Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 10-K

 


 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
  EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
  EXCHANGE ACT OF 1934

For the transition period from                         to 

 

Commission file number 001-31978

 


Assurant, Inc.

(Exact name of registrant as specified in its charter)

 


 

Delaware   39-1126612

(State or Other Jurisdiction

of Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

One Chase Manhattan Plaza, 41st Floor

New York, New York

  10005
(Address of Principal Executive Offices)   (Zip Code)

 

Registrant’s telephone number, including area code:

(212) 859-7000

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class


 

Name of Each Exchange on Which Registered


Common Stock, $0.01 Par Value   New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:

 

None

 


 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

 

Note—Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

 

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

 

x   Large accelerated filer         ¨  Accelerated filer         ¨  Non-accelerated filer

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

 

The aggregate market value of the Common Stock held by non-affiliates of the registrant was $5,036 million at June 30, 2006 based on the closing sale price of $48.40 per share for the common stock on such date as traded on the New York Stock Exchange.

 

The number of shares of the registrant’s Common Stock outstanding at February 15, 2007 was 122,346,154.

 

Documents Incorporated by Reference

 

Certain information contained in the definitive proxy statement for the annual meeting of stockholders to be held on May 17, 2007 (2007 Proxy Statement) is incorporated by reference into Part III hereof.


 

 


Table of Contents

ASSURANT, INC.

 

ANNUAL REPORT ON FORM 10-K

 

For the Fiscal Year Ended December 31, 2006

 

TABLE OF CONTENTS

 

Item

Number


        Page
Number


PART I

1.

  

Business

   1

1A.

  

Risk Factors

   13

1B.

  

Unresolved Staff Comments

   34

2.

  

Properties

   34

3.

  

Legal Proceedings

   34

4.

  

Submission of Matters to a Vote of Security Holders

   34
PART II

5.

  

Market of Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities

   35

6.

  

Selected Financial Data

   39

7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   40

7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   72

8.

  

Financial Statements and Supplementary Data

   77

9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   77

9A.

  

Controls and Procedures

   77

9B.

  

Other Information

   77
PART III

10.

  

Directors, Executive Officers and Corporate Governance

   78

11.

  

Executive Compensation

   78

12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   78

13.

  

Certain Relationships and Related Transactions, and Director Independence

   78

14.

  

Principal Accounting Fees and Services

   78
PART IV

15.

  

Exhibits and Financial Statement Schedules

   79

Signatures

   84

EX-23.1: CONSENT OF PRICEWATERHOUSECOOPERS LLP

    

EX-31.1: CERTIFICATION

    

EX-31.2: CERTIFICATION

    

EX-32.1: CERTIFICATION

    

EX-32.2: CERTIFICATION

    

 

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FORWARD-LOOKING STATEMENTS

 

Some of the statements under “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this report may contain forward-looking statements which reflect our current views with respect to, among other things, future events and financial performance. You can identify these forward-looking statements by the use of forward-looking words such as “outlook,” “believes,” “expects,” “potential,” “continues,” “may,” “will,” “should,” “seeks,” “approximately,” “predicts,” “intends,” “plans,” “estimates,” “anticipates” or the negative version of those words or other comparable words. Any forward-looking statements contained in this report are based upon our historical performance and on current plans, estimates and expectations. The inclusion of this forward looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. Such forward-looking statements are subject to various risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in this report. We believe that these factors include but are not limited to those described under the subsection entitled “Risk Factors” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

 

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Any forward-looking statements you read in this report reflect our current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, financial condition, growth strategy and liquidity.

 

 

 

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PART I

 

Item 1. Business

 

Legal Organization

 

Assurant, Inc. (“Assurant”) is a Delaware corporation, formed in connection with the Initial Public Offering (“IPO”) of its common stock, which began trading on the New York Stock Exchange (“NYSE”) on February 5, 2004. Prior to the IPO, Fortis, Inc., a Nevada corporation, had formed Assurant and merged into it on February 4, 2004. The merger was executed in order to redomesticate Fortis, Inc. from Nevada to Delaware and to change its name. As a result of the merger, Assurant is the successor to the business operations and obligations of Fortis, Inc.

 

Prior to the IPO, 100% of the outstanding common stock of Fortis, Inc. was owned indirectly by Fortis N.V., a public company with limited liability incorporated as naamloze vennootschap under Dutch law, and Fortis SA/ NV, a public company with limited liability incorporated as société anonyme/naamloze vennootschap under Belgian law. Following the IPO, Fortis N.V. and Fortis SA/ NV, through a wholly owned subsidiary Fortis Insurance N.V., owned approximately 35% (50,199,130 shares) of the outstanding common stock of Assurant.

 

On January 21, 2005, Fortis N.V. and Fortis SA/ NV, through a wholly owned subsidiary Fortis Insurance N.V., owned approximately 36% (50,199,130 shares) of the outstanding common stock of Assurant based on the number of shares outstanding that day and sold 27,200,000 of those shares in a secondary offering to the public. Assurant did not receive any of the proceeds from the sale of shares of common stock. Fortis N.V. received all net proceeds from the sale and concurrently sold exchangeable bonds, due January 26, 2008, that are mandatorily exchangeable for their remaining 22,999,130 shares of Assurant. The exchangeable bonds and the shares of Assurant’s common stock into which they are exchangeable have not been and will not be registered under the Securities Act of 1933 (“Securities Act”) and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

 

In this report, references to the “Company,” “Assurant,” “we,” “us” or “our” refer to (1) Fortis, Inc. and its subsidiaries, and (2) Assurant, Inc. and its subsidiaries after the consummation of the merger described above. References to “Fortis” refer collectively to Fortis N.V. and Fortis SA/ NV. References to our “separation” from Fortis refer to the fact that Fortis reduced its ownership of our common stock in connection with the secondary offering.

 

Dollar amounts are presented in U.S. dollars and all amounts are in thousands, except number of shares, per share amounts, registered holders, number of employees and beneficial owners.

 

Business Organization

 

Assurant’s mission is to be the premier provider of specialized insurance products and related services in North America and selected international markets. To achieve this mission, we focus on the following areas:

 

   

Building and maintaining a portfolio of diverse, specialty insurance businesses

 

   

Leveraging a set of core capabilities—managing risk; managing relationships with large distribution partners; and integrating complex administrative systems—for competitive advantage

 

   

Managing targeted growth initiatives

 

   

Identifying and adapting to evolving market needs

 

   

Centralizing certain key functions in the Corporate segment to achieve economies of scale

 

Building and maintaining a portfolio of diverse, specialty insurance businesses—We currently are made up of four operating business segments each focused on serving specific segments of the insurance market. We

 

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believe that the uncorrelated nature of the risks in our businesses allows us to maintain a greater level of financial stability since our businesses will likely not be affected in the same way by the same economic and operating trends.

 

Leveraging core capabilities for competitive advantage—We pursue a differentiated strategy of building leading positions in specialized market segments for insurance products and related services in North America and selected international markets. These markets are generally complex, have a relatively limited number of competitors and, we believe, offer attractive long-term profitable growth opportunities. In these markets, we leverage the experience of our management team and apply our core capabilities for competitive advantage—managing risk; managing relationships with large distribution partners; and integrating complex administrative systems. These core capabilities represent areas of expertise which are evident within each of our businesses. We seek to generate insurance industry top-quartile returns by building on specialized market knowledge, well- established distribution relationships and economies of scale. As a result of our strategy, we are a leader in many of our chosen markets and products.

 

Managing targeted growth initiatives—Our approach to mergers, acquisitions and other growth opportunities reflects our prudent and disciplined approach to managing our business. We make decisions based on strict guidelines ensuring that any new business will support our business model. We have established performance goals related to short-term incentive compensation for senior management based on those and other initiatives.

 

Identifying and adapting to evolving market needs—Assurant’s businesses adapt quickly to changing market conditions by tailoring product and service offerings to specific client and customer needs. This flexibility was developed, in part, as a result of our entrepreneurial culture and the encouragement of management autonomy at each business segment. By understanding the dynamics of our core markets, we design innovative products and services and seek to sustain long-term profitable growth and market leading positions.

 

Centralizing certain key functions in the Corporate segment to achieve economies of scale—At the Corporate level, Assurant, Inc. provides strategic management and key resources for its operating businesses, including asset management, employee benefits, finance, treasury, tax, accounting, legal, organizational and leadership development, mergers and acquisitions and communications. We also provide support services in such areas as information technology, financial and human resources systems management, enabling the operating business segments to focus on their target markets and distribution relationships while enjoying the economies of scale realized by operating these businesses together and benefiting from being part of a larger, diversified specialty insurance company. Our overall strategy and financial objectives are set and continuously monitored at the corporate level to ensure that our capital resources are being properly allocated.

 

Competition

 

Assurant’s businesses focus on niche segments within broader insurance markets. While we face competition in each of our businesses, we believe that no single competitor competes against us in all of our business lines and the business lines in which we operate are generally characterized by a limited number of competitors. Competition in our operating business segments is based on a number of factors, including: quality of service, product features, price, scope of distribution, financial strength ratings and name recognition. The relative importance of these factors depends on the particular product and market. We compete for customers and distributors with insurance companies and other financial services companies in our various businesses.

 

Assurant Solutions and Assurant Specialty Property face competition in their product lines, but we believe that no other company participates in all of the same lines or offers comparable comprehensive capabilities as these two businesses. Competitors include insurance companies, financial institutions and, in the case of preneed—regional insurers. Assurant Health’s main competitors are other health insurance companies, Health Maintenance Organizations (“HMOs”) and the Blue Cross/Blue Shield plans in states where we write business. Assurant Employee Benefits competitors include other benefit and life insurance companies, dental managed care entities and not-for-profit dental plans.

 

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Segments

 

On April 1, 2006, the Company separated its Assurant Solutions business segment into two business segments: Assurant Solutions and Assurant Specialty Property. In addition, concurrent with the creation of the new Assurant Solutions and Assurant Specialty Property segments, the Company realigned the Preneed segment under the new Assurant Solutions segment. Segment income statements for the years ended December 31, 2005 and December 31, 2004 and segment assets for the year ended December 31, 2005 have been recast to reflect the new segment reporting structure.

 

Assurant Solutions

 

    

For the Year Ended

December 31, 2006


  

For the Year Ended

December 31, 2005


Gross Written Premium for selected product groupings (1):

             

Domestic Credit

   $ 714,791    $ 767,466

International Credit

   $ 680,097    $ 647,467

Domestic Extended Service Contracts(2)

   $   1,258,292    $   1,120,227

International Extended Service Contracts(2)

   $ 341,886    $ 247,506

Preneed (face sales)

   $ 433,510    $ 542,512

Net earned premiums and other considerations

   $ 2,371,605    $ 2,220,145

Segment net income

   $ 198,893    $ 133,147

Equity(3)

   $ 1,564,795    $ 1,576,176

(1) Gross written premium does not necessarily translate to an equal amount of subsequent net earned premiums since Assurant Solutions reinsures a portion of its premiums to insurance subsidiaries of its clients.
(2) Extended service contracts include warranty contracts for products such as personal computers, consumer electronics and appliances.
(3) Equity excludes accumulated other comprehensive income.

 

Products and Services

 

Assurant Solutions targets growth in three key product areas: domestic extended service contracts (“ESC”) and warranties; preneed life insurance sales; and international credit and ESC. In addition, we offer debt protection services through financial institutions.

 

ESC and Warranties: Through partnerships with leading retailers, we underwrite and provide administrative services for extended service contracts and warranties. These contracts provide consumers with coverage on appliances, consumer electronics, personal computers, cellular phones, automobiles and recreational vehicles protecting them from losses incurred due to product failures. We pay the cost of repairing or replacing customers’ property in the event of damages due to mechanical breakdown, accidental damage, and casualty losses such as theft, fire, and water damage. Our strategy is to seamlessly provide a total solution to our clients that addresses all aspects of the warranty or extended service contract, including program design and marketing strategy. We provide technologically advanced administration, claims handling and customer service. We believe that we maintain a differentiated position in the marketplace as a provider of both the required administrative infrastructure and insurance underwriting capabilities.

 

Preneed Life Insurance: Preneed life insurance allows individuals to prepay for a funeral in a single payment or in multiple payments over a fixed number of years. The insurance policy proceeds are used to address funeral costs at death. These products are generally structured as whole life insurance policies in the United States and as annuity products in Canada.

 

Credit Insurance: Our credit insurance programs provide our clients’ customers with products that offer protection from life events and uncertainties that arise in purchasing and borrowing transactions thereby

 

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providing the consumer peace of mind. Credit insurance programs generally offer consumers a convenient option to protect a credit card balance or installment loan in the event of death, involuntary unemployment or disability and are generally available to all consumers without the underwriting restrictions that apply to term life insurance.

 

Debt Protection/Debt Deferment: Debt protection products are offered by our clients to their customers and are typically underwritten by the institution that issues the credit card. Due to regulatory changes and the resulting shift to debt deferment products by financial institutions, we have seen a reduction in domestic written premium generated in the credit insurance market. Consequently, the largest credit card issuing institutions have migrated from credit insurance towards debt protection programs. We have worked with our clients to offer alternative products such as debt deferment and protection services. Our debt protection programs generate fee income.

 

Marketing and Distribution

 

Assurant Solutions focuses on establishing strong, long-term distribution relationships with market leaders. We partner with six of the top ten largest credit companies to market our credit insurance and debt protection programs and five of the ten largest consumer electronics and appliance retailers (based on combined product sales) to market our warranty and extended service contracts.

 

Several of our distribution agreements are exclusive. Typically these agreements have terms of one to five years and allow us to integrate our administrative systems with those of our clients. This integration enables us to exchange information in an almost real-time environment.

 

In addition to our domestic market, we operate in Canada, the United Kingdom, Denmark, Germany, Spain, Italy, Argentina, Brazil, Mexico and Puerto Rico. In these markets, we primarily sell extended service contracts and credit insurance products through agreements with financial institutions, retailers and cellular-phone companies. Although there has been shrinkage in the domestic credit insurance market, the international markets are experiencing growth in the credit insurance business. Expertise gained in the domestic credit insurance market has enabled us to extend our administrative infrastructure internationally. Systems, training, computer hardware and the overall market development approach are customized to fit the particular needs of each targeted international market.

 

Our pre-funded funeral programs are marketed in the United States and Canada. In November 2005 we sold our US independent distribution business to Forethought Life Insurance Company (“Forethought”) to allow us to focus on our exclusive distribution partnership with Service Corporation International (“SCI”) and continue to develop our other growth area; independent business in Canada. We are the sole provider through September 30, 2010 of preneed life insurance for SCI, the largest funeral provider in the US based on total revenue. In Canada, we market our preneed programs through independent and corporate funeral homes and selected third-party general agencies. In late 2006 we entered into an agreement to acquire 100% of the outstanding stock of Mayflower National Life Insurance Company (“Mayflower”) from SCI and extend our exclusive marketing agreement with SCI to September 30, 2013. The transaction is expected to close in 2007. Mayflower will add approximately $50,000 in annual net earned premiums.

 

Underwriting and Risk Management

 

We write a significant portion of our contracts on a retrospective commission basis. This allows us to adjust commissions based on claims experience. Under this commission arrangement, as permitted by law, compensation to the financial institutions and other clients is predicated upon the actual losses incurred compared to premiums earned after a specific net allowance to us. We believe that this aligns our clients’ interests with ours and helps us to better manage risk exposure. A distinct characteristic of our credit insurance program is that the majority of these products have relatively low exposures per incident. This is because policy size is equal to the

 

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size of the installment loan or credit card balance. Thus, catastrophic loss severity for most of this business is low relative to insurance companies writing more traditional lines of property insurance.

 

Our claims processing is automated and combines the efficiency of centralized claims handling, customer service centers and the flexibility of field representatives. This flexibility adds savings and efficiencies to the claims-handling process. Our claims department also provides continuous automated feedback to the underwriting team to help with risk assessment and pricing.

 

We have extensive knowledge-based experience and risk management expertise in the extended service contract and warranty areas and utilize an integrated model to address the complexities of pricing, marketing, training, risk retention and client service.

 

Profitability generated through our preneed life insurance programs is generally earned from interest rate spreads—the difference between the death benefit growth rates on underlying policies and the investment returns generated on the assets we hold related to those policies. To manage those spreads, we monitor the movement in new money yields and evaluate monthly our actual net new achievable yields among other techniques.

 

Assurant Specialty Property

 

     For the Year Ended
December 31, 2006


    For the Year Ended
December 31, 2005


 

Net Earned Premiums and Other Considerations by Major Product Grouping:

                

Homeowners (Creditor Placed and Voluntary)

   $ 753,169     $ 443,526  

Manufactured Housing (Creditor Placed and Voluntary)

     214,461       217,424  

Other (1)

     240,681       197,898  
    


 


Total

   $ 1,208,311     $ 858,848  
    


 


Segment Net Income

   $ 241,121     $ 143,227  

Loss Ratio (2)

     33.8 %     37.0 %

Expense Ratio (3)

     44.0 %     47.2 %

Combined Ratio (4 )

     76.5 %     82.6 %

Equity (5)

   $ 752,913     $ 524,403  

(1) This includes flood, renters, agricultural, specialty auto and other insurance products.
(2) The loss ratio is equal to policyholder benefits divided by net earned premiums and other considerations.
(3) The expense ratio is equal to selling, underwriting and general expenses divided by net earned premiums and other considerations and fees and other income.
(4) The combined ratio is equal to total benefits, losses and expenses divided by net earned premiums and other considerations and fees and other income.
(5) Equity excludes accumulated other comprehensive income.

 

Products and Services

 

Assurant Specialty Property is pursuing long-term profitable growth in creditor-placed homeowners insurance and seeks to extend this model into two emerging markets, creditor-placed automobile and renters liability and property.

 

Creditor-placed homeowners insurance: The largest product line within Assurant Specialty Property is homeowners insurance consisting principally of fire and dwelling hazard insurance offered primarily through our creditor-placed programs. The creditor-placed program provides collateral protection to our mortgage lender clients in the event that a homeowner fails to purchase or renew homeowners insurance on a mortgaged dwelling.

 

We use a proprietary insurance tracking administration system to continuously monitor a client’s mortgage portfolio to verify the existence of insurance on each mortgaged property. In the event that a mortgagee is not

 

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maintaining adequate insurance coverage, they will be notified and, if the situation continues, we will issue an insurance policy on the property on behalf of the creditor. This process works through the integration of our proprietary loan tracking system with the back offices of our clients.

 

The creditor-placed programs are administered separately for homeowner mortgages and manufactured housing mortgages. Our hazard products can also be sold on a voluntary basis. In addition, we provide fee-based administration services for some of the largest mortgage lenders and servicers, manufactured housing lenders, dealers and vertically integrated builders and equipment leasing institutions in the United States. Manufactured housing retailers use our proprietary premium rating technology which allows them to sell property coverages at the point of sale.

 

We believe this proven business model will allow us to continue our growth due to seamless integration with our clients and the inherent efficiencies of this integration. Additionally, we are optimistic about the opportunities before us to expand this business model with the addition of new clients, new products for existing clients, and the acquisition of new business such as the May 2006 acquisition of the creditor-placed business of Safeco Financial Institution Solutions, Inc. (“SFIS”). The acquisition of SFIS raised our market share of outsourced creditor-placed business to approximately 70%.

 

Creditor-Placed Auto and Renters: We have developed products using our creditor-placed business model to meet similar needs in adjacent and emerging markets, such as the creditor-placed automobile and creditor-placed rental markets. Both of these markets have been expanding in recent years. The creditor-placed automobile market has benefited from regulatory improvements made by the National Association of Insurance Commissioners. The creditor-placed rental market continues to expand as more property management companies mandate tenant liability coverage.

 

As a result of our efficiency in handling certain back-office functions, the vast majority of our mortgage lender and servicing clients outsource their insurance processing to us. We also act as an administrator for the Federal Government under the voluntary National Flood Insurance Program for which we earn an expense reimbursement for collecting premiums and processing claims. This is a public flood insurance program and is restricted as to rates, underwriting, coverages and claims management procedures. We do not assume any underwriting risk with respect to this program; however, we underwrite a smaller separate voluntary flood insurance program.

 

Marketing and Distribution

 

Our marketing strategy is to establish relationships with institutions that are leaders in their chosen markets. Our creditor-placed homeowners program is marketed through financial institutions and other mortgage lenders. Our clients in this program consist of 17 of the top 25 prime mortgage lenders/servicers and 14 of the top 25 sub-prime mortgage lenders/servicers.

 

We offer our manufactured housing insurance programs primarily through three channels; manufactured housing lenders, manufactured housing retailers and independent specialty agents. The independent specialty agents distribute our products to individuals subsequent to new home purchases.

 

Underwriting and Risk Management

 

We maintain a disciplined approach to the management of our product lines. Our creditor-placed homeowners insurance program is unique in that it is not underwritten on an individual basis. Contracts with our clients require us to automatically issue these policies, after notice, when a homeowners policy lapses or is terminated. These products are priced after factoring in this inherent underwriting risk.

 

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As part of our overall risk management focus, we continually monitor pricing adequacy on a product by region, state, risk and producer. We proactively seek to make timely commission, premium and coverage modifications, subject to regulatory considerations, where we determine them to be appropriate. In addition, we maintain a segregated risk management area that concentrates on catastrophic exposure management, the adequacy and pricing of reinsurance coverage and continuous analytical review of risk retention and subsequent profitability in the property lines. For the lines where there is exposure to catastrophes (e.g. homeowners policies), we monitor and manage our aggregate risk exposure by geographic area and, when appropriate, enter into reinsurance contracts to manage our exposure to catastrophic events. Additionally, in the event of a catastrophic loss, we have the mechanism in place to reinstate, as needed, reinsurance coverages for protection from potential subsequent catastrophic events within the policy year.

 

Assurant Health

 

     For the Year Ended
December 31, 2006


    For the Year Ended
December 31, 2005


 

Net Earned Premiums and Other Considerations:

                

Individual Markets:

Individual Medical

   $ 1,213,677     $ 1,164,498  

Short-term Medical

     101,454       110,912  
    


 


Subtotal

     1,315,131       1,275,410  

Small Employer Group

     768,826       888,555  
    


 


Total

   $ 2,083,957     $ 2,163,965  
    


 


Segment Net Income

   $ 167,919     $ 178,055  

Loss ratio (1)

     62.4 %     62.1 %

Expense ratio (2)

     30.2 %     29.8 %

Combined ratio (3 )

     91.4 %     90.8 %

Equity (4)

   $ 416,765     $ 479,564  

(1) The loss ratio is equal to policyholder benefits divided by net earned premiums and other considerations.
(2) The expense ratio is equal to selling, underwriting and general expenses divided by net earned premiums and other considerations and fees and other income.
(3) The combined ratio is equal to total benefits, losses and expenses divided by net earned premiums and other considerations and fees and other income.
(4) Equity excludes accumulated other comprehensive income.

 

Product and Services

 

In business since 1892, Assurant Health is focused on pursuing long-term profitable growth opportunities in the individual medical market by offering traditional medical insurance, short-term medical insurance and student medical plans to individuals and families. Products are offered with different plan options to meet a broad range of customer needs. Assurant Health also offers traditional medical insurance to small employer groups.

 

Individual Medical: Our medical insurance products are sold to individuals, primarily between the ages of 18 and 64 years, and their families who do not have employer-sponsored coverage. We emphasize the sale of individual products through associations and trusts that act as the master policyholder for such products. Products marketed and sold through associations and trusts offer flexibility in pricing and product design which increase our ability to respond to market changes.

 

Substantially all of the individual health insurance products we sell are Preferred Provider Organization (“PPO”) plans, which offer members the ability to select from a wide range of health care providers. Coverage is typically available with a variety of co-payment or deductible and coinsurance options, with the total benefit for

 

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covered services limited by certain policy maximums. Members can also add an HSA (“Health Savings Account”) option with their high deductible health plan. We offer extensive HSA training to our independent agents and offer internet-based HSA tools making it easier for our customers to integrate their HSA into the plan of their choice and better manage their health care spending. These products are individually underwritten, taking into account the member’s medical history and other factors. The remaining products we sell are indemnity, or fee-for-service plans. Indemnity plans offer a member the ability to select any health care provider for covered services.

 

Short-term Medical Insurance and Student Health Insurance: The short-term medical insurance product is designed for individuals who are between jobs or seeking interim coverage before their major medical coverage becomes effective. Short-term medical insurance products are generally sold to individuals in order to fill gaps in coverage of twelve months or less. Student health coverage plans are medical insurance plans sold to full-time college students who are not covered by their parents’ health insurance, are no longer eligible for dependant coverage, or are seeking a more comprehensive alternative to a college-sponsored plan.

 

Small Group Medical: Our group medical insurance sold to small employers focuses primarily on companies with two to fifty employees, although larger employer coverage is available. As of December 31, 2006, our average group size was approximately five employees. In the case of our small employer group health insurance, we underwrite the entire group and examine the medical risk factors of the individual groups for pricing purposes only. Substantially all of the small employer health insurance products that we sold in 2006 and 2005 were PPO products. We also offer HSA and HRA (“Health Reimbursement Account”) options and a variety of ancillary products to meet the demands of small employers for life insurance, short-term disability insurance and dental insurance.

 

Marketing and Distribution

 

Breadth and depth of distribution is a key competitive advantage for Assurant Health. Our health insurance products are principally marketed through an extensive network of independent agents by our distributors. We also market our products to individuals through a variety of exclusive and non-exclusive national account relationships and direct distribution channels. In addition, we market our products through NorthStar Marketing, a wholly owned affiliate that proactively seeks business directly from independent agents. Since 2000, we have had an exclusive national marketing agreement with a major mutual insurance company, pursuant to which their captive agents market our individual health products. Captive agents are representatives of a single insurer or group of insurers who are obligated to submit business only to that insurer, or at a minimum, give that insurer first refusal rights on a sale. The term of this agreement will expire in June 2008, but may be extended if agreed to by both parties. We also have a solid relationship with a well-known association. Through our agreement with this well-known association’s administrator, we provide many of our individual health insurance products. The term of the agreement with this administrator will expire in September 2008, but will be automatically extended for an additional two-year term unless prior notice of a party’s intent to terminate is given to the other party. We also have a long-term relationship with a national marketing organization with more than 50 offices. We, and our direct writing agents, also sell short-term medical insurance plans through the internet.

 

In 2006, we launched Advantage Agent, an array of new products, tools and capabilities designed to make it easy for agents to do business with Assurant Health. Along with the introduction of a new individual medical portfolio designed to meet a broad spectrum of customer needs, Advantage Agent also includes a new on-line program called EASE (Electronic Agent Sales Experience) that shortens approval periods and makes the application process easier for applicants and agents while maintaining the integrity of our disciplined risk management requirements.

 

Underwriting and Risk Management

 

Our underwriting and risk management capabilities include pricing discipline, policy underwriting and renewal optimization, development and retention of provider networks, product development and claims

 

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processing. In establishing premium rates for our health care plans, we use underwriting criteria based upon our accumulated actuarial data, with adjustments for factors such as claims experience and member demographics to evaluate anticipated health care costs. Our pricing considers the expected frequency and severity of claims and the costs of providing the necessary coverage, including the cost of administering policy benefits, sales and other administrative costs.

