GEICO CASUALTY COMPANY EXAMINATION: DECEMBER 31, 2009 NAIC NUMBER: 41491

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1 GEICO CASUALTY COMPANY EXAMINATION: DECEMBER 31, 2009 NAIC NUMBER: 41491

2 TABLE OF CONTENTS Page Salutation. 1 Scope of Examination...1 Status of Prior Examination Findings...2 Summary of Significant Findings...2 Subsequent Events...3 History...3 General...3 Capital Stock...4 Dividends to Stockholders...4 Management...4 Committees...6 Conflicts of Interest...6 Corporate Records...6 Affiliated Companies...6 Intercompany Agreements...8 Fidelity Bond and Other Insurance...9 Pension, Stock Ownership and Insurance Plans...9 Statutory Deposits...9 Territory and Plan of Operation...10 Insurance Products and Related Practices...11 Growth of Company...11 Loss Experience...12 Reinsurance...12 Accounts and Records...13 Financial Statements...14 Balance Sheet...15 Assets...15 Liabilities, Surplus and Other Funds...16 Statement of Income...17 Capital and Surplus Account...18 Analysis of Examination Changes to Surplus...19 Comparative Financial Position of the Company...20 Notes to Financial Statements...21 Comments and Recommendations...23 Conclusion...25 Signatures...26

3 Baltimore, Maryland December 1, 2010 Honorable Joseph Torti, III Chairman, NAIC Financial Condition (E) Committee Superintendent Rhode Island Division of Insurance Department of Business Regulation State of Rhode Island 1511 Pontiac Avenue, Bldg. #69-2 Cranston, Rhode Island Honorable Elizabeth Sammis Acting Insurance Commissioner Maryland Insurance Administration 200 St. Paul Place, Suite 2700 Baltimore, Maryland Dear Madam and Sir: In compliance with your instructions and in accordance with Section of the Insurance Article of the Annotated Code of Maryland, an association examination has been conducted of the financial condition and activities of the GEICO CASUALTY COMPANY (hereinafter called the Company), at its home offices located at 5260 Western Ave; Chevy Chase, Maryland 20815, and the following Report on Examination is submitted. SCOPE OF EXAMINATION This examination, covering the period from January 1, 2005 to December 31, 2009, including any material transactions and/or events noted occurring subsequent to December 31, 2009, was conducted under the Association Plan of the National Association of Insurance Commissioners (NAIC) by examiners of the Maryland Insurance Administration, representing the Northeastern Zone of the NAIC. The Southeastern, Midwestern, and Western zones were invited to participate but did not respond to the examination call. Concurrent with this examination, we also examined the following companies in the GEICO Corporation Group: Government Employees Insurance Company GEICO General Insurance Company GEICO Indemnity Company

4 Our examination was conducted in accordance with examination policies and standards established by the Maryland Insurance Administration and in accordance with the NAIC s Financial Condition Examiners Handbook. The Handbook requires that we: plan and perform the examination to evaluate the financial condition and identify prospective risks of the company by obtaining information about the company, including corporate governance; identify and assess inherent risks within the company; and evaluate controls and procedures used to mitigate those risks. An examination also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation, and management s compliance with Statutory Accounting Principles and annual statement instructions. All accounts and activities of the company were considered in accordance with the riskfocused examination process. The Company was audited annually by an independent public accounting firm. The firm expressed unqualified opinions on the Company s financial statements for calendar years 2005 through We placed substantial reliance on the audited financial statements for calendar years 2005 through 2008, and consequently performed only minimal testing for those periods. We concentrated our examination efforts on the year ended December 31, We reviewed the working papers prepared by the independent public accounting firm related to the audit for the year ended December 31, 2009 and directed our efforts to the extent practical to those areas not covered by the firm s audit. STATUS OF PRIOR EXAMINATION FINDINGS Our prior examination of the Company was a full scope examination covering the period from January 1, 2000 to December 31, There were no recommendations noted in our Report of Examination, which was dated January 12, SUMMARY OF SIGNIFICANT FINDINGS Our examination did not disclose any material adverse findings or material adjustments to the Company s 2009 annual statement. However, our examination disclosed areas of non-compliance and areas in which board oversight could be improved, which are discussed in the Comments and Recommendations section of this Report, under the captions Conflicts of Interest, Corporate Records, Dividends to Stockholder, and Custodial Arrangements. 2

