10-Q/A 1 r10q063005a.txt 2ND QUARTER 2005 AMENDED FORM 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A (AMENDMENT NO. 1) Quarterly Report Under Section 13 or 15 (d) of the Securities Exchange Act of 1934 ------------------------------------------------------ For Quarter Ended Commission file number June 30, 2005 0-5534 BALDWIN & LYONS, INC. (Exact name of registrant as specified in its charter) INDIANA 35-0160330 ------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1099 NORTH MERIDIAN STREET, INDIANAPOLIS, INDIANA 46204 ------------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (317) 636-9800 -------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ X ] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock as of August 3, 2005: TITLE OF CLASS NUMBER OF SHARES OUTSTANDING Common Stock, No Par Value: Class A (voting) 2,666,666 Class B (nonvoting) 12,069,521 Index to Exhibits located on page 20. 2 BALDWIN & LYONS, INC. FORM 10-Q/A EXPLANATORY NOTE (DOLLARS IN THOUSANDS) This amendment No. 1 to the Baldwin & Lyons, Inc. Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005 (the "Form 10-Q/A") includes unaudited restated condensed consolidated financial statements as of June 30, 2005 and for the three and six months ended June 30, 2005. The Company accounts for its investments in limited partnerships using the equity method of accounting. The accompanying restated condensed consolidated financial statements, including the notes thereto, have been revised to reflect income statement recognition of the Company's proportionate share of unrealized investment gains attributable to certain of the Company's investments in limited partnerships. See footnote 4 to the enclosed restated condensed consolidated financial statements for a more detailed discussion regarding the accounting policies and the net gains reported for the Company's investments in limited partnerships. The following table summarizes the restatement effects on the company's condensed consolidated balance sheets and condensed consolidated statements of income as of and for the three and six months ended June 30, 2005. There were no adjustments necessary for periods prior to the 2005 second quarter.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) AS REPORTED ADJUSTMENT AS RESTATED --------------- ---------------- --------------- FOR THE THREE MONTHS ENDED JUNE 30, 2005 Net gains on investments $ 532 $ 2,656 $ 3,188 Federal income taxes 3,611 930 4,541 Net income 7,473 1,726 9,199 Basic earnings per share .51 .12 .63 Diluted earnings per share .50 .12 .62 FOR THE SIX MONTHS ENDED JUNE 30, 2005 Net gains on investments $ 5,468 $ 2,656 $ 8,124 Federal income taxes 8,744 930 9,674 Net income 17,819 1,726 19,545 Basic earnings per share 1.21 .12 1.33 Diluted earnings per share 1.20 .12 1.32 UNAUDITED BALANCE SHEET (IN THOUSANDS) AS REPORTED ADJUSTMENT AS RESTATED --------------- ---------------- --------------- JUNE 30, 2005 Unrealized net gains on investments $ 41,172 $ (1,726) $ 39,446 Retained earnings 256,897 1,726 258,623 Total shareholders' equity 336,151 - 336,151
The restatement had no effect on net cash provided by operating activities as the change in net income for the three and six months ended June 30, 2005 consisted entirely of non-cash 3 transactions. Except for the effects of the restatement, this Form 10-Q/A has not been updated for changes in events, estimates or other developments subsequent to August 3, 2005, the date of the original filing of the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005. Please refer to the company's current filings with the Securities and Exchange Commission for information subsequent to August 3, 2005. 4 PART I - FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS
BALDWIN & LYONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) JUNE 30 December 31 2005 2004 ---------------- ----------------- (AS RESTATED, SEE NOTES 3 AND 4) ASSETS Investments: Fixed maturities $ 288,755 $ 331,281 Equity securities 127,888 133,042 Other long-term 32,673 15,989 Short-term 69,930 36,406 ---------------- ---------------- 519,246 516,718 Cash and cash equivalents 74,390 57,384 Accounts receivable 30,082 33,481 Reinsurance recoverable 216,515 236,466 Notes receivable from employees 2,353 2,514 Other assets 21,652 22,000 ---------------- ---------------- $ 864,238 $ 868,563 ================ ================ LIABILITIES AND SHAREHOLDERS' EQUITY Reserves for losses and loss expenses $ 422,503 $ 441,821 Reserves for unearned premiums 34,542 33,233 Notes payable to banks 3,000 6,000 Accounts payable and accrued expenses 57,052 48,224 Current federal income taxes 1,407 660 Deferred federal income taxes 9,583 12,077 ---------------- ---------------- 528,087 542,015 Shareholders' equity: Common stock-no par value 629 628 Additional paid-in capital 37,453 37,083 Unrealized net gains on investments 39,446 44,497 Retained earnings 258,623 244,340 ---------------- ---------------- 336,151 326,548 ---------------- ---------------- $ 864,238 $ 868,563 ================ ================ See notes to condensed consolidated financial statements.
