiums earned after a specific net allowance to Assurant Solutions. We believe that this aligns our clients interests with ours and helps us to better manage risk exposure. A distinct characteristic of our credit insurance and debt deferment programs is that the majority of these products have relatively low exposures per incident. This is because policy size is equal to the size of the installment loan or credit card balance. Thus, catastrophic loss severity for most of this business is low relative to insurance companies writing more traditional lines of property insurance.
In Assurant Solutions, our claims processing is automated and combines the efficiency of centralized claims handling, customer service centers and the flexibility of field representatives. This flexibility adds savings and efficiencies to the claims-handling process. Our claims department also provides continuous automated feedback to the underwriting team to help with risk assessment and pricing. In our Specialty Property division, we have both automated claims processing and field representatives, both internal and independent, who manage the claims process on the ground as needed. Our strategy of expanding the use of internal adjusters has resulted in more efficient claim settlement both in terms of responsiveness and losses per case.
Assurant Health, which we began operating in 1978, is a writer of individual and short-term major medical health insurance. We also provide small employer group health insurance to employer groups primarily of two to fifty employees in size, and health insurance plans to full-time college students. We serve about one million people throughout the United States. Our focus is on consumer choice health care, which empowers consumers to take control of their health care purchasing decisions. Products such as our High Deductible plans, HSA and Health Reimbursement Accounts (HRA) are all gaining wide acceptance from both individuals and employer groups alike. In 2005, we also introduced our RightStart product, a lower cost product designed for the under- and un-insured population. These products represent Assurants attempt to help create a freer market that will help to mitigate the rising costs of health care, promote innovation, expand choice, and increase access to better medical care.
Products and Services
Individual Health Insurance Products. Assurant Healths individual health insurance products are sold to individuals, primarily between the ages of 18 and 64 years, and their families who do not have employer-sponsored coverage. We emphasize the sale of individual products through associations and trusts that act as the master policyholder for such products. Our association and trust products offer greater flexibility in pricing, underwriting and product design compared to products sold directly to individuals on an individual policy basis.
Substantially all of the individual health insurance products we sell are PPO plans, which offer members the ability to select any health care provider, with benefits reimbursed, or to add an HSA or HRA option with their high deductible health plan. Coverage is typically subject to co-payments or deductibles and coinsurance, with the total benefit for covered services limited by lifetime policy maximums. These plans often include inpatient pre-certification and benefits for preventative services. These products are individually underwritten, taking into account the members medical history and other factors, and consist primarily of major medical insurance that renews on an annual basis. The remaining products we sell are indemnity, or fee-for-service, plans. Indemnity plans offer a member the ability to select any health care provider for covered services.
Assurant Health markets additional products to the individual market: short-term medical insurance and student health coverage plans. The short-term medical insurance product is designed for individuals who are between jobs or seeking interim coverage before their major medical coverage becomes effective. Short-term medical insurance products are generally sold to individuals with gaps in coverage for twelve months or less. Student health coverage plans are medical insurance plans sold to full-time college students who are not
covered by their parents health insurance, are no longer eligible for dependant coverage, or are seeking a more comprehensive alternative to a college-sponsored plan.
Small Employer Health Insurance Products. Our small employer market primarily includes companies with two to fifty employees, although larger employer coverage is available. As of December 31, 2005, our average group size was approximately five employees. In the case of our small employer group health insurance, we underwrite the entire group and examine the medical risk factors of the individual groups for pricing purposes. Substantially all of the small employer health insurance products that we sold in 2005 and 2004 were PPO products. We offer HRAs, which are employer-funded accounts provided to employees for reimbursement of qualifying medical expenses, as well as HSAs to both individuals and small employer groups. We also offer certain ancillary products to meet the demands of small employers for life insurance, short-term disability insurance and dental insurance.
Marketing and Distribution
Our health insurance products are principally marketed to an extensive network of independent agents by Assurant Health distributors. We also market our products to individuals through a variety of exclusive and non-exclusive national account relationships and direct distribution channels. In addition, we market our products through NorthStar Marketing, a wholly owned affiliate that proactively seeks business directly from independent agents. Since 2000, Assurant Health has had an exclusive national marketing agreement with a major mutual insurance company, pursuant to which their captive agents market Assurant Healths individual health products. Captive agents are representatives of a single insurer or group of insurers who are obligated to submit business only to that insurer, or at a minimum, give that insurer first refusal rights on a sale. The term of this agreement will expire in June 2008, but may be extended if agreed to by both parties. We also have a solid relationship with a well known association. Through Assurant Healths agreement with this well known associations administrator, we provide many of our individual health insurance products. The term of the agreement with this administrator will expire in September 2006, but will be automatically extended for an additional two-year term unless prior notice of a partys intent to terminate is given to the other party. Assurant Health also has had a long-term relationship with a national marketing organization with more than 50 offices. Short-term medical insurance plans are also sold through the internet by Assurant Health and numerous direct writing agents.
Underwriting and Risk Management
Assurant Healths underwriting and risk management capabilities include pricing discipline, policy underwriting, renewal optimization, development and retention of provider networks, and claims processing.
In establishing premium rates for our health care plans, we use underwriting criteria based upon our accumulated actuarial data, with adjustments for factors such as claims experience and member demographics to evaluate anticipated health care costs. Our pricing considers the expected frequency and severity of claims and the costs of providing the necessary coverage, including the cost of administering policy benefits, sales and other administrative costs. State rate regulation significantly affects pricing. Our health insurance operations are subject to a variety of legislative and regulatory requirements and restrictions covering a range of trade and claim settlement practices. State insurance regulatory authorities have broad discretion in approving a health insurers proposed rates. In addition, the Health Insurance Portability and Accountability Act of 1996 requires certain guaranteed issuance and renewability of health insurance coverage for individuals and small employer groups, and limits exclusions based on existing conditions.
Assurant Health offers a broad choice of PPO network options in each of its markets and enrolls members in the network that Assurant Health believes reduces our price paid for health care services while providing high quality care. Assurant Health enrolls indemnity customers in selected PPO networks to obtain discounts on provider services that would otherwise not be available. In situations where a customer does not obtain services from a contracted provider, Assurant Health applies various usual and customary fees, which limit the amount paid to providers within specific geographic areas.
Assurant Health retains provider networks through a variety of relationships, which include leased networks that contract directly with individual health care providers, proprietary contracts, and Private Health Care Systems, Inc. (PHCS). PHCS is a national private company that maintains a provider network, and has a staff solely dedicated to provider relations. Assurant Health was a co-founder of PHCS.
We utilize a broad range of focused traditional cost containment and care management processes across our various product lines to manage risk and to lower costs. These include case management, disease management and pharmacy benefits management programs.
Effective July 1, 2003, Assurant Health transitioned its pharmacy benefits management function to Medco Health Solutions, formerly known as Merck-Medco. Medco Health Solutions has established itself as a leader in its industry with almost 60,000 participating retail pharmacies nationwide and its extensive mail-order service. Through Medco Health Solutions advanced technology platforms, Assurant Health is able to access information about customer utilization patterns on a timelier basis to improve its risk management capabilities. In addition to the technology-based advantages, Medco Health Solutions allows us to purchase our pharmacy benefits at competitive prices. Our agreement with Medco Health Solutions expires June 30, 2007. Assurant Health also utilizes co-payments and deductibles to reduce prescription drug costs.
Assurant Employee Benefits
Assurant Employee Benefits, which we began operating with the acquisition of Mutual Benefit Life Group Division in 1991, markets employer-sponsored group life, disability and dental insurance and managed care products, primarily to small-to-medium size employer groups with 500 or fewer employees.
We believe that the marketplace of small-to-medium size employers offers significant long-term opportunity for a carrier strategically focused on its unique needs, thus this market is the core of our business. Long-term success in this market is dependent upon a carriers ability to underwrite and service many smaller accounts efficiently and profitably. Our administrative systems and processes are structured to allow us flexibility in efficiently customizing products for large numbers of diverse smaller employers. While our emphasis is on small-to-medium size employers, we are willing to write cases with more than 500 eligible employees when they meet our risk and profitability profile.
Trends in the U.S. employment market and, in particular, the cost of medical benefits, continue to lead increasing numbers of employers to offer new and existing benefits on a voluntary, or employee-paid basis. Each of our principal product lines includes plans available on a voluntary basis, as well as plans where the employer and employee share responsibility for the payment of premiums. We continue to enhance our voluntary product portfolio, and in 2005 we launched an educational campaign designed to promote our voluntary offerings with select employee benefits brokers. In late 2005 we realigned our sales organization in order to give more of our sales representatives access to our voluntary product lines.
Competition for the sale and retention of our customers comes primarily from other insurers and managed dental care companies. We compete primarily through our array of product offerings, the manner in which we market and sell our products, and through our service to customers. Our broad portfolio of products and flexible rating and administrative systems enable us to tailor our benefit packages to meet the needs and budgets of our customers. While pricing is a significant factor in purchase decisions in our markets, we strive to limit the impact of customer price sensitivity by customizing our offerings.
Products and Services
Group Dental. Success in the group dental business requires strong provider network development and management, a focus on expense management and a claim system capable of efficiently and accurately adjudicating high volumes of transactions. These success factors are the cornerstone of our dental business.
Dental benefit plans provide funding for necessary or elective dental care. Customers may select a traditional indemnity arrangement, a PPO arrangement, or a prepaid or managed care arrangement. Coverage is subject to deductibles, coinsurance and annual or lifetime maximums. In a prepaid plan, members must use participating dentists in order to receive benefits.
In addition to fully insured and managed care dental benefits, we offer Administrative Services Only (ASO) for self-funded dental plans. Under the ASO arrangement, an employer or plan sponsor pays a fee for us to provide administrative services.
Group Disability Insurance. Group disability insurance provides partial replacement of lost earnings for insured employees who become disabled as defined by their plan provisions. Our group disability products include both short- and long-term disability coverage options. We also reinsure disability policies written by other carriers through our subsidiary Disability RMS.
Group long-term disability insurance provides income protection for extended work absences due to sickness or injury. Most policies commence benefits following 90- or 180-day waiting periods, with benefits limited to specified maximums as a percentage of income. Group short-term disability insures temporary loss of income due to injury or sickness, and often provides benefits immediately for disabilities caused by accidents or after one week for disabilities caused by sickness.
Group Term Life Insurance. Group term life insurance provided through the workplace provides financial coverage in the event of premature death. Accidental death and dismemberment (AD&D) as well as coverage for spouses, children or domestic partners is also available. Insurance consists primarily of renewable term life insurance with the amount of coverage either a flat amount, a multiple of the employees earnings, or a combination of the two.
Marketing and Distribution
Our insurance and managed care products are distributed through a group sales force strategically positioned in 35 U.S. offices located near major metropolitan areas. These company employees distribute our products and services through independent employee benefits advisors, including brokers and other intermediaries, and are compensated through a salary and incentive package. Daily account management is provided through the local sales office, further supported by one of four regional sales service centers and a home office customer relations department. Compensation to brokers is generally provided at the time of sale, and in some cases includes a performance incentive, based on volume and retention of business.
Marketing efforts concentrate on the identification of our target customers benefit needs, the development of tailored products and services to meet those needs, alignment of our Company with select high-potential brokers and other intermediaries who value our approach to the market, and the promotion of the Assurant Employee Benefits brand.
Disability RMS, our wholly owned subsidiary, provides reinsurance to other carriers wanting to supplement their core product offerings with a turnkey group disability insurance solution. Services are provided for a fee and may include product development, state insurance regulatory filings, underwriting, claims management or any of the other functions typically performed by an insurers back office. The risks written by Disability RMS various clients are reinsured into a pool, with the clients generally retaining shares ranging from 0% to 50% of the risk. Because Disability RMS clients operate in niches not often reached through our traditional distribution, our participation in the pools enables us to reach new customers.
Underwriting and Risk Management
The pricing of our products is based on the expected cost of benefits, calculated using assumptions for mortality, morbidity, interest, expenses and persistency, depending upon the specific product features. Group
underwriting takes into account demographic factors such as age, gender and occupation of members of the group as well as the geographic location and concentration of the group. Some policies limit the payment of benefits for certain defined or pre-existing conditions, or in other ways seek to limit the risk from anti-selection. Our block of business is highly diversified by industry and geographic location, which serves to limit some of the risks associated with changing economic conditions.
Claims management focuses on facilitating positive return-to-work through a supportive network of services that may include physical therapy, vocational rehabilitation, and workplace accommodation. In addition to claims specialists, we also employ or contract with a staff of doctors, nurses and vocational rehabilitation specialists, and use a broad range of additional outside medical and vocational experts for independent evaluations and local vocational services. Our dental business uses a highly automated claims system focused on rapid handling of claims.
Assurant PreNeed, which we began operating with the acquisition of United Family Life Insurance Company in 1980, is the market leader in Canada in pre-funded funeral insurance and with our acquisition of AMLIC in 2000, we became the sole provider of pre-funded funeral insurance for SCI. SCI is the largest funeral provider in North America based on total revenues. This relationship is governed by an exclusive ten-year marketing agreement, which commenced on October 1, 2000. Pre-funded funeral insurance provides whole life insurance death benefits or annuity benefits used to fund costs incurred in connection with pre-arranged funerals. An annuity is a contract that provides for periodic payments to an annuitant for a specified period of time. In the case of annuities sold by Assurant PreNeed, all the benefits under the contract are generally paid out at the death of the purchaser of the annuity. We distribute our pre-funded funeral insurance products through two separate channels, our IndependentCanada channel and our AMLIC channel. Our pre-funded funeral insurance products provide benefits to cover the costs incurred in connection with pre-arranged funeral contracts and are distributed primarily through funeral homes and sold mainly to consumers over the age of 65, with an average issue age of 73. Our pre-funded funeral insurance products are typically structured as whole life insurance policies in the United States and as annuity products in Canada. In November 2005, we sold the US Independent distribution to Forethought Life Insurance Company to allow further focus on our growth areas of expanding the IndependentCanada and AMLIC channels.
Growth in preneed sales has been traditionally driven by distribution with a high correlation between new sales of pre-funded funeral insurance and the number of preneed counselors or enrollers marketing the product and expansion of sales and marketing capabilities. In addition, as alternative distribution channels are identified, such as targeting affinity groups and employers, we believe growth in this market could accelerate. We believe that the preneed market is characterized by an aging population combined with low penetration of the over-65 market.
In Assurant PreNeed, our strategy in the Independent-Canada channel is to increase sales by broadening our distribution relationships. Through our general agency system, we provide programs and a sales force for our funeral firm clients that increase their local market share. Through our AMLIC channel, our strategy is to reduce SCIs cost to sell and manage its preneed operation. We integrate our processes for managing SCIs insurance production into its process for managing its preneed business. Additionally, in keeping with our goal of aligning SCIs interest with ours, our arrangement with SCI is commission-based; however, we compensate SCI with an escalating production-based commission, with a defined maximum.
Pre-Funded Funeral Insurance Policies. Pre-funded funeral insurance provides whole life insurance death benefits or annuity benefits to fund the costs incurred in connection with pre-arranged funeral contracts, or, in a
minority of situations, pre-arranged funerals without a pre-arranged funeral contract. Pre-arranged funeral costs typically include funeral firm merchandise and services. Our pre-funded funeral insurance products are typically structured as whole life insurance policies in the United States. In Canada, our pre-funded funeral insurance products are typically structured as annuity contracts for single lump-sum business and whole life contracts for multi-payment polices. Consumers have the choice of making their policy payments as a single lump-sum payment or through multi-payment plans that spread payments out over a period of time. A pre-arranged funeral contract is an arrangement between a funeral firm and an individual whereby the funeral firm agrees to perform the selected funeral upon the individuals death. The consumer then purchases an insurance policy intended to cover the cost of the pre-arranged funeral, and the funeral home generally becomes the irrevocable assignee, or, in certain cases, the beneficiary, of the insurance policy proceeds. However, the insured may name a beneficiary other than the funeral home. The funeral home agrees to provide the selected funeral at death in exchange for the policy proceeds. Because the death benefit under many of our policies is designed to grow over time, the funeral firm that is the assignee of such a policy has managed some or all of its funeral inflation risk. We do not provide any funeral goods and services in connection with our pre-funded funeral insurance policies; these policies pay death benefits in cash only.
Marketing and Distribution
We currently distribute our pre-funded funeral insurance products through two distribution channels: the IndependentCanada channel, which distributes through independent and corporate funeral homes and selected third-party general agencies, and our AMLIC channel, which distributes through an exclusive relationship with SCI in North America. Our policies are sold by licensed insurance agents or enrollers who, in some cases, may also be a funeral director.