 

We also utilize a broad range of focused traditional cost containment and care management processes across our various product lines to manage risk and to lower costs. These include case management, disease management and pharmacy benefits management programs. We retain provider networks through a variety of relationships. These relationships generally include leased networks, such as Private Health Care Systems, Inc. (“PHCS”), which contract directly with individual health care providers. Assurant Health was a co-founder of PHCS. Although we sold our equity interest in PHCS during 2006, we continue to have access to the PHCS network. Pharmacy benefits management is provided by Medco Health Solutions, formerly known as Merck-Medco. Medco Health Solutions has established itself as a leader in its industry with almost 60,000 participating retail pharmacies nationwide and its extensive mail-order service. Through Medco Health Solutions’ advanced technology platforms, Assurant Health is able to access information about customer utilization patterns on a timelier basis to improve its risk management capabilities. In addition to the technology-based advantages, Medco Health Solutions allows us to purchase our pharmacy benefits at competitive prices. Our agreement with Medco Health Solutions expires June 30, 2007 and we are currently in negotiations to renew this contract. We also utilize co-payments and deductibles to reduce prescription drug costs.

 

Assurant Employee Benefits

 

    

For the Year Ended

December 31, 2006


   

For the Year Ended

December 31, 2005


 

Net Earned Premiums and Other Considerations:

                

Group Dental

   $ 428,218     $ 502,789  

Group Disability Single Premiums for Closed Blocks (1)

     46,313       26,700  

All Other Group Disability

     480,924       489,840  

Group Life

     224,447       258,509  
    


 


Total

   $ 1,179,902     $ 1,277,838  
    


 


Segment Net Income

   $ 83,603     $ 68,366  

Loss ratio (2)

     70.4 %     73.3 %

Expense ratio (3)

     33.7 %     32.1 %

Equity (4)

   $ 615,612     $ 610,248  

(1) This represents single premium on closed blocks of group disability business.
(2) The loss ratio is equal to policyholder benefits divided by net earned premiums and other considerations.
(3) The expense ratio is equal to selling, underwriting and general expenses divided by net earned premiums and other considerations and fees and other income.
(4) Equity excludes accumulated other comprehensive income.

 

Products and Services

 

We focus our group business around the needs of the small employer, which we define as businesses with fewer than 500 employees. We believe that our core capabilities around small group risk selection, administrative systems that can efficiently handle thousands of cases, and our strong relationships with brokers who work primarily with small businesses gives us a competitive advantage over other companies.

 

We offer a full range of group disability, dental, life and voluntary products as well as individual dental products. The group products are offered with funding option choices ranging from fully employer paid to fully employee paid (voluntary).

 

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Group Disability: Group disability insurance provides partial replacement of lost earnings for insured employees who become disabled as defined by their plan provisions. Our group disability products include both short-and long-term disability coverage options. We also reinsure disability policies written by other carriers through our subsidiary Disability Reinsurance Management Services, Inc. (“DRMS”).

 

Group long-term disability insurance provides income protection for extended work absences due to sickness or injury. Most policies commence benefits following 90- or 180-day waiting periods, with benefits limited to specified maximums as a percentage of income. Group short-term disability insures temporary loss of income due to injury or sickness, and often provides benefits immediately for disabilities caused by accidents or after one week for disabilities caused by sickness.

 

Group Dental: Dental benefit plans provide funding for necessary or elective dental care. Customers may select a traditional indemnity arrangement, a PPO arrangement, or a prepaid or managed care arrangement. Coverage is subject to deductibles, coinsurance and annual or lifetime maximums. In a prepaid plan, members must use participating dentists in order to receive benefits.

 

In addition to fully insured and managed care dental benefits, we offer Administrative Services Only (“ASO”) for self-funded dental plans. Under the ASO arrangement, an employer or plan sponsor pays us a fee to provide administrative services.

 

Success in the group dental business requires strong provider network development and management, a focus on expense management and a claim system capable of efficiently and accurately adjudicating high volumes of transactions. These success factors are the cornerstone of our dental business.

 

In 2006, we entered a joint network leasing agreement with Aetna which will strengthen our Dental PPO network position beginning in 2007. Aetna will add to its PPO offerings the dentists contracted with Dental Health Alliance, L.L.C.®, the dental PPO operated by Assurant Employee Benefits. Assurant Employee Benefits will begin marketing a network comprised of the Dental Health Alliance® and the Aetna Dental Access® networks. This agreement opens up an additional 30+ dental PPO markets and, we believe, enhances the attractiveness of our dental offerings to the small employer.

 

Group Life: Group term life insurance provided through the workplace provides financial coverage in the event of premature death. Accidental death and dismemberment (“AD&D”) insurance, as well as coverage for spouses, children or domestic partners is also available. Insurance consists primarily of renewable term life insurance with the amount of coverage either a flat amount, a multiple of the employee’s earnings, or a combination of the two.

 

Marketing and Distribution

 

Our insurance products and services are distributed through a group sales force strategically positioned in 35 U.S. offices located near major metropolitan areas. These company employees distribute our products and services through independent employee benefits advisors, including brokers and other intermediaries, and are compensated through a salary and incentive package. Daily account management is provided through the local sales office, further supported by one of four regional sales service centers and a home office customer relations department. Compensation to brokers is generally provided at the time of sale, and in some cases includes a performance incentive, based on volume and retention of business.

 

Marketing efforts concentrate on the identification of our target customers’ benefit needs, the development and communication of products and services tailored to meet those needs, alignment of our Company with select high-potential brokers and other intermediaries who value our approach to the market, and the promotion of the Assurant Employee Benefits’ brand.

 

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DRMS, our wholly owned subsidiary, assists customers in obtaining reinsurance for other carriers wanting to supplement their core product offerings with a turnkey group disability insurance solution. Services are provided for a fee and may include product development, state insurance regulatory filings, underwriting, claims management or any of the other functions typically performed by an insurer’s back office. The risks written by DRMS’ various clients are reinsured into a pool, with the clients generally retaining shares ranging from 20% to 60% of the risk. Because DRMS’ clients operate in niches not often reached through our traditional distribution, our participation in the pools enables us to reach new customers.

 

Underwriting and Risk Management

 

The pricing of our products is based on the expected cost of benefits, calculated using assumptions for mortality, morbidity, interest, expenses and persistency, depending upon the specific product features. Group underwriting takes into account demographic factors such as age, gender and occupation of members of the group as well as the geographic location and concentration of the group. Some policies limit the payment of benefits for certain defined or pre-existing conditions, or in other ways seek to limit the risk from anti-selection. Our block of business is highly diversified by industry and geographic location, which serves to limit some of the risks associated with changing economic conditions.

 

Disability claims management focuses on facilitating positive return-to-work through a supportive network of services that may include physical therapy, vocational rehabilitation, and workplace accommodation. In addition to claims specialists, we also employ or contract with a staff of doctors, nurses and vocational rehabilitation specialists, and use a broad range of additional outside medical and vocational experts for independent evaluations and local vocational services. Our dental business uses a highly automated claims system focused on rapid handling of claims.

 

Ratings

 

Rating organizations continually review the financial position of insurers, including our insurance subsidiaries. Insurance companies are assigned financial strength ratings by independent rating agencies based upon factors relevant to policyholders. Ratings provide both industry participants and insurance consumers meaningful information on specific insurance companies and are an important factor in establishing the competitive position of insurance companies. Most of our active domestic operating insurance subsidiaries are rated by A.M. Best. A.M. Best maintains a letter scale rating system ranging from “A++” (Superior) to “S” (Suspended). Six of our domestic operating insurance subsidiaries are also rated by Moody’s. In addition, seven of our domestic operating insurance subsidiaries are rated by S&P.

 

All of our domestic operating insurance subsidiaries rated by A.M. Best have financial strength ratings of A (“Excellent”), which is the second highest of ten ratings categories and the highest within the category based on modifiers (i.e., A and A- are “Excellent”), or A- (“Excellent”), which is the second highest of ten ratings categories and the lowest within the category based on modifiers.

 

The Moody’s financial strength rating for six of our domestic operating insurance subsidiaries is A2 (“Good”), which is the third highest of nine ratings categories and mid-range within the category based on modifiers (i.e., A1, A2 and A3 are “Good”).

 

The S&P financial strength rating for four of our domestic operating insurance subsidiaries is A (“Strong”), which is the third highest of nine ratings categories and mid-range within the category based on modifiers (i.e., A+, A and A- are “Strong”), and for three of our domestic operating insurance subsidiaries is A- with a positive outlook (“Strong”), which is the third highest of nine ratings categories and the lowest within the category based on modifiers.

 

The objective of A.M. Best’s, Moody’s and S&P’s ratings systems is to assist policyholders and to provide an opinion of an insurer’s financial strength, operating performance, strategic position and ability to meet

 

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ongoing obligations to its policyholders. These ratings reflect the opinions of A.M. Best, Moody’s and S&P of our ability to pay policyholder claims, are not applicable to our common stock or debt securities and are not a recommendation to buy, sell or hold any security, including our common stock or debt securities. These ratings are subject to periodic review by and may be revised upward, downward or revoked at the sole discretion of A.M. Best, Moody’s and S&P.

 

Employees

 

We had approximately 13,400 employees as of February 15, 2007. Assurant Solutions has employees in Argentina, Brazil, Italy and Mexico that are represented by labor unions and trade organizations.

 

Available Information

 

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, the Statements of Beneficial Ownership of Securities on Forms 3, 4 and 5 for our Directors and Officers and all amendments to such reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available free of charge at the Securities and Exchange Commission (“SEC”) website at www.sec.gov. These documents are also available free of charge through our website at www.assurant.com.

 

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Item 1A. Risk Factors

 

Risks Related to Our Company

 

Our income and profitability may decline if we are unable to maintain our relationships with significant clients, distributors and other parties important to the success of our business.

 

Our relationships and contractual arrangements with significant clients, distributors and other parties with whom we do business are important to the success of our business segments. Many of these arrangements are exclusive. For example, in Assurant Specialty Property, we have exclusive relationships with manufactured housing and mortgage lenders. In Assurant Solutions, we have exclusive relationships with retailers and financial and other institutions through which we distribute our products, including an exclusive preneed distribution relationship with SCI relating to the distribution of pre-funded funeral insurance policies. In Assurant Health, we have exclusive distribution relationships for our individual health insurance products with a major mutual insurance company as well as a relationship with a well known association through which we provide many of our individual health insurance products. We also maintain contractual relationships with several separate networks of health and dental care providers, each referred to as a PPO, through which we obtain discounts. Typically, these relationships and contractual arrangements have terms ranging from one to five years.

 

Although we believe we have generally been successful in maintaining our client, distribution and associated relationships, if these parties decline to renew or seek to terminate these arrangements or seek to renew these contracts on terms less favorable to us, our results of operations and financial condition could be materially adversely affected. For example, a loss of one or more of the discount arrangements with PPOs could lead to higher medical or dental costs and/or a loss of members to other medical or dental plans. In addition, we are subject to the risk that these parties may face financial difficulties, reputational issues or problems with respect to their own products and services, which may lead to decreased sales of our products and services. Moreover, if one or more of our clients or distributors consolidate or align themselves with other companies, we may lose business or suffer decreased revenues.

 

Sales of our products and services may be reduced if we are unable to attract and retain sales representatives or develop and maintain distribution sources.

 

We distribute our insurance products and services through a variety of distribution channels, including independent employee benefits specialists, brokers, managing general agents, life agents, financial institutions, mortgage lenders and servicers, retailers, funeral homes, association groups and other third-party marketing organizations.

 

Our relationships with these various distributors are significant both for our revenues and profits. We generally do not distribute our insurance products and services through captive or affiliated agents. In Assurant Health, we depend in large part on the services of independent agents and brokers and on associations in the marketing of our products. In Assurant Employee Benefits, independent agents and brokers who act as advisors to our customers market and distribute our products. Strong competition exists among insurers to form relationships with agents and brokers of demonstrated ability. We compete with other insurers for sales representatives, agents and brokers primarily on the basis of our financial position, support services, compensation and product features. Independent agents and brokers are typically not exclusively dedicated to us, but instead usually also market the products of our competitors and therefore we face continued competition from our competitors’ products. Moreover, our ability to market our products and services depends on our ability to tailor our channels of distribution to comply with changes in the regulatory environment in which we and such agents and brokers operate. For example, in the past, both the marketing of health insurance through association groups and broker compensation arrangements have come under increased scrutiny. An interruption in, or changes to, our relationships with various third-party distributors or our inability to respond to regulatory changes that threaten to disrupt our distribution processes could impair our ability to compete and market our

 

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insurance products and services that could cause a material adverse effect on our results of operations and financial condition.

 

We have our own sales representatives whose role in the distribution process varies by segment. We depend in large part on our sales representatives to develop and maintain client relationships. Our inability to attract and retain effective sales representatives could materially adversely affect our results of operations and financial condition.

 

General economic, financial market and political conditions may adversely affect our results of operations and financial condition.

 

General economic, financial market and political conditions may have a material adverse effect on our results of operations and financial condition. These conditions include economic cycles such as insurance industry cycles, levels of employment, levels of consumer lending, levels of consumer spending, levels of inflation and movements of the financial markets.

 

Fluctuations in interest rates, mortgage rates, monetary policy, demographics, and legislative and competitive factors also influence our performance. Our expansion into foreign countries may result in similar risks, including currency fluctuations, unstable political climates, and governmental and competitive factors. During periods of economic downturn:

 

   

individuals and businesses may choose not to purchase our insurance products and other related products and services, may terminate existing policies or contracts or permit them to lapse, may choose to reduce the amount of coverage purchased or, in Assurant Employee Benefits and in small group employer health insurance in Assurant Health, may have fewer employees requiring insurance coverage due to reductions in their staffing levels;

 

   

new disability insurance claims and claims on other specialized insurance products tend to rise;

 

   

there is a higher loss ratio on credit card and installment loan insurance due to rising unemployment and disability levels;

 

   

insureds tend to increase their utilization of health and dental benefits if they anticipate becoming unemployed or losing benefits; and

 

In addition, general inflationary pressures may affect the costs of medical and dental care, as well as repair and replacement costs on our real and personal property lines, increasing the costs of paying claims. Inflationary pressures may also affect the costs associated with our preneed insurance policies, particularly those that are guaranteed to grow with the Consumer Price Index (“CPI”).

 

Our actual claims losses may exceed our reserves for claims, which may require us to establish additional reserves that may materially reduce our earnings, profitability and capital.

 

We maintain reserves to cover our estimated ultimate exposure for claims and claim adjustment expenses with respect to reported and incurred but not reported claims (“IBNR”) as of the end of each accounting period. Reserves, whether calculated under accounting principles generally accepted in the United States of America (“GAAP”) or Statutory Accounting Principles (“SAP”), do not represent an exact calculation of exposure, but instead represent our best estimates, generally involving actuarial projections at a given time, of what we expect the ultimate settlement and administration of a claim or group of claims will cost based on our assessment of facts and circumstances then known. The adequacy of reserves will be impacted by future trends in claims severity, frequency, judicial theories of liability and other factors. These variables are affected by both external and internal events, such as changes in the economic cycle, changes in the social perception of the value of work,

 

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emerging medical perceptions regarding physiological or psychological causes of disability, emerging health issues and new methods of treatment or accommodation, inflation, judicial trends, legislative changes and claims handling procedures. Many of these items are not directly quantifiable, particularly on a prospective basis. Reserve estimates are refined as experience develops. Adjustments to reserves, both positive and negative, are reflected in the statement of operations of the period in which such estimates are updated. Because establishment of reserves is an inherently uncertain process involving estimates of future losses, there can be no certainty that ultimate losses will not exceed existing claims reserves. In addition, future loss development could require reserves to be increased, which could have a material adverse effect on our earnings in the periods in which such increases are made.

 

We may be unable to accurately predict benefits, claims and other costs or to manage such costs through our loss limitation methods, which could have a material adverse effect on our results of operations and financial condition.

 

Our profitability could vary depending on our ability to predict benefits, claims and other costs, including medical and dental costs, and predictions regarding the frequency and magnitude of claims on our disability and property coverages. It also depends on our ability to manage future benefit and other costs through product design, underwriting criteria, utilization review or claims management and, in health and dental insurance, negotiation of favorable provider contracts. Utilization review is a review process designed to control and limit medical expenses, which includes, among other things, requiring certification for admission to a health care facility and cost-effective ways of handling patients with catastrophic illnesses. Claims management entails the use of a variety of means to mitigate the extent of losses incurred by insureds and the corresponding benefit cost, which includes efforts to improve the quality of medical care provided to insureds and to assist them with vocational services. Our ability to predict and manage costs and claims, as well as our business, results of operations and financial condition may be adversely affected by changes in health and dental care practices, inflation, new technologies, the cost of prescription drugs, clusters of high cost cases, changes in the regulatory environment, economic factors, the occurrence of catastrophes and increased construction and repair related costs.

 

The judicial and regulatory environments, changes in the composition of the kinds of work available in the economy, market conditions and numerous other factors may also materially adversely affect our ability to manage claim costs. The aging of the population, other demographic characteristics and advances in medical technology continue to contribute to rising health care costs. As a result of one or more of these factors or other factors, claims could substantially exceed our expectations, which could have a material adverse effect on our results of operations and financial condition.

 

As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues relating to claims and coverage may emerge. These issues could materially adversely affect our results of operations and financial condition by either extending coverage beyond our underwriting intent or by increasing the number or size of claims or both. We may be limited in our ability to respond to such changes, by insurance regulations, existing contract terms, contract filing requirements, market conditions or other factors.

 

Our investment portfolio is subject to several risks that may diminish the value of our invested assets and affect our profitability.

 

Our investment portfolio may suffer reduced returns or losses that could reduce our profitability.

 

Investment returns are an important part of our overall profitability and significant fluctuations in the fixed income market could impair our profitability, financial condition and/or cash flows. Our investments are subject to market-wide risks and fluctuations, as well as to risks inherent in particular securities. In particular, volatility of claims may force us to liquidate securities prior to maturity, which may cause us to incur capital losses. If we

 

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do not structure our investment portfolio so that it is appropriately matched with our insurance liabilities, we may be forced to liquidate investments prior to maturity at a significant loss to cover such liabilities. Our net investment income and net realized gains on investments collectively accounted for approximately 11% of our total revenues during the year ending December 31, 2006 and 9% of our total revenues during the year ending December 31, 2005. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Investments” and “Item 7A—Quantitative and Qualitative Disclosures About Market Risk” for additional information on our investment portfolio and related risks.

 

The performance of our investment portfolio is subject to fluctuations due to changes in interest rates and market conditions.

 

Changes in interest rates can negatively affect the performance of some of our investments. Interest rate volatility can reduce unrealized gains or create unrealized losses in our portfolios. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Fixed maturity and short-term investments represented 76% of the fair value of our total investments as of December 31, 2006 and December 31, 2005. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Investments” and “Item 7A—Quantitative and Qualitative Disclosures About Market Risk” for additional information on the effect of fluctuations in interest rates.

 

The fair market value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. Because substantially all of our fixed maturity securities are classified as available for sale, changes in the market value of these securities are reflected in our balance sheet. The fair market value generally increases or decreases in an inverse relationship with fluctuations in interest rates, while net investment income realized by us from future investments in fixed maturity securities will generally increase or decrease with interest rates. In addition, actual net investment income and/or cash flows from investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities, may differ from those anticipated at the time of investment as a result of interest rate fluctuations. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities, commercial mortgage obligations and bonds in our investment portfolio are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates, and we may be required to reinvest those funds in lower interest-bearing investments. As of December 31, 2006, mortgage-backed and other asset-backed securities represented $1,206,597, or 9.7%, of the fair value of our total investments.

 

We employ asset/liability management strategies to reduce the adverse effects of interest rate volatility and to ensure that cash flows are available to pay claims as they become due. Our asset/liability management strategies include asset/liability duration management, structuring our bond and commercial mortgage loan portfolios to limit the effects of prepayments and consistent monitoring of, and appropriate changes to, the pricing of our products.

 

Asset/liability management strategies may fail to eliminate or reduce the adverse effects of interest rate volatility, and no assurances can be given that significant fluctuations in the level of interest rates will not have a material adverse effect on our results of operations and financial condition.

 

 

In addition, our preneed insurance policies are generally whole life insurance policies with increasing death benefits. In extended periods of declining interest rates or high inflation, there may be compression in the spread between the death benefit growth rates on these policies and the investment earnings that we can earn, resulting in a negative spread. As a result, declining interest rates or high inflation rates may have a material adverse effect on our results of operations and our overall financial condition. See “Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Inflation Risk” for additional information.

 

Assurant Employee Benefits calculates reserves for long-term disability and life waiver of premium claims using net present value calculations based on current interest rates at the time claims are funded and expectations

 

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regarding future interest rates. Waiver of premium refers to a provision in a life insurance policy pursuant to which an insured with a disability that lasts for a specified period no longer has to pay premiums for the duration of the disability or for a stated period, during which time the life insurance coverage provides continued coverage. If interest rates decline, reserves for open and/or new claims in Assurant Employee Benefits would need to be calculated using lower discount rates thereby increasing the net present value of those claims and the required reserves. Depending on the magnitude of the decline, this could have a material adverse effect on our results of operations and financial condition. In addition, investment income may be lower than that assumed in setting premium rates.

 

Our investment portfolio is subject to credit risk.

 

We are subject to credit risk in our investment portfolio, primarily from our investments in corporate bonds and preferred stocks. Defaults by third parties in the payment or performance of their obligations could reduce our investment income and realized investment gains or result in investment losses. Further, the value of any particular fixed maturity security is subject to impairment based on the creditworthiness of a given issuer. As of December 31, 2006, fixed maturity securities represented 73% of the fair value of our total invested assets. Our fixed maturity portfolio also includes below investment grade securities (rated “BB” or lower by nationally recognized securities rating organizations). These investments generally provide higher expected returns, but present greater risk and can be less liquid than investment grade securities. A significant increase in defaults and impairments on our fixed maturity investment portfolio could materially adversely affect our results of operations and financial condition. See “Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Credit Risk” for additional information on the composition of our fixed maturity investment portfolio.

 

The Company currently invests in a small amount of equity securities (approximately 6% of the fair value of our total investments as of December 31, 2006). However, we have had higher percentages in the past and may make more such investments in the future. Investments in equity securities generally provide higher expected total returns, but present greater risk to preservation of principal than our fixed maturity investments.

 

In addition, while we currently do not utilize derivative instruments to hedge or manage our interest rate or equity risk, we may do so in the future. Derivative instruments generally present greater risk than fixed income investments or equity investments because of their greater sensitivity to market fluctuations. Since August 1, 2003, we have been utilizing derivative instruments to manage the exposure to inflation risk created by our preneed insurance policies that are tied to the CPI. However, we would not be fully protected by the derivative instruments if there were a sharp increase in inflation on a sustained long-term basis which could have a material adverse effect on our results of operations and financial condition.

 

Our commercial mortgage loans and real estate investments subject us to liquidity risk.

 

Our commercial mortgage loans on real estate investments (which represented approximately 10% of the fair value of our total investments as of December 31, 2006) are relatively illiquid, thus increasing our liquidity risk. In addition, if we require extremely large amounts of cash on short notice, we may have difficulty selling these investments at attractive prices, in a timely manner, or both.

 

The risk parameters of our investment portfolio may not target an appropriate level of risk, thereby reducing our profitability and diminishing our ability to compete and grow.

 

We seek to earn returns on our investments to enhance our ability to offer competitive rates and prices to our customers. Accordingly, our investment decisions and objectives are a function of the underlying risks and product profiles of each of our business segments. However, if we do not succeed in targeting an appropriate overall risk level for our investment portfolio, the return on our investments may be insufficient to meet our profit targets over the long term, thereby reducing our profitability. If, in response, we choose to increase our product prices to maintain profitability, we may diminish our ability to compete and grow.

 

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Environmental liability exposure may result from our commercial mortgage loan portfolio and real estate investments.

 

Liability under environmental protection laws resulting from our commercial mortgage loan portfolio and real estate investments may harm our financial strength and reduce our profitability. Under the laws of several states, contamination of a property may give rise to a lien on the property to secure recovery of the costs of the cleanup. In some states, this kind of lien has priority over the lien of an existing mortgage against the property, which would impair our ability to foreclose on that property should the related loan be in default. In addition, under the laws of some states and under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, under certain circumstances, we may be liable for costs of addressing releases or threatened releases of hazardous substances that require remedy at a property securing a mortgage loan held by us. We also may face this liability after foreclosing on a property securing a mortgage loan held by us after a loan default.

 

Catastrophe losses, including man-made catastrophe losses, could materially reduce our profitability and have a material adverse effect on our results of operations and financial condition.

 

Our insurance operations expose us to claims arising out of catastrophes, particularly in our homeowners, life and other personal business lines. We have experienced, and expect in the future to experience, catastrophe losses that may materially reduce our profitability or have a material adverse effect on our results of operations and financial condition. Catastrophes can be caused by various natural events, including, but not limited to, hurricanes, windstorms, earthquakes, hailstorms, severe winter weather, fires and epidemics, or can be man-made catastrophes, including terrorist attacks or accidents such as airplane crashes. The frequency and severity of catastrophes are inherently unpredictable. Catastrophe losses can vary widely and could significantly exceed our recent historic results. It is possible that both the frequency and severity of man-made catastrophes will increase and that we will not be able to implement exclusions from coverage in our policies or obtain reinsurance for such catastrophes.

 

The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most of our catastrophe claims in the past have related to homeowners and other personal lines coverages, which, for the year ended December 31, 2006, represented approximately 84% of our net earned premiums in our Assurant Specialty Property segment. In addition, as of December 31, 2006, approximately 37% of the insurance in force in our homeowners and other personal lines related to properties located in California, Florida and Texas. As a result of our creditor-placed homeowners and creditor-placed manufactured housing insurance products, which automatically provide coverage against an insured’s property being destroyed or damaged by various perils, our concentration in these areas may increase in the future. If other insurers withdraw coverage in these or other states, this may lead to adverse selection and increased utilization of our creditor-placed homeowners or creditor-placed manufactured housing insurance in these areas and may negatively impact loss experience. Adverse selection refers to the process by which an applicant who believes him or herself to be uninsurable, or at greater than average risk, seeks to obtain an insurance policy at a standard premium rate. Claims resulting from natural or man-made catastrophes could cause substantial volatility in our financial results for any fiscal quarter or year and could materially reduce our profitability or harm our financial condition. Our ability to write new business also could be affected. Increases in the value and geographic concentration of insured property and the effects of inflation could increase the severity of claims from catastrophes in the future.

