Annual report - TexasMutual

Annual report - TexasMutual

The Benefitsof OwnershipTexas Mutual Insurance Company2012 Annual Report

On the cover:Policyholder owner Perry Sooter,president of Western Hot Oil Service Inc.Most consumer/business relationships are simple:The business provides a product or service, andyou pay their fee. Typically, you get nothing moreand, you hope, nothing less. Your relationship withTexas Mutual Insurance Company works differently.When you chose to protect your business andyour employees with a Texas Mutual ® policy, youpurchased an ownership stake in the company.Texas Mutual is not publicly traded, and it does notanswer to stockholders. Our singular focus is ondelivering benefits to our policyholder owners.The Benefitsof OwnershipContentsLetter From the Chairman and the President | 1Financial Highlights | 4Board of Directors | 5Independent Auditors’ Report | 7Financial Statements | 9Senior Leadership and Agent Advisory Council | 32

Letter From the Chairman and the PresidentTo Our Policyholder OwnersTexas Mutual operates on the simple principle that if something is good for ourpolicyholder owners, it is good for us. Our service culture has earned us the honorof being Texas’ leading choice for workers’ compensation insurance. Strong,experienced leadership by your board of directors is the foundation of thiscompany’s success.Texas Mutual’s ongoingfinancial stability propelledus to an A.M. Best strength ratingof A (Excellent) in 2012.The rating provides furtherassurance that we willbe here for you and youremployees, regardless ofmarket conditions.Your board members are Texans, just like you. They are also businesspeople whounderstand your needs and concerns. Representing your interests is the board’sprimary responsibility.Collaborating with senior leadership, the board sets the company’s strategiccourse. Our staff, in turn, partners with insurance agents, trade associations,health care providers and policyholders to execute that strategy. All of TexasMutual’s accomplishments during the past 20 years are products of deliberate,strategic decisions designed to benefit our owners.Benefits of OwnershipTexas Mutual is a policyholder-owned company committed to delivering value foryour premium dollars. You are among the 54,000 Texans who count on us to helpthem control their workers’ compensation costs, prevent workplace accidentsand minimize their consequences.Safety groups are a cornerstone of our strategy for making workers’ compensationaffordable. Safety groups allow businesses in similar industries to earn premiumdiscounts by purchasing their coverage as a group. We partner with insuranceagents to offer 32 safety group options. Safety groups traditionally have the supportof their respective trade associations, including the National Federation ofIndependent Business, Texas Restaurant Association, Texas Oil and GasAssociation, and the AGC Texas Building Branch. In addition to premiumdiscounts, safety group members have access to industry-specific workplacesafety resources, including a safety professional with experience in their industry.Texas Mutual employs the state’s largest team of workplace safety professionals.In 2012, they made 10,000 worksite safety visits, helping policyholders preventon-the-job accidents and their associated costs. As a policyholder, you also haveexclusive access to 2,000 free streaming videos, DVDs, interactive tools and othermaterials in our safety resource center at workplace safety is a core element of Texas Mutual’s mission.We recognize, however, that accidents happen, even in the safest workplaces.When they do, we work hard to minimize their consequences.Texas Mutual created its workers’ compensation health care network to helpinjured employees recover and return to productive employment. Network doctorshave unique experience treating workplace injuries. They collaborate with networkcase managers and Texas Mutual claims professionals to ensure your injuredemployees receive timely, appropriate care. This coordinated approach helpsinjured employees return to work an average of eight days sooner than theirnon-network counterparts. By facilitating timely return-to-work, the network saves14 percent in wage-replacement benefits compared with non-network claims.2012 Annual Report 1

Letter From the Chairman and the President, cont.Texas Mutual’s focus on service over profit sets the standard other carriers strivetoward. To ensure we continue to deliver the services and peace of mind youexpect, we must remain financially solid.$1.2B Investment in TexasTexas Mutual wrote a company-record $935 million in premiums during 2012.By responsibly managing our costs, we have maintained a strong policyholders’surplus. The money belongs to you, and it ensures we will fulfill our promises toyou and your employees.Bob BarnesChairmanTexas Mutual’s ongoing financial stability propelled us to an A.M. Best strength rating of A (Excellent) in 2012. The rating provides furtherassurance that we will be here for you and your employees, regardless ofmarket conditions.When Texas Mutual succeeds, we share that success with qualifying policyholdersthrough our dividend programs. In 2012, your board was proud to authorizeTexas Mutual to distribute $150 million in individual policyholder dividends amongemployers who share the company’s commitment to workplace safety. Since1999, Texas Mutual has distributed $1.2 billion in dividends. We have distributedmore than $1 billion of that total since 2005. The money has bolstered the Texaseconomy and helped you build for the future.Richard GergaskoPresidentTexas Mutual’s strength is not the exception in today’s workers’ compensationsystem. The system as a whole is thriving, and employers are reaping the benefits.Dividends paid1,1001,000900800700600500400300Individual Policyholder DividendsInception to Date[in $ millions]12011010090807060504030Safety Group DividendsInception to Date[in $ millions]20020100100’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’120’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’122012 Annual Report 2

Letter From the Chairman and the President, cont.Coverage is Available and AffordableIn the late 1980s, the Texas workers’ compensation system was broken. Medicalcosts were among the highest in the nation, premiums were on the rise, and formany Texas employers, affordable coverage was difficult to obtain.Furthermore, a high percentage of claim disputes were resolved in the courts,and attorneys were involved in nearly 50 percent of all but the smallest claims.The picture is drastically different today.In 2012, your boardwas proud to authorizeTexas Mutual to distribute$150 million in individualpolicyholder dividendsamong employers who sharethe company’s commitmentto workplace safety.In its 2012 biennial report to the Legislature, the Texas Department of Insurance,Division of Workers’ Compensation noted that other states are struggling withmany of the issues that plagued our workers’ compensation system in the past.Texas employers, conversely, are benefitting from falling premiums, decreasinginjury rates and improving return-to-work results. Not surprisingly, the number ofemployers choosing workers’ compensation is growing.A healthy workers’ compensation system is critical to Texas’ business climate.By focusing on our mission, Texas Mutual helps ensure long-term stability forthe system and the people it serves.We Remain True to Our MissionTwenty years ago, a handful of Texas Mutual leaders set out to draft a missionstatement. They knew it had to be more than a mere shelf document. It had toembody, in just a few sentences, every promise Texas Mutual would make toyou and your employees.Today, many of those leaders are still with Texas Mutual, and the missionstatement they crafted drives everything we do:The company provides a stable, competitive source of workers’ compensationinsurance for Texas employers, acts as insurer of last resort, and helps to preventon-the-job injuries and illnesses and minimize their consequences.You can rely on us to continue offering competitive rates, delivering exceptionalservice and paying dividends when financial conditions allow. Whether youoperate in the manufacturing hub of the Valley, the oil patches of West and SouthTexas, the “Silicon Hills” of Austin or somewhere in between, Texas Mutual willalways be here to help you keep your employees safe and manage your claims.With your board of directors’ support, we will constantly explore new ways tobetter serve you.On behalf of everyone at Texas Mutual, thank you for your business partnership.We look forward to many more years of mutual success.Bob BarnesChairman of the BoardRichard GergaskoPresident2012 Annual Report 3