Assurant PreNeed generally writes whole life insurance policies with increasing death benefits and obtains the majority of its profits from interest rate spreads. Interest rate spreads refer to the difference between the death benefit growth rates on pre-funded funeral insurance policies and the investment returns generated on the assets we hold related to those policies. To manage these spreads, we monitor the movement in new money yields and monthly evaluate our actual net new achievable yields. This information is used to evaluate rates to be credited on applicable new and in force pre-funded funeral insurance policies and annuities. In addition, we review asset benchmarks and perform asset/liability matching studies to develop the optimum portfolio to maximize yield and reduce risk.
In Assurant PreNeed, we utilize underwriting to select and price insurance risks. We regularly monitor mortality assumptions to determine if experience remains consistent with these assumptions and to ensure that our product pricing remains appropriate. We periodically review our underwriting, agent and policy contract provisions and pricing guidelines so that our policies remain competitive and supportive of our marketing strategies and profitability goals.
Many of our pre-funded whole-life funeral insurance policies have increasing death benefits. As of December 31, 2005, approximately 84% of Assurant PreNeeds in force insurance policy reserves relate to policies that provide for death benefit growth, some of which provide for minimum death benefit growth pegged to changes in the Consumer Price Index (CPI). Policies that have rates guaranteed to change with the CPI represented approximately 12% of Assurant PreNeeds reserves as of December 31, 2005. We have employed risk mitigation strategies to seek to minimize our exposure to a rapid increase in inflation.
Rating organizations continually review the financial position of insurers, including our insurance subsidiaries. Insurance companies are assigned financial strength ratings by independent rating agencies based
upon factors relevant to policyholders. Ratings provide both industry participants and insurance consumers meaningful information on specific insurance companies and are an important factor in establishing the competitive position of insurance companies. Most of our active domestic operating insurance subsidiaries are rated by A.M. Best. A.M. Best maintains a letter scale rating system ranging from A++ (Superior) to S (Suspended). Six of our domestic operating insurance subsidiaries are also rated by Moodys. In addition, seven of our domestic operating insurance subsidiaries are rated by S&P.
All of our domestic operating insurance subsidiaries rated by A.M. Best have financial strength ratings of A (Excellent), which is the second highest of ten ratings categories and the highest within the category based on modifiers (i.e., A and A- are Excellent), or A- (Excellent), which is the second highest of ten ratings categories and the lowest within the category based on modifiers.
The Moodys financial strength rating for six of our domestic operating insurance subsidiaries is A2 (Good), which is the third highest of nine ratings categories and mid-range within the category based on modifiers (i.e., A1, A2 and A3 are Good).
The S&P financial strength rating for four of our domestic operating insurance subsidiaries is A (Strong), which is the third highest of nine ratings categories and mid-range within the category based on modifiers (i.e., A+, A and A- are Strong), and for three of our domestic operating insurance subsidiaries is A- (Strong), which is the third highest of nine ratings categories and the lowest within the category based on modifiers.
The objective of A.M. Bests, Moodys and S&Ps ratings systems is to assist policyholders and to provide an opinion of an insurers financial strength, operating performance, strategic position and ability to meet ongoing obligations to its policyholders. These ratings reflect the opinions of A.M. Best, Moodys and S&P of our ability to pay policyholder claims, are not applicable to our common stock or debt securities and are not a recommendation to buy, sell or hold any security, including our common stock or debt securities. These ratings are subject to periodic review by and may be revised upward, downward or revoked at the sole discretion of A.M. Best, Moodys and S&P.
As of March 1, 2006, we had approximately 12,000 employees. In Assurant Solutions, we have employees in Brazil, Mexico and Argentina who are represented by labor unions. None of our other employees are subject to collective bargaining agreements governing employment with us or represented by labor unions.
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, the Statements of Beneficial Ownership of Securities on Forms 3, 4 and 5 for our Directors and Officers and all amendments to such reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available free of charge at the Securities and Exchange Commission (SEC) website at www.sec.gov. These documents are also available free of charge through our website at www.assurant.com.
Item 1A. Risk Factors
Risks Related to Our Company
Our income and profitability may decline if we are unable to maintain our relationships with significant clients, distributors and other parties important to the success of our business.
Our relationships and contractual arrangements with significant clients, distributors and other parties with whom we do business are important to the success of our business segments. Many of these arrangements are exclusive. For example, in Assurant Solutions, we have exclusive relationships with several mortgage lenders and servicers, retailers, third party administrators, credit card issuers and other financial institutions through which we distribute our products. In Assurant Health, we have exclusive distribution relationships for our individual health insurance products with a major mutual insurance company as well as a relationship with a well known association through which we provide many of our individual health insurance products. We also maintain contractual relationships with several separate networks of health and dental care providers, each referred to as a PPO, through which we obtain discounts. In Assurant PreNeed, we have an exclusive distribution relationship with SCI, relating to the distribution of pre-funded funeral insurance policies. Typically, these relationships and contractual arrangements have terms ranging from one to five years.
Although we believe we have generally been successful in maintaining our client, distribution and associated relationships, if these parties decline to renew or seek to terminate these arrangements or seek to renew these contracts on terms less favorable to us, our results of operations and financial condition could be materially adversely affected. For example, a loss of one or more of the discount arrangements with PPOs could lead to higher medical or dental costs and/or a loss of members to other medical or dental plans. In addition, we are subject to the risk that these parties may face financial difficulties, reputational issues or problems with respect to their own products and services, which may lead to decreased sales of our products and services. Moreover, if one or more of our clients or distributors consolidate or align themselves with other companies, we may lose business or suffer decreased revenues.
Sales of our products and services may be reduced if we are unable to attract and retain sales representatives or develop and maintain distribution sources.
We distribute our insurance products and services through a variety of distribution channels, including independent employee benefits specialists, brokers, managing general agents, life agents, financial institutions, mortgage lenders and servicers, retailers, funeral directors, association groups and other third-party marketing organizations.
Our relationships with these various distributors are significant both for our revenues and profits. We generally do not distribute our insurance products and services through captive or affiliated agents. In Assurant Health, we depend in large part on the services of independent agents and brokers and on associations in the marketing of our products. In Assurant Employee Benefits, independent agents and brokers who act as advisors to our customers market and distribute our products. Strong competition exists among insurers to form relationships with agents and brokers of demonstrated ability. We compete with other insurers for sales representatives, agents and brokers primarily on the basis of our financial position, support services, compensation and product features. Independent agents and brokers are typically not exclusively dedicated to us, but instead usually also market the products of our competitors. Therefore, by relying on independent agents and brokers to distribute products for us, we face continued competition from our competitors products. Moreover, our ability to market our products and services depends on our ability to tailor our channels of distribution to comply with changes in the regulatory environment. Recently, both the marketing of health insurance through association groups and broker compensation arrangements have come under increased scrutiny. An interruption in, or changes to, our relationships with various third-party distributors or our inability to respond to regulatory changes that threaten to disrupt our distribution processes could impair our ability to compete and market our insurance products and services that could cause a material adverse effect on our results of operations and financial condition.
We have our own sales representatives whose role in the distribution process varies by segment. We depend in large part on our sales representatives to develop and maintain client relationships. Our inability to attract and retain effective sales representatives could materially adversely affect our results of operations and financial condition.
General economic, financial market and political conditions may adversely affect our results of operations and financial condition.
General economic, financial market and political conditions may have a material adverse effect on our results of operations and financial condition. These conditions include economic cycles such as insurance industry cycles, levels of employment, levels of consumer lending, levels of inflation and movements of the financial markets.
Fluctuations in interest rates, monetary policy, demographics, and legislative and competitive factors also influence our performance. Our expansion into foreign countries may result in similar risks, including currency fluctuations, unstable political climates, and governmental and competitive factors. During periods of economic downturn:
In addition, general inflationary pressures may affect the costs of medical and dental care, as well as repair and replacement costs on our real and personal property lines, increasing the costs of paying claims. Inflationary pressures may also affect the costs associated with our pre-funded funeral insurance policies, particularly those that are guaranteed to grow with the CPI.
Our actual claims losses may exceed our reserves for claims, which may require us to establish additional reserves that may materially reduce our earnings, profitability and capital.
We maintain reserves to cover our estimated ultimate exposure for claims and claim adjustment expenses with respect to reported and incurred but not reported claims (IBNR) as of the end of each accounting period. Reserves, whether calculated under accounting principles generally accepted in the United States of America (GAAP) or Statutory Accounting Principles (SAP), do not represent an exact calculation of exposure, but instead represent our best estimates, generally involving actuarial projections at a given time, of what we expect the ultimate settlement and administration of a claim or group of claims will cost based on our assessment of facts and circumstances then known. The adequacy of reserves will be impacted by future trends in claims severity, frequency, judicial theories of liability and other factors. These variables are affected by both external and internal events, such as changes in the economic cycle, changes in the social perception of the value of work, emerging medical perceptions regarding physiological or psychological causes of disability, emerging health issues and new methods of treatment or accommodation, inflation, judicial trends, legislative changes and claims handling procedures. Many of these items are not directly quantifiable, particularly on a prospective basis. Reserve estimates are refined as experience develops. Adjustments to reserves, both positive and negative, are reflected in the statement of operations of the period in which such estimates are updated. Because establishment
of reserves is an inherently uncertain process involving estimates of future losses, there can be no certainty that ultimate losses will not exceed existing claims reserves. In addition, future loss development could require reserves to be increased, which could have a material adverse effect on our earnings in the periods in which such increases are made.
We may be unable to accurately predict benefits, claims and other costs or to manage such costs through our loss limitation methods, which could have a material adverse effect on our results of operations and financial condition.
Our profitability could vary depending on our ability to predict benefits, claims and other costs, including medical and dental costs, and predictions regarding the frequency and magnitude of claims on our disability and property coverages. It also depends on our ability to manage future benefit and other costs through product design, underwriting criteria, utilization review or claims management and, in health and dental insurance, negotiation of favorable provider contracts. Utilization review is a review process designed to control and limit medical expenses, which includes, among other things, requiring certification for admission to a health care facility and cost-effective ways of handling patients with catastrophic illnesses. Claims management entails the use of a variety of means to mitigate the extent of losses incurred by insureds and the corresponding benefit cost, which includes efforts to improve the quality of medical care provided to insureds and to assist them with vocational services. Our ability to predict and manage costs and claims, as well as our business, results of operations and financial condition may be adversely affected by changes in health and dental care practices, inflation, new technologies, the cost of prescription drugs, clusters of high cost cases, changes in the regulatory environment, economic factors, the occurrence of catastrophes and increased construction and repair related costs.
The judicial and regulatory environments, changes in the composition of the kinds of work available in the economy, market conditions and numerous other factors may also materially adversely affect our ability to manage claim costs. The aging of the population, other demographic characteristics and advances in medical technology continue to contribute to rising health care costs. As a result of one or more of these factors or other factors, claims could substantially exceed our expectations, which could have a material adverse effect on our results of operations and financial condition.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues relating to claims and coverage may emerge. These issues could materially adversely affect our results of operations and financial condition by either extending coverage beyond our underwriting intent or by increasing the number or size of claims or both. We may be limited in our ability to respond to such changes, by insurance regulations, existing contract terms, contract filing requirements, market conditions or other factors.
Our investment portfolio is subject to several risks that may diminish the value of our invested assets and affect our profitability.
Our investment portfolio may suffer reduced returns or losses that could reduce our profitability.
Investment returns are an important part of our overall profitability and significant fluctuations in the fixed income market could impair our profitability, financial condition and/or cash flows. Our investments are subject to market-wide risks and fluctuations, as well as to risks inherent in particular securities. In particular, volatility of claims may force us to liquidate securities prior to maturity, which may cause us to incur capital losses. If we do not structure our investment portfolio so that it is appropriately matched with our insurance liabilities, we may be forced to liquidate investments prior to maturity at a significant loss to cover such liabilities. Our net investment income and net realized gains on investments collectively accounted for approximately 9% of our total revenues during the years ended December 31, 2005 and December 31, 2004. See Item 7Managements Discussion and Analysis of Financial Condition and Results of OperationsInvestments and Item 7AQuantitative and Qualitative Disclosures About Market Risk for additional information on our investment portfolio and related risks.
The performance of our investment portfolio is subject to fluctuations due to changes in interest rates and market conditions.
Changes in interest rates can negatively affect the performance of some of our investments. Interest rate volatility can reduce unrealized gains or create unrealized losses in our portfolios. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Fixed maturity and short-term investments represented 75% of the fair value of our total investments as of December 31, 2005 and 77% as of December 31, 2004. See Item 7Managements Discussion and Analysis of Financial Condition and Results of OperationsInvestments and Item 7AQuantitative and Qualitative Disclosures About Market Risk for additional information on the effect of fluctuations in interest rates.
The fair market value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. Because substantially all of our fixed maturity securities are classified as available for sale, changes in the market value of these securities are reflected in our balance sheet. The fair market value generally increases or decreases in an inverse relationship with fluctuations in interest rates, while net investment income realized by us from future investments in fixed maturity securities will generally increase or decrease with interest rates. In addition, actual net investment income and/or cash flows from investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities, may differ from those anticipated at the time of investment as a result of interest rate fluctuations. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities, commercial mortgage obligations and bonds in our investment portfolio are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates, and we may be required to reinvest those funds in lower interest-bearing investments. As of December 31, 2005, mortgage-backed and other asset-backed securities represented 1,492,684, or 10%, of the fair value of our total investments.
We employ asset/liability management strategies to reduce the adverse effects of interest rate volatility and to ensure that cash flows are available to pay claims as they become due. Our asset/liability management strategies include asset/liability duration management, structuring our bond and commercial mortgage loan portfolios to limit the effects of prepayments and consistent monitoring of, and appropriate changes to, the pricing of our products.
Asset/liability management strategies may fail to eliminate or reduce the adverse effects of interest rate volatility, and no assurances can be given that significant fluctuations in the level of interest rates will not have a material adverse effect on our results of operations and financial condition.
In addition, our pre-funded funeral insurance policies are generally whole life insurance policies with increasing death benefits. In extended periods of declining interest rates or high inflation, there may be compression in the spread between the death benefit growth rates on these policies and the investment earnings that we can earn, resulting in a negative spread. As a result, declining interest rates or high inflation rates may have a material adverse effect on our results of operations and our overall financial condition. See Item 7AQuantitative and Qualitative Disclosures About Market RiskInflation Risk for additional information.
Assurant Employee Benefits calculates reserves for long-term disability and life waiver of premium claims using net present value calculations based on current interest rates at the time claims are funded and expectations regarding future interest rates. Waiver of premium refers to a provision in a life insurance policy pursuant to which an insured with a disability that lasts for a specified period no longer has to pay premiums for the duration of the disability or for a stated period, during which time the life insurance coverage provides continued coverage. If interest rates decline, reserves for open and/or new claims in Assurant Employee Benefits would need to be calculated using lower discount rates thereby increasing the net present value of those claims and the required reserves. Depending on the magnitude of the decline, this could have a material adverse effect on our results of operations and financial condition. In addition, investment income may be lower than that assumed in setting premium rates.
Our investment portfolio is subject to credit risk.
We are subject to credit risk in our investment portfolio, primarily from our investments in corporate bonds and preferred stocks. Defaults by third parties in the payment or performance of their obligations could reduce our investment income and realized investment gains or result in investment losses. Further, the value of any particular fixed maturity security is subject to impairment based on the creditworthiness of a given issuer. As of December 31, 2005, fixed maturity securities represented 72% of the fair value of our total invested assets. Our fixed maturity portfolio also includes below investment grade securities (rated BB or lower by nationally recognized securities rating organizations). These investments generally provide higher expected returns, but present greater risk and can be less liquid than investment grade securities. A significant increase in defaults and impairments on our fixed maturity investment portfolio could materially adversely affect our results of operations and financial condition. See Item 7AQuantitative and Qualitative Disclosures About Market RiskCredit Risk for additional information on the composition of our fixed maturity investment portfolio.
The Company currently invests in a small amount of equity securities (approximately 5% of the fair value of our total investments as of December 31, 2005). However, we have had higher percentages in the past and may make more such investments in the future. Investments in equity securities generally provide higher expected total returns, but present greater risk to preservation of principal than our fixed maturity investments.
In addition, while currently we do not utilize derivative instruments to hedge or manage our interest rate or equity risk, we may do so in the future. Derivative instruments generally present greater risk than fixed income investments or equity investments because of their greater sensitivity to market fluctuations. Since August 1, 2003, we have been utilizing derivative instruments to manage the exposure to inflation risk created by our pre-funded funeral insurance policies that are tied to the CPI. However, we would not be protected by the derivative instruments if there were a sharp increase in inflation on a sustained long-term basis which could have a material adverse effect on our results of operations and financial condition.
