| GAINSCO INC ITEM 1A RISK FACTORS Readers of this Annual Report on Form 10-K should consider the risk factors described in the following paragraphs in conjunction with the other information included herein |
| See also "e Forward-Looking Statements” appearing in ITEM 7, MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” Failure to successfully resolve our remaining commercial lines claims could have an adverse affect on our results of operations |
| On February 7, 2002, we announced our decision to cease writing commercial insurance due to continued adverse claims development and unprofitable results |
| As a result, there are no commercial policies remaining in force at December 31, 2005 |
| We continue to settle and reduce our inventory of commercial lines claims |
| At December 31, 2005, there were 149 claims associated with our runoff book outstanding, compared to 264 at December 31, 2004 |
| Due to the long tail and litigious nature of these claims, we anticipate that it will take a substantial number of years to complete the adjustment and settlement process with regard to existing claims and the additional claims we expect to receive in the future from our past business writings |
| Most of the remaining claims are in litigation and our future results may be impacted negatively if we are unable to resolve the remaining claims and new anticipated claims within our established reserve level |
| Our profitability is affected by the availability of reinsurance |
| Our insurance subsidiaries’ business depends on their ability to transfer or “cede” significant amounts of the risks they insure |
| Our insurance subsidiaries cede portions of the risks related to our nonstandard automobile insurance business through reinsurance arrangements with third parties |
| The amount, availability and cost of reinsurance are subject to prevailing market conditions that are beyond our control |
| These conditions will affect our level of business and profitability |
| Reinsurance makes the assuming reinsurer liable to the extent of the risks ceded |
| We will be subject to credit risks with respect to the reinsurers because ceding risks to reinsurers will not relieve our insurance subsidiaries’ ultimate liability to their insureds |
| The insolvency of any reinsurer or the inability of a reinsurer to make payments could have a material adverse effect on our business, our results of operations and our financial condition |
| We have also used reinsurance to dispose of certain of our discontinued and runoff businesses |
| Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred, it does not relieve us of our liability to our policyholders |
| At December 31, 2005, we had approximately dlra27dtta8 million in reinsurance receivables, comprised primarily of reserves for future claim payments |
| Approximately 89prca of these receivables were concentrated with 11 reinsurers, all of which were companies rated A- or better by AM Best |
| One company with a B+ rating owed approximately 3prca of the reinsurance receivables, one company with a B- rating owed approximately 4prca of the reinsurance receivables and one company with a C rating owed approximately 3prca of the reinsurance receivables |
| The remaining 1prca of the reinsurance receivables was owed by six companies, none of individually were greater than dlra65cmam000 |
| The failure of reinsurers to pay amounts due to us on a timely basis or at all would adversely affect our results of operations |
| 20 _________________________________________________________________ [70]Table of Contents Failure to implement our business strategy could adversely affect our operations |
| We only write nonstandard personal automobile insurance and currently have no plans to write any other lines of insurance |
| Our current plan is to grow that business strategically to establish a broader, more geographically diversified earnings base by expanding into markets to achieve growth with diversification of risk |
| We limited our business to Florida until the fourth quarter of 2003, when we began writing nonstandard personal automobile insurance policies in Texas |
| In 2004, we began writing nonstandard personal automobile insurance policies in Arizona and Nevada and in 2005 initiated a California program with an independent managing general agency |
| We are entering the South Carolina market in 2006 |
| Our growth strategy necessarily entails increased operational risks and other challenges that are greater than and different from those to which we have previously been subject in writing nonstandard personal automobile insurance |
| These new risks and challenges include, but are not limited to, the following: • competitive conditions for our product have intensified recently, and further pressures on pricing are anticipated; • generally, new business initially produces higher loss ratios than more seasoned in-force business, and this factor is likely to be magnified to the extent that we enter multiple new states and market areas within a short period of time |
| Furthermore, it amplifies the importance of our ability to assess any new trends accurately and respond effectively; • pricing decisions in new states and markets, involving different claims environments, distribution sources and customer demographics, will be made without the same level of experience and data that is available in existing markets; • our expected growth will require additional personnel resources, including management and technical underwriting, claims and servicing personnel, relationships with agents and vendors with whom we have not previously done business, and additional dependence on operating systems and technology |