Financial HighlightsFor the year ended December 31, 2012(in thousands)Gross premiums written $935,318Gross premiums earned $853,155Net premiums earned $844,843Net investment income $232,208Other income $438Claim benefits paid and incurred $521,981Underwriting expense $222,078Dividends to policyholders $163,532Provision for uncollectible premiums $1,224Net income $168,674At December 31, 2012(in thousands, except number of policies in force)Admitted assets $4,890,294Liabilities $2,955,905Policyholders’ surplus $1,934,389Number of policies in force 54,383Key indicators, year ended December 31, 2012Incurred loss ratio 61.8%Statutory combined ratio 85.8%Combined ratio including dividends 103.5%Premiums written to surplus ratio 0.48:12012 at a Glance■■Declared a combined $164 millionin individual policyholder dividendsand safety group dividends■■Earned a financial strength rating ofA (Excellent) from A.M. Best Co.■■Issued $102 million in premiumdiscounts through our workers’compensation health care network■■Partnered with the Texas Oil andGas Association to launch a safedrivingcampaign■■Collaborated with the NationalFederation of Independent Businessto host workers’ compensationworkshops for its members■■Funded free workplace safetycourses for the public■■Made 10,000 worksite safety visits■■Recovered $10 million of ourpolicyholders’ money from thirdparties who contributed to on-thejobaccidents■■Earned recognition as a highperformer from the TexasDepartment of Insurance, Divisionof Workers’ CompensationKey Indicators$935,318Premiums written (in thousands)Policies in force$614,701$674,417$716,113 $706,591 $750,173 $760,489 $768,319$645,036 $609,186$749,008$425,315$242,41732,851$309,63631,027 31,177 36,08740,729 43,49947,94745,372 45,989 47,508 47,927 49,27051,09354,3831999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20122012 Annual Report 4

Board of DirectorsOur board membersrepresent a diverse mixof Texas industries andregions. They bring awealth of experienceand perspective, andthey understand ourmission is unique intoday’s market.The Governor, withthe advice and consentof the Texas Senate,appoints five of thenine directors,including the chair.Policyholders elect theother four directors.Bob BarnesChairmanAppointedMr. Barnes, Granbury,Texas, is chairman ofTexas Mutual InsuranceCompany’s board ofdirectors; he wasappointed to the board in2007. He currently ownsVision Asset Mgm’t Ltd.,Multi Concepts Ltd.and was partner,president and CEO ofSchlotzsky’s Deli, amultinational restaurantchain. Mr. Barnes serveson the board of directorsand is a former statepresident of the TexasRestaurant Association.He is former chairman ofthe Midland-OdessaTransportation Allianceand the Texas MotorVehicle Board, and hewas a founding memberof The University of Texasof the Permian BasinDevelopment Board.Linda Foster-Smith,Vice ChairAppointedMrs. Foster-Smith,Georgetown, Texas, isvice chair of Texas MutualInsurance Company’sboard of directors; shewas appointed to theboard in 2008. She isretired from AT&T, whereshe served for 37 years,the last 15 years asdirector of external affairsfor the Permian Basin.Mrs. Foster-Smith is aformer member of theboard of trustees for theMidland IndependentSchool District, a formermember and chairwomanof the Midland Chamberof Commerce, and formerboard chairwoman andcampaign chairwoman forthe United Way ofMidland. She is formerboard secretary for thePermian Basin CommunityCenter and past boardpresident of the MidlandIndependent SchoolDistrict’s EducationalFoundation. Mrs. Foster-Smith currently serves assecretary of the board ofdirectors for Seeds ofStrength of Georgetown,a women’s philanthropicgroup.Jay EisenSecretaryAppointedMr. Eisen, Beaumont,Texas, is secretary ofTexas Mutual InsuranceCompany’s board ofdirectors. He wasappointed to the board in2008 to fill a vacantposition, and he wasreappointed in 2011.Mr. Eisen, a longtimeTexas Mutual policyholder,is president of SampsonSteel Corp. in Beaumont.He is a member of thepolitical advisorycommittee for the TexasAssociation of Business,a former member of theassociation’s statewideboard and former chairmanof the association’sSoutheast Chapter.Bernie FrancisElectedMr. Francis, Carrollton,Texas, was elected toTexas Mutual InsuranceCompany’s board ofdirectors in 2009. He isowner and CEO ofAddison-based BusinessControl Systems LP andDallas-based First ClassCaregivers Inc. He is amember of the board ofSenior Quality LifestylesCorp. and of WorkforceSolutions for NorthCentral Texas. Mr. Francisserves on the executivecommittee of the TexasBusiness LeadershipCouncil. He is pastchairman of the TexasState University Systemboard of regents andformer chairman of theTexas State TechnicalCollege board of regents.He served three terms onthe Carrollton CityCouncil in the 1990s.2012 Annual Report 5

Statutory Statements of Admitted Assets,Liabilities and Policyholders’ SurplusDecember 31,2012 2011Admitted AssetsCash and invested assets (Note 2):Bonds $ 3,193,680,354 $ 3,097,179,516Common stocks and mutual funds 1,036,717,818 791,497,131Real estate 19,513,336 20,877,505Cash, cash equivalents, and short-term investments 148,882,686 142,000,944Other invested assets 164,036,757 67,738,299Total cash and invested assets 4,562,830,951 4,119,293,395Premiums receivable, net of allowance 293,631,676 227,074,767Reinsurance recoverable on paid losses (Note 5) 1,245,666 1,223,051Investment income due and accrued 29,366,720 28,924,501Furniture and electronic data processing equipment 806,595 1,427,305Other assets 2,412,777 2,016,966Total Admitted Assets $ 4,890,294,385 $ 4,379,959,985Liabilities and Policyholders' SurplusLiabilitiesReserve for losses and loss adjustment expenses (Note 3) $ 2,422,760,410 $ 2,271,645,336Unearned premiums 428,272,676 346,110,040Taxes, licenses, and fees 20,337,367 12,234,500Commissions payable 41,372,143 36,290,446Advance premiums 9,156,130 8,936,743Other liabilities 34,006,656 27,526,364Total liabilities 2,955,905,382 2,702,743,429Commitments and contingencies (Note 7)Policyholders' SurplusUnassigned surplus 1,934,389,003 1,677,216,556Policyholders' surplus 1,934,389,003 1,677,216,556Total Liabilities and Policyholders' Surplus $ 4,890,294,385 $ 4,379,959,985The accompanying notes are an integral part of these statutory financial statements.2012 Annual Report 9

