BUSINESS COMBINATIONS

12 Months Ended

Dec. 31, 2013

Business Combinations [Abstract]

BUSINESS COMBINATIONS

BUSINESS COMBINATIONS

On March 28, 2011, we acquired 100 percent of the outstanding common stock of Mercer Insurance Group, Inc. for $191,475. The acquisition was funded through a combination of cash and $79,900 of short-term debt. Accordingly, the results of operations for Mercer Insurance Group, Inc. have been included in the accompanying consolidated financial statements from that date forward. There were no acquisitions in 2013 and 2012.

The excess of the purchase price over the estimated fair value of the tangible assets acquired and liabilities assumed through the acquisition of Mercer Insurance Group at the acquisition date has been allocated to goodwill and intangible assets of our property and casualty insurance segment.

The following is a summary of the fair value of the tangible and intangible assets acquired and liabilities assumed of Mercer Insurance Group at the date of acquisition:

	March 28, 2011
Assets
Available-for-sale fixed maturity securities	$	401,548
Equity securities	10,266
Short-term investments	400
Cash and cash equivalents	18,855
Accrued investment income	3,741
Premiums receivable	35,822
Value of business acquired	27,436
Property and equipment	14,985
Reinsurance receivables and recoverables	58,193
Prepaid reinsurance premiums	6,289
Income taxes receivable	2,657
Deferred income taxes	2,837
Goodwill and intangible assets	32,293
Other assets	11,353
Total assets	$	626,675
Liabilities
Reserves for losses, claims and loss settlement expenses	$	310,647
Unearned premiums	72,249
Accrued expenses and other liabilities	33,690
Debt	3,000
Trust preferred securities	15,614
Total liabilities	$	435,200
Total net assets acquired	$	191,475

The fair value of available-for-sale fixed maturity securities is primarily based on quoted prices for similar financial instruments in markets that are not active or on inputs that are observable either directly or indirectly for the full term of the financial instrument. The fair value of equity securities is primarily based on unadjusted quoted prices in active markets for identical financial instruments that we have the ability to access.

The fair value of reserves for losses, claims and loss settlement expenses related to incurred claims and reinsurance receivables and recoverables is determined using a valuation model that is based on actuarial estimates of future cash flows for the underwriting liabilities. These future cash flows are adjusted for the time value of money using duration-matched risk-free interest rates that approximate current U.S. Treasury bill rates and a risk margin to compensate the acquirer for the risk associated with these liabilities.

The value of business acquired (“VOBA”) at the acquisition date is an intangible asset relating to the difference between the unearned premium reserves acquired in the transaction and the estimated fair value of the unexpired insurance policies, which consists of two components: (1) a provision for loss and loss settlement expenses that will be incurred as the premium is earned and (2) a provision for policy maintenance costs related to servicing those policies until they expire. Loss and loss settlement expenses are valued in a manner identical to that used for loss reserve valuation. Policy maintenance costs are valued based on estimates of future cash flows that are discounted to present value using duration-matched risk-free interest rates. VOBA is reported as a component of deferred policy acquisition costs in the accompanying Consolidated Balance Sheets and is amortized over a twelve-month period from the acquisition date in proportion to the timing of the estimated underwriting profit associated with the in-force business. The amortization pattern for the VOBA asset will be greater in the initial months subsequent to the acquisition date in correlation to the remaining term of the policies that were underwritten by Mercer Insurance Group. We recorded amortization expense of $1,673 and $25,763 in 2012 and 2011, respectively.

The fair value of property and equipment related to land and buildings approximates the appraised value of the respective assets at the acquisition date.

The fair value of the intangible asset for agency relationships was established using the excess earnings method, which is an income approach based on estimated financial projections developed by management using market participant assumptions. Fair value has been estimated as the present value of the benefits anticipated from our continued relationship with these agencies that are in excess of the return required on the investment in contributory assets necessary to realize those benefits. The rate used to discount the net benefits is based on a risk-adjusted rate that takes into consideration market-based rates of return and is representative of the relative risk of the acquired asset.

The fair value of the intangible asset for software was established using the replacement cost method, which estimates the cost to recreate the utility of the subject asset in consideration of the technological and functional obsolescence of the acquired software.

The fair value of the intangible asset for trade names was established using the relief from royalty method, which treats the trade name as being licensed in an arm’s length transaction to a third party. A review was performed of comparable arm’s length royalty or license agreements involving assets that reflect similar risk and return investment characteristics with the subject trade name. The royalty rate selected is then multiplied by the net revenue expected to be generated by the trade names over the course of the assumed life of the trade names. The product of the royalty rate and the revenue provides an estimate of the royalty income that could be generated hypothetically by licensing the subject trade name.

The fair value of the intangible asset for licenses was estimated by assigning values to state insurance licenses to determine the value of the company if it were sold as a “shell company” (i.e., no policies in force but with the license to write business in certain states). Value is derived from the states having limited the number of insurers licensed or from the significant expense of obtaining a new license from the state.

The fair value of all other tangible assets and liabilities approximates their carrying values at the acquisition date due to their short-term duration.

The following is a summary of our unaudited pro forma historical results as if Mercer Insurance Group had been acquired on January 1, 2011:

	Year Ended December 31,
	2011
Revenue	$	741,833
Net income (1)	8,139
Basic earnings per share	0.31
Diluted earnings per share	0.31

(1) The year ended December 31, 2011 excludes transaction related expenses incurred that reduced net income by $11.9 million.

The unaudited pro forma results above have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that actually would have resulted had the acquisition occurred at January 1, 2011, and they are not necessarily indicative of future operating results. Annualized revenues of Mercer Insurance Group were $145,868 for 2011. Total revenues and net loss related to Mercer Insurance Group for the year ended December 31, 2011 recorded in the accompanying Consolidated Statements of Income and Comprehensive Income were $109,043 and $14,650, respectively.