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BALDWIN & LYONS, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) Three Months Ended Six Months Ended June 30 June 30 ------------------------------ ------------------------------- 2005 2004 2005 2004 ------------- ------------- -------------- ------------- (AS (AS RESTATED, RESTATED, SEE NOTES 3 SEE NOTES 3 AND 4) AND 4) REVENUES Net premiums earned $ 43,473 $ 43,403 $ 90,132 $ 81,900 Net investment income 3,547 3,008 6,855 6,180 Net gains on investments 3,188 2,290 8,124 8,108 Other income 1,803 1,803 3,639 3,709 ------------- ------------- -------------- ------------- 52,011 50,504 108,750 99,897 EXPENSES Losses and loss expenses incurred 27,972 29,735 59,584 54,981 Other operating expenses 10,299 7,720 19,947 15,809 ------------- ------------- -------------- ------------- 38,271 37,455 79,531 70,790 ------------- ------------- -------------- ------------- INCOME BEFORE FEDERAL INCOME TAXES 13,740 13,049 29,219 29,107 Federal income taxes 4,541 4,185 9,674 9,344 ------------- ------------- -------------- ------------- NET INCOME $ 9,199 $ 8,864 $ 19,545 $ 19,763 ============= ============= ============== ============= PER SHARE DATA: BASIC EARNINGS $ .63 $ .61 $ 1.33 $ 1.35 ============= ============= ============== ============= DILUTED EARNINGS $ .62 $ .60 $ 1.32 $ 1.34 ============= ============= ============== ============= DIVIDENDS PAID TO SHAREHOLDERS $ .10 $ .40 $ .35 $ .90 ============= ============= ============== ============= Reconciliation of shares outstanding: Average shares outstanding - basic 14,728 14,624 14,726 14,614 Dilutive effect of options outstanding 103 171 110 189 ------------- ------------- -------------- ------------- Average shares outstanding - diluted 14,831 14,795 14,836 14,803 ============= ============= ============== ============= See notes to condensed consolidated financial statements.
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BALDWIN & LYONS, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) Six Months Ended June 30 2005 2004 ---------------- --------------- Net cash provided by operating activities $ 15,800 $ 26,571 Investing activities: Purchases of long-term investments (54,142) (92,640) Proceeds from sales or maturities of long-term investments 97,880 90,574 Net sales (purchases) of short-term investments (33,524) 3,479 Decrease in notes receivable from employees 138 1,364 Other investing activities (1,207) (500) ---------------- --------------- Net cash provided by investing activities 9,145 2,277 Financing activities: Dividends paid to shareholders (5,153) (13,157) Repayment on notes payable (3,000) - Proceeds from sales of common stock 214 358 ---------------- --------------- Net cash used in financing activities (7,939) (12,799) ---------------- --------------- Increase in cash and cash equivalents 17,006 16,049 Cash and cash equivalents at beginning of period 57,384 30,078 ---------------- --------------- Cash and cash equivalents at end of period $ 74,390 $ 46,127 ================ =============== See notes to condensed consolidated financial statements.
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION: The accompanying unaudited condensed financial statements have been prepared in accordance with the instructions to Form 10Q and do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the year ended December 31, 2005. Interim financial statements should be read in conjunction with the Company's annual audited financial statements and other disclosures included in the Company's most recent Form 10K. 7 NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (2) FORWARD-LOOKING STATEMENTS: Forward-looking statements in this report are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve inherent risks and uncertainties. Readers are encouraged to review the Company's annual report for its full statement regarding forward-looking information. (3) RESTATEMENT: On December 20, 2005, and in conjunction with the Company's preparations for year-end reporting, the Company concluded that its accounting treatment for certain of its investments in limited partnerships to be technically incorrect. As a result, the Company has restated these interim financial statements for the 2005 second quarter. This discovery will also affect the Company's financial statements for the 2005 third quarter which will also be restated. No interim or annual periods ending prior to June 30, 2005 are affected by this restatement. Accounting principles generally accepted in the United States currently require an investor in a limited partnership to record their proportionate share of the investee's net income using the equity method of accounting. To the extent that the limited partnership investees include both realized and unrealized investment gains or losses in the determination of net income or loss, then the investor would also recognize, through its income statement, its proportionate share of the investee's unrealized as well as realized investment gains or losses. The Company invests in limited partnerships