Statutory Statements of OperationsFor the Years EndedDecember 31,2012 2011PremiumsPremiums written - direct and assumed $ 935,318,041 $ 749,008,338Change in unearned premium reserve (82,162,637) (34,260,944)Premiums earned 853,155,404 714,747,394Less cost of reinsurance (Note 5) (8,312,650) (7,262,044)Net premiums earned 844,842,754 707,485,350Losses and Expenses IncurredLosses and loss adjustment expenses (Note 3) 521,981,453 433,618,170Underwriting expenses 222,078,222 194,407,294Total losses and expenses incurred 744,059,675 628,025,464Net underwriting gain 100,783,079 79,459,886Net Investment Income (Note 2)Net interest and dividend income 139,346,010 142,975,816Net realized capital gains on investments 92,862,176 86,074,464Net investment income 232,208,186 229,050,280Other Income (Expense)Finance and service charges 264,722 137,451Provision for uncollectible premiums (1,223,932) (646,757)Miscellaneous income 174,520 233,924Total other expense (784,690) (275,382)Net income before dividends to policyholders 332,206,575 308,234,784Dividends to policyholders (Note 4) 163,532,087 169,164,102Net Income $ 168,674,488 $ 139,070,682The accompanying notes are an integral part of these statutory financial statements.2012 Annual Report 10

Statutory Statements ofPolicyholders’ SurplusFor the Years EndedDecember 31,2012 2011Total policyholders' surplus, beginning of the year $ 1,677,216,556 $ 1,610,178,770Net income 168,674,488 139,070,682Change in net unrealized capital gains 92,534,780 (69,867,839)Change in non-admitted assets (2,520,694) (2,137,081)Change in provision for reinsurance (3,768) (1,589)Change in post retirement medical plan (1,512,359) (26,387)Change in policyholders' surplus for the year 257,172,447 67,037,786Total policyholders' surplus, end of the year $ 1,934,389,003 $ 1,677,216,556The accompanying notes are an integral part of these statutory financial statements.2012 Annual Report 11

Notes to Financial StatementsNote 1 - Organization and Summary of Significant Accounting Policies(a)Description of operationsEffective September 1, 2001, the Texas Workers' Compensation Insurance Fund, which began operations onJanuary 1, 1992, became Texas Mutual Insurance Company (the “Company”). This change occurred throughthe passage of Texas House Bill 3458, acts of the 77 th Regular Session of the Legislature. The legislationmandates that the Company operate as a domestic mutual insurance company, authorized to write workers’compensation insurance in the state of Texas. The Company currently has a contract with another carrier toprovide workers’ compensation coverage to certain Texas policyholders of the Company for their out-of-stateoperations (Note 5). All monies, revenues and assets belong solely to the Company and may not be borrowedor appropriated by the state of Texas. The Company is subject to the rules, regulations, taxes and assessmentsof the Texas Department of Insurance (“TDI”). The Company serves as a competitive force in the Texasworkers’ compensation insurance market and as the insurer of last resort.The Company has a nine-member Board of Directors (the “Board”). Five members, including the chair, areappointed by the Governor and confirmed by the Senate, and the Company’s policyholders elect the remainingfour.(b) Summary of significant accounting policiesBasis of presentationThe accompanying financial statements have been prepared in conformity with the accounting practicesprescribed or permitted by the TDI.The TDI has adopted the National Association of Insurance Commissioners’ statutory accounting practices(“NAIC SAP”) except that it has retained certain prescribed accounting practices that differ from those found inNAIC SAP. Among these differences that impact the Company is the prescribed practice of admitting officefurniture and electronic data processing equipment to the extent that the total value of those assets is less thanfive percent of the other admitted assets of the Company. The Company’s statutory surplus would bedecreased by $709,791 and $999,492 as of December 31, 2012 and 2011, respectively, if office furniture werenon-admitted as required by NAIC SAP. Additionally, the Company’s statutory surplus would be decreased by$96,804 and $427,813 as of December 31, 2012 and 2011, respectively, if electronic data processingequipment were non-admitted. The accompanying statutory financial statements vary in some respects fromaccounting principles generally accepted in the United States of America (“generally accepted accountingprinciples” or “GAAP”).The more significant differences between statutory accounting principles and GAAP are as follows:• Policy acquisition costs, such as commissions, premium taxes, and other expenses directly related to thecost of acquiring new business are expensed as incurred, while under GAAP, they are deferred andamortized over the policy term to provide for proper matching of revenue and expense;• Investments in bonds and preferred stocks are generally carried at amortized cost, while under GAAP, theywould be classified as available for sale and are carried at fair value;• Assets are reported under NAIC SAP at “admitted-asset” value and “non-admitted” assets are excludedthrough a charge against policyholders’ surplus, while under GAAP, all assets are reported on the balancesheet, net of any required valuation allowance;2012 Annual Report 13

Notes to Financial StatementsInvestmentsUnder provisions of the Company’s Statement of Investment Policies and Objectives and in accordance withapplicable Texas regulations, the Company is restricted to investments authorized by law as provided by Chapter424 of the Texas Insurance Code. The Company’s investment portfolio consists primarily of U.S. Treasury andgovernment agency securities, corporate bonds, mortgage-backed and asset-backed securities, collateralizedmortgage obligations, equity securities, investments in mutual funds, and cash.Other invested assets consist of a minority ownership interest in limited liability companies and a limitedpartnership, which are recorded at initial cost and subsequently adjusted to recognize the Company’s share ofaudited GAAP basis earnings or losses, adjusted for any distributions received or additional capitalcontributions. This adjustment is recorded as an increase/decrease to the carrying value with an offsettingamount recorded to unrealized capital gains and losses on investments.All of the Company’s investments are valued in accordance with guidelines established by the NAIC SAP. Whendetermining the value of investments the Company segregates securities subject to Statement of StatutoryAccounting Principles (SSAP) No. 43R, Loan Backed and Structured Securities, from the general portfolio. SSAPNo. 43R provides specific guidance on the valuation and disclosure standards for loan-backed and structuredsecurities. Loan-backed securities and structured securities as defined by SSAP No. 43R, are valued inaccordance with the flow chart prescribed by the NAIC. All other bonds with NAIC designations of 1 and 2 arestated at amortized cost using the effective interest method. Bonds with an NAIC designation of 3 through 6 arestated at the lower of amortized cost or fair value. Prepayment assumptions are obtained from investmentmanagers or Bloomberg.Premiums and discounts are amortized or accreted until maturity or earlier call date for each security. Theamortization or accretion is an adjustment to yield using the effective interest method. For loan-backedsecurities and structured securities, the constant-yield method is used based on the anticipated prepaymentsand the estimated economic life of the securities. When estimates of prepayments change, the effective yield isrecalculated to reflect actual payments to date and anticipated future payments.Common stocks and mutual funds are stated at fair value.Short-term investments include those securities that mature within one year and are stated at amortized cost,which approximates fair value.Unrealized holding gains and losses are excluded from income and reported as net unrealized capital gains orlosses in policyholders’ surplus. Investment income consists primarily of interest and dividends. Interest isrecognized on an accrual basis and dividends are recorded as earned at the ex-dividend date. Realized capitalgains and losses on sales of investments are recognized in income on a first-in, first-out basis. Investmentsecurities are regularly reviewed by management for impairment based on criteria that include the extent towhich cost exceeds fair value, the duration of the valuation decline, the financial health and specific prospectsfor the issuer, and the Company’s intent and ability to hold the investment to recovery. A decline in the fairvalue below cost that is deemed other than temporary is charged to income in the reporting period for which theassessment is made. SSAP 43R requires additional consideration be given for structured and loan-backedsecurities that have declined below book value to determine if the present value of expected cash flows is lessthan the amortized cost.Investments in real estate are depreciated over an estimated useful life and stated at depreciated cost.2012 Annual Report 15