5 SUBSEQUENT EVENTS Reinsurance: Effective January 1, 2010, the reinsurance agreement between the Company and its parent, GEICO Indemnity Company (GEICO Indemnity) was terminated. Under the termination clause of the agreement, the parent shall return to the Company the 90% Quota Share of net retained losses and underwriting expenses on policies written by the Company and assumed by the parent. On January 1, 2010, the portfolio cession resulted in the following liabilities being returned to the Company: unearned premium reserves, loss reserves, loss adjustment expense reserves, other underwriting liabilities and taxes, licenses and fees liabilities. The Company received approximately $354 million from the parent as settlement of the liabilities. As a result of the transaction, any development on policies ceded by the Company prior to January 1, 2010, will develop in the Company. Capital Contribution: In connection with the aforementioned termination of the reinsurance agreement, the Company received a $225 million cash capital contribution from its parent GEICO Indemnity on March 31, 2010 to ensure that the Company will have sufficient capital. General: HISTORY The Company was incorporated on August 31, 1982 under the laws of Maryland as the Guardian Casualty Company. The name of the Company was changed to Criterion Casualty Company in early 1983 and actual operations began in May, The current name was later changed to GEICO Casualty Company on January 6, The Company is wholly owned by GEICO Indemnity Company (GEICO Indemnity), a Maryland domestic property and casualty insurer. GEICO Indemnity in turn is a wholly-owned subsidiary of GEICO Corporation. On August 25, 1995, the boards of directors of Berkshire Hathaway Inc. (Berkshire) and GEICO Corporation approved an Agreement and Plan of Merger for Berkshire to acquire GEICO Corporation. At the same time, HPKF Inc., an indirect subsidiary of Berkshire, would be merged into GEICO Corporation, with GEICO Corporation as the surviving entity. Following the merger, GEICO Corporation became an indirect wholly owned subsidiary of Berkshire. The agreement was subject to the approval of state insurance regulators as well as the holders of a majority of GEICO Corporation s shares not previously owned by Berkshire. The agreement was approved by the Maryland Insurance Administration effective October 13, 1995, and the merger was consummated on January 2, The primary purpose for which the Company was formed was to write insurance against any kind of loss, damage or liability subject to insurance, if such insurance was not disapproved by the Maryland Insurance Commissioner as being contrary to the law or public 3

6 policy. The Company primarily writes automobile and physical damage insurance at nonstandard rates for persons who do not qualify as preferred or standard risks. Capital Stock: The Company s Articles of Amendment to Articles of Incorporation authorized the Company to issue 860,000 shares of common stock with a par value of $3.50 per share. As of December 31, 2009, the Company had 860,000 shares of common stock outstanding with an aggregate par value of $3,010,000. All of the outstanding common stock is owned by GEICO Indemnity Company. Dividends to Stockholder: The Company did not declare or pay any dividends during our examination period. Management: The following persons were serving as the Company's directors as of December 31, 2009: Name and Address Olza M. Nicely, Chairman Great Falls, VA Michael H. Campbell Potomac, MD Seth M. Ingall Melville, NY Principal Occupation Chairman of the Board, President and Chief Executive Officer, GEICO Casualty Company Senior and Chief Financial Officer, GEICO Casualty Company, GEICO Casualty Company S. Gregory Kalinsky, San Diego, CA GEICO Casualty Company Donald R. Lyons Tampa, FL Robert M. Miller Dallas, TX Nancy L. Pierce Alexandria, VA Senior, GEICO Casualty Company Senior, GEICO Casualty Company, GEICO Casualty Company 4

7 Jess C. Reed Gaithersburg, MD William E. Roberts Cabin John, MD Group and Chief Information Officer, GEICO Casualty Company Executive, GEICO Casualty Company The following persons were serving as the Company's officers as of December 31, 2009: Name Position Olza M. Nicely Chairman of the Board, President and Chief Executive Officer William E. Roberts Executive Donald R. Lyons Senior Robert M. Miller Senior Michael H. Campbell Senior and Chief Financial Officer Jess C. Reed Group and Chief Information Officer J. Gary Brown Shawn A. Burklin Steven W. Cunningham Martha T. Furnas Richard T. Guertin Lily S. Hopkins Seth M. Ingall John J. Izzo S. Gregory Kalinsky Richard A. Kidd Warren A. Klawitter and Chief Actuary John W. McCutcheon William J. McDonald Controller James F. Nayden, Jr. and Legislative Counsel Nancy L. Pierce Dana K. Proulx, General Counsel and Assistant Secretary William C. E. Robinson Secretary George W. Rogers Rynthia M. Rost-Buccine Tama S. Ruiz Charles G. Schara Treasurer Daniel S. Schechter Jan C. Stewart Joseph R. Thomas Edward W. Ward, III 5