 

Pre-tax catastrophe losses in excess of $5,000 (before the benefits of reinsurance) that we have experienced in recent years include (total losses do not include amounts paid in connection with the National Flood Insurance Program as we are only an administrator and have no risk under the Program):

 

   

total losses of approximately $339,000 incurred through December 31, 2005, in connection with Hurricanes Dennis, Katrina, Rita and Wilma. Total reinsurance recoveries related to these events were approximately $296,000; and

 

   

total losses of approximately $125,000 incurred through December 31, 2004, in connection with the four Florida hurricanes. Total reinsurance recoveries related to these events were approximately $34,000.

 

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No liquidation in investments was required in connection with these catastrophes as the claims were paid from current cash flow, cash on hand or short-term investments.

 

In addition, our group life and health insurance operations could be materially impacted by catastrophes such as a terrorist attack, a natural disaster, a pandemic or an epidemic that causes a widespread increase in mortality or disability rates or that causes an increase in the need for medical care. If the severity of such an event were sufficiently high, it could exceed our reinsurance coverage limits and could have a material adverse effect on our results of operations and financial condition. In addition, with respect to our preneed insurance policies, the average age of policyholders is in excess of 73 years. This group is more susceptible to certain epidemics than the overall population, and an epidemic resulting in a higher incidence of mortality could have a material adverse effect on our results of operations and financial condition.

 

Some of our business segments may also face the loss of premium income due to a large scale business interruption caused by a catastrophe combined with legislative or regulatory reactions to the event. For example, following hurricanes in 2005, several states suspended premium payment or precluded insurers from canceling coverage in defined areas. While the premiums uncollected were immaterial, a more serious catastrophe combined with a similar legislative or regulatory response could materially impact our ability to collect premiums in connection with our liabilities and thereby have a material adverse effect on our results of operations and financial condition.

 

Our ability to manage these risks depends in part on our successful utilization of catastrophic property and life reinsurance to limit the size of property and life losses from a single event or multiple events, and life and disability reinsurance to limit the size of life or disability insurance exposure on an individual insured life. It also depends in part on state regulation that may prohibit us from excluding such risks or from withdrawing from or increasing premium rates in catastrophe-prone areas. As discussed further below, catastrophe reinsurance for our group insurance lines is not currently widely available. This means that the occurrence of a significant catastrophe could materially reduce our profitability and have a material adverse effect on our results of operations and financial condition.

 

Reinsurance may not be available or adequate to protect us against losses, and we are subject to the credit risk of reinsurers.

 

As part of our overall risk and capacity management strategy, we purchase reinsurance for certain risks underwritten by our various business segments. Market conditions beyond our control determine the availability and cost of the reinsurance protection we purchase. Reinsurance for certain types of catastrophes generally could become unavailable for some of our businesses and has become more expensive. Due to these changes in the reinsurance market, our exposure to the risk of significant losses from natural or man-made catastrophes may hinder our ability to write future business.

 

As part of our business, we have reinsured certain life, property and casualty and health risks to reinsurers. Although the reinsurer is liable to us to the extent of the ceded reinsurance, we remain liable to the insured as the direct insurer on all risks reinsured. As a result, ceded reinsurance arrangements do not eliminate our obligation to pay claims. We are subject to credit risk with respect to our ability to recover amounts due from reinsurers. Due to insolvency, adverse underwriting results or inadequate investment returns, our reinsurers may not pay the reinsurance recoverables that they owe to us or they may not pay such recoverables on a timely basis.

 

Our reinsurance facilities are generally subject to annual renewal. We may not be able to maintain our current reinsurance facilities and, even where highly desirable or necessary, we may not be able to obtain other reinsurance facilities in adequate amounts and at favorable rates. If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase or, if we are unwilling to bear an increase in net exposures, we may have to reduce the level of our underwriting commitments. Either of these potential developments could materially adversely affect our results of operations and financial condition.

 

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We have sold businesses through reinsurance that could again become our direct financial and administrative responsibility if the purchasing companies were to become insolvent.

 

In the past, we have sold businesses through reinsurance ceded to third parties. For example, in 2001 we sold the insurance operations of our Fortis Financial Group (“FFG”) division to The Hartford Financial Services Group, Inc. (“The Hartford”) and in 2000 we sold our Long Term Care (“LTC”) division to John Hancock Life Insurance Company (“John Hancock”), now a subsidiary of Manulife Financial Corporation. Most of the general account assets backing reserves coinsured with The Hartford and John Hancock are held in trusts that could aid in protecting us financially if The Hartford or John Hancock were to fail. However, such trusts have varying provisions regarding how fully funded they are required to be and how often they must be restored to such funded status. Therefore, protection from the trusts is only existent to the extent the coinsurance trusts are funded at the time of reinsurer default. Aside from the coinsurance, a portion of the assets backing FFG general account reserves and all of the FFG separate accounts remain on our balance sheet pursuant to modified coinsurance arrangements. In addition to the financial risk, we have the additional risk of becoming responsible for administering these businesses in the event of a default by either reinsurer. We do not have the administrative systems and capabilities to process this business today. Accordingly, we would need to obtain those capabilities in the event of an insolvency of one or more of the reinsurers of these businesses. We might be forced to obtain such capabilities on unfavorable terms with a resulting material adverse effect on our results of operations and financial condition.

 

Due to the structure of our commission program, we are exposed to the credit risk of some of our agents and our clients in Assurant Solutions and Assurant Specialty Property.

 

We advance agents’ commissions as part of our preneed insurance product offerings. These advances are a percentage of the total face amount of coverage as opposed to a percentage of the first-year premium paid, the formula that is more common in other life insurance markets. There is a one-year payback provision against the agency if death or lapse occurs within the first policy year. In addition, if SCI were unable to fulfill its payback obligations, this could have an adverse effect on our operations and financial condition.

 

In addition, we are subject to the credit risk of the clients and/or agents with which we contract in Assurant Solutions and Assurant Specialty Property. If these parties fail to remit payments owed to us or fail to pass on payments they collect on our behalf, it could have an adverse effect on our results of operations.

 

A further decline in the manufactured housing market may adversely affect our results of operations and financial condition.

 

The manufactured housing industry has experienced a significant decline in both shipments and retail sales in the last seven years. The downturn in the manufactured housing industry is a result of several factors, including the impact of repossessions, the lack of retail financing, reduced resale values, and the consolidations of manufacturers and lenders of manufactured housing. In the year ended December 31, 2006, our sales of homeowners’ policies in the manufactured housing sector comprised 18% of Assurant Specialty Property’s net written premiums. If these downward trends continue, without diversification and growth in other manufactured housing product lines, our results of operations and financial condition may be adversely affected.

 

A.M. Best, Moody’s, and S&P rate the financial strength of our insurance company subsidiaries, and a decline in these ratings could affect our standing in the insurance industry and cause our sales and earnings to decrease.

 

Ratings have become an increasingly important factor in establishing the competitive position of insurance companies. A.M. Best rates most of our domestic operating insurance subsidiaries. Moody’s rates six of our domestic operating insurance subsidiaries and S&P rates seven of our domestic operating insurance subsidiaries. The ratings reflect A.M. Best’s, Moody’s, and S&P’s opinions of our subsidiaries’ financial strength, operating

 

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performance, strategic position and ability to meet their obligations to policyholders. The ratings are not evaluations directed to investors and are not recommendations to buy, sell or hold our securities. These ratings are subject to periodic review by A.M. Best, Moody’s, and S&P, and we cannot assure you that we will be able to retain these ratings. For more information on the specific A.M. Best, Moody’s, and S&P ratings of our domestic operating insurance subsidiaries, see “Item 1—Business—Ratings.”

 

If our ratings are reduced from their current levels by A.M. Best, Moody’s, or S&P, or placed under surveillance or review with possible negative implications, our competitive position in the respective insurance industry segments could suffer and it could be more difficult for us to market our products. Rating agencies may take action to lower our ratings in the future due to, among other things the competitive environment in the insurance industry, which may adversely affect our revenues, the inherent uncertainty in determining reserves for future claims, which may cause us to increase our reserves for claims, the outcome of pending litigation and regulatory investigations, which may adversely affect our financial position and reputation and possible changes in the methodology or criteria applied by the rating agencies.

 

As customers and their advisors place importance on our financial strength ratings, we may lose customers and compete less successfully if we are downgraded. In addition, ratings impact our ability to attract investment capital on favorable terms. If our financial strength ratings are reduced from their current levels by A.M. Best, Moody’s, or S&P, our cost of borrowing would likely increase, our sales and earnings could decrease and our results of operations and financial condition could be materially adversely affected.

 

Contracts representing approximately 23% of Assurant Solutions’ net earned premiums and fee income for the year ended December 31, 2006 contain provisions requiring the applicable subsidiaries to maintain minimum A.M. Best financial strength ratings ranging from “A” or better to “B” or better, depending on the contract. Our clients may terminate these contracts or not renew contracts if the subsidiaries’ ratings fall below these minimum or other acceptable levels. Under our ten-year marketing agreement with SCI, American Memorial Life Insurance Company (“AMLIC”), one of our subsidiaries, is required to maintain an A.M. Best financial strength rating of “B” or better throughout the term of the agreement. If AMLIC fails to maintain this rating for a period of 180 days, SCI may terminate the agreement.

 

The failure to effectively maintain and modernize our information systems could adversely affect our business.

 

Our business is dependent upon the ability to keep up to date with technological advances. This is particularly important where our systems, including our ability to keep our systems integrated with those of our clients, are critical to the operation of our business. If we do not update our systems to reflect technological advancements or protect our systems, our relationships and ability to do business with our clients may be adversely affected.

 

Our business depends significantly on effective information systems, and we have many different information systems for our various businesses. We must commit significant resources to maintain and enhance our existing information systems and develop new information systems in order to keep pace with continuing changes in information processing technology, evolving industry, regulatory and legal standards and changing customer preferences. A failure to maintain effective and efficient information systems, or a failure to efficiently and effectively consolidate our information systems to eliminate redundant or obsolete applications, could have a material adverse effect on our results of operations and financial condition. If we do not maintain adequate systems we could experience adverse consequences, including inadequate information on which to base pricing, underwriting and reserving decisions, the loss of existing customers, difficulty attracting new customers, customer, provider and agent disputes, regulatory problems, such as failure to meet prompt payment obligations, litigation exposure, or increases in administrative expenses.

 

Our management information, internal control and financial reporting systems may need further enhancements and development to satisfy continuing financial and other reporting requirements of being a public company.

 

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Failure to protect our clients’ confidential information and privacy could result in the loss of reputation and customers, reduction to our profitability and/or subject us to fines, litigation and penalties.

 

A number of our businesses are subject to privacy regulations and to confidentiality obligations. For example, the collection and use of patient data in our Assurant Health and Assurant Employee Benefits segments is the subject of national and state legislation, including the Health Insurance Portability and Accountability Act (“HIPAA”), and certain activities conducted by our segments are subject to the privacy regulations of the Gramm-Leach-Bliley Act. We also have contractual obligations to protect certain confidential information we obtain from our existing vendors, servicing companies, and clients. These obligations generally include protecting such confidential information to the same extent as we protect our own confidential information or in accordance with laws that govern our clients. The actions we take to protect such confidential information vary by business segment and may include, among other things, training and educating our employees regarding our obligations relating to confidential information, actively monitoring our record retention plans and any changes in state or federal privacy and compliance requirements, drafting appropriate contractual provisions into any contract that raises proprietary and confidentiality issues, maintaining and utilizing appropriately secure storage facilities for tangible records, and limiting access, as appropriate, to both tangible records and to electronic information.

 

In addition, we maintain a comprehensive written information security program with appropriate administrative, technical and physical safeguards to protect such confidential information. If we do not properly comply with privacy and security laws and regulations that require us to protect confidential information, we could experience adverse consequences, including loss of customers and related revenue, regulatory problems (including fines and penalties), loss of reputation and civil litigation.

 

See “Risks Related to Our Industry—Costs of compliance with privacy and security laws could adversely affect our business and results of operations.”

 

Our inability to achieve our desired market positions may be significantly impaired if we do not find suitable acquisition candidates or new insurance ventures and even if we do, we may not successfully integrate any such acquired companies or successfully invest in such ventures, which could have an adverse effect on our results of operations.

 

From time to time, we evaluate possible acquisition transactions and the start-up of complementary businesses, and at any given time, we may be engaged in discussions with respect to possible acquisitions and new ventures. While our business model is not dependent upon acquisitions or new insurance ventures, the time frame for achieving or further improving upon our desired market positions can be significantly shortened through opportune acquisitions or new insurance ventures. Historically, acquisitions and new insurance ventures have played a significant role in achieving desired market positions in some, but not all, of our businesses. No assurance can be given that we will be able to identify suitable acquisition transactions or insurance ventures, that such transactions will be financed and completed on acceptable terms or that our future acquisitions or ventures will be successful. The process of integrating any companies we do acquire or investing in new ventures could have a material adverse effect on our results of operations and financial condition.

 

In addition, implementation of an acquisition strategy entails a number of risks, including among other things inaccurate assessment of undisclosed liabilities; difficulties in realizing projected efficiencies, synergies and cost savings; failure to achieve anticipated revenues, earnings or cash flow; an increase in our indebtedness; and a limitation in our ability to access additional capital when needed. For example, we recognized a goodwill impairment of $1,260,939 in 2002 related to an earlier acquisition. Our failure to adequately address these acquisition risks could materially adversely affect our results of operations and financial condition.

 

The inability of our subsidiaries to pay dividends to us in sufficient amounts could harm our ability to meet our obligations and pay future stockholder dividends.

 

As a holding company whose principal assets are the capital stock of our subsidiaries, we rely primarily on dividends and other statutorily permissible payments from our subsidiaries to meet our obligations for payment

 

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of interest and principal on outstanding debt obligations, dividends to stockholders (including any dividends on our common stock) and corporate expenses. The ability of our subsidiaries to pay dividends and to make such other payments in the future will depend on their statutory surplus, future statutory earnings and regulatory restrictions. Except to the extent that we are a creditor with recognized claims against our subsidiaries, claims of the subsidiaries’ creditors, including policyholders, have priority with respect to the assets and earnings of the subsidiaries over the claims of our creditors. If any of our subsidiaries should become insolvent, liquidate or otherwise reorganize, our creditors and stockholders will have no right to proceed against the assets of that subsidiary or to cause the liquidation, bankruptcy or winding-up of the subsidiary under applicable liquidation, bankruptcy or winding-up laws. The applicable insurance laws of the jurisdiction where each of our insurance subsidiaries is domiciled would govern any proceedings relating to that subsidiary. The insurance authority of that jurisdiction would act as a liquidator or rehabilitator for the subsidiary. Both creditors and policyholders of the subsidiary would be entitled to payment in full from the subsidiary’s assets before we, as a stockholder, would be entitled to receive any distribution from the subsidiary.

 

The payment of dividends to us by any of our regulated operating subsidiaries in excess of a certain amount (i.e., extraordinary dividends) must be approved by the subsidiary’s domiciliary state department of insurance. Ordinary dividends, for which no regulatory approval is generally required, are limited to amounts determined by a formula, which varies by state. The formula for the majority of the states in which our subsidiaries are domiciled is based on the prior year’s statutory net income or 10% of the statutory surplus as of the end of the prior year. Some states limit ordinary dividends to the greater of these two amounts, others limit them to the lesser of these two amounts and some states exclude prior year realized capital gains from prior year net income in determining ordinary dividend capacity. Some states have an additional stipulation that dividends may only be paid out of earned surplus. If insurance regulators determine that payment of an ordinary dividend or any other payments by our insurance subsidiaries to us (such as payments under a tax sharing agreement or payments for employee or other services) would be adverse to policyholders or creditors, the regulators may block such payments that would otherwise be permitted without prior approval. No assurance can be given that there will not be further regulatory actions restricting the ability of our insurance subsidiaries to pay dividends. We may seek approval of regulators to pay dividends in excess of any amounts that would be permitted without such approval. If the ability of insurance subsidiaries to pay dividends or make other payments to us is materially restricted by regulatory requirements, it could adversely affect our ability to pay any dividends on our common stock and/or service our debt and pay our other corporate expenses. For more information on the maximum amount our subsidiaries could pay us in 2007 without regulatory approval, see “Item 5—Market For Registrants Common Equity and Related Stockholder Matters—Dividend Policy.”

 

Our credit facilities also contain limitations on our ability to pay dividends to our stockholders if we are in default or such dividend payments would cause us to be in default of the credit facilities.

 

Risks Related to Our Industry

 

Our business is subject to risks related to litigation and regulatory actions.

 

In addition to the occasional employment-related litigation to which businesses are subject, we are a defendant in actions arising out of, and are involved in, various regulatory investigations and examinations relating to, our insurance and other related business operations. We may from time to time be subject to a variety of legal and regulatory actions relating to our current and past business operations, including, but not limited to:

 

   

disputes over coverage or claims adjudication including, but not limited to, pre-existing conditions in individual medical contracts;

 

   

disputes regarding sales practices, disclosures, premium refunds, licensing, regulatory compliance and compensation arrangements;

 

   

disputes with our agents, producers or network providers over compensation and termination of contracts and related claims;

 

 

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disputes concerning past premiums charged by companies acquired by us for coverage that may have been based on factors such as race;

 

   

disputes relating to customers regarding the ratio of premiums to benefits in our various business segments;

 

   

disputes alleging packaging of credit insurance products with other products provided by financial institutions;

 

   

disputes relating to certain excess of loss programs in the London markets;

 

   

disputes with taxation and insurance authorities regarding our tax liabilities;

 

   

disputes relating to certain businesses we have acquired or disposed of;

 

   

periodic examinations of compliance with applicable federal securities laws;

 

   

disputes relating to customers’ claims that the customer was not aware of the full cost of insurance or that insurance was in fact being purchased; and

 

   

industry-wide investigations regarding business practices including, but not limited to, the use of certain loss mitigation products and finite risk insurance.

 

The outcome of these actions cannot be predicted, and no assurances can be given that such actions or any litigation would not materially adversely affect our results of operations and financial condition. In addition, if we were to experience difficulties with our relationship with a regulatory body in a given jurisdiction, it could have a material adverse effect on our ability to do business in that jurisdiction.

 

In addition, plaintiffs continue to bring new types of legal claims against insurance and related companies. Current and future court decisions and legislative activity may increase our exposure to these types of claims. Multiparty or class action claims may present additional exposure to substantial economic, non-economic or punitive damage awards. The loss of even one of these claims, if it resulted in a significant damage award or a judicial ruling that was otherwise detrimental, could have a material adverse effect on our results of operations and financial condition. This risk of potential liability may make reasonable settlements of claims more difficult to obtain. We cannot determine with any certainty what new theories of recovery may evolve or what their impact may be on our businesses.

 

Recently, the insurance industry has experienced substantial volatility as a result of litigation, investigations and regulatory activity by various insurance, governmental and enforcement authorities concerning certain practices within the insurance industry. These practices include the payment of contingent commissions by insurance companies to insurance brokers and agents and the extent to which such compensation has been disclosed, the solicitation and provision of fictitious or inflated quotes and the use of inducements to brokers or companies in the sale of group insurance products. In accordance with a long-standing and widespread industry practice, we have paid and continue to pay contingent commissions to insurance brokers and agents, primarily in our Assurant Employee Benefits segment. Assurant Employee Benefits follows a policy of full disclosure consistent with its understanding of existing regulations in this area. With respect to improper sales practices, we have received inquiries and informational requests from insurance departments in certain states in which our insurance subsidiaries operate. We have conducted an internal review under the supervision of outside counsel and have confirmed that our employees have not provided inflated or fictitious quotes or used improper inducements in the sale of group insurance products in our Assurant Employee Benefits segment.

 

Another focus of regulators has been the accounting treatment for finite reinsurance or other non-traditional or loss mitigation insurance products. Some state regulators have made routine inquiries to some of our insurers regarding finite reinsurance. Additionally, as part of ongoing, industry-wide investigations, we received various subpoenas and requests from the SEC and the United States Attorney for the Southern District of New York in connection with various investigations into certain loss mitigation products and the use of finite risk insurance.

 

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We are cooperating fully with these investigations and are complying with these requests. We conducted an evaluation of the transactions that could potentially fall within the scope of the subpoenas, as defined by the authorities, and have provided information as requested. Based on our investigation to date, we have concluded that there was a verbal side agreement with respect to one of our reinsurers under our catastrophic reinsurance program. While management believes that the difference resulting from the appropriate alternative accounting treatment would be immaterial to our financial position or results of operations, regulators may reach a different conclusion. In 2004 and 2003, premiums ceded to this reinsurer were $2,600 and $1,500, respectively, and losses ceded were $10,000 and zero, respectively. This contract expired in December 2004 and was not renewed. The Audit Committee of the Board of Directors, with the assistance of independent and Company counsel as it deemed appropriate, also completed its own investigation of the matters raised by the subpoenas, continues to respond to inquiries from the regulatory agencies and otherwise continues to fully cooperate with the regulatory agencies. The Audit Committee has not found any wrongdoing on the part of any of our officers.

 

We cannot predict at this time the effect that current litigation, investigations and regulatory activity will have on the insurance industry or our business. Given our prominent position in the insurance industry, it is possible that we will become subject to further investigations and have lawsuits filed against us. Our involvement in any investigations and lawsuits would cause us to incur legal costs and, if we were found to have violated any laws, we could be required to pay fines and damages, perhaps in material amounts. In addition, we could be materially adversely affected by the negative publicity for the insurance industry related to any such proceedings, and by any new industry-wide regulations or practices that may result from any such proceedings.

 

We face significant competitive pressures in our businesses, which may reduce premium rates and prevent us from pricing our products at rates that will allow us to be profitable.

 

In each of our lines of business, we compete with other insurance companies or service providers, depending on the line and products, although we have no single competitor who competes against us in all of the business lines in which we operate. Assurant Solutions and Assurant Specialty Property have numerous competitors in their product lines, but we believe no other company participates in all of the same lines or offers comparable comprehensive capabilities. Competitors for both business segments include insurance companies, financial institutions and, in the case of preneed, regional insurers.

 

While we are among the largest competitors in terms of market share in many of our business lines, in some cases there are one or more major market players in a particular line of business. In Assurant Health, we believe the market is characterized by many competitors, and our main competitors include health insurance companies, HMOs and the Blue Cross/Blue Shield plans in the states in which we write business. In Assurant Employee Benefits, competitors include benefits and life insurance companies, dental managed care entities and not-for-profit dental plans.

 

Competition in our businesses is based on many factors, including quality of service, product features, price, scope of distribution, scale, financial strength ratings and name recognition. We compete, and will continue to compete, for customers and distributors with many insurance companies and other financial services companies. We compete not only for business and individual customers, employer and other group customers, but also for agents and distribution relationships. Some of our competitors may offer a broader array of products than our specific subsidiaries with which they compete in particular markets, may have a greater diversity of distribution resources, may have better brand recognition, may from time to time have more competitive pricing, may have lower cost structures or, with respect to insurers, may have higher financial strength or claims paying ratings. Some may also have greater financial resources with which to compete. For example, many of our insurance products, particularly our group benefits and health insurance policies, are underwritten annually and, accordingly, there is a risk that group purchasers may be able to obtain more favorable terms from competitors rather than renewing coverage with us. The effect of competition may, as a result, adversely affect the

 

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persistency of these and other products, as well as our ability to sell products in the future. In Assurant Solutions, as a result of state and federal regulatory developments and changes in prior years, certain financial institutions are now able to offer a product called debt protection which is similar to credit insurance and financial institutions are able to affiliate with other insurance companies to offer services similar to our own. This has resulted in new competitors with significant financial resources entering some of our markets. Assurant Solutions currently provides debt protection administration and as financial institutions gain experience with debt protection administration, their reliance on third party administrators may diminish.

 

Moreover, some of our competitors may have a lower target for returns on capital allocated to their business than we do, which may lead them to price their products and services lower than we do. In addition, from time to time, companies enter and exit the markets in which we operate, thereby increasing competition at times when there are new entrants. For example, several large insurance companies have recently entered the market for individual health insurance products. We may lose business to competitors offering competitive products at lower prices, or for other reasons, which could materially adversely affect our results of operations and financial condition.

 

In certain markets, we compete with organizations that have a substantial market share. In addition, with regard to Assurant Health, organizations with sizable market share or provider-owned plans may be able to obtain favorable financial arrangements from health care providers that are not available to us. Without our own similar arrangements, we may not be able to compete effectively in such markets.

 

New competition could also cause the supply of insurance to change, which could affect our ability to price our products at attractive rates and thereby adversely affect our underwriting results. Although there are some impediments facing potential competitors who wish to enter the markets we serve, the entry of new competitors into our markets can occur, affording our customers significant flexibility in moving to other insurance providers.

 

The insurance industry is cyclical, which may impact our results.

 

The insurance industry is cyclical. Although no two cycles are the same, insurance industry cycles have typically lasted for periods ranging from two to ten years. The segments of the insurance markets in which we operate tend not to be correlated to each other, with each segment having its own cyclicality. Periods of intense price competition due to excessive underwriting capacity, periods when shortages of underwriting capacity permit more favorable rate levels, consequent fluctuations in underwriting results and the occurrence of other losses characterize the conditions in these markets. Historically, insurers have experienced significant fluctuations in operating results due to volatile and sometimes unpredictable developments, many of which are beyond the direct control of the insurer, including competition, frequency of occurrence or severity of catastrophic events, levels of capacity, general economic conditions and other factors. This may cause a decline in revenue at times in the cycle if we choose not to reduce our product prices in order to maintain our market position, because of the adverse effect on profitability of such a price reduction. We can be expected, therefore, to experience the effects of such cyclicality and changes in customer expectations of appropriate premium levels, the frequency or severity of claims or other loss events or other factors affecting the insurance industry that generally could have a material adverse effect on our results of operations and financial condition.

 

The insurance and related businesses in which we operate may be subject to periodic negative publicity, which may negatively impact our financial results.

 

We communicate with and distribute our products and services ultimately to individual consumers. There may be a perception that some of these purchasers may be unsophisticated and in need of consumer protection. Accordingly, from time to time, consumer advocate groups or the media may focus attention on our products and services, thereby subjecting our industries to the possibility of periodic negative publicity. We may also be negatively impacted if another company in one of our industries or in a related industry engages in practices resulting in increased public attention to our businesses. Negative publicity may also occur as a result of judicial

 

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inquiries and regulatory or governmental action with respect to our products, services and industry commercial practices. Negative publicity may result in increased regulation and legislative scrutiny of industry practices as well as increased litigation or enforcement action by civil and criminal authorities. Additionally, negative publicity may increase our costs of doing business and adversely affect our profitability by impeding our ability to market our products and services, requiring us to change our products or services or increasing the regulatory burdens under which we operate.

 

Ongoing focus by the government and the National Association of Insurance Commissioners (“NAIC”) on certain industry practices, including but not limited to, broker contingent commissions and finite or financial reinsurance, has created negative publicity for some insurers and the reinsurance industry, including those seeking reinsurance covers.

 

We are subject to extensive governmental laws and regulations, which increase our costs and could restrict the conduct of our business.