that include unrealized investment gains and losses in the determination of their net income or loss. For the quarter ending June 30, 2005, as previously reported, the Company recorded its share of limited partnership unrealized gains in shareholders' equity. The Company's income statement reflected only gains or losses reported as realized by the limited partnerships. While the proper carrying value of the investments was recorded on the Company's balance sheet at June 30, 2005, the Company's reporting of the portion of the increase in value of the limited partnerships attributable to unrealized gains as a component of the Company's shareholders' equity has subsequently been determined to be not in technical compliance with authoritative accounting guidance. An unaudited table presenting the effects of the revisions to the Company's financial statements is set forth below: 8
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) AS REPORTED ADJUSTMENT AS RESTATED --------------- ---------------- --------------- FOR THE THREE MONTHS ENDED JUNE 30, 2005 Net gains on investments $ 532 $ 2,656 $ 3,188 Federal income taxes 3,611 930 4,541 Net income 7,473 1,726 9,199 Basic earnings per share .51 .12 .63 Diluted earnings per share .50 .12 .62 FOR THE SIX MONTHS ENDED JUNE 30, 2005 Net gains on investments $ 5,468 $ 2,656 $ 8,124 Federal income taxes 8,744 930 9,674 Net income 17,819 1,726 19,545 Basic earnings per share 1.21 .12 1.33 Diluted earnings per share 1.20 .12 1.32 UNAUDITED BALANCE SHEET (IN THOUSANDS) AS REPORTED ADJUSTMENT AS RESTATED --------------- --- ---------------- --- --------------- JUNE 30, 2005 Unrealized net gains on investments $ 41,172 $ (1,726) $ 39,446 Retained earnings 256,897 1,726 258,623 Total shareholders' equity 336,151 - 336,151
(4) NET GAINS ON INVESTMENTS: Amounts reported as net gain on investments consist of three components: (1) net gains or losses realized upon the actual sale of investments managed directly by the Company's investment managers, (2) changes in the allowance for "other-than-temporary impairment" of investments, and (3) equity in earnings or losses of investments in limited partnerships. The Company accounts for investments in limited partnerships using the equity method of accounting, which requires an investor in a limited partnership to record its proportionate share of the limited partnership's net income. To the extent that the limited partnership investees include both realized and unrealized investment gains or losses in the determination of net income or loss, then the Company would also recognize, through its income statement, its proportionate share of the investee's unrealized as well as realized investment gains or losses. The Company invests in limited partnerships that include both realized and unrealized investment gains or losses in the determination of their net income. Readers are cautioned that inclusion of such unrealized gains is not consistent with the recognition of temporary valuation changes of equity and debt securities that are directly owned and held for sale and may result in significant fluctuations in quarterly amounts reported under this caption. In addition, because of inherent time lags in receiving valuation reports from certain limited partnership investees, the Company must rely on estimations of valuation changes for the most recent month or quarter ended on the reporting date. To the extent that the actual valuations subsequently reported differ from estimates utilized, the differences are included in gains from investments in the quarter reported to the Company. 9 Following is a summary of the components of net gains on investments for the periods presented in the accompanying statements of income.
THREE MONTHS Three Months SIX MONTHS Six Months ENDED Ended ENDED Ended JUNE 30, 2005 June 30, 2004 JUNE 30, 2005 June 30, 2004 --------------- --------------- --------------- ---------------- Realized net gains on the disposal of securities $ 2,532 $ 1,470 $ 4,702 $ 6,719 Change in allowance for other-than-temporary impairment of invested assets 150 975 145 1,113 Equity in earnings (losses) of limited partnership investments (realized and unrealized) 506 (155) 3,277 276 --------------- --------------- --------------- ---------------- Totals $ 3,188 $ 2,290 $ 8,124 $ 8,108 =============== =============== =============== ================
The limited partnerships in which the Company holds an ownership interest invest in a broad range of publicly traded and privately held equity and debt securities, both domestic and foreign, as well as real estate and other business ventures. The earnings or losses reported by the limited partnerships may be subject to significant volatility. Readers are cautioned that the recording of the Company's proportionate share of the limited partnership's earnings or losses may result in significant fluctuations in the quarterly amounts reported under this caption. (5) REINSURANCE: The following table summarizes the Company's transactions with reinsurers for the 2005 and 2004 comparative periods.