Our commercial mortgage loans and real estate investments subject us to liquidity risk.
Our commercial mortgage loans on real estate investments (which represented approximately 10% of the fair value of our total investments as of December 31, 2005) are relatively illiquid, thus increasing our liquidity risk. In addition, if we require extremely large amounts of cash on short notice, we may have difficulty selling these investments at attractive prices, in a timely manner, or both.
The risk parameters of our investment portfolio may not target an appropriate level of risk, thereby reducing our profitability and diminishing our ability to compete and grow.
We seek to earn returns on our investments to enhance our ability to offer competitive rates and prices to our customers. Accordingly, our investment decisions and objectives are a function of the underlying risks and product profiles of each of our business segments. However, if we do not succeed in targeting an appropriate overall risk level for our investment portfolio, the return on our investments may be insufficient to meet our profit targets over the long term, thereby reducing our profitability. If, in response, we choose to increase our product prices to maintain profitability, we may diminish our ability to compete and grow.
Environmental liability exposure may result from our commercial mortgage loan portfolio and real estate investments.
Liability under environmental protection laws resulting from our commercial mortgage loan portfolio and real estate investments may harm our financial strength and reduce our profitability. Under the laws of several states, contamination of a property may give rise to a lien on the property to secure recovery of the costs of the cleanup. In some states, this kind of lien has priority over the lien of an existing mortgage against the property, which would impair our ability to foreclose on that property should the related loan be in default. In addition, under the laws of some states and under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, under certain circumstances, we may be liable for costs of addressing releases or
threatened releases of hazardous substances that require remedy at a property securing a mortgage loan held by us. We also may face this liability after foreclosing on a property securing a mortgage loan held by us after a loan default.
Catastrophe losses, including man-made catastrophe losses, could materially reduce our profitability and have a material adverse effect on our results of operations and financial condition.
Our insurance operations expose us to claims arising out of catastrophes, particularly in our homeowners, life and other personal business lines. We have experienced, and expect in the future to experience, catastrophe losses that may materially reduce our profitability or have a material adverse effect on our results of operations and financial condition. Catastrophes can be caused by various natural events, including, but not limited to, hurricanes, windstorms, earthquakes, hailstorms, severe winter weather, fires and epidemics, or can be man-made catastrophes, including terrorist attacks or accidents such as airplane crashes. The frequency and severity of catastrophes are inherently unpredictable. Catastrophe losses can vary widely and could significantly exceed our recent historic results. It is possible that both the frequency and severity of man-made catastrophes will increase and that we will not be able to implement exclusions from coverage in our policies or obtain reinsurance for such catastrophes.
The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most of our catastrophe claims in the past have related to homeowners and other personal lines coverages, which, for the year ended December 31, 2005, represented approximately 27% of our net earned premiums in our Assurant Solutions segment. In addition, as of December 31, 2005, approximately 37% of the insurance in force in our homeowners and other personal lines related to properties located in California, Florida and Texas. As a result of our creditor-placed homeowners insurance product, which automatically provides coverage against an insureds property being destroyed or damaged by various perils, our concentration in these areas may increase in the future. If other insurers withdraw coverage in these or other states, this may lead to adverse selection and increased utilization of our creditor-placed homeowners insurance in these areas and may negatively impact loss experience. Adverse selection refers to the process by which an applicant who believes himself to be uninsurable, or at greater than average risk, seeks to obtain an insurance policy at a standard premium rate. Claims resulting from natural or man-made catastrophes could cause substantial volatility in our financial results for any fiscal quarter or year and could materially reduce our profitability or harm our financial condition. Our ability to write new business also could be affected. Increases in the value and geographic concentration of insured property and the effects of inflation could increase the severity of claims from catastrophes in the future.
Pre-tax catastrophe losses in excess of $1,000 (before the benefits of reinsurance) that we have experienced in recent years include:
No liquidation in investments was required in connection with these catastrophes as the claims were paid from current cash flow, cash on hand or short-term investments.
In addition, our group life and health insurance operations could be materially impacted by catastrophes such as a terrorist attack, a natural disaster, a pandemic or an epidemic that causes a widespread increase in mortality or disability rates or that causes an increase in the need for medical care. Losses due to these types of
catastrophes would not generally be covered by reinsurance in these lines of business and could have a material adverse effect on our results of operations and financial condition. In addition, with respect to our pre-funded funeral insurance policies, the average age of policyholders is in excess of 73 years. This group is more susceptible to certain epidemics than the overall population, and an epidemic resulting in a higher incidence of mortality could have a material adverse effect on our results of operations and financial condition.
Some of our business segments may also face the loss of premium income due to a large scale business interruption caused by a catastrophe combined with legislative or regulatory reactions to the event. For example, following recent hurricanes, several states suspended premium payment or precluded insurers from canceling coverage in defined areas. While the premium uncollected was immaterial in 2005, a more serious catastrophe combined with a similar legislative or regulatory response could materially impact our ability to collect premiums in connection with our liabilities and thereby have a material adverse effect on our results of operations and financial condition.
Our ability to manage these risks depends in part on our successful utilization of catastrophic property and life reinsurance to limit the size of property and life losses from a single event or multiple events, and life and disability reinsurance to limit the size of life or disability insurance exposure on an individual insured life. It also depends in part on state regulation that may prohibit us from excluding such risks or from withdrawing from or increasing premium rates in catastrophe-prone areas. As discussed further below, catastrophe reinsurance for our group insurance lines is not currently widely available. This means that the occurrence of a significant catastrophe could materially reduce our profitability and have a material adverse effect on our results of operations and financial condition.
Reinsurance may not be available or adequate to protect us against losses, and we are subject to the credit risk of reinsurers.
As part of our overall risk and capacity management strategy, we purchase reinsurance for certain risks underwritten by our various business segments. Market conditions beyond our control determine the availability and cost of the reinsurance protection we purchase. Beginning in late 2001, reinsurance for certain types of catastrophes became generally unavailable in some of our business or, where and to the extent available, much more expensive. Due to these changes in the reinsurance market, our exposure to the risk of significant losses from natural or man-made catastrophes may hinder our ability to write future business.
As part of our business, we have reinsured certain life, property and casualty and health risks to reinsurers. Although the reinsurer is liable to us to the extent of the ceded reinsurance, we remain liable to the insured as the direct insurer on all risks reinsured. As a result, ceded reinsurance arrangements do not eliminate our obligation to pay claims. We are subject to credit risk with respect to our ability to recover amounts due from reinsurers. Due to insolvency, adverse underwriting results or inadequate investment returns, our reinsurers may not pay the reinsurance recoverables that they owe to us or they may not pay such recoverables on a timely basis.
Our reinsurance facilities are generally subject to annual renewal. We may not be able to maintain our current reinsurance facilities and, even where highly desirable or necessary, we may not be able to obtain other reinsurance facilities in adequate amounts and at favorable rates. If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase or, if we are unwilling to bear an increase in net exposures, we may have to reduce the level of our underwriting commitments. Either of these potential developments could materially adversely affect our results of operations and financial condition.
We have sold businesses through reinsurance that could again become our direct financial and administrative responsibility if the purchasing companies were to become insolvent.
In the past, we have sold businesses through reinsurance ceded to third parties. For example, in 2001 we sold the insurance operations of our FFG division to The Hartford and in 2000 we sold our long term care
division to John Hancock. Most of the general account assets backing reserves coinsured with The Hartford and John Hancock are held in trusts that could aid in protecting us financially if The Hartford or John Hancock were to fail. However, such trusts have varying provisions regarding how fully funded they are required to be and how often they must be restored to such funded status. Therefore, protection from the trusts is only existent to the extent the coinsurance trusts are funded at the time of reinsurer default. Aside from the coinsurance, a portion of the assets backing FFG general account reserves and all of the FFG separate accounts remain on our balance sheet pursuant to modified coinsurance arrangements. In addition to the financial risk, we have the additional risk of becoming responsible for administering these businesses in the event of a default by either reinsurer. We do not have the administrative systems and capabilities to process this business today. Accordingly, we would need to obtain those capabilities in the event of an insolvency of one or more of the reinsurers of these businesses. We might be forced to obtain such capabilities on unfavorable terms with a resulting material adverse effect on our results of operations and financial condition.
Due to the structure of our commission program, we are exposed to the credit risk of some of our agents in Assurant PreNeed and our clients in Assurant Solutions.
We advance agents commissions as part of our pre-funded funeral insurance product offerings. These advances are a percentage of the total face amount of coverage as opposed to a percentage of the first-year premium paid, the formula that is more common in other life insurance markets. There is a one-year payback provision against the agency if death or lapse occurs within the first policy year. As a result of the sale of the Independent-United States distribution channel, Assurant PreNeed will incur losses or advances from agents who have been terminated and are unable to repay their obligation. Assurant PreNeed also has a very large producer of these pre-funded funeral insurance products which, if it were unable to fulfill its payback obligations, could have an adverse effect on our results of operations and financial condition.
In addition, we are subject to the credit risk of the clients and/or agents with which we contract in Assurant Solutions. If these parties fail to remit payments owed to us or pass on payments they collect on our behalf, it could have an adverse effect on our results of operations.
A further decline in the manufactured housing market may adversely affect our results of operations and financial condition.
The manufactured housing industry has experienced a significant decline in both shipments and retail sales in the last seven years. The downturn in the manufactured housing industry is a result of several factors, including the impact of repossessions, reduced resale values, and consolidations of manufacturers, dealers and lenders of manufactured housing. In the year ended December 31, 2005, our sales of homeowners policies in the manufactured housing sector comprised 8% of Assurant Solutions net written premiums. If these downward trends continue, our results of operations and financial condition may be adversely affected.
The financial strength of our insurance company subsidiaries is rated by A.M. Best, Moodys, and S&P, and a decline in these ratings could affect our standing in the insurance industry and cause our sales and earnings to decrease.
Ratings have become an increasingly important factor in establishing the competitive position of insurance companies. Most of our domestic operating insurance subsidiaries are rated by A.M. Best. Six of our domestic operating insurance subsidiaries are rated by Moodys and seven of our domestic operating insurance subsidiaries are rated by S&P. The ratings reflect A.M. Bests, Moodys, and S&Ps opinions of our subsidiaries financial strength, operating performance, strategic position and ability to meet their obligations to policyholders. The ratings are not evaluations directed to investors and are not recommendations to buy, sell or hold our securities. These ratings are subject to periodic review by A.M. Best, Moodys, and S&P, and we cannot assure you that we will be able to retain these ratings. For more information on the specific A.M. Best, Moodys, and S&P ratings of our domestic operating insurance subsidiaries, see Item 1BusinessRatings.
If our ratings are reduced from their current levels by A.M. Best, Moodys, or S&P, or placed under surveillance or review with possible negative implications, our competitive position in the respective insurance
industry segments could suffer and it could be more difficult for us to market our products. Rating agencies may take action to lower our ratings in the future due to, among other things the competitive environment in the insurance industry, which may adversely affect our revenues, the inherent uncertainty in determining reserves for future claims, which may cause us to increase our reserves for claims, the outcome of pending litigation and regulatory investigations, which may adversely affect our financial position and reputation and possible changes in the methodology or criteria applied by the rating agencies.
As customers and their advisors place importance on our financial strength ratings, we may lose customers and compete less successfully if we are downgraded. In addition, ratings impact our ability to attract investment capital on favorable terms. If our financial strength ratings are reduced from their current levels by A.M. Best, Moodys, or S&P, our cost of borrowing would likely increase, our sales and earnings could decrease and our results of operations and financial condition could be materially adversely affected.
Contracts representing approximately 22% of Assurant Solutions net earned premiums and fee income for the year ended December 31, 2005, contain provisions requiring the applicable subsidiaries to maintain minimum A.M. Best financial strength ratings ranging from A or better to B or better, depending on the contract. Our clients may terminate these contracts if the subsidiaries ratings fall below these minimum acceptable levels. Under our ten-year marketing agreement with SCI, AMLIC, one of our subsidiaries in the Assurant PreNeed segment, is required to maintain an A.M. Best financial strength rating of B or better throughout the term of the agreement. If AMLIC fails to maintain this rating for a period of 180 days, SCI may terminate the agreement.
The failure to effectively maintain and modernize our information systems could adversely affect our business.
Our business is dependent upon the ability to keep up to date with technological advances. This is particularly important in Assurant Solutions, where our systems, including our ability to keep our systems integrated with those of our clients, are critical to the operation of our business. If we do not update our systems to reflect technological advancements or protect our systems, our relationships and ability to do business with our clients may be adversely affected.
Our business depends significantly on effective information systems, and we have many different information systems for our various businesses. We must commit significant resources to maintain and enhance our existing information systems and develop new information systems in order to keep pace with continuing changes in information processing technology, evolving industry, regulatory and legal standards and changing customer preferences. A failure to maintain effective and efficient information systems, or a failure to efficiently and effectively consolidate our information systems to eliminate redundant or obsolete applications, could have a material adverse effect on our results of operations and financial condition. If we do not maintain adequate systems we could experience adverse consequences, including inadequate information on which to base pricing, underwriting and reserving decisions, the loss of existing customers, difficulty attracting new customers, customer, provider and agent disputes, regulatory problems, such as failure to meet prompt payment obligations, litigation exposure, or increases in administrative expenses.
Our management information, internal control and financial reporting systems may need further enhancements and development to satisfy continuing financial and other reporting requirements of being a public company.
Continued compliance with the Sarbanes-Oxley Act may entail significant expenditure.
The Sarbanes-Oxley Act of 2002 and rules subsequently implemented by the Securities and Exchange Commission (the SEC), and the New York Stock Exchange (the NYSE), required changes to various accounting and corporate governance practices. We expect our continued compliance with these rules and regulations to increase our accounting, legal and other costs and to make certain activities, such as making acquisitions and dispositions, changing operational and accounting processes, and implementing changes in accounting policies, more time consuming and/or costly.
Failure to protect our clients confidential information and privacy could result in the loss of reputation and customers, reduction to our profitability and/or subject us to fines, litigation and penalties.
A number of our businesses are subject to privacy regulations and to confidentiality obligations. For example, the collection and use of patient data in our Assurant Health and Assurant Employee Benefits segments is the subject of national and state legislation, including the HIPAA, and certain activities conducted by our segments are subject to the privacy regulations of the Gramm-Leach-Bliley Act. We also have contractual obligations to protect certain confidential information we obtain from our existing vendors and clients. These obligations generally include protecting such confidential information in the same manner and to the same extent as we protect our own confidential information. The actions we take to protect such confidential information vary by business segment and may include, among other things, training and educating our employees regarding our obligations relating to confidential information, actively monitoring our record retention plans and any changes in state or federal privacy and compliance requirements, drafting appropriate contractual provisions into any contract that raises proprietary and confidentiality issues, maintaining and utilizing appropriately secure storage facilities for tangible records, and limiting access, as appropriate, to both tangible records and to electronic information.
In addition, we maintain a comprehensive written information security program with appropriate administrative, technical and physical safeguards to protect such confidential information. If we do not properly comply with privacy and security laws and regulations that require us to protect confidential information, we could experience adverse consequences, including loss of customers and related revenue, regulatory problems (including fines and penalties), loss of reputation and civil litigation.
See Risks Related to Our IndustryCost of compliance with privacy laws could adversely affect our business and results of operations.
We may not find suitable acquisition candidates or new insurance ventures and even if we do, we may not successfully integrate any such acquired companies or successfully invest in such ventures.
From time to time, we evaluate possible acquisition transactions and the start-up of complementary businesses, and at any given time, we may be engaged in discussions with respect to possible acquisitions and new ventures. While our business model is not dependent upon acquisitions or new insurance ventures, the time frame for achieving or further improving upon our desired market positions can be significantly shortened through opportune acquisitions or new insurance ventures. Historically, acquisitions and new insurance ventures have played a significant role in achieving desired market positions in some, but not all, of our businesses. No assurance can be given that we will be able to identify suitable acquisition transactions or insurance ventures, that such transactions will be financed and completed on acceptable terms or that our future acquisitions or ventures will be successful. The process of integrating any companies we do acquire or investing in new ventures could have a material adverse effect on our results of operations and financial condition.
In addition, implementation of an acquisition strategy entails a number of risks, including among other things inaccurate assessment of undisclosed liabilities; difficulties in realizing projected efficiencies, synergies and cost savings; failure to achieve anticipated revenues, earnings or cash flow; an increase in our indebtedness; and a limitation in our ability to access additional capital when needed. For example, we recognized a goodwill impairment of $1,260,939 in 2002 related to an earlier acquisition. Our failure to adequately address these acquisition risks could materially adversely affect our results of operations and financial condition.