 

Our operating subsidiaries are subject to extensive regulation and supervision in the jurisdictions in which they do business. Such regulation is generally designed to protect the interests of policyholders, as opposed to stockholders and other investors. To that end, the laws of the various states establish insurance departments with broad powers with respect to such things as:

 

   

licensing and authorizing companies and agents to transact business;

 

   

regulating capital and surplus and dividend requirements;

 

   

regulating underwriting limitations;

 

   

regulating companies’ ability to enter and exit markets;

 

   

imposing statutory accounting requirements and annual statement disclosures;

 

   

approving policy forms and mandating certain insurance benefits;

 

   

restricting companies’ ability to provide, terminate or cancel certain coverages;

 

   

regulating premium rates, including the ability to increase or maintain premium rates;

 

   

regulating trade and claims practices;

 

   

regulating certain transactions between affiliates;

 

   

regulating the content of disclosures to consumers;

 

   

regulating the type, amounts and valuation of investments;

 

   

mandating assessments or other surcharges for guaranty funds and the ability to recover such assessments in the future through premium increases; and

 

   

regulating market conduct and sales practices of insurers and agents.

 

Our non-insurance operations and certain aspects of our insurance operations are subject to federal and state regulation including state and federal consumer protection laws. Similarly, our foreign subsidiaries are subject to legislation in the countries in which they are domiciled. We face the challenge of conducting business in a multi-national setting with varying regulations.

 

Assurant Health is also required by some jurisdictions to provide coverage to persons who would not otherwise be considered eligible by insurers. Each of these jurisdictions dictates the types of insurance and the level of coverage that must be provided to such involuntary risks. Our share of these involuntary risks is mandatory and generally a function of our respective share of the voluntary market by line of insurance in each jurisdiction. Assurant Health is exposed to some risk of losses in connection with mandated participation in such

 

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programs in those jurisdictions in which they are still effective. HIPAA requires certain guaranteed issuance and renewability of health insurance coverage for individuals and small groups (generally 50 or fewer employees) and limits exclusions based on pre-existing conditions. See also “—Risks Related to Our Industry—Costs of compliance with privacy and security laws could adversely affect our business and results of operations.” If regulatory requirements impede our ability to raise premium rates, utilize new policy forms or terminate, deny or cancel coverage in any of our businesses, our results of operations and financial condition could be materially adversely affected.

 

The capacity for an insurance company’s growth in premiums is in part a function of its statutory surplus. Maintaining appropriate levels of statutory surplus, as measured by Statutory Accounting Practices (“SAP”) and procedures, is considered important by insurance regulatory authorities and the private agencies that rate insurers’ claims-paying abilities and financial strength. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny and enforcement, action by regulatory authorities or a downgrade by rating agencies.

 

We may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations. Also, some regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or monetarily penalize us. That type of action could materially adversely affect our results of operations and financial condition.

 

Changes in regulation may reduce our profitability and limit our growth.

 

Legislation or other regulatory reform that increases the regulatory requirements imposed on us or that changes the way we are able to do business may significantly harm our business or results of operations in the future. For example, some states have imposed new time limits for the payment of uncontested covered claims and require health care and dental service plans to pay interest on uncontested claims not paid promptly within the required time period. Some states have also granted their insurance regulatory agencies additional authority to impose monetary penalties and other sanctions on health and dental plans engaging in certain unfair payment practices. If we were to be unable for any reason to comply with these requirements, it could result in substantial costs to us and may materially adversely affect our results of operations and financial condition.

 

Legislative or regulatory changes that could significantly harm us and our subsidiaries include, but are not limited to:

 

   

legislation that holds insurance companies or managed care companies liable for adverse consequences of medical or dental decisions;

 

   

limitations or imposed reductions on premium levels or the ability to raise premiums on existing policies;

 

   

increases in minimum capital, reserves and other financial viability requirements;

 

   

impositions of fines, taxes or other penalties for improper licensing, the failure to promptly pay claims, however defined, or other regulatory violations;

 

   

increased licensing requirements;

 

   

prohibitions or limitations on provider financial incentives and provider risk-sharing arrangements;

 

   

imposition of more stringent standards of review of our coverage determinations;

 

   

new benefit mandates;

 

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increased regulation relating to the use of associations and trusts in the sale of individual health insurance;

 

   

limitations on our ability to build appropriate provider networks and, as a result, manage health care and utilization due to “any willing provider” legislation, which requires us to take any provider willing to accept our reimbursement;

 

   

limitations on the ability to manage health care and utilization due to direct access laws that allow insureds to seek services directly from specialty medical providers without referral by a primary care provider; and

 

   

restriction of solicitation of preneed insurance consumers by funeral board laws.

 

In recent years, the state insurance regulatory framework has come under increased federal scrutiny and some state legislatures have considered or enacted laws that may alter or increase state authority to regulate insurance companies and insurance holding companies. Further, the NAIC and state insurance regulators are re-examining existing laws and regulations, specifically focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws. Although the U.S. federal government does not directly regulate the insurance business, changes in federal legislation and administrative policies in several areas could significantly impact the insurance industry and us. Federal legislation and administrative policies in areas such as employee benefit plan regulation, financial services regulation and federal taxation can reduce our profitability. Additionally, there have been attempts by the NAIC and several states to limit the use of discretionary clauses in policy forms. The elimination of discretionary clauses could increase our costs under our life, health and disability insurance policies. New interpretations of existing laws and the passage of new legislation may harm our ability to sell new policies and increase our claims exposure on policies we issued previously.

 

A number of legislative proposals have been made at the federal level over the past several years that could impose added burdens on Assurant Health. These proposals would, among other things, mandate benefits with respect to certain diseases or medical procedures, require plans to offer an independent external review of certain coverage decisions, establish association health plans for small businesses, and establish a national health insurance program. Any of these proposals, if implemented, could adversely affect our results of operations or financial condition. Federal changes in Medicare and Medicaid that reduce provider reimbursements could have negative implications for the private sector due to cost shifting. State small employer group and individual health insurance market reforms to increase access and affordability could also reduce profitability by precluding us from appropriately pricing for risk in our individual and small employer group health insurance policies.

 

With respect to Assurant Specialty Property, federal legislative proposals regarding National Catastrophe Insurance, if adopted, could reduce the business need for some of the property and casualty related products provided by Assurant Specialty Property.

 

The NAIC has adopted the Annual Financial Reporting Model Act (which prior to revision was known as the Model Audit Rule), that, when adopted by states, will impose internal controls similar to those mandated by Section 404 of the Sarbanes-Oxley Act of 2002 (which we refer to as SOX 404), with some differences for insurance companies. The latest date of adoption by any state, as prescribed by the NAIC, is 2010. These SOX 404 type controls will add an additional layer of internal review for insurer financial statements and subject insurers to varying levels of review by state insurance regulators. This could result in potential exposure for fines and penalties for non-compliance. In addition, the NAIC is considering changes in statutory accounting principles, which may negatively impact insurer financial reporting requirements and the profitability of insurance operations on a statutory basis.

 

Additionally, the Attorney General of Mississippi has initiated legal actions against a number of large insurers to invalidate or interpret the flood exclusion in various insurance policies of hurricane-affected

 

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claimants, so as to require coverage for losses from hurricane floods and tidal waves. The named insurers are contesting such action. Although none of the Assurant companies has been specifically named as defendants, the lawsuit names as unknown defendants, “any business entity qualified to do business in the State of Mississippi who offered insurance, similar to the named insurers, to the detriment of the citizens of the State.” As a result, if any of our companies are determined to be a defendant and the Mississippi Attorney General prevails, this could result in negative publicity or have a materially adverse effect on our current financial results as well as future pricing and profitability.

 

We cannot predict with certainty the effect any proposed or future legislation, regulations or NAIC initiatives may have on the conduct of our business. The insurance laws or regulations adopted or amended from time to time may be more restrictive or may result in materially higher costs than current requirements.

 

It is difficult to predict the effect of the current investigations in connection with insurance industry practices. See the preceding section entitled “—Our business is subject to risks related to litigation and regulatory actions.”

 

Costs of compliance with privacy and security laws could adversely affect our business and results of operations.

 

State privacy laws, particularly those with “opt-in” clauses, or provisions that enable an individual to elect information sharing instead of being automatically included, can affect all our businesses. These laws make it harder for our affiliated businesses to share information for marketing purposes, such as generating new sales leads and participating in joint marketing arrangements.

 

Similarly, the federal and various state “do not solicit” lists could pose a litigation risk to Assurant Solutions. Even an inadvertent failure to comply with consumers’ requests to be added to the “do not solicit” list could result in litigation.

 

HIPAA and the implementing regulations that have been adopted impose obligations for issuers of health and dental insurance coverage and health and dental benefit plan sponsors. HIPAA also establishes requirements for maintaining the confidentiality and security of individually identifiable health information and standards for electronic health care transactions. The Department of Health and Human Services promulgated final HIPAA regulations in 2002. The privacy regulations required compliance by April 2003, the electronic transactions regulations by October 2003 and the security regulations by April 2005. There are new provisions relating to the National Provider Identification Number that our health and dental businesses are working to comply with by May 2007. As have other entities in the health care industry, we have incurred and will continue to incur substantial costs in complying with the requirements of the HIPAA regulations.

 

HIPAA is far-reaching and complex and proper interpretation and practice under the law continue to evolve. Consequently, our efforts to measure, monitor and adjust our business practices to comply with HIPAA are ongoing. Failure to comply with HIPAA could result in regulatory fines and civil lawsuits. Knowing and intentional violations of these rules may also result in federal criminal penalties.

 

Beginning in early 2005, several large organizations became subjects of intense public scrutiny due to high-profile data security breaches involving sensitive financial and health information. These events focused national attention on identity theft and the duty of organizations to notify impacted consumers in the event of a data security breach. Several federal bills are pending in Congress and currently 27 states have passed legislation requiring customer notification in the event of a data security breach. Most state laws take their lead from recently enacted California Civil Code Section 1798.82, which requires businesses that conduct business in California to disclose any breach of security to any resident whose unencrypted data is believed to have been disclosed. Several significant legal, operational and reputational risks exist with regard to data breach and customer notification. Federal pre-emption relating to this issue may reduce our compliance costs. Nonetheless, a breach of data security requiring public notification can result in regulatory fines, penalties or sanctions, civil lawsuits, loss of reputation, loss of customers and reduction of our profitability.

 

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Risks Related to Our Relationship with Fortis

 

Fortis continues to be a significant stockholder of the Company, which gives them the right to register their shares and the ability to influence the market price of our stock.

 

Sales of a substantial number of shares of our common stock, or the perception by the market that those sales could occur, could cause the market price of our common stock to decline or could make it more difficult for us to raise funds through the sale of equity in the future. Fortis owned 22,999,130 shares of our common stock as of December 31, 2006, or approximately 19% of our outstanding common stock. All of these shares are subject to the terms of the exchangeable bonds, due January 26, 2008, that were sold by Fortis concurrently with the closing of our secondary offering on January 21, 2005. However, Fortis could choose not to exchange its shares for the bonds. If the exchangeable bonds are not exchanged for shares of our common stock, Fortis could retain its existing ownership interest in our Company. In that case, under the terms of a Registration Rights Agreement, dated as of February 10, 2004, as amended on January 10, 2005, Fortis would have the right to affect the registration of such shares of our common stock, making them freely tradable in the public market. Sales of a large number of these shares by Fortis at any time could have an adverse effect on the market price of our common stock. Additionally, Fortis would continue to be represented on our Board of Directors.

 

Because Fortis Bank operates U.S. branch offices, we are subject to regulation and oversight by the Federal Reserve Board under the Bank Holding Company Act (“BHCA”).

 

Fortis Bank S.A./N.V. (“Fortis Bank”), which is a company in the Fortis Group, obtained approval in 2002 from state banking authorities and the Board of Governors of the Federal Reserve System (“Federal Reserve”) to establish branch offices in Connecticut and New York. By virtue of the opening of these offices, the Fortis Group’s operations and investments (including the Fortis Group’s investment in us) became subject to the nonbanking prohibitions of Section 4 of the BHCA. Except to the extent that a BHCA exemption or authority is available, Section 4 of the BHCA does not permit foreign banking organizations with U.S. branches to own more than 5% of any class of voting shares or otherwise to control any company that conducts commercial activities, such as manufacturing, distribution of goods or real estate development.

 

To broaden the scope of activities and investments permissible for the Fortis Group and us, the Fortis Group in 2002 notified the Federal Reserve of its election to be a “financial holding company” for purposes of the BHCA and the Federal Reserve’s implementing regulations in Regulation Y. As a financial holding company, the Fortis Group may own shares of companies engaged in activities in the United States that are “financial in nature,” “incidental to such financial activity” or “complementary to a financial activity.” Activities that are “financial in nature” include, among other things:

 

   

insuring, guaranteeing or indemnifying against loss, harm, damage, illness, disability or death, or providing and issuing annuities; and

 

   

acting as principal, agent or broker for purposes of the foregoing.

 

In connection with Fortis Bank’s establishment of U.S. branches, staff of the Federal Reserve inquired as to whether certain of our activities are financial in nature under Section 4(k) of the BHCA. In light of the Fortis Group’s contemplated divestiture of our shares, this inquiry was suspended at the Fortis Group’s and our request. To the extent that any of our activities might be deemed not to be financial in nature under Section 4(k), the Fortis Group may rely on an exemption in Section 4(a)(2) of the BHCA that permits the Fortis Group to continue to hold interests in companies engaged in activities that are not financial in nature for an initial period of two years and, with Federal Reserve approval for each extension, for up to three additional one-year periods. The Federal Reserve also has the discretion to permit the Fortis Group to hold such interests after the five-year period under certain provisions other than Section 4(a)(2). The initial two-year period under Section 4(a)(2) expired on December 2, 2004. The first one-year extension expired on December 2, 2005 and the second one-year extension expired on December 2, 2006. The Fortis Group has obtained an additional one-year extension of the divestiture

 

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period through December 2, 2007, and has informed the Federal Reserve that the divestiture is scheduled to be completed early in 2008. Further, the Fortis Group has committed to notify the Federal Reserve within 10 days of the consummation of the divestiture.

 

The Federal Reserve has jurisdiction under the BHCA over all of the Fortis Group’s direct and indirect U.S. subsidiaries. We and our subsidiaries will be considered subsidiaries of the Fortis Group for purposes of the BHCA so long as the Fortis Group owns 25% or more of any class of our voting shares or otherwise controls or has been determined to have a controlling influence over us within the meaning of the BHCA. The Federal Reserve could take the position that the Fortis Group continues to control us until the Fortis Group reduces its ownership to less than 5% of our voting shares. So long as the Fortis Group controls us for purposes of the BHCA, the Federal Reserve could require us immediately to discontinue, restructure or divest any of our operations that are deemed to be impermissible under the BHCA, which could result in reduced revenues, increased costs or reduced profitability for us.

 

Risks Related to Our Common Stock

 

Applicable laws and our certificate of incorporation and by-laws may discourage takeovers and business combinations that our stockholders might consider in their best interests.

 

State laws and our certificate of incorporation and by-laws may delay, defer, prevent or render more difficult a takeover attempt that our stockholders might consider in their best interests. For instance, they may prevent our stockholders from receiving the benefit from any premium to the market price of our common stock offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging takeover attempts in the future.

 

State laws and our certificate of incorporation and by-laws may also make it difficult for stockholders to replace or remove our directors. These provisions may facilitate director entrenchment, which may delay, defer or prevent a change in our control, which may not be in the best interests of our stockholders.

 

The following provisions in our certificate of incorporation and by-laws have anti-takeover effects and may delay, defer or prevent a takeover attempt that our stockholders might consider in their best interests. In particular, our certificate of incorporation and by-laws:

 

   

permit our Board of Directors to issue one or more series of preferred stock;

 

   

divide our Board of Directors into three classes;

 

   

limit the ability of stockholders to remove directors;

 

   

except for Fortis, prohibit stockholders from filling vacancies on our Board of Directors;

 

   

prohibit stockholders from calling special meetings of stockholders and from taking action by written consent;

 

   

impose advance notice requirements for stockholder proposals and nominations of directors to be considered at stockholder meetings;

 

   

subject to limited exceptions, require the approval of at least two-thirds of the voting power of our outstanding capital stock entitled to vote on the matter to approve mergers and consolidations or the sale of all or substantially all of our assets; and

 

   

require the approval by the holders of at least two-thirds of the voting power of our outstanding capital stock entitled to vote on the matter for the stockholders to amend the provisions of our by-laws and certificate of incorporation described in the second through seventh bullet points above and this supermajority provision.

 

In addition, Section 203 of the General Corporation Law of the State of Delaware may limit the ability of an “interested stockholder” to engage in business combinations with us. An interested stockholder is defined to include persons owning 15% or more of our outstanding voting stock.

 

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Applicable insurance laws may make it difficult to effect a change of control of our Company.

 

Before a person can acquire control of an insurance company in the U.S. and certain other countries, prior written approval must be obtained from the insurance commissioner of the jurisdiction where the insurer is domiciled. For example, generally, state statutes provide that control over a domestic insurer is presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote, or holds proxies representing, 10% or more of the voting securities of the domestic insurer. However, the State of Florida, in which certain of our insurance subsidiaries are domiciled, defines control as 5% or more. Because a person acquiring 5% or more of our common stock would indirectly control the same percentage of the stock of our Florida subsidiaries, the insurance change of control laws of Florida would apply to such transaction and at 10%, the laws of many other states would likely apply to such a transaction. Prior to granting approval of an application to acquire control of a domestic insurer, a state insurance commissioner will typically consider such factors as the financial strength of the applicant, the integrity of the applicant’s board of directors and executive officers, the applicant’s plans for the future operations of the domestic insurer and any anti-competitive results that may arise from the consummation of the acquisition of control.

 

Our stock and the stocks of other companies in the insurance industry are subject to stock price and trading volume volatility.

 

From time to time, the stock price and the number of shares traded of companies in the insurance industry experience periods of significant volatility. Company-specific issues and developments generally in the insurance industry and in the regulatory environment may cause this volatility. Our stock price may fluctuate in response to a number of events and factors, including:

 

   

quarterly variations in operating results;

 

   

natural disasters, terrorist attacks and epidemics;

 

   

changes in financial estimates and recommendations by securities analysts;

 

   

operating and stock price performance of other companies that investors may deem comparable;

 

   

press releases or publicity relating to us or our competitors or relating to trends in our markets;

 

   

regulatory changes and adverse outcomes from litigation and government or regulatory investigations;

 

   

sales of stock by insiders;

 

   

changes in our financial strength ratings;

 

   

limitations on premium levels or the ability to raise premiums on existing policies; and

 

   

increases in minimum capital, reserves and other financial viability requirements.

 

In addition, broad market and industry fluctuations may adversely affect the trading price of our common stock, regardless of our actual operating performance.

 

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Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

We own seven properties, including five buildings that serve as headquarters locations for our operating business segments and two buildings that serve as operation centers for Assurant Solutions and Assurant Specialty Property. Assurant Solutions and Assurant Specialty Property share headquarters buildings located in Miami, Florida and Atlanta, Georgia and Assurant Specialty Property has operation centers located in Florence, South Carolina and Springfield, Ohio. Assurant Solution’s preneed business also has a headquarters building in Rapid City, South Dakota. Assurant Employee Benefits has a headquarters building in Kansas City, Missouri. Assurant Health has a headquarters building in Milwaukee, Wisconsin. We lease office space for various offices and service centers located throughout the United States and internationally, including our New York corporate office and our data center in Woodbury, Minnesota. Our leases have terms ranging from month-to-month to twenty-five years. We believe that our owned and leased properties are adequate for our current business operations.

 

Item 3. Legal Proceedings

 

We are regularly involved in litigation in the ordinary course of business, both as a defendant and as a plaintiff. We may from time to time be subject to a variety of legal and regulatory actions relating to our current and past business operations. While we cannot predict the outcome of any pending or future litigation, examination or investigation and although no assurances can be given, we do not believe that any pending matter will have a material adverse effect individually or in the aggregate on our financial position or results of operations.

 

As part of ongoing, industry-wide investigations, we have received various subpoenas and requests from the SEC and the United States Attorney for the Southern District of New York in connection with various investigations into certain loss mitigation products and the use of finite risk insurance. We are cooperating fully with these investigations and are complying with these requests.

 

We conducted an evaluation of the transactions that could potentially fall within the scope of the subpoenas, as defined by the authorities, and have provided information as requested. Based on our investigation to date, we have concluded that there was a verbal side agreement with respect to one of our reinsurers under our catastrophic reinsurance program. While management believes that the difference resulting from the appropriate alternative accounting treatment would be immaterial to our financial position or results of operations, regulators may reach a different conclusion. In 2004 and 2003, premiums ceded to this reinsurer were $2,600 and $1,500, respectively, and losses ceded were $10,000 and zero, respectively. This contract expired in December 2004 and was not renewed.

 

The Audit Committee of the Board of Directors, with the assistance of independent and Company counsel as it deemed appropriate, also completed its own investigation of the matters raised by the subpoenas, continues to respond to inquiries from the regulatory agencies and otherwise continues to fully cooperate with the regulatory agencies. The Audit Committee has not found any wrongdoing on the part of any of our officers.

 

We believe, based on information currently available, that the amounts accrued for currently outstanding disputes are adequate. The inherent uncertainty of arbitrations and lawsuits, including the uncertainty of estimating whether any settlements we may enter into in the future, would be on favorable terms, makes it difficult to predict the outcomes with certainty.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

No matter was submitted to a vote of the stockholders of Assurant, Inc. during the fourth quarter of 2006.

 

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PART II

 

Item 5. Market of Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Stock Performance Graph

 

The following chart compares the total stockholder returns (stock price increase plus dividends) on our common stock from February 4, 2004 (the date of the initial public offering of our common stock) through December 31, 2006 with the total stockholder returns for the S&P 400 Midcap Index, as the broad equity market index, and the S&P 400 Multi-Line Insurance Index and S&P 500 Multi-Line Insurance Index, as the published industry indexes. The graph assumes that the value of the investment in the common stock and each index was $100 on February 4, 2004 and that all dividends were reinvested.

 

LOGO

 

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Total Return To Stockholders

(Includes reinvestment of dividends)

 

     Base
Period
2/4/04


  

INDEXED RETURNS

Six Months Ending


Company / Index


      6/30/04

   12/31/04

   6/30/05

   12/31/05

   6/30/06

   12/31/06

Assurant Inc.

   100    120.24    139.95    166.08    200.87    224.40    257.13

S&P 400 Midcap Index

   100    104.98    115.27    119.71    129.75    135.25    143.14

S&P 500 Multi-line Insurance Index

   100    102.84    97.20    89.54    105.73    95.80    113.74

S&P 400 Multi-line Insurance Index

   100    104.12    107.80    118.63    128.89    134.71    156.93
         

RETURN PERCENTAGE

Six Months Ending


Company / Index


   6/30/04

   12/31/04

   6/30/05

   12/31/05

   6/30/06

   12/31/06

Assurant Inc

   20.24    16.38    18.68    20.95    11.71    14.58

S&P 400 Midcap Index

   4.98    9.80    3.85    8.38    4.24    5.83

S&P 500 Multi-line Insurance Index

   2.84    -5.49    -7.88    18.09    -9.39    18.73

S&P 400 Multi-line Insurance Index

   4.12    3.54    10.04    8.65    4.51    16.49

 

Common Stock Price

 

Our common stock is listed on the NYSE under the symbol “AIZ”. The following table sets forth the high and low intraday sales prices per share of our common stock as reported by the NYSE for the periods indicated.

 

Year Ended December 31, 2006


   High

   Low

   Dividends

First Quarter

   $ 49.80    $ 42.80    $ 0.08

Second Quarter

   $ 51.68    $ 45.12    $ 0.10

Third Quarter

   $ 54.10    $ 46.73    $ 0.10

Fourth Quarter

   $ 56.76    $ 52.20    $ 0.10

Year Ended December 31, 2005


   High

   Low

   Dividends

First Quarter

   $ 35.01    $ 29.70    $ 0.07

Second Quarter

   $ 36.41    $ 31.90    $ 0.08

Third Quarter

   $ 38.96    $ 35.60    $ 0.08

Fourth Quarter

   $ 44.68    $ 35.79    $ 0.08

 

Equity Compensation Plan Information

 

The following table shows aggregate information, as of December 31, 2006, with respect to compensation plans under which equity securities of Assurant are authorized for issuance.

 

Plan Category


  

(a)

Number of Securities

to be Issued Upon

Exercise of

Outstanding Options,

Warrants and Rights


  

(b)

Weighted-Average

Exercise Price of

Outstanding Options,

Warrants and Rights


  

(c)

Number of Securities
Remaining Available

for Future Issuance

Under Equity

Compensation Plans

(Excluding Securities

Reflected
in Column (a))


Equity Compensation Plans Approved by Security Holders

   2,574,655    $ 32.35    7,332,252

Equity Compensation Plans Not Approved by Security Holders

   —        —      —  
    
  

  

Total

   2,574,655    $ 32.35    7,332,252
    
  

  

 

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Holders

 

On February 15, 2007, there were approximately 495 registered holders of record of our common stock. The closing price of our common stock on the NYSE on February 15, 2007 was $54.64.

 

Shares Repurchased

 

Period in 2006


   Total Number
of Shares
Purchased


   Average Price
Paid per Share


   Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs


   Maximum Number
of Shares that may
yet be Purchased
under the Plans or
Programs (1)


January 1 – January 31

   450,200    $ 44.33    450,200    8,183,435

February 1 – February 28

   416,600    $ 44.49    416,600    7,868,909

March 1 – March 31

   550,000    $ 46.38    550,000    6,735,802
    
         
    

Total first quarter

   1,416,800    $ 45.17    1,416,800     
    
         
    

April 1 – April 30

   475,000    $ 48.86    475,000    6,405,065

May 1 – May 31

   475,000    $ 49.90    475,000    5,827,145

June 1 – June 30

   1,190,000    $ 47.67    1,190,000    4,712,978
    
         
    

Total second quarter

   2,140,000    $ 48.43    2,140,000     
    
         
    

July 1 – July 31

   1,040,000    $ 48.21    1,040,000    3,694,683

August 1 – August 31

   1,101,000    $ 50.14    1,101,000    2,386,228

September 1 – September 30

   940,000    $ 52.95    940,000    1,366,775
    
         
    

Total third quarter

   3,081,000    $ 50.34    3,081,000     
    
         
    

October 1 – October 31

   1,030,000    $ 53.88    1,030,000    332,469

November 1 – November 30

   430,100    $ 54.79    430,100    10,806,791

December 1 – December 31

   366,316    $ 55.65    366,316    10,381,092
    
         
    

Total fourth quarter

   1,826,416    $ 54.45    1,826,416     
    
         
    

Total through December 31

   8,464,216           8,464,216    10,381,092
    
         
  

(1) On November 11, 2005, the Company’s Board of Directors approved a stock repurchase program under which the Company could repurchase $400,000 of its outstanding stock. On November 21, 2006, the Company reached the $400,000 threshold under this program. On November 10, 2006, the Company’s Board of Directors approved another stock repurchase program under which the Company may repurchase up to an additional $600,000 of its outstanding common stock.