Notes to Financial StatementsReserve for losses and loss adjustment expensesThe reserve for losses and loss adjustment expenses (“LAE”) is comprised of the following: aggregate casebasisestimates of reported losses in the process of settlement, estimates of incurred but not reported losses(“IBNR”), and estimates of LAE to be incurred in the settlement of claims. The reserve represents the estimatedclaim costs and LAE necessary to cover the ultimate net costs of investigating and settling all losses incurredand unpaid. These estimates are adjusted in the aggregate for ultimate loss expectations based on historicalexperience and current economic trends.The Company projects estimated ultimate losses, which are used in determining the estimated reserve for lossesand LAE. Independent consulting actuaries are also retained to review the Company’s loss projections and relatedreserves. Management believes that the provision for losses and LAE is adequate to cover the ultimate liability atDecember 31, 2012 and 2011. However, the actual amounts paid when claims are settled may be different fromsuch estimates. Adjustments to these estimates are reflected as adjustments to incurred losses in the period inwhich such adjustments are known.Escrow deposits for funding deductiblesPolicyholders who purchase coverage under a deductible plan are required to deposit a predetermined escrowamount with the Company at inception of coverage. Funds held of $1,747,459 and $905,553 at December 31,2012 and 2011, respectively, are included in other liabilities. These amounts are held by the Company in a liability(escrow) account until one of the following two events occur:• Default by insured - if insured fails to remit payment for advances made by the Company on the insured’sbehalf on a monthly basis as billed, the Company may elect to cancel the policy for nonpayment and mayoffset any amounts due against such escrow funds.• Policyholder terminates the relationship with the Company - as stated in a security agreement with thepolicyholder, the balance in the escrow account is held by the Company after the expiration of the policy and isreturned to the policyholder over a period of 36 months or when all claims related to the policyholder areclosed.The Company is liable for claims under deductible plan policies even if the policyholder is unable to meet theobligations under the terms of the policy.Premium revenuesPremiums are calculated from rates established by the Board based on recommendations from the Company’sconsulting actuary. For policies on interim reporting, premiums are earned over the policy term based on theperiodic reports submitted by policyholders during the term of their coverage. Premiums for all other policies areearned using the daily pro rata method over the term of the policy. Unearned premium reserves are establishedto cover the unexpired portion of premiums written. Upon expiration or cancelation, a policy is audited or reviewedto determine the actual premiums earned and revenues are increased or decreased accordingly.SubrogationSubrogation claims (claims against third parties) are recognized as reduction of losses incurred upon collection.2012 Annual Report 16

Notes to Financial StatementsReinsuranceIn the normal course of business, the Company reinsures risks above certain retention levels with other insurancecompanies. Reinsurance recoverable on paid losses in which the Company is not relieved of its legal liability to thepolicyholders is reported separately on the statutory statements of admitted assets, liabilities and policyholders’surplus.Federal income taxesThe Company is exempt from federal income taxation under Section 501(c)(27) of the Internal Revenue Code.Accordingly, the accompanying statutory financial statements do not include a provision for income taxes.Disclosures about fair value of financial instrumentsIn preparing disclosures about the fair value of financial instruments, the Company has assumed that thecarrying amount approximates fair value for cash and short-term investments, premiums receivable, premiumand maintenance tax payable and other liabilities because of the short maturities of these instruments. The fairvalue of bonds and stocks is determined by the Company based on fair values obtained from third party pricingservices. If not available, the quoted market values or estimated values using the current interest ratesavailable to the Company for investments with similar terms and remaining maturities are used. See Note 9 foradditional fair value disclosures.Adoption of new accounting standardsIn March 2012, the NAIC adopted SSAP No. 92, Accounting for Postretirement Benefits Other than Pensions(“SSAP No. 92”). This new pronouncement supersedes SSAP No. 14, Postretirement Benefits Other thanPensions, and provides guidance for those entities with a defined benefit plan. SSAP 92 requires reportingentities to account for post-retirement benefits for both vested and non-vested employees. The provisions ofSSAP No. 92 are effective for January 1, 2013, with interim and annual financial statement reporting thereafter.Early adoption is permitted for December 31, 2012 annual financial statements. The Company elected to earlyadopt this pronouncement as of December 31, 2012. Pursuant to the adoption of SSAP No. 92, the Companyrecognized the additional post-retirement benefits for non-vested employees. See Note 6 for impacts to thefinancial statements as a result of adopting this guidance.2012 Annual Report 17

Notes to Financial StatementsNote 2 - InvestmentsThe amortized cost/adjusted carrying value, gross unrealized capital gains and losses, and fair value of investmentsare as follows:December 31, 2012Amortized Gross GrossCost/Adjusted Unrealized Unrealized FairCarrying Value Gains Losses ValueU.S. Treasury securities andobligations of U.S. governmentcorporations and agencies $ 610,207,973 $ 22,729,092 $ (262,993) $ 632,674,072Foreign government 21,735,439 580,888 - 22,316,327Industrial and miscellaneous 1,677,973,301 120,671,245 (560,448) 1,798,084,098Mortgage-backed securities 163,511,342 9,567,902 (10,249) 173,068,995Asset-backed securities 170,347,853 6,707,766 (510,362) 176,545,257Collateralized mortgage obligations 549,904,446 32,592,289 (1,039,547) 581,457,188Total bonds 3,193,680,354 192,849,182 (2,383,599) 3,384,145,937Common stocks and mutual funds 852,634,843 196,341,402 (12,258,427) 1,036,717,818$ 4,046,315,197 $ 389,190,584 $ (14,642,026) $ 4,420,863,755December 31, 2011Amortized Gross GrossCost/Adjusted Unrealized Unrealized FairCarrying Value Gains Losses ValueU.S. Treasury securities andobligations of U.S. governmentcorporations and agencies $ 777,476,833 $ 35,353,938 $ (27,904) $ 812,802,867Foreign government 27,701,260 625,035 (601,422) 27,724,873Industrial and miscellaneous 1,486,485,285 73,124,323 (6,899,089) 1,552,710,519Mortgage-backed securities 179,786,596 11,215,967 (660) 191,001,903Asset-backed securities 137,494,738 1,721,839 (4,551,313) 134,665,264Collateralized mortgage obligations 488,234,804 23,765,682 (7,053,701) 504,946,785Total bonds 3,097,179,516 145,806,784 (19,134,089) 3,223,852,211Common stocks and mutual funds 685,943,922 137,698,233 (32,145,024) 791,497,131$ 3,783,123,438 $ 283,505,017 $ (51,279,113) $ 4,015,349,3422012 Annual Report 18