8 Mary F. Zarcone John J. Zinno Committees: As of December 31, 2009, the Company's Board of Directors had not appointed any committees. However, the Company s Chief Executive Officer had created several management committees, including an audit committee. Conflicts of Interest: Code of Maryland Regulation requires companies to have a Board of Directors resolution or by-law setting forth the company s policy as to disclosure of a possible conflict of interest on the part of its officers, directors and responsible employees and that any potential conflict be referred to the Board of Directors for review and appropriate action. In accordance with this regulation, the Company has adopted a conflict of interest policy requiring all directors, officers and responsible employees to annually complete a questionnaire disclosing any potential conflicts. However, our review of the conflict of interest questionnaires for the years under examination disclosed that while some of the questionnaires disclosed potential conflicts and these potential conflicts were reviewed by the Company s general counsel, the conflicts were not disclosed to the board. It should be noted that the potential conflicts reported did not appear to adversely affect the Company. See additional comments regarding conflicts of interest in the Comments and Recommendations section of this Report, under the caption Conflicts of Interest. Corporate Records: We reviewed the minutes of the meetings of the Board of Directors for the period under examination. Based on our review, except as noted below, it appeared that the minutes documented the Company s significant transactions and events and that the directors approved those transactions and events. However, as disclosed in the Conflicts of Interest section of this Report, the Company s board did not review the conflict of interest questionnaires from the Company s directors, officers and responsible employees. In addition, the minutes did not document the board s review and acceptance of the Maryland Insurance Administration s 2004 report on examination or the independent auditors annual audit reports. See additional comments regarding these conditions in the Comments and Recommendation section of this Report, under the caption Corporate Records. AFFILIATED COMPANIES The Company is a wholly owned subsidiary of GEICO Indemnity Company (GEICO Indemnity), a Maryland domestic property and casualty insurer. GEICO Indemnity is a wholly owned subsidiary of GEICO Corporation, a Delaware insurance holding company. GEICO Corporation in turn is ultimately owned by Berkshire Hathaway Inc. (Berkshire), a publicly traded holding company owning subsidiaries engaged in a number of diverse business activities, including significant insurance activities, utilities and energy, finance, 6

9 manufacturing, services and retailing. According to the Company, as of December 31, 2009, Warren E. Buffett owned and controlled approximately 32% of the voting stock of Berkshire. There were no other stockholders who owned and/or controlled more than 5% of Bershire. Portions of the holding company structure as of December 31, 2009, are depicted in the following chart: Berkshire Hathaway Inc. (Delaware) OBH Inc. (Delaware) National Indemnity Company (Nebraska) Insurer GEICO Corporation (Delaware) Maryland Ventures, Inc. (Delaware) Government Employees Insurance Company (Maryland) Insurer GEICO Indemnity Company (Maryland) Insurer Geico Insurance Agency, Inc. GEICO General Insurance Company (Maryland) Insurer Criterion Insurance Agency, Inc. (Texas) GEICO Casualty Company (Maryland) Insurer All of the subsidiaries shown above are 100% owned. 7

10 Intercompany Charge Agreement: INTERCOMPANY AGREEMENTS Effective August 19, 1992, the Company entered into an Intercompany Charge Agreement that set forth the procedures and methods to be used for the allocation and settlement of premium receipts, claim payments and expenses among the members of the GEICO Corporation group. The agreement states that any transactions under the Intercompany Charge Agreement will be handled in accordance with the method of allocation described in Uniform Accounting: Instruction for Uniform Classification of Expenses, as set forth in the National Association of Insurance Commissioner s (NAIC s) Financial Condition Examiners Handbook. The agreement also provides examples of the basis of allocation. Under the terms of the agreement, the Company s affiliate, Government Employees Insurance Company (GEICO), was designated as the entity that initially processes all premium, claims and expense remittances and payments. Premium and claims related transactions are to include sufficient coding to properly identify the policy and/or claim and the specific entity to which the transaction relates. Expenses are allocated among the entities based initially upon classification as fixed, variable or allocated expenses, with allocations determined based upon coding within their automated Expense Allocation System. The aforementioned agreement has been amended from time to time to add new affiliates of the Company s holding company system, and to delete affiliates that are no longer part of the Company s holding company system. On February 4, 2008, the agreement was also amended to specifically state that allocated expenses are to be calculated monthly in arrears, and that settlements shall be processed within 45 days after the close of each month. During 2009, the Company incurred $112,797,495 for services rendered in conjunction with this agreement. Consolidated Federal Income Tax Allocation Agreements: GEICO Corporation has entered into a Consolidated Federal Income Tax Agreement with its ultimate parent Berkshire Hathaway Inc. The Company is not a party to that agreement. However, the Company and the other entities comprising the GEICO Corporation holding company system are participants in an agreement, dated February 4, 2008, for the allocation of their share of the consolidated tax liability between the members of GEICO Corporation for financial reporting purposes. Under the terms of this agreement, tax liability shall be allocated among members of the group in conformity with specified sections of the Internal Revenue Service Regulations. Under these Regulations, the consolidated tax liability allocated to each of the individual entities will be equivalent to the tax that would have been paid and/or received as if the entity had filed on a separate return basis. Estimated and finalized cash payments and/or refunds are initially settled between the parties and GEICO Corporation. Any subsequent tax obligation or recovery is to be born and/or kept by GEICO Corporation. This agreement replaced the prior Consolidated Federal Income Tax Agreement between members of the GEICO Corporation holding company system which was effective from June 30, 1988 through February 3,

