ALPS Property & Casualty Insurance Company

Transcription

1 ALPS Property & Casualty Insurance Company Statutory Financial Statements and Supplemental Schedules (With Independent Auditor s Report Thereon) December 31, 2014 and 2013

2 Contents Independent Auditor s Report 1-2 Statutory Financial Statements Statutory statements of admitted assets, liabilities, capital and surplus 3 Statutory statements of operations 4 Statutory statements of changes in capital and surplus 5 Statutory statements of cash flows 6 Notes to statutory financial statements 7-28 Supplemental Information Summary investment schedule 29 Investment risks interrogatories Reinsurance interrogatories 38-40

3 Independent Auditor s Report To the Board of Directors ALPS Property & Casualty Insurance Company d/b/a Attorneys Liability Protection Society, A Risk Retention Group Missoula, Montana Report on the Financial Statements We have audited the accompanying statutory financial statements of ALPS Property & Casualty Insurance Company (a wholly owned subsidiary of ALPS Corporation), which comprise the statutory statements of admitted assets, liabilities, capital and surplus as of December 31, 2014 and 2013; the related statutory statements of operations, changes in capital and surplus, and cash flows for the years then ended; and the related notes to the statutory financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these statutory financial statements in accordance with accounting practices prescribed or permitted by Montana Commissioner of Securities and Insurance; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these statutory financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the statutory financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the statutory financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the statutory financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the statutory financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the statutory financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Basis for Adverse Opinion on U.S. Generally Accepted Accounting Principles As described in Note 2 to the statutory financial statements, ALPS Property & Casualty Insurance Company has prepared the financial statements in conformity with accounting practices prescribed or permitted by the Montana Commissioner of Securities and Insurance, which practices differ from generally accepted accounting principles. The effects on the financial statements of the variances between statutory accounting practices and accounting principles generally accepted in the United States of America are material and are described in Note 2. 1

4 Adverse Opinion on U.S. Generally Accepted Accounting Principles In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion on U.S. Generally Accepted Accounting Principles paragraph, the financial statements referred to above do not present fairly, in accordance with accounting principles generally accepted in the United States of America, the financial position of ALPS Property & Casualty Insurance Company as of December 31, 2014 and 2013, or the results of its operations or its cash flows for the years then ended. Opinion on Regulatory Basis of Accounting In our opinion, the statutory financial statements referred to above present fairly, in all material respects, the admitted assets, liabilities, capital and surplus of ALPS Property & Casualty Insurance Company as of December 31, 2014 and 2013, and the results of its operations and its cash flows for the years then ended, on the basis of accounting described in Note 2. Report on the Supplemental Schedules Our audit was conducted for the purpose of forming an opinion on the basic statutory financial statements taken as a whole. The accompanying summary investment schedule as of December 31, 2014, and supplemental investment risks and reinsurance interrogatories as of December 31, 2014, and for the year then ended (Supplemental Schedules) are presented for purposes of additional analysis and are not a required part of the basic statutory financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the statutory financial statements. The effects on the Supplemental Schedules of the variances between the statutory accounting practices and accounting principles generally accepted in the United States of America are material and are described in Note 2. As a consequence, the Supplemental Schedules do not present fairly, in conformity with accounting principles generally accepted in the United States of America, such information of the Company as of December 31, 2014, and for the year then ended. The Supplemental Schedules have been subjected to the auditing procedures applied in the audit of the statutory financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the statutory financial statements, or to the statutory financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the Supplemental Schedules are fairly stated in all material respects in relation to the statutory financial statements taken as a whole. Omaha, Nebraska April 24,

5 Statutory Statements of Admitted Assets, Liabilities, Capital and Surplus December 31, 2014 and 2013 Admitted Assets Invested Assets and Cash Bonds $ 71,329,638 $ 66,074,624 Common stocks 8,334,643 12,683,926 Mortgage loans - 1,079,815 Other invested assets 2,171,718 2,418,234 Receivable for securities 302, ,188 Cash and short-term investments 7,436,943 6,871,443 Total invested assets and cash 89,575,891 89,779,230 Other Admitted Assets Premiums receivable 3,276,663 4,012,510 Accrued investment income 1,053,648 1,001,817 Reinsurance receivable 2,815, ,783 Deferred tax assets 3,606,869 1,940,234 Federal income tax receivable 294,393 - Deductible receivable 86, ,755 Receivable from affiliates 21,837 - Total other admitted assets 11,155,435 7,576,099 Total admitted assets $ 100,731,326 $ 97,355,329 Liabilities, Capital and Surplus Liabilities Reserve for loss and loss adjustment expense $ 45,324,148 $ 40,363,787 Unearned premiums 13,182,903 12,622,659 Ceded reinsurance premium payable 703,155 1,467,557 Funds held under reinsurance treaties 1,820,938 1,742,416 Advanced premiums 1,999,381 2,473,815 Accrued taxes and licenses payable 435, ,411 Other expenses payable 49, ,936 Remittances and items not allocated 308, ,841 Due to broker 756, ,899 Due to parent, subsidiaries and affiliates - 579,320 Amounts withheld or retained by Company for the account of others 3,049 2,773 Federal income tax payable - 502,429 Total liabilities 64,584,144 61,728,843 Capital and Surplus Certificates of contribution 525, ,565 Common stock, $1 par; 5,000,000 shares authorized, issued and outstanding 5,000,000 5,000,000 Paid-in and contributed surplus 1,759,881 3,210,928 Surplus notes 11,346,358 11,352,676 Unassigned surplus 17,515,619 15,438,317 Total capital and surplus 36,147,182 35,626,486 Total liabilities and capital and surplus $ 100,731,326 $ 97,355,329 See. 3

