| MIDLAND CO ITEM 1A Risk Factors |
| If any of the following risks actually occur, our business, financial condition or results of operations could be materially and adversely affected |
| The risks and uncertainties described below are not the only ones we may face |
| Additional risks and uncertainties presently not known to us or that we currently believe to be immaterial may also harm our business |
| We could incur substantial losses from catastrophes and weather-related events American Modern, like other property and casualty insurers, has experienced, and will experience in the future, catastrophe losses, which may materially reduce our financial results and harm our financial condition |
| Catastrophes can be caused by various natural events, including hurricanes, windstorms, tornadoes, floods, earthquakes, hail, severe winter weather and fires |
| The incidence and severity of catastrophes are inherently unpredictable |
| Hurricanes and earthquakes may produce significant damage in large areas, especially those that are heavily populated |
| In 2005, approximately 50dtta0prca of American Modern’s gross property and casualty written premium was derived from the southeastern United States, Oklahoma and Texas |
| Because of this concentration of business, American Modern may be more exposed to hurricanes, tornadoes, floods and other weather-related losses than some of its competitors |
| A single large catastrophe loss, a number of small or large catastrophe losses in a short amount of time or losses from a series of storms or other events that do not constitute a catastrophic event under American Modern’s reinsurance treaties, could have a material adverse effect on our financial condition or results and could result in substantial outflows of cash as losses are paid |
| American Modern’s ability 7 ______________________________________________________________________ [8]Table of Contents to write new business could also be affected should such an event result in a material reduction in our statutory surplus |
| Increases in the value and geographic concentration of insured property and the effects of inflation could increase the severity of claims from catastrophic events in the future |
| These factors can contribute to significant quarter-to-quarter and year-to-year fluctuations in the underwriting results of American Modern and our net earnings |
| Because of the possibility of these fluctuations in underwriting results, historical periodic results of operations may not be indicative of future results of operations |
| Periodic fluctuations in our operating results could adversely affect the market price of our common stock |
| Our results may fluctuate as a result of many factors, including cyclical changes in the insurance industry and general economic conditions The results of companies in the property and casualty insurance industry historically have been subject to significant fluctuations and uncertainties |
| Rates for property and casualty insurance are influenced primarily by factors that are outside of our control, including market and competitive conditions and regulatory issues |
| Our profitability can be affected significantly by: • downturns in the economy, which historically result in an increase in the fire loss ratio; • higher actual costs that are not known to American Modern at the time it prices its products; • volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes; • any significant decrease in the rates for property and casualty insurance in the segments American Modern serves or its inability to maintain or increase such rates; • changes in loss reserves resulting from the legal environment in which American Modern operates as different types of claims arise and judicial interpretations relating to the scope of the insurer’s liability develop; and • fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect our return on invested assets |
| 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 |
| Due to the concentration of American Modern’s business in the southeastern United States, Oklahoma and Texas, changes in the general economy, regulatory environment and other factors specifically affecting that region could adversely affect our financial conditions and results |
| The property and casualty insurance industry historically is cyclical in nature |
| These fluctuations in demand and competition could produce underwriting results that could harm our financial condition or results |
| The specialty insurance industry is highly competitive and will require significant technology expenditures The specialty insurance lines offered by American Modern are highly competitive |
| American Modern competes with national and regional insurers, many of whom have greater financial and marketing resources than American Modern |
| The types of insurance coverage that American Modern sells are often a relatively small portion of the business sold by some of American Modern’s competitors |
| Also, other financial institutions, such as banks and brokerage firms, are now able to offer services similar to those offered by American Modern as a result of the Gramm-Leach-Bliley Act, which was enacted in November 1999 |
| New competition from these developments could harm our financial condition or results |
| Many of our competitors are better capitalized than we are and may be able to withstand significant reductions in their profit margins to capture market share |
| If our competitors decide to target American Modern’s customer base with lower-priced insurance, American Modern may decide not to respond competitively, which could result in reduced premium volume |