11 Investment Management Agreement: Effective January 1, 2007, the Company and certain affiliates entered into an investment management agreement with Maryland Ventures, Inc. (MVI), a subsidiary of GEICO Corporation. Under the terms of the agreement, MVI agreed to act in the capacity of an advisor by formulating an investment policy and performing management and investment of the Company s assets, including investment reporting, market analysis, valuation of potential assets, and the providing of data processing services. Upon written authorization from the Company, MVI could effect securities transactions under guidelines previously authorized by the Company. The fees and expenses incurred for the services rendered are to be allocated to the individual parties in accordance with the principles set forth in the Intercompany Charge Agreement described above. The allocated expenses are calculated monthly in arrears and settlement is to be processed within thirty (30) days after the close of each month. This agreement replaced the Company s previous Investment Advisory Agreements with GEICO Corporation which had been effective from January 1, 1990 through December 31, During 2009, the Company incurred $15,140 for services provided by MVI. All of the above agreements and amendments to the agreements were submitted to and approved by the Maryland Insurance Administration. FIDELITY BOND AND OTHER INSURANCE GEICO Corporation and its subsidiaries, including the Company, are covered by a fidelity bond with coverage in the amount of $10,000,000 with a single loss limit of liability for forgery/alteration and securities of $5,000,000 each, and a single loss deductible of $250,000. The coverage exceeded the minimum amount of fidelity bond coverage recommended by the National Association of Insurance Commissioners for these companies on a consolidated basis. In addition, the Company had insurance coverage for other risks (e.g., general liability, workers compensation and professional liability). Based on our review, the Company s insurance coverage for these other risks appeared to be adequate. PENSION, STOCK OWNERSHIP AND INSURANCE PLANS As disclosed in the Intercompany Agreements section of this Report, the Company operates under an Intercompany Charge Agreement between members of the GEICO Corporation in which all expenses (including salary and pension and other employee related benefits) are initially paid by the Company s affiliate Government Employees Insurance Company (GEICO) and then allocated to the appropriate company within the holding company system. A pension plan, profit sharing plan, post retirement benefit plan, bonus plans and other employee benefits are administered and maintained by GEICO, and any associated liabilities are recorded by GEICO. The Company s share of any related expenses are charged to the Company under the aforementioned Intercompany Charge Agreement. STATUTORY DEPOSITS 9

12 In compliance with Section of the Insurance Article of the Annotated Code of Maryland, as of December 31, 2009 the Company had deposited in trust with the Maryland State Treasurer, U.S. Treasury Notes with a par value of $2,600,000 and a market value of $2,652,735. This deposit was held for the benefit of all of the Company s policyholders and creditors. In addition, the Company had statutory deposits, consisting of United States Treasury Notes, with the following jurisdictions. These deposits were held for the protection of the policyholders in those jurisdictions. Jurisdiction Par Value Market Value Florida $ 250,000 $ 252,498 Georgia 75,000 75,749 Massachusetts 150, ,499 New Mexico 440, ,397 North Carolina 350, ,190 Virginia 300, ,497 Total $ 1,565,000 $ 1,591,830 TERRITORY AND PLAN OF OPERATION As of December 31, 2009, the Company was authorized to transact the business of insurance in the District of Columbia and forty-nine states of the United States (all except Michigan). The Company obtained its license to write business in Massachusetts, North Carolina, Texas, Vermont and West Virginia during our examination period. During 2009, the Company wrote direct premiums in all of these jurisdictions totaling approximately $471.9 million. The majority of the Company s business was written in the states of California (32%), Florida (13%), Maryland (9%), New Jersey (8%) and Pennsylvania (6%). The Company specializes in the writing of non-standard private passenger automobile insurance to drivers who do not qualify for the standard or preferred risk products offered by its parent, GEICO Indemnity Company, and its affiliates, Government Employees Insurance Company and GEICO General Insurance Company. As indicated in the Reinsurance section of this Report, during our examination period the Company ceded 90% of its business to its parent, GEICO Indemnity Company. This reinsurance agreement was terminated effective January 1, Sales of the Company s products are mainly through the means of telephone and the internet. 10