6 Statutory Statements of Operations Years Ended December 31, 2014 and Underwriting income: Gross premiums written $ 43,214,070 $ 42,190,661 Reinsurance ceded (14,146,589) (14,112,282) Net premiums written 29,067,481 28,078,379 Change in unearned premiums (560,244) (209,326) Net premiums earned 28,507,237 27,869,053 Underwriting expenses: Losses incurred 9,909,185 8,108,858 Loss adjustment expenses incurred 10,087,853 9,632,973 Other underwriting expenses, net of reinsurance ceding commission of $479,914 and $161,179, respectively 9,245,519 9,970,671 Total losses and underwriting expenses 29,242,557 27,712,502 Underwriting income (loss) (735,320) 156,551 Realized gain on investments, net of income taxes of $23,360 and $24,757, respectively 43,383 74,271 Investment income, net of investment expense of $1,026,073 and $1,024,029, respectively 3,636,031 3,391,403 Other income 212, ,447 Income before federal income taxes 3,156,134 3,902,672 Provision for federal income taxes (1,046,917) (1,026,627) Net income $ 2,109,217 $ 2,876,045 See. 4

7 Statutory Statements of Changes in Capital and Surplus Years Ended December 31, 2014 and 2013 Common Stock Paid-In and Contributed Certificates of Surplus Unassigned Shares Amount Surplus Contribution Notes Surplus Total Balance, December 31, ,000,000 $ 5,000,000 $ 4,184,226 $ 734,847 $ 11,414,258 $ 12,312,482 $ 33,645,813 Net change in unrealized gains , ,973 Surplus refunds (110,282) - - (110,282) Adjustment to paid-in surplus - - (973,298) - 973, Repayment of surplus notes (1,034,880) - (1,034,880) Net change in provision for reinsurance ,311 56,311 Net change in nonadmitted assets , ,256 Net change in deferred taxes (379,750) (379,750) Net income ,876,045 2,876,045 Balance, December 31, ,000,000 5,000,000 3,210, ,565 11,352,676 15,438,317 35,626,486 Net change in unrealized gains (769,610) (769,610) Surplus refunds (99,241) - - (99,241) Adjustment to paid-in surplus - - (1,451,047) - 1,451, Repayment of surplus notes (1,457,365) - (1,457,365) Dividend declared and paid (505,509) (505,509) Net change in nonadmitted assets , ,802 Net change in deferred taxes , ,402 Net income ,109,217 2,109,217 Balance, December 31, ,000,000 $ 5,000,000 $ 1,759,881 $ 525,324 $ 11,346,358 $ 17,515,619 $ 36,147,182 See. 5

8 Statutory Statements of Cash Flows Years Ended December 31, 2014 and Cash Flows From Operating Activities Premiums collected, net of reinsurance $ 28,564,492 $ 29,660,114 Benefits and loss-related payments (9,141,828) (8,968,620) Commissions and expenses paid (17,705,693) (20,708,264) Investment income, net 3,832,945 3,647,779 Miscellaneous income 212, ,447 Federal income taxes paid (1,867,099) (1,556,867) Net cash flows from operating activities 3,894,857 2,354,589 Cash Flows From Investing Activities Proceeds from sales, maturities, and repayments of bonds 11,228,845 15,218,861 Proceeds from sale of stocks 8,776,086 2,720,651 Proceeds from redemption of mortgage loans 1,079,815 2,466 Purchase of bonds (16,659,288) (22,004,431) Purchase of stocks (5,675,885) (2,887,299) Proceeds from other invested assets 305,009 1,827,473 Miscellaneous proceeds 418,511 80,574 Net cash flows from investing activities (526,907) (5,041,705) Cash Flows From Financing Activities Surplus notes, capital and surplus repaid (1,457,365) (1,034,880) Dividends to stockholders (505,509) - Miscellaneous proceeds (applications) (839,576) 579,876 Net cash flows from financing activities (2,802,450) (455,004) Net change in cash and short-term investments 565,500 (3,142,120) Cash and Short-Term Investments at Beginning of Year 6,871,443 10,013,563 Cash and Short-Term Investments at End of Year $ 7,436,943 $ 6,871,443 See. 6

