AmTrust Financial's Statutory Financials Indicate Reported GAAP Profits Might Be Overstated

Feb.26.14 | About: AmTrust Financial (AFSI)

The statutory filings of AmTrust Financial Services, Inc. (Ticker: AFSI) indicate the Company's underwriting results are much worse than they report to investors. In fact, it appears AFSI is losing money in their insurance operations instead of generating the profits they claim.

Investors, regulators, and rating agencies should take note. If or when they do, the stock could fall significantly.

AFSI US Statutory Filing Financials (Net):

Statutory filings for US groups (in AFSI's case Technology Insurance Company & Affiliates) show the financial results of various entities net of reinsurance, even if the reinsurer is owned by the same holding company as is the case for AmTrust International Insurance (AFSI's Bermuda Captive Reinsurer). Based on these results, it would appear that AFSI's US operations are stable and profitable. However, this doesn't tell the full story.

Below are the results of TIC & Affiliates for 2010-2012 net of all reinsurance (including from other AFSI subs):

Source: TIC & Affiliates Statutory Filings

I pulled the data from statutory filings and show screenshots of the source below:

Source: TIC & Affiliates Statutory Filings

AFSI US Statutory Filing Financials, Adjusted to Eliminate Reinsurance from other AFSI subs

Since the financials shown above include the benefit of reinsurance, one would need to adjust those to eliminate the benefit of reinsurance from other AFSI subs (but not from third parties) to see what the US operations contributed to profits across all AFSI entities (net of third party reinsurance).

Fortunately, the Schedule Y allows us to do this. As AFSI's CEO, Barry Zyskind said on the most recent conference call:

I want to address the references to Schedule Y to the annual statements filed by our US insurers. Schedule Y is intended to show the net income effect of reinsurance agreements with affiliated insurers within a holding company group. Schedule Y shows correctly the aggregate net income effect to our Luxembourg companies resulting from their assumption of intra-company financial losses from AmTrust International. It corresponds to the reduction of their equalization reserves. Schedule Y also shows the net effect to AmTrust International of all intra-company reinsurance, including a cession of a net loss to the Luxembourg companies.

In other words, Schedule Y (column 9 below) shows the subsidy received (provided) by other insurance companies owned by the holding company.

Adjusting for the subsidies AFSI's US insurance entities are receiving from offshore AFSI subsidiaries (to see the total profit/loss to AFSI from US operations regardless of where it ends up, onshore or offshore), the results look rather different and show significant losses in 2011 and 2012:

Source: TIC & Affiliates Statutory Filings

This is in stark contrast to the results AFSI reports to investors (SEC filings show $110mm - $150mm of underwriting profits for 2010-2012). Since 70% of AFSI's premiums earned are in the US (Source: 10-K) and there are only minor accounting differences in GAAP and SAP accounting (the main one being the timing of acquisition cost recognition).

Further, insurance regulators and rating agencies use this data to determine the strength and quality of AFSI's insurance operations. By reporting steady profits on a net basis, AFSI gets credit from AM Best and regulators for its ability to generate earnings to replenish capital. If the intra-company agreements that turn losses into reported profits are not well disclosed in the "interrogatories," regulators might take a different view of AFSI.

I intend to write a follow-up article on AFSI's reinsurance interrogatories and how they conflict with management statements elsewhere, which will further highlight the problems with AFSI's disclosures.

Schedule Y screenshots below. US entities that are part of the TIC & Affiliates reporting group are outlined in red.

Source: TIC & Affiliates Statutory Filings

Note: The company was unresponsive when I reached out to them for comment.

Disclosure: I am short AFSI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.