The inability of our subsidiaries to pay dividends to us in sufficient amounts could harm our ability to meet our obligations and pay future stockholder dividends.
As a holding company whose principal assets are the capital stock of our subsidiaries, we rely primarily on dividends and other statutorily permissible payments from our subsidiaries to meet our obligations for payment
of interest and principal on outstanding debt obligations, dividends to stockholders (including any dividends on our common stock) and corporate expenses. The ability of our subsidiaries to pay dividends and to make such other payments in the future will depend on their statutory surplus, future statutory earnings and regulatory restrictions. Except to the extent that we are a creditor with recognized claims against our subsidiaries, claims of the subsidiaries creditors, including policyholders, have priority with respect to the assets and earnings of the subsidiaries over the claims of our creditors. If any of our subsidiaries should become insolvent, liquidate or otherwise reorganize, our creditors and stockholders will have no right to proceed against the assets of that subsidiary or to cause the liquidation, bankruptcy or winding-up of the subsidiary under applicable liquidation, bankruptcy or winding-up laws. The applicable insurance laws of the jurisdiction where each of our insurance subsidiaries is domiciled would govern any proceedings relating to that subsidiary. The insurance authority of that jurisdiction would act as a liquidator or rehabilitator for the subsidiary. Both creditors and policyholders of the subsidiary would be entitled to payment in full from the subsidiarys assets before we, as a stockholder, would be entitled to receive any distribution from the subsidiary.
The payment of dividends to us by any of our regulated operating subsidiaries in excess of a certain amount (i.e., extraordinary dividends) must be approved by the subsidiarys domiciliary state department of insurance. Ordinary dividends, for which no regulatory approval is generally required, are limited to amounts determined by a formula, which varies by state. The formula for the majority of the states in which our subsidiaries are domiciled is based on the prior years statutory net income or 10% of the statutory surplus as of the end of the prior year. Some states limit ordinary dividends to the greater of these two amounts, others limit them to the lesser of these two amounts and some states exclude prior year realized capital gains from prior year net income in determining ordinary dividend capacity. Some states have an additional stipulation that dividends may only be paid out of earned surplus. If insurance regulators determine that payment of an ordinary dividend or any other payments by our insurance subsidiaries to us (such as payments under a tax sharing agreement or payments for employee or other services) would be adverse to policyholders or creditors, the regulators may block such payments that would otherwise be permitted without prior approval. No assurance can be given that there will not be further regulatory actions restricting the ability of our insurance subsidiaries to pay dividends. We may seek approval of regulators to pay dividends in excess of any amounts that would be permitted without such approval. If the ability of insurance subsidiaries to pay dividends or make other payments to us is materially restricted by regulatory requirements, it could adversely affect our ability to pay any dividends on our common stock and/or service our debt and pay our other corporate expenses. For more information on the maximum amount our subsidiaries could pay us in 2006 and did pay us in 2005 without regulatory approval, see Item 5Market For Registrants Common Equity and Related Stockholder MattersDividend Policy.
Our credit facilities also contain limitations on our ability to pay dividends to our stockholders if we are in default or such dividend payments would cause us to be in default of the credit facilities.
Risks Related to Our Industry
Our business is subject to risks related to litigation and regulatory actions.
In addition to the occasional employment-related litigation to which businesses are subject, we are a defendant in actions arising out of, and are involved in, various regulatory investigations and examinations relating to, our insurance and other related business operations. We may from time to time be subject to a variety of legal and regulatory actions relating to our current and past business operations, including, but not limited to:
The outcome of these actions cannot be predicted, and no assurances can be given that such actions or any litigation would not materially adversely affect our results of operations and financial condition. In addition, if we were to experience difficulties with our relationship with a regulatory body in a given jurisdiction, it could have a material adverse effect on our ability to do business in that jurisdiction.
In addition, plaintiffs continue to bring new types of legal claims against insurance and related companies. Current and future court decisions and legislative activity may increase our exposure to these types of claims. Multiparty or class action claims may present additional exposure to substantial economic, non-economic or punitive damage awards. The loss of even one of these claims, if it resulted in a significant damage award or a judicial ruling that was otherwise detrimental, could have a material adverse effect on our results of operations and financial condition. This risk of potential liability may make reasonable settlements of claims more difficult to obtain. We cannot determine with any certainty what new theories of recovery may evolve or what their impact may be on our businesses.
Recently, the insurance industry has experienced substantial volatility as a result of litigation, investigations and regulatory activity by various insurance, governmental and enforcement authorities concerning certain practices within the insurance industry. These practices include the payment of contingent commissions by insurance companies to insurance brokers and agents and the extent to which such compensation has been disclosed, the solicitation and provision of fictitious or inflated quotes and the use of inducements to brokers or companies in the sale of group insurance products. In accordance with a long-standing and widespread industry practice, we have paid and continue to pay contingent commissions to insurance brokers and agents, primarily in our Assurant Employee Benefits segment. Assurant Employee Benefits follows a policy of full disclosure consistent with its understanding of existing regulations in this area. With respect to improper sales practices, we have received inquiries and informational requests from insurance departments in certain states in which our insurance subsidiaries operate. We have conducted an internal review under the supervision of outside counsel and have confirmed that our employees have not provided inflated or fictitious quotes or used improper inducements in the sale of group insurance products in our Assurant Employee Benefits segment.
Another focus of regulators has been the accounting treatment for finite reinsurance or other non-traditional or loss mitigation insurance products. Some state regulators have made routine inquiries to some of our insurers regarding finite reinsurance. Additionally, as part of ongoing, industry-wide investigations, we received subpoenas from the SEC and the United States Attorney for the Southern District of New York requesting information regarding certain loss mitigation products and documents relating to the use of finite risk insurance. We conducted an evaluation of the transactions that could potentially fall within the scope of the subpoenas, as defined by the authorities, and provided information as requested. Based on our investigation to date into this matter, we have concluded that there was a verbal side agreement with respect to one of our reinsurers under our catastrophic reinsurance program. While we believe that the difference resulting from the
appropriate alternative accounting treatment would be immaterial to our financial position or results of operations, regulators may reach a different conclusion. In 2004 and 2003, premiums ceded to this reinsurer were $2,600 and $1,500, respectively, and losses ceded were $10,000 and zero, respectively. This contract expired in December 2004 and was not renewed. The Audit Committee of the Board of Directors, with the assistance of independent counsel, also completed an investigation of the matters raised by the subpoenas. The Audit Committee has not found any wrongdoing on the part of any of our current officers. We have enhanced our internal controls regarding reinsurance and will continue to further evaluate their effectiveness. We cannot predict at this time the effect that current litigation, investigations and regulatory activity will have on the insurance industry or our business. Given our prominent position in the insurance industry, it is possible that we will become subject to further investigations and have lawsuits filed against us. Our involvement in any investigations and lawsuits would cause us to incur legal costs and, if we were found to have violated any laws, we could be required to pay fines and damages, perhaps in material amounts. In addition, we could be materially adversely affected by the negative publicity for the insurance industry related to any such proceedings, and by any new industry-wide regulations or practices that may result from any such proceedings.
We face significant competitive pressures in our businesses, which may reduce premium rates and prevent us from pricing our products at rates that will allow us to be profitable.
In each of our lines of business, we compete with other insurance companies or service providers, depending on the line and products, although we have no single competitor who competes against us in all of the business lines in which we operate. Assurant Solutions has numerous competitors in its product lines, but we believe no other company participates in all of the same lines or offers comparable comprehensive capabilities. Competitors include insurance companies and financial institutions. In Assurant Health, we believe the market is characterized by many competitors, and our main competitors include health insurance companies, HMOs and the Blue Cross/Blue Shield plans in the states in which we write business. In Assurant Employee Benefits, commercial competitors include benefits and life insurance companies as well as dental managed care entities and not-for-profit Delta Dental plans. In November 2005, Assurant PreNeed exited the non-SCI funeral home market in the U.S. Assurant PreNeed continues to actively market preneed insurance to independent funeral homes in Canada in addition to marketing through its exclusive distribution relationship with SCI in the U.S. and Canada. As part of this exit, Assurant PreNeed agreed to sell its independent sales distribution network to Forethought in exchange for a percentage of future sales from Forethought for a ten-year period. Assurant has agreed not to compete with Forethought in the non-SCI United States market for ten years. There is a transition period during which Assurant PreNeed agents will continue to write Assurant PreNeed products until November of 2006, when the transition of new independent sales to Forethought should be completed. Given the exclusive distribution relationship with SCI and the agreement not to compete with Forethought in the U.S., Assurant PreNeeds only competitors at the present time are in the Independent channel in Canada. These competitors include Unity Life Insurance Company and several Canadian trust companies. While we are among the largest competitors in terms of market share in many of our business lines, in some cases there are one or more major market players in a particular line of business.
Competition in our businesses is based on many factors, including quality of service, product features, price, scope of distribution, scale, financial strength ratings and name recognition. We compete, and will continue to compete, for customers and distributors with many insurance companies and other financial services companies. We compete not only for business and individual customers, employer and other group customers, but also for agents and distribution relationships. Some of our competitors may offer a broader array of products than our specific subsidiaries with which they compete in particular markets, may have a greater diversity of distribution resources, may have better brand recognition, may from time to time have more competitive pricing, may have lower cost structures or, with respect to insurers, may have higher financial strength or claims paying ratings. Some may also have greater financial resources with which to compete. For example, many of our insurance products, particularly our group benefits and health insurance policies, are underwritten annually and, accordingly, there is a risk that group purchasers may be able to obtain more favorable terms from competitors rather than renewing coverage with us. The effect of competition may, as a result, adversely affect the
persistency of these and other products, as well as our ability to sell products in the future. In Assurant Solutions, as a result of state and federal regulatory developments and changes in prior years, certain financial institutions are now able to offer a product similar to credit life, disability and loss of employment insurance (debt protection) and are able to affiliate with other insurance companies to offer services similar to our own. This has resulted in new competitors with significant financial resources entering some of our markets. Assurant Solutions currently provides debt protection administration and as financial institutions gain experience with debt protection administration, their reliance on third party administrators may diminish.
Moreover, some of our competitors may have a lower target for returns on capital allocated to their business than we do, which may lead them to price their products and services lower than we do. In addition, from time to time, companies enter and exit the markets in which we operate, thereby increasing competition at times when there are new entrants. For example, several large insurance companies have recently entered the market for individual health insurance products. We may lose business to competitors offering competitive products at lower prices, or for other reasons, which could materially adversely affect our results of operations and financial condition.
In certain markets, we compete with organizations that have a substantial market share. In addition, with regard to Assurant Health, organizations with sizable market share or provider-owned plans may be able to obtain favorable financial arrangements from health care providers that are not available to us. Without our own similar arrangements, we may not be able to compete effectively in such markets.
New competition could also cause the supply of insurance to change, which could affect our ability to price our products at attractive rates and thereby adversely affect our underwriting results. Although there are some impediments facing potential competitors who wish to enter the markets we serve, the entry of new competitors into our markets can occur, affording our customers significant flexibility in moving to other insurance providers.
The insurance industry is cyclical, which may impact our results.
The insurance industry is cyclical. Although no two cycles are the same, insurance industry cycles have typically lasted for periods ranging from two to ten years. The segments of the insurance markets in which we operate tend not to be correlated to each other, with each segment having its own cyclicality. Periods of intense price competition due to excessive underwriting capacity, periods when shortages of underwriting capacity permit more favorable rate levels, consequent fluctuations in underwriting results and the occurrence of other losses characterize the conditions in these markets. Historically, insurers have experienced significant fluctuations in operating results due to volatile and sometimes unpredictable developments, many of which are beyond the direct control of the insurer, including competition, frequency of occurrence or severity of catastrophic events, levels of capacity, general economic conditions and other factors. This may cause a decline in revenue at times in the cycle if we choose not to reduce our product prices in order to maintain our market position, because of the adverse effect on profitability of such a price reduction. We can be expected, therefore, to experience the effects of such cyclicality and changes in customer expectations of appropriate premium levels, the frequency or severity of claims or other loss events or other factors affecting the insurance industry that generally could have a material adverse effect on our results of operations and financial condition.
The insurance and related businesses in which we operate may be subject to periodic negative publicity, which may negatively impact our financial results.
We communicate with and distribute our products and services ultimately to individual consumers. There may be a perception that some of these purchasers may be unsophisticated and in need of consumer protection. Accordingly, from time to time, consumer advocate groups or the media may focus attention on our products and services, thereby subjecting our industries to the possibility of periodic negative publicity. We may also be negatively impacted if another company in one of our industries or in a related industry engages in practices resulting in increased public attention to our businesses. Negative publicity may also occur as a result of judicial inquiries and regulatory or governmental action with respect to our products, services and industry commercial
practices. Negative publicity may result in increased regulation and legislative scrutiny of industry practices as well as increased litigation or enforcement action by civil and criminal authorities. Additionally, negative publicity may increase our costs of doing business and adversely affect our profitability by impeding our ability to market our products and services, requiring us to change our products or services or increasing the regulatory burdens under which we operate.
Recent focus by the government and the National Association of Insurance Commissioners (NAIC) on certain industry practices, including but not limited to, broker contingent commissions and finite or financial reinsurance, has created negative publicity for some insurers and the reinsurance industry, including those seeking reinsurance covers.
We are subject to extensive governmental laws and regulations, which increase our costs and could restrict the conduct of our business.
Our operating subsidiaries are subject to extensive regulation and supervision in the jurisdictions in which they do business. Such regulation is generally designed to protect the interests of policyholders, as opposed to stockholders and other investors. To that end, the laws of the various states establish insurance departments with broad powers with respect to such things as:
Our non-insurance operations and certain aspects of our insurance operations are subject to federal and state regulation including state and federal consumer protection laws. Similarly, our foreign subsidiaries are subject to legislation in the countries in which they are domiciled. We face the challenge of conducting business in a multi national setting with varying regulations.
Assurant Health is also required by some jurisdictions to provide coverage to persons who would not otherwise be considered eligible by insurers. Each of these jurisdictions dictates the types of insurance and the level of coverage that must be provided to such involuntary risks. Our share of these involuntary risks is mandatory and generally a function of our respective share of the voluntary market by line of insurance in each jurisdiction. Assurant Health is exposed to some risk of losses in connection with mandated participation in such programs in those jurisdictions in which they are still effective. HIPAA requires certain guaranteed issuance and renewability of health insurance coverage for individuals and small groups (generally 50 or fewer employees) and limits exclusions based on pre-existing conditions. See also Risks Related to Our IndustryCosts of compliance with privacy laws could adversely affect our business and results of operations. If regulatory
requirements impede our ability to raise premium rates, utilize new policy forms or terminate, deny or cancel coverage in any of our businesses, our results of operations and financial condition could be materially adversely affected. The capacity for an insurance companys growth in premiums is in part a function of its statutory surplus. Maintaining appropriate levels of statutory surplus, as measured by SAP and procedures, is considered important by insurance regulatory authorities and the private agencies that rate insurers claims-paying abilities and financial strength. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny and enforcement, action by regulatory authorities or a downgrade by rating agencies.
We may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authoritys interpretation of the laws and regulations. Also, some regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or monetarily penalize us. That type of action could materially adversely affect our results of operations and financial condition.
Changes in regulation may reduce our profitability and limit our growth.
Legislation or other regulatory reform that increases the regulatory requirements imposed on us or that changes the way we are able to do business may significantly harm our business or results of operations in the future. For example, some states have imposed new time limits for the payment of uncontested covered claims and require health care and dental service plans to pay interest on uncontested claims not paid promptly within the required time period. Some states have also granted their insurance regulatory agencies additional authority to impose monetary penalties and other sanctions on health and dental plans engaging in certain unfair payment practices. If we were to be unable for any reason to comply with these requirements, it could result in substantial costs to us and may materially adversely affect our results of operations and financial condition.
Legislative or regulatory changes that could significantly harm us and our subsidiaries include, but are not limited to:
In recent years, the state insurance regulatory framework has come under increased federal scrutiny and some state legislatures have considered or enacted laws that may alter or increase state authority to regulate insurance companies and insurance holding companies. Further, the NAIC and state insurance regulators are re-examining existing laws and regulations, specifically focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws. Although the U.S. federal government does not directly regulate the insurance business, changes in federal legislation and administrative policies in several areas could significantly impact the insurance industry and us. Federal legislation and administrative policies in areas such as employee benefit plan regulation, financial services regulation and federal taxation can reduce our profitability. Additionally, there have been attempts by the NAIC and several states to limit the use of discretionary clauses in policy forms. The elimination of discretionary clauses could increase our costs under our life, health and disability insurance policies. New interpretations of existing laws and the passage of new legislation may harm our ability to sell new policies and increase our claims exposure on policies we issued previously.