9 Note 1. Organization ALPS Property & Casualty Insurance Company (the Company) is a wholly owned subsidiary of ALPS Corporation, a stock corporation and parent holding company organized under Montana law. In addition to owning 100 percent of the outstanding shares of the Company, ALPS Corporation also owns 100 percent of the outstanding shares of the following entities: (i) Peak Investment Management, Ltd. (Peak), a Montana corporation that operates as an investment management company; (ii) ALPS Risk and Insurance Services, Inc., a Montana corporation that provides captive startup and management services; (iii) ALPS Insurance Agency, Inc. (AIA), a Montana corporation that provides underwriting, claims adjusting and insurance producer services; and (iv) First Lawyers Trust Company, a South Dakota chartered trust company. In addition to the to the Tax Allocation Agreement referred to in Note 6, the Company has entered into the following agreements with its affiliated entities: (i) Administrative Services and Cost Sharing Agreement; (ii) Insurance Services Agreement; and (iii) Investment Management Agreement. Under the Administrative Services and Cost Sharing Agreement, ALPS Corporation provides the Company with the following services: corporate officers, corporate services, financial and accounting, legal and regulatory, reinsurance, human resources, actuarial, policy form development and filing, information technology, production, mailroom, strategic planning, executive management, and travel and transportation services. In addition, ALPS Corporation also leases to the Company certain office space and equipment located in the Company s corporate headquarters. Under the Insurance Services Agreement, AIA provides the Company with underwriting, claims, sales, marketing and insurance producer services. Under the Investment Management Agreement, Peak provides the Company with investment management services as a registered investment advisor. The Company is a Montana corporation, admitted in and regulated by the State of Montana as a casualty insurance company. The Company issues policies of professional liability insurance, employment practices liability insurance and cyber risk liability insurance to attorneys and law firms. From the date it commenced business on March 1, 1988, until 2013, the Company was structured and operated exclusively as a risk retention group pursuant to the provisions of the federal Liability Risk Retention Act (LRRA). As of December 31, 2014, the Company was licensed as an admitted insurer and holds a Certificate of Authority (COA) in the following jurisdictions (in addition to its state of domicile, Montana): Alaska, Arizona, Arkansas, Colorado, Delaware, District of Columbia, Georgia, Hawaii, Idaho, Indiana, Kansas, Maine, Maryland, Michigan, Mississippi, Missouri, Nebraska, Nevada, New Hampshire, New Mexico, North Carolina, North Dakota, Rhode Island, South Carolina, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin, Wyoming and the U.S. Virgin Islands. As of December 31, 2014, the Company remained registered to do business as a risk retention group in Connecticut, Illinois, Iowa, Massachusetts, Minnesota, New York, Pennsylvania, Virginia and the Northern Mariana Islands. 7

10 Note 2. Summary of Significant Accounting Policies Basis of accounting: The Company prepares its statutory financial statements in conformity with accounting practices prescribed or permitted by the Montana Commissioner of Securities and Insurance, which requires insurance companies domiciled in the state of Montana to prepare their statutory financial statements in accordance with the National Association of Insurance Commissioners Accounting Practices and Procedures Manual, subject to any deviations prescribed or permitted by the Montana Commissioner of Securities and Insurance. Effective as of March 6, 2013, and with the permission of the Montana Commissioner of Securities and Insurance, the Company allowed ALPS Corporation to restructure the June 30, 2012, Promissory Note in consideration of ALPS Corporation making additional payments to reduce the outstanding balance of the Promissory Note by approximately fifty percent (50%). Accordingly, ALPS Corporation issued to the Company a newly restructured Promissory Note dated March 6, 2013, in the principal sum of $1,530,000, which bears interest at the rate of 2.51 percent per annum. The terms of the March 6, 2013, Promissory Note require ALPS Corporation to pay the Company thirty-two (32) equal monthly installments of $25,990, commencing April 30, 2013, and continuing until November 30, On or before December 31, 2015, ALPS Corporation shall make a final balloon payment in an amount equal to the entire remaining unpaid principal balance of the Promissory Note, currently estimated at $780,000. The outstanding principal balance on the Promissory Note at December 31, 2014, is $1,043,999. The Company, with the explicit permission of the Commissioner of Securities and Insurance of the State of Montana, and in accordance with Statement of Statutory Accounting Principles (SSAP) Nos. 25 and 64, has classified the balance as other invested assets. These statutory accounting practices (SAP) comprise a comprehensive basis of accounting other than accounting practices generally accepted in the United States of America (GAAP) and differ in some respects. The more significant of these differences are as follows: Certain assets designated as nonadmitted are excluded from the statutory statement of admitted assets, liabilities, capital and surplus. The change in nonadmitted assets is credited directly to or charged directly against unassigned surplus. Under GAAP, these nonadmitted assets are included in the balance sheet, subject to realizability. Investments in bonds with an NAIC rating of 1 or 2 are carried at amortized cost, whereas bonds with an NAIC rating of 3 through 6 are written down to fair value (if less than amortized cost) by charging statutory surplus. Under GAAP, bonds are classified as held-to-maturity, available-for-sale, or trading. Bonds classified as held-to-maturity are carried at amortized cost; bonds classified as available-forsale are stated at fair value, with the resulting unrealized gains and losses, net of applicable income taxes, credited or charged to surplus; and bonds held for trading purposes are carried at fair value, with the resulting unrealized gains and losses reported in earnings. The fair value of investments on a statutory basis is determined by the Securities Valuation Office (SVO), whereas for GAAP, the fair value of investments is determined based on the exit price. 8