13 INSURANCE PRODUCTS AND RELATED PRACTICES The Maryland Insurance Administration s Property and Casualty Section s Market Conduct Unit conducted a target examination of the Company s practice of using education and occupation as underwriting factors, and issued a report dated June 8, This report did not disclose any violations. With the exception of this target examination, during our examination period and as of the date of this Report, the Unit had not conducted and was not planning to conduct a market conduct examination of the Company. A market conduct examination would include detailed reviews of the Company s sales and advertising, agent licensing, underwriting and rating, claims processing and complaint handling practices and procedures. During our examination, we did not review the following market conduct related areas: Policy Forms Fair Underwriting Practices Advertising and Sales Materials Treatment of Policyholders Claims Processing (Timeliness) Complaints GROWTH OF COMPANY The following represents the premium activity and it relationship to surplus over the period of our examination (in 000 s): Gross Premium Written: Direct Premiums $471,880 $491,783 $555,239 $620,832 $680,828 Assumed Premiums Affiliates 537 1, Non-Affiliates Total Assumed Premiums $537 $1,130 $3 $14 $609 Total Gross Premium Written $472,417 $492,913 $555,242 $620,846 $681,437 Surplus $145,582 $127,204 $119,078 $109,533 $98,361 Gross Premium Written-to- Surplus 325% 387% 466% 567% 693% As indicated above, direct premiums written have decreased steadily over our examination period from approximately $680,828,000 in 2005 to $471,880,000 in Likewise, gross written premium has decreased steadily over our examination period from approximately $681,437,000 in 2005 to $472,417,000 in This decline is due to a combination of undesirable underwriting results in certain states which prompted the Company to decrease their writings in those states, and a decision to begin writing standard risks in certain states beginning in 2010 resulting in decreased writings as the 11

14 Company attempts to exit the nonstandard market in these areas. The Company s surplus has steadily increased during our examination period from approximately $98,361,000 in 2005 to $145,582,000 in 2009 as a result of investment income. As stated in the Reinsurance section of this Report, the Company cedes 90% of its business to its parent, GEICO Indemnity Company. LOSS EXPERIENCE The Company is required to establish and maintain Case claim reserves, in an amount estimated to be sufficient to cover all known unpaid losses and loss adjustment expenses, and an Incurred but not reported (IBNR) reserve, for incurred losses that have not yet been reported. The combination of the aforementioned reserves should be sufficient to cover the Company s known claims, incurred but not reported claims, and loss adjustment expenses. The following represents the 5-year history of the required reserves (in 000 s): Case claim reserve net $17,365 $17,851 $19,211 $20,050 $21,188 Incurred but not reported reserve (IBNR) - net 5,554 4,813 5,824 6,559 6,448 Total loss reserves $22,919 $22,664 $25,035 $26,609 $27,636 Loss adjustment expense reserves 4,002 3,844 4,202 4,508 4,662 Total loss and loss adjustment expense reserves $26,921 $26,508 $29,237 $31,117 $32,298 Assumed Reinsurance: REINSURANCE During 2009, the Company assumed written premiums totaling $537,365. As of December 31, 2009, the Company had known loss and loss expense reserves for assumed business totaling approximately $146,000. All of the reinsurance assumed by the Company was from its affiliate, Government Employees Insurance Company (GEICO). This business represented non-standard auto liability business that GEICO initially assumed in conjunction with a 100 percent quota share agreement in place with Colonial County Mutual Insurance Company, a Texas-domiciled company, with the business then retroceded 100 percent to the Company. 12

15 Ceded Reinsurance: During 2009, the Company ceded written premiums totaling $424,743,169 and as of December 31, 2009 had recorded reinsurance credits totaling approximately $343,512,000, comprised of $113,138,000 for ceded unearned premiums, $165,304,000 for loss and loss adjustment expense reserves and $65,070,000 for incurred but not reported loss and loss adjustment expense reserves. To the extent that the reinsurers were not able to meet their obligations under the agreement, the Company would be liable for these amounts. The Company ceded 90 percent of its business to its parent, GEICO Indemnity Company, under a quota share reinsurance treaty. This treaty represented over 99.9 percent of the premium cessions by the Company in 2009 and all of the ceded loss and loss adjustment expense reserves as of December 31, Effective January 1, 2010, the treaty was terminated. The remaining ceded premiums related to cessions under mandatory State participating pools. Our review of the aforementioned ceded reinsurance treaty disclosed no unusual provisions. ACCOUNTS AND RECORDS The Company s general accounting records consisted of an automated general ledger and various subsidiary ledgers. Our review did not disclose any significant deficiencies in these records. 13

16 FINANCIAL STATEMENTS The following financial statements reflect the financial condition of the Company as of December 31, 2009, as determined by this examination: STATEMENT PAGE(S) Balance Sheet: Assets 15 Liabilities, Surplus and Other Funds 16 Statement of Income 17 Capital and Surplus Account 18 Analysis of Examination Changes to Surplus 19 Comparative Financial Position of the Company 20 The accompanying Notes to Financial Statements are an integral part of these financial statements. 14