Notes to Financial StatementsThe amortized cost/adjusted carrying value and estimated fair value of bonds are shown below by contractualmaturities as of December 31, 2012. Expected maturities may differ from contractual maturities because borrowersmay have the right to prepay obligations without call or prepayment penalties.December 31, 2012AmortizedCost/AdjustedFairCarrying Value ValueDue in one year or less $ 60,546,442 $ 61,879,100Due after one year through five years 1,104,027,295 1,161,041,477Due after five years through ten years 1,070,756,520 1,146,993,916Due after ten years 74,586,456 83,160,0042,309,916,713 2,453,074,497Mortgage-backed securities 163,511,342 173,068,995Asset-backed securities 170,347,853 176,545,257Collateralized mortgage obligations 549,904,446 581,457,188$ 3,193,680,354 $ 3,384,145,937Proceeds from the sale of bonds for the years ended December 31, 2012 and 2011, were $2,654,621,534 and$2,636,384,318, respectively. Gross gains of $67,067,228 and $69,705,178, and gross losses of $4,671,818 and$10,889,464, were realized from the sales of bonds for the years ended December 31, 2012 and 2011, respectively.Proceeds from the sale of stocks for the years ended December 31, 2012 and 2011, were $170,509,519 and$343,517,264, respectively. Gross gains of $43,288,571 and $45,351,551 and gross losses of $6,932,708 and$5,967,171, were realized from the sales of stocks for the years ended December 31, 2012 and 2011, respectively.The Company’s sales of investment securities in an unrealized loss position are due primarily to perceived changesin financial or other circumstances of an issuer.During the years ended December 31, 2012 and 2011, the fair value of certain securities was lower than the relatedcost basis and these declines in value were determined to be other than temporary. Impairment losses totaled$6,001,171 and $13,776,280 for the years ended December 31, 2012 and 2011, respectively.The following two tables reflect securities whose fair values were lower than the related cost basis at December 31,2012 and 2011, respectively. However, these declines in value were not deemed to be other than temporary. Thetables show the fair value and the unrealized losses, aggregated by investment category and category of durationthat individual securities have been in a continuous unrealized loss position.2012 Annual Report 19

Notes to Financial StatementsLess than Twelve MonthsDecember 31, 2012Twelve Months or GreaterUnrealizedUnrealizedFair Value Losses Fair Value LossesU.S. Treasury securities andobligations of U.S. governmentcorporations and agencies $ 45,607,214 $ (262,993) $ - $ -Industrial and miscellaneous 73,702,601 (358,074) 10,232,284 (202,374)Mortgage-backed securities 754,363 (9,688) 35,421 (561)Asset-backed securities 13,060,046 (23,636) 13,055,078 (486,726)Collateralized mortgage obligations 60,231,922 (413,337) 14,481,014I (626,210)Total bonds 193,356,146 (1,067,728)h37,803,797 (1,315,871)Common stocks 73,940,839 (5,429,942) 83,055,598 (6,828,485)$ 267,296,985 $ (6,497,670) $ 120,859,395 $ (8,144,356)December 31, 2011Less than Twelve MonthsTwelve Months or GreaterUnrealizedUnrealizedFair Value Losses Fair Value LossesU.S. Treasury securities andobligations of U.S. governmentcorporations and agencies $ 23,738,509 $ (27,904) $ - $ -Foreign government 3,461,198 (138,067) 3,235,931 (463,355)Industrial and miscellaneous 243,422,574 (6,663,439) 3,479,641 (235,650)Mortgage-backed securities 47,531 (660) - -Asset-backed securities 59,971,765 (2,748,954) 17,421,703 (1,802,359)Collateralized mortgage obligations 69,371,376 (3,343,475) 25,362,575 (3,710,225)Total bonds 400,012,953 (12,922,499) 49,499,850 (6,211,590)Common stocks 166,016,727 (28,760,569) 10,767,323 (3,384,455)$ 566,029,680 $ (41,683,068) $ 60,267,173 $ (9,596,045)2012 Annual Report 20

Notes to Financial StatementsThe Company does not have a significant amount of exposure to sub-prime mortgage securities. The majority of theunrealized losses related to stocks were due to market fluctuations resulting from cyclical and other economicpressures.The Company employs a systematic methodology to evaluate declines in fair value below the amortized cost for itsinvestments. In addition, the methodology incorporates a qualitative process ensuring that available evidenceconcerning the declines in fair value below amortized cost is evaluated in a disciplined manner. Based on theevaluation and the Company’s ability and intent to hold the investment for a reasonable period of time sufficient for arecovery of fair value, the Company views the decline in market value of each of the investments represented in thetable above as being temporary in accordance with the Company’s impairment policy.The Company applies measurement and disclosure provisions of SSAP No. 43R for loan-backed and structuredsecurities. As defined in SSAP No. 43R, when the holder of a loan-backed security or structured security (“security”)with an unrealized loss position either has the intent to sell or does not have the intent and ability to hold the securityfor the period of time sufficient to recover the amortized cost basis, the security is considered other-than-temporarilyimpaired and must be written down to fair value. Additionally, if the holder of a security does not expect to recoverthe entire amortized cost basis of the security even if the holder has no intent to sell and has the intent and ability tohold the security, the security is considered other-than-temporarily impaired and should be written down to thepresent value of cash flows expected to be collected. The other-than-temporary write-down shall be recognized inearnings as a realized loss.The following two tables summarize other-than-temporary impairments for loan-backed securities recorded duringthe years ended December 31, 2012 and December 31, 2011. The Company had either the intent to sell thesecurities or the inability, or the lack of intent to retain the securities for a period of time sufficient to recover theamortized cost basis, or the present value of cash flows expected to be collected was less than the amortized cost:For the Year Ended December 31, 2012Amortized Cost Recognized FairBefore CurrentYear OTTIOTTIValueAggregate intent to sell $ - $ - $ -Aggregate inability & lack of intent to hold - - -Aggregate PV of projected cash flows 630,854 (49,539) 414,048Annual Aggregate Total $ 630,854 $ (49,539) $ 414,048For the Year Ended December 31, 2011Amortized Cost Recognized FairBefore CurrentYear OTTIOTTIValueAggregate intent to sell $ - $ - $ -Aggregate inability & lack of intent to hold 4,968,741 (2,091,698) 2,877,043Aggregate PV of projected cash flows 10,155,687 (1,163,302) 7,668,648Annual Aggregate Total $ 15,124,428 $ (3,255,000) $ 10,545,6912012 Annual Report 21