2005 2004 ------------ ----------- Quarter ended June 30: Premiums ceded to reinsurers $ 9,490 $ 21,637 Losses and loss expenses ceded to reinsurers 8,674 30,170 Commissions from reinsurers 1,950 5,733 Six months ended June 30: Premiums ceded to reinsurers 23,088 40,886 Losses and loss expenses ceded to reinsurers 22,888 48,118 Commissions from reinsurers 5,086 10,936
(6) COMPREHENSIVE INCOME OR LOSS: Total realized and unrealized income for the quarter ended June 30, 2005 was $11,170 and compares to total realized and unrealized income of $3,286 for the quarter ended June 30, 2004. For the six months ended June 30, 2005, total realized and unrealized income was $14,385 and compares to total realized and unrealized income of $14,509 for the six months ended June 30, 2004. 10 NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (7) REPORTABLE SEGMENTS - PROFIT OR LOSS: The following table provides certain profit and loss information for each reportable segment. All amounts presented are computed based upon generally accepted accounting principles. In addition, segment profit for fleet trucking includes the direct marketing agency operations conducted by the parent company and is computed after elimination of inter-company commissions and, accordingly, segment profit presented here will not agree with statutory underwriting gains for this segment which may be quoted elsewhere in the Company's financial statements.
2005 2004 -------------------------------------------- ------------------------------------------ DIRECT AND NET Direct and Net ASSUMED PREMIUM SEGMENT Assumed Premium Segment PREMIUM EARNED AND PROFIT Premium Earned and Profit WRITTEN FEE INCOME (LOSS) Written Fee Income (Loss) ------------ ------------ ------------ ------------- ------------ ------------ QUARTER ENDED JUNE 30: PROTECTIVE PRODUCTS: Fleet trucking $34,859 $ 27,789 $ 7,795 $ 44,345 $ 25,650 $ 7,141 Reinsurance assumed 1,927 2,706 1,121 1,918 2,913 1,756 SAGAMORE PRODUCTS: Personal division 8,418 11,296 899 8,799 11,600 1,820 Commercial division: Small fleet trucking 4,117 2,289 128 4,338 2,559 136 Workers' compensation 97 837 (146) 3,110 2,125 (441) ------------ ------------ ------------ ----------- ----------- ------------ Total Commercial division 4,214 3,126 (18) 7,448 4,684 (305) All other 515 262 (235) 379 307 (105) ------------ ------------ ------------ ----------- ----------- ------------ Totals $49,933 $ 45,179 $ 9,562 $ 62,889 $ 45,154 $ 10,307 ============ ============ ============ =========== =========== ============ SIX MONTHS ENDED JUNE 30: PROTECTIVE PRODUCTS: Fleet trucking $ 78,106 $ 58,612 $ 14,608 $ 3,516 $ 46,916 $ 13,462 Reinsurance assumed 4,418 5,228 2,619 4,836 5,988 3,663 SAGAMORE PRODUCTS: Personal division 23,487 22,325 2,129 23,980 22,828 3,171 Commercial division: Small fleet trucking 7,634 4,489 250 8,203 5,083 468 Workers' compensation 92 2,222 115 5,898 4,070 (670) ------------ ------------ ------------ ----------- ----------- ------------ Total Commercial division 7,726 6,711 365 14,101 9,153 (202) All other 793 694 (394) 619 549 (187) ------------ ------------ ------------ ----------- ----------- ------------ Totals $ 114,530 $ 93,570 $ 19,327 $ 27,052 $ 85,434 $19,907 ============ ============ ============ =========== =========== ============
11 NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (8) REPORTABLE SEGMENTS - RECONCILIATION TO CONSOLIDATED REVENUE AND CONSOLIDATED PROFIT OR LOSS: The following tables are reconciliations of reportable segment revenues and profit or loss to the Company's consolidated revenue and income before federal income taxes, respectively.
