Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") represents an overview of our results of operations and financial condition and should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Part II, Item 8 of this Form 10-K. Except for the historical information contained herein, the discussions in MD&A contain forward-looking statements that involve risks and uncertainties. Our future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Item 1A. Risk Factors" of this Form 10-K.
In addition, we entered into a new five-year $125.0 million secured credit agreement (the "Credit Agreement") in August 2012 with a syndicate of lenders, among them Wells Fargo Bank, N.A., who also serves as administrative agent. This Credit Agreement provides for a $50.0 million term loan facility, as well as a $75.0 million revolving credit facility. The Credit Agreement includes a provision pursuant to which, from time to time, the Borrowers may request that the lenders in their discretion increase the maximum amount of
We earn service and administrative fees from a variety of activities, including the administration of credit insurance, the administration of debt cancellation programs, the administration of motor club programs, the administration of warranty programs and the administration of collateral tracking and asset recovery programs.
revenues are typically affected in a corresponding fashion. In a declining premium rate environment, the resulting decline in our revenue may be offset, in whole or in part, by an increase in commission rates from insurance carriers and by an increased likelihood that insured parties may use the savings generated by the reduction in premium rates to purchase greater coverage. In an increasing pricing environment, the resulting increase in our revenue may be offset, in whole or in part, by a decrease in commission rates by insurance carriers and by an increased likelihood that insured parties may determine to reduce the amount of coverage they purchase. The market for P&C insurance products is cyclical from a capacity and pricing perspective. We refer to a period of reduced capacity and rising premium rates as a "hard" market and a period of increased capacity and declining premium rates as a "soft" market.
Depreciation. Depreciation expense is the allocation of the capitalized cost of property and equipment over the periods benefited by the use of the asset.
As of December 31, 2012, we were under examination by the Internal Revenue Service ("IRS") for the 2009 and 2010 tax years. In February 2013, the IRS completed its field audit for those tax years and presented preliminary findings. We have agreed to those findings and paid $57.0 thousand, an amount considered immaterial to the consolidated group as of December 31, 2012. In March 2013, we received notice from the IRS that the audit report has been fully approved. The assessment will be expensed in the 1st quarter of 2013.
Revenues for the year ended December 31, 2011 decreased $1.5 million or 8.7%, to $15.6 million from $17.1 million for the year ended December 31, 2010. The decrease was driven by lower service and administrative fees for our insurance company clients which decreased $2.5 million due to regulatory changes that slowed the production for one of our main customers in 2011. This was offset by an increase in service and administrative fees of $0.1 million on debt cancellation programs for credit card companies and $0.9 million of additional revenue from our 2011 fourth quarter acquisition of PBG.
EBITDA, excluding the loss on the sale of subsidiary of $0.5 million, for the year ended December 31, 2011 was $8.2 million compared to $5.7 million for the year ended December 31, 2010. As a result, EBITDA margin for the Brokerage segment was 22.2% and 19.8% for 2011 and 2010, respectively.
No income or expenses were allocated to the Corporate segment for the year ended December 31, 2012. Operating expenses for the year ended December 31, 2011 were $1.8 million compared to $2.1 million for the year ended December 31, 2010. The expenses for the year ended December 31, 2011 included professional fees, transaction costs and costs associated with the moving of our Jacksonville, FL based operations. Operating expenses for the year ended December 31, 2010 were attributable to acquisition costs and re-audit professional fees and travel costs.
Member benefit claims for the three months ended March 31, 2012 increased $0.4 million, or 50.3%, to $1.3 million from $0.9 million for the three months ended March 31, 2011. The increase resulted from increased claims activity in our Motor Clubs division as a result of increased in force policies.
Commissions for the three months ended March 31, 2012 increased $2.1 million, or 7.0%, to $32.0 million, from $29.9 million for the same period in 2011.The $2.1 million increase in commission expense resulted from growth in net earned premiums and the associated increase of $1.5 million in commission expense in our Payment Protection division and higher Service and administrative fees with a corresponding increase of commission expense of $0.6 million in our Motor Clubs division.