Notes to Financial StatementsThe following table summarizes other-than-temporary impairments for loan-backed securities held at December 31,2012, recorded based on the fact that the present value of projected cash flows expected to be collected was lessthan the amortized cost of securities:CUSIPBACVAmortizedCost BeforeOTTIProjectedCash FlowsDecember 31, 2012RecognizedOTTIBACVAmortizedCost AfterOTTIEstimatedFair Value atDate of OTTIDate ofFinancialStatementWhereReported02150J-AV-4 $ 7,861,961 $ 5,739,231 $ (2,122,729) $ 5,739,231 $ 5,606,683 9/30/200902151A-BK-5 5,676,603 4,768,346 (908,256) 4,768,346 4,514,844 9/30/200905946X-JC-8 362,717 311,937 (50,780) 311,937 287,598 9/30/200912567A-AD-9 5,544,135 4,379,867 (1,164,268) 4,379,867 3,789,678 9/30/200912666R-AC-4 3,520,906 2,640,680 (880,227) 2,640,680 1,635,530 9/30/2009126673-NE-8 825,998 776,438 (49,560) 776,438 603,161 9/30/200912667G-BB-8 2,472,813 2,151,347 (321,466) 2,151,347 1,801,680 9/30/200912668B-EY-5 294,141 267,668 (26,473) 267,668 222,961 9/30/200912668B-YQ-0 2,951,933 2,509,143 (442,790) 2,509,143 2,107,795 9/30/200912668R-AA-6 535,405 433,678 (101,727) 433,678 358,490 9/30/200923242E-AC-3 3,993,757 2,795,630 (1,198,127) 2,795,630 1,980,064 9/30/200923242E-AJ-8 2,159,793 1,835,824 (323,969) 1,835,824 1,583,203 9/30/20093622E8-AE-5 6,407,128 4,805,346 (1,601,782) 4,805,346 4,337,280 9/30/200945257E-AB-0 5,881,685 5,411,150 (470,535) 5,411,150 3,653,949 9/30/200945660L-VM-8 7,417,573 7,046,695 (370,879) 7,046,695 5,037,626 9/30/200946627M-CU-9 1,524,121 1,280,262 (243,859) 1,280,262 994,544 9/30/2009525221-CT-2 573,882 430,412 (143,471) 430,412 404,439 9/30/2009525237-BF-9 4,062,734 2,843,914 (1,218,820) 2,843,914 2,716,725 9/30/200957645W-AA-8 684,816 602,638 (82,178) 602,638 459,261 9/30/200974922K-AH-8 679,031 570,386 (108,645) 570,386 457,652 9/30/2009761118-TB-4 676,583 466,842 (209,741) 466,842 459,714 9/30/2009863579-Y6-9 8,295,053 6,884,894 (1,410,159) 6,884,894 5,500,512 9/30/200994985G-AE-6 3,730,282 3,394,556 (335,725) 3,394,556 2,949,812 9/30/200946627M-CU-9 1,130,814 942,345 (188,469) 942,345 877,649 12/31/2010525237-BF-9 1,781,464 1,348,822 (432,641) 1,348,822 1,184,047 12/31/2010073888-AC-3 4,870,367 3,815,311 (1,055,056) 3,815,311 3,815,311 12/31/201012666R-AC-4 2,579,144 1,865,285 (713,858) 1,865,285 1,865,285 12/31/201007387A-AB-1 1,252,716 1,200,965 (51,751) 1,200,965 981,685 12/31/201145660L-VM-8 5,515,522 4,648,835 (866,687) 4,648,835 4,154,586 12/31/201174922K-AH-8 488,220 349,110 (139,109) 349,110 336,687 12/31/20113622EC-AA-4 630,854 581,315 (49,539) 581,315 414,048 3/31/2012$ 94,382,151 $ 77,098,872 $ (17,283,276) $ 77,098,872 $ 65,092,4992012 Annual Report 22

Notes to Financial StatementsSecurities on depositAs of December 31, 2012 and 2011, U.S. Treasury notes with a total fair market value of $8,965,971 and$9,083,484, respectively, were on deposit with the Federal Reserve Bank in compliance with regulations establishedunder the Federal Longshore and Harbor Workers’ Compensation Act.Investment IncomeNet investment income consists of the following:Interest and dividend income:For the Years EndedDecember 31,2012 2011Bonds $ 124,180,485 $ 134,554,839Stocks 26,083,327 19,044,325Cash equivalents and short-term investments 223,513 275,476Other invested assets 1,426,583 -Less investment expenses (13,315,930) (11,405,423)Total interest and dividend income (net of expenses) 138,597,978 142,469,217Net realized gains (losses) on investments:Bonds 61,301,141 55,264,199Stocks 31,491,394 29,239,364Cash equivalents and short-term investments (181,948) -Other invested assets 251,589 1,570,901Total net realized gains on investments 92,862,176 86,074,464Other investment income (loss):Miscellaneous investments 1,627,772 414,079Net real estate loss (879,740) (682,027)Securities lending - 774,547Total other investment income 748,032 506,599Net investment income $ 232,208,186 $ 229,050,2802012 Annual Report 23

Notes to Financial StatementsReal estateThe Company owns land and a commercial building for its main office located in Austin, Texas. Depreciationexpense on the building totaled $1,329,298 and $1,301,501 for the years ended December 31, 2012 and 2011,respectively. Accumulated depreciation on the building, for the years ended December 31, 2012 and 2011, totaled$11,349,935 and $10,020,638, respectively.The Company also owns land and a commercial building for its regional office in Lubbock, Texas. Depreciationexpense on the building totaled $94,297 and $93,025 for the years ended December 31, 2012 and 2011,respectively. Accumulated depreciation on the building, for the years ended December 31, 2012 and 2011, totaled$395,563 and $301,266, respectively.Note 3 - Reserve for Losses and Loss Adjustment ExpensesThe changes in reserves for losses and LAE consist of the following:For the Years EndedDecember 31,2012 2011Reserve for losses and LAE, net of reinsurance, at January 1 $ 2,271,645,336 $ 2,180,990,470Incurred losses and LAE, net of reinsurance:Provision for insured events of the current year 691,195,597 614,763,032Change in provision for insured events of prior years (169,214,144) (181,144,862)Total incurred losses and LAE, net of reinsurance 521,981,453 433,618,170Payments for losses and LAE, net of reinsurance:Attributable to insured events of the current year (165,414,601) (155,056,715)Attributable to insured events of the prior years (205,451,778) (187,906,589)Losses and LAE paid during the year, net of reinsurance (370,866,379) (342,963,304)Reserve for losses and LAE, net of reinsurance, at December 31 $ 2,422,760,410 $ 2,271,645,336Losses and LAE of $521,981,453 and $433,618,170 were decreased by $169,214,414 and $181,144,862 due tofavorable development of prior year estimates for the years ended December 31, 2012 and 2011, respectively. Thefavorable development was attributable to the re-estimation of unpaid losses and LAE. As the Company matures, thereserve data matures allowing the Company to better assess development patterns. Original estimates areincreased or decreased, as this additional information becomes known.2012 Annual Report 24