A number of legislative proposals have been made at the federal level over the past several years that could impose added burdens on Assurant Health. These proposals would, among other things, mandate benefits with respect to certain diseases or medical procedures, require plans to offer an independent external review of certain coverage decisions, establish association health plans for small businesses, and establish a national health insurance program. Any of these proposals, if implemented, could adversely affect our results of operations or financial condition. Federal changes in Medicare and Medicaid that reduce provider reimbursements could have negative implications for the private sector due to cost shifting. State small employer group and individual health insurance market reforms to increase access and affordability could also reduce profitability by precluding us from appropriately pricing for risk in our individual and small employer group health insurance policies.
The NAIC is considering various models that will impose internal controls similar to those mandated by Section 404 of the Sarbanes-Oxley Act of 2002, which we refer to as SOX 404, on insurance companies and introduce changes in SAP relating to reinsurance. These SOX 404 type controls will add an additional layer of internal review for insurer financial statements and subject insurers to varying levels of review by state insurance regulators. This could result in potential exposure for fines and penalties for non-compliance. Changes in statutory accounting principles may negatively impact insurer financial reporting requirements and the profitability of insurance operations on a statutory basis.
Additionally, the Attorney General of Mississippi has initiated legal actions against a number of large insurers to invalidate or interpret the flood exclusion in various insurance policies of hurricane-affected claimants, so as to require coverage for losses from hurricane floods and tidal waves. The named insurers are contesting such action. Although none of the Assurant companies has been specifically named as defendants, the lawsuit names as unknown defendants, any business entity qualified to do business in the State of Mississippi who offered insurance, similar to the named insurers, to the detriment of the citizens of the State. As a result, if any of our companies are determined to be a defendant and the Mississippi Attorney General prevails, this could result in negative publicity or have a materially adverse effect on our current financial results as well as future pricing and profitability.
We cannot predict with certainty the effect any proposed or future legislation, regulations or NAIC initiatives may have on the conduct of our business. The insurance laws or regulations adopted or amended from time to time may be more restrictive or may result in materially higher costs than current requirements.
It is difficult to predict the effect of the current investigations in connection with insurance industry practices. See Our business is subject to risks related to litigation and regulatory actions.
Costs of compliance with privacy laws could adversely affect our business and results of operations.
State privacy laws, particularly those with opt-in clauses, or provisions that enable an individual to elect information sharing instead of being automatically included, can affect our pre-funded funeral insurance business
and Solutions business. These laws make it harder for our affiliated businesses to share information for marketing purposes, such as generating new sales leads. In addition, there is currently pending litigation in the Ninth Circuit Court of Appeals that could further affect the extent to which various subsidiaries of the same parent company may share non-public personal information about consumers with one another. Depending on the outcome of this litigation, Assurant may be required to take steps to segregate certain information from one business segment to another, which could increase costs in operations and marketing.
Similarly, the federal and various state do not solicit lists could pose a litigation risk to Assurant Solutions. Even an inadvertent failure to comply with consumers requests to be added to the do not solicit list could result in litigation.
HIPAA and the implementing regulations that have thus far been adopted impose new obligations for issuers of health and dental insurance coverage and health and dental benefit plan sponsors. HIPAA also establishes new requirements for maintaining the confidentiality and security of individually identifiable health information and new standards for electronic health care transactions. The Department of Health and Human Services promulgated final HIPAA regulations in 2002. The privacy regulations required compliance by April 2003, the electronic transactions regulations by October 2003 and the security regulations by April 2005. As have other entities in the health care industry, we have incurred substantial costs in meeting the requirements of these HIPAA regulations and expect to continue to incur costs to maintain compliance.
HIPAA is far-reaching and complex and proper interpretation and practice under the law continue to evolve. Consequently, our efforts to measure, monitor and adjust our business practices to comply with HIPAA are ongoing. Failure to comply with HIPAA could result in regulatory fines and civil lawsuits. Knowing and intentional violations of these rules may also result in federal criminal penalties.
Beginning in early 2005, several large organizations became subjects of intense public scrutiny due to high-profile data security breaches involving sensitive financial and health information. These events focused national attention on identity theft and the duty of organizations to notify impacted consumers in the event of a data security breach. Several federal bills are pending in Congress and, as of year-end, 21 states and one municipality have passed legislation requiring customer notification in the event of a data security breach. Most state laws take their lead from Californias Senate Bill 1386, which requires businesses that conduct business in California to disclose any breach of security to any resident whose unencrypted data is believed to have been disclosed. Several significant legal, operational and reputational risks exist with regard to data breach and customer notification. Federal pre-emption relating to this issue may reduce our compliance costs. However, a breach of data security requiring public notification could result in regulatory fines, penalties or sanctions, civil lawsuits, loss of reputation, loss of customers and reduction of our profitability.
Risks Related to Our Relationship with Fortis
Fortis continues to be a significant stockholder of the Company, which gives them the right to register their shares and the ability to influence the market price of our stock.
Sales of a substantial number of shares of our common stock, or the perception by the market that those sales could occur, could cause the market price of our common stock to decline or could make it more difficult for us to raise funds through the sale of equity in the future. Based on a Schedule 13G filed on February 10, 2006, Fortis owned 22,999,130 shares of our common stock as of December 31, 2005, or approximately 17.6% of our outstanding common stock. All of these shares are subject to the terms of the exchangeable bonds, due January 26, 2008, that were sold by Fortis concurrently with the closing of our secondary offering on January 21,
2005. If, however, the exchangeable bonds are not exchanged for shares of our common stock, Fortis could retain some ownership interest in our company. In that case, under the terms of a Registration Rights Agreement, dated as of February 10, 2004, as amended on January 10, 2005, Fortis would have the right to affect the registration of such shares of our common stock, making them freely tradable in the public market. Sales of a large number of these shares by Fortis at any time could have an adverse effect on the market price of our common stock.
Because Fortis Bank operates U.S. branch offices, we are subject to regulation and oversight by the Federal Reserve Board under the Bank Holding Company Act (BHCA).
Fortis Bank S.A./N.V. (Fortis Bank), which is a company in the Fortis Group, obtained approval in 2002 from state banking authorities and the Board of Governors of the Federal Reserve System (Federal Reserve) to establish branch offices in Connecticut and New York. By virtue of the opening of these offices, the Fortis Groups operations and investments (including the Fortis Groups investment in us) became subject to the nonbanking prohibitions of Section 4 of the BHCA. Except to the extent that a BHCA exemption or authority is available, Section 4 of the BHCA does not permit foreign banking organizations with U.S. branches to own more than 5% of any class of voting shares or otherwise to control any company that conducts commercial activities, such as manufacturing, distribution of goods or real estate development.
To broaden the scope of activities and investments permissible for the Fortis Group and us, the Fortis Group in 2002 notified the Federal Reserve of its election to be a financial holding company for purposes of the BHCA and the Federal Reserves implementing regulations in Regulation Y. As a financial holding company, the Fortis Group may own shares of companies engaged in activities in the United States that are financial in nature, incidental to such financial activity or complementary to a financial activity. Activities that are financial in nature include, among other things:
In connection with Fortis Banks establishment of U.S. branches, staff of the Federal Reserve inquired as to whether certain of our activities are financial in nature under Section 4(k) of the BHCA. In light of the Fortis Groups contemplated divestiture of our shares, this inquiry was suspended at the Fortis Groups and our request. To the extent that any of our activities might be deemed not to be financial in nature under Section 4(k), the Fortis Group may rely on an exemption in Section 4(a)(2) of the BHCA that permits the Fortis Group to continue to hold interests in companies engaged in activities that are not financial in nature for an initial period of two years and, with Federal Reserve approval for each extension, for up to three additional one-year periods. The Federal Reserve also has the discretion to permit the Fortis Group to hold such interests after the five-year period under certain provisions other than Section 4(a)(2). The initial two-year period under Section 4(a)(2) expired on December 2, 2004. The first one-year extension expired on December 2, 2005. The Fortis Group has obtained an additional one-year extension of the divestiture period through December 2, 2006.
If the Federal Reserve does not grant further extensions of the exemption period for any one-year period or if Fortis holds more than 5% of any class of our voting shares after December 2, 2007, without the consent or acquiescence of the Federal Reserve, and the Federal Reserve determines that certain of our activities are nonfinancial, the Fortis Group may be required (i) to rely on another provision of the BHCA, (ii) to close the U.S. branches of Fortis Bank, or (iii) to divest any of our shares exceeding 5% of any class of our voting shares and to divest any control over us for purposes of the BHCA.
The Fortis Group will continue to qualify as a financial holding company so long as Fortis Bank remains well capitalized and well managed, as those terms are defined in Regulation Y. Generally, Fortis Bank will be considered well capitalized if it maintains tier 1 and total RBC ratios of at least 6% and 10%, respectively.
The Fortis Group will be considered well managed if it has received at least a satisfactory composite rating of its U.S. branch operations at its most recent examination. If the Fortis Group lost and were unable to regain its financial holding company status, the Fortis Group could be required (i) to close the U.S. branches of Fortis Bank or (ii) to divest any of our shares exceeding 5% of any class of our voting securities and to divest any control over us for purposes of the BHCA.
In addition, the Federal Reserve has jurisdiction under the BHCA over all of the Fortis Groups direct and indirect U.S. subsidiaries. We and our subsidiaries will be considered subsidiaries of the Fortis Group for purposes of the BHCA so long as the Fortis Group owns 25% or more of any class of our voting shares or otherwise controls or has been determined to have a controlling influence over us within the meaning of the BHCA. The Federal Reserve could take the position that the Fortis Group continues to control us until the Fortis Group reduces its ownership to less than 5% of our voting shares. So long as the Fortis Group controls us for purposes of the BHCA, the Federal Reserve could require us immediately to discontinue, restructure or divest any of our operations that are deemed to be impermissible under the BHCA, which could result in reduced revenues, increased costs or reduced profitability for us.
Risks Related to Our Common Stock
Applicable laws and our certificate of incorporation and by-laws may discourage takeovers and business combinations that our stockholders might consider in their best interests.
State laws and our certificate of incorporation and by-laws may delay, defer, prevent or render more difficult a takeover attempt that our stockholders might consider in their best interests. For instance, they may prevent our stockholders from receiving the benefit from any premium to the market price of our common stock offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging takeover attempts in the future.
State laws and our certificate of incorporation and by-laws may also make it difficult for stockholders to replace or remove our directors. These provisions may facilitate directors entrenchment, which may delay, defer or prevent a change in our control, which may not be in the best interests of our stockholders.
The following provisions in our certificate of incorporation and by-laws have anti-takeover effects and may delay, defer or prevent a takeover attempt that our stockholders might consider in their best interests. In particular, our certificate of incorporation and by-laws:
In addition, Section 203 of the General Corporation Law of the State of Delaware may limit the ability of an interested stockholder to engage in business combinations with us. An interested stockholder is defined to include persons owning 15% or more of our outstanding voting stock.
Applicable insurance laws may make it difficult to effect a change of control of our Company.
Before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where the domestic insurer is domiciled. Generally, state statutes provide that control over a domestic insurer is presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote, or holds proxies representing, 10% or more of the voting securities of the domestic insurer. However, the State of Florida, in which certain of our insurance subsidiaries are domiciled, defines control as 5% or more. Because a person acquiring 5% or more of our common stock would indirectly control the same percentage of the stock of our Florida subsidiaries, the insurance change of control laws of Florida would apply to such transaction and at 10%, the laws of many other states would likely apply to such a transaction. Prior to granting approval of an application to acquire control of a domestic insurer, a state insurance commissioner will typically consider such factors as the financial strength of the applicant, the integrity of the applicants board of directors and executive officers, the applicants plans for the future operations of the domestic insurer and any anti-competitive results that may arise from the consummation of the acquisition of control.
Our stock and the stocks of other companies in the insurance industry are subject to stock price and trading volume volatility.
From time to time, the stock price and the number of shares traded of companies in the insurance industry experience periods of significant volatility. Company-specific issues and developments generally in the insurance industry and in the regulatory environment may cause this volatility. Our stock price may fluctuate in response to a number of events and factors, including:
In addition, broad market and industry fluctuations may adversely affect the trading price of our common stock, regardless of our actual operating performance.
Item 2. Properties
We own seven properties, including five buildings that serve as headquarters locations for our operating business segments and two buildings that serve as operation centers for Assurant Solutions. Assurant Solutions has headquarters buildings located in Miami, Florida and Atlanta, Georgia. Assurant Solutions operation centers are located in Florence, South Carolina and Springfield, Ohio. Assurant Employee Benefits has a headquarters building in Kansas City, Missouri. Assurant Health has a headquarters building in Milwaukee, Wisconsin. Assurant PreNeeds AMLIC channel has a headquarters building in Rapid City, South Dakota. We lease office space for various offices and service centers located throughout the United States and internationally, including our New York corporate office and our data center in Woodbury, Minnesota. Our leases have terms ranging from month-to-month to twenty-five years. We believe that our owned and leased properties are adequate for our current business operations.
Item 3. Legal Proceedings
We are regularly involved in litigation in the ordinary course of business, both as a defendant and as a plaintiff. We may from time to time be subject to a variety of legal and regulatory actions relating to our current and past business operations. While we cannot predict the outcome of any pending or future litigation, examination or investigation and although no assurances can be given, we do not believe that any pending matter will have a material adverse effect individually or in the aggregate on our financial condition or results of operations.
One of our subsidiaries, American Reliable Insurance Company (ARIC), participated in certain excess of loss reinsurance programs in the London market and, as a result, reinsured certain personal accident, ransom and kidnap insurance risks from 1995 to 1997. ARIC and a foreign affiliate ceded a portion of these risks to retrocessionaires. ARIC ceased reinsuring such business in 1997. However, certain risks continued beyond 1997 due to the nature of the reinsurance contracts written. ARIC and some of the other reinsurers involved in the programs are seeking to avoid certain treaties on various grounds, including material misrepresentation and non-disclosure by the ceding companies and intermediaries involved in the programs. Similarly, some of the retrocessionaires are seeking avoidance of certain treaties with ARIC and the other reinsurers and some reinsureds are seeking collection of disputed balances under some of the treaties. The disputes generally involve multiple layers of reinsurance, and allegations that the reinsurance programs involved interrelated claims spirals devised to disproportionately pass claims losses to higher-level reinsurance layers. Many of the companies involved in these programs, including ARIC, are currently involved in negotiations, arbitrations and/or litigation between multiple layers of retrocessionaires, reinsurers, ceding companies and intermediaries, including brokers, in an effort to resolve these disputes. Many of the disputes involving ARIC and an affiliate, relating to the 1995 and 1997 program years have been resolved by settlement or arbitration. As a result of the settlements and an arbitration in which ARIC did not prevail, additional information became available in 2005 and the Company recorded additional reserves. On February 28, 2006, many of the disputes relating to losses in the 1996 program year were settled. Loss accruals previously established relating to the 1996 program were adequate. Negotiations, arbitration and litigation are still ongoing or proposed for the remaining disputes. We believe, based on information currently available, that the amounts accrued for currently outstanding disputes are adequate.
We were notified on August 26, 2004 that one of our employees is being investigated by the criminal division of the Internal Revenue Service (IRS) for responses he made to questions he was asked by the IRS relating to an approximately $18,000 tax reserve taken by us in 1999. At this stage, it would be speculative to predict the outcome of this investigation. However, it could result in a fine assessed against the employee and the Company, negative publicity for the Company or more serious sanctions.
As part of ongoing, industry-wide investigations, we have received subpoenas from the SEC and the United States Attorney for the Southern District of New York requesting information regarding certain loss mitigation
products and documents relating to the use of finite risk insurance. We conducted an evaluation of the transactions that could potentially fall within the scope of the subpoenas, as defined by the authorities, and have provided information as requested. Based on our investigation to date, we have concluded that there was a verbal side agreement with respect to one of our reinsurers under our catastrophic reinsurance program. While management believes that the difference resulting from the appropriate alternative accounting treatment would be immaterial to our financial position or results of operations, regulators may reach a different conclusion. In 2004 and 2003, premiums ceded to this reinsurer were $2,600 and $1,500, respectively, and losses ceded were $10,000 and zero, respectively. This contract expired in December 2004 and was not renewed. The Audit Committee of the Board of Directors, with the assistance of independent counsel, also completed an investigation of the matters raised by the subpoenas. The Audit Committee has not found any wrongdoing on the part of any of our current officers. We have enhanced our internal controls regarding reinsurance and they are being appropriately monitored to ensure their effectiveness.