Commissions increased $10.6 million, or 54.6%, to $29.9 million for the three months ended March 31, 2011, from $19.3 million for the three months ended March 31, 2010. The increase in commission expense resulted from an $11.4 million increase in Motor Club commissions in the three months of 2011 with no comparable costs in the prior year period and a $0.9 million increase in deferred policy acquisition cost amortization offset by a decrease of $1.3 million in Retrospective Commissions due to unfavorable underwriting results and a $0.5 million decrease in commissions earned on assumed credit insurance products sold.
Net revenues for the three months ended June 30, 2012 increased $1.6 million, or 11.6%, to $14.9 million from $13.3 million for the three months ended June 30, 2011. Ceding commission increased $1.0 million resulting from higher underwriting profits of $1.0 million due to more favorable loss experience for 2012 under certain contracts, additional service and administrative fees of $0.1 million from increased insurance production in 2012, offset by net investment income, including realized gains, from assets held in trust by our reinsurers which decreased by $0.1 million during the period. In addition, underwriting revenue was $1.5 million above the 2011 period and resulted from increased earned premiums offset by growth in commissions due to an increase in direct and assumed earned premium and a decrease in loss ratio in our risk retained business. Net investment income on our portfolio decreased by $0.2 million due to lower investment yields. Net realized gains on the sale of investments decreased by $1.1 million due to the sale of assets in the first quarter of 2011 not repeated in the first quarter of 2012.
Our investment policy and strategy is reviewed and approved by the board of directors of each of our insurance subsidiaries on a regular basis in order to review and consider investment activities, tactics and new investment opportunities. Our investment strategy seeks long-term returns through disciplined security selection, portfolio diversity and an integrated approach to risk management. We select and monitor investments to balance the goals of safety, stability, liquidity, growth and after-tax total return with the need to comply with regulatory investment requirements. Our investment portfolio is managed by a third-party provider of asset management services, which specializes in the insurance sector. Asset liability management is accomplished by setting an asset target duration range that is influenced by the following factors: (i) the estimated reserve payout pattern, (ii) the inclusion of our tactical capital market views into the investment decision making process and (iii) our overall risk tolerance. We aim to achieve a relatively safe and stable income stream by maintaining a broad-based portfolio of investment grade fixed maturity securities. These holdings are supplemented by investments in additional asset types with the objective of further enhancing the portfolio's diversification and expected returns. These additional asset types include common and redeemable preferred stock. We manage our investment risks through consideration of duration of liabilities, diversification, credit limits, careful analytic review of each investment decision, and comprehensive risk assessments of the overall portfolio.
(2) - Due to the variable interest rate and amortizing payments required on the note payable to Well Fargo and the impact of interest rate swap on the preferred trust securities interest payable, we made certain assumptions regarding future interest rates. The assumptions we made are as follows:
The Company operates in three business segments: (i) Payment Protection, (ii) Business Process Outsourcing ("BPO") and (iii) Brokerage. Payment Protection specializes in protecting lenders and their consumers from death, disability or other events that could otherwise impair their ability to repay a debt and also offers warranty and service contracts and motor club solutions. BPO provides an assortment of administrative services tailored to insurance and other financial services companies through a virtual insurance company platform. Brokerage uses a pure wholesale sell-through model to sell specialty casualty and surplus lines insurance and also provides web-hosted applications used by insurers, reinsurers and reinsurance brokers for the global reinsurance market.
The Company earns service and administrative fees from a variety of activities, including the administration of credit insurance, the administration of debt cancellation programs, the administration of motor club programs, the administration of warranty programs and the administration of collateral tracking and asset recovery programs. The Payment Protection administrative service revenue is recognized consistent with the earnings recognition pattern of the underlying insurance policies, debt cancellation contracts and motor club memberships being administered, using Rule of 78's, modified Rule of 78's, pro rata, or other methods as appropriate for the contract. Management selects the appropriate method based on available information, and periodically reviews the selections as additional information becomes available. The BPO service fee revenue is recognized as the services are performed. These services include fulfillment, BPO software development, and claims handling for the Company's customers. Collateral tracking fee income is recognized when the service is performed and billed. Asset recovery service revenue is recognized upon the location of a recovered unit and or the location and delivery of a unit. Management reviews the financial results under each significant BPO contract on a monthly basis. Any losses that may occur due to a specific contract would be recognized in the period in which the loss occurs. During the years ended December 31, 2012, 2011 and 2010, the Company has not incurred a loss with respect to a specific significant BPO contract.