| 8 ______________________________________________________________________ [9]Table of Contents Changing practices caused by the Internet have led to greater competition in the insurance industry |
| In response, American Modern has invested substantially in the development of modernLINK™, an enterprise-wide computer network that is being developed in stages and is intended to connect American Modern’s internal systems directly to its sales and distribution channel partners as well as policyholders over the Internet |
| The cost of this system is significant and its development and installation will decrease operating profits in the short term |
| This system is in development and its effectiveness has not been proven |
| Significant changes to the technology interface between American Modern and its distribution channel participants and policyholders could significantly disrupt or alter its distribution channel relationships |
| Disruptions to our information technology systems could also occur periodically during the installation of the modernLINK™ system and adversely affect our business |
| Our results are significantly affected by conditions in the manufactured housing industry Level of Manufactured Housing Sales A significant number of the insurance policies American Modern issues each year are written in conjunction with the sale of new manufactured homes |
| A significant or prolonged downturn in the level of new manufactured housing sales, such as the one which this industry is currently experiencing, could cause a decline in American Modern’s premium volume and income, which could harm our financial condition or results |
| The market for manufactured housing is affected by many factors, including general economic conditions, interest rate levels, the availability of credit and government regulations |
| In the current economic environment, lenders have reduced the amount of credit available for manufactured housing purchases |
| This trend could result in a significant decrease in manufactured housing premium volume for American Modern |
| Reduction of Chattel Financing Manufactured housing sales have traditionally been financed as personal property through a financing transaction referred to as chattel financing |
| The manufactured housing industry has experienced a substantial reduction in the number of lenders providing chattel or other personal property financing for manufactured housing in recent years |
| This reduction has resulted in a trend toward traditional mortgage financing for manufactured housing units |
| Because chattel lenders are an important channel of distribution for American Modern, this trend could harm our financial condition or results |
| American Modern has historically had strong relationships with the major chattel financing sources |
| To the extent that the manufactured housing lending market moves away from chattel financing to traditional mortgage financing, American Modern may not be able to replace lost premium volume |
| Our motorcycle product has not experienced consistent profitable underwriting results Over the last several years American Modern has experienced underwriting losses related to its motorcycle product |
| During this time, we implemented changes to the motorcycle product, including rate increases and more stringent underwriting parameters |
| However, it is uncertain if this line of business will produce a consistent underwriting profit |
| To the extent that rating and underwriting actions are insufficient, we could experience results that could harm our financial results |
| American Modern’s insurance ratings may be downgraded, which would reduce its ability to compete and sell insurance products Insurance companies are rated by established insurance rating agencies based on the rating agencies’ opinions of the company’s ability to pay claims and on the company’s financial strength |
| Ratings have become an increasingly important factor in establishing the competitive position of insurance companies |
| Ratings are based upon factors relevant to policyholders and are not designed to protect shareholders |
| Rating agencies periodically review their ratings |
| There can be no assurance that current ratings will be maintained in the future |
| Most recently, AM Best has given a group rating of “A+ (Superior)” to American Modern’s property and casualty insurance subsidiaries and has given a rating of “A- (Excellent)” to American Modern’s credit life insurance companies |
| In particular, financial institutions, including banks and credit unions, are sensitive to ratings and may discontinue using an insurance company if the insurance company is downgraded |
| A downgrade in American Modern’s insurance rating could also have a negative impact on its ability to obtain favorable reinsurance rates and terms |
| Downgrades in the ratings of American Modern’s insurance company subsidiaries could harm our financial condition or results |
| 9 ______________________________________________________________________ [10]Table of Contents American Modern may be unable to reinsure insurance risks and cannot guarantee that American Modern’s reinsurers will pay claims on a timely basis, if at all American Modern uses reinsurance to attempt to limit the risks, especially catastrophe risks, associated with its insurance products |
| The availability and cost of reinsurance are subject to prevailing market conditions and trends |
| Poor conditions in the reinsurance market could cause American Modern to reduce its volume of business and impact its profitability |
| American Modern’s reinsurance treaties are generally subject to annual renewal |
| American Modern may be unable to maintain its current reinsurance treaties or to obtain other reinsurance treaties in adequate amounts and at favorable rates and terms |