Three Months Ended Six Months Ended June 30 June 30 2005 2004 2005 2004 --------------- ---------------- --------------- ----------------- (AS RESTATED, (AS RESTATED, SEE NOTES 3 SEE NOTES 3 AND 4) AND 4) REVENUE: Net premium earned and fee income $ 45,179 $ 45,154 $ 93,570 $ 85,434 Net investment income 3,547 3,008 6,855 6,180 Net gains on investments 3,188 2,290 8,124 8,108 Other 97 52 201 175 --------------- ---------------- --------------- ----------------- Total consolidated revenue $ 52,011 $ 50,504 $ 108,750 $ 99,897 =============== ================ =============== ================= PROFIT: Segment profit $ 9,562 $ 10,307 $ 19,327 $ 19,907 Net investment income 3,547 3,008 6,855 6,180 Net gains on investments 3,188 2,290 8,124 8,108 Corporate expenses (2,557) (2,556) (5,087) (5,088) --------------- ---------------- --------------- ----------------- Income before federal income taxes $ 13,740 $ 13,049 $ 29,219 $ 29,107 =============== ================ =============== =================
(9) LOANS TO EMPLOYEES: In 2000, 2001 and 2002 the Company provided loans to certain employees for the sole purpose of purchasing the Company's Class B common stock in the open market. $7,260 of such full-recourse loans were issued and $2,282 remain outstanding at June 30, 2005 and carry interest rates of between 4.75% and 6%, payable annually on the loan anniversary date. The underlying securities serve as collateral for these loans, which must be repaid no later than 10 years from the date of issue. No additional loans will be made under this program. 12 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ------------------------------------------------------------------------------- OF OPERATIONS ------------- LIQUIDITY AND CAPITAL RESOURCES ------------------------------- The Company generally experiences positive cash flow from operations resulting from the fact that premiums are collected on insurance policies in advance of the disbursement of funds in payment of claims. Operating costs of the property/casualty insurance subsidiaries, other than loss and loss expense payments and commissions paid to related agency companies, generally average between 25% and 35% of premiums earned and the remaining amount is available for investment for varying periods of time pending the settlement of claims relating to the insurance coverage provided. The Company's cash flow relating to premiums is significantly affected by reinsurance programs in effect from time-to-time whereby the Company cedes both premium and risk to other insurance and reinsurance companies. These programs vary significantly among products and overall premium ceded rates, net of ceding commission allowances, have generally decreased since 2001, reflective of the effect of the provisions of reinsurance agreements currently in place. For the six months ended June 30, 2005, the Company experienced positive cash flow from operations totaling $15.8 million, down significantly from the $26.6 million generated during the first half of 2004. The decrease in positive cash flow is due largely to a $14.6 million increase in net losses paid when compared to the first six months of 2004. Additionally, the Company returned $2.4 million in deposits held on behalf of its insureds during the first half of 2005 compared to a $3.1 million increase in deposits held during the 2004 period corresponding with a decrease in direct premium written. Although direct premium writings decreased, changes in reinsurance agreements allowed for a modest increase ($1.4 million) in net premiums collected when compared to the first six months of 2004. Operating expense paid, before consideration of ceding commission from reinsurers, also decreased $6.9 million from the 2004 period commensurate with the decrease in premium volume. For several years, the Company's investment philosophy has emphasized the purchase of relatively short-term instruments with maximum quality and liquidity. The average life of the Company's fixed income (bond and short-term investment) portfolio was approximately 2.2 years at June 30, 2005 representing a small decrease from the prior year end as significant portions of the proceeds from maturing investments and new cash flows have been placed in short-term investments in anticipation of further interest rate increases. The Company's assets at June 30, 2005 included $74.4 million in investments classified as short-term or cash equivalents that were readily convertible to cash without significant market penalty. An additional $111.0 million of fixed maturity investments will mature within the twelve-month period following June 30, 2005. The Company believes that these liquid investments are more than sufficient to provide for projected claim payments and operating cost demands even before consideration of current positive cash flows. Consolidated shareholders' equity is composed largely of GAAP shareholder's equity of the insurance subsidiaries. As such, there are statutory restrictions on the transfer of portions of this equity to the parent holding company. At June 30, 2005, $49.3 million may be transferred by dividend or loan to the parent company without approval by, or notification to, regulatory authorities. An additional $201.8 million of shareholder's equity of the insurance subsidiaries may be advanced or loaned to the parent holding company with prior notification to, and approval from, regulatory authorities. The Company believes that these restrictions pose no material liquidity concerns to the Company. The financial strength and stability of the subsidiaries would permit ready access by the parent company to short-term and long-term sources of credit. 