Notes to Financial StatementsNote 4 - Policyholders’ SurplusOn December 1, 1991, as authorized by Section 18.19 of House Bill 62, the Texas Public Finance Authority (“TPFA”)issued the Texas Public Finance Authority Texas Workers’ Compensation Insurance Fund Maintenance TaxSurcharge Revenue Bonds, Taxable Series 1991 (the “Revenue Bonds”), in the aggregate principal amount of $300million. The Revenue Bonds were issued in order to establish the initial surplus of the Company, establish andmaintain reserves, pay initial operating costs, pay costs related to issuance of the bonds, and pay other costs relatedto the bonds as deemed necessary by the Board.As of June 1999, the total $300 million in initial issue Revenue Bonds had been redeemed through normal sinking fundpayments, repurchased or economically defeased, by the Company. Since the Company’s inception, approximately$429 million has been recorded as direct reductions to policyholders’ surplus for amounts paid by the Company forRevenue Bond principal, interest and expense payments, industry studies, and grants. The Company does not haveany future obligations or commitments to distribute surplus.Policyholder dividends totaled $163,532,087 and $169,164,102 for the years ended December 31, 2012 and 2011,respectively. Included in this amount are dividends paid to safety group policyholders totaling $13,657,627 and$14,304,203 for the years ended December 31, 2012 and 2011, respectively. All dividends declared by the Companyhave been approved by the TDI. Future dividends to policyholders, if any, will be determined based on futureoperating results, and will be expensed as declared by the Board and approved by the TDI.The portion of unassigned surplus represented or (reduced) by each item below is as follows:December 31,2012 2011Net unrealized capital gains $ 203,156,375 $ 110,621,595Non-admitted asset values $ (14,932,523) $ (12,411,829)Post-retirement benefit obligation $ (1,573,594) $ (61,235)Provision for Reinsurance $ (5,357) $ (1,589)See Note 1 detailing the prescribed practice of admitting office furniture and electronic data processing equipmentand the resulting impact on unassigned surplus.Note 5 - ReinsuranceThe Company currently has a contract with Argonaut Insurance Company (“Argonaut”) to provide workers’compensation coverage to certain Texas policyholders of the Company for their out-of-state operations. Thecontract calls for 100% reinsurance of premiums, losses and LAE. As of December 31, 2012 and 2011, securitieswith a total fair market value of $46,696,449 and $40,992,742 million, respectively, were held in trust as collateral forlosses paid by Argonaut. The Company also cedes insurance to other companies for catastrophic exposures.Various reinsurers provide the reinsurance coverage either directly or through pools or associations. For bothcontract years 2012 and 2011, the program reinsured losses in excess of $30 million on a per occurrence basis upto a maximum of $220 million. Reinsurance contracts do not relieve the Company from its direct obligations to itspolicyholders. The Company is potentially liable if the reinsurance companies are unable to meet their obligationsunder the existing agreements.2012 Annual Report 25

Notes to Financial StatementsThe effect of reinsurance on premiums written and earned is as follows:For the Years EndedDecember 31,2012 2011Written Earned Written EarnedDirect $ 906,404,861 $ 829,189,970 $ 729,912,131 $ 698,358,746Assumed 28,913,180 23,965,434 19,096,207 16,388,648Ceded - (8,312,650) - (7,262,044)Net $ 935,318,041 $ 844,842,754 $ 749,008,338 $ 707,485,350Ceded premiums are recorded on an earned basis, which is consistent with terms of the reinsurance contract. Cededlosses incurred for the calendar years ended December 31, 2012 and 2011 were $20,082,904 and $7,710,442,respectively. Assumed losses incurred for the calendar years ended December 31, 2012 and 2011 were $25,358,076and $19,447,027, respectively.Reinsurance recoverable on paid losses at December 31, 2012 and 2011 totaled $1,245,666 and $1,223,051,respectively. Reinsurance recoverable on unpaid losses at December 31, 2012 and 2011 totaled $82,685,830 and$66,128,276, respectively.Note 6 - Retirement PlansThe Company sponsors defined contribution retirement plans (the “Plans”) as provided for under Section 401(a) and401(k) of the Internal Revenue Code. All employees who are 18 years of age and older automatically participate in thePlans. Under the terms of the Section 401(a) Plan, the Company makes nonelective employer contributions to the Planon behalf of plan participants in the amount equal to 4 percent of each participant’s salary plus 4 percent of the excessof each participant’s salary over the Social Security wage base. Under terms of the Section 401(k) Plan, eachparticipant may elect to contribute a percentage of their eligible compensation into the Plan, subject to IRS limitations.The Company matches 75% of participant contributions to the Section 401(k) Plan, up to a maximum matchingcontribution by the Company of 4.5% of the participant’s salary. The Company’s contributions totaled $4,600,280 and$4,726,933 for the years ended December 31, 2012 and 2011, respectively.The Company sponsors a postretirement medical plan. An employee who is covered by the Company’s medical plan atthe time of retirement is eligible for continued coverage provided his/her age plus years of services equal or exceeds 80at the time of retirement. Provisions also exist for spouses of the retirees. Retirees would be required to pay two-thirdsof the cost of the premiums and the Company would pay the remainder. This plan is self-funded with no specificallyidentified plan assets. There was only one vested employee as of December 31, 2011. The Company has earlyadopted SSAP No. 92 recognizing the additional post-retirement benefits for non-vested employees as of December 31,2012. The accumulated postretirement benefit obligation was $1,582,860 and $63,463 as of December 31, 2012 and2011, respectively.2012 Annual Report 26

Notes to Financial StatementsFor the Years EndedDecember 31,2012 2011Change in Accumulated Postretirement Benefit Obligation:Accumulated postretirement benefit obligation at the beginning of year $ 63,463 $ 36,326Interest cost 2,779 1,816Actuarial (gain) or loss (11,775) 28,898Estimated benefits paid (12,457) (20,745)Change in accounting principle 1,528,674 -Estimated plan participant contributions 12,176 17,168Accumulated postretirement benefit obligation at the end of the year 1,582,860 63,463Change in Plan Assets:Estimated benefits paid (12,457) (20,745)Estimated employer contributions 281 3,577Estimated plan participant contributions 12,176 17,168Fair value of assets at the end of the year - -Funded Status at the End of the Year $ 1,582,860 $ 63,463Note 7 - Commitments and ContingenciesLeasesThe Company has entered into various operating leases that expire over the next seven years. The leases containvarious renewal options. In 2006, the Company entered into new lease agreements for two regional offices thatprovide for certain escalations and rent abatements, which must be considered in determining the annual rentexpense to be recognized by the Company. For financial reporting purposes, rent expense is charged to operationson a straight-line basis over the term of the lease, resulting in a liability for deferred rent of $355,552 and $403,737included in other liabilities at December 31, 2012 and 2011, respectively. The deferred rent represents thedifference between the actual lease payments and the rent expense recognized.Rental expense for operating leases totaled $5,003,231 and $4,524,019 for the years ended December 31, 2012 and2011, respectively. The future minimum rental payments required under operating leases for office space andequipment that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2012 areas follows:2013 $ 5,948,6862014 4,030,9972015 2,471,8802016 1,815,5142017 557,406Later years 70,585$ 14,895,0682012 Annual Report 27