| Recently, the property and casualty industry has experienced significant increases in reinsurance rates |
| If American Modern is unable or unwilling to renew its expiring treaties or to obtain new reinsurance treaties, either its net exposure to risk would increase or, if American Modern is unwilling to bear an increase in net risk exposures, American Modern would have to reduce the amount of risk it underwrites |
| Although the reinsurer is liable to American Modern to the extent of the ceded reinsurance, American Modern remains liable as the direct insurer on all risks reinsured |
| As a result, ceded reinsurance arrangements do not eliminate American Modern’s obligation to pay claims |
| Although we record an asset for the amount of claims paid that American Modern expects to recover from reinsurers, we cannot be certain that American Modern will be able to ultimately collect these amounts |
| The reinsurer may be unable to pay the amounts recoverable, may dispute American Modern’s calculation of the amounts recoverable or may dispute the terms of the reinsurance treaty |
| Our investment portfolio could lose value Market Volatility and Changes in Interest Rates Midland’s investment portfolio, most of which is held by subsidiaries of Midland, primarily consists of fixed income securities (such as corporate debt securities and US government securities) and publicly traded equity securities |
| As of December 31, 2005, approximately 79prca of Midland’s investment portfolio was invested in fixed income securities and approximately 21prca was invested in equity securities |
| The fair value of securities in Midland’s investment portfolio may fluctuate depending on general economic and market conditions or events related to a particular issuer of securities |
| In addition, Midland’s fixed income investments are subject to risks of loss upon default and price volatility in reaction to changes in interest rates |
| Changes in the fair value of securities in Midland’s investment portfolio are reflected in our financial statements and, therefore, could affect our financial condition or results |
| Furthermore, a decrease in the value of American Modern’s equity securities would also cause a decrease in American Modern’s statutory surplus, which in turn would limit American Modern’s ability to write insurance |
| Concentration of Investments As of December 31, 2005, approximately 37dtta6prca of Midland’s equity investment portfolio and 7dtta8prca of its total investment portfolio (approximately dlra73dtta5 million in market value) was invested in the common stock of US Bancorp |
| A material decrease in the price of common stock of US Bancorp would cause the value of Midland’s investment portfolio to decline and would also result in a decrease in American Modern’s statutory surplus |
| If American Modern’s loss reserves prove to be inadequate, then we would incur a charge to earnings American Modern’s insurance subsidiaries regularly establish reserves to cover their estimated liabilities for losses and loss adjustment expenses for both reported and unreported claims |
| These reserves do not represent an exact calculation of liabilities |
| Rather, these reserves are management’s estimates of the cost to settle and administer claims |
| These expectations are based on facts and circumstances known at the time, predictions of future events, estimates of future trends in the severity and frequency of claims and judicial theories of liability and inflation |
| The establishment of appropriate reserves is an inherently uncertain process, and we cannot be sure that ultimate losses and related expenses will not materially exceed American Modern’s reserves |
| To the extent that reserves prove to be inadequate in the future, American Modern would have to increase its reserves and incur a charge to earnings in the period such reserves are increased, which could have a material and adverse impact on our financial condition and results |
| 10 ______________________________________________________________________ [11]Table of Contents The reserves established for our run-off commercial liability lines business could be inadequate The Company has established loss reserves designed to cover losses and loss adjustment expenses related to its run-off commercial liability lines business, which it exited in 2001 |
| However, the ultimate liability related to this business is uncertain |
| Regulatory actions could impair our business American Modern’s insurance subsidiaries are subject to regulation under the insurance laws of states in which they operate |
| These laws primarily provide safeguards for policyholders, not shareholders |
| Governmental agencies exercise broad administrative power to regulate many aspects of the insurance business, including: • standards of solvency, including risk-based capital measurements; • restrictions on the amount, type, nature, quality and concentration of investments; • policy forms and restrictions on the types of terms that American Modern can include in its insurance policies; • how we acquire business from agents and how producers are compensated; • certain required methods of accounting; • reserves for unearned premium, losses and other purposes; • premium rates; • marketing practices; • capital adequacy and the amount of dividends that can be paid; • licensing of agents; • approval of reinsurance contracts and inter-company contracts; • approval of proxies; and • potential assessments in order to provide funds to settle covered claims under insurance policies provided by impaired, insolvent or failed insurance companies |