11 Note 2. Summary of Significant Accounting Policies (Continued) For loan-backed and structured securities, if the Company determines that they intend to sell a security or no longer have the ability and intent to retain the investment for a period of time sufficient to recover the amortized cost, that security shall be written down to fair value. For statutory purposes, if the Company subsequently changes their assertion, and now believe they do not intend to sell the security and have the ability and intent to retain the investment for a period of time sufficient to recover the amortized cost, that security will continue to be carried at the lower of cost or market, with any future decreases in fair value charged through operations until the security is disposed. For GAAP purposes, once the Company alters their assertion, that security s amortized cost basis will not be decreased for future reductions in fair value unless a subsequent other-than-temporary impairment is determined to have occurred. Also, for GAAP purposes other-than-temporary impairment losses related to nonloan-backed and structured securities are bifurcated between credit and noncredit, whereas for statutory purposes the total other-than-temporary impairment loss is reported in earnings. Cash and short-term investments in the statutory statements of cash flows represent cash balances and investments with initial maturities of one year or less. Under GAAP, the corresponding caption of cash and cash equivalents includes cash balances and investments with maturities of three months or less at the time of purchase. Further, GAAP requires the presentation of a reconciliation of net income to cash flows from operating activities. Commissions and other costs of acquiring and renewing business are expensed when incurred. Under GAAP, such costs, to the extent recoverable, are deferred and amortized to income as premiums are earned. Commissions allowed by reinsurers on business ceded are reported as income when received rather than being deferred and amortized with deferred policy acquisition costs, as required under GAAP. Reserves for losses and loss adjustment expenses ceded to reinsurers have been reported as reductions of the related reserves rather than as assets, as would be required by GAAP. Deferred federal income taxes are provided for the tax effects of certain income and expense items recognized for income tax purposes in different years than for financial reporting purposes. The change in the deferred tax asset or liability is reflected in surplus. GAAP requires the change to be reported in income. Admittance testing may result in a charge to capital and surplus for nonadmitted portions of the deferred tax asset. State taxes are not considered for statutory purposes in calculating a deferred tax asset or liability; however, they are considered for GAAP purposes. Both statutory and GAAP guidance requires a valuation allowance be established where the deferred tax asset is reduced, if based on the weight of available evidence it is more likely than not that some portion or all of a gross deferred tax asset will not be realized, to its realizable value. Changes in valuation allowance are reported in a similar manner to which changes in deferred tax assets and liabilities are reported, as noted above. Surplus notes are included in surplus for statutory purposes, but are considered liabilities for GAAP. Interest expense is not recognized for statutory purposes until it is approved by the state of domicile, whereas for GAAP, the interest is accrued monthly. Receivables over 90 days outstanding are not admitted in the statutory financial statements and are charged to surplus, whereas, for GAAP, the Company assesses the collectibility of premiums receivable and any charge is to the income statement. 9

12 Note 2. Summary of Significant Accounting Policies (Continued) Comprehensive income is not reflected in accordance with the requirements of GAAP. Instead, changes in unrealized gains and losses on investments are charged directly to unassigned surplus. Statutory financial statements are prepared in a form and using language and groupings substantially the same as the annual statements of the Company filed with the National Association of Insurance Commissioners (NAIC) and state regulatory authorities, which differ from the presentation and disclosure of financial statements presented in accordance with GAAP. A reconciliation of net income and capital and surplus between amounts presented in conformity with GAAP and amounts presented herein is as follows for the years ended December 31: Net Income (Loss) Capital and Surplus Amounts stated in conformity with GAAP $ 2,628,746 $ 2,377,092 $ 31,116,069 $ 29,000,891 Other investment adjustments (35,325) 87,910 (5,345,637) (1,753,637) Deferred policy acquisition costs (1,829) 109,839 (1,470,102) (1,468,273) Nonadmitted assets - (1,482,899) (2,232,701) Deferred income taxes (511,278) 338,097 1,988, ,951 Surplus note fees 28,903 23,410 (5,519) (34,422) Surplus notes ,346,358 11,352,677 Bad-debt allowance - (60,303) - - Amounts stated in conformity with SAP $ 2,109,217 $ 2,876,045 $ 36,147,182 $ 35,626,486 Risk and uncertainties: Certain risks and uncertainties are inherent in the Company s day-to-day operations and in the process of preparing its statutory financial statements. The more significant of those risks and uncertainties, as well as the Company s method for mitigating the risks, are presented below and throughout the notes to the statutory financial statements. Accounting estimates: The preparation of financial statements in conformity with the statutory accounting principles requires management to make estimates and assumptions that affect the amounts reported in the statutory financial statements, accompanying schedules, and accompanying footnotes and general interrogatories. It also requires estimates in the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. Reinsurance: Reinsurance contracts do not relieve the Company from its obligations to insureds. Failure of reinsurers to honor their obligation could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. Investments: The Company is exposed to risks that issuers of securities owned by the Company will default or that interest rates will change and cause a decrease in the market value of its investments. With mortgage-backed securities and mortgage loans on real estate, the Company is also exposed to risks such as prepayment, default and deterioration of collateral value. As interest rates decline, the rate at which these securities pay down the principal will increase. Management mitigates these risks by conservatively investing in high-grade securities and by matching maturities of its investments with the anticipated payouts of its liabilities. 10