Inventory, which is included in other assets as a result of the 2012 acquisition of ProtectCELL, consists of cell phone handsets and totaled $1.4 million at December 31, 2012. All inventoried handsets are recorded at actual cost, using the specific identification method, with the exception of repaired devices received from a single supplier relationship, which are recorded using an average cost method. Damaged or obsolete inventory is adjusted out of inventory on a monthly basis and recorded as an expense for the period. Handsets that are either obsolete or beyond economical repair are sent to be recycled. Handsets that are refurbished are recorded into inventory at their repair costs.
Under ASC 718, compensation expense is measured using fair value and is recorded over the requisite service or performance period of the awards, or to an employee’s eligible retirement date under the award agreement, if earlier. The Company measures stock-based compensation expense using the calculated value method. Under this method, the Company estimates the fair value of each
The Company's investments in less than majority-owned companies in which it has the ability to exercise significant influence over operating and financial policies are accounted for using the equity method except when they qualify as Variable Interest Entities ("VIEs") and the Company is the primary beneficiary, in which case the investments are consolidated in accordance with ASC 810, "Consolidation." Investments that do not meet the above criteria are accounted for under the cost method.
The effects of these restatements to the Consolidated Statements of Income, Consolidated Balance Sheets, and Consolidated Statements of Cash Flows as of and for the years ended December 31, 2011 and 2010 are presented in the financial statement schedules below, by line item. Also shown in the schedules below are the effects of the Company's retrospective adoption of ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, because these effects, which are not corrections of errors, are part of the reconciliation from previously reported information to restated amounts.
During 2010 the Company acquired Continental and United, which began the Company's Motor Clubs division. In 2010 and subsequent reporting periods, the Motor Clubs revenues were presented on a net basis in service and administrative fees on the Consolidated Statements of Income. This net presentation consisted of service and administration fees less member benefit claims expense and commission expense. During 2011, the acquisition of Auto Knight increased the revenues of the Company's Motor Clubs division.
The Company did not issue shares of its common stock in connection with any of the acquisitions completed during the years ended December 31, 2012, 2011 and 2010, respectively.
At the Company's election, borrowings under the Revolving Facility will bear interest either at the base rate plus an applicable interest margin or the adjusted LIBO rate plus an applicable interest margin; provided, however, that all swingline loans will be base rate loans. The base rate is a fluctuating interest rate equal to the highest of: (i) Wells Fargo's publicly announced prime lending rate; (ii) the federal funds rate plus 0.50%; and (iii) the adjusted LIBO rate, determined on a daily basis for an interest period of one month, plus 1.0%.
Fortegra has an active share repurchase plan which allows the Company to purchase up to $10.0 million in total of the Company's common stock to be purchased from time to time through open market or private transactions. The plan was approved by the Board of Directors in November 2011 and provides for shares to be repurchased for general corporate purposes, which may include serving as a resource for funding potential acquisitions and employee benefit plans. The timing, price and quantity of purchases are at the discretion of Fortegra. The plan may be discontinued or suspended at any time and has no expiration date. None of the shares repurchased during the years ended December 31, 2012 and 2011, respectively, have been retired.
The Company has a 401(k) plan (the "401(k) Plan") available to employees meeting certain eligibility requirements. The 401(k)Plan allows employees to contribute, at their discretion, a percentage of their pre-tax annual compensation and allows for employees to select from various investment options based on their individual investment goals and risk tolerances. Under the 401(k) Plan, the Company will match 100% of each dollar of the employee contribution up to the maximum of 5% of the employee's annual compensation. The contributions of the 401(k) Plan are invested at the election of the employee in one or more investment options by a third party plan administrator. In July 2009, the Company suspended the matching contribution. The matching contribution was reinstated in January 2010 and subsequently suspended in August 2010.
The Company conducts business through three business segments: (i) Payment Protection; (ii) BPO; and (iii) Brokerage. The revenue for each segment is presented to reflect the operating characteristics of the segment. The Company allocates certain revenues and expenses to the segments. These items consist primarily of corporate-related income, transaction related costs, executive stock compensation and other overhead expenses. Segment assets are not presented to the Company's chief operating decision maker for operational decision-making and therefore are not disclosed in the accompanying table.