 

Dividend Policy

 

On February 15, 2007, we announced that our Board of Directors declared a quarterly dividend of $0.10 per common shares payable on March 12, 2007 to stockholders of record as of February 26, 2007. We paid dividends of $0.08 per common share on March 7, 2006, $.10 per common share on June 13, 2006, $.10 per common share on September 12, 2006 and $.10 per common share on December 11, 2006. Any determination to pay future dividends will be at the discretion of our Board of Directors and will be dependent upon: our subsidiaries’ payment of dividends and/or other statutorily permissible payments to us; our results of operations and cash flows; our financial position and capital requirements; general business conditions; any legal, tax, regulatory and contractual restrictions on the payment of dividends; and any other factors our Board of Directors deems relevant.

 

We are a holding company and, therefore, our ability to pay dividends, service our debt and meet our other obligations depends primarily on the ability of our regulated U.S. domiciled insurance subsidiaries to pay dividends

 

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and make other statutorily permissible payments to us. Our insurance subsidiaries are subject to significant regulatory and contractual restrictions limiting their ability to declare and pay dividends. See “Item 1A—Risk Factors—Risks Relating to Our Company—The inability of our subsidiaries to pay dividends to us in sufficient amounts could harm our ability to meet our obligations and pay future stockholder dividends.” For the calendar year 2007, the maximum amount of dividends that our regulated U.S. domiciled insurance subsidiaries could pay to us under applicable laws and regulations without prior regulatory approval is approximately $476,070. Dividends were paid by our subsidiaries totaling $554,270 through December 31, 2006.

 

We may seek approval of regulators to pay dividends in excess of any amounts that would be permitted without such approval. However, there can be no assurance that we would obtain such approval if sought.

 

In addition, payments of dividends on the shares of common stock are subject to the preferential rights of preferred stock that our Board of Directors may create from time to time. For more information regarding restrictions on the payment of dividends by us and our insurance subsidiaries, including pursuant to the terms of our revolving credit facilities, see “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

 

In addition, our $500,000 senior revolving credit facility restricts payments of dividends in the event that an event of default under the facility has occurred or a proposed dividend payment would cause an event of default under the facility.

 

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Item 6. Selected Financial Data

 

Five-Year Summary of Selected Financial Data Assurant, Inc.

 

     As of and for the years ended December 31,

 
     2006

   2005

   2004

    2003

   2002

 
     (in thousands, except share amounts and per share data)  

Consolidated Statement of Operations Data:

                                     

Revenues

                                     

Net earned premiums and other considerations

   $ 6,843,775    $ 6,520,796    $ 6,482,871     $ 6,156,772    $ 5,681,596  

Net investment income

     736,686      687,257      634,749       607,313      631,828  

Net realized gains (losses) on investments

     111,865      8,235      24,308       1,868      (118,372 )

Amortization of deferred gain on disposal of businesses

     37,300      42,508      57,632       68,277      79,801  

(Loss)/Gain on disposal of businesses

     —        —        (9,232 )     —        10,672  

Fees and other income

     340,958      238,879      220,386       241,988      246,675  
    

  

  


 

  


Total revenues

     8,070,584      7,497,675      7,410,714       7,076,218      6,532,200  

Benefits, losses and expenses

                                     

Policyholder benefits

     3,538,947      3,707,809      3,839,769       3,657,763      3,435,175  

Amortization of deferred acquisition costs and value of businesses acquired

     1,185,113      926,608      820,456       834,662      732,010  

Underwriting, general and administrative expenses

     2,189,539      2,146,392      2,155,980       2,004,481      1,876,222  

Interest expense

     61,243      61,258      56,418       1,175      —    

Distributions on mandatorily redeemable preferred securities

     —        —        2,163       112,958      118,396  

Interest premium on redemption of preferred securities

     —        —        —         205,822      —    
    

  

  


 

  


Total benefits, losses and expenses

     6,974,842      6,842,067      6,874,786       6,816,861      6,161,803  

Income before income taxes and cumulative effect of change in accounting principle

     1,095,742      655,608      535,928       259,357      370,397  

Income taxes

     379,871      176,253      185,368       73,705      110,657  
    

  

  


 

  


Net income before cumulative effect of change in accounting principle

     715,871      479,355      350,560       185,652      259,740  

Cumulative effect of change in accounting principle (1)

     1,547      —        —         —        (1,260,939 )
    

  

  


 

  


Net income (loss)

   $ 717,418    $ 479,355    $ 350,560     $ 185,652    $ (1,001,199 )
    

  

  


 

  


Earnings per share:

                                     

Basic

                                     

Net income before cumulative effect of change in accounting principle

   $ 5.65    $ 3.53    $ 2.53     $ 1.70    $ 2.38  

Cumulative effect of change in accounting principle

     0.01      —        —         —        (11.55 )
    

  

  


 

  


Net income (loss)

   $ 5.66    $ 3.53    $ 2.53     $ 1.70    $ (9.17 )
    

  

  


 

  


Diluted

                                     

Net income before cumulative effect of change in accounting principle

   $ 5.56    $ 3.50    $ 2.53     $ 1.70    $ 2.38  

Cumulative effect of change in accounting principle (1)

     0.01      —        —         —        (11.55 )
    

  

  


 

  


Net income (loss)

   $ 5.57    $ 3.50    $ 2.53     $ 1.70    $ (9.17 )
    

  

  


 

  


Dividends per share

   $ 0.38    $ 0.31    $ 0.21     $ 1.66    $ 0.38  

Share Data:

                                     

Weighted average shares outstanding used in per share calculations

     126,846,990      135,773,551      138,358,767       109,222,276      109,222,276  

Plus: Dilutive securities

     1,965,823      1,171,759      108,797       —        —    
    

  

  


 

  


Weighted average shares used in diluted per share calculations

     128,812,813      136,945,310      138,467,564       109,222,276      109,222,276  
    

  

  


 

  


 

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     As of and for the years ended December 31,

     2006

   2005

   2004

   2003

   2002

     (in thousands, except share amounts and per share data)

Selected Consolidated Balance Sheet Data:

                                  

Cash and cash equivalents and investments

   $ 13,416,817    $ 13,371,392    $ 12,955,128    $ 12,302,585    $ 10,694,772

Total assets

   $ 25,165,148    $ 25,365,453    $ 24,548,106    $ 24,093,444    $ 22,257,699

Policy liabilities (2)

   $ 14,608,402    $ 14,391,691    $ 13,471,716    $ 12,932,661    $ 12,388,623

Debt

   $ 971,774    $ 971,690    $ 971,611    $ 1,750,000    $ —  

Mandatorily redeemable preferred securities

   $ —      $ —      $ —      $ 196,224    $ 1,446,074

Mandatorily redeemable preferred stock

   $ 22,160    $ 24,160    $ 24,160    $ 24,160    $ 24,660

Total stockholder’s equity

   $ 3,832,597    $ 3,699,559    $ 3,635,431    $ 2,632,103    $ 2,555,059

Per Share Data:

                                  

Total book value per share (3)

   $ 31.26    $ 28.33    $ 26.01    $ 24.10    $ 23.39

(1) On January 1, 2006, we adopted FAS 123R. As a result, we recognized a cumulative adjustment of $1,547. On January 1, 2002, we adopted FAS 142. As a result, we recognized a non-cash goodwill impairment charge of $1,260,939.
(2) Policy liabilities include future policy benefits and expenses, unearned premiums and claims and benefits payable.
(3) Total stockholders’ equity divided by the basic shares of common stock outstanding. At December 31, 2006, 2005 and 2004 there were 122,618,317, 130,591,834 and 139,766,177 shares, respectively, of common stock outstanding. At December 31, 2003 and 2002, there were 109,222,276 shares of common stock outstanding.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and accompanying notes which appear elsewhere in this report. It contains forward-looking statements that involve risks and uncertainties. Please see “Forward-Looking Statements” for more information. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this report, particularly under the headings “Item 1A—Risk Factors” and “Forward-Looking Statements.”

 

General

 

On April 1, 2006, the Company separated its Assurant Solutions business segment into two business segments: Assurant Solutions and Assurant Specialty Property. In addition, concurrent with the creation of the new Assurant Solutions and Assurant Specialty Property segments, the Company realigned the Preneed segment under the new Assurant Solutions segment. Segment income statements for the years ended December 31, 2005 and 2004 have been recast to reflect the new segment reporting structure.

 

We report our results through five segments: Assurant Solutions, Assurant Specialty Property, Assurant Health, Assurant Employee Benefits, and Corporate and Other. The Corporate and Other segment includes activities of the holding company, financing expenses, net realized gains (losses) on investments, interest income earned from short-term investments held, interest income from excess surplus of insurance subsidiaries not allocated to other segments, run-off Asbestos business, and additional costs associated with excess of loss reinsurance and ceded to certain subsidiaries in the London market between 1995 and 1997. The Corporate and Other segment also includes the amortization of deferred gains associated with the portions of the sales of FFG and LTC. FFG and LTC were sold through reinsurance agreements as described below.

 

Critical Factors Affecting Results

 

Our results depend on the adequacy of our product pricing, underwriting and the accuracy of our methodology for the establishment of reserves for future policyholder benefits and claims, returns on invested assets and our ability to manage our expenses. Therefore, factors affecting these items may have a material adverse effect on our results of operations or financial condition.

 

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Revenues

 

We generate our revenues primarily from the sale of our insurance policies and, to a lesser extent, fee income by providing administrative services to certain clients. Sales of insurance policies are recognized in revenue as earned premiums while sales of administrative services are recognized as fee income. In late 2000, the majority of Assurant Solutions’ domestic credit insurance clients began a transition from the purchase of our credit insurance products, from which we earned premium revenue, to debt protection administration programs, from which we earn fee income. Debt protection administration programs include services for non-insurance products that cancel or defer the required monthly payment on outstanding loans when covered events occur.

 

Our premium and fee income is supplemented by income earned from our investment portfolio. We recognize revenue from interest payments, dividends and sales of investments. Currently, our investment portfolio is primarily invested in fixed maturity securities. Both investment income and realized capital gains on these investments can be significantly impacted by changes in interest rates.

 

Interest rate volatility can reduce unrealized gains or create unrealized losses in our portfolios. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Fluctuations in interest rates affect our returns on, and the market value of, fixed maturity and short-term investments.

 

The fair market value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. The fair market value generally increases or decreases in an inverse relationship with fluctuations in interest rates, while net investment income realized by us from future investments in fixed maturity securities will generally increase or decease with interest rates. We also have investments that carry pre-payment risk, such as mortgage backed and asset backed securities. Actual net investment income and/or cash flows from investments that carry prepayment risk may differ from estimates at the time of investment as a result of interest rate fluctuations. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities, commercial mortgage obligations and bonds are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates. Therefore, we may be required to reinvest those funds in lower interest-bearing investments.

 

Expenses

 

Our expenses are primarily policyholder benefits, selling, underwriting and general expenses and interest expense.

 

Our profitability depends in large part on accurately predicting policyholder benefits, claims and other costs, including medical and dental costs. It also depends on our ability to manage future policyholder benefit and other costs through product design, underwriting criteria, utilization review or claims management catastrophe reinsurance coverage and, in health and dental insurance, negotiation of favorable provider contracts. Changes in the composition of the kinds of work available in the economy, market conditions and numerous other factors may also materially adversely affect our ability to manage claim costs. As a result of one or more of these factors or other factors, claims could substantially exceed our expectations, which could have a material adverse effect on our business, results of operations and financial condition.

 

Selling, underwriting and general expenses consist primarily of commissions, premium taxes, licenses, fees, amortization of deferred acquisition costs (“DAC”) and value of businesses acquired (“VOBA”) and general operating expenses. For a description of DAC and VOBA, see Notes 2, 9 and 11 of the Notes to Consolidated Financial Statements included elsewhere in this report.

 

At December 31, 2006 and December 31, 2005, we had $993,934 and $995,850, respectively of debt and mandatorily redeemable preferred stock. This has had an impact on our annual interest and dividend costs.

 

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Dispositions of Businesses

 

Our results of operations were affected by the following dispositions:

 

On November 9, 2005, the Company signed an agreement with Forethought to sell via reinsurance new preneed insurance polices written as of October 1, 2005 in the United States via independent funeral homes and funeral home chains other than those owned and operated by SCI. The Company will receive payments from Forethought over the next ten years based on the amount of business the Company transitions to Forethought. This agreement does not impact preneed’s Independent—Canada operation or SCI distribution channels.

 

On May 3, 2004, we sold the assets of our WorkAbility division of CORE, Inc. (“CORE”). We recorded a pre-tax loss on the sale of $9,232, which was included in the Corporate and Other segment.

 

Critical Accounting Estimates

 

There are certain accounting policies that we consider to be critical due to the amount of judgment and uncertainty inherent in the application of those policies. In calculating financial statement estimates, the use of different assumptions could produce materially different estimates. In addition, if factors such as those described above or in “Item 1A.—Risk Factors” cause actual events to differ from the assumptions used in applying the accounting policies and calculating financial estimates, there could be a material adverse effect on our results of operations, financial condition and liquidity.

 

We believe the following critical accounting policies require significant estimates which, if such estimates are not materially correct, could affect the preparation of our consolidated financial statements.

 

Reserves

 

Reserves are established according to GAAP using generally accepted actuarial methods and are based on a number of factors. These factors include experience derived from historical claim payments and actuarial assumptions to arrive at loss development factors. Such assumptions and other factors include trends, the incidence of incurred claims, the extent to which all claims have been reported and internal claims processing charges. The process used in computing reserves cannot be exact, particularly for liability coverages, since actual claim costs are dependent upon such complex factors as inflation, changes in doctrines of legal liabilities and damage awards. The methods of making such estimates and establishing the related liabilities are periodically reviewed and updated.

 

Reserves do not represent an exact calculation of exposure, but instead represent our best estimates, generally involving actuarial projections at a given time, of what we expect the ultimate settlement and administration of a claim or group of claims will cost based on our assessment of facts and circumstances then known. The adequacy of reserves will be impacted by future trends in claims severity, frequency, judicial theories of liability and other factors. These variables are affected by both external and internal events, such as: changes in the economic cycle, changes in the social perception of the value of work, emerging medical perceptions regarding physiological or psychological causes of disability, emerging health issues and new methods of treatment or accommodation, inflation, judicial trends, legislative changes and claims handling procedures.

 

Many of these items are not directly quantifiable, particularly on a prospective basis. Reserve estimates are refined as experience develops. Adjustments to reserves, both positive and negative, are reflected in the statement of operations of the period in which such estimates are updated. Because establishment of reserves is an inherently uncertain process involving estimates of future losses, there can be no certainty that ultimate losses will not exceed existing claims reserves. Future loss development could require reserves to be increased, which could have a material adverse effect on our earnings in the periods in which such increases are made.

 

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The following table provides reserve information by our major lines of business for the years ended December 31, 2006 and 2005:

 

    December 31, 2006

  December 31, 2005

    Future
Policy
Benefits and
Expenses


  Unearned
Premiums


  Case
Reserve


  Incurred
But Not
Reported
Reserves


  Future
Policy
Benefits and
Expenses


  Unearned
Premiums


  Case
Reserve


  Incurred
But Not
Reported
Reserves


Long Duration Contracts:

                                               

Pre-funded funeral life insurance policies and investment-type annuity contracts

  $ 3,031,487   $ 3,339   $ 10,599   $ 3,094   $ 2,902,918   $ 3,616   $ 11,476   $ 3,443

Life insurance no longer offered

    502,406     784     1,356     467     513,426     820     1,612     517

Universal life and other products no longer offered

    331,257     1,537     263     8,289     346,928     1,699     339     7,128

FFG and LTC disposed businesses

    2,743,154     45,129     262,960     34,743     2,724,575     46,956     218,311     15,243

Medical

    152,954     23,827     34,454     43,602     172,441     31,650     50,866     45,926

All other

    5,085     504     11,532     7,213     4,566     608     8,548     7,926

Short Duration Contracts:

                                               

Group term life

    —       6,787     327,180     53,221     —       6,207     331,040     58,953

Group disability

    —       2,195     1,362,594     156,296     —       2,110     1,330,091     168,825

Medical

    —       95,651     123,736     192,394     —       89,776     143,379     180,727

Dental

    —       3,796     4,746     19,873     —       4,226     4,631     23,332

Property and Warranty

    —       1,488,253     195,306     296,336     —       1,261,145     415,654     531,364

Credit Life and Disability

    —       494,113     125,909     93,261     —       571,723     154,964     120,279

Extended Service Contract

    —       2,179,345     3,075     32,462     —       1,784,292     6,726     27,900

All other

    —       84,633     3,251     3,954     —       46,786     3,694     2,329
   

 

 

 

 

 

 

 

Total

  $ 6,766,343   $ 4,429,893   $ 2,466,961   $ 945,205   $ 6,664,854   $ 3,851,614   $ 2,681,331   $ 1,193,892
   

 

 

 

 

 

 

 

 

For a description of our reserving methodology, see Note 12 of the Notes to Consolidated Financial Statements included elsewhere in this report.

 

The following discusses the reserving process for our major long duration product line.

 

Long Duration

 

Reserves for future policy benefits are recorded as the present value of future benefits to policyholders and related expenses less the present value of future net premiums. Reserve assumptions are selected using best estimates for expected investment yield, inflation, mortality and withdrawal rates. These assumptions reflect current trends, are based on Company experience and include provision for possible unfavorable deviation. We also record an unearned revenue reserve which represents the balance of the excess of gross premiums over net premiums that is still to be recognized in future years’ income in a constant relationship to insurance in force.

 

Risks related to the reserves recorded for contracts from FFG and LTC disposed businesses have been 100% ceded via reinsurance. While the Company has not been released from the contractual obligation to the policyholders, changes in and deviations from economic and mortality assumptions used in the calculation of these reserves will not directly affect the Company unless there is a default by the assuming reinsurer. We have sold these businesses through reinsurance.

 

Loss recognition testing is performed annually and reviewed quarterly. Such testing involves the use of best estimate assumptions to determine if the net liability position (all liabilities less DAC) exceeds the minimum

 

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liability needed. Any premium deficiency would first be addressed by removing the provision for adverse deviation. To the extent a premium deficiency still remains, it would be recognized immediately by a charge to the statement of operations and a corresponding reduction in DAC. Any additional deficiency would be recognized as a premium deficiency reserve.

 

Historically, loss recognition testing has not resulted in an adjustment to DAC or reserves. Such adjustments would occur only if economic or mortality conditions significantly deteriorated.

 

Short Duration

 

For short duration contracts, claims and benefits payable reserves are reported when insured events occur. The liability is based on the expected ultimate cost of settling the claims. The claims and benefits payable reserves include (1) case reserves for known but unpaid claims as of the balance sheet date; (2) IBNR reserves for claims where the insured event has occurred but has not been reported to us as of the balance sheet date; and (3) loss adjustment expense reserves for the expected handling costs of settling the claims. Periodically, we review emerging experience and make adjustments to our case reserves and assumptions where necessary. Below are further discussions on the reserving process for our major short duration products.

 

Group Disability and Group Term Life

 

Case or claim reserves are set for active individual claims on group long term disability policies and for disability waiver of premium benefits on group term life policies. Assumptions considered in setting such reserves include disabled life mortality and claim recovery rates, claim management practices, awards for social security and other benefit offsets and yield rates earned on assets supporting the reserves. Group long term disability and group term life waiver of premium reserves are discounted because the payment pattern and ultimate cost are fixed and determinable on an individual claim basis.

 

Factors considered when setting IBNR reserves include patterns in elapsed time from claim incidence to claim reporting, and elapsed time from claim reporting to claim payment.

 

Key sensitivities for group long-term disability claim reserves include the discount rate and claim termination rates.

 

    

Claims and

Benefits Payable


       

Claims and

Benefits Payable


Group disability, discount rate decreased by 100 basis points

   $1,589,249   

Group disability, claim termination rate 10% lower

   $1,570,982

Group disability, as reported

   $1,518,890   

Group disability, as reported

   $1,518,890

Group disability, discount rate increased by 100 basis points

   $1,452,698   

Group disability, claim termination rate 10% higher

   $1,470,360

 

The discount rate is also a key sensitivity for group term life waiver of premium reserves.

 

     Claims and Benefits Payable

Group term life, discount rate decreased by 100 basis points

   $ 388,123

Group term life, as reported

   $ 380,401

Group life, discount rate increased by 100 basis points

   $ 372,212

 

Medical

 

IBNR reserves represent the largest component of reserves estimated for claims and benefits payable in our Medical line of business, and the primary methods we use in their estimation are the loss development method

 

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and the projected claim method for recent claim periods. Under the loss development method, we estimate ultimate losses for each incident period by multiplying the current cumulative losses by the appropriate loss development factor. Under the projected claim method, we use ultimate loss ratios when development methods do not provide enough data to reliably estimate reserves. In addition, we use variations on each method as well as a blend of the two. The primary variation is the use of projected claims using differing experience periods. We primarily use these two methods in our Medical line of business because of the limitations of relying exclusively on a single method.

 

We develop the best estimate of expected outstanding liabilities for medical IBNR reserves using generally accepted actuarial principles. The various product lines are evaluated using experience data of sufficient detail to allow for the compilation of historical loss patterns including but not limited to claim lag factors, projected claims per member and restated development factors. If sufficient experience data is not available, experience data from other similar blocks may be used. Industry data as well as data from consulting actuaries provide additional benchmarks when historical experience is too limited. This information is used to provide a range in which the expected outstanding liabilities may fall. The selection of the ultimate loss estimate varies by product line as the credibility of certain methods differs depending upon the in-force volume, the product’s claim volatility and the method itself. The selection is also influenced by other available information that may indicate that historical experience data may not be appropriate to use for current liability estimates. Examples of such information include but are not limited to changes in claims inventory levels, changes in provider negotiated rates or cost savings initiatives, increasing or decreasing medical cost trends, product changes and demographic changes in the underlying insured population.

 

The development of prior period estimates are also reviewed to assist in establishing the current period’s loss reserves. The short claim lag time inherent in many of our Medical products allows for emerging trends to be identified quickly.

 

We evaluate all pertinent information and indicated ranges using experience and actuarial judgment to establish our best estimate for the associated liabilities.

 

A key sensitivity is the loss development factors used. Loss development factors selected take into consideration claims processing levels, claims under case management, medical inflation, seasonal effects, medical provider discounts and product mix.

 

     Claims and Benefits Payable

 

Medical, loss development factors 1% lower

   $ 342,130 *

Medical, as reported

   $ 316,130  

Medical, loss development factors 1% higher

   $ 295,130  

* This refers to loss development factors for the most recent four months. Our historical claims experience indicates that approximately 84% of medical claims are paid within four months of the incurred date.

 

None of the changes in incurred claims from prior years in our Medical line of business, and the related downward revisions in our Medical estimated reserves, were attributable to any change in our reserve methods or assumptions.

 

Property and Warranty

 

We develop the best estimate of loss reserves for our Property and Warranty line of business on a product line basis using generally accepted actuarial principles. Our Property and Warranty line of business includes creditor-placed homeowners, manufactured housing homeowners, credit property, credit unemployment and warranty insurance and some longer-tail coverages (e.g., asbestos, environmental, other general liability and personal accident). Our Property and Warranty loss reserves consist of case reserves, IBNR and development on

 

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case reserves. The method we most often use in setting our Property and Warranty reserves is the loss development method. Under this method, we estimate ultimate losses for each accident period by multiplying the current cumulative losses by the appropriate loss development factor. We then calculate the reserve as the difference between the estimate of ultimate losses and the current case-incurred losses (paid losses plus case reserves). We select loss development factors based on a review of historical averages, and we consider recent trends and business specific matters such as current claims payment practices.

 

The loss development method involves aggregating loss data (paid losses and case-incurred losses) by accident quarter (or accident year) and accident age in quarters (or years) for each product or product grouping. As the data ages, we compile loss development factors that measure emerging claim development patterns between reporting periods. By selecting the most appropriate loss development factors, we project the known losses to an ultimate incurred basis for each accident period.

 

The data is analyzed at a minimum using four different loss development methods by product or product grouping: a) annual paid losses, b) annual case-incurred losses, c) quarterly paid losses and d) quarterly case-incurred losses. Also, in addition to the above, some product groupings are analyzed using the expected loss ratio and Bornhuetter-Ferguson loss development methods.

 

Each of these reserve methodologies produces an indication of the loss reserves for the product or product grouping. The process to select the best estimate differs across lines of business. The single best estimate is determined based on many factors, including but not limited to:

 

   

the nature and extent of the underlying assumptions,

 

   

the quality and applicability of historical data – whether it be internal or industry data,

 

   

current and future market conditions – the economic environment will often impact the development of loss triangles,

 

   

the extent of data segmentation – data should be homogenous yet credible enough for loss development methods to apply, and

 

   

the past variability of loss estimates – the loss estimates on some product lines will vary from actual loss experience more than others.

 

We review operational and claims activity to gather additional pertinent information. After reviewing all additional pertinent information, a final IBNR amount for each product grouping is selected. We may use other methods depending on data credibility and product line. We use the estimates generated by the various methods to establish a range of reasonable estimates. The best estimate of Property and Warranty reserves is generally selected from the middle to upper end of the third quartile of the range of reasonable estimates.

 

Most of our credit insurance business is written on a retrospective commission basis, which permits management to adjust commissions based on claims experience. Thus, any adjustment to prior years’ incurred claims in this line of business is largely offset by a change in contingent commissions which is included in the selling, underwriting and general expenses line in our results of operations.

 

While management has used its best judgment in establishing its estimate of required reserves, different assumptions and variables could lead to significantly different reserve estimates. Two key measures of loss activity are loss frequency, which is a measure of the number of claims per unit of insured exposure, and loss severity, which is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations.

 

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If the actual level of loss frequency and severity are higher or lower than expected, the ultimate reserves will be different than management’s estimate. The effect of higher and lower levels of loss frequency and severity levels on our ultimate costs for claims occurring in 2006 would be as follows:

 

Change in both loss frequency and

severity for all Property and Warranty


  

Ultimate cost of claims

occurring in 2006


  

Change in cost of claims

occurring in 2006


 

3% higher

   $ 521,724    $ 29,949  

2% higher

   $ 511,643    $ 19,868  

1% higher

   $ 501,660    $ 9,885  

Base scenario

   $ 491,642    $ —    

1% lower

   $ 481,890    $ (9,885 )

2% lower

   $ 471,907    $ (19,868 )

3% lower

   $ 461,826    $ (29,949 )

 

Reserving for Asbestos and Other Claims

 

We have exposure to asbestos, environmental and other general liability claims arising from our participation in various reinsurance pools from 1971 through 1985. This exposure arose from a short duration contract that we discontinued writing many years ago. We believe the balance of case reserves for these liabilities and bulk reserves for IBNR are adequate. However, any estimation of these liabilities is subject to greater than normal variation and uncertainty due to the general lack of sufficiently detailed data, reporting delays and absence of a generally accepted actuarial methodology for those exposures. There are significant unresolved industry legal issues, including such items as whether coverage exists and what constitutes an occurrence. In addition, the determination of ultimate damages and the final allocation of losses to financially responsible parties are highly uncertain. However, based on information currently available, and after consideration of the reserves reflected in the financial statements, we believe that any changes in reserve estimates for these claims are not reasonably likely to be material.