13 The Company's annualized premium writing to surplus ratio for the first half of 2005 was approximately 44%. Regulatory guidelines generally allow for writings of 200% of surplus. Accordingly, the Company can increase premium writings significantly with no need to raise additional capital. Further, the Insurance Subsidiaries' individual capital levels are several times higher than the minimum amounts designated by the National Association of Insurance Commissioners. RESULTS OF OPERATIONS --------------------- COMPARISONS OF SECOND QUARTER, 2005 TO SECOND QUARTER, 2004 ----------------------------------------------------------- Net premium earned during the second quarter of 2005 was essentially level with the second quarter of 2004. A 9% increase in premiums from the Company's fleet trucking program was offset by decreases in the remainder of the Company's products. In particular, premiums from the Company's small business workers' compensation program decreased 60% due to its discontinuance late in 2004. The small fleet trucking and private passenger automobile programs decreased 11% and 3%, respectively, due primarily to competitive pressures in the marketplace. Direct premiums written and assumed during the second quarter of 2005 totaled $49.9 million, a 21% decrease from the $62.9 million reported a year earlier. This decrease is due largely to a $9.5 million (21%) decrease in direct premiums written from the Company's fleet trucking program. Included in this decrease is a return premium adjustment on experience-rated policies within the Company's Independent Contractor program of approximately $4.1 million which was significantly higher than the $.4 million return recorded in the second quarter of 2004 and the average of $1.2 million per quarter for the year 2004. The remainder of the decrease for fleet trucking is due to competitive pressures in a softening market. In addition, direct premiums written for the Company's discontinued small business workers' compensation product dropped $3.0 million (97%) from the prior year period. Decreases in premium writings for the Company's private passenger automobile and small fleet trucking programs of $.4 million (4%) and $.2 million (5%), respectively, contributed to the decline from the prior year period. Premium ceded to reinsurers averaged 19.8% of direct premium production for the current quarter compared to 35.8% a year earlier reflecting changes in reinsurance agreements whereby the Company is retaining a larger portion of risks underwritten. This reduction in premium ceded was instrumental in allowing for net premium earned to remain level for the quarter despite the decline in gross production. Net investment income, before tax, during the second quarter of 2005 was 18% higher than the second quarter of 2004 due to increases in both average invested assets and in yields on bonds and short-term investments. Pre-tax yields on short-term investments quadrupled from the prior year period. Overall after tax yields posted similar increases. The second quarter 2005 net investment gain of $3.2 million consisted primarily of net gains on equity securities and limited partnership investments of $2.8 million and $.6 million, respectively, and was partially offset by net losses on fixed maturity investments of $.2 million. The limited partnerships in which the Company holds an ownership interest invest in a broad range of publicly traded and privately held equity and debt securities, both domestic and foreign, as well as real estate and other business ventures. The earnings or losses reported by the limited partnerships may be subject to significant volatility. Readers are cautioned that the recording of the Company's proportionate share of the limited partnership's earnings or losses may result in significant fluctuations in the quarterly amounts reported under this caption. See footnote 4 to the enclosed financial statements for a more detailed discussion regarding the accounting policies and the net gains reported for the Company's investments in limited partnerships. 14 Losses and loss expenses incurred during the second quarter of 2005 decreased $1.8 million from that experienced during the second quarter of 2004. Loss ratios for each of the Company's major product lines were as follows:
2005 2004 ------- ------- Fleet trucking 65.5% 78.4% Private passenger automobile 65.0 56.7 Small fleet trucking 54.7 60.7 Voluntary reinsurance assumed 40.2 17.8 Small business workers' compensation 101.9 87.8 All lines 64.3 68.5
The decrease in the fleet trucking ratio is due to the reserve savings on claims related to the experience-rated policies previously mentioned and a return to historical levels of frequency and severity. The Company's large policy limits and net retention of risk in its fleet trucking products may result in significant variation in loss activity from period to period. Other operating expenses for the second quarter of 2005 increased 33% from the second quarter of 2004. Adjusted for ceding allowances, operating expenses decreased 9% from the second quarter of 2004 and compares favorably with level premiums earned for the quarter as many of the Company's expenses do not vary directly with premium volume. Ceding allowances as a percentage of direct expenses have declined due to changes in the Company's reinsurance structure whereby the Company now retains a greater percentage of the risk compared to prior periods, particularly within the Large and Medium Fleet trucking products. Ceding allowances totaled $2.0 million for the 2005 quarter compared to $5.7million for the 2004 quarter. The ratio of consolidated other operating expenses to operating revenue was 21.1% during the second quarter of 2005 compared to 16.0% for the 2004 second quarter. The effective federal tax rate for consolidated operations for the second quarter of 2005 was 33.0% and is less than the statutory rate primarily because of tax exempt investment income. As a result of the factors mentioned above, net income increased $.3 million (3.3%) during the second quarter of 2005 as compared with the 2004 second quarter. COMPARISONS OF SIX MONTHS ENDED JUNE 30, 2005 TO ------------------------------------------------ SIX MONTHS ENDED JUNE 30, 2004 ------------------------------ Net premiums earned increased $8.2 million (10%) during the first six months of 2005 as compared to the same period of 2004. The increased premium volume is primarily attributable to a 26% increase in the Company's fleet trucking product. The Company experienced decreases in the remainder of its products, primarily from the discontinued small business workers' compensation product which posted a 44% decline. In addition, net premiums earned for the voluntary reinsurance assumed, small fleet and private passenger automobile products decreased 14%, 11% and 3%, respectively. Direct premiums written and assumed during the first half of 2005 totaled $114.5 million, a 10% decrease from the $127.1 million reported a year earlier. All products experienced a decline in direct premium volume for reasons cited in the comparison of the second quarters. The most significant decrease was in the discontinued small business workers' compensation product, at $5.8 million. Premium ceded to reinsurers averaged 21.0% of direct premium production for the current period compared to 33.7% a year earlier. 