17 Assets BALANCE SHEET ASSETS Nonadmitted Assets Admitted Assets Examination Adjustments Increase (Decrease) Net Admitted Assets Per Examination Bonds (Note 1) $ 41,652,548 $ $ 41,652,548 $ $ 41,652,548 Stocks: (Note 2) Preferred 28,550,000 28,550,000 28,550,000 Common 12,760,852 12,760,852 12,760,852 Cash (174,345), cash equivalents (84,198,518), and short-term investments (32,229,562) 116,602, ,602, ,602,425 Subtotals, cash and invested assets $ 199,565,825 $ 0 $ 199,565,825 $ 0 $ 199,565,825 Investment income due and accrued $ 914,737 $ $ 914,737 $ $ 914,737 Uncollected premiums and agents' balances in course of collection 19,359, ,326 18,916,081 18,916,081 Deferred premiums, agents' balances and installments booked but deferred and not yet due 64,271, ,775 64,123,897 64,123,897 Amounts recoverable from reinsurers 23,116,003 23,116,003 23,116,003 Guaranty funds receivable or on deposit 3,341 3,341 3,341 Furniture and equipment 40,259 40, Receivable from parent, subsidiaries and affiliates Aggregate write-ins for other than invested assets 16,558 1,419 15,139 15,139 Total admitted assets $ 307,287,906 $ 632,883 $ 306,655,023 $ 0 $ 306,655,023 15

18 LIABILITIES, SURPLUS AND OTHER FUNDS Losses (Notes 3, 4 and 5) $ 22,918,419 Reinsurance payable on paid losses and loss adjustment expenses 11,932 Loss adjustment expenses (Notes 3, 4 and 5) 4,001,562 Other expenses (excluding taxes, licenses and fees) 65,711 Taxes, licenses and fees 145,487 Current federal and foreign income taxes 3,193,196 Net deferred tax liability 4,457,593 Unearned premiums (after deducting unearned premiums for ceded reinsurance of $113,137,716) 12,678,046 Advance premium 2,699,190 Ceded reinsurance premiums payable 84,020,329 Amounts withheld by company for account of others 130,874 Payable to parent, subsidiaries and affiliates 26,743,665 Aggregate write-ins for liabilities 6,846 Total liabilities $ 161,072,850 Common capital stock $ 3,010,000 Gross paid-in and contributed surplus 14,875,000 Unassigned funds (surplus) 127,697,173 Surplus as regards policyholders $ 145,582,173 Totals $ 306,655,023 16

19 STATEMENT OF INCOME Underwriting Income Premiums earned $ 47,838,895 Underwriting deductions: Losses incurred $ 29,105,931 Loss adjustment expenses incurred 5,144,475 Other underwriting expenses incurred 9,261,204 Total underwriting deductions $ 43,511,610 Net underwriting gain or (loss) $ 4,327,285 Investment Income Net investment income earned $ 7,049,412 Net realized capital gains or (losses) 0 Net investment gain or (loss) $ 7,049,412 Other Income Net gain (loss) from agents' or premium balances charged off $ (569,260) Finance and service charges not included in premiums 800,107 Miscellaneous income (796,198) Total other income $ (565,351) Net income after dividends to policyholders but before federal income taxes $ 10,811,346 Federal and foreign income taxes incurred 3,193,197 Net income $ 7,618,149 17

20 CAPITAL AND SURPLUS ACCOUNT Surplus as regards policyholders per examination, December 31, 2004 $ 85,069,826 Net income, 2005 $ 13,364,201 Change in net deferred income tax (497,000) Change in non-admitted assets 423,699 Change in surplus as regards policyholders for the year $ 13,290,900 Surplus as regards policyholders, December 31, 2005 $ 98,360,726 Net income, 2006 $ 11,395,840 Change in net deferred income tax (303,313) Change in non-admitted assets 79,799 Change in surplus as regards policyholders for the year $ 11,172,326 Surplus as regards policyholders, December 31, 2006 $ 109,533,052 Net income, 2007 $ 10,368,325 Change in net deferred income tax (129,636) Change in non-admitted assets (693,932) Change in surplus as regards policyholders for the year $ 9,544,757 Surplus as regards policyholders, December 31, 2007 $ 119,077,809 Net income, 2008 $ 8,377,869 Change in net unrealized capital gain or (losses) less capital gains tax (333,127) Change in net deferred income tax (333,352) Change in non-admitted assets 414,956 Change in surplus as regards policyholders for the year $ 8,126,346 Surplus as regards policyholders, December 31, 2008 $ 127,204,155 Net income, 2009 $ 7,618,149 Change in net unrealized capital gain or (losses) less capital gains tax 10,935,181 Change in net deferred income tax (59,227) Change in non-admitted assets (116,085) Change in surplus as regards policyholders for the year $ 18,378,018 Surplus as regards policyholders per examination, December 31, 2009 $ 145,582,173 18

21 ANALYSIS OF EXAMINATION CHANGES TO SURPLUS There were no changes to the Company s surplus as a result of our examination. 19