We believe, based on information currently available, that the amounts accrued for currently outstanding disputes are adequate. The inherent uncertainty of arbitrations and lawsuits, including the uncertainty of estimating whether any settlements we may enter into in the future, would be on favorable terms, makes it difficult to predict the outcomes with certainty.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of the stockholders of Assurant, Inc. during the fourth quarter of 2005.
Item 5. Market For Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock Price
Our common stock is listed on the NYSE under the symbol AIZ. The following table sets forth the high and low intraday sales prices per share of our common stock as reported by the NYSE since our initial public offering in February 2004 for the periods indicated.
Equity Compensation Plan Information
The following table shows aggregate information, as of December 31, 2005, with respect to compensation plans under which equity securities of Assurant are authorized for issuance.
On March 1, 2006, there were approximately 137 registered holders of record of our common stock, and we estimate that there were approximately 55,807 beneficial owners of our common stock. The closing price of our common stock on the NYSE on March 1, 2006 was $45.42.
On February 8, 2006, we announced that our Board of Directors has declared a quarterly dividend of $0.08 per common shares payable on March 7, 2006 to shareholders of record as of February 21, 2006. We paid dividends of $0.08 per share of common stock on June 7, 2005, September 7, 2005 and December 12, 2005. We paid dividends of $0.07 per share of common stock on June 8, 2004, September 7, 2004, December 7, 2004 and March 14, 2005. Any determination to pay future dividends will be at the discretion of our Board of Directors and will be dependent upon: our subsidiaries payment of dividends and/or other statutorily permissible payments to us; our results of operations and cash flows; our financial position and capital requirements; general business conditions; any legal, tax, regulatory and contractual restrictions on the payment of dividends; and any other factors our board of directors deems relevant.
We are a holding company and, therefore, our ability to pay dividends, service our debt and meet our other obligations depends primarily on the ability of our insurance subsidiaries to pay dividends and make other statutorily permissible payments to us. Our insurance subsidiaries are subject to significant regulatory and contractual restrictions limiting their ability to declare and pay dividends. See Item 1ARisk FactorsRisks Relating to Our CompanyThe inability of our subsidiaries to pay dividends to us in sufficient amounts could harm our ability to meet our obligations and pay future stockholder dividends. For the calendar year 2006, the maximum amount of dividends that our subsidiaries could pay to us under applicable laws and regulations
without prior regulatory approval is approximately $292,300. Dividends were paid by our subsidiaries totaling $530,094 through December 31, 2005.
We may seek approval of regulators to pay dividends in excess of any amounts that would be permitted without such approval. However, there can be no assurance that we would obtain such approval if sought.
In addition, payments of dividends on the shares of common stock are subject to the preferential rights of preferred stock that our board of directors may create from time to time. For more information regarding restrictions on the payment of dividends by us and our insurance subsidiaries, including pursuant to the terms of our revolving credit facilities, see Item 7Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources.
In addition, our $500,000 senior revolving credit facility restricts payments of dividends in the event that an event of default under the facility has occurred or a proposed dividend payment would cause an event of default under the facility.
Item 6. Selected Financial Data
Five-Year Summary of Selected Financial Data Assurant, Inc.
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and accompanying notes which appear elsewhere in this report. It contains forward-looking statements that involve risks and uncertainties. Please see Forward-Looking Statements for more information. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this report, particularly under the headings Item 1ARisk Factors and Forward-Looking Statements.
We report our results through five segments: Assurant Solutions, Assurant Health, Assurant Employee Benefits, Assurant PreNeed and Corporate and Other. The Corporate and Other segment includes activities of the holding company, financing expenses, net realized gains (losses) on investments, interest income earned from short-term investments held, interest income from excess surplus of insurance subsidiaries not allocated to other segments and additional costs associated with excess of loss reinsurance and ceded to certain subsidiaries in the London market between 1995 and 1997. The Corporate and Other segment also includes the amortization of deferred gains associated with the portions of the sales of FFG and LTC. FFG and LTC were sold through reinsurance agreements as described below.
Critical Factors Affecting Results
Our results depend on the adequacy of our product pricing, underwriting and the accuracy of our methodology for the establishment of reserves for future policyholder benefits and claims, returns on invested assets and our ability to manage our expenses. Therefore, factors affecting these items may have a material adverse effect on our results of operations or financial condition.
We generate our revenues primarily from the sale of our insurance policies and, to a lesser extent, fee income by providing administrative services to certain clients. Sales of insurance policies are recognized in revenue as earned premiums while sales of administrative services are recognized as fee income. In late 2000, the majority of Assurant Solutions credit insurance clients began a transition from the purchase of our credit
insurance products from which we earned premium revenue to debt protection administration programs, from which we earn fee income. Debt protection administration programs include services for non-insurance products that cancel or defer the required monthly payment on outstanding loans when covered events occur.
Our premium and fee income is supplemented by income earned from our investment portfolio. We recognize revenue from interest payments, dividends and sales of investments. Currently, our investment portfolio is primarily invested in fixed maturity securities. Both investment income and realized capital gains on these investments can be significantly impacted by changes in interest rates.
Interest rate volatility can reduce unrealized gains or create unrealized losses in our portfolios. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Fluctuations in interest rates affect our returns on, and the market value of, fixed maturity and short-term investments.
The fair market value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. The fair market value generally increases or decreases in an inverse relationship with fluctuations in interest rates, while net investment income realized by us from future investments in fixed maturity securities will generally increase or decease with interest rates. We also have investments that carry pre-payment risk, such as mortgage backed and asset backed securities. Actual net investment income and/or cash flows from investments that carry prepayment risk may differ from estimates at the time of investment as a result of interest rate fluctuations. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities, commercial mortgage obligations and bonds are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates. Therefore, we may be required to reinvest those funds in lower interest-bearing investments.
Our expenses are primarily policyholder benefits, selling, underwriting and general expenses, interest expense and distributions on preferred securities of subsidiary trusts.
Our profitability depends in large part on accurately predicting policyholder benefits, claims and other costs, including medical and dental costs. It also depends on our ability to manage future policyholder benefit and other costs through product design, underwriting criteria, utilization review or claims management and, in health and dental insurance, negotiation of favorable provider contracts. Changes in the composition of the kinds of work available in the economy, market conditions and numerous other factors may also materially adversely affect our ability to manage claim costs. As a result of one or more of these factors or other factors, claims could substantially exceed our expectations, which could have a material adverse effect on our business, results of operations and financial condition.
Selling, underwriting and general expenses consist primarily of commissions, premium taxes, licenses, fees, amortization of deferred acquisition costs (DAC) and value of businesses acquired (VOBA) and general operating expenses. For a description of DAC and VOBA, see Notes 2, 8 and 10 of the Notes to Consolidated Financial Statements included elsewhere in this report.
At December 31, 2005 and December 31, 2004, we had $995,850 and $995,771, respectively of debt and mandatorily redeemable preferred stock. This has had an impact on our annual interest and dividend costs.
Dispositions of Businesses
Our results of operations were affected by the following dispositions, including:
On November 9, 2005, the Company signed an agreement with Forethought whereby the Company agreed to discontinue writing new PreNeed insurance polices in the United States via independent funeral homes and
non-SCI Corporate funeral home chains for a period of 10 years. The Company will receive payments from Forethought over the next ten years based on the amount of business the Company transitions to Forethought. This agreement does not impact Assurant PreNeeds IndependentCanada or AMLICs relationship with SCI. The transaction will not have a material impact on the Companys consolidated financial position or results of operation.
On May 3, 2004, we sold the assets of our WorkAbility division of CORE, Inc. (CORE). We recorded a pre-tax loss on the sale of $9,232, which was included in the Corporate and Other segment.
Critical Accounting Estimates
There are certain accounting policies that we consider to be critical due to the amount of judgment and uncertainty inherent in the application of those policies. In calculating financial statement estimates, the use of different assumptions could produce materially different estimates. In addition, if factors such as those described above or in Item 1A.Risk Factors cause actual events to differ from the assumptions used in applying the accounting policies and calculating financial estimates, there could be a material adverse effect on our results of operations, financial condition and liquidity.
We believe the following critical accounting policies require significant estimates which, if such estimates are not materially correct, could affect the preparation of our consolidated financial statements.
Reserves are established according to GAAP using generally accepted actuarial methods and are based on a number of factors. These factors include experience derived from historical claim payments and actuarial assumptions to arrive at loss development factors. Such assumptions and other factors include trends, the incidence of incurred claims, the extent to which all claims have been reported and internal claims processing charges. The process used in computing reserves cannot be exact, particularly for liability coverages, since actual claim costs are dependent upon such complex factors as inflation, changes in doctrines of legal liability and damage awards. The methods of making such estimates and establishing the related liabilities are periodically reviewed and updated.
Reserves do not represent an exact calculation of exposure, but instead represent our best estimates, generally involving actuarial projections at a given time, of what we expect the ultimate settlement and administration of a claim or group of claims will cost based on our assessment of facts and circumstances then known. The adequacy of reserves will be impacted by future trends in claims severity, frequency, judicial theories of liability and other factors. These variables are affected by both external and internal events, such as: changes in the economic cycle, changes in the social perception of the value of work, emerging medical perceptions regarding physiological or psychological causes of disability, emerging health issues and new methods of treatment or accommodation, inflation, judicial trends, legislative changes and claims handling procedures.
Many of these items are not directly quantifiable, particularly on a prospective basis. Reserve estimates are refined as experience develops. Adjustments to reserves, both positive and negative, are reflected in the statement of operations of the period in which such estimates are updated. Because establishment of reserves is an inherently uncertain process involving estimates of future losses, there can be no certainty that ultimate losses will not exceed existing claims reserves. Future loss development could require reserves to be increased, which could have a material adverse effect on our earnings in the periods in which such increases are made.
The following table provides reserve information by our major lines of business for the years ended December 31, 2005 and 2004:
For a description of our reserving methodology, see Note 11 of the Notes to Consolidated Financial Statements included elsewhere in this report.
The following discusses the reserving process for our major long duration product line.
Reserves for future policy benefits are recorded as the present value of future benefits to policyholders and related expenses less the present value of future net premiums. Reserve assumptions are selected using best estimates for expected investment yield, inflation, mortality and withdrawal rates. These assumptions reflect current trends, are based on Company experience and provide for possible unfavorable deviation. We also record an unearned revenue reserve which represents the balance of the excess of gross premiums over net premiums that is still to be recognized in future years income in a constant relationship to insurance in force.
Risks related to the reserves recorded for contracts from FFG and LTC disposed businesses have been 100% ceded via reinsurance. While the Company has not been released from the contractual obligation to the policyholders, changes in and deviations from economic and mortality assumptions used in the calculation of these reserves will not directly affect the Company unless there is a default by the assuming reinsurer. We have sold businesses through reinsurance.
Loss recognition testing is performed annually and reviewed quarterly. Such testing involves the use of best estimate assumptions to determine if the net liability position (all liabilities less DAC) exceeds the minimum
liability needed. Any premium deficiency would first be addressed by removing the provision for adverse deviation. To the extent a premium deficiency still remains, it would be recognized immediately by a charge to the statement of operations and a corresponding reduction in DAC. Any additional deficiency would be recognized as a premium deficiency reserve.
Historically, loss recognition testing has not resulted in an adjustment to DAC or reserves. Such adjustments would occur only if economic or mortality conditions significantly deteriorated.
For short duration contracts, claims and benefits payable reserves are reported when insured events occur. The liability is based on the expected ultimate cost of settling the claims. The claims and benefits payable reserves include (1) case reserves for known but unpaid claims as of the balance sheet date; (2) IBNR reserves for claims where the insured event has occurred but has not been reported to us as of the balance sheet date; and (3) loss adjustment expense reserves for the expected handling costs of settling the claims. Periodically, we review emerging experience and make adjustments to our case reserves and assumptions where necessary. Below are further discussions on the reserving process for our major short duration products.
Group Disability and Group Term Life
Case or claim reserves are set for active individual claims on group long term disability policies and for disability waiver of premium benefits on group term life policies. Assumptions considered in setting such reserves include disabled life mortality and claim termination rates (the rates at which disabled claimants come off claim, either through recovery or death), claim management practices, awards for social security and other benefit offsets and yield rates earned on assets supporting the reserves. Group long term disability and group term life waiver of premium reserves are discounted because the payment pattern and ultimate cost are fixed and determinable on an individual claim basis.
Factors considered when setting IBNR reserves include patterns in elapsed time from claim incidence to claim reporting, and elapsed time from claim reporting to claim payment.
Key sensitivities for group long-term disability claim reserves include the discount rate and claim termination rates.
The discount rate is also a key sensitivity for group term life waiver of premium reserves.
IBNR reserves represent the largest component of reserves estimated for claims and benefits payable in our Medical line of business, and we use a number of methods in their estimation, including the loss development method and the projected claim method for recent claim periods. Under the loss development method, we estimate ultimate losses for each incident period by multiplying the current cumulative losses by the appropriate loss development factor. Under the projected claim method, we use ultimate loss ratios when development methods do not provide enough data to reliably estimate reserves. We use several methods in our Medical line of business because of the limitations of relying exclusively on a single method.
A key sensitivity is the loss development factors used. Loss development factors selected take into consideration claims processing levels, claims under case management, medical inflation, seasonal effects, medical provider discounts and product mix.
None of the changes in incurred claims from prior years in our Medical line of business, and the related downward revisions in our Medical estimated reserves, were attributable to any change in our reserve methods or assumptions.
Property and Warranty
Our Property and Warranty line of business includes creditor-placed homeowners, manufactured housing homeowners, credit property, credit unemployment and warranty insurance and some longer-tail coverages (e.g., asbestos, environmental, other general liability and personal accident). Our Property and Warranty loss reserves consist of case reserves and bulk reserves. Bulk reserves consist of IBNR and development on case reserves. The method we most often use in setting our Property and Warranty bulk reserves is the loss development method. Under this method, we estimate ultimate losses for each accident period by multiplying the current cumulative losses by the appropriate loss development factor. We then calculate the bulk reserve as the difference between the estimate of ultimate losses and the current case-incurred losses (paid losses plus case reserves). We select loss development factors based on a review of historical averages, and we consider recent trends and business specific matters such as current claims payment practices.
We may use other methods depending on data credibility and product line. We use the estimates generated by the various methods to establish a range of reasonable estimates. The best estimate is selected from the middle to upper end of the third quartile of the range of reasonable estimates.
Most of our credit insurance business is written on a retrospective commission basis, which permits Assurant Solutions to adjust commissions based on claims experience. Thus, any adjustment to prior years incurred claims in this line of business is largely offset by a change in contingent commissions which is included in the selling, underwriting and general expenses line in our results of operations.
While management has used its best judgment in establishing its estimate of required reserves, different assumptions and variables could lead to significantly different reserve estimates. Two key measures of loss activity are loss frequency, which is a measure of the number of claims per unit of insured exposure, and loss severity, which is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations. If
the actual level of loss frequency and severity are higher or lower than expected, the ultimate reserves will be different than managements estimate. The effect of higher and lower levels of loss frequency and severity levels on our ultimate costs for claims occurring in 2005 would be as follows:
Reserving for Asbestos and Other Claims
We have exposure to asbestos, environmental and other general liability claims arising from our participation in various reinsurance pools from 1971 through 1985. This exposure arose from a short duration contract that we discontinued writing many years ago. We believe the balance of case reserves for these liabilities and bulk reserves for IBNR are adequate. However, any estimation of these liabilities is subject to greater than normal variation and uncertainty due to the general lack of sufficiently detailed data, reporting delays and absence of a generally accepted actuarial methodology for those exposures. There are significant unresolved industry legal issues, including such items as whether coverage exists and what constitutes an occurrence. In addition, the determination of ultimate damages and the final allocation of losses to financially responsible parties are highly uncertain. However, based on information currently available, and after consideration of the reserves reflected in the financial statements, we believe that any changes in reserve estimates for these claims are not reasonably likely to be material.
One of our subsidiaries, ARIC, participated in certain excess of loss reinsurance programs in the London market and, as a result, reinsured certain personal accident, ransom and kidnap insurance risks from 1995 to 1997. ARIC and a foreign affiliate ceded a portion of these risks to retrocessionaires. ARIC ceased reinsuring such business in 1997. However, certain risks continued beyond 1997 due to the nature of the reinsurance contracts written. ARIC and some of the other reinsurers involved in the programs are seeking to avoid certain treaties on various grounds, including material misrepresentation and non-disclosure by the ceding companies and intermediaries involved in the programs. Similarly, some of the retrocessionaires are seeking avoidance of certain treaties with ARIC and the other reinsurers and some reinsureds are seeking collection of disputed balances under some of the treaties. The disputes generally involve multiple layers of reinsurance, and allegations that the reinsurance programs involved interrelated claims spirals devised to disproportionately pass claims losses to higher-level reinsurance layers. Many of the companies involved in these programs, including ARIC, are currently involved in negotiations, arbitrations and/or litigation between multiple layers of retrocessionaries, reinsurers, ceding companies and intermediaries, including brokers, in an effort to resolve these disputes.