15 Net investment income during the first half of 2005 was 11% higher than the 2004 period for the same reasons as indicated in the quarterly comparison above. After tax investment income was also 11% higher than 2004 levels. Overall pre-tax and after tax yields were higher during the current period while average invested funds increased 4% from the prior year, resulting from positive cash flow. The net gain on investments of $8.1 million for the first six months of 2005 consists of net gains on equity securities and limited partnership investments of $5.0 million and $3.3 million, respectively, and was partially offset by $.1 million in losses on fixed maturity investments, after consideration of impairment changes during the period. The limited partnerships in which the Company holds an ownership interest invest in a broad range of publicly traded and privately held equity and debt securities, both domestic and foreign, as well as real estate and other business ventures. The earnings or losses reported by the limited partnerships may be subject to significant volatility. Readers are cautioned that the recording of the Company's proportionate share of the limited partnership's earnings or losses may result in significant fluctuations in the quarterly amounts reported under this caption. See footnote 4 to the enclosed financial statements for a more detailed discussion regarding the accounting policies and the net gains reported for the Company's investments in limited partnerships. Losses and loss expenses incurred during the first six months of 2005 increased $4.6 million from the first six months of 2004, consistent with the increased premium volume previously discussed. Loss and loss expense ratios for the comparative six-month periods were as follows:
2005 2004 ------- ------- Fleet trucking 70.1% 77.1% Private passenger automobile 62.8 58.3 Small fleet trucking 54.7 59.2 Voluntary reinsurance assumed 34.4 14.7 Small business workers' compensation 73.3 85.2 All lines 66.1 67.1
Other operating expenses increased $4.1 million (26%) during the first six months of 2005 compared to the same period of 2004. Ceding commission allowances included in net expenses were $5.1 million for the 2005 period compared to $10.9 million in the prior year period, while expenses before consideration of ceding allowances actually decreased $1.7 million despite the 10% increase in premium earned. The ratio of other operating expenses to total operating revenue (adjusted for realized gains) was 19.8% for 2005 compared to 17.2% for 2004 for reasons mentioned in the quarterly comparison. The effective federal tax rate for consolidated operations for the first six months of 2005 was 33.1% and is less than the statutory rate primarily because of tax exempt investment income. As a result of the factors mentioned above, net income decreased $.2 million (1.1%) during the first half of 2005 as compared with the 2004 period. 16 FORWARD-LOOKING INFORMATION --------------------------- Any forward-looking statements in this report, including without limitation, statements relating to the Company's plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following: (i) the Company's plans, strategies, objectives, expectations and intentions are subject to change at any time at the discretion of the Company; (ii) the Company's business is highly competitive and the entrance of new competitors into or the expansion of the operations by existing competitors in the Company's markets and other changes in the market for insurance products could adversely affect the Company's plans and results of operations; (iii) other risks and uncertainties indicated from time to time in the Company's filings with the Securities and Exchange Commission; and (iv) other risks and factors which may be beyond the control or foresight of the Company. CRITICAL ACCOUNTING POLICIES ---------------------------- Subsequent to the filing of the Form 10-Q for the quarter ended June 30, 2005, management determined that the accounting policy related to the recognition of income from limited partnership investments was not in technical compliance with generally accepted accounting principles. Specifically, that portion of increases in the valuation of limited partnership investees estimated to consist of unrealized gains was originally reported by the Company as an adjustment to shareholders' equity rather than as current income. As such, the Company accounted for these reported increases in value as it would if it held the underlying assets directly, by recording the realized gain component in income and the unrealized gain component directly in equity. As more fully described in footnotes (3) and (4) starting on page 7, the accompanying unaudited financial statements have been restated to reflect the correct accounting treatment, which is to treat all increases in value, realized or unrealized, as current income. No periods ending prior to June 30, 2005 were affected by this restatement. There have been no other changes in the Company's critical accounting policies as disclosed in the Form 10K filed for the year ended December 31, 2004. CONCENTRATIONS OF CREDIT RISK ----------------------------- The insurance subsidiaries cede portions of their gross premiums to numerous reinsurers under quota share and excess of loss treaties as well as facultative placements. These reinsurers assume commensurate portions of the risk of loss covered by the contracts. As losses