 

One of our subsidiaries, American Reliable Insurance Company (“ARIC”), participated in certain excess of loss reinsurance programs in the London market and, as a result, reinsured certain personal accident, ransom and kidnap insurance risks from 1995 to 1997. ARIC and a foreign affiliate ceded a portion of these risks to retrocessionaires. ARIC ceased reinsuring such business in 1997. However, certain risks continued beyond 1997 due to the nature of the reinsurance contracts written. ARIC and some of the other reinsurers involved in the programs are seeking to avoid certain treaties on various grounds, including material misrepresentation and non-disclosure by the ceding companies and intermediaries involved in the programs. Similarly, some of the retrocessionaires are seeking avoidance of certain treaties with ARIC and the other reinsurers and some reinsureds are seeking collection of disputed balances under some of the treaties. The disputes generally involve multiple layers of reinsurance, and allegations that the reinsurance programs involved interrelated claims “spirals” devised to disproportionately pass claims losses to higher-level reinsurance layers. Many of the companies involved in these programs, including ARIC, are currently involved in negotiations, arbitrations and/or litigation between multiple layers of retrocessionaries, reinsurers, ceding companies and intermediaries, including brokers, in an effort to resolve these disputes.

 

Many of the disputes involving ARIC and an affiliate, Bankers Insurance Company Limited (“BICL”), relating to the 1995 and 1997 program years, have been resolved by settlement or arbitration. As a result of the settlements and an arbitration (in which ARIC did not prevail) additional information became available in 2005, and, based on management’s best estimate, we increased our reserves and recorded a total pre-tax charge of $61,943 for the year ended December 31, 2005. On February 28, 2006, many of the disputes relating to losses in the 1996 program were settled. Loss accruals previously established relating to the 1996 program were adequate. Negotiations, arbitrations and litigation are still ongoing or will be scheduled for the remaining disputes. We believe, based on information currently available, that the amounts accrued for currently outstanding disputes are adequate. However, the inherent uncertainty of arbitrations and lawsuits, including the

 

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uncertainty of estimating whether any settlements we may enter into in the future would be on favorable terms, makes it difficult to predict the outcomes with certainty.

 

DAC

 

The costs of acquiring new business that vary with and are primarily related to the production of new business have been deferred to the extent that such costs are deemed recoverable from future premiums or gross profits. Acquisition costs primarily consist of commissions, policy issuance expenses, premium tax and certain direct marketing expenses.

 

Loss recognition testing is performed annually and reviewed quarterly. Such testing involves the use of best estimate assumptions, including the anticipation of interest income to determine if anticipated future policy premiums are adequate to recover all DAC and related claims, benefits and expenses. To the extent a premium deficiency exists, it is recognized immediately by a charge to the statement of operations and a corresponding reduction in DAC. If the premium deficiency is greater than unamortized DAC, a liability will be accrued for the excess deficiency.

 

Long Duration Contracts

 

Acquisition costs for pre-funded funeral life insurance policies and life insurance policies no longer offered are deferred and amortized in proportion to anticipated premiums over the premium-paying period. These acquisition costs consist primarily of first year commissions paid to agents and sales and policy issue costs.

 

For pre-funded funeral investment-type annuities and universal life insurance policies and investment-type annuity contracts that are no longer offered, DAC is amortized in proportion to the present value of estimated gross margins or profits from investment, mortality, expense margins and surrender charges over the estimated life of the policy or contract. The assumptions used for the estimates are consistent with those used in computing the policy or contract liabilities.

 

Acquisition costs relating to worksite group disability consist primarily of first year commissions to brokers and one time policy transfer fees and costs of issuing new certificates. These acquisition costs are front-end loaded, thus they are deferred and amortized over the estimated terms of the underlying contracts.

 

Acquisition costs relating to individual medical contracts issued prior to 2003 and currently in a limited number of jurisdictions are deferred and amortized over the estimated average terms of the underlying contracts. These acquisition costs relate to commissions and policy issuance expenses. Commissions represent the majority of deferred costs and result from commission schedules that pay significantly higher rates in the first year. The majority of deferred policy issuance expenses are the costs of separately underwriting each individual medical contract.

 

Short Duration Contracts

 

Acquisition costs relating to property contracts, warranty and extended service contracts and single premium credit insurance contracts are amortized over the term of the contracts in relation to premiums earned.

 

Acquisition costs relating to monthly pay credit insurance business consist mainly of direct marketing costs and are deferred and amortized over the estimated average terms and balances of the underlying contracts.

 

Acquisition costs relating to group term life, group disability and group dental consist primarily of compensation to sales representatives. These acquisition costs are front-end loaded; thus, they are deferred and amortized over the estimated terms of the underlying contracts.

 

Acquisition costs on individual medical contracts issued in most jurisdictions after 2002 and small group medical contracts consist primarily of commissions to agents and brokers and compensation to representatives.

 

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These contracts are considered short duration because the terms of the contract are not fixed at issue and they are not guaranteed renewable. As a result, these costs are not deferred, but rather are recorded in the statement of operations in the period in which they are incurred.

 

Investments

 

We regularly monitor our investment portfolio to ensure that investments that may be other-than-temporarily impaired are identified in a timely fashion and properly valued and that any impairments are charged against earnings in the proper period. Our methodology to identify potential impairments requires professional judgment.

 

The Company monitors its investment portfolio to identify investments that may be other than temporarily impaired. In addition, securities whose market price is equal to 85% or less of their original purchase price are added to the impairment watchlist, which is discussed at quarterly meetings attended by members of the Company’s investment, accounting and finance departments. Any security whose price decrease is deemed other-than-temporary is written down to its then current market level with the amount of the writedown reported as a realized loss in that period. Assessment factors include, but are not limited to, the length of time and the extent to which the market value has been less than cost, the financial condition and rating of the issuer, whether any collateral is held and the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery.

 

Realized gains and losses on sales of investments and declines in value judged to be other-than-temporary are recognized on the specific identification basis.

 

Inherently, there are risks and uncertainties involved in making these judgments. Changes in circumstances and critical assumptions such as a continued weak economy, a more pronounced economic downturn or unforeseen events which affect one or more companies, industry sectors or countries could result in additional writedowns in future periods for impairments that are deemed to be other-than-temporary. See also “Investments” in Note 2 of the Notes to Consolidated Financial Statements included elsewhere in this report and “Item 1A—Risk Factors—Our investment portfolio is subject to several risks that may diminish the value of our invested assets and affect our profitability.”

 

Reinsurance

 

Reinsurance recoverables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims, future policyholder benefits and policyholder contract deposits. The cost of reinsurance is accounted for over the terms of the underlying reinsured policies using assumptions consistent with those used to account for the policies. Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves and are reported in our consolidated balance sheets. The ceding of insurance does not discharge our primary liability to our insureds. An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, management’s experience and current economic conditions.

 

The following table sets forth our reinsurance recoverables as of the dates indicated:

 

    

As of

December 31, 2006


   As of
December 31, 2005


     (in thousands)

Reinsurance recoverables

   $ 3,914,972    $ 4,447,810

 

We have used reinsurance to exit certain businesses, such as the dispositions of FFG and LTC. The reinsurance recoverables relating to these dispositions amounted to $2,728,216 and $2,440,480 at December 31, 2006 and 2005, respectively.

 

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In the ordinary course of business, we are involved in both the assumption and cession of reinsurance with non-affiliated companies. The following table provides details of the reinsurance recoverables balance for the years ended December 31:

 

     2006

   2005

     (in thousands)

Ceded future policyholder benefits and expense

   $ 2,635,445    $ 2,565,223

Ceded unearned premium

     637,447      691,787

Ceded claims and benefits payable

     577,052      928,882

Ceded paid losses

     65,028      261,918
    

  

Total

   $ 3,914,972    $ 4,447,810
    

  

 

We utilize reinsurance for loss protection and capital management, business dispositions and, in Assurant Solutions, client risk and profit sharing. See also “Item 7A–Quantative and Qualitative Disclosures About Market Risk—Credit Risk.”

 

Retirement and Other Employee Benefits

 

We sponsor a pension and a retirement health benefit plan covering our employees who meet specified eligibility requirements. The reported expense and liability associated with these plans requires an extensive use of assumptions which include the discount rate, expected return on plan assets and rate of future compensation increases. We determine these assumptions based upon currently available market and industry data, historical performance of the plan and its assets, and consultation with an independent consulting actuarial firm to aid us in selecting appropriate assumptions and valuing our related liabilities. The actuarial assumptions used in the calculation of our aggregate projected benefit obligation may vary and include an expectation of long-term market appreciation in equity markets which is not changed by minor short-term market fluctuations, but does change when large interim deviations occur. The assumptions we use may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of the participants.

 

Contingencies

 

We follow the requirements of Statement of Financial Accounting Standards (“FAS”) No. 5, Accounting for Contingencies (“FAS 5”). This requires management to evaluate each contingent matter separately. A loss is reported if reasonably estimable and probable. We establish reserves for these contingencies at the best estimate, or, if no one estimated number within the range of possible losses is more probable than any other, we report an estimated reserve at the low end of the estimated range. Contingencies affecting the Company include litigation matters which are inherently difficult to evaluate and are subject to significant changes.

 

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Results of Operations

 

Assurant Consolidated

 

Overview

 

The table below presents information regarding our consolidated results of operations:

 

    

For the Year Ended

December 31,


 
     2006

    2005

    2004

 
     (in thousands)  

Revenues:

                        

Net earned premiums and other considerations

   $ 6,843,775     $ 6,520,796     $ 6,482,871  

Net investment income

     736,686       687,257       634,749  

Net realized gains on investments

     111,865       8,235       24,308  

Amortization of deferred gains on disposal of businesses

     37,300       42,508       57,632  

Loss on disposal of businesses

     —         —         (9,232 )

Fees and other income

     340,958       238,879       220,386  
    


 


 


Total revenues

     8,070,584       7,497,675       7,410,714  
    


 


 


Benefits, losses and expenses:

                        

Policyholder benefits

     (3,538,947 )     (3,707,809 )     (3,839,769 )

Selling, underwriting and general expenses(1)

     (3,374,652 )     (3,073,000 )     (2,976,436 )

Interest expense

     (61,243 )     (61,258 )     (56,418 )

Distributions on preferred securities

     —         —         (2,163 )
    


 


 


Total benefits, losses and expenses

     (6,974,842 )     (6,842,067 )     (6,874,786 )
    


 


 


Income before income taxes and cumulative effect of change in accounting principle

     1,095,742       655,608       535,928  

Income taxes

     (379,871 )     (176,253 )     (185,368 )
    


 


 


Net income before cumulative effect of change in accounting principle

     715,871       479,355       350,560  

Cumulative effect of change in accounting principle

     1,547       —         —    
    


 


 


Net income

   $ 717,418     $ 479,355     $ 350,560  
    


 


 



(1) Includes amortization of DAC and VOBA and underwriting, general and administrative expenses.

 

The following discussion provides a high level analysis of how the consolidated results were affected by our four operating business segments and our Corporate and Other segment. Please see the results of operations discussion for each of these segments contained in this document for more detailed analysis of the fluctuations.

 

Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

 

Net income increased $238,063, or 50%, to $717,418 for the twelve months ended December 31, 2006 from $479,355 for the twelve months ended December 31, 2005. The increase was primarily driven by an increase in Assurant Specialty Property’s creditor-placed homeowners business net earned premiums, fee income, improved loss experience and the lack of significant catastrophes in 2006. Assurant Solutions also contributed to the increase in net income primarily due to higher fee income from a $40,500 (after tax) legal settlement, growth in the extended service contract business and one-time fee income recognized from a closed block of extended service contract business. Corporate and Other also contributed to the increase in net income primarily due to higher net realized gains due to $63,900 (after tax) from the sale of our investment in PHCS. The $1,547 cumulative effect of change in accounting principle is a result of adopting FAS 123R and reflects the difference

 

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between compensation expense that would have been recognized using actual forfeitures and compensation expense that would have been recognized using expected forfeitures.

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

Net income increased $128,795, or 37%, to $479,355 for the twelve months ended December 31, 2005 from $350,560 for the twelve months ended December 31, 2004. The increase was primarily driven by Assurant Specialty Property’s creditor-placed homeowners business with lower net catastrophe losses, improved loss experience absent catastrophes and increased net earned premiums. Assurant Solutions also contributed to the increase in net income primarily due to an increase in net investment income and fee and other income. Also adding to this increase was a lower benefit loss ratio in Assurant Health’s small employer group business and the release of previously provided tax accruals due to the resolution of IRS audits in Corporate and Other. Offsetting these increases was a strengthening of reserve accruals of approximately $40,300 (after-tax) on certain excess of loss reinsurance programs sold by our subsidiaries in the London market between 1995 and 1997 in Corporate and Other.

 

Assurant Solutions

 

Overview

 

The table below presents information regarding Assurant Solutions’ segment results of operations:

 

    

For the Year Ended

December 31,


 
     2006

    2005

    2004

 
     (in thousands)  

Revenues:

                        

Net earned premiums and other considerations

   $ 2,371,605     $ 2,220,145     $ 2,205,988  

Net investment income

     392,510       371,565       318,705  

Fees and other income

     221,751       132,730       113,515  
    


 


 


Total revenues

     2,985,866       2,724,440       2,638,208  
    


 


 


Benefits, losses and expenses:

                        

Policyholder benefits

     (998,770 )     (1,046,900 )     (1,094,884 )

Selling, underwriting and general expenses

     (1,689,776 )     (1,477,505 )     (1,413,562 )
    


 


 


Total benefits, losses and expenses

     (2,688,546 )     (2,524,405 )     (2,508,446 )
    


 


 


Segment income before income tax

     297,320       200,035       129,762  

Income taxes

     (98,427 )     (66,888 )     (39,044 )
    


 


 


Segment income after tax

   $ 198,893     $ 133,147     $ 90,718  
    


 


 


Gross written premiums for selected product groupings: (1)

                        

Domestic Credit

   $ 714,791     $ 767,466     $ 853,011  

International Credit

   $ 680,097     $ 647,467     $ 594,646  

Domestic Extended Service Contracts (2)

   $ 1,258,292     $ 1,120,227     $ 960,352  

International Extended Service Contracts (2)

   $ 341,886     $ 247,506     $ 73,103  

Preneed (Face Sales)

   $ 433,510     $ 542,512     $ 582,197  

(1) Gross written premium does not necessarily translate to an equal amount of subsequent net earned premiums since Assurant Solutions reinsures a portion of its premium to insurance subsidiaries of its clients.
(2) Extended Service Contracts includes warranty contracts for products such as personal computers, consumer electronics and appliances.

 

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Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

 

Net Income

 

Segment net income increased by $65,746, or 49%, to $198,893 for the twelve months ended December 31, 2006 from $133,147 for the twelve months ended December 31, 2005. The increase in segment net income was primarily due to a legal settlement resulting in $40,500 (after tax) of other income and $5,041 (after tax) of one-time fee income recognized from a closed block of extended service contract business. This was partially offset by $3,363 (after tax) of lower investment income from real estate partnerships. Absent these events the Solutions’ segment net income increased by $23,568, or 18%, which is primarily attributable to higher fee income resulting from growth in our extended service contract business and an increase in investment income primarily due to an increase in average invested assets.

 

Total Revenues

 

Total revenues increased by $261,426 or 10%, to $2,985,866 for the twelve months ended December 31, 2006 from $2,724,440 for the twelve months ended December 31, 2005. This increase is primarily due to an increase in net earned premiums and other considerations of $151,460. This increase is primarily attributable to higher net earned premiums in our extended service contract and international businesses. These increases are partially offset by the decrease in the net earned premium in our Preneed business due to the sale of the Independent-U.S. distribution channel as well as decreases in other runoff businesses. The increase in revenues was also due to an increase in fees and other income of $89,021, primarily driven by a legal settlement of $62,300 and continued growth from our extended service contract business, including $7,756 of one-time fee income from a closed block of extended service contract business. The legal settlement is with a former customer and was first disclosed as a pending legal judgment in our 2004 10-K. We are anticipating a reduction in fee income in 2007 due to the loss of a large debt deferment client. This client contributed approximately $18,000 of fee income in 2006. Net investment income increased by $20,945, or 6%, primarily due to higher average invested assets from growth in our extended service contract businesses both domestically and abroad.

 

We experienced sales growth in most of our core product lines, with the exception of our domestic credit and Preneed businesses. Gross written premiums in our domestic credit business decreased by $52,675 due to the continued decline of this product line. Gross written premiums from our international credit business increased by $32,630 due to growth in our expansion countries. Gross written premiums in our domestic extended service contract business increased by $138,065 due to the addition of new clients and growth generated from existing clients. Gross written premiums in our international extended service contract business increased by $94,380, mainly due to the continued growth of a client signed in late 2004. We also experienced a decrease in our preneed businesses due to the sale of the U.S. Independent distribution channel in November 2005.

 

Total Benefits, Losses and Expenses

 

Total benefits, losses and expenses increased by $164,141, or 7%, to $2,688,546 for the twelve months ended December 31, 2006 from $2,524,405 for the twelve months ended December 31, 2005. This increase was primarily due to an increase in selling, underwriting and general expenses of $212,271. Commissions, taxes, licenses and fees, of which amortization of DAC is a component, increased by $187,036 primarily due to the associated increase in revenues and the change in the mix of business. Commissions increased due to higher commission rates on our increasing extended service contract business versus lower commission rates on the decreasing U.S. Independent Preneed business. General expenses increased by $25,235 due to higher expenses directly related to the growth of the business. Policyholder benefits decreased by $48,130 primarily as a result of the sale via reinsurance of the U.S. Independent Preneed channel and lower policyholder benefits attributable to the termination of a block of accidental death business. This was offset by an increase in extended service contract policyholder benefits, mostly from growth in the business.

 

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Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004

 

Net Income

 

Segment net income increased by $42,429, or 47%, to $133,147 for the twelve months ended December 31, 2005 from $90,718 for the twelve months ended December 31, 2004. The increase in segment net income is primarily attributable to an increase in investment income driven by the increased invested assets as a result of growth in our domestic and international extended service contract business combined with $6,116 (after tax) of additional investment income from a real estate partnership. The growth in our extended service contract and international products fee income also contributed to an increase in segment net income.

 

Total Revenues

 

Total revenues increased by $86,232, or 3%, to $2,724,440 for the twelve months ended December 31, 2005 from $2,638,208 for the twelve months ended December 31, 2004. This increase is primarily due to an increase in net investment income of $52,860, or 17%. The increase was a result of an increase in the average portfolio yield and average invested assets, combined with income from a real estate partnership transaction of $9,409 and approximately $7,300 of non-recurring investment income items in 2005. Also contributing to the increase was an increase in fee income of $19,215, or 17%, mainly due to growth in our extended service contract and debt deferment products. Net earned premiums and other considerations increased by $14,157, or 1%, primarily from higher net earned premiums in our extended service contract and international products, partially offset by the continued decline of our domestic credit insurance products and the decrease in net earned premiums in our Preneed business due to the sale of the Preneed Independent-U.S. distribution channel.

 

We experienced sales growth in all of our core product groupings, with the exception of our domestic credit and Preneed businesses. Gross written premiums in our domestic credit products decreased by $85,545, or 10%, due to the continued decline of this product line. Gross written premiums from our international credit products increased by $52,821, or 9%, due to our focus on international expansion. Gross written premiums in our domestic extended service contract products increased by $159,875, or 17%, due to the addition of new clients and growth generated from existing clients. Gross written premiums in our international extended service contract products increased by $174,403, or over 100%, mainly due to the signing of a new client in Canada in late 2004.

 

Total Benefits, Losses and Expenses

 

Total benefits, losses and expenses increased by $15,959 or 1%, to $2,524,405 for the twelve months ended December 31, 2005 from $2,508,446 for the twelve months ended December 31, 2004. This increase was primarily due to an increase in selling, underwriting and general expenses of $63,943. Commission, taxes, licenses and fees, of which amortization of DAC is a component, increased by $45,207 primarily due to the associated increase in revenues, partially offset by lower premium taxes attributable to the change in the mix of business. General expenses increased by $18,736 due to growth in the business, severance and costs related to the sale of the Independent-U.S. distribution channel, and increased expenses related to SOX 404. This increase was offset by a decrease in policyholder benefits of $47,984, or 4%, primarily attributable to a decline in policyholder benefits associated with the sale of the Independent-U.S. distribution channel.

 

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Assurant Specialty Property

 

Overview

 

The table below presents information regarding Assurant Specialty Property’s segment results of operations:

 

    

For the Year Ended

December 31,


 
     2006

    2005

    2004

 
     (in thousands)  

Revenues:

                        

Net earned premiums and other considerations

   $ 1,208,311     $ 858,848     $ 768,773  

Net investment income

     74,501       61,953       72,546  

Fees and other income

     49,424       38,159       37,013  
    


 


 


Total revenues

     1,332,236       958,960       878,332  
    


 


 


Benefits, losses and expenses:

                        

Policyholder benefits

     (408,721 )     (317,507 )     (363,926 )

Selling, underwriting and general expenses

     (553,452 )     (422,999 )     (401,327 )
    


 


 


Total benefits, losses and expenses

     (962,173 )     (740,506 )     (765,253 )
    


 


 


Segment income before income tax

     370,063       218,454       113,079  

Income taxes

     (128,942 )     (75,227 )     (38,138 )
    


 


 


Segment income after tax

   $ 241,121     $ 143,227     $ 74,941  
    


 


 


Net earned premiums and other considerations by major product groupings:

                        

Homeowners (Creditor Placed and Voluntary)

   $ 753,169     $ 443,526     $ 392,561  

Manufacturing Housing (Creditor Placed and Voluntary)

     214,461       217,424       210,824  

Other(1)

     240,681       197,898       165,388  
    


 


 


Total

   $ 1,208,311     $ 858,848     $ 768,773  
    


 


 


Ratios:

                        

Loss ratio(2)

     33.8 %     37.0 %     47.3 %

Expense ratio(3)

     44.0 %     47.2 %     49.8 %

Combined ratio(4)

     76.5 %     82.6 %     95.0 %

(1) This includes flood, renters, agricultural, specialty auto and other insurance products.
(2) The loss ratio is equal to policyholder benefits divided by net earned premiums and other considerations.
(3) The expense ratio is equal to selling, underwriting and general expenses divided by net earned premiums and other considerations and fees and other income.
(4) The combined ratio is equal to total benefits, losses and expenses divided by net earned premiums and other considerations and fees and other income.

 

Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

 

Net Income

 

Segment net income increased by $97,894, or 68%, to $241,121 for the twelve months ended December 31, 2006 from $143,227 for the twelve months ended December 31, 2005. The increase in segment net income is primarily due to increased net earned premiums, fee income and improved loss experience in our creditor placed homeowners business, the lack of significant catastrophes in 2006, the acquisition of SFIS and favorable settlements with two former clients of $5,500 (after tax). The increase in net income was partially offset by a reduction in loss adjustment expense reimbursements from the National Flood Insurance Program and one-time favorable settlements with clients in 2005.

 

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Total Revenues

 

Total revenues increased by $373,276 or 39%, to $1,332,236 for the twelve months ended December 31, 2006 from $958,960 for the twelve months ended December 31, 2005. The increase is primarily due to an increase in net earned premiums and other considerations of $349,463, or 41%. This increase was primarily attributable to the growth in our creditor placed and voluntary homeowners product lines, due to continued organic growth of these businesses combined with $123,818 of net earned premium resulting from the acquisition of SFIS. The increase in revenues was also driven by an increase in fee income of $11,265, or 30%, primarily from growth in creditor-placed homeowners loan tracking services. Also contributing to the increase in revenues was higher investment income of $12,548, or 20%, due to higher invested assets combined with higher investment yields.

 

Total Benefits, Losses and Expenses

 

Total benefits, losses and expenses increased by $221,667 or 30%, to $962,173 for the twelve months ended December 31, 2006 from $740,506 for the twelve months ended December 31, 2005. This increase was primarily due to an increase in policyholder benefits of $91,214 and an increase in selling, underwriting and general expenses of $130,453. The combined ratio decreased 610 basis points from 82.6% to 76.5% primarily due to lower catastrophe losses and proactive risk management. The increase in policyholder benefits is primarily attributable to the growth in our creditor-placed homeowners business and approximately $8,000 in lower reimbursements from the National Flood Insurance Program for the adjudication of expenses related to the 2005 catastrophe flood losses (from approximately $18,500 in 2005 to $10,500 in 2006). This increase is partially offset by lower net catastrophe losses of approximately $42,000 and a favorable settlement with two former clients of $8,500. Commissions, taxes, licenses and fees, of which amortization of DAC is a component, increased by $69,939 primarily due to the associated increase in revenues combined with approximately $11,400 of one time income recognized in 2005 related to favorable settlements with two clients which resulted in a release of certain accrued commissions. General expenses increased by $60,514 due to increases in employment related expenses consistent with business growth and additional operating expenses associated with the SFIS business.

 

Year Ended December 31, 2005 Compared to December 31, 2004

 

Net Income

 

Segment net income increased by $68,286, or 91%, to $143,227 for the twelve months ended December 31, 2005 from $74,941 for the twelve months ended December 31, 2004. The increase in segment net income is primarily attributable to lower net catastrophe losses, improved loss experience absent catastrophe losses and higher net earned premiums in our creditor placed homeowners business. Net income was also positively impacted by approximately $11,100 (after-tax) primarily related to the release of certain accrued commissions and claims payable associated with three clients, two of which previously declared bankruptcy. We favorably settled many of our claims with these clients during 2005.

 

Total Revenues

 

Total revenues increased by $80,628, or 9%, to $958,960 for the twelve months ended December 31, 2005 from $878,332 for the twelve months ended December 31, 2004. This increase is primarily due to an increase in net earned premiums and other considerations of $90,075 or 12%, primarily due to an increase in net earned premiums in our creditor placed homeowners business. This was partially offset by a reduction in net earned premiums of approximately $26,000, due to additional catastrophe reinsurance reinstatement premiums related to the hurricanes.

 

Total Benefits, Losses and Expenses

 

Total benefits, losses and expenses decreased by $24,747 or 3%, to $740,506 for the twelve months ended December 31, 2005 from $765,253 for the twelve months ended December 31, 2004. This decrease is primarily

 

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due to a decrease in policyholder benefits offset by an increase in selling, underwriting and general expenses. The decrease in policyholder benefits of $46,419, or 13%, is primarily attributable to $44,400 in lower catastrophe losses, net of reinsurance in 2005 versus 2004. We incurred losses from catastrophes, net of reinsurance of $48,700 in 2005, compared to $93,100 in 2004. The decrease was a result of the different severity of gross losses from each storm and the change in composition of our reinsurance coverage in 2005. Additionally, we collected approximately $18,500 of loss adjustment expense reimbursements from the National Flood Insurance Program for providing processing and adjudication services, which resulted in reduced policyholder benefits. We continued to see improvement in our overall loss ratio in 2005, excluding catastrophe losses. In addition, benefits and losses reflect a one-time reduction of claims payable of $5,700 associated with a client that previously declared bankruptcy. Selling, underwriting and general expenses increased by $21,672, or 5%. Commissions, taxes, licenses and fees, of which amortization of DAC is a component, decreased by $3,365 primarily due to a one-time reduction of $11,400 of commission liabilities as a result of favorable settlements with two clients offset by higher expenses related to the growth of our creditor placed homeowners insurance products. General expenses increased by $25,037 due to growth in the business and expenses relating to the 2005 hurricane season, including guaranty fund assessments.