| Regulations of state insurance departments may affect the cost or demand for American Modern’s products and may impede American Modern from obtaining rate increases or taking other actions it might wish to take to increase its profitability |
| Further, American Modern may be unable to maintain all required licenses and approvals and its 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 American Modern does not have the requisite licenses and approvals or does not comply with applicable regulatory requirements, insurance regulatory authorities could stop or temporarily suspend American Modern from conducting some or all of its activities or assess fines or penalties against American Modern |
| In light of several recent significant property and casualty insurance company insolvencies, it is possible that assessments American Modern must pay to state guarantee funds may increase |
| In addition, insurance laws or regulations adopted or amended from time to time may result in higher costs to American Modern or may require American Modern to alter its business practices or result in increased competition |
| 11 ______________________________________________________________________ [12]Table of Contents The effects of emerging claim and coverage issues, such as mold, on American Modern’s business are uncertain As industry practices and legal, judicial, social, environmental and other conditions change, unexpected and unintended issues related to claims and coverages may emerge |
| These issues can have a negative effect on American Modern’s business by either extending coverage beyond its underwriting intent or by increasing the number or size of claims |
| Recent examples of emerging claims and coverage issues include increases in the number and size of water damage claims related to expenses for testing and remediation of mold conditions and a growing trend of plaintiffs targeting property and casualty insurers in purported class action litigation relating to claim-handling and other practices, particularly with respect to the handling of personal lines claims |
| The effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict and could harm our financial condition or results |
| The existence of certain airborne mold spores resulting from moisture trapped in confined areas has been alleged to cause severe health and environmental hazards |
| American Modern has current and potential future exposure to mold claims in both its commercial and personal lines of business |
| Due to uncertainty of future changes in state regulation, we cannot estimate American Modern’s future probable liability for mold claims |
| Also, as case law expands, American Modern may be subject to mold-related losses beyond those intended by policy coverage and not addressed by exclusionary or limiting language |
| Loss reserve additions arising from future unfavorable judicial trends cannot be reasonably estimated at the present time |
| It would be difficult for a third party to acquire Midland Controlling Shareholders Members or trusts of the Hayden and LaBar families beneficially own approximately 45prca of our common stock |
| Some members of these families serve as our executive officers and directors |
| Through their ownership of common stock and their positions with us, these families have the practical ability to effectively control Midland |
| They have the practical ability to elect a number of directors and exercise significant influence over the approval or disapproval of mergers or similar transactions and amending our Articles of Incorporation |
| A third party may need the approval of some members of these families to gain control of Midland |
| Anti-Takeover Considerations Certain provisions of our Articles of Incorporation and Code of Regulations and of Ohio law make it difficult for a third party to acquire control of Midland without the consent of our Board |
| These anti-takeover defenses may discourage, delay or prevent a transaction involving a change in control of our company |
| In cases where Board approval is not obtained, these provisions could also discourage proxy contests and make it more difficult for you and other shareholders to elect directors of your choosing and cause us to take other corporate actions you desire |
| These provisions include: • a staggered Board of Directors; • the authorization of undesignated preferred stock, the terms of which may be established and shares of which may be issued without shareholder approval; • limitations on persons authorized to call a special meeting of shareholders; and • advance notice procedures required for shareholders to nominate candidates for election as directors or to bring matters before an annual meeting of shareholders |
| We are also subject to the laws of various states that govern insurance companies and insurance holding companies |
| Under these laws, a person generally must obtain the applicable insurance department’s approval to acquire, directly or indirectly, 5prca or 10prca or more of our outstanding voting securities or the outstanding voting securities of our insurance 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 acquirer’s financial stability, the competence of its management and whether competition in that state would be reduced |
| These laws may delay or prevent a takeover of our company or our insurance company subsidiaries |
| 12 ______________________________________________________________________ [13]Table of Contents Provisions in Ohio law relating to business combinations and interested shareholder transactions may also make it difficult for Midland to be acquired |
| Midland and its subsidiaries may be unable to pay dividends Midland and American Modern are organized as holding companies |
| Almost all of our operations are conducted by subsidiaries |