are reported and reserved, portions of the gross losses attributable to reinsurers are established as receivable assets and losses incurred are reduced. At June 30, 2005, amounts due from reinsurers on paid and unpaid losses total approximately $217 million. Included in this total are known losses of approximately $22 million due from Converium Insurance (North America) Inc., approximately $5 million due from PMA Re and approximately $.7 million from Trenwick Re., each of which have reported substantial reserve strengthening and/or impairment of assets which have negatively affected their reported financial positions. All amounts due from these reinsurers on paid claims are current and the Company has no information at this time to indicate that all obligations of these reinsurers will not be met. At June 30, 2005, other long-term investments includes approximately $23.8 million consisting of three limited partnerships which are managed by organizations in which two of the Company's directors are officers, directors, general partners or owners. Certain of these investments contain profit sharing agreements to the affiliated organizations. 17 ITEM 4. CONTROLS AND PROCEDURES ------------------------------- (a) The Corporation's Chief Executive Officer and Chief Financial Officer evaluated the disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Corporation's disclosure controls and procedures were not effective as of June 30, 2005 based solely on the impact of the restatement of the enclosed unaudited condensed consolidated financial statements as of and for the three and six months ending June 30, 2005. The Company invests in limited partnerships that include unrealized investment gains and losses in the determination of their net income or loss. Generally accepted accounting principles require an investor in a limited partnership to record their proportionate share of the limited partnership's net income using the equity method of accounting. To the extent that the limited partnerships include both realized and unrealized investment gains or losses in the determination of net income or loss, then the investor would also recognize, through its income statement, its proportionate share of the limited partnerships unrealized as well as realized investment gains or losses. For the three and six months ending June 30, 2005, the Company initially recorded its share of limited partnership unrealized gains in shareholders' equity and the Company's income statement reflected only gains or losses reported as realized by the limited partnerships. The Company has determined that its accounting for certain limited partnerships was technically incorrect and as a result, has restated its interim financial statements as of and for the three and six months ending June 30, 2005. The restatement resulted from a failure on the part of Company personnel to recognize that accounting for the ownership of assets through a limited partnership may be different from accounting for the same assets, if owned directly. The failure to properly interpret generally accepted accounting principles, in this instance, resulted in a material change in reported net income. The restatement resulted in no change to total invested assets, total assets, total shareholders' equity, comprehensive income or cash flow. In the fourth quarter of 2005, the Company's management made the appropriate changes to its accounting policy for limited partnership investments. Due to the isolated nature of this error, management is confident this issue has been remediated. (b) Other than indicated above, there were no significant changes in the Corporation's internal control over financial reporting identified in connection with the foregoing evaluation that occurred during the Corporation's last fiscal quarter that have affected, or are reasonably likely to materially affect, the Corporation's internal control over financial reporting. However, subsequent to June 30, 2005, the Company took the remedial actions described above. 18 PART II - OTHER INFORMATION ITEM 6 (a) EXHIBITS -------------------- NUMBER AND CAPTION FROM EXHIBIT TABLE OF REGULATION S-K ITEM 601 EXHIBIT NO. -------------------------------- ----------- (11) Statement regarding computation EXHIBIT 11 - of per share earnings Computation of Per Share Earnings (31.1) Certification of CEO EXHIBIT 31.1 pursuant to Section 302 of the Certification of CEO Sarbanes-Oxley Act of 2002 (31.2) Certification of CFO EXHIBIT 31.2 pursuant to Section 302 of the Certification of CFO Sarbanes-Oxley Act of 2002 (32.1) Certification of CEO EXHIBIT 32.1 pursuant to 18 U.S.C. 1350, as Certification of CEO adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (32.2) Certification of CFO EXHIBIT 32.2 pursuant to 18 U.S.C. 1350, as Certification of CFO adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ITEM 6 (b) REPORTS ON FORM 8-K ------------------------------- A Form 8-K was filed by the registrant on April 27, 2005 regarding its earnings announcement for the first quarter of 2005. 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. BALDWIN & LYONS, INC. Date JANUARY 18, 2006 By /S/ GARY W. MILLER ----------------------- -------------------------------- Gary W. Miller, Chairman and CEO Date JANUARY 18, 2006 By /S/ G. PATRICK CORYDON ----------------------- -------------------------------- G. Patrick Corydon, Senior Vice President - Finance (Principal Financial and Accounting Officer) 20 BALDWIN & LYONS, INC. Form 10-Q/A for the fiscal quarter ended June 30, 2005 INDEX TO EXHIBITS Begins on sequential page number of Form Exhibit Number 10-Q/A -------------- ------------------------------- EXHIBIT 11 Filed herewith electronically Computation of per share earnings EXHIBIT 31.1 Filed herewith electronically Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act EXHIBIT 31.2 Filed herewith electronically Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act EXHIBIT 32.1 Filed herewith electronically Certification of CEO pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act EXHIBIT 32.2 Filed herewith electronically Certification of CFO pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act