 

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Assurant Health

 

Overview

 

The table below presents information regarding Assurant Health’s segment results of operations:

 

    

For the Year Ended

December 31,


 
   2006

    2005

    2004

 
   (in thousands)  

Revenues:

                        

Net earned premiums and other considerations

   $ 2,083,957     $ 2,163,965     $ 2,231,298  

Net investment income

     75,215       69,056       67,902  

Fees and other income

     41,560       40,344       38,708  
    


 


 


Total revenues

     2,200,732       2,273,365       2,337,908  
    


 


 


Benefits, losses and expenses:

                        

Policyholder benefits

     (1,300,817 )     (1,344,624 )     (1,422,783 )

Selling, underwriting and general expenses

     (641,328 )     (657,899 )     (674,907 )
    


 


 


Total benefits, losses and expenses

     (1,942,145 )     (2,002,523 )     (2,097,690 )
    


 


 


Segment income before income tax

     258,587       270,842       240,218  

Income taxes

     (90,668 )     (92,787 )     (81,931 )
    


 


 


Segment income after tax

   $ 167,919     $ 178,055     $ 158,287  
    


 


 


Net earned premiums and other considerations:

                        

Individual Markets

                        

Individual Medical

   $ 1,213,677     $ 1,164,498     $ 1,100,868  

Short term medical

     101,454       110,912       114,583  
    


 


 


Subtotal

     1,315,131       1,275,410       1,215,451  

Small employer group:

     768,826       888,555       1,015,847  
    


 


 


Total

   $ 2,083,957     $ 2,163,965     $ 2,231,298  
    


 


 


Membership by product line:

                        

Individual Markets

                        

Individual medical

     641       644       675  

Short term medical

     87       102       107  
    


 


 


Subtotal

     728       746       782  

Small employer group:

     207       255       333  
    


 


 


Total

     935       1,001       1,115  
    


 


 


Ratios:

                        

Loss ratio (1)

     62.4 %     62.1 %     63.8 %

Expense ratio (2)

     30.2 %     29.8 %     29.7 %

Combined ratio (3)

     91.4 %     90.8 %     92.4 %

(1) The loss ratio is equal to policyholder benefits divided by net earned premiums and other considerations.
(2) The expense ratio is equal to selling, underwriting and general expenses divided by net earned premiums and other considerations and fees and other income.
(3) The combined ratio is equal to total benefits, losses and expenses divided by net earned premiums and other considerations and fees and other income.

 

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Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

 

Net Income

 

Segment net income decreased by $10,136, or 6%, to $167,919 for the twelve months ended December 31, 2006 from $178,055 for the twelve months ended December 31, 2005. The decrease in segment income was primarily attributable to an overall decline in membership due to continued increased competition and our strict adherence to underwriting guidelines. The decrease in net income was partially offset by an increase in investment income from real estate partnerships of approximately $4,900 (after tax).

 

Total Revenues

 

Total revenues decreased by $72,633, or 3%, to $2,200,732 for the twelve months ended December 31, 2006 from $2,273,365 for the twelve months ended December 31, 2005. Net earned premiums and other considerations from our individual markets business increased by $39,721, or 3%, primarily due to premium rate increases. Net earned premiums and other considerations from our small employer group business decreased by $119,729, or 13%, due to a decline in members, partially offset by premium rate increases. The small employer group business continues to experience decreases in new business due to increased competition and our strict adherence to underwriting guidelines. The decrease was partially offset by an increase in investment income of $6,159, or 9%, primarily due to an increase in real estate partnership investment income of approximately $7,500.

 

Total Benefits, Losses and Expenses

 

Total benefits, losses and expenses decreased by $60,378, or 3%, to $1,942,145 for the twelve months ended December 31, 2006 from $2,002,523 for the twelve months ended December 31, 2005. Policyholder benefits decreased by $43,807, or 3%. The benefit loss ratio increased by 30 basis points, from 62.1% to 62.4%. The decrease in policyholder benefits was primarily due to the decline in net earned premiums, partially offset by higher claims experience primarily on individual medical business. Selling, underwriting and general expenses decreased by $16,571, or 3%. The expense ratio increased by 40 basis points, from 29.8% to 30.2%. The decrease in expenses was primarily due to decreased commission expense resulting from the decline in small employer group business.

 

Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004

 

Net Income

 

Segment net income increased by $19,768, or 12%, to $178,055 for the year ended December 31, 2005 from $158,287 for the year ended December 31, 2004. The increase in segment income is primarily attributable to an improved benefit loss ratio in the small employer group business. The increase is partially offset by two items. First, an overall decline in membership due to continued increased competition and strict adherence to our underwriting guidelines. Second, an increase in expenses of approximately $6,500 (after-tax) due to increased spending on initiatives aimed at growing the individual markets business.

 

Total Revenues

 

Total revenues decreased by $64,543, or 3%, to $2,273,365 for the year ended December 31, 2005, from $2,337,908 for the year ended December 31, 2004. Net earned premiums and other considerations from our individual markets business increased by $59,959, or 5%, primarily due to premium rate increases, partially offset by a decline in members. Net earned premiums and other considerations from our small employer group business decreased by $127,292, or 13%, due to a decline in members, partially offset by premium rate increases. Both individual markets and the small employer group business continue to experience decreases in new business due to increased competition in their respective markets and strict adherence to our underwriting guidelines.

 

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Total Benefits, Losses, and Expenses

 

Total benefits, losses and expenses decreased by $95,167, or 5%, to $2,002,523 for the year ended December 31, 2005, from $2,097,690 for the year ended December 31, 2004. The benefit loss ratio decreased by 170 basis points, from 63.8% to 62.1%. The improvement in the benefit loss ratio is due to a decrease in policyholder benefits of $78,159, or 5%, primarily due to the overall decline in members and favorable claims experience in the small employer group business. The expense ratio increased by 10 basis points, from 29.7% to 29.8%. The increase in the expense ratio is primarily due to a proportionately smaller decrease in expenses compared to the decrease in net earned premiums and fees and other income. Selling, underwriting and general expenses decreased by $17,008, or 3%, primarily due to a decline in first year business in 2005 compared to 2004, resulting in decreased commission expense and other acquisition costs in both individual markets and small employer group business. This decrease was partially offset by an increase of approximately $10,000 in spending on initiatives aimed at growing the individual markets business.

 

Assurant Employee Benefits

 

Overview

 

The table below presents information regarding Assurant Employee Benefits’ segment results of operations:

 

    

For the Year Ended

December 31,


 
   2006

    2005

    2004

 
   (in thousands)  

Revenues:

                        

Net earned premiums and other considerations

   $ 1,179,902     $ 1,277,838     $ 1,276,812  

Net investment income

     158,525       156,889       149,718  

Fees and other income

     27,541       26,214       29,306  
    


 


 


Total revenues

     1,365,968       1,460,941       1,455,836  
    


 


 


Benefits, losses and expenses:

                        

Policyholder benefits

     (830,634 )     (936,835 )     (950,235 )

Selling, underwriting and general expenses

     (407,020 )     (418,542 )     (409,737 )
    


 


 


Total benefits, losses and expenses

     (1,237,654 )     (1,355,377 )     (1,359,972 )
    


 


 


Segment income before income tax

     128,314       105,564       95,864  

Income taxes

     (44,711 )     (37,198 )     (33,654 )
    


 


 


Segment income after tax

   $ 83,603     $ 68,366     $ 62,210  
    


 


 


Ratios:

                        

Loss ratio (1)

     70.4 %     73.3 %     74.4 %

Expense ratio (2)

     33.7 %     32.1 %     31.4 %

Net earned premiums and other considerations:

                        

By major product groupings:

                        

Group dental

   $ 428,218     $ 502,789     $ 520,513  

Group disability single premiums for closed blocks (3)

     46,313       26,700       40,906  

All Other group disability

     480,924       489,840       465,517  

Group life

     224,447       258,509       249,876  
    


 


 


Total

   $ 1,179,902     $ 1,277,838     $ 1,276,812  
    


 


 



(1) The loss ratio is equal to policyholder benefits divided by net earned premiums and other considerations.
(2) The expense ratio is equal to selling, underwriting and general expenses divided by net earned premiums and other considerations and fees and other income.
(3) This represents single premium on closed blocks of group disability business.

 

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Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

 

Net Income

 

Segment net income increased by $15,237, or 22%, to $83,603 for the year ended December 31, 2006 from $68,366 for the year ended December 31, 2005. The increase in segment income was primarily driven by continued favorable group disability experience and improved group dental experience. Disability recovery rates, which include claimants who return to work, and experience in our DRMS channel, were improved. The improvement in loss ratios is partially offset by the decrease in revenues.

 

Total Revenues

 

Total revenues decreased by $94,973, or 7%, to $1,365,968 for the year ended December 31, 2006 from $1,460,941 for the years ended December 31, 2005. Excluding group disability single premium for closed blocks, net earned premiums and other considerations decreased $117,549 or 9%, from the prior year primarily due to increased lapses and decreased sales. Lapse experience and sales trends reflect the transition to the business’ small case strategy along with disciplined pricing in a competitive marketplace.

 

Total Benefits, Losses and Expenses

 

Total benefits, losses and expenses decreased by $117,723, or 9%, to $1,237,654 for the year ended December 31, 2006 from $1,355,377 for the year ended December 31, 2005. The loss ratio decreased 290 basis points, from 73.3% to 70.4%, primarily due to continued favorable group disability experience. Group disability recovery rates, which include claimants who return to work, and deaths were higher compared to the prior year. Experience in our DRMS channel also improved. Group dental experience has improved primarily due to disciplined pricing actions. The expense ratio increased 160 basis points from 32.1% to 33.7%. The increase in the expense ratio is primarily driven by the decrease in revenues that was proportionally larger than the decrease in general expenses. Selling, underwriting and general expenses have decreased $11,522, or 3%, year over year. In the prior year, we had a non-recurring reduction in short-term incentive compensation expenses. Excluding the prior year non-recurring reduction, selling, general and underwriting expenses have decreased primarily due to expense management consistent with revenue trends.

 

Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004

 

Net Income

 

Segment net income increased by $6,156, or 10%, to $68,366 for the year ended December 31, 2005, from $62,210 for the year ended December 31, 2004. The increase in segment income was primarily due to a decrease in policyholder benefits. This decrease was driven by improved group life mortality and improved group dental experience, partially offset by lower group disability claim closures.

 

Total Revenues

 

Total revenues remained relatively flat increasing $5,105 to $1,460,941 for the year ended December 31, 2005, from $1,455,836 for the year ended December 31, 2004. Net earned premiums and other considerations remained flat compared to prior year due to our increased focus on small case and voluntary business. The increase in revenues was primarily due to an increase in net investment income of $7,171, or 5%. During the third quarter, we recognized $2,560 of investment income from a real estate partnership. The remaining increase in net investment income is primarily due to an increase in average invested assets of approximately 3%.

 

Total Benefits, Losses, and Expenses

 

Total benefits, losses and expenses decreased by $4,595, or less than 1%, to $1,355,377 for the year ended December 31, 2005, from $1,359,972 for the year ended December 31, 2004. The loss ratio decreased 110 basis

 

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points, from 74.4% to 73.3%. The decrease in the loss ratio and the decrease in policyholder benefits of $13,400, or 1%, was primarily due to improved group life mortality and improved group dental experience partially offset by lower group disability claim closures. The expense ratio increased 70 basis points, from 31.4% to 32.1%. The increase in the expense ratio is due to an increase in selling, underwriting and general expenses of $8,805, or 2%, primarily driven by higher technology-related costs due to implementation of technology aimed at improving our customer service.

 

Corporate and Other

 

The table below presents information regarding the Corporate and Other segment’s results of operations:

 

    

For the Year Ended

December 31,


 
   2006

    2005

    2004

 
   (in thousands)  

Revenues:

                        

Net investment income

   $ 35,935     $ 27,794     $ 25,878  

Net realized gains on investments

     111,865       8,235       24,308  

Amortization of deferred gains on disposal of businesses

     37,300       42,508       57,632  

Loss on disposal of business

     —         —         (9,232 )

Fees and other income

     682       1,432       1,844  
    


 


 


Total revenues

     185,782       79,969       100,430  
    


 


 


Benefits, losses and expenses:

                        

Policyholder benefits

     (5 )     (61,943 )     (7,941 )

Selling, underwriting and general expenses

     (83,076 )     (96,055 )     (76,903 )

Interest expense

     (61,243 )     (61,258 )     (58,581 )
    


 


 


Total benefits, losses and expenses

     (144,324 )     (219,256 )     (143,425 )
    


 


 


Segment income (loss) before income tax

     41,458       (139,287 )     (42,995 )

Income taxes

     (17,123 )     95,847       7,399  
    


 


 


Segment income (loss) after tax

   $ 24,335     $ (43,440 )   $ (35,596 )
    


 


 


 

As of December 31, 2006, we had approximately $249,911 (pre-tax) of deferred gains that had not yet been amortized. We expect to amortize deferred gains from dispositions through 2031. The deferred gains are being amortized in a pattern consistent with the expected future reduction of the in-force blocks of business ceded to The Hartford and John Hancock. This reduction is expected to be more rapid in the first few years after sale and to be slower as the liabilities in the blocks decrease.

 

Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

 

Net Income

 

Segment net income improved by $67,775, or over 100%, to $24,335 for the twelve months ended December 31, 2006 from a net loss of ($43,440) for the twelve months ended December 31, 2005. This improvement is mainly due to a realized gain of $63,900 (after tax) from the sale of our investment in PHCS, a realized gain from the reduction of our mortgage loan loss reserve, strengthening of reserve accruals on certain excess of loss programs in 2005 that did not recur in 2006 and a reduction in stock appreciation rights expense upon adopting FAS 123R. This improvement was partially offset by the 2005 release of $39,400 of previously provided tax accruals which were no longer considered necessary due to the resolution of IRS audits and $5,500 of tax benefit related to the technical correction of tax legislation under the American Jobs Creation Act of 2004 (“Jobs Act”) that did not recur in 2006.

 

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Total Revenues

 

Total revenues increased by $105,813, or over 100%, to $185,782 for the twelve months ended December 31, 2006 from $79,969 for the twelve months ended December 31, 2005. Revenues increased mainly due to a $103,630 increase in realized gains on investments primarily due to the sale of our investment in PHCS, resulting in a pre-tax gain of $98,300 and a reduction of our mortgage loan loss reserve of $15,168 due to a refinement of management’s best estimate of this reserve.

 

Total Benefits, Losses and Expenses

 

Total benefits, losses and expenses decreased by $74,932, or 34%, to $144,324 for the twelve months ended December 31, 2006 from $219,256 for the twelve months ended December 31, 2005. This decrease is primarily due to $61,943 of costs incurred in 2005 on excess of loss reinsurance programs, related to personal accident, ransom and kidnap insurance risks, reinsured and ceded by certain subsidiaries in the London market between 1995 and 1997. In addition, stock appreciation rights expense declined, due to the adoption of FAS 123R on January 1, 2006. These expense declines were partially offset by a $5,000 contribution to the Assurant Charitable Foundation.

 

Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004

 

Net Income

 

Segment net loss increased by $7,844, or 22%, to $(43,440) for the year ended December 31, 2005, from $(35,596) for the year ended December 31, 2004. The increase in net loss was primarily due to an increase in policyholder benefits due to the strengthening of reserve accruals on certain excess of loss reinsurance programs sold by our subsidiaries in the London market between 1995 and 1997, an increase in selling, underwriting and general expenses due to stock compensation and a reduction in the amortization of deferred gains on disposal of business. The increase in net loss was partially offset by approximately $39,400 of income tax accrual releases due to the resolution of IRS audits.

 

Total Revenues

 

Total revenues decreased by $20,461, or 20%, to $79,969 for the year ended December 31, 2005, from $100,430 for the year ended December 31, 2004. This decrease was primarily due to lower net realized gains on investments and lower amortization of deferred gains on disposal of businesses due to continued runoff of the sold businesses. In addition, as a result of our annual review of estimates affecting the deferred gain on disposal of businesses we took a charge of approximately $4,600.

 

Total Benefits, Losses, and Expenses

 

Total benefits, losses and expenses increased by $75,831, or 53%, to $219,256 for the year ended December 31, 2005, from $143,425 for the year ended December 31, 2004. The increase is primarily due to an increase in policyholder benefits of $54,002 as a result of costs incurred on excess of loss reinsurance programs, related to personal accident, ransom and kidnap insurance risks, reinsured and ceded by certain subsidiaries in the London market between 1995 and 1997. These charges include a settlement with one of our largest reinsurers for 1997 and strengthening of reserves for remaining portions of the program. Selling, underwriting and general expenses increased by $19,152, or 25%, primarily due to stock appreciation rights (“SARs”), which increased by $18,000 in 2005 compared to 2004 primarily as a result of appreciation in the stock price.

 

Income Taxes

 

The income tax benefits increased by $88,448 to $95,847 for the year ended December 31, 2005 from $7,399 for the year end December 31, 2004. Approximately $39,400 of the increased benefit was primarily due to the release of previously provided tax accruals, which were no longer considered necessary based on the resolution of IRS audits. In addition, approximately $5,500 of the increased benefit was due to a recaptured tax

 

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benefit from the $19,000 of tax expense we incurred in 2004 on the repatriation of capital from Puerto Rico, primarily due to a technical correction of the Jobs Act.

 

Investments

 

The following table shows the carrying value of our investments by type of security as of the dates indicated:

 

    

As of

December 31, 2006


   

As of

December 31, 2005


 
     (in thousands)  

Fixed maturities

   $ 9,118,049    73 %   $ 8,961,778    72 %

Equity securities

     741,639    6 %     693,101    5 %

Commercial mortgage loans on real estate

     1,266,158    10 %     1,212,006    10 %

Policy loans

     58,733    1 %     61,043    1 %

Short-term investments

     314,114    3 %     427,474    3 %

Collateral held under securities lending

     365,958    3 %     610,662    5 %

Other investments

     564,494    4 %     549,759    4 %
    

        

      

Total investments

   $ 12,429,145    100 %   $ 12,515,823    100 %
    

        

      

 

Of our fixed maturity securities shown above, 67% and 66% (based on total fair value) were invested in securities rated “A” or better as of December 31, 2006 and December 31, 2005, respectively. As interest rates increase, the market value of fixed maturity securities decreases.

 

The following table provides the cumulative net unrealized gains (losses), pre-tax, on fixed maturity securities and equity securities as of the dates indicated:

 

    

As of

December 31, 2006


  

As of

December 31, 2005


 

Fixed maturities:

               

Amortized cost

   $ 8,934,017    $ 8,668,595  

Net unrealized gains

     184,032      293,183  
    

  


Fair value

   $ 9,118,049    $ 8,961,778  
    

  


Equities:

               

Cost

   $ 735,566    $ 694,977  

Net unrealized gains (losses)

     6,073      (1,876 )
    

  


Fair value

   $ 741,639    $ 693,101  
    

  


 

Net unrealized gains on fixed maturity securities decreased by $109,151 from December 31, 2005 to December 31, 2006. The decrease in net unrealized gains on fixed maturity securities was primarily due to an increase in treasury yield. The yield on 5-year treasury securities increased by approximately 39 basis points and the yield on 10-year treasury securities increased by 34 basis points between December 31, 2005 and December 31, 2006. Net unrealized gains on equity securities increased by $7,949 from December 31, 2005 to December 31, 2006. The increase was primarily due to changes in the preferred stock market. The price return of Merrill Lynch Global Bond Index—Preferred Stock, Hybrid index ended 2006 up slightly after decreasing for most of the year.

 

Net investment income increased by $49,429, or 7%, to $736,686 at December 31, 2006 from $687,257 at December 31, 2005. The increase is primarily the result of an increase in yields and average invested assets. Net investment income includes $18,578 of investment income from real estate partnerships in 2006 compared to

 

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$12,565 in 2005. The yield on average invested assets and cash and cash equivalents, which excludes real estate investment income, was 5.67% in 2006 compared to 5.54% in 2005.

 

Net investment income increased by $52,508, or 8%, to $687,257 at December 31, 2005 from $634,749 at December 31, 2004. The increase is primarily the result of real estate partnership income and increased average invested assets. Net investment income includes $12,565 of investment income from real estate partnerships in 2005 compared to zero in 2004. The yield on average invested assets and cash equivalents, which excludes real estate investment income, remained relatively flat at 5.54% in 2005 compared to 5.55% in 2004.

 

We recorded $810, $765, and $600 of realized losses in 2006, 2005 and 2004, respectively, associated with other-than-temporary declines in value of available for sale securities. We also recorded $854, zero, and $4,217 of pre-tax realized losses in 2006, 2005, and 2004, respectively, associated with other investments.

 

The investment category and duration of our gross unrealized losses on fixed maturities and equity securities at December 31, 2006 were as follows:

 

     Less than 12 months

    12 Months or More

    Total

 
     Fair Value

   Unrealized
Losses


    Fair Value

   Unrealized
Losses


    Fair Value

   Unrealized
Losses


 

Fixed maturities

                                             

Bonds:

                                             

United States Government and government agencies and authorities

   $ 189,037    $ (1,373 )   $ 24,036    $ (745 )   $ 213,073    $ (2,118 )

States, municipalities and political subdivisions

     21,423      (214 )     9,398      (158 )     30,821      (372 )

Foreign governments

     247,291      (2,823 )     12,899      (326 )     260,190      (3,149 )

Public utilities

     346,570      (7,267 )     45,626      (1,531 )     392,196      (8,798 )

All other corporate bonds

     2,136,342      (37,521 )     250,908      (7,717 )     2,387,250      (45,238 )

Mortgage backed securities

     713,912      (8,850 )     99,713      (3,330 )     813,625      (12,180 )
    

  


 

  


 

  


Total fixed maturities

   $ 3,654,575    $ (58,048 )   $ 442,580    $ (13,807 )   $ 4,097,155    $ (71,855 )
    

  


 

  


 

  


Equity securities

                                             

Common stocks:

                                             

Banks, trusts and insurance companies

   $ 140    $ (30 )   $ —      $ —       $ 140    $ (30 )

Industrial, miscellaneous and all other

     102      (2 )     —        —         102      (2 )

Non-redeemable preferred stocks:

                                             

Non-sinking fund preferred stocks

     248,030      (5,425 )     67,143      (2,917 )     315,173      (8,342 )
    

  


 

  


 

  


Total equity securities

   $ 248,272    $ (5,457 )   $ 67,143    $ (2,917 )   $ 315,415    $ (8,374 )
    

  


 

  


 

  


 

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The investment category and duration of our gross unrealized losses on fixed maturities and equity securities at December 31, 2005 were as follows:

 

    Less than 12 months

    12 Months or More

    Total

 
    Fair Value

  Unrealized
Losses


    Fair Value

  Unrealized
Losses


    Fair Value

  Unrealized
Losses


 

Fixed maturities

                                         

Bonds:

                                         

United States Government and government agencies and authorities

  $ 128,125   $ (1,617 )   $ 22,380   $ (691 )   $ 150,505   $ (2,308 )

States, municipalities and political subdivisions

    6,521     (44 )     12,179     (234 )     18,700     (278 )

Foreign governments

    142,116     (2,081 )     10,142     (469 )     152,258     (2,550 )

Public utilities

    240,259     (5,358 )     36,752     (1,135 )     277,011     (6,493 )

All other corporate bonds

    1,611,483     (28,926 )     131,084     (5,383 )     1,742,567     (34,309 )

Mortgage Backed Securities

    707,930     (8,082 )     124,754     (4,053 )     832,684     (12,135 )
   

 


 

 


 

 


Total fixed maturities

  $ 2,836,434   $ (46,108 )   $ 337,291   $ (11,965 )   $ 3,173,725   $ (58,073 )
   

 


 

 


 

 


Equity securities

                                         

Common stocks:

                                         

Banks, trusts and insurance companies

  $ 10   $ (1 )   $ —     $ —       $ 10   $ (1 )

Industrial, miscellaneous and all other

    55     (44 )     —       —         55     (44 )

Non-redeemable preferred stocks:

                                         

Non-sinking fund preferred stocks

    307,918     (7,468 )     71,798     (4,286 )     379,716     (11,754 )
   

 


 

 


 

 


Total equity securities

  $ 307,983   $ (7,513 )   $ 71,798   $ (4,286 )   $ 379,781   $ (11,799 )
   

 


 

 


 

 


 

The total unrealized losses represent less than 2% of the aggregate fair value of the related securities at December 31, 2006 and 2005. Approximately 79% and 77% of these unrealized losses have been in a continuous loss position for less than twelve months in 2006 and 2005, respectively. The total unrealized losses are comprised of 1,394 and 1,172 individual securities with 94% of the individual securities having an unrealized loss of less than $200 in 2006 and 2005, respectively. The total unrealized losses on securities that were in a continuous unrealized loss position for greater than six months but less than 12 months were approximately $2,171 and $9,388 in 2006 and 2005, respectively. There were no securities with an unrealized loss of greater than $200 having a market value below 88% and 79% of book value at December 31, 2006 and 2005, respectively.

 

As part of our ongoing monitoring process, we regularly review our investment portfolio to ensure that investments that may be other-than-temporarily impaired are identified on a timely basis and that any impairment is charged against earnings in the proper period. We have reviewed these securities and recorded $810, $765, and $600 of additional other-than-temporary impairments as of December 31, 2006, 2005, and 2004, respectively. Due to issuers’ continued satisfaction of the securities’ obligations in accordance with their contractual terms and their continued expectations to do so, as well as our evaluation of the fundamentals of the issuers’ financial condition, we believe that the prices of the securities in an unrealized loss position as of December 31, 2006 in the sectors discussed above were temporarily depressed primarily as a result of the prevailing level of interest rates at the time the securities were purchased. The Company has the intent and ability to hold these assets until the date of recovery.

 

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Loss Protection and Capital Management

 

As part of our overall risk and capital management strategy, we purchase reinsurance for certain risks underwritten by our various business segments, including significant individual or catastrophic claims, and to free up capital to enable us to write additional business.

 

For those product lines where there is exposure to catastrophes, we closely monitor and manage the aggregate risk exposure by geographic area, and we have entered into reinsurance treaties to manage exposure to these types of events.

 

Under indemnity reinsurance transactions in which we are the ceding insurer, we remain liable for policy claims if the assuming company fails to meet its obligations. To limit this risk, we have control procedures to evaluate the financial condition of reinsurers and to monitor the concentration of credit risk to minimize this exposure. The selection of reinsurance companies is based on criteria related to solvency and reliability and, to a lesser degree, diversification as well as developing strong relationships with our reinsurers for the sharing of risks.