Notes to Financial StatementsLitigationThe Company is party to lawsuits and claims generally incidental to its business, which are expected to beadequately covered by loss reserves established at December 31, 2012. The ultimate disposition of these matters isnot expected to have a significantly adverse effect on the Company’s financial position, results of operations or cashflows.Guaranty fund assessmentsEffective January 1, 2000 the Company became a member of the Texas Property and Casualty Insurance GuarantyAssociation (“TPCIGA”). The TPCIGA is a non-profit, unincorporated association of all Texas-licensed property andcasualty insurers and exists to protect Texas policyholders by providing payment for covered claims of insolventinsurance companies. The TPCIGA assesses member insurers based on premium written in the year preceding theassessment. The Company records liabilities for these assessments when it is probable that an assessment will beimposed and the amount can be reasonably estimated. The State of Texas provides premium tax credits for allTPCIGA assessments paid, allowing recovery of these payments ratably over a ten-year period. Due to theanticipated recoverability of the assessed amounts through premium tax offsets, the Company records guaranty fundassessments as an asset that is amortized in conjunction with the corresponding offset to premium taxes. Theassets will be recovered through premium tax credits over a ten-year period for each applicable assessment.As of December 31, 2012 and 2011, guaranty fund assets totaled $149,181 and $517,036, respectively. Anassessment was not incurred for the years ended December 31, 2012 and 2011; however, the Company doesanticipate future assessments. Currently, these future assessments cannot be reasonably estimated; therefore, noliability has been accrued.Note 8 - High DeductiblesAs of December 31, 2012 and 2011, the Company had no reserve credit recorded for high deductibles on unpaidlosses and the deductible amounts billed and recoverable on paid claims were $118,322 and $30,944, respectively.These amounts were not in excess of collateral specifically held, and therefore were admissible as assets.Note 9 - Fair Value MeasurementsThe investments carried at fair value on the financial statements have been classified, for disclosure purposes,based on the hierarchy defined by the SSAP No. 100, Fair Value Measurements. The Statement defines fair valueas the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date. SSAP No. 100 establishes a fair value hierarchy that distinguishesbetween market participant assumptions developed on market data obtained from sources independent of theCompany (observable inputs) and the Company’s own assumptions about market participants based on bestinformation available in the circumstances (unobservable inputs). The asset’s classification in the hierarchy is basedon the lowest level of input that is significant to its valuation. The levels of the fair value hierarchy are as follows:• Level 1 – Quoted prices for identical instruments in active markets.• Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instrumentsin markets that are not active; inputs other than quoted prices that are observable for the asset or liability; inputs thatare derived principally from or corroborated by observable market data by correlation or other means.• Level 3 – Significant Unobservable Inputs for the asset or liability that reflect the Company’s own assumptionsabout the assumptions that market participants would use in pricing the asset or liability.2012 Annual Report 28

Notes to Financial StatementsLevel 1 financial assetsThese assets include actively-traded exchange-listed common stocks.securities are provided by various independent pricing services.Unadjusted quoted prices for theseLevel 2 financial assetsThe assets in this category include bonds with fair values provided by independent pricing services, utilizingobservable inputs. The Company has obtained an understanding of the methods, models and inputs used in pricing,and controls in place to validate that amounts provided represent current fair values.Typical inputs to models used by independent pricing services include but are not limited to benchmark yields,reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers, reference data, andindustry and economic events. Because some bonds do not trade daily, independent pricing services regularlyderive fair values using recent trades of securities with similar features. When recent trades are not available, pricingmodels are used to estimate the fair values of securities by discounting future cash flows at estimated marketinterest rates. As part of the Company’s control over pricing, management reviews all prices obtained to insurereasonableness of values and corroborates these prices with other independent sources.Level 3 financial assetsThese assets include bonds with fair values provided by independent broker quotations, utilizing inputs that cannotbe corroborated by observable market data.Fair Value Measurements at Reporting DateThe following two tables provide information about the Company’s financial assets measured and reported at fairvalue as of December 31, 2012 and December 31, 2011, respectively.December 31, 2012Level 1 Level 2 Level 3 TotalBondsIndustrial and miscellaneous $ - $ 27,533,559 $ - $ 27,533,559Asset-backed securities - 2,488,379 - 2,488,379Collateralized mortgageobligations - 14,562,508 - 14,562,508Total bonds - 44,584,446 - 44,584,446Common StockIndustrial and miscellaneous $ 1,036,717,818 $ - $ - $ 1,036,717,818Total Common Stock 1,036,717,818 - - 1,036,717,818Total Assets at Fair Value $ 1,036,717,818 $ 44,584,446 $ - $ 1,081,302,2642012 Annual Report 29

Notes to Financial StatementsDecember 31, 2011Level 1 Level 2 Level 3 TotalBondsIndustrial and miscellaneous $ - $ 41,708,447 $ - $ 41,708,447Asset-Backed Securities - 1,383,028 - 1,383,028Mortgage-backed securities - 33,385,107 - 33,385,107Total bonds - 76,476,582 - 76,476,582Common StockIndustrial and miscellaneous $ 791,497,131 $ - $ - $ 791,497,131Total Common Stock 791,497,131 - - 791,497,131Total Assets at Fair Value $ 791,497,131 $ 76,476,582 $ - $ 867,973,713Fair Values for All Financial InstrumentsThe table below reflects the fair values and admitted values of all admitted assets and liabilities that are financialinstruments excluding those accounted for under the equity method (limited partnership and limited liability companyinterests). The fair values are also categorized into the three-level fair value hierarchy as described above.Financial instrumentsFair ValueDecember 31, 2012AdmittedValue Level 1 Level 2 Level 3Bonds $3,384,145,937 $3,384,145,937 $ - $3,361,202,595 $22,943,342Common stocks 1,036,717,818 1,036,717,818 1,036,717,818 - -Cash, cash equivalents &short-term investments 148,882,686 148,882,686 125,398,341 23,484,345 -Total assets $4,569,746,441 $4,569,746,441 $1,162,116,159 $3,384,686,940 $22,943,3422012 Annual Report 30

Senior LeadershipRichard GergaskoPresident & CEOMike BarronSenior Vice President andChief Financial OfficerLynette CaldwellVice PresidentHuman ResourcesTerry FrakesSenior Vice PresidentPublic AffairsBill HuckabyGeneral AuditorRandy JohnsonSenior Vice PresidentInvestmentsSteve MathSenior Vice PresidentUnderwritingBill McLellanSenior Vice PresidentInformation TechnologyMary NicholsSenior Vice President/General CounselJeanette WardSenior Vice PresidentClaimsJoe YurkovichSenior Vice PresidentStrategic Planning &Policyholder ServicesAgent Advisory CouncilSteve AddkisonDwayne BakerGary BanksPeter BatjerMatt Berry Sr.Jerry BlystoneAllen BordenJeff BradyBill BridgesRob BridgesJohn BrimberryCory BrookePhilip BrucePaul CeroneRobert CrosbyBob DeanKim DrydenGary FelkerScott ForeeRandall GreenKathy GregoryMike HaseldenGary HowellRonnie HudsonJoe HutchisonGary LaFourSteve LappGreg Louvier Sr.John McCarden Jr.Ken MitchellKeith MontgomeryDon MorrissRobert NitschePatsy PiceynskiWes PittsTom RobertsChris RookerGerri RougeauDouglas SanfordAnne SheahenBen SmithBart TuckerStuart WallacePatrick WatkinsBrian WelchJohn Wilson©2013 Texas Mutual Insurance Company51000-2033-13012012 Annual Report 32

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