22 COMPARATIVE FINANCIAL POSITION OF THE COMPANY The comparative financial position of the Company for the five-year period ended December 31, 2009 was as follows: Assets $306,655,023 $251,552,904 $245,726,724 $272,005,663 $248,321,031 Liabilities 161,072, ,348, ,648, ,472, ,960,305 Capital and surplus 145,582, ,204, ,077, ,533,052 98,360,726 Net underwriting gain (loss) 4,327,285 7,648,129 9,200,187 11,512,119 15,809,162 Net investment gain (loss) 7,049,412 5,225,386 6,668,231 6,113,125 4,848,421 Total other income (565,351) (365,221) (484,442) (543,402) (726,822) Net income (loss) 7,618,149 8,377,869 10,368,325 11,395,840 13,364,201 NOTE: Amounts in the preceding financial statements for the years ended December 31, 2005 through 2008 were taken from the Company s Annual Statements as filed with the Administration. Amounts for the years ended December 31, 2004 and December 31, 2009 are amounts per examination. 20

23 NOTES TO FINANCIAL STATEMENTS 1. The Company reported Bonds totaling $41,652,548. Our examination disclosed that this included subordinated notes from an entity carried at a par value of $25.0 million and a reported cost of $25.0 million that carry an NAIC Designation of 4. These securities were acquired on October 6, 2008 and are scheduled to mature in The Company is prohibited from transferring, selling or assigning these notes to unaffiliated third parties. Our examination disclosed that the market rate for these notes as of December 31, 2009, as determined by the Securities Valuation Office, exceeded the par value and as such, the Company properly carried its investment in the notes at amortized cost or par value in accordance with the National Association of Insurance Commissioners Accounting Practices and Procedures Statement on Statutory Accounting Principle No The Company reported Preferred Stock and Common Capital Stock totaling $28,550,000 and $12,760,852, respectively. Our examination disclosed that these amounts included investments in an unaffiliated entity s 10% cumulative perpetual preferred stock and warrants carried at a fair market value of approximately $41.3 million, which were acquired for an aggregate cost of $25.0 million on October 1, The preferred stock may be redeemed at any time at a price of $110,000 per share ($27.5 million in aggregate). The warrants expire in 2013 and may be exercised by the Company to purchase 217,391 shares of common stock at a price of $115 per share ($25.0 million in aggregate). These securities were sold exclusively to the Company s ultimate parent, Berkshire Hathaway Inc. (Berkshire), and its subsidiaries, including the Company, and as such, are not traded on an exchange in active markets and there are no other similar securities that are traded on active markets from which to derive a fair market value. The securities are carried by the Company at fair market value as determined by Berkshire through valuation modeling, discounted cash flow models and other valuation techniques they believe to be appropriate. The valuation methodology and resulting values reported by the Company for these securities as of December 31, 2009 were reviewed by the National Association of Insurance Commissioner s Securities Valuation Office and were determined to be reasonable. 3. The Company reported Losses and Loss adjustment expenses reserves totaling $22,918,419 and $4,001,562, respectively. These amounts are shown net of estimated amounts recoverable from reinsurers under the Company s reinsurance agreements. If the reinsurers are not able to meet their obligations under these agreements, the Company would be liable for any defaulted amounts. The Company has recorded reserve credits related to estimated amounts recoverable from reinsurers as of December 31, 2009 totaling approximately $203.9 million for losses and $26.5 million for loss adjustment expenses. The methodologies utilized by the Company to compute reserves, and the adequacy of the loss reserves and loss adjustment expense reserves as of December 31, 2009, were reviewed by our actuary and were determined to be reasonable and adequate. 21

24 In addition, the Company enters into structured settlements to settle claims and is subject to class-action lawsuits in several areas related to its claims settlement practices. See additional comments below under Notes 4 and For the settlement of certain claims, referred to as structured settlements, the Company purchases annuities to fund payments required to be made pursuant to the structured settlement agreements. The annuities are purchased from a life insurer, are payable to the claimants, and once purchased pursuant to the structured settlement agreement, the Company no longer carries loss reserve liabilities for the applicable claims. However, the Company would be liable for these annuity payments in the event the insurer, from whom the annuities were purchased, fails to make the scheduled payments to the claimants. The present value of all structured settlement annuity contracts in force as of December 31, 2009, totaled approximately $1.2 million. 5. The Company and its affiliates are defendants in class-action lawsuits related to claimsettlement practices, including omitted repairs, determination of repairer labor rates, and medical bill review practices. Management has been vigorously defending its position on these claim-settlement procedures in similar class-actions. These lawsuits are in various stages of development. In most instances, no specific monetary damages have been alleged and the ultimate outcome can not be reasonably determined. For lawsuits where a loss is probable and the amount of loss can be reasonably estimated, a loss and allocated loss adjustment expense reserve has been established. As of December 31, 2009, the Company established reserves totaling $138,000 for these class-action lawsuits in its Losses and Loss adjustment expenses reserves. The Company and its affiliates are also defendants in class-action lawsuits related to its selection and pricing of policies, workers classification issues surrounding overtime exceptions for auto damage adjusters, and patent issues surrounding telephone interactive voice technology. These lawsuits are in various stages of development, and management is vigorously defending its position. No specific monetary damages have been alleged and the ultimate outcome cannot be reasonably determined and/or management does not consider any potential loss from these cases to be probable or have a material effect on the financial position of the Company as of December 31, In the normal course of business, the Company is also involved in other litigation with claimants, beneficiaries, and others. The Company believes that the total amounts that would ultimately be paid, if any, arising from such actions in excess of amounts currently reserved would not have a material impact on the financial position as of December 31,