 

Business Dispositions

 

To exit certain businesses, we have used reinsurance to facilitate transactions because the businesses share legal entities with business segments we retain. Assets supporting liabilities ceded relating to these businesses are held in trusts and the separate accounts relating to divested business are still reflected in our balance sheet.

 

Segments Client Risk and Profit Sharing

 

The Assurant Solutions and Assurant Specialty Property segments write business produced by clients, such as mortgage lenders and servicers and financial institutions, and reinsures all or a portion of such business to insurance subsidiaries of the clients. Such arrangements allow significant flexibility in structuring the sharing of risks and profits on the underlying business.

 

A substantial portion of Assurant Solutions and Assurant Specialty Property reinsurance activities are related to agreements to reinsure premiums and risk related to business generated by certain clients to the clients’ captive insurance companies or to reinsurance subsidiaries in which the clients have an ownership interest. Through these arrangements, our insurance subsidiaries share some of the premiums and risk related to client-generated business with these clients. When the reinsurance companies are not authorized to do business in our insurance subsidiary’s domiciliary state, our insurance subsidiary generally obtains collateral, such as a trust or a letter of credit, from the reinsurance company or its affiliate in an amount equal to the outstanding reserves to obtain full statutory financial credit in the domiciliary state for the reinsurance. Our reinsurance agreements do not relieve us from our direct obligation to our insured. Thus, a credit exposure exists to the extent that any reinsurer is unable to meet the obligations assumed in the reinsurance agreements. To minimize our exposure to reinsurance insolvencies, we evaluate the financial condition of our reinsurers and hold substantial collateral (in the form of funds, trusts and letters of credit) as security under the reinsurance agreements. See “Item 7A—Quantitative and Qualitative Disclosures about Market Risk—Credit Risk.”

 

Liquidity and Capital Resources

 

Regulatory Requirements

 

Assurant, Inc. is a holding company, and as such, has limited direct operations of its own. Our holding company assets consist primarily of the capital stock of our subsidiaries. Accordingly, our future cash flows depend upon the availability of dividends and other statutorily permissible payments from our subsidiaries, such as payments under our tax allocation agreement and under management agreements with our subsidiaries. The ability to pay such dividends and to make such other payments will be limited by applicable laws and regulations of the states in which our subsidiaries are domiciled, which subject our subsidiaries to significant regulatory

 

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restrictions. The dividend requirements and regulations vary from state to state and by type of insurance provided by the applicable subsidiary. These laws and regulations require, among other things, our insurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay to the holding company. Solvency regulations, capital requirements and rating agencies are some of the factors used in determining the amount of capital used for dividends. For 2007, the maximum amount of distributions our subsidiaries could pay, under applicable laws and regulations without prior regulatory approval for our statutory subsidiaries, is approximately $476,070.

 

Liquidity

 

Dividends paid by our subsidiaries totaled $554,270, $530,094 and $361,700 for the years ended December 31, 2006, 2005 and 2004, respectively. We used these cash inflows primarily to pay expenses, to make interest payments on indebtedness, to make dividend payments to our stockholders, and to repurchase our outstanding shares.

 

The primary sources of funds for our subsidiaries consist of premiums and fees collected, the proceeds from the sales and maturity of investments and investment income. Cash is primarily used to pay insurance claims, agent commissions, operating expenses and taxes. We generally invest our subsidiaries’ excess funds in order to generate income.

 

We conduct periodic asset liability studies to measure the duration of our insurance liabilities, to develop optimal asset portfolio maturity structures for our significant lines of business and ultimately to assess that cash flows are sufficient to meet the timing of cash needs. These studies are conducted in accordance with formal Company-wide Asset Liability Management (“ALM”) guidelines.

 

To complete a study for a particular line of business, models are developed to project asset and liability cash flows and balance sheet items under a large, varied set of plausible economic scenarios. These models consider many factors including the current investment portfolio, the required capital for the related assets and liabilities, our tax position and projected cash flows from both existing and projected new business.

 

Alternative asset portfolio structures are analyzed for significant lines of business. An investment portfolio maturity structure is then selected from these profiles given our return hurdle and risk preference. Sensitivity testing of significant liability assumptions and new business projections is also performed.

 

Given our ALM asset allocation processes and the nature of the products we offer, we have minimal exposure to disintermediation risk. Our liabilities have limited policyholder optionality which results in policyholder behavior that is mainly insensitive to the interest rate environment. In addition, our investment portfolio is largely comprised of highly liquid fixed income securities with a sufficient component of such securities invested that are near maturity which may be sold with minimal risk of loss to meet cash needs.

 

Generally, our subsidiaries’ premiums, fees and investment income, along with planned asset sales and maturities, provide sufficient cash to pay claims and expenses. However, there are instances where unexpected cash needs arise in excess of that available from usual operating sources. In such instances, we have several options to raise needed funds including selling assets from the subsidiaries’ investment portfolios, using holding company cash (if available), issuing commercial paper and drawing funds from our revolving credit facility. We consider the permanence of the cash need as well as the cost of each source of funds in determining which option to utilize.

 

On February 15, 2007, we announced that our Board of Directors declared a quarterly dividend of $0.10 per common shares payable on March 12, 2007 to stockholders of record as of February 26, 2007. We paid dividends of $0.08 per share of common stock on March 7, 2006 and $.10 per share of common stock on June 13, 2006, September 12, 2006 and December 11, 2006. We paid dividends of $0.07 per share of common stock on March 14, 2005 and $0.08 per share of common stock on June 7, 2005, September 7, 2005 and December 12, 2005. Any determination to pay future dividends will be at the discretion of our Board of Directors and will be

 

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dependent upon: our subsidiaries’ payment of dividends and/or other statutorily permissible payments to us; our results of operations and cash flows; our financial position and capital requirements; general business conditions; any legal, tax, regulatory and contractual restrictions on the payment of dividends; and any other factors our Board of Directors deems relevant.

 

Retirement and Other Employee Benefits

 

We sponsor a pension and a retirement health benefit plan covering our employees who meet specified eligibility requirements. The reported expense and liability associated with these plans requires an extensive use of assumptions which include the discount rate, expected return on plan assets and rate of future compensation increases. We determine these assumptions based upon currently available market and industry data, historical performance of the plan and its assets, and consultation with an independent consulting actuarial firm to aid us in selecting appropriate assumptions and valuing our related liabilities. The actuarial assumptions used in the calculation of our aggregate projected benefit obligation may vary and include an expectation of long-term market appreciation in equity markets which is not changed by minor short-term market fluctuations, but does change when large interim deviations occur. The assumptions we use may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of the participants.

 

Our pension plans were under-funded by $113,026 at December 31, 2006. We established a funding policy in which service cost plus 15% of plan deficit will be contributed annually. We made $19,500 of pension plan contributions in 2006. See Note 21 of Notes to the Consolidated Financial Statements included elsewhere in this report for the components of the net periodic benefit cost.

 

Commercial Paper Program

 

The Company maintains a $500,000 commercial paper program, which is available for working capital and other general corporate purposes. Our commercial paper program is rated AMB-2 by A.M. Best, P-2 by Moody’s and A2 by S&P. Our subsidiaries do not maintain commercial paper or other borrowing facilities at their level. This program is backed up by a $500,000 senior revolving credit facility with a syndicate of banks arranged by J.P. Morgan Securities, Inc. (successor by merger to Banc One Capital Markets, Inc.) and Citigroup Global Market, Inc., which was established on January 30, 2004. In April 2005, we amended and restated our $500,000 senior revolving credit facility with a syndicate of banks arranged by Citibank and JP Morgan Chase Bank. The amended and restated credit facility is unsecured and is available until April 2010, so long as the Company is in compliance with all the covenants. This facility is also available for general corporate purposes, but to the extent used thereto, would be unavailable to back up the commercial paper program. There were no amounts relating to the commercial paper program outstanding at December 31, 2006. We did not use the revolving credit facility during 2006 and no amounts are outstanding.

 

The revolving credit facility contains restrictive covenants. The terms of the revolving credit facility also require that we maintain certain specified minimum ratios or thresholds. We are in compliance with all covenants and we maintain all specified minimum ratios and thresholds.

 

Senior Notes

 

On February 18, 2004, we issued two series of senior notes in an aggregate principal amount of $975,000. The first series is $500,000 in principal amount, bears interest at 5.625% per year and is payable in a single installment due February 15, 2014. The second series is $475,000 in principal amount, bears interest at 6.750% per year and is payable in a single installment due February 15, 2034. Our senior notes are rated bbb by A.M. Best, Baa1 by Moody’s and BBB+ by S&P.

 

Interest on our senior notes is payable semi-annually on February 15 and August 15 of each year. The senior notes are unsecured obligations and rank equally with all of our other senior unsecured indebtedness. The senior notes are not redeemable prior to maturity.

 

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Management believes that our subsidiaries’ cash flow from operations together with our income and gains from our investment portfolio will provide sufficient liquidity to meet our needs in the ordinary course of business.

 

Cash Flows

 

We monitor cash flows at the consolidated, holding company and subsidiary levels. Cash flow forecasts at the consolidated and subsidiary levels are provided on a monthly basis, and we use trend and variance analyses to project future cash needs making adjustments to the forecasts when needed.

 

The table below shows our recent net cash flows:

 

    

For the Year Ended

December 31,


 
     2006

    2005

    2004

 
     (in thousands)  
Net cash provided by (used in):                   

Operating activities(1)

   $ 934,158     $ 899,176     $ 821,850  

Investing activities

     (84,511 )     (548,688 )     (744,962 )

Financing activities

     (717,544 )     (302,001 )     (228,003 )
    


 


 


Net change in cash

   $ 132,103     $ 48,487     $ (151,115 )
    


 


 


 

(1) Includes effect of exchange rate changes on cash and cash equivalents.

 

Cash Flows for the Years Ended December 31, 2006, 2005, and 2004.

 

Operating activities:

 

Net cash provided by operating activities was $934,158 and $899,176 for the years ended December 31, 2006 and 2005, respectively. The $34,982 increase in net cash provided by operating activities in 2006 over the comparable period in 2005 is primarily due to cash provided by reinsurance recoverables relating to settlements for 2005 hurricane losses offset by a decrease in accounts payable.

 

Net cash provided by operating activities was $899,176 and $821,850 for the years ended December 31, 2005 and 2004, respectively. The $77,326 increase in net cash provided by operating activities in 2006 over the comparable period in 2005 is primarily attributable to increased reserves and accounts payable and other liabilities, partially offset by increased reinsurance recoverables.

 

Investing Activities:

 

Net cash used in investing activities was $84,511 and $548,688 for the years ended December 31, 2006 and 2005, respectively. The $464,177 decrease in net cash used in investing activities in 2006 over the comparable period in 2005 is primarily attributable to significant net cash received from the sale of short-term investments in 2006 compared to cash used to purchase short-term investments for the comparable period in 2005. Also, the net cash received from the SFIS acquisition, a decrease in cash outflows for investments in commercial mortgage loans on real estate and the cash received from the sale of PHCS, partially offset by an increase in cash used to purchase fixed maturities, contributed to the overall decrease in cash used in investing activities.

 

Net cash used in investing activities was $548,688 and $744,962 for the years ended December 31, 2005 and 2004, respectively. The $196,274 decrease in net cash used in investing activities in 2005 over the comparable period in 2004 is primarily attributable to the decrease in net cash used to purchase fixed maturities and equity securities. This was partially offset by an increase in cash used to purchase short-term investments in 2005 compared to 2004.

 

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Financing Activities:

 

Net cash used in financing activities was $717,544 and $302,001 for the years ended December 31, 2006 and 2005, respectively. The $415,543 increase in net cash used in financing activities in 2006 over the comparable period in 2005 is primarily attributable to an increase in net cash used to purchase treasury stock and a change in collateral held under securities lending.

 

Net cash used in financing activities was $302,001 and $228,003 for the years ended December 31, 2005 and 2004, respectively. The $73,998 increase in net cash used in financing activities in 2005 over the comparable period in 2004 is primarily attributable to an increase in cash used to purchase treasury stock, the issuance of common stock and a change in collateral held under securities lending. Offsetting these changes was the net repayment of debt in 2004.

 

The table below shows our cash outflows for distributions and dividends for the periods indicated:

 

     For the Year Ended December 31,

     2006

   2005

   2004

     (in thousands)
Security               

Mandatory redeemable preferred securities of subsidiary trust

   $ —      $ —      $ 66,734

Mandatory redeemable preferred stock dividends and interest paid

     61,159      61,179      37,709

Common stock dividends

     48,157      42,050      29,676
    

  

  

Total

   $ 109,316    $ 103,229    $ 134,119
    

  

  

 

Commitments and Contingencies

 

We have obligations and commitments to third parties as a result of our operations. These obligations and commitments, as of December 31, 2006, are detailed in the table below by maturity date as of the dates indicated:

 

     As of December 31,

     Less than 1 Year

  

1-3

Years


  

3-5

Years


   More than 5
Years


   Total

     (in thousands)

Contractual obligations :

                                  

Insurance liabilities (1)

   $ 1,790,344    $ 1,557,398    $ 1,363,427    $ 11,668,762    $ 16,379,931

Debt and related interest

     60,188      120,375      120,375      1,736,626      2,037,564

Mandatory redeemable preferred stock

     —        —        —        22,160      22,160

Operating leases

     35,129      52,795      28,135      30,978      147,037

Pension obligations and postretirement benefit

     31,539      53,773      56,604      185,561      327,477

Commitments:

                                  

Investment purchases outstanding:

                                  

Unsettled trades

     9,647      —        —        —        9,647

Commercial mortgage loans on real estate

     34,260      —        —        —        34,260

Other investments

     19,497      —        —        —        19,497
    

  

  

  

  

Total obligations and commitments

   $ 1,980,604    $ 1,784,341    $ 1,568,541    $ 13,644,087    $ 18,977,573
    

  

  

  

  

 

(1) Insurance liabilities, reflected in the commitments and contingencies table above, include products for which we are currently making periodic payments and products for which we are not making periodic payments, but for which we believe the amount and timing of future payments is essentially fixed and determinable. Amounts included in insurance liabilities reflect estimated cash payments to be made to policyholders.

 

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Liabilities for future policy benefits and expenses of $6,766,343 and claims and benefits payable of $3,412,166 have been included in the commitments and contingencies table. Significant uncertainties relating to these liabilities include mortality, morbidity, expenses, persistency, investment returns, inflation, contract terms and the timing of payments.

 

Letters of Credit

 

In the normal course of business, letters of credit are issued primarily to support reinsurance arrangements. These letters of credit are supported by commitments with financial institutions. We had approximately $33,219 and $28,216 of letters of credit outstanding as of December 31, 2006 and December 31, 2005, respectively.

 

Off-Balance Sheet Arrangements

 

The Company does not have any off-balance sheet arrangements that are reasonably likely to have a material effect on the financial condition, results of operations, liquidity, or capital resources of the Company.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

As a provider of insurance products, effective risk management is fundamental to our ability to protect both our customers’ and stockholders’ interests. We are exposed to potential loss from various market risks, in particular interest rate risk and credit risk. Additionally, we are exposed to inflation risk and to a small extent to foreign currency risk.

 

Interest rate risk is the possibility the fair value of liabilities will change more or less than the market value of investments in response to changes in interest rates, including changes in the slope or shape of the yield curve and changes in spreads due to credit risks and other factors.

 

Credit risk is the possibility that counterparties may not be able to meet payment obligations when they become due. We assume counterparty credit risk in many forms. A counterparty is any person or entity from which cash or other forms of consideration are expected to extinguish a liability or obligation to us. Primarily, our credit risk exposure is concentrated in our fixed income investment portfolio and, to a lesser extent, in our reinsurance recoverables.

 

Inflation risk is the possibility that a change in domestic price levels produces an adverse effect on earnings. This typically happens when only one of invested assets or liabilities is indexed to inflation.

 

Foreign exchange risk is the possibility that changes in exchange rates produce an adverse effect on earnings and equity when measured in domestic currency. This risk is largest when assets backing liabilities payable in one currency are invested in financial instruments of another currency. Our general principle is to invest in assets that match the currency in which we expect the liabilities to be paid.

 

Interest Rate Risk

 

Interest rate risk arises as we invest substantial funds in interest-sensitive fixed income assets, such as fixed maturity investments, mortgage-backed and asset-backed securities and commercial mortgage loans, primarily in the United States and Canada. There are two forms of interest rate risk—price risk and reinvestment risk. Price risk occurs when fluctuations in interest rates have a direct impact on the market valuation of these investments. As interest rates rise, the market value of these investments falls, and conversely, as interest rates fall, the market value of these investments rises. Reinvestment risk occurs when fluctuations in interest rates have a direct impact on expected cash flows from mortgage-backed and asset-backed securities. As interest rates fall, an increase in prepayments on these assets results in earlier than expected receipt of cash flows forcing us to reinvest the proceeds in an unfavorable lower interest rate environment, and conversely as interest rates rise, a decrease in

 

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prepayments on these assets results in later than expected receipt of cash flows forcing us to forgo reinvesting in a favorable higher interest rate environment.

 

We expect to manage interest rate risk by selecting investments with characteristics such as duration, yield, currency and liquidity tailored to the anticipated cash outflow characteristics of our insurance and reinsurance liabilities.

 

Our group long term disability reserves are also sensitive to interest rates. Group long-term disability and group term life waiver of premium reserves are discounted to the valuation date at the valuation interest rate. The valuation interest rate is determined by taking into consideration actual and expected earned rates on our asset portfolio.

 

The interest rate sensitivity relating to price risk of our fixed maturity security assets is assessed using hypothetical scenarios that assume several positive and negative parallel shifts of the yield curves. We have assumed that the United States and Canadian yield curve shifts are of equal direction and magnitude. The individual securities are repriced under each scenario using a valuation model. For investments such as callable bonds and mortgage-backed and asset-backed securities, a prepayment model was used in conjunction with a valuation model. Our actual experience may differ from the results noted below particularly due to assumptions utilized or if events occur that were not included in the methodology. The following table summarizes the results of this analysis for bonds, mortgage-backed and asset-backed securities held in our investment portfolio:

 

Interest Rate Movement Analysis

of Market Value of Fixed Maturity Securities Investment Portfolio

As of December 31, 2006

 

     -100

    -50

    0

    50

    100

 
     (in thousands)  

Total market value

   $ 9,733,684     $ 9,420,078     $ 9,118,049     $ 8,828,083     $ 8,549,122  

% Change in market value from base case

     6.75 %     3.31 %     —   %     -3.18 %     -5.77 %

$ Change in market value from base case

   $ 615,635     $ 302,029     $ —       $ (289,966 )   $ (568,927 )

 

The interest rate sensitivity relating to reinvestment risk of our fixed maturity security assets is assessed using hypothetical scenarios that assume purchases in the primary market and considers the effects of interest rates on sales. The effects of embedded options including call or put features are not considered. Our actual results may differ from the results noted below particularly due to assumptions utilized or if events occur that were not included in the methodology.

 

The following table summarizes the results of this analysis on our reported portfolio yield:

 

Interest Rate Movement Analysis

Of Portfolio Yield of Fixed Maturity Securities Investment Portfolio

As of December 31, 2006

 

     -100

    -50

    0

    50

    100

 

Portfolio Yield

   5.69 %   5.75 %   5.82 %   5.89 %   5.95 %

Basis Point Change in Portfolio Yield

   (0.13 )%   (0.07 )%   —   %   0.07 %   0.13 %

 

Credit Risk

 

We have exposure to credit risk primarily as a holder of fixed income securities and by entering into reinsurance cessions.

 

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Our risk management strategy and investment policy is to invest in debt instruments of high credit quality issuers and to limit the amount of credit exposure with respect to any one issuer. We attempt to limit our credit exposure by imposing fixed maturity portfolio limits on individual issuers based upon credit quality. Currently our portfolio limits are 1.5% for issuers rated AA-and above, 1% for issuers rated A- to A+, 0.75% for issuers rated BBB- to BBB+ and 0.38% for issuers rated BB- to BB+. These portfolio limits are further reduced for certain issuers with whom we have credit exposure on reinsurance agreements. We use the lower of Moody’s or Standard & Poor’s ratings to determine an issuer’s rating.

 

The following table presents our fixed maturity investment portfolio by ratings of the nationally recognized securities rating organizations as of December 31, 2006:

 

Rating


   Fair Value

  

Percentage of

Total


 
     (in thousands)       

Aaa/Aa/A

   $ 6,127,830    67 %

Baa

     2,386,317    26 %

Ba

     479,037    6 %

B and lower

     124,865    1 %
    

  

Total

   $ 9,118,049    100 %
    

  

 

We are also exposed to the credit risk of our reinsurers. When we reinsure, we are still liable to our insureds regardless of whether we get reimbursed by our reinsurer. As part of our overall risk and capacity management strategy, we purchase reinsurance for certain risks underwritten by our various business segments as described above under “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reinsurance.”

 

For at least 50% of our $3,914,972 of reinsurance recoverables at December 31, 2006, we are protected from the credit risk by using various types of risk mitigation mechanisms such as trusts, letters of credit or by withholding the assets in a modified coinsurance or co-funds-withheld arrangement. For example, reserves of $1,366,601 and $1,361,615 as of December 31, 2006 relating to two large coinsurance arrangements with The Hartford and John Hancock, respectively, related to sales of businesses. If the value of the assets in these trusts falls below the value of the associated liabilities, The Hartford and John Hancock, as the case may be, will be required to put more assets in the trusts. We may be dependent on the financial condition of The Hartford and John Hancock, whose A.M. Best ratings are currently A+ and A++, respectively. For recoverables that are not protected by these mechanisms, we are dependent solely on the credit of the reinsurer. Occasionally, the credit worthiness of the reinsurer becomes questionable. See “Item 1A—Risk Factors—Risks Related to Our Company—Reinsurance may not be available or adequate to protect us against losses, and we are subject to the credit risk of reinsurers.” We believe that a majority of our reinsurance exposure has been ceded to companies rated A- or better by A.M. Best.

 

Inflation Risk

 

Inflation risk arises as we invest substantial funds in nominal assets, which are not indexed to the level of inflation, whereas the underlying liabilities are indexed to the level of inflation. Approximately 12% of Assurant preneed’s insurance policies with reserves of approximately $398,000 as of December 31, 2006 have death benefits that are guaranteed to grow with the CPI. In times of rapidly rising inflation, the credited death benefit growth on these liabilities increases relative to the investment income earned on the nominal assets resulting in an adverse impact on earnings. We have partially mitigated this risk by purchasing contracts with payments tied to the CPI. See “—Derivatives.”

 

In addition, we have inflation risk in our individual and small employer group health insurance businesses to the extent that medical costs increase with inflation, and we have not been able to increase premiums to keep pace with inflation.

 

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Foreign Exchange Risk

 

We are exposed to some foreign exchange risk arising from our international operations mainly in Canada. We also have limited foreign exchange risk exposure to currencies other than the Canadian dollar, primarily the British pound and Danish krone. However, total invested assets denominated in these other currencies were less than 2% of our total invested assets at December 31, 2006.

 

Foreign exchange risk is mitigated by matching our liabilities under insurance policies that are payable in foreign currencies with investments that are denominated in such currency. We have not established any hedge to our foreign currency exchange rate exposure.

 

The foreign exchange risk sensitivity of our fixed maturity security assets denominated in Canadian dollars on our entire fixed maturity portfolio is summarize in the following table:

 

Foreign Exchange Movement Analysis

Of Market Value of Fixed Maturity Securities Assets

As of December 31, 2006

 

 

Foreign exchange spot rate at December 31,

2006, US Dollar to Canadian Dollar


   -10%

    -5%

    0

    5%

    10%

 

Total market value

   $ 9,046,178     $ 9,082,113     $ 9,118,049     $ 9,153,984     $ 9,189,920  

% change of market value from base case

     (0.79 )%     (0.39 )%     —   %     0.39 %     0.79 %

$ change of market value from base case

   $ (71,871 )   $ (35,936 )   $ —       $ 35,935     $ 71,871  

 

The foreign exchange risk sensitivity of our consolidated net income is assessed using hypothetical test scenarios that assume earnings in Canadian dollars are recognized evenly throughout a period. Our actual results may differ from the results noted below particularly due to assumptions utilized or if events occur that were not included in the methodology. The following table summarizes the results of this analysis on our reported net income:

 

Foreign Exchange Movement Analysis

Of Net Income

As of December 31, 2006

 

Foreign exchange daily average rate for the year ended
2006, US Dollar to Canadian Dollar


   -10%

    -5%

    0

    5%

    10%

 

Net income

   $ 713,792     $ 715,604     $ 717,418     $ 719,230     $ 721,042  

% change of net income from base case

     (0.51 )%     (0.25 )%     —   %     0.25 %     0.51 %

$ change of net income from base case

   $ (3,625 )   $ (1,813 )   $ —       $ 1,813     $ 3,625  

 

Derivatives

 

Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices or the prices of securities or commodities. Derivative financial instruments may be exchange-traded or contracted in the over-the-counter market and include swaps, futures, options and forward contracts.

 

Under insurance statutes, our insurance companies may use derivative financial instruments to hedge actual or anticipated changes in their assets or liabilities, to replicate cash market instruments or for certain income-generating activities. These statutes generally prohibit the use of derivatives for speculative purposes. We generally do not use derivative financial instruments.

 

We have purchased contracts to cap the inflation risk exposure inherent in some of our preneed insurance policies.

 

 

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In 2003, we determined that the modified coinsurance agreement with The Hartford contained an embedded derivative. In accordance with DIG B36, we bifurcated the contract into its debt host and embedded derivative (i.e., total return swap) and recorded the embedded derivative at fair value on the balance sheet. Contemporaneous with the adoption of DIG B36, we reclassified the invested assets related to this modified coinsurance agreement from fixed maturities available for sale to trading securities, included in other investments. The combination of the two aforementioned transactions has no net impact in the consolidated statements of operations for all periods presented.

 

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Item 8. Financial Statements and Supplementary Data.

 

The consolidated financial statements and financial statement schedules in Part IV, Item 15(a) 1 and 2 of this report are incorporated by reference into this Item 8.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

 

There have been no disagreements with accountants on accounting and financial disclosure.

 

Item 9A. Controls and Procedures.

 

Disclosure Controls and Procedures.

 

The management of Assurant is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934. As of December 31, 2006, an evaluation was performed under the supervision and with the participation of the Company’s management, including the chief executive officer and chief financial officer, of the effectiveness of the design and operation of Assurant’s disclosure controls and procedures. Based on that evaluation, management concluded that Assurant’s disclosure controls and procedures as of December 31, 2006, were effective.

 

Management’s Annual Report on Internal Control Over Financial Reporting

 

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. A company’s internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

The Company’s management assessed its internal control over financial reporting as of December 31, 2006 using criteria established in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

Management, including the Company’s chief executive officer and its chief financial officer, based on their evaluation of the Company’s internal control over financial reporting (as defined in Securities Exchange Act Rule 13a-15(f)), have concluded that the Company’s internal control over financial reporting was effective