13 Note 2. Summary of Significant Accounting Policies (Continued) Loss reserves: The reserves for policy and contract claims consist of case-basis estimates for reported claims and estimates for unreported claims based on past claims-reporting experience. The management of the Company believes reserves for policy and contract claims are adequate to cover the ultimate liability. However, the ultimate claim costs may vary from the amounts presently provided. External and regulatory factors: The Company is highly regulated by the state in which it is domiciled, as well as states in which it does business. Such regulations, among other things, limit the amount of rate increases on policies and impose restrictions on the amount and type of investments and the minimum surplus required to conduct business in the state. The Company monitors economic and regulatory developments that have the potential to impact its business. Federal legislation has allowed banks and other financial organizations to have greater participation in insurance businesses. This legislation may present an increased level of competition for sales of the Company s products. The impact of the regulatory initiatives in response to the recent financial crisis, including the Dodd-Frank Act Wall Street Reform and Consumer Protection Act, could subject the Company to substantial additional regulation. These additional regulatory requirements may make it more expensive for the Company to conduct its business and materially affect the profitability of the results of operations. Risk-based capital: The NAIC has developed property-casualty risk-based capital (RBC) standards that relate an insurer s reported statutory surplus to the risks inherent in its overall operations. The RBC formula uses the statutory annual statement to calculate the minimum indicated surplus level to protect the Company from various risks that it faces. The NAIC model law calls for various levels of regulatory action based on the magnitude of an indicated RBC capital deficiency, if any. The Company continues to monitor its internal requirements and the NAIC s RBC requirements. The Company has determined that its surplus levels are in excess of the minimum capital requirements for all RBC action levels. Management believes that the Company s surplus levels are sufficient to support the level of risk inherent in its operations. Concentrations of credit risk: The credit quality of the bond portfolio at December 31, 2014 and 2013, is presented in the following table: Statement Statement Amount Percentage Amount Percentage NAIC 1 Highest quality $ 63,363,776 89% $ 58,299,428 88% NAIC 2 High quality 5,600,004 8% 5,342,305 8% NAIC 3 Medium quality 1,409,034 2% 1,276,060 2% NAIC 4 Low quality 246,996 0% 542,969 1% NAIC 5 Lower quality 674,754 1% 573,322 1% NAIC 6 In or near default 35,074 0% 40,540 0% $ 71,329, % $ 66,074, % Bonds with ratings from AAA to BBB, as assigned by Standard and Poor s Corporation, are generally considered investment-grade securities. Some securities issued by the United States government or an agency thereof are not rated but are considered to be investment grade. The NAIC regards United States Treasuries and agencies and all A ratings as Class 1 (highest quality), BBB ratings as Class 2 (high quality), BB ratings as Class 3 (medium quality), B ratings as Class 4 (low quality), C ratings as Class 5 (lower quality), and D ratings as Class 6 (in or near default). 11

14 Note 2. Summary of Significant Accounting Policies (Continued) Revenue recognition: Premiums are recognized as revenue on a daily pro rata basis over the policy period. Unearned premiums are established to cover the unexpired portion of premiums written and are computed on a pro rata method. Advanced premiums are deferred until the effective date of the policy, at which time they are recognized as revenue on a pro rata basis over the term of the policy. Loss and loss adjustment expenses: Unpaid losses and loss adjustment expenses include an amount determined from individual case estimates and loss reports and an amount, based on past experience, for losses incurred but not reported. Such liabilities are necessarily based on assumptions and estimates and, while management believes the amount is adequate, the ultimate liability may be in excess of or less than the amount provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed, and any adjustments are reflected in the period determined. Cash and short-term investments: The Company considers all highly liquid investments with a maturity of 12 months or less at the date of acquisition and all nonnegotiable certificates of deposit to be part of cash and short- term investments. From time to time, certain bank accounts that are subject to limited Federal Deposit Insurance Corporation (FDIC) coverage exceed their insured limits, sometimes by substantial amounts. The Company periodically reviews the risk this poses, and has determined it to be minimal. Investments: Investments, excluding residential and commercial mortgage-backed securities not guaranteed by federal or federally sponsored agencies, are stated at carrying values prescribed by the NAIC s SVO. Accordingly, nonloan-backed bonds rated 1 and 2 by the NAIC are stated at amortized cost using the scientific-interest method, with bonds containing call provisions being amortized to the call or maturity date, whichever results in a lower asset value. Loan-backed bonds rated 1 and 2 by the NAIC are stated at amortized cost using the scientific-interest method, including anticipated prepayments. Bonds rated 3 through 6 are carried at fair value with the change run through capital and surplus, net of applicable taxes. Short-term investments are stated at amortized value using the interest method. Non investment-grade short-term investments are stated at the lower of amortized cost or fair value. The retrospective adjustment method is used to value all loan-backed securities. Prepayment assumptions for single-class and multi-class mortgage-backed/asset-backed securities were obtained from broker-dealer survey values or internal estimates. Common stocks and mutual funds are stated at fair value. Investments in joint ventures and partnerships are stated at the underlying audited GAAP equity value. 12