| We will face substantial challenges in maintaining adequate customer service and retaining business, particularly because of the additional complexity of operating in multiple states and time zones and managing the ongoing consolidation of some of our administrative and processing capabilities from Florida to Dallas, Texas; and • if we grow significantly or if adverse underwriting results occur, additional capital may be required, and such capital may not be available on favorable or acceptable terms |
| Our ability to maintain sufficient capital and perform successfully will be important factors in determinations of our AM Best rating, and that rating could have an adverse impact on our results of operations |
| Our ability to manage these risks and challenges will determine in large part whether our strategy for profitable growth can be implemented successfully |
| There is no assurance that we will be able to achieve the objectives of our growth strategy |
| Even if we successfully implement our business strategy, our concentration on nonstandard automobile insurance may make us more susceptible to unfavorable market conditions |
| Our success depends on our ability to underwrite risks accurately and to charge adequate rates to policyholders |
| Our financial condition, cash flows and results of operations depend on our ability to underwrite and set rates accurately for the risks we underwrite |
| Rate adequacy is necessary to generate sufficient premium to offset losses, loss adjustment expenses and underwriting expenses and to earn a profit |
| 21 _________________________________________________________________ [71]Table of Contents Our ability to price accurately is subject to a number of risks and uncertainties, including, without limitation: • the availability of sufficient reliable data; • our ability to conduct a complete and accurate analysis of available data; • our ability to recognize changes in trends in a timely manner and to project both the severity and frequency of losses with reasonable accuracy; • uncertainties inherent in estimates and assumptions, generally; • our ability to project changes in certain operating expenses with reasonable certainty; • the development, selection and application of appropriate rating formulae or other pricing methodologies; • our ability to innovate with new pricing strategies and marketing initiatives, and the success of those innovations; • our ability to predict policyholder retention accurately; • unanticipated court decisions, legislation or regulatory action; • ongoing changes in our claim settlement practices; • changing driving patterns; • unexpected changes in the medical sector of the economy; • unanticipated changes in automobile repair costs, automobile parts prices and used car prices; and • timely approval of proposed rates by regulatory agencies |
| Such risks may result in our pricing being based on stale, inadequate or inaccurate data or inappropriate analyses, assumptions or methodologies, and may cause us to estimate incorrectly future changes in the frequency or severity of claims |
| As a result, we could underprice risks, which would negatively affect our margins, or we could overprice risks, which could reduce our volume and competitiveness |
| In either event, our operating results, financial condition and cash flows could be materially adversely affected |
| Insurance agents’ improper use of authority may materially affect our business |
| As of December 31, 2005, we marketed our products and services through over 2cmam200 independent retail agents in Arizona, Florida, Nevada and Texas and one general agency in California that markets through approximately 900 independent retail agents |
| These agents have the ability to bind us with respect to insurance coverage issued on our behalf |
| Since the agents are independent, we have only limited ability to exercise control over these agents |
| In the event that an independent agent exceeds its authority by binding us on a risk that does not comply with our underwriting guidelines, we are at risk for that policy until we receive the application and effect a cancellation |
| Although we have not experienced a material loss from improper use of binding authority of our agents, improper use of such authority may result in losses that could have a material adverse effect on our business, results of operations or financial condition |
| 22 _________________________________________________________________ [72]Table of Contents Our industry is highly competitive with cyclical periods of intense price competition, which could adversely affect our results of operations |
| The property and casualty insurance industry is highly competitive and, except for regulatory considerations, there are very few barriers to entry |
| We believe that competition in our lines of business is based on price, service, commission structure, product features, financial strength ratings, reputation and name or brand recognition |
| Our competitors sell through various distribution channels, including independent agents, captive agents, and directly to the consumer |
| The agents typically represent numerous insurance companies, which compete with us |
| Some of our competitors offer a broader array of products, have more competitive pricing, or have higher claims paying ability ratings |
| Our competition includes entities which have, or are affiliated with entities that have, greater financial and other resources than our company, and they may be able to develop superior technology which would adversely affect our ability to attract or retain business |
| The property and casualty insurance industry has historically been characterized by cyclical periods of intense price competition due to excess underwriting capacity, as well as periods of shortages of underwriting capacity that allow for attractive premiums and attract additional competitors |
| The periods of intense price competition may adversely affect our operating results, and the overall cyclicality of the industry may cause fluctuations in our operating results and affect our ability to manage the business profitably |
| We are subject to comprehensive regulation, and our results may be unfavorably impacted by these regulations |
| We are subject to comprehensive governmental regulation and supervision |
| Most insurance regulations are designed to protect the interests of policyholders rather than the shareholders and other investors of the insurance companies |
| These regulations, administered by the department of insurance in each state in which we do business, relate to, among other things: • establishing mandatory minimum policy limits and coverages, • approval of policy forms, rates and rating methodologies, • standards of solvency, including risk based capital measurements developed by the NAIC and used by state insurance regulators to identify inadequately capitalized insurance companies, • licensing of insurers and their agents, • restrictions on the nature, quality and concentration of investments, • restrictions on the ability of insurance company subsidiaries to pay dividends, • restrictions on transactions between the insurance company subsidiaries and their affiliates, • requiring certain methods of accounting, • periodic examinations of operations and finances, 23 _________________________________________________________________ [73]Table of Contents • prescribing the form and content of records of financial condition to be filed, • requiring reserves for unearned premium, losses and other purposes, • sales plans and practices and commission structures, • permitted advertising, and • market conduct |
| State insurance departments also conduct periodic examinations of the affairs of insurance companies and require filing of annual and other reports relating to the financial condition of insurance companies, holding company issues and other matters |
| Insurance regulations and regulators have an impact on a number of factors that could affect our ability to respond to changes in our competitive environment and which could have a material adverse effect on our operations |
| These factors include regulating our ability to exit a book of business or to exit a state in which we have been producing insurance, our ability to receive adequate premiums to achieve acceptable profitability levels, and the amount of statutory dividends from our subsidiaries which may be needed to pay expenses and dividends |
| Prior to conducting insurance business in any states other than those states in which we currently have authorization to operate, we or our insurance subsidiaries will need to obtain a certificate of authority to conduct insurance business in such states |
| We or our insurance subsidiaries may not be able to obtain a certificate of authority in additional states, and the failure to do so would limit our ability to expand geographically |
| In addition, any changes in laws and regulations, including the adoption of consumer initiatives, regarding rates charged for automobile or other insurance coverage, sales practices or commission structures, could materially adversely affect our business, results of operations and financial condition |
| The operation of our insurance subsidiaries is an integral part of our business strategy |
| The NAIC has adopted a system of assessing the financial condition and stability of insurance companies, known as “IRIS ratios”, and a system to test the adequacy of statutory capital, known as “risk-based capital”, each of which will apply to our insurance subsidiaries |
| The IRIS ratios consist of 11 ratios that are compiled annually from an insurance company’s statutory financial reports and then compared against the NAIC established “usual range” for each ratio |
| Our insurance subsidiaries may not be able to maintain the required statutory capital levels or stay within the acceptable ranges of the IRIS ratios |
| Failure to maintain risk-based capital at the required levels or IRIS ratios within the NAIC’s usual range could adversely affect our insurance subsidiaries’ ability to secure regulatory approvals as necessary or appropriate and would materially adversely affect their general business, ability to operate and overall financial condition |
| Our business depends on compliance with applicable laws and regulations and our ability to maintain valid licenses and approvals for our operations |
| Regulatory authorities may deny or revoke licenses for various reasons, including violations of regulations |
| Changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities, could have a material adverse affect on our operations |
| State statutes limit the aggregate amount of dividends that our subsidiaries may pay us, thereby limiting our funds to pay expenses and dividends |
| 24 _________________________________________________________________ [74]Table of Contents Litigation may adversely affect our financial condition, results of operations and cash flows |
| As a property and casualty insurance company, we are subject to various claims and litigation seeking damages and penalties, based upon, among other things, payments for claims we have denied and other monetary damages |
| Some litigation against us could take the form of class action complaints by consumers |
| As automobile insurance industry practices and regulatory, judicial and consumer conditions change, unexpected and unintended issues related to claims and coverage may emerge, such as, a growing trend of plaintiffs targeting automobile insurers in purported class action litigation relating to claim-handling practices and regulatory noncompliance |
| These issues can have a negative effect on our business by either extending coverage beyond our underwriting intent or the way we are permitted to price products, limiting the factors we may consider when we underwrite risks, or by requiring us to change our claims handling procedures or our practices for charging fees, or by increasing the size of claims or resulting in other monetary damages |
| The relief requested by the plaintiffs varies but may include requests for compensatory, statutory and punitive damages |
| The Company and certain of our directors and executive officers are named as defendants in a putative class action proceeding pending in the United States District Court for the Northern District of Texas, Fort Worth Division |
| In the proceeding, which is a consolidation of two previously pending actions involving essentially the same facts and claims, the plaintiffs allege violations of the Federal securities laws in connection with alleged non-disclosures and deceptive disclosures in our press releases and filings with the Securities and Exchange Commission regarding our acquisition, operation and divestiture of our former Tri-State, Ltd |
| subsidiary, a South Dakota company selling nonstandard personal automobile insurance |
| The second amended complaint does not specify the amount of damages the plaintiffs seek |
| The Office of the New York Attorney General and other state attorneys general are investigating certain insurance industry practices |
| The New York Attorney General has filed a lawsuit against Marsh & McLennan Companies, Inc |
| and, in so doing, named various insurance companies who may have had involvement in the insurance industry practices in question |
| The investigations appear to center around practices by which other insurance companies paid contingent compensation to insurance brokers based on the volume or profitability of the insurance placed with the insurance company for their clients, allegedly in violation of the brokers’ duty to act in the best interest of their clients rather than their own undisclosed pecuniary interest |
| We were not named in this lawsuit; however, we may become involved at some point in the future |
| The expenses and other effects of our potential involvement in this litigation on our business, financial condition and results of operations cannot be predicted and may be material |
| Several of our competitors are named as defendants in a number of putative class action and other lawsuits challenging various aspects of their insurance business operations |
| These lawsuits include cases alleging damages as a result of the use of after-market parts; total loss evaluation methodology; the use of credit in underwriting and related requirements under the federal Fair Credit Reporting Act; the methods used for evaluating and paying certain bodily injury, personal injury protection and medical payment claims; and policy implementation and renewal procedures, among other matters |
| Litigation may be filed against us and/or our subsidiaries or disputes may arise in the future concerning these or other business practices |
| From time to time, we also may be involved in such litigation or other disputes alleging that our business practices violate the patent, trademark or other intellectual property rights of third parties |
| In addition, lawsuits have been filed, and other lawsuits may be filed in the future, against our competitors and other businesses, and although we are not a party to such litigation, the results of those cases may create additional risks for, and/or impose additional costs and/or limitations on, our subsidiaries’ business operations |
| Lawsuits against us often seek significant monetary damages |
| Moreover, as courts resolve individual or class action litigation in insurance or related fields, a new layer of court-imposed regulation could emerge, resulting in material increases in our costs of doing business |
| Such litigation is inherently unpredictable |
| Except to the extent we have established reserves with respect to particular lawsuits that are currently pending against us, we are unable to predict the effect, if any, that these pending or future lawsuits may have on the business, operations, profitability or financial condition |
| 25 _________________________________________________________________ [75]Table of Contents An adverse resolution of the litigation pending or threatened against us could have a material adverse effect on our financial condition, results of operations or cash flows |
| The insurance and related businesses in which we operate may be subject to periodic negative publicity, which may negatively impact our financial condition |
| The nature of the market for our nonstandard automobile insurance and related products and services we provide is that we interface with and distribute our products and services ultimately to individual consumers |
| There may be a perception that 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 periodic negative publicity |
| We may also be negatively impacted if another company engages in practices resulting in increased public attention to our businesses |
| Negative publicity may result in increased regulation and legislative scrutiny of industry practices as well as increased litigation, which may further 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 |
| Because we are primarily a personal automobile insurer, our business may be adversely affected by conditions in that industry |
| Our results of operations may be adversely affected by competitive, regulatory or economic conditions that influence the automobile insurance industry in general |
| The profitability of companies operating in the nonstandard personal automobile insurance business lines is also affected by fluctuations in loss cost trends |
| Driving patterns, inflation in the cost of automobile repairs and medical care, and increasing litigation of liability claims are some of the more important factors that affect loss cost trends |
| We and other nonstandard automobile insurers are generally unable to increase premiums unless permitted by regulators, typically after the costs associated with the coverage have increased |
| Accordingly, profit margins generally decline in a period of increasing loss costs |
| We may be unable to continue our growth or we may need additional capital to execute our business plan if our margins decline during a business phase characterized by intense competition and declining premiums |
| Catastrophic losses could have a material, adverse effect on our business |
| Catastrophic losses could occur either as a result of insurance claims or because of interruption in our ability to conduct business efficiently |
| Property and casualty insurance companies are subject to claims arising from natural and man-made catastrophes that may have a significant impact on their business, results of operations and financial condition |
| Catastrophic losses can be caused by a wide variety of events, including hurricanes, tropical storms, tornadoes, wind, hail, fires, riots, terrorism and explosions, and their incidence and severity are inherently unpredictable |
| The extent of losses from a catastrophe is a function of two factors: the total amount of an insurance company’s exposure in the area affected by the event and the severity of the event |
| Our policyholders are currently concentrated in geographic areas that are periodically subject to adverse weather and other conditions |
| Accordingly, the occurrence of a catastrophe in the states in which we operate or in which we may operate in the future could have a material adverse effect on our business, results of operations and financial condition |
| Separately, a catastrophic interruption of our technology systems could disrupt our operations or prevent us from providing acceptable customer service or managing other aspects of our business effectively |
| 26 _________________________________________________________________ [76]Table of Contents Estimating reserves accurately is an inherently uncertain process, and if our loss reserves are not adequate, it will have an unfavorable impact on our results |
| We maintain loss reserves to cover estimated liabilities for unpaid losses and loss adjustment expenses for reported and unreported claims incurred as of the end of each accounting period |
| Reserves represent management’s best estimates of what the ultimate settlement and administration of claims will cost and are subject to uncertainties, including the following considerations: • estimates of loss and loss expense liabilities are subject to large potential errors of estimation as the ultimate disposition of claims incurred prior to the financial statement date, whether reported or not, is subject to the outcome of events that have not yet occurred, such as jury decisions, court interpretations, legislative changes, subsequent damage to property, changes in the medical condition of claimants, public attitudes and social and economic conditions such as inflation, • estimates of losses do not make provision for extraordinary future emergence of new classes of losses or types of losses not sufficiently represented in our historical data base or which are not yet quantifiable, and • estimates of future costs are subject to the inherent limitation on the ability to predict the aggregate course of future events |
| These estimates, which generally involve actuarial projections, are based on assessments of facts and circumstances then known, as well as estimates of future trends in claim severity, frequency, judicial theories of liability, and other factors |
| As a result, these reserves do not represent an exact calculation of liability |
| These variables are affected by both internal and external events, such as changes in claim handling procedures, inflation, judicial trends and legislative changes |
| Our independent actuary has indicated that there are significant risks and uncertainties that could result in material adverse deviation of our unpaid claim and claim adjustment expenses |
| Furthermore, our expansion into new markets and states may increase the risk that our reserves do not accurately reflect the ultimate losses that will occur in those markets and states |
| Additionally, there may be a significant reporting lag between the occurrence of an event and the time it is reported to us |
| The inherent uncertainties of estimating reserves are greater for certain types of liabilities, particularly those in which the various considerations affecting the type of claim are subject to change and in which long periods of time may elapse before a definitive determination of liability is made |
| Reserve estimates are continually refined in a regular and ongoing process as experience develops and further claims are reported and settled |
| Adjustments to reserves are reflected in the results of the periods in which such estimates are changed |
| Ultimate claim and claim adjustment expenses may vary from the established reserves |
| Furthermore, factors such as future inflation, claims settlement patterns, legislative activity and litigation trends, all of which are difficult to predict, may have a substantial impact on our loss experience |
| Because settling reserves is an inherently uncertain process, we cannot assure that the current reserves will prove adequate |
| An increase in the reserves results in a reduction in or elimination of our net income for the period in which the deficiency in reserves is identified |
| Accordingly, an increase in reserves could have a material adverse effect on our results of operations, liquidity and financial condition |
| 27 _________________________________________________________________ [77]Table of Contents A downgrade in our financial strength ratings may negatively affect our business |
| Financial strength ratings are an important factor in establishing the competitive position of insurance companies and may be expected to have an effect on an insurance company’s sales |
| An insurance company’s ability to effectively compete in the marketplace is in part dependent upon the rating determination of AM Best, the principal rating agency of the insurance industry |
| AM Best provides ratings of insurance companies based on comprehensive quantitative and qualitative evaluations and expresses its rating as an opinion of an insurer’s ability to meet its obligations to policyholders |
| Since October 2005, the AM Best rating of our insurance subsidiaries has been “B” (Fair) with a stable outlook |
| AM Best assigns “B” and “B-” ratings to companies that have, in the opinion of AM Best, a fair ability to meet their current obligations to policyholders, but are financially vulnerable to adverse changes in underwriting and economic conditions |
| If we do not successfully implement our business plan, if the risks we describe in this prospectus materially and adversely affect our results or our financial position or if our written premiums exceed levels deemed prudent by AM Best, we would face the risk of a downgrade by AM Best |
| A downgrade in our rating may cause our independent agents to limit or stop their marketing of our products and may limit that availability or adversely affect the terms of capital sources to us |
| We may need to raise additional capital |
| We anticipate that we will need additional capital to continue expanding our business |
| There can be no assurance that we will be able to raise sufficient additional capital or to raise such capital on acceptable terms |
| If we are unable to obtain required capital on terms favorable to us, or at all, we may be forced to change our business plan and may be unable to respond to competitive pressures in our business |
| Even if we are able to raise additional capital through the issuance of equity or debt securities, those securities may have rights, preferences or privileges senior to the rights of existing investors |
| In addition, if we raise capital through senior credit facilities, we would experience risks typically associated with credit borrowings, such as risks of defaults that we are unable to cure, enforcement of any liens or other security interests we may grant and restrictions on our operations, including those that might be required to comply with any financial and non-financial covenants |
| A change in immigration policies could adversely affect our growth |
| We believe that a majority of our current and potential customers are Hispanic, and a key element of our growth strategy involves our continued focus on marketing our nonstandard automobile insurance in this market niche |
| An important element to this strategy is our belief that a growing percentage of potential customers for personal nonstandard automobile insurance are Hispanic |
| In recent years, there have been a variety of legislative proposals to limit immigration to the United States |
| If one or more proposals were to be adopted and had the effect of curtailing such immigration, this would result in decline in growth of the Hispanic market, which may have an adverse effect on our abilities to achieve our growth strategies and our ability to expand our business in the markets in which we currently operate and may operate in the future |
| The performance of our portfolio of fixed-income and equity securities may affect our profitability, capitalization and financial performance |
| We maintain an investment portfolio that currently consists primarily of fixed-income securities |
| The quality and yield of the portfolio may be affected by a number of factors, including the general economic and business environment, changes in the credit quality of the issuer of the fixed-income securities, changes in market conditions, changes in interest rates, or regulatory changes |
| These securities are issued by both domestic and foreign entities and are backed either by collateral or the credit of the underlying issuer |
| Factors such as an economic downturn or political change in the country of the issuer, a regulatory change pertaining to the issuer’s industry, a deterioration in the cash flows or the quality of assets of the issuer, or a change in the issuer’s marketplace may adversely affect our ability to collect principal and interest from the issuer |
| 28 _________________________________________________________________ [78]Table of Contents Both equity and fixed income securities have been impacted over the past several years, and may be impacted in the future, by large man-made and natural disasters and corporate events |
| Examples of such events would include the September 2001 terrorist attacks, hurricanes, corporate accounting scandals, mergers, and LBO transactions |
| Credit rating downgrades, defaults, and impairments may result in write-downs in the value of the fixed income securities held by the Company |
| As of December 31, 2005, we held dlra56dtta3 million of fixed income securities, dlra3dtta6 million of which were rated below BBB based on Standard & Poor’s credit ratings |
| The investments our insurance company subsidiaries hold are highly regulated by specific legislation in Oklahoma and Texas that governs the type, amount, and credit quality of allowable investments, and the fixed income securities in which we invest are evaluated by the NAIC’s Security Valuation Office (the “SVO”) |
| Legislative changes or changes in the SVO’s evaluations could force us to adjust investment carrying values, with a resulting adverse effect on the level of our statutory capital |
| We may use derivative instruments that are hedging in nature in order to manage our interest rate and equity market risk |
| Although we take precautions to minimize our exposure, our profitability may be adversely affected if a counterparty to the derivative instrument defaults in its payment |
| Our success depends on retaining our current key personnel and attracting additional personnel Our success will depend largely on the continuing efforts of our executive officers and senior management, especially those of Robert W Stallings, our Chairman of the Board and Chief Strategic Officer, Glenn W Anderson, our President, Chief Executive Officer and Director and James R Reis, our Executive Vice President |
| Our business may be adversely affected if the services of these officers or any of our other key personnel become unavailable to us |
| We have entered into employment agreements with Messrs |
| Stallings, Anderson and Reis |
| Even with these employment agreements, there is a risk that these individuals will not continue to serve for any particular period of time |
| In addition, we have recently hired a number of key employees, each of whom has been with us for less than one year |
| In addition, we intend to endeavor to hire additional key employees and officers to support our business growth, our focus on the nonstandard personal automobile insurance business, our expansion into new geographic markets and the improvement and enhancement of our systems and technologies |
| To integrate into our company, these individuals must spend a significant amount of time learning our business model and management systems, in addition to performing their regular duties |
| If we fail to complete this integration in an efficient manner, our business and prospects will suffer |
| Hiring management personnel is very competitive in our industry due to the limited number of people available with the necessary skills, experience and understanding of our business procedures and the necessary leadership ability to guide us through the strategic development initiatives contemplated in the immediate years ahead |
| In November 2005, we adopted a new long-term focused system of performance-based equity compensation for key personnel |
| Pursuant to such plan, the Compensation Committee, all of whose members are independent, is authorized to offer performance-based incentive grants and potentially issue up to 10prca of our outstanding common stock over time based on achievement of performance targets |
| Our inability to attract, train or retain the number of highly qualified personnel that our business needs may cause our business and prospects to suffer |
| Certain of our executives and directors own a majority of our outstanding capital stock, and therefore exercise voting control over the Company |
| Our executive officers and directors, together with our largest shareholder, beneficially own a majority of our outstanding common stock (71dtta2prca as of December 31, 2005), they potentially have the power to control the actions of the Company with respect to items requiring shareholder approval, including the election of directors, the adoption of amendments to our articles of incorporation and bylaws, and the approval of mergers or other significant corporate transactions |
| Their interests in approving such actions might not be aligned with the interests of other owners of our common stock |
| 29 _________________________________________________________________ [79]Table of Contents We cannot be certain that the net operating loss tax carryforwards will continue to be available to offset our tax liability |
| As of December 31, 2005, we had net operating loss tax carryforwards for Federal income tax purposes, which we refer to as “NOLs,” of approximately dlra68dtta8 million |
| In order to utilize the NOLs, we must generate taxable income which can offset such carryforwards |
| The availability of NOLs to offset taxable income would be substantially reduced if we were to undergo an “ownership change” within the meaning of Section 382(g)(1) of the Internal Revenue Code |
| We will be treated as having had an “ownership change” if there is more than a 50prca change in stock ownership during a three year “testing period” by “5prca stockholders” |
| The NOLs will expire in various amounts, if not used, between 2020 and 2023 |
| We cannot assure you that we would prevail if the IRS were to challenge the availability of the NOLs |
| If the IRS was successful in challenging our NOLs, all or some portion of the NOLs would not be available to offset our future consolidated income |
| Our stock price may be volatile |
| The market price of our common stock has fluctuated significantly in the past and is likely to fluctuate significantly in the future |
| In addition, the securities markets have experienced significant price and volume fluctuations and the market prices of the securities of insurance companies, including nonstandard automobile insurance companies, have been especially volatile |
| Such fluctuations can result from, among other things: • quarterly variations in operating results; • changes in market valuations of other similar companies; • announcements by us or our competitors of new products, contracts, acquisitions, strategic partnerships or joint ventures; • additions or departures of key personnel; • significant sales of common stock or the perception that such sales could occur; • general economic trends and conditions; • deterioration in the trading market for our common stock; and • future issuances of stock or debt securities to fund our anticipated growth |
| In addition, the stock market has recently experienced extreme volatility that has often been unrelated to the performance of particular companies |
| These market fluctuations may cause our stock price to fall and could negatively affect an investment in the Company’s common stock regardless of our performance |
| In the past, companies that have experienced volatility in the market price of their stock, including us, have been the object of securities class action litigation |
| Securities class action litigation could result in substantial costs and a diversion of management’s attention and resources |