| ALFA CORP Item 1A Risk Factors |
| Risk factors are uncertainties and events over which the Company has limited or no control and which can have a materially adverse effect on the business, the results of operations or the financial condition of the Company and its subsidiaries |
| The Company and its business segments are subject to a variety of risk factors |
| The following sections set forth management’s evaluation of the most prevalent material risk factors for the Company and its subsidiaries |
| There may be risks which management does not presently consider material or which are not presently known to management that may later prove to be material risk factors as well |
| Regulatory Environment The Company’s insurance subsidiaries are subject to extensive governmental regulation in all of the state and similar jurisdictions in which they operate |
| These regulations relate to licensing requirements, types of insurance products that may be sold, premium rates, marketing practices, capital and surplus requirements, investment limitations, underwriting limitations, dividend payment limitations, transactions with affiliates, accounting practices, taxation and other matters |
| While most of the regulation is at the state level, the federal government has increasingly expressed an interest in regulating the insurance industry through the Graham-Leach-Bliley Act, the Patriot Act, financial services regulation, changes in the Internal Revenue Code and other legislation |
| All of these regulations increase the cost of conducting insurance business through increased compliance expenses |
| Furthermore, as existing regulations evolve through administrative and court interpretations, and as new regulations are adopted, there can be no way of predicting what impact these changes will have on the Company in the future |
| Such impact could adversely affect the Company’s profitability and limit its growth |
| Geographic Concentration Risk The Company’s property casualty insurance business is generated in 13 southeastern states and its life insurance business is generated in 3 states |
| For the year ended December 31, 2005, approximately dlra514 million of premiums and policy charges representing 81prca of such amounts were from policies written in Alabama |
| Accordingly, unusually severe storms or other disasters in this state might have a more significant effect on the Company than a more geographically diversified company and could have an adverse impact on the Company’s financial condition and operating results |
| In addition, the revenues and profitability of the Company are subject to prevailing regulatory, legal, economic, demographic, competitive and other conditions in these states |
| Changes in any of these conditions could make it less attractive for the Company to do business in these states and could have an adverse effect on the Company’s financial results |
| 9 ______________________________________________________________________ [47]Table of Contents [48]Index to Financial Statements Catastrophic Loss Risk The insurance operations expose the Company to claims arising out of catastrophic events |
| Catastrophes can be caused by various unpredictable events, including hurricanes, hailstorms, tornadoes, severe winter weather, earthquakes, and other natural or man-made disasters |
| Property Casualty: While the Company limits the property exposures it writes in coastal exposure areas, the Company’s critical catastrophic risk is hurricanes because of the proximity of southeastern markets to the Gulf of Mexico |
| The Company also limits its catastrophic loss risk by participating in a catastrophe protection program through an intercompany pooling arrangement (more fully discussed in Note 2—Pooling Agreement in the Notes to Consolidated Financial Statements) |
| A catastrophic event in excess of the Company’s upper catastrophe pool limit could adversely affect the Company’s business, results of operations and financial condition |
| Reserves Reserves are the amounts that an insurance company sets aside for its anticipated policy liabilities |
| Property Casualty: Claim reserves are an estimate of liability for unpaid claims and claims defense and adjustment expenses, and cover reported as well as incurred, but not yet reported claims |
| It is not possible to calculate precisely what these liabilities will amount to in advance and, therefore, the reserves represent a best estimate at any point in time |
| Such estimates are based upon known historical loss data and trending using actuarial techniques and modeling |
| Reserve estimates are periodically reviewed in consideration of known developments and, where necessary, adjusted as circumstances may warrant |
| Nevertheless, the reserving process is inherently uncertain |
| If for any of these reasons, reserve estimates prove to be inadequate, the Company’s subsidiaries will increase their reported liabilities |
| Such an occurrence could result in a materially adverse impact on the Company’s results of operations and financial condition |
| Life: Reserve for life-contingent contract benefits is computed on the basis of long-term actuarial assumptions of future investment yields, mortality, morbidity, policy terminations and expenses |
| The Company reviews the adequacy of these reserves on an aggregate basis and, if future experience differs significantly from assumptions, adjustments to reserves may be required, which could have a material adverse impact on the Company’s results of operations and financial condition |
| Excessive Losses and Loss Expenses The greatest risk factor common to all insurance coverages is excessive losses due to unanticipated claims frequency, severity or a combination of both |
| Many of the factors affecting the frequency and severity of claims depend upon the type of insurance coverage |
| Severity and frequency can be affected by unexpectedly adverse outcomes in claims litigation, often as a result of unanticipated jury verdicts, changes in court-made law and adverse court interpretations of insurance policy provisions resulting in increased liability or new judicial theories of liability, together with unexpectedly high costs of defending claims |
| Investment Risks (Interest and Equity) The invested assets of the Company’s subsidiaries are centrally managed by the Company |
| The majority of these invested assets consist of fixed maturity securities |
| Changes in interest rates directly affect the income from, and the market value of fixed maturity investments and could reduce the value of the Company’s investment portfolio and adversely affect the Company’s, and its subsidiaries’ results of operations and financial condition |
| A smaller percentage of total investments are in equity securities |
| A change in general economic conditions, the stock market, or many other external factors could 10 ______________________________________________________________________ [49]Table of Contents [50]Index to Financial Statements adversely affect the value of those investments and, in turn, the Company’s, or its subsidiaries’ results and financial condition |
| Further, the Company manages its fixed maturity investments by taking into account the maturities of such securities and the anticipated liquidity needs of the Company and its subsidiaries |
| Should the Company suddenly experience greater than anticipated liquidity needs for any reason, it could face a liquidity risk that may adversely affect the Company’s financial condition or results of operations |
