In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"), which requires the consolidation of certain entities considered to be variable interest entities ("VIEs"). An entity is considered to be a VIE when it has equity investors who lack the characteristics of having a controlling financial interest, or its capital is insufficient to permit it to finance its activities without additional subordinated financial support. Consolidation of a VIE by an investor is required when it is determined that the investor will absorb a majority of the VIE's expected losses if they occur, receive a majority of the entity's expected residual returns if they occur, or both. The adoption of Interpretation No. 46 did not have any impact on our Consolidated Financial Statements.
Receivable for investments sold increased $2.1 million or 100% from nothing as of December 31, 2002 to $2.1 million as of December 31, 2003. The increase is a result of investment trading activity that occurred in late December 2003 and did not settle until early January 2004.
Premiums receivable were $7.3 million as of December 31, 2003, a decrease of $1.1 million or 12.5% as compared to $8.4 million outstanding as of December 31, 2002. The decline can be attributed to the decline in automobile written premiums and the diversification of our product lines. The predominate user of the finance products is the automobile customer. There is less of a tendency to finance homeowner premiums due to policyholder mortgage escrow arrangements and only a modest need to finance commercial general liability insurance.
Our primary sources of capital in 2003 were revenues generated from operations, issuance of debt securities, investment income and borrowings under the Revolving Loan Agreement ("Revolving Agreement"), described below. Because we are a holding company, we are largely dependent upon fees from our subsidiaries for cash flow.
In addition, our investment portfolio is highly liquid as it consists almost entirely of readily marketable securities. Cash flow used in net investing activities was $21.9 million for the year ended December 31, 2003, as we invested the cash flow from operating and financing activities. While in a period in which written premiums are increasing, it is reasonably expected that cash from premiums will be used for investing activities. Proceeds from the sale of property and certain owned agencies generated $1.6 million during the year. In the future, we expect a continued cash flow deficit from investing activities, as we invest cash from operations.
The Revolving Agreement, as amended, expires September 30, 2004 and we intend to negotiate a similar agreement to replace the expiring agreement.
Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its shareholders except out of that part of its available and accumulated capital surplus funds which is derived from realized net operating profits on its business and net realized capital gains. A Florida domestic insurer may not make dividend payments or distributions to shareholders without prior approval of the Florida Department of Financial Services if the dividend or distribution would exceed the larger of (i) the lesser of (a) 10.0% of its capital surplus or (b) net income, not including realized capital gains, plus a two-year carryforward, (ii) 10.0% of capital surplus with dividends payable constrained to unassigned funds minus 25% of unrealized capital gains or (iii) the lesser of (a) 10.0% of capital surplus or (b) net investment income plus a three-year carryforward with dividends payable constrained to unassigned funds minus 25.0% of unrealized capital gains. Alternatively, a Florida domestic insurer may pay a dividend or distribution without the prior written approval of the Florida Department of Financial Services (i) if the dividend is equal to or less than the greater of (a) 10.0% of the insurer's capital surplus as regards policyholders derived from realized net operating profits on its business and net realized capital gains or (b) the insurer's entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, (ii) the insurer will have policy holder capital surplus equal to or exceeding 115.0% of the minimum required statutory capital surplus after the dividend or distribution, (iii) the insurer files a notice of the dividend or distribution with the Florida Department of Financial Services at least ten business days prior to the dividend payment or distribution and (iv) the notice includes a certification by an officer of the insurer attesting that, after the payment of the dividend or distribution, the insurer will have at least 115% of required statutory capital surplus as to policyholders. Except as provided above, a Florida domiciled insurer may only pay a dividend or make a distribution (i) subject to prior approval by the Florida Department of Financial Services or (ii) 30 days after the Florida Department of Financial Services has received notice of such dividend or distribution and has not disapproved it within such time.
During 2002, Federated National entered into a 10% quota-share agreement with its affiliate American Vehicle. The agreement ceded 10% of its premium and losses on all policies with an effective date of 2002. For presentation purposes and in accordance with the principles of consolidation, the effect of the agreement between the two affiliated insurance companies has been eliminated.
CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
See Note 4 for the activity in the allowance for credit losses for finance contracts and pay advances receivable.
Our reinsurance contracts provide ceding commissions for premiums written which are subject to adjustment. The amount of ceding commissions is determined by the loss experience for the reinsurance agreement term. The reinsurer provides commissions on a sliding scale with maximum and minimum achievable levels. The reinsurer provides us with the provisional commissions. We have recognized the commissions based on the current loss experience for the policy year premiums. This results in establishing a liability for the excess of provisional commissions retained compared to amounts recognized, which is subject to variation until the ultimate loss experience is determinable. There were no contingent ceding commissions recognized for the year ending December 31, 2003 due to the provisions contained in the reinsurance contract allowing for a flat rate commission schedule. For the years ended December 31, 2002 and December 31, 2001, respectively, there were $369,000 and $42,000 of contingent ceding commissions recognized.
Amortization of goodwill was $-0- for 2003 and 2002, compared to $540,010 in 2001. The decrease is the result of no longer amortizing goodwill, subsequent to the adoption of SFAS 142.
Below is a summary of fixed maturities at December 31, 2003 and 2002 by contractual or expected maturity periods. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Federated Premium's operations are funded by a revolving loan agreement ("Revolving Agreement") with FlatIron Funding Company LLC ("FlatIron"). The Revolving Agreement is structured as a sale of contracts receivable under a sale and assignment agreement with FPF, Inc. (a wholly-owned subsidiary of FlatIron), which gives FPF Inc. the right to sell or assign these contracts receivable. Federated Premium, which services these contracts, has recorded transactions under the Revolving Agreement as secured borrowings. The Revolving Agreement, which was amended and revised in September 2001, allowed for a maximum credit commitment of $7.0 million plus an initial additional amount of $700,000 for the transition from September 30, 2001 when the previous agreement expired. The line declined by $100,000 each month beginning November 1, 2001. In September 2002 the line was amended and revised allowing for a maximum credit commitment of $4.0 million.
Supplemental segment information as of and for the year ended December 31, 2003, 2002 and 2001 follows:
The weighted average fair value of options granted during 2003, 2002 and 2001 estimated on the date of grant using the Black-Scholes option-pricing model was $6.32 to $12.46; $2.17 to $8.06 in 2002 and $2.38 to $2.92 in 2001. The fair value of options granted is estimated on the date of grant using the following assumptions:
Earnings (loss) per share and earnings (loss) per share assuming dilution Net income (loss) before extraordinary gain $ (0.72) Extraordinary gain 0.38 Net income (loss) (0.34)