15 Note 2. Summary of Significant Accounting Policies (Continued) The assessment of other-than-temporary impairments is performed on a case-by-case basis. Factors considered by management in determining whether an other-than-temporary impairment exists (in other than loan-backed or structured investment securities) include: the financial condition, business prospects and creditworthiness of the issuer, the length of time and extent to which fair value has been less than cost for equity securities or amortized cost for fixed-income securities, and the Company s intent and ability to retain such investments until the fair value recovers. If it is determined that the decline in fair market value is other than temporary, the carrying amount of the investment is written down to fair value as its new basis, and the amount of the write-down is recorded as a realized loss. For loan-backed or structured securities, factors considered by management in determining whether an other-than-temporary impairment exists include the Company s stated intent to not sell, the Company s ability to hold such investments until the fair value recovers, and the discounted cash flows of the security based on the yield at the date of acquisition. If the Company intends to sell or if the Company does not have the ability and intent to hold the security for a period of time sufficient to recover its amortized cost basis, an other-thantemporary impairment exists, and the security is written down to fair value with the amount of the writedown recorded as a realized loss. If the Company does not intend to sell the security and has the ability and intent to hold the security for a period of time sufficient to recover the amortized cost basis, the Company calculates the cash flows expected to be collected. In this calculation, the Company compares the present value of cash flows expected to be collected, discounted at the security s effective interest rate at the date of purchase, to the amortized cost basis. If the present value of cash flows is less than the amortized cost basis, a realized loss is recorded for the difference. The present value of cash flows then becomes the new cost basis. Income taxes: The Company employs the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Certain net deferred tax assets are nonadmitted assets in accordance with SSAP No Accrued investment income: Investment income is accrued when it is legally due to be paid to the Company. The Company does not admit investment income due and accrued over 90 days past due. Reclassifications: Certain reclassifications have been made to the December 31, 2013, statutory financial statements to conform to the December 31, 2014, presentation. These reclassifications had no effect on previously reported net loss or capital and surplus. 13

16 Note 3. Investments At December 31, 2014 and 2013, the amortized cost and the estimated fair value of the Company s investment securities are as follows: Gross Gross Book Unrealized Unrealized Estimated Value Gains Losses Fair Value December 31, 2014: Bonds: U.S. government and agencies $ 110,967 $ - $ 684 $ 110,283 State, municipal and other governments 53,777,538 4,206,968 49,529 57,934,977 Corporate securities 1,901, ,203-2,013,393 Commercial mortgage-backed securities 2,412, ,864 2,406,873 Residential mortgage-backed securities 8,889, ,823 9,132 9,484,935 Other asset-backed securities 4,238, ,412-4,724,815 Total fixed maturities 71,329,638 5,410,847 65,209 76,675,276 Equity securities 10,101,566 1,214,205 2,981,128 8,334,643 Total $ 81,431,204 $ 6,625,052 $ 3,046,337 $ 85,009,919 Gross Gross Book Unrealized Unrealized Estimated Value Gains Losses Fair Value December 31, 2013: Bonds: U.S. government and agencies $ 111,407 $ - $ 1,424 $ 109,983 State, municipal and other governments 45,090,701 1,443, ,538 45,892,005 Corporate securities 2,599, ,569 3,388 2,745,387 Commercial mortgage-backed securities 2,722,482 9,944 13,419 2,719,007 Residential mortgage-backed securities 11,579, ,102 58,764 12,163,478 Other asset-backed securities 3,971, ,205 17,491 4,198,402 Total fixed maturities 66,074,624 2,490, ,024 67,828,262 Equity securities 13,160,387 1,948,523 2,424,984 12,683,926 Total $ 79,235,011 $ 4,439,185 $ 3,162,008 $ 80,512,188 14

17 Note 3. Investments (Continued) The following tables present the estimated fair value and the gross unrealized losses, aggregated by investment category and length of time that individual investment securities have been in an unrealized loss position, at December 31, 2014 and 2013: December 31, 2014 Greater Than or Less Than 12 Months Equal to 12 Months Total Gross Gross Gross Estimated Unrealized Estimated Unrealized Estimated Unrealized Fair Value Losses Fair Value Losses Fair Value Losses Bonds: U.S. government agencies $ - $ - $ 110,284 $ 684 $ 110,284 $ 684 State, municipal and other governments 2,280,326 11,186 1,487,863 38,343 3,768,189 49,529 Corporate securities Commercial mortgagebacked securities 1,930,391 5, ,930,391 5,864 Residential mortgagebacked securities 443,265 1, ,978 7,691 1,013,243 9,132 Other asset-backed securities ,653,982 18,491 2,168,125 46,718 6,822,107 65,209 Equity securities 2,512,686 1,437,504 2,271,470 1,543,624 4,784,156 2,981,128 Total $ 7,166,668 $ 1,455,995 $ 4,439,595 $ 1,590,342 $ 11,606,263 $ 3,046,337 December 31, 2013 Greater Than or Less Than 12 Months Equal to 12 Months Total Gross Gross Gross Estimated Unrealized Estimated Unrealized Estimated Unrealized Fair Value Losses Fair Value Losses Fair Value Losses Bonds: U.S. government agencies $ 109,984 $ 1,423 $ - $ - $ 109,984 $ 1,423 State, municipal and other governments 16,731, , ,920 32,304 17,727, ,538 Corporate securities 296,241 3, ,241 3,388 Commercial mortgagebacked securities 1,833,193 13, ,833,193 13,419 Residential mortgagebacked securities 466,670 9,362 1,795,613 49,403 2,262,283 58,765 Other asset-backed securities 384,615 1, ,616 15, ,231 17,491 19,821, ,791 3,183,149 97,233 23,004, ,024 Equity securities 2,491, ,831 3,635,290 1,837,153 6,126,347 2,424,984 Total $ 22,312,787 $ 1,227,622 $ 6,818,439 $ 1,934,386 $ 29,131,226 $ 3,162,008 15