25 COMMENTS AND RECOMMENDATIONS Conflicts of Interest: Code of Maryland Regulation No requires companies to have a Board of Directors resolution or by-law setting forth the Company s policy as to disclosure of a possible conflict of interest on the part of its officers, directors and responsible employees, and that any potential conflict be referred to the Board of Directors for review and appropriate action. In accordance with this regulation, the Company had adopted a conflict of interest policy requiring all directors, officers and responsible employees to annually complete a questionnaire disclosing any potential conflicts. However, our review of the conflict of interest questionnaires for the years under examination disclosed that while some of the questionnaires disclosed potential conflicts and these potential conflicts were reviewed by the Company s general counsel, the conflicts were not vetted by the board. It should be noted that the potential conflicts reported did not appear to adversely affect the Company. However, we recommend that the Company ensure that all future potential conflicts of interest are properly disclosed, reviewed and evaluated by the Company s Board of Directors. Corporate Records: We reviewed the minutes of the Board of Directors meetings for the period under examination. Based on our review, except as noted below, it appeared that the minutes generally documented the Company s significant transactions and events, and that the directors approved these transactions and events. As noted above under the caption Conflicts of Interest, the minutes did not document the board s review of the conflict of interest questionnaires. Furthermore, the minutes did not document that the board reviewed and accepted the Maryland Insurance Administration s 2004 examination report and the annual audited financial reports of its external auditor. We recommend that the Company ensure that the minutes of the Board of Directors meetings document all significant transactions and events, and the board s approval of these transactions, including its review of examination and audit reports and conflicts of interest questionnaires. Custodial Arrangements: Code of Maryland Regulations No provides that domestic insurance companies may have bonds or stocks registered in the names of nominees and deposited in a depository trust company approved by the Commissioner if a custody agreement with a bank or trust company, meeting certain requirements, is filed with the Administration for approval. The Regulation further provides that insurance companies failing to comply with this requirement shall report securities held under non-approved custodial arrangements as Assets-Not Admitted. Our examination disclosed that as of December 31, 2009, the Company owned securities with a market value totaling approximately $2.2 million registered and held under a non-approved custodian s nominee name. During our examination, after we brought this condition to the Company s attention, the Company transferred a portion of these securities to its approved custodian and moved the remainder of these securities into its safe deposit box. We 23

26 recommend that, in the future, the Company strictly comply with the aforementioned provisions of the Code of Maryland Regulations. Furthermore, we recommend that the Company non-admit all securities that are not held under approved custodial arrangements in all future Quarterly and Annual Statement filings. Additional Comments and Recommendations: In addition to the above Comments and Recommendations, during our examination we made a number of other suggestions and recommendations to the Company with regard to record keeping and other procedures relating to its operations. 24

27 CONCLUSION Our examination disclosed that as of December 31, 2009 the Company had: Admitted Assets $ 306,655,023 Liabilities and Reserves $ 161,072,850 Common Capital Stock $ 3,010,000 Gross Paid-in and Contributed Surplus 14,875,000 Unassigned Funds (surplus) 127,697,173 Surplus as Regards Policyholders $ 145,582,173 Total Liabilities and Surplus $ 306,655,023 In our opinion, the accompanying balance sheet properly presents the statutory financial position of the Company as of December 31, 2009, and the accompanying statement of income properly presents the statutory results of operations for the period then ended. The supporting financial statements properly present the information prescribed by the Annotated Code of Maryland, the Code of Maryland Regulations and the National Association of Insurance Commissioners. Sections and of the Insurance Article specify the minimum required capital and surplus for the Company. We concluded that the Company s surplus funds exceeded the minimum requirement during the period under examination. 25

28 SIGNATURES In addition to the undersigned, the following examiners representing the Maryland Insurance Administration participated in certain phases of this examination: Mary Rodack, CFE, INS Regulatory Insurance Services, Inc. Edward Bowe, INS Regulatory Insurance Services, Inc. Yohaness Negash, Maryland Insurance Administration Emily Cheng, Maryland Insurance Administration Puru Shrestha, Maryland Insurance Administration The actuarial portion of this examination was completed by Greg Wilson, FCAS, MAAA, actuary with the firm of Lewis and Ellis, Inc. Respectfully submitted, Original Signature on File Robert J. Rodack, CFE Examiner-in-Charge INS Regulatory Insurance Services, Inc Representing the Maryland Insurance Administration Under the supervision of, Original Signature on File Susan L. Smith, CPA, CFE Assistant Chief Examiner Maryland Insurance Administration Representing the Northeastern Zone 26

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