Many of the disputes involving ARIC and an affiliate, Bankers Insurance Company Limited (BICL), relating to the 1995 and 1997 program years, have been resolved by settlement or arbitration. As a result of the settlements and an arbitration (in which ARIC did not prevail) additional information became available in 2005, and, based on managements best estimate, we increased our reserves and recorded a total pre-tax charge of $61,943 for the year ended December 31, 2005, respectively. On February 28, 2006, many of the disputes relating to losses in the 1996 program were settled. Loss accruals previously established relating to the 1996 program were adequate. Negotiations, arbitrations and litigation are still ongoing or will be scheduled for the remaining disputes. We believe, based on information currently available, that the amounts accrued for currently outstanding disputes are adequate. However, the inherent uncertainty of arbitrations and lawsuits, including the
uncertainty of estimating whether any settlements we may enter into in the future would be on favorable terms, makes it difficult to predict the outcomes with certainty.
The costs of acquiring new business that vary with and are primarily related to the production of new business have been deferred to the extent that such costs are deemed recoverable from future premiums or gross profits. Acquisition costs primarily consist of commissions, policy issuance expenses, premium tax and certain direct marketing expenses.
Loss recognition testing is performed annually and reviewed quarterly. Such testing involves the use of best estimate assumptions, including the anticipation of interest income to determine if anticipated future policy premiums are adequate to recover all DAC and related claims, benefits and expenses. To the extent a premium deficiency exists, it is recognized immediately by a charge to the statement of operations and a corresponding reduction in DAC. If the premium deficiency is greater than unamortized DAC, a liability will be accrued for the excess deficiency.
Long Duration Contracts
Acquisition costs for pre-funded funeral life insurance policies and life insurance policies no longer offered are deferred and amortized in proportion to anticipated premiums over the premium-paying period. These acquisition costs consist primarily of first year commissions paid to agents and sales and policy issue costs.
For pre-funded funeral investment-type annuities and universal life insurance policies and investment-type annuity contracts that are no longer offered, DAC is amortized in proportion to the present value of estimated gross margins or profits from investment, mortality, expense margins and surrender charges over the estimated life of the policy or contract. The assumptions used for the estimates are consistent with those used in computing the policy or contract liabilities.
Acquisition costs relating to worksite group disability consist primarily of first year commissions to brokers and one time policy transfer fees and costs of issuing new certificates. These acquisition costs are front-end loaded, thus they are deferred and amortized over the estimated terms of the underlying contracts.
Acquisition costs relating to individual medical contracts issued prior to 2003 and in a limited number of jurisdictions are deferred and amortized over the estimated average terms of the underlying contracts. These acquisition costs relate to commissions and policy issuance expenses. Commissions represent the majority of deferred costs and result from commission schedules that pay significantly higher rates in the first year. The majority of deferred policy issuance expenses are the costs of separately underwriting each individual medical contract.
Short Duration Contracts
Acquisition costs relating to property contracts, warranty and extended service contracts and single premium credit insurance contracts are amortized over the term of the contracts in relation to premiums earned.
Acquisition costs relating to monthly pay credit insurance business consist mainly of direct marketing costs and are deferred and amortized over the estimated average terms and balances of the underlying contracts.
Acquisition costs relating to group term life, group disability and group dental consist primarily of new business underwriting, field sales support, commissions to agents and brokers, and compensation to sales representatives. These acquisition costs are front-end loaded; thus, they are deferred and amortized over the estimated terms of the underlying contracts.
Acquisition costs on individual medical contracts issued in most jurisdictions after 2002 and small group medical contracts consist primarily of commissions to agents and brokers and compensation to representatives.
These contracts are considered short duration because the terms of the contract are not fixed at issue and they are not guaranteed renewable. As a result, these costs are not deferred, but rather are recorded in the statement of operations in the period in which they are incurred.
We regularly monitor our investment portfolio to ensure that investments that may be other-than-temporarily impaired are identified in a timely fashion and properly valued and that any impairments are charged against earnings in the proper period. Our methodology to identify potential impairments requires professional judgment.
Changes in individual security values are regularly monitored in order to identify potential problem credits. In addition, pursuant to our impairment process, each month the portfolio holdings are screened for securities whose market price is equal to 85% or less of their original purchase price. Management then makes their assessment as to which of these securities are other-than-temporarily impaired. Assessment factors include, but are not limited to, the financial condition and rating of the issuer, any collateral held and the length of time the market value of the security has been below cost. Each quarter, the watchlist is discussed at a meeting attended by members of our investment, accounting and finance departments. At this meeting, any security whose price decrease is deemed to have been other than temporarily impaired is written down to its then current market level, with the amount of the writedown reflected in our statement of operations for that quarter. Previously impaired issues are also monitored monthly, with additional writedowns taken quarterly if necessary.
Inherently, there are risks and uncertainties involved in making these judgments. Changes in circumstances and critical assumptions such as a continued weak economy, a more pronounced economic downturn or unforeseen events which affect one or more companies, industry sectors or countries could result in additional writedowns in future periods for impairments that are deemed to be other-than-temporary. See also Investments in Note 2 of the Notes to Consolidated Financial Statements included elsewhere in this report and Item 1ARisk FactorsOur investment portfolio is subject to several risks that may diminish the value of our invested assets and affect our profitability.
Reinsurance recoverables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims, future policyholder benefits and policyholder contract deposits. The cost of reinsurance is accounted for over the terms of the underlying reinsured policies using assumptions consistent with those used to account for the policies. Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves and are reported in our consolidated balance sheets. The ceding of insurance does not discharge our primary liability to our insureds. An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, managements experience and current economic conditions.
The following table sets forth our reinsurance recoverables as of the dates indicated:
We have used reinsurance to exit certain businesses, such as the dispositions of FFG and LTC. The reinsurance recoverables relating to these dispositions amounted to $2,440,480 and $2,389,622 at December 31, 2005 and 2004, respectively.
In the ordinary course of business, we are involved in both the assumption and cession of reinsurance with non-affiliated companies. The following table provides details of the reinsurance recoverables balance for the years ended December 31:
We utilize reinsurance for loss protection and capital management, business dispositions and, in Assurant Solutions, client risk and profit sharing. See also Item 7AQuantative and Qualitative Disclosures About Market RiskCredit Risk.
Retirement and Other Employee Benefits
We sponsor a pension and a retirement health benefit plan covering our employees who meet specified eligibility requirements. The reported expense and liability associated with these plans requires an extensive use of assumptions which include the discount rate, expected return on plan assets and rate of future compensation increases. We determine these assumptions based upon currently available market and industry data, historical performance of the plan and its assets, and consultation with an independent consulting actuarial firm to aid us in selecting appropriate assumptions and valuing our related liabilities. The actuarial assumptions used in the calculation of our aggregate projected benefit obligation may vary and include an expectation of long-term market appreciation in equity markets which is not changed by minor short-term market fluctuations, but does change when large interim deviations occur. The assumptions we use may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of the participants.
We follow the requirements of Statement of Financial Accounting Standards (FAS) No. 5, Accounting for Contingencies (FAS 5). This requires management to evaluate each contingent matter separately. A loss is reported if reasonably estimable and probable. We establish reserves for these contingencies at the best estimate, or, if no one estimated number within the range of possible losses is more probable than any other, we report an estimated reserve at the low end of the estimated range. Contingencies affecting the Company include litigation matters which are inherently difficult to evaluate and are subject to significant changes.
Change in Accounting Principle
We adopted FAS No. 142, Goodwill and Other Intangible Assets (FAS 142), on January 1, 2002. As part of the adoption of FAS 142, we are required to test goodwill on at least an annual basis. We performed a January 1, 2005 impairment test during the first quarter and concluded that goodwill is not impaired. Effective September 30, 2005, the Company changed the date of its annual goodwill impairment test to the fourth quarter based on actual data through October 1st. The Company determined this change in accounting principle is preferable because it will allow management to incorporate this test into the normal flow of the financial planning and reporting cycle and provide more timely analysis on the recoverability of goodwill. Our fourth quarter 2005 impairment test also concluded that goodwill is not impaired.
Results of Operations
The table below presents information regarding our consolidated results of operations:
The following discussion provides a high level analysis of how the consolidated results were affected by our four operating business segments and our Corporate and Other segment. Please see the results of operations discussion for each of these segments contained in this document for more detailed analysis of the fluctuations.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Net income increased $128,795, or 37%, to $479,355 for the twelve months ended December 31, 2005 from $350,560 for the twelve months ended December 31, 2004. The increase was primarily driven by lower catastrophe losses net of reinsurance, improved loss experience absent catastrophes and increased net earned premiums in Assurant Solutions Specialty Property business. Also adding to this increase was a lower benefit loss ratio in Assurant Healths small employer group business and the release of previously provided tax accruals due to the resolution of IRS audits in Corporate and Other. Offsetting these increases was a strengthening of reserve accruals on certain excess of loss reinsurance programs sold by our subsidiaries in the London market between 1995 and 1997 in Corporate and Other.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Net income increased $164,908, or 89%, to $350,560 for the twelve months ended December 31, 2004 from $185,652 for the twelve months ended December 31, 2003. The increase was primarily driven by a non-recurring interest premium on the redemption of mandatorily redeemable preferred securities in 2003. Also contributing to
the increase were strong sales and a lower benefit loss ratio in individual markets business in Assurant Health. Offsetting these increases were higher catastrophe losses in Assurant Solutions.
The table below presents information regarding Assurant Solutions segment results of operations:
Year Ended December 31, 2005 Compared to December 31, 2004
Segment net income increased by $115,162, or 91%, to $241,320 for the twelve months ended December 31, 2005 from $126,158 for the twelve months ended December 31, 2004. The increase in segment net income is
primarily attributable to lower catastrophe losses, net of reinsurance recoveries, improved loss experience absent catastrophe losses, and higher net earned premiums in the Specialty Property business. Growth in the Consumer Protection business also contributed to the improved underwriting results as well as increases in fee income and investment income. Net income was also positively impacted by approximately $11,100 after-tax primarily related to the release of certain accrued commissions and claims payable associated with three clients, two of which previously declared bankruptcy. We favorably settled many of our claims with these clients during the year.
Total revenues increased by $207,663, or 7%, to $2,984,973 for the twelve months ended December 31, 2005 from $2,777,310 for the twelve months ended December 31, 2004. This increase is primarily due to an increase in net earned premiums and other considerations of $164,373 or 7%. Net earned premiums and other considerations from the Specialty Property business increased by $89,981, or 12%, primarily due to an increase in net earned premiums in our creditor placed homeowners insurance products. This was partially offset by a reduction in net earned premiums of approximately $26,000, due to additional reinstatement reinsurance premiums related to the hurricanes. Net earned premiums and other considerations from the Consumer Protection business increased by $74,392, or 4%, primarily from higher net earned premiums in our extended service contract and international products, partially offset by the continued decline of our domestic credit insurance products. The increase in revenues was also driven by an increase in net investment income of $19,611 or 11%. The increase was a result of an increase in the average portfolio yield of 10 basis points to 4.88% for the twelve months ended December 31, 2005, from 4.78% for the twelve months ended December 31, 2004 and average invested assets increased by approximately 8%. Approximately $7,300 of the increase in net investment income was due to non-recurring items in 2005. The increase in revenues was also driven by an increase in fees and other income of $23,679, or 16%, mainly due to an increase in fee income related to growth from extended service contract and debt deferment products.
We experienced growth in all of our core product groupings, with the exception of our domestic credit insurance products. Gross written premiums in our domestic credit insurance products decreased by $85,545, or 10%, due to the continued decline of this product line. See Item 1BusinessOperating Business SegmentsAssurant Solutions. Gross written premiums from our international credit products increased by $52,821, or 9%, due to our focus on international expansion. Gross written premiums in our domestic extended service contract products increased by $159,875, or 17%, due to the addition of new clients and growth generated from existing clients. Gross written premiums in our international extended service contract products increased by $174,403, or over 100%, mainly due to the signing of a new client in Canada in late 2004. Gross written premiums from the Specialty Property products increased by $154,984, or 12%, primarily due to growth in our creditor placed homeowners insurance products from existing and new clients.
Total Benefits, Losses and Expenses
Total benefits, losses and expenses increased by $26,742 or 1%, to $2,620,575 for the twelve months ended December 31, 2005 from $2,593,833 for the twelve months ended December 31, 2004. This increase is primarily due to an increase in selling, underwriting and general expenses offset by a decrease in policyholder benefits. The decrease in policyholder benefits of $56,713, or 6%, is primarily attributable to $44,000 in lower catastrophe losses, net of reinsurance in 2005 versus 2004. We incurred losses from catastrophes, net of reinsurance, of $48,700 in 2005, compared to $93,100 in 2004. The decrease was a result of the different severity of gross losses from each storm and the change in composition of our reinsurance coverage in 2005. Additionally, we were reimbursed approximately $18,500 of loss adjustment expenses from the National Flood Insurance Program for providing processing and adjudication services. This reimbursement reduced policyholder benefits expense. We continued to see improvement in our overall Specialty Property loss ratio in 2005, excluding catastrophe losses, in addition to a one time reduction of claims payable of $5,700 associated with a client that previously declared bankruptcy. Commissions, taxes, licenses and fees, of which amortization of DAC is a component, increased by $48,581 primarily due to the associated increase in revenues, partially offset by lower premium taxes attributable to the change in the mix of business, and a $11,400 reduction of commission liabilities as a result of favorable
settlements with two clients. General expenses increased by $34,875 due to growth in the business, expenses relating to the 2005 hurricane season, including guaranty fund assessments and Sarbanes-Oxley expenses.
Year Ended December 31, 2004 Compared to December 31, 2003
Segment net income decreased by $7,031, or 5%, to $126,158 for the twelve months ended December 31, 2004 from $133,189 for the twelve months ended December 31, 2003. The decrease in segment income is primarily attributable to higher catastrophe losses, net of reinsurance recoveries, partially offset by improved loss experience absent catastrophe losses, and higher net earned premiums in the specialty property business.
Total revenues increased by $89,158, or 3%, to $2,777,310 for the twelve months ended December 31, 2004 from $2,688,152 for the twelve months ended December 31, 2003. This increase is primarily due to an increase in net earned premiums and other considerations of $86,826, or 4%. Net earned premiums and other considerations from the Specialty Property business increased by $36,261, or 5%, primarily due to an increase in net earned premiums in our creditor placed and voluntary homeowners insurance products, partially offset by lower net earned premium in our manufactured housing products, primarily from the overall decline of the manufactured housing sales. Net earned premiums and other considerations from the consumer protection business increased by $50,565, or 3%, primarily from higher net earned premiums in our extended service contract and international products, partially offset by the continued decline of our domestic credit insurance products. The increase in revenues was also driven by an increase in fees and other income of $4,231, or 3%, mainly due to an increase in fee income related to growth from extended service contract and debt deferment products.
Total Benefits, Losses and Expenses
Total benefits, losses and expenses increased by $94,399, or 4%, to $2,593,833 for the twelve months ended December 31, 2004 from $2,499,434 for the twelve months ended December 31, 2003. This increase was due to an increase in policyholder benefits of $36,202, or 4%. The increase in policyholder benefits is primarily attributable to higher catastrophe losses, net of reinsurance, of $63,300 in 2004 versus 2003. We incurred losses from catastrophes, net of reinsurance, of $93,100 in 2004, compared to $29,800 in 2003. Additionally, excluding catastrophe losses, we experienced decreased losses in the Specialty Property business due to improved loss experience absent the catastrophes. Commissions, taxes, licenses and fees, of which amortization of DAC is a component, increased by $13,261 which is consistent with the change in the mix of business. General expenses increased by $44,936, primarily due to the increased business from our extended service contracts, international, and creditor-placed homeowners insurance products. Additionally, in 2004 we incurred Sarbanes-Oxley related expenses and an increase in the guaranty fund assessments attributable to the four hurricanes.
The table below presents information regarding Assurant Healths segment results of operations:
Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004
Segment net income increased by $19,768, or 12%, to $178,055 for the year ended December 31, 2005, from $158,287 for the year ended December 31, 2004. The increase in segment income is primarily
attributable to an improved benefit loss ratio in the small employer group business. The increase is partially offset by two items. First, an overall decline in membership due to continued increased competition and strict adherence to our underwriting guidelines. Second, an increase in expenses of approximately $10,000 due to increased spending on initiatives aimed at growing the individual markets business.