18 Note 3. Investments (Continued) The majority of the unrealized losses on securities are due to interest rate changes and market segments that are experiencing temporary value declines. The Company periodically examines its investment portfolio to determine if any investments are other-than-temporarily impaired. The Company held no securities that were determined to be other-than-temporarily impaired for the years ended December 31, 2014 and The Company asserts that it has the intent and ability to hold securities in an unrealized loss position long enough to allow the cost basis of these securities to be recovered. These conclusions are supported by a detailed analysis of each security by the Company s asset managers. It is possible that the Company could recognize other-than-temporary impairments in the future on some securities if future events, information, and the passage of time cause it to conclude that declines in value are other than temporary. The amortized cost and the estimated fair value of bonds at December 31, 2014, by contractual maturities, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Book Value Fair Value Due in one year or less $ 719,377 $ 7,620,394 Due after one year through five years 7,526,286 25,339,350 Due after five years through 10 years 15,192,180 33,891,446 Due after 10 years through 20 years 38,722,372 9,330,541 Due after 20 years 9,169, ,545 Total $ 71,329,638 $ 76,675,276 Major categories of net investment income are summarized as follows: Years Ended December Fixed maturities $ 3,704,758 $ 3,457,076 Equity securities 878, ,531 Mortgage loans 42,597 76,146 Short-term investments 6,694 5,624 Other 30,051 55,055 4,662,794 4,415,432 Less investment expenses: Surplus note interest 384, ,625 Other investment expense 642, ,404 1,026,763 1,024,029 Net investment income $ 3,636,031 $ 3,391,403 16

19 Note 3. Investments (Continued) Realized gains (losses) on investments recognized in the statutory statements of operations during the years presented, are summarized below: Years Ended December Realized: Gross realized gains on sales: Fixed-income securities $ 13,834 $ 27,117 Equity securities 1,255, ,427 Other invested assets 23,169 87,059 Total 1,292, ,603 Gross realized losses on sales: Fixed-income securities (11,640) (46,730) Equity securities (1,213,678) (502,845) Total (1,225,318) (549,575) Tax effect of net realized capital (gains) losses (23,360) (24,757) Net realized capital gains, net of tax $ 43,383 $ 74,271 The Company has determined the fair value of its investments through the application of SSAP No. 100, Fair Value Measurements. Under SSAP No. 100, all of the Company s investments are measured using the market approach on a recurring basis using Level 1 or Level 2 inputs. Level 1 inputs are quoted prices in active markets as of the measurement date. Level 2 inputs are quoted market prices for similar assets in inactive markets as of the measurement date. Level 3 inputs are derived from techniques that require significant unobservable inputs. At December 31, 2014 and 2013, all equity securities were measured with Level 1 inputs, with the exception of alternative assets (Lawyers Re) being measured with Level 3 inputs. All special revenue bonds, industrial bonds, and miscellaneous bonds were measured with Level 2 inputs. Other invested assets consist of a promissory note and an investment in a limited liability company (LLC). At December 31, 2014 and 2013, the collateral loan had an outstanding balance of $1,043,999 and $1,325,840, respectively. The investment in the LLC had an outstanding balance of $1,127,719 and $1,092,394 at December 31, 2014 and 2013, respectively. The Company has placed in trust with the Montana Commissioner of Securities and Insurance investments valued at $2,808,148 and $2,804,862 and with various other states $1,010,122 and $1,010,351 at December 31, 2014 and 2013, respectively, as required by state law. 17

20 Note 4. Losses and Loss Adjustment Expense Reserves The following table provides a reconciliation of the beginning and ending reserve balances for losses and loss adjustment expenses (LAE), net of reinsurance recoverable, for the years ended December 31, 2014 and 2013: Reserve for losses and LAE, beginning of year (net of reinsurance recoverable of $$30,620,807 and $25,254,926 in 2014 and 2013, respectively) $ 40,363,787 $ 42,759,706 Add provision (reduction) for losses and LAE, net of reinsurance, applicable to claims reported in: Current year 20,379,629 19,588,589 Prior years (382,591) (1,846,758) Total incurred losses during the current year 19,997,038 17,741,831 Payments for losses and LAE, net of reinsurance, reported in: Current year 3,420,233 4,200,293 Prior years 11,616,444 15,937,457 Net claim payments during the year 15,036,677 20,137,750 Reserve for losses and LAE, end of year (net of reinsurance recoverable of $30,587,580 and $30,620,807 in 2014 and 2013, respectively) $ 45,324,148 $ 40,363,787 Reserves for incurred losses and LAE attributable to claims reported to the Company in prior years have decreased by approximately $383,000 and $1,850,000 during 2014 and 2013, respectively. These changes are generally the result of ongoing analysis of claim files. Original estimates are increased or decreased as additional information becomes known regarding individual claims. Note 5. Reinsurance The Company utilizes reinsurance contracts to reduce its exposure to losses in all aspects of its insurance business. Such reinsurance permits recovery of a portion of losses from reinsurers, although it does not relieve the Company from its primary liability to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial strength of potential reinsurers and continually monitors the financial condition of reinsurers. Amounts recoverable from reinsurers are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Management believes the recoverables are appropriately established. The Company generally strives to diversify its credit risks related to reinsurance ceded. At December 31, 2014, the Company did not have any recoverable losses from a reinsurer that exceeded 3 percent of the Company s surplus. There were no disputes with reinsurers at December 31, 2014 or The Company holds letters of credit in the amount of approximately $13,416,000 and $12,408,000 at December 31, 2014 and 2013, respectively, to secure recoverable balances from unauthorized reinsurers. 18

