ii) CREDIT RISK - the risk that financial instruments, which potentially subject us to concentrations of credit risk, may decline in value or default, or the risk that reinsurers, to which we cede some of our business and from which receivables are recorded on the balance sheet, may not pay. We minimize this risk by adhering to a conservative investment strategy and entering into reinsurance agreements with financially sound reinsurers and obtaining letters of credit from reinsurers, if necessary.
When determining reserves, our management and financial analysts, who have extensive experience, analyze various factors such as our historical loss experience and that of the insurance industry, claims frequency and severity, our business mix, our claims processing procedures, legislative enactments, judicial decisions and legal developments in imposition of damages, and general economic conditions, including inflation. A change in any of these factors from the assumptions implicit in our estimates can cause our ultimate loss experience to be better or worse than indicated by our reserves, and the difference could be material. Due to the correlated nature of the aforementioned factors, there is no precise method for evaluating the impact of any one specific factor in isolation, and an element of judgment is ultimately required.
The main drivers in the Loss Development models are the selected development factors. Development factors are calculated by age period (i.e., 12-24 months, 24-36 months, etc.), by taking the current year’s total incurred or paid losses and LAE for the particular accident year and dividing by the prior year’s total incurred or paid losses and LAE for the particular accident year. Averages of the resulting development factors in each age period are calculated, such as the three-year average, five-year average, cumulative average, and cumulative average excluding the high and low. An evaluation of the calculated development factors and their resulting averages is performed and judgment is used to select a particular development factor per age period. The selected development factors are used to project expected ultimate losses and LAE by accident year.
The $7.9 million decrease in ceded unearned premiums is mainly the result of a Total Insured Value (“TIV”)-related adjustment to our private reinsurance premiums. On September 30, 2007, our actual TIV was lower than what had been estimated for September 30, 2007 at the inception of the reinsurance contracts; therefore, we recorded premium adjustments of $7.0 million that lowered our ceded unearned premium related to those reinsurance contracts. No TIV-related premium adjustments were recorded at September 30, 2008.
Losses and LAE increased by $2.4 million, or 9.4% during 2008, compared to 2007. The increase is primarily attributable to $3.3 million of incurred losses and LAE for claims resulting from Tropical Storm Fay and an increase of $0.7 million in other claims paid and case incurred losses and LAE. This was offset by a decrease in IBNR losses and LAE of $1.6 million. The $1.6 million reduction in IBNR expenses reflects favorable loss development of our main line of business. Claims originating in prior accident years are another year older; therefore, most losses and LAE have been reported and, in many cases, paid on those claims and significantly less additional IBNR is expected on those claims than was expected at December 31, 2007.
Our parent company has no business operations of its own. There are no restrictions on the payment of dividends to our holding company by our non-insurance company subsidiaries other than state corporate laws regarding solvency. As a result, our non-insurance company subsidiaries generate revenues, profits and net cash flows that are generally unrestricted as to their availability for payment of dividends to UIHC.
Our note agreement with CB&T contains certain covenants, including the maintenance of minimum specified financial ratios and balances. On August 13, 2008, CB&T waived, until January 1, 2009, the debt covenant related to maintenance of a minimum debt service coverage ratio of at least 2:1 on a quarterly basis. We were in compliance with the terms of the covenants at December 31, 2008. We anticipate we will be in compliance with this ratio during 2009.
We have audited the accompanying consolidated balance sheets of United Insurance Holdings Corp. and subsidiaries (the “Company”), a Delaware corporation, as of December 31, 2008 and 2007 and the related consolidated statements of income, consolidated statements of stockholders’ equity and comprehensive income (loss), and consolidated statements of cash flows for each of the years in the three-year period ended December 31, 2008. Our audits also included the financial statement schedules included in Item 15. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.
Our cash and cash equivalents include demand deposits with financial institutions and short-term, highly-liquid instruments with original maturities of three months or less.
Depreciation of property and equipment resulted in charges to expense totaling $70, $40 and $30 during the years ended 2008, 2007, and 2006, respectively.
In February 2007, we entered into a $33,000 loan agreement with CB&T (“CB&T note”), a related party. The terms and conditions of our note agreement, including interest rates and collateral, are substantially similar to the terms and conditions of other loan agreements that CB&T entered into with other customers. The note matures on February 20, 2010 and is secured by the operation of the MGA agreement and related fees paid to UIM, by the ownership interest in UIH, and by all tangible and intangible assets of UIH and UIM. The security agreement states that if an event of default occurs under the CB&T note, the bank may, at its option, cause the acceleration of the CB&T note, which shall become immediately due and payable, take possession of the collateral, and have the right to assign, sell, lease, or otherwise dispose of and deliver all or any part of the collateral, to satisfy our obligations under this agreement.
The table below reconciles our consolidated GAAP net income to the statutory net income (loss) of UPCIC:
We provide a 401(k) plan for substantially all of our employees. We match 100% of the first 5% of employees’ contributions to the plan. Our contributions to the plan on behalf of the participating employees were $80, $73 and $57 for the years ended December 31, 2008, 2007 and 2006, respectively.