| Reinsurance Reinsurance is a contractual arrangement whereby one insurer (the reinsurer) assumes some or all of the risk exposure written by another insurer (the reinsured) |
| The Company uses reinsurance to manage its risks both in terms of the amount of coverage it is able to write, the amount it is able to retain for its own account, and the price at which it is able to write it |
| The availability of reinsurance and its price, however, are determined in the reinsurance market by conditions beyond the Company’s control |
| Reinsurance does not relieve the reinsured company of its primary liability to its insureds in the event of a loss |
| It merely reimburses the reinsured company |
| The ability and willingness of reinsurers to honor their obligations represent credit risks inherent in reinsurance transactions |
| The Company addresses this risk by limiting its reinsurance to those reinsurers it considers the best credit risks with limited duration contracts |
| There can be no assurance that the Company will be able to find the desired or even adequate amounts of reinsurance at favorable rates from acceptable reinsurers in the future |
| If unable to do so, the Company would be forced to reduce the volume of business it writes or retain increased amounts of liability exposure |
| This could adversely affect the Company’s results of operations and financial condition |
| Litigation The Company and its subsidiaries are named defendants in a number of lawsuits |
| Litigation, by its nature, is unpredictable and the outcome of these cases is uncertain |
| The precise nature of the relief that may be sought or granted in any lawsuits is uncertain and may, if these lawsuits are determined adversely to the Company, negatively impact results of operations |
| Pricing Property casualty premium rates are generally determined on the basis of historical data for claims frequency and severity as well as related production and other expense patterns |
| In the event ultimate claims and expenses exceed historically projected levels, premium rates are likely to prove insufficient |
| Premium rate inadequacy may not become evident quickly and may require time to correct |
| For currently issued life products, initial premiums are guaranteed for a short period and may be increased thereafter, subject to contractual maximums, if insured mortality experience deteriorates |
| The Company does not assume mortality improvement when setting the initial premium scale |
| Inadequate premiums, much like excessive losses, if material, can adversely affect the Company’s results of operations and financial condition |
| 11 ______________________________________________________________________ [51]Table of Contents [52]Index to Financial Statements Liquidity Risk As indicated above, the Company manages its fixed maturity investments with a view toward matching the maturities of those investments with the anticipated liquidity needs of its subsidiaries for the payment of claims and expenses |
| If a subsidiary suddenly experienced greater than anticipated liquidity needs for any reason, an injection of funds might be required that may not necessarily be available to the Company at that point in time |
| Dividend Dependence and Liquidity The Parent Company is a financial services holding company with no significant operations |
| Its principal asset is the stock and interests of its subsidiaries |
| The Parent Company relies upon dividends from the insurance subsidiaries in order to pay the interest on debt obligations, dividends to its shareholders and corporate expenses |
| The ability of the insurance subsidiaries to declare and pay dividends is subject to regulations under state laws that limit dividends based on the amount of adjusted unassigned surplus and earnings and require the subsidiaries to maintain minimum amounts of capital, surplus and reserves |
| Dividends in excess of the ordinary limitations can only be declared and paid with prior regulatory approval, of which there can be no assurance |
| The inability of the insurance subsidiaries to pay dividends in an amount sufficient to meet debt service and cash dividends on stock, as well as other cash requirements of the Company could result in liquidity issues for the Company |
| Competition Each of the Company’s lines of insurance is highly competitive and is likely to remain so for the foreseeable future |
| Moreover, existing competitors and the capital markets have brought an influx of capital and newly organized entrants into the industry in recent years, and changes in laws have allowed financial institutions, like banks and savings and loans, to sell insurance products |
| Increases in competition threaten to reduce demand for the Company’s insurance products, reduce its market share, reduce its growth, reduce its profitability and generally adversely affect its results of operations and financial condition |
| Rating Downgrades The competitive positions of insurance companies, in general, have come to depend increasingly on independent ratings of their financial strength and claims-paying ability |
| The rating agencies base their ratings on criteria they establish regarding an insurer’s financial strength, operating performance, strategic position and ability to meet its obligations to policyholders |
| A significant downgrade in the ratings of any of the Company’s insurance subsidiaries could negatively impact their ability to compete for new business and retain existing business and, as a result, adversely affect the Company’s results of operations and financial condition |
| Guaranty Funds and Residual Markets In nearly all states, licensed insurers are required to participate in guaranty funds through assessments covering a portion of insurance claims against impaired or insolvent insurers |
| Any increase in the number or size of impaired companies would likely result in an increase in the Company’s share of such assessments |
| Residual market or pooling arrangements exist in many states to provide various types of insurance coverage to those that are otherwise unable to find private insurers willing to insure them |
| All licensed property casualty insurers writing such coverage voluntarily are required to participate in these residual markets or pooling mechanisms |
| 12 ______________________________________________________________________ [53]Table of Contents [54]Index to Financial Statements A material increase in any of these assessments or charges could adversely affect the Company’s results of operations and financial condition |
| Prior Approval of Rates Most of the lines of property casualty insurance underwritten by the Company are subject to prior regulatory approval of premium rates in a majority of the states in which it operates |
| The process of securing regulatory approval can be time consuming and can impair the Company’s ability to effect necessary rate increases in an expeditious manner |
| For most types of life business, initial premium rates are not subject to regulatory approval |
| However, if mortality experience deteriorates on a block of business, the process of securing regulatory approval for a necessary rate increase can be time consuming and impair the Company’s ability to remedy the premium insufficiency in an expeditious manner |
| There is a risk that regulators will not approve a requested increase |
| To the extent that rate increases are not approved on an adequate and timely basis, the Company’s results of operations and financial condition may be adversely impacted |