Total revenues decreased by $64,543, or 3%, to $2,273,365 for the year ended December 31, 2005, from $2,337,908 for the year ended December 31, 2004. Net earned premiums and other considerations from our individual markets business increased by $59,959, or 5%, primarily due to premium rate increases, partially offset by a decline in members. Net earned premiums and other considerations from our small employer group business decreased by $127,291, or 13%, due to a decline in members, partially offset by premium rate increases. Both individual markets and the small employer group business continue to experience decreases in new business due to increased competition in their respective markets and strict adherence to our underwriting guidelines.
Total Benefits, Losses, and Expenses
Total benefits, losses and expenses decreased by $95,167, or 5%, to $2,002,523 for the year ended December 31, 2005, from $2,097,690 for the year ended December 31, 2004. The benefit loss ratio decreased by 170 basis points, from 63.8% to 62.1%. The improvement in the benefit loss ratio is due to a decrease in policyholder benefits of $78,159, or 5%, primarily due to the overall decline in members and favorable claims experience in the small employer group business. The expense ratio increased by 10 basis points, from 29.7% to 29.8%. The increase in the expense ratio is primarily due to a proportionately smaller decrease in expenses compared to the decrease in net earned premiums and fees and other income. Selling, general and underwriting expenses decreased by $17,008, or 3%, primarily due to a decline in first year business in 2005 compared to 2004, resulting in decreased commission expense and other acquisition costs in both individual markets and small employer group business. This decrease was partially offset by an increase of approximately $10,000 in spending on initiatives aimed at growing the individual markets business.
Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003
Segment net income increased by $37,274, or 31%, to $158,287 for the year ended December 31, 2004, from $121,013 for the year ended December 31, 2003. The increase in segment net income is primarily attributable to an increase in individual markets business, investment income and an improved benefit loss ratio in the individual markets business, partially offset by a decline in members in the small employer group business.
Total revenues increased by $246,975, or 12%, to $2,337,908 for the year ended December 31, 2004, from $2,090,933 for the year ended December 31, 2003. Net earned premiums and other considerations increased by $222,050, or 11%. Net earned premium growth in the individual markets business was attributable to continued sales growth, which partially reflects the success of HSAs that were introduced on January 1, 2004, and premium rate increases. Net earned premium growth in our small employer group business was attributable to premium rate increases partially offset by decreases in membership. Net investment income increased by $18,472, or 37%, primarily due to an increase in average invested assets of approximately 39%, partially offset by a decline in the average portfolio yield.
Total Benefits, Losses, and Expenses
Total benefits, losses and expenses increased by $191,361, or 10%, to $2,097,690 for the year ended December 31, 2004, from $1,906,329 for the year ended December 31, 2003. The benefit loss ratio decreased by 180 basis points, from 65.6% to 63.8%. This improvement was attributable to favorable loss experience predominantly on individual markets business, as well as a higher mix of individual markets business compared
to small employer group health business in 2004. Policyholder benefits increased by $105,737, or 8%, primarily due to increased sales partially offset by the favorable loss experience. The expense ratio increased by 80 basis points, from 28.9% to 29.7%. Selling, general and underwriting expenses increased by $85,624, or 15%, due to increased commission expense on first year individual health insurance business and additional spending on initiatives to improve our product offerings, distribution, customer service and infrastructure.
Assurant Employee Benefits
The table below presents information regarding Assurant Employee Benefits segment results of operations:
Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004.
Segment net income increased by $6,156, or 10%, to $68,366 for the year ended December 31, 2005, from $62,210 for the year ended December 31, 2004. The increase in segment income was primarily due to a decrease in policyholder benefits. This decrease was driven by improved group life mortality and improved group dental experience, partially offset by lower group disability claim closures.
Total revenues remained relatively flat increasing $5,105 to $1,460,941 for the year ended December 31, 2005, from $1,455,836 for the year ended December 31, 2004. Net earned premiums and other considerations remained flat compared to prior year due to our increased focus on small case and voluntary business. The increase in revenues was primarily due to an increase in net investment income of $7,171, or 5%. During the third quarter, we recognized $2,560 of investment income from a real estate partnership. The remaining increase in net investment income is primarily due to an increase in average invested assets of approximately 3%.
Total Benefits, Losses, and Expenses
Total benefits, losses and expenses decreased by $4,595, or less than 1%, to $1,355,377 for the year ended December 31, 2005, from $1,359,972 for the year ended December 31, 2004. The loss ratio decreased 110 basis points, from 74.4% to 73.3%. The decrease in the loss ratio and the decrease in policyholder benefits of $13,400, or 1%, was primarily due to improved group life mortality and improved group dental experience partially offset by lower group disability claim closures. The expense ratio increased 70 basis points, from 31.4% to 32.1%. The increase in the expense ratio is due to an increase in selling, underwriting and general expenses of $8,805, or 2%, primarily driven by higher technology-related costs due to implementation of technology aimed at improving our customer service.
Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003
Segment net income increased by $643, or 1%, to $62,210 for the year ended December 31, 2004, from $61,567 for the year ended December 31, 2003. The slight increase in segment net income was due to a net decrease in expense driven by the sale of the WorkAbility division in 2004. See Corporate and Other.
Total revenues increased by $5,657, or less than 1%, to $1,455,836 for the year ended December 31, 2004, from $1,450,179 for the year ended December 31, 2003. The increase in total revenues is primarily due to an increase in net earned premiums and other considerations and net investment income, partially offset by a decrease in fee income. Net earned premium growth of $20,382, or 2%, was driven by an increase in disability premiums written through alternate distribution sources as well as the transition of a block of business from administrative fee only business to fully insured business. Net investment income increased $9,762, or 7%. This is primarily due to an increase in average invested assets of approximately 10%, partially offset by a decrease in the average portfolio yield. The decrease in fee income was primarily due to the sale of the WorkAbility division.
Total Benefits, Losses, and Expenses
Total benefits, losses and expenses increased by $5,832, or less than 1%, to $1,359,972 for the year ended December 31, 2004, from $1,354,140 for the year ended December 31, 2003. The loss ratio increased 110 basis points from 73.3% to 74.4%. The increase in loss ratio was primarily driven by a reduction in reserves in 2003. During the third quarter of 2003, we completed actuarial reserve adequacy studies for group disability, group life, and group dental products, which reflected that, in the aggregate, these reserves were redundant by $17,915. Therefore, we reduced reserves by $17,915 in the third quarter of 2003 to reflect these estimates. Also contributing to the increase was poor experience on a single large disability case and deterioration in group dental experience, partially offset by lower group disability incidence and improved group life mortality experience. The expense ratio decreased by 170 basis points from 33.1%, to 31.4%. The decrease was primarily driven by the sale of the WorkAbility division as well as the writedown of previously capitalized software in 2003, not incurred in 2004.
The table below presents information regarding Assurant PreNeeds segment results of operations:
Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004.
Segment net income increased by $819, or 2%, to $35,054 for the year ended December 31, 2005, from $34,235 for the year ended December 31, 2004. This increase was principally due to an increase in investment income. This increase was partially offset by an increase in the Consumer Price Index (CPI) which increased policyholder benefits and decreased the value of our CPI Cap. Also, severance and related costs increased due to the sale of the IndependentUnited States distribution.
Total revenues decreased by $40,803, or 6%, to $698,427 for the year ended December 31, 2005, from $739,230 for the year ended December 31, 2004. This decrease is primarily due to a decrease in net earned premiums and other considerations of $60,141, or 11%. The sale of the IndependentUnited States distribution in November 2005 accounted for $19,507 of the decrease, with the remainder of the decrease due to an overall decline in sales of life policies. IndependentUnited States sales have declined as a result of continued pricing discipline on certain new business, resulting in the loss of several large customers prior to the sale. Sales at AMLIC have declined due to changes in the sales force structure at SCI, AMLICs principal customer. IndependentCanada life sales declined due to a shift to annuity sales. Overall life and annuity sales in IndependentCanada increased due to expansion into Quebec and growth in sales through corporate owned funeral homes. The overall decrease in revenues was partially offset by an increase in net investment income of
$22,656, or 11%, primarily due to an increase in invested assets of 5% and $9,409 of investment income from a real estate partnership. Additionally, fees and other income decreased $3,318, or 49%, primarily due to a decrease in the value of the CPI Cap.
Total Benefits, Losses, and Expenses
Total benefits, losses and expenses decreased by $43,470, or 6%, to $644,336 for the year ended December 31, 2005, from $687,806 for the year ended December 31, 2004. The decrease was primarily due to a decrease in policyholder benefits of $45,631, or 9%, due to the sale of the Independent-United States distribution and a decline in sales of life policies. These declines were offset by higher crediting paid on CPI indexed products. The decrease was also offset by an increase in selling, underwriting and general expenses of $2,161, primarily due to severance and costs related to the sale of the Independent-United States distribution of approximately $5,800, partially offset by lower amortization of deferred costs related to the IndependentUnited States channel and lower premium taxes.
Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003
Segment net income decreased by $1,787, or 5%, to $34,235 for the year ended December 31, 2004, from $36,022 for the year ended December 31, 2003. This decrease was principally due to a decline in investment yields offset by a reduction of crediting rates on certain new business.
Total revenues increased by $16,412, or 2%, to $739,230 for the year ended December 31, 2004, from $722,818 for the year ended December 31, 2003. The increase was primarily due to an increase in net investment income of $18,076, or 10%, due to an increase in the average invested assets of approximately 14%, partially offset by a decrease in the average portfolio yield of 23 basis points to 6.34% for 2004 from 6.57% for 2003.
Total Benefits, Losses, and Expenses
Total benefits, losses and expenses increased by $20,324, or 3%, to $687,806 for the year ended December 31, 2004, from $667,482 for the year ended December 31, 2003. The decrease was primarily due to an increase in policyholder benefits of $10,780, or 2%, due to the sale of new business partially offset by a reduction of crediting rates on certain business of approximately $5,300 and an increase in selling, underwriting and general expenses of $9,544, or 6%, primarily due to higher amortized commissions and expenses incurred as a result of the change in mix of new business sales to more single-pay sales.
Corporate and Other
The Corporate and Other segment includes activities of the holding company, financing expenses, net realized gains (losses) on investments, interest income earned from short-term investments held, interest income from excess surplus of insurance subsidiaries not allocated to other segments and additional costs associated with excess of loss reinsurance programs reinsured and ceded to certain subsidiaries in the London market between 1995 and 1997. The Corporate and Other segment also includes the amortization of deferred gains associated with the sales of the FFG and LTC businesses.
The table below presents information regarding the Corporate and Other segments results of operations:
As of December 31, 2005, we had approximately $287,212 (pre-tax) of deferred gains that had not yet been amortized. We expect to amortize deferred gains from dispositions through 2031. The deferred gains are being amortized in a pattern consistent with the expected future reduction of the in-force blocks of business ceded to The Hartford Financial Services Group, Inc. (The Hartford) and John Hancock Life Insurance Company (John Hancock), now a subsidiary of Manulife Financial Corporation. This reduction is expected to be more rapid in the first few years after sale and to be slower as the liabilities in the blocks decrease.
Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004
Segment net loss increased by $13,110, or 43%, to $(43,440) for the year ended December 31, 2005, from $(30,330) for the year ended December 31, 2004. The increase in net loss was primarily due to an increase in policyholder benefits due to the strengthening of reserve accruals on certain excess of loss reinsurance programs sold by our subsidiaries in the London market between 1995 and 1997, an increase in selling, underwriting and general expenses due to stock compensation and a reduction in the amortization of deferred gains on disposal of business. The increase in net loss was partially offset by approximately $39,400 of income tax accrual releases due to the resolution of IRS audits.
Total revenues decreased by $20,461, or 20%, to $79,969 for the year ended December 31, 2005, from $100,430 for the year ended December 31, 2004. This decrease was primarily due to lower net realized gains on investments and lower amortization of deferred gains on disposal of businesses due to continued runoff of the sold businesses. In addition, as a result of our annual review of estimates affecting the deferred gain on disposal of businesses we took a charge of approximately $4,600.
Total Benefits, Losses, and Expenses
Total benefits, losses and expenses increased by $83,771, or 62%, to $219,256 for the year ended December 31, 2005, from $135,485 for the year ended December 31, 2004. The increase is primarily due to an
increase in policyholder benefits of $61,943, or 100%, as a result of costs incurred on excess of loss reinsurance programs, related to personal accident, ransom and kidnap insurance risks, reinsured and ceded by certain subsidiaries in the London market between 1995 and 1997. These charges include a settlement with one of our largest reinsurers for 1997 and strengthening of reserves for remaining portions of the program. Selling, underwriting and general expenses increased by $19,151, or 25%, primarily due to stock appreciation rights (SARs), which increased by $18,000 in 2005 compared to 2004 primarily as a result of appreciation in the stock price.
The income tax benefits increased by $91,122 to $95,847 for the year ended December 31, 2005 from $4,725 for the year end December 31, 2004. Approximately $39,400 of the increased benefit was primarily due to the release of previously provided tax accruals, which were no longer considered necessary based on the resolution of IRS audits. In addition, approximately $5,500 of the increased benefit was due to a recaptured tax benefit from the $19,000 of tax expense we incurred in 2004 on the repatriation of capital from Puerto Rico, primarily due to a technical correction of the American Jobs Creation Act of 2004.
Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003
Segment net loss decreased by $135,809, or 82%, to $(30,330) for the year ended December 31, 2004, from $(166,139) for the year ended December 31, 2003. The decrease in net loss was primarily due to non-recurring interest premium of $205,822 on the redemption of mandatorily redeemable preferred securities in 2003 and the reduction in distributions on mandatorily redeemable preferred securities due to the redemption of the securities in December 2003 and January 2004. Also, net investment income declined due to lower average invested assets and lower interest rates. These declines were partially offset by the increase in interest expense due to the issuance of senior notes in February 2004 and the increase in net realized gains on investments.
Total revenues decreased by $23,706, or 19%, to $100,430 for the year ended December 31, 2004, from $124,136 for the year ended December 31, 2003. This decreased is primarily due to reductions in net investment income due to the lower average invested assets and lower interest rates, reductions in amortization of deferred gain on disposal of businesses and the loss incurred on disposal of the WorkAbility division of $9,232. These declines were partially offset by the increase in net realized gains on investments of $22,440 as a result of fewer other-than-temporary impairments in 2004.
Total Benefits, Losses, and Expenses
Total benefits, losses and expenses decreased by $253,991, or 65%, to $135,485 for the year ended December 31, 2004, from $389,476 for the year ended December 31, 2003. This decrease is primarily due to a decrease in distributions on mandatorily redeemable preferred securities and the interest premium on the redemption of mandatorily redeemable preferred securities incurred in 2003 as a result of the early redemption of the securities in December 2003 and January 2004. These declines were partially offset by an increase in interest expense due to the issuance of senior notes in February 2004. See Liquidity and Capital Resources.
The income tax benefit decreased by $94,476, to $4,725 for the year ended December 31, 2004 from $99,201 for the year ended December 31, 2003. In December of 2004, pursuant to the Jobs Act, we repatriated $110,000 of capital from our Puerto Rico subsidiary and incurred approximately $19,000 of tax expense. In addition, during the fourth quarter of 2004, an analysis of the Federal Tax liability resulted in a $10,000 reduction of our tax liability.
The following table shows the carrying value of our investments by type of security as of the dates indicated:
Of our fixed maturity securities shown above, 66% and 67% (based on total fair value) were invested in securities rated A or better as of December 31, 2005 and December 31, 2004, respectively. As interest rates increase, the market value of fixed maturity securities decreases.
The following table provides the cumulative net unrealized gains (losses), pre-tax, on fixed maturity securities and equity securities as of the dates indicated:
Net unrealized gains on fixed maturity securities decreased by $198,453, or 40%, to December 31, 2005 from December 31, 2004. Net unrealized gains on equity securities decreased by $21,750, or 109%, to December 31, 2005 from December 31, 2004. The decrease in net unrealized gains was primarily due to an increase in treasury yield. The yield on 5-year treasury securities increased by approximately 72 basis points and the yield on 10-year treasury securities increased by 14 basis points between December 31, 2004 and December 31, 2005.
We recorded $765, $600, and $20,271 of pre-tax realized losses in 2005, 2004 and 2003, respectively, associated with other-than-temporary declines in value of available for sale securities. We also recorded zero, $4,217, and $11,125 of pre-tax realized losses in 2005, 2004 and 2003, respectively, associated with other investments.
The investment category and duration of our gross unrealized losses on fixed maturities and equity securities at December 31, 2005 were as follows: