| MEADOWBROOK INSURANCE GROUP INC Item 1A Risk Factors If our reserves for losses and loss adjustment expenses are not adequate, we will have to increase our reserves, which would result in reductions in net income, retained earnings, and statutory surplus, along with ability to pay dividends |
| We establish reserves for losses and expenses related to the adjustment of losses under the insurance policies we write |
| We determine the amount of these reserves based on our best estimate and judgment of the losses and costs we will incur on existing insurance policies |
| Our Insurance Company Subsidiaries obtain an annual statement of opinion from an independent actuary firm on these reserves |
| While we believe that our reserves are adequate, we base these reserves on assumptions about past and future events |
| The following factors could have a substantial impact on our future loss experience: • the amounts of claims settlements and awards; • legislative activity; and • changes in inflation and economic conditions |
| Actual losses and the costs we incur related to the adjustment of losses under insurance policies may be different from the amount of reserves we establish |
| When we increase reserves, our net income for the period will decrease by a corresponding amount |
| Our performance is dependent on the continued services and performance of our senior management and other key personnel |
| The success of our business is dependent on our ability to retain and motivate our senior management and key management personnel |
| The loss of the services of any of our executive officers or other key employees could have a material adverse effect on our business, financial condition, and results of operations |
| We have existing employment agreements with some of our executive officers |
| We maintain “key person” life insurance policies on our key personnel |
| Our future success also will depend on our ability to attract, train, motivate and retain other highly skilled technical, managerial, marketing, and customer service personnel |
| Competition for these employees is intense and we may not be able to successfully attract, integrate or retain sufficiently qualified personnel |
| In addition, our future success depends on our ability to attract, retain and motivate our agents |
| Our failure to attract and retain the necessary personnel and agents could have a material adverse effect on our business, financial condition, and results of operations |
| If market conditions cause our reinsurance to be more costly or unavailable, we may be required to bear increased risks or reduce the level of our underwriting commitments |
| As part of our overall risk and capacity management strategy, we purchase reinsurance for significant amounts of risk underwritten by our Insurance Company Subsidiaries, especially for the excess-of-loss and severity risks |
| Market conditions beyond our control determine the availability and cost of the reinsurance we purchase, which may affect the level of our business and profitability |
| Our reinsurance facilities are generally subject to annual renewal |
| We may be unable to maintain our current reinsurance facilities or to obtain other reinsurance in adequate amounts and at favorable rates |
| If we are unable to renew our expiring facilities or to obtain new reinsurance, either our net exposure to risk would increase or, if we are unwilling to bear an increase in net risk exposures, we would have to reduce the amount of risk we underwrite |
| 17 _________________________________________________________________ MEADOWBROOK INSURANCE GROUP, INC We cannot guarantee that our reinsurers will pay in a timely fashion, if at all, and, as a result, we could experience losses |
| We transfer some of the risk we have assumed to reinsurance companies in exchange for a portion of the premium we receive in connection with the risk |
| Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred, it does not relieve us of our original liability to the policyholders |
| Our reinsurers may not pay the reinsurance recoverables they owe us or they may not pay on a timely basis |
| If our reinsurers fail to pay us or fail to pay us on a timely basis, our financial results could be adversely affected |
| Our results may fluctuate as a result of many factors, including cyclical changes in the insurance industry |
| The results of companies in the property and casualty insurance industry historically have been subject to significant fluctuations and uncertainties |
| Our industry’s profitability can be affected by: • rising levels of actual costs that are not known by companies at the time they price their products; • volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes or terrorist attacks; • changes in loss reserves resulting from the general claims and legal environments as different types of claims arise and judicial interpretations relating to the scope of insurer’s liability develop; • fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect returns on invested assets and may impact the ultimate payout of losses; and • increase in medical costs beyond historic or expected annual inflationary levels |
| The demand for property and casualty insurance can also vary significantly, rising as the overall level of economic activity increases and falling as that activity decreases |
| The property and casualty insurance industry historically is cyclical in nature |
| These fluctuations in demand and competition could produce underwriting results that would have a negative impact on our financial condition and results of operations |
| We face competitive pressures in our business that could cause demand for our products to fall and adversely affect our profitability |
| We compete with a large number of other companies in our selected lines of business |
| We compete, and will continue to compete, with major United States, foreign, and other regional insurers, as well as mutual companies, specialty insurance companies, underwriting agencies, and diversified financial services companies |
| Many of our competitors have greater financial and marketing resources than we do |
| Our profitability could be adversely affected if we lose business to competitors offering similar or better products at or below our prices |
| In addition, a number of new, proposed or potential legislative or industry developments could further increase competition in our industry |
| New competition from these developments could cause the demand for our products to fall, which could adversely affect our profitability |
| A number of new, proposed or potential legislative or industry developments could further increase competition in our industry |
| These developments include: • the formation of new insurers and an influx of new capital in the marketplace as existing companies attempt to expand their business as a result of better pricing and/or terms; • programs in which state-sponsored entities provide property insurance in catastrophe-prone areas or other alternative market types of coverage; and • changing practices created by the internet, which has increased competition within the insurance business |
| 18 _________________________________________________________________ MEADOWBROOK INSURANCE GROUP, INC These developments could make the property and casualty insurance marketplace more competitive by increasing the supply of insurance capacity |
| In that event, recent favorable industry trends could be reversed and may negatively influence our ability to maintain or increase rates |
| Accordingly, these developments could have an adverse effect on our business, financial condition and results of operations |
| Because we are heavily regulated by the states in which we operate, we may be limited in the way we operate |
| We are subject to extensive supervision and regulation in the states in which we operate |
| The supervision and regulation relate to numerous aspects of our business and financial condition |
| The primary purpose of the supervision and regulation is to maintain compliance with insurance regulations, protect policyholders and not our shareholders |
| The extent of regulation varies, but generally is governed by state statutes |
| These statutes delegate regulatory, supervisory and administrative authority to state insurance departments |
| This system of regulation covers, among other things: • standards of solvency, including risk-based capital measurements; • restrictions on the nature, quality and concentration of investments; • restrictions on the types of terms that we can include in the insurance policies we offer; • required methods of accounting; • reserves for unearned premiums, losses and other purposes; and • potential assessments for the provision of funds necessary for the settlement of covered claims under certain insurance policies provided by impaired, insolvent or failed insurance companies |
| The regulations of the state insurance departments may affect the cost or demand for our products and may impede us from obtaining rate increases or taking other actions we might wish to take to increase our profitability |
| Furthermore, 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 authority’s interpretation of the laws and regulations |
| Also, 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 stop or temporarily suspend us from conducting some or all of our activities or monetarily penalize us |
| We could be forced to sell investments to meet our liquidity requirements |
| We believe that we maintain adequate amounts of cash and short-term investments to pay claims, and do not expect to have to sell securities prematurely for such purposes |
| We may, however, decide to sell securities as a result of changes in interest rates, credit quality, the rate or repayment or other similar factors |
| A significant increase in market interest rates could result in a situation in which we are required to sell securities at depressed prices to fund payments to our insureds |
| Since we carry debt securities at fair value, we expect these securities would be sold with no material impact on our net equity, although it could result in net realized losses |
| If these securities are sold, future net investment income may be reduced if we are unable to reinvest in securities with similar yields |
| Because our investment portfolio consists primarily of fixed income securities, our investment income could suffer as a result of fluctuations in interest rates |
| We currently maintain and intend to continue to maintain an investment portfolio consisting primarily of fixed income securities |
| The fair value of these securities fluctuates depending on changes in interest rates |
| Generally, the fair market value of these investments increases or decreases in an inverse relationship with changes in interest rates, while net investment income earned by us from future investments in fixed income securities will generally increase or decrease with interest rates |
| Changes in interest rates may result in 19 _________________________________________________________________ MEADOWBROOK INSURANCE GROUP, INC fluctuations in the income derived from, and the valuation of, our fixed income investments, which could have an adverse effect on our financial condition and results of operations |
| We are subject to credit risk with respect to the obligations of our reinsurers and the payment of claims by our clients’ captive, rent-a-captive, large deductible programs, indemnification agreements, or on the portion of risk either ceded to the captives, or retained by our clients |
| The inability of our risk-sharing partners to meet their obligations could adversely affect our profitability |
| Our Insurance Company Subsidiaries cede insurance to other insurers under pro rata and excess-of-loss contracts |
| These reinsurance arrangements diversify our business and minimize our exposure to large losses or from hazards of an unusual nature |
| The ceding of insurance does not discharge the original insurer from its primary liability to its policyholder |
| If all or any of the reinsuring companies are unable to meet their obligations, we would be liable for such defaulted amounts |
| Therefore, we are subject to a credit risk with respect to the obligations of our reinsurers |
| In order to minimize our exposure to significant losses from reinsurer insolvencies, we evaluate the financial condition of our reinsurers and monitor the economic characteristics of the reinsurers on an ongoing basis |
| In addition, with our risk-sharing programs, we are subject to credit risk with respect to the payment of claims by our clients’ captive, rent-a-captive, large deductible programs, indemnification agreements, or on the portion of risk either ceded to the captives, or retained by our clients |
| The capitalization and credit worthiness of prospective risk-sharing partners is one of the factors we consider upon entering into and renewing risk-sharing programs |
| Generally, we collateralize balances due from our risk-sharing partners through funds withheld trusts or stand-by letters of credit issued by highly rated banks |
| To date, we have not, in the aggregate, experienced material difficulties in collecting balances from our risk-sharing partners |
| No assurance can be given, however, regarding the future ability of any of our risk-sharing partners to meet their obligations |
| The inability of our risk-sharing partners to meet their obligations could adversely affect our profitability |
| Provisions of the Michigan Business Corporation Act, our articles of incorporation and other corporate governing documents and the insurance laws of Michigan, Missouri, California, and Florida may discourage takeover attempts |
| The Michigan Business Corporation Act contains “anti-takeover” provisions |
| Chapter 7A and 7B of the Business Corporation Act apply to us and may have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a shareholder might consider in their best interest, including those attempts that might result in shareholders receiving a premium over market price for their shares |
| Our articles of incorporation allow the Board of Directors to issue one or more classes or series of preferred stock with voting rights, preferences and other privileges as the Board of Directors may determine |
| Also, we have adopted a shareholder rights plan which if triggered would significantly dilute the stock ownership percentage of anyone who acquires more than fifteen percent of our shares without the approval of our Board of Directors |
| The existence of our shareholder rights plan and the possible issuance of preferred shares could adversely affect the holders of our common stock and could prevent, delay or defer a change of control |
| We are also subject to the laws of various states, such as Michigan, Missouri, California, and Florida, governing insurance holding companies |
| Under these laws, a person generally must obtain the applicable Insurance Department’s approval to acquire, directly or indirectly, five to ten percent or more of the outstanding voting securities of our Insurance Company Subsidiaries |
| An Insurance Department’s determination of whether to approve an acquisition would be based on a variety of factors, including an evaluation of the acquiror’s financial stability, the competence of its management, and whether competition in that state would be reduced |
| These laws may prevent, delay or defer a change of control of us or our Insurance Company Subsidiaries |
| 20 _________________________________________________________________ MEADOWBROOK INSURANCE GROUP, INC If our financial strength ratings are reduced, we may be adversely impacted |
| Insurance companies are subject to financial strength ratings produced by external rating agencies |
| Higher ratings generally indicate greater financial stability and a stronger ability to pay claims |
| Ratings are assigned by rating agencies to insurers based upon factors they believe are important to policyholders |
| Ratings are not recommendations to buy, hold, or sell our securities |
| Our ability to write business is most influenced by our rating from AM Best |
| AM Best ratings are designed to assess an insurer’s financial strength and ability to meet continuing obligations to policyholders |
| Currently, our rating from AM Best is B++ (Very Good) for Star Insurance Company, Savers Property and Casualty Insurance Company, and Williamsburg National Insurance Company |
| The AM Best rating for Ameritrust Insurance Corporation is B+ (Very Good), with a positive outlook |
| We believe as a result of our improved balance sheet and operating performance our rating will remain at least at its current level, if not at an upgraded level |
| A rating downgrade from AM Best could materially adversely affect the business we write and our results of operations |
| Most states assess our Insurance Company Subsidiaries to provide funds for failing insurance companies and those assessments could be material |
| Our Insurance Company Subsidiaries are subject to assessments in most states where we are licensed for the provision of funds necessary for the settlement of covered claims under certain policies provided by impaired, insolvent or failed insurance companies |
| Maximum contributions required by law in any one year vary by state, and have historically been less than 1prca of annual premiums written |
| We cannot predict with certainty the amount of future assessments |
| Significant assessments could have a material adverse effect on our financial condition and results of operations |
| We rely on our information technology and telecommunications systems to conduct our business |
| Our business is dependent upon the uninterrupted functioning of our information technology and telecommunication systems |
| We rely upon our systems, as well as the systems of our vendors to underwrite and process our business, make claim payments, provide customer service, provide policy administration services, such as, endorsements, cancellations and premium collections, comply with insurance regulatory requirements and perform actuarial and other analytical functions necessary for pricing and product development |
| Our operations are dependent upon our ability to timely and efficiently process our business and protect our information and telecommunications systems from physical loss, telecommunications failure or other similar catastrophic events, as well as from security breaches |
| While we have implemented business contingency plans and other reasonable and appropriate internal controls to protect our systems from interruption, loss or security breaches, a sustained business interruption or system failure could adversely impact our ability to process our business, provide customer service, pay claims in a timely manner or perform other necessary business functions |
| Likewise, a security breach of our computer systems could also interrupt or damage our operations or harm our reputation in the event confidential customer information is disclosed to third-parties |
| Either of these circumstances could have a material adverse effect upon our financial condition, operations or reputation |