21 Note 5. Reinsurance (Continued) The Company has no uncollectible reinsurance recoverables that were written off during the year. The Company has unsecured aggregate recoverables for losses, paid and unpaid, loss adjustment expenses, and unearned premium with the following individual reinsurers, authorized or unauthorized, exceeding 3 percent of policyholders surplus at December 31: AM Best Rating American Safety Reinsurance Ltd. NR $ 4,550,000 $ 4,620,000 Aspen Insurance A 3,122,000 2,772,000 AXA RE NR 1,577,000 1,270,000 Everest Reinsurance Co. A+ 2,658,000 2,088,000 Hannover Ruckversicherungs Aktiengesellschaft NR 1,114,000 1,135,000 JRG Reinsurance Co. A- 5,565,000 4,466,000 Lawyer's Reinsurance Co. NR 2,613,000 3,094,000 Lloyd's LIB 4472 NR 1,129,000 1,186,000 Navigators Ins Co A 1,442,000 1,459,000 Transatlantic Reinsurance Co. A 4,670,000 3,499,000 Lloyd's Syndicate Number 2623 NR 1,378,000 - $ 29,818,000 $ 25,589,000 A summary of the impact of ceded reinsurance on written, earned and unearned premium for the years ended December 31, 2014 and 2013, is as follows: Premiums written: Direct $ 43,214,070 $ 42,190,661 Ceded (14,146,589) (14,112,282) Net premiums written $ 29,067,481 $ 28,078,379 Premiums earned: Direct $ 42,733,026 $ 41,579,849 Ceded (14,225,789) (13,710,796) Net premiums earned $ 28,507,237 $ 27,869,053 Losses and loss adjustment expenses incurred: Direct $ 28,419,091 $ 30,237,476 Ceded (8,422,053) (12,495,645) Net losses and loss adjustment expenses incurred $ 19,997,038 $ 17,741,831 19

22 Note 6. Equity The Company was originally organized as a mutual insurer and obtained its operating surplus through surplus contributions from its insured policyholders. The original surplus contributions were evidenced by Certificates of Surplus Contribution. Effective January 1, 2001, the Company demutualized and converted to a stock insurer. Under the Plan of Demutualization approved by the Company s Board of Directors and the Montana Commissioner of Securities and Insurance, each holder of a Certificate of Surplus Contribution elected to either (1) convert the Certificate to shares of Class A common stock; (2) donate the Certificate to a bar foundation designated by the holder; or (3) receive annual cash payments until the amount of the Certificate was repaid, without interest, with payments made only in years following a year in which the Company had positive net income. An exception to this, where payments may be made in years following a year in which the Company had a net loss, is in the event of death of the certificate holder or the certificate holder s retirement from the practice of law. The amount returned as cash refunds during 2014 and 2013 was $99,241 and $110,282, respectively. Dividends on common stock are declared by the Company s Board of Directors. Under the insurance regulations of the state of Montana, dividends are classified into two types: ordinary and extraordinary. Ordinary dividends require 15-day advance notice to the Montana Commissioner of Securities and Insurance prior to payment. Extraordinary dividends, those which in total exceed 10 percent of the current year-end policyholders surplus, require approval from the Commissioner 30 days prior to payment. For the year ended December 31, 2014, dividends in excess of $3,562,648 would be considered extraordinary. No dividends were declared or paid in An ordinary dividend in the amount of $505,509 was declared and paid by the Company on December 31, Note 7. Surplus Notes The Company has issued the following surplus debentures or similar obligations as of December 31, 2014: Principal Total Unapproved and/or Principal Principal Date Interest Par Carrying Interest Paid and/or and/or Date of Issued Rate Value Value Current Year Interest Paid Interest Maturity 10/14/2005 LIBOR % $ 10,000,000 $ 10,000,000 $ 328,728 $ 5,383,751 $ 15,794 10/15/ /23/2005 Fed fund rate 1,346,358 1,346,358 1,208,977 9,920, ,128 None The Company has issued the following surplus debentures or similar obligations as of December 31, 2013: Principal Total Unapproved and/or Principal Principal Date Interest Par Carrying Interest Paid and/or and/or Date of Issued Rate Value Value Current Year Interest Paid Interest Maturity 10/14/2005 LIBOR % $ 10,000,000 $ 10,000,000 $ 382,728 $ 5,055,023 $ 15,794 10/15/ /23/2005 Fed fund rate 1,346,359 1,346,359 1,460,058 8,711, ,281 None 20