The provision (benefit) for income taxes for the year ended December 31, 2017 includes a reduction in the deferred tax asset of $12.5 million as a result of the enactment of legislation to reduce the corporate income tax rate. The provision (benefit) for income taxes for the year ended December 31, 2014 includes a decrease in the valuation allowance for the deferred tax asset of $22.4 million.
Net realized gains on investments, available-for-sale during the year ended December 31, 2016 included $4.8 million from the previously-mentioned sale of fixed maturities. Net realized gains are net of $147 thousand of charges related to other-than-temporary-impairment (“OTTI”) on a mutual fund and other net realized gains from redemptions.
We incurred $4.3 million of interest expense during the year ended December 31, 2016, compared with interest expense of $3.0 million during the year ended December 31, 2015. Interest expense related to the financing of the July 1, 2015 Titan acquisition account for $2.4 and $2.1 million of the expense during 2016 and 2015, respectively. The remaining interest expense was related to the debentures issued in June 2007. For additional information, see “Liquidity and Capital Resources” in this report.
We believe that existing cash and investment balances, when combined with anticipated cash flows as noted above, will be adequate to meet our expected liquidity needs, for both the holding company and our insurance company subsidiaries, in both the short-term and the foreseeable future.
Regarding our most recent estimate, for the year ended December 31, 2017, we experienced favorable development on reserves at December 31, 2016 of $2.3 million, which decreased our loss and loss adjustment expense for prior accident periods. This favorable development was the net result of favorable LAE development related to bodily injury claims over the 2014-2016 accident years, offset by unfavorable development on losses related to bodily injury severity over the 2014-2016 accident years.
First Acceptance Corporation (the “Company”) is a holding company based in Nashville, Tennessee with operating subsidiaries whose primary operations include the selling, servicing, and underwriting of non-standard personal automobile insurance and related products. In 2017, our insurance operations generated revenue from selling non-standard personal automobile insurance products and related products in 16 states and conducted our servicing and underwriting operations in 13 states. In December 2016, we closed all of our retail locations and ceased writing new business in the state of Missouri. The Company issued policies of insurance through three wholly-owned subsidiaries: First Acceptance Insurance Company, Inc., First Acceptance Insurance Company of Georgia, Inc. and First Acceptance Insurance Company of Tennessee, Inc. (collectively, the “Insurance Companies”).
Other investments consist of limited partnership interests and an investment in the common stock of a real estate investment trust (“REIT”). Limited partnership interests are recorded at net asset value which approximates fair value. Valuations are based upon the GAAP financial statements of the partnerships which are required to be audited annually. The common stock of the REIT is recorded at a fair value with the corresponding unrealized appreciation or depreciation, net of deferred income taxes, reported in other comprehensive loss.
Approximately 18% of the Company’s total revenues are subject to the guidance in ASU No. 2014-09. Historically, approximately 40% of these revenues are in the form of commissions paid by third party insurance carriers which are earned upon the effective date of bound coverage, less an estimated allowance for return commissions based upon historical experience, since no significant performance obligation remains in these arrangements after coverage is bound and the control of the underlying insurance policy is transferred to the customer. Approximately 30% of these revenues are in the form of commissions paid by a third-party entity on the sales of ancillary insurance products that are earned on a pro-rata basis over the life of the underlying contracts, since the Company has a contractual performance obligation for these contracts. Approximately 30% of these revenues are derived from various fees related to insurance contracts that are recognized into income as the related services are performed and costs are incurred.
Realized gains and losses on sales and redemptions are computed based on specific identification. The non-credit related portion of OTTI is included in other comprehensive loss. The amounts of non-credit OTTI for securities still owned was $1.0 million at both December 31, 2017 and 2016.
The Company did not recognize any OTTI charges in net loss for the years ended December 31, 2017 and 2015. The Company recognized an OTTI charge for one mutual fund resulting in a loss of $147 thousand for the year ending December 31, 2016.
The information about incurred and paid claims development for the 2008 to 2016 years, and the average annual percentage payout of incurred claims by age as of December 31, 2017, is presented as required supplementary information.
The Company is named as a defendant in various lawsuits, arising in the ordinary course of business, generally relating to its insurance operations. All legal actions relating to claims made under insurance policies are considered by the Company in establishing its loss and loss adjustment expense reserves. The Company also faces lawsuits from time to time that seek damages beyond policy limits, commonly known as bad faith claims, as well as class action and individual lawsuits that involve issues arising in the course of the Company’s business. The Company continually evaluates potential liabilities and reserves for litigation of these types using the criteria established by FASB ASC 450, Contingencies (“FASB ASC 450”). Pursuant to FASB ASC 450, reserves for a loss may only be recognized if the likelihood of occurrence is probable and the amount can be reasonably estimated. If a loss, while not probable, is judged to be reasonably possible, management will disclose, if it can be estimated, a possible range of loss or state that an estimate cannot be made. Management evaluates each legal action and records reserves for losses as warranted by establishing a reserve in its consolidated balance sheets in loss and loss adjustment expense reserves for bad faith claims and in other liabilities for other lawsuits. Amounts incurred are recorded in the Company’s consolidated statements of operations and comprehensive loss in losses and loss adjustment expenses for bad faith claims and in insurance operating expenses for other lawsuits unless otherwise disclosed.
The maximum amount of dividends which can be paid by First Acceptance Insurance Company, Inc. (“FAIC”) to the Company, without the prior approval of the Texas insurance commissioner, is limited to the greater of 10% of statutory capital and surplus at December 31st of the next preceding year or net income for the year. In addition, dividends may only be paid from unassigned funds (surplus) and an insurance company’s remaining surplus must be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. At December 31, 2017, FAIC could not pay any dividends to the Company due to a negative unassigned surplus position.
The National Association of Insurance Commissioners (“NAIC”) Model Act for risk-based capital provides formulas to determine each December 31 on an annual basis the amount of statutory capital and surplus that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. Failure to meet applicable minimum risk-based capital requirements could subject our insurance company subsidiaries to further examination or corrective action imposed by state regulators, including limitations on their writing of additional business, state supervision or even liquidation. Risk-based capital calculations are only made as of each December 31, and the three insurance company subsidiaries were each above the minimum regulatory company action levels as of December 31, 2016. There are also statutory guidelines that suggest that on an annual calendar year basis an insurance company should not exceed a ratio of net premiums written to statutory capital and surplus of 3-to-1. On a combined basis, the ratio for the insurance company subsidiaries of net premiums written for the last twelve months to statutory capital and surplus was 4.27-to-1 at December 31, 2017 which is in excess of the suggested guidelines. Management is currently operating under a business plan to reduce premium writings and increase statutory capital and surplus to address the net premiums written to statutory capital and surplus guideline. For the year ended December 31, 2017, the insurance company subsidiaries experienced an increase in combined statutory capital and surplus of $7.2 million and a reduction in premiums written by $17.0 million, or 6%.