Annual Report 2011 - SNL Financial

Annual Report 2011 - SNL Financial

Our investment performance may suffer as a result of adverse capital market developments, which may affect our

financial results and ability to conduct business.

We invest the premiums we receive from policyholders until cash is needed to pay insured claims or other expenses. As

of December 31, 2011, the Company held investments with an estimated fair value of $178.8 million. For the year ended

December 31, 2011, the Company had $3.7 million of net investment income, representing 2.7% of its total revenues. Our

investments are subject to a variety of investment risks, including risks relating to general economic conditions, market

volatility, interest rate fluctuations, liquidity risk and credit risk. In particular, an unexpected increase in the volume or

severity of claims may force us to liquidate investments, which may cause us to incur capital losses. If we do not structure

the duration of our investments to match our insurance and reinsurance liabilities, we may be forced to liquidate investments

prior to maturity at a significant loss to cover such payments. Investment losses could significantly decrease our asset base

and statutory surplus, thereby affecting our ability to conduct business.

Our fixed income securities include investments in state and municipal bonds with an estimated fair value of $42.3

million as of December 31, 2011. Most states and many municipalities are experiencing financial difficulties and budget

deficits as a result of the current economic environment and, as a result, the risks associated with our state and municipal

bond portfolio have increased. Negative publicity surrounding state and municipality bond issues has resulted in reduced

liquidity in the state and municipal bond market. The reduced market liquidity, as well as rising interest rates, has negatively

impacted the estimated fair value of state and municipal bonds. If the liquidity in the state and municipal bond market does

not improve, or worsens, the estimated fair value of the Company’s state and municipal bonds could decline further.

Furthermore, the Company may experience an other-than-temporary impairment if a state or municipality in which the

Company has an investment defaults on its obligations under the terms of the bond.

Our revenues may fluctuate with changes in interest rates.

Our investment portfolio contains a significant amount of fixed income securities, including bonds, mortgage-backed

securities (“MBSs”), collateralized mortgage obligations (“CMOs”), and other asset-backed securities. The market values of

all of our investments fluctuate depending on economic and political conditions and other factors beyond our control. The

market values of our fixed income securities are particularly sensitive to changes in interest rates.

For example, if interest rates rise, fixed income securities generally will decrease in value. If interest rates decline, these

securities generally will increase in value, except for MBSs, which may decline due to higher prepayments on the mortgages

underlying the securities.

As of December 31, 2011, MBSs, including CMOs, constituted 15.9% of the estimated fair value of the Company’s

investment portfolio. MBSs and CMOs are subject to prepayment risks that vary with, among other things, interest rates.

During periods of declining interest rates, MBSs generally prepay faster as the underlying mortgages are prepaid and/or

refinanced by the borrowers in order to take advantage of lower interest rates. MBSs that have an amortized cost that is

greater than par (i.e., purchased at a premium) may incur a reduction in yield or a loss as a result of prepayments. In addition,

during such periods, we generally will be unable to reinvest the proceeds of any prepayment at comparable yields.

Conversely, during periods of rising interest rates, the frequency of prepayments generally decreases, and we may receive

interest payments that are below the then prevailing interest rate for longer than expected. MBSs that have an amortized cost

that is less than par (i.e., purchased at a discount) may incur a decrease in yield or a loss as a result of slower prepayments.

If we fail to comply with insurance industry regulations, or if those regulations become more burdensome, we may not be

able to operate profitably.

Our insurance subsidiaries are regulated by government agencies in the states in which we conduct business, and we

must comply with a number of state and federal laws and regulations. Most insurance regulations are intended to protect the

interests of policyholders rather than those of shareholders and other investors.

If we fail to comply with these laws and regulations, state insurance departments can exercise a range of remedies from

the imposition of fines to being placed in rehabilitation or liquidation. State insurance departments also conduct periodic

examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial

condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our

ability to achieve some or all of our business objectives.

Part of our strategy includes expanded licensing and product filings for the Company. Regulatory authorities, however,

have broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. If we do not have


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