| For us to pay dividends to our shareholders and meet our other obligations, we must receive management fees and dividends from American Modern and M/G Transport |
| In order for American Modern to pay dividends and management fees to us and meet its other obligations, American Modern must receive dividends and management fees from its subsidiaries |
| Payments of dividends by our insurance subsidiaries are regulated under state insurance laws |
| The regulations in the states where each insurance company subsidiary is domiciled limit the amount of dividends that can be paid without prior approval from state insurance regulators |
| In addition, state regulators have broad discretion to limit the payment of dividends by insurance companies |
| Without regulatory approval, the maximum amount of dividends that can be paid in 2006 by American Modern is dlra64dtta5 million |
| The maximum dividend permitted by law does not necessarily indicate an insurer’s actual ability to pay dividends |
| Our ability to pay dividends may be further constrained by business and regulatory considerations, such as the impact of dividends on American Modern’s surplus |
| A decrease in surplus could affect American Modern’s ratings, competitive position, covenants under borrowing arrangements with banks, the amount of premium that can be written and our ability to pay future dividends |
| A prolonged, significant decline in insurance subsidiary profits or regulatory action limiting dividends could subject us to shortages of cash because our subsidiaries will not be able to pay us dividends |
| American Modern depends on agents and distribution partners who may discontinue sales of its policies at any time American Modern’s relationship with its independent agents and other distribution channel partners is critical to its success |
| These agencies and other distribution partners are independent and typically offer products of competing companies |
| They require that American Modern provide competitive product offering, timely application and claims processing, efficient technology solutions and that they receive prompt attention to their questions and concerns |
| If these agents and distribution partners find it easier to do business with American Modern’s competitors or choose to sell the insurance products of its competitors on the basis of cost, terms or commission structure, American Modern’s sales volume would decrease, harming our financial conditions and results |
| We cannot be certain that these agents and distribution partners will continue to sell American Modern’s insurance products to the individuals they represent |
| We are subject to various litigation American Modern’s insurance subsidiaries are routinely involved in litigation that arises in the ordinary course of business |
| It is possible that a court could impose significant punitive, bad faith, extra-contractual or other extraordinary damages against American Modern or one of its subsidiaries |
| This could harm our financial condition or results |
| In addition, a substantial number of civil jury verdicts have been returned against insurance companies in several jurisdictions in the United States, including jurisdictions in which American Modern has business |
| Some of these verdicts have resulted from suits that allege improper sales practices, agent misconduct, failure to properly supervise agents and other matters |
| Increasingly, these lawsuits have resulted in the award of substantial judgments against insurance companies |
| Some of these judgments have included punitive damages that are in high proportion to the actual damages |
| Any such judgment against American Modern could harm our financial condition or results |
| Our relatively low trading volume may limit your ability to sell your shares Although shares of our common stock are listed on the Nasdaq National Market, on many days in recent months, the daily trading volume for our common stock was less than 20cmam000 shares |
| As a result of this low trading volume, you may have difficulty selling a large number of shares of our common stock in the manner or at a price that might be attainable if our common stock were more actively traded |
| 13 ______________________________________________________________________ [14]Table of Contents Our success depends on retaining our key personnel Our performance depends on the continued service of our senior management |
| None of our senior management is bound by an employment agreement nor do we have key person life insurance on any of our senior management |
| Our success also depends on our continuing ability to attract, hire, train and retain highly skilled managerial, underwriting, claims, risk management, sales, marketing and customer support personnel |
| In addition, new hires frequently require extensive training before they achieve desired levels of productivity |
| Competition for qualified personnel is intense, and we may fail to retain our key employees or to attract or retain other highly qualified personnel |
| Risks related to M/G Transport M/G Transport operates a barge chartering and freight brokerage business |
| It arranges for the movement of dry bulk commodities such as petroleum coke, ore, barite, fertilizers, sugar and other dry cargos primarily on the lower Mississippi River and its tributaries |
| Such operations can be dangerous and may, from time to time, cause damage to other vessels and other water facilities |
| Any damage in excess of insurance coverage could harm our operations |
| The release of foreign materials into the waterways could cause damage to the environment and subject M/G Transport to remediation costs and penalties |
| Any such release could harm our financial condition or results |