We are a smaller reporting company as defined in Regulation S-K; therefore; pursuant to Regulation S-K we are not required to make disclosures under this Item.
United Insurance Holdings Corp. is a property and casualty insurance holding company. On September 30, 2008, United Insurance Holdings Corp. (formerly known as FMG Acquisition Corp. or “FMG”), completed a merger pursuant to an Amended and Restated Agreement and Plan of Merger, dated August 15, 2008, as amended on September 23, 2008, whereby United Subsidiary Corp., a wholly-owned subsidiary of FMG, merged with and into United Insurance Holdings, L.C. (“UIH”), a Florida limited liability company, with UIH remaining as the surviving entity (the “Merger”). In connection with the Merger, FMG changed its name to United Insurance Holdings Corp.
We were formed to capitalize on legislation designed to attract capital to the Florida homeowner insurance market. United Insurance Holdings Corp. and its subsidiaries (which is collectively referred to herein as “UIHC”, “United”, “we” or “us”) primarily offer homeowner and dwelling insurance policies in the State of Florida. UIH’s gross written premiums have increased from $18.0 million in 1999 to $141.6 million in 2008.
During 2008 compared to 2007, our gross premiums written decreased $3.5 million due to an increase of approximately $41.2 million resulting from an increase in the number of net new policies, endorsements and coverage increases. The increase was offset by a decrease of approximately $44.7 million due to the wind mitigation credits enacted by the Florida Legislature. We began implementing the wind mitigation credits during the fourth quarter of 2007.
We have decided to discontinue offering our commercial product, called e-Z Pac Insurance, which was designed for auto-service professionals. The e-Z Pac Insurance, which we refer to as our “Garage” line of business, represented approximately 4%, 3% and 2% of our gross premiums written for the fiscal years ended December 31, 2008, 2007 and 2006, respectively. We have entered into an agreement, to be effective April 1, 2009, granting the renewal rights on these Garage policies to another insurer; therefore, we will not renew Garage policies on or after that date. As consideration for these renewal rights, we will receive a percentage of the gross net written premium (adjusted for certain items) for any of the Garage policies that are underwritten by the other insurer or its affiliates between April 1, 2009 and March 31, 2010. There is no assurance that we will receive any amounts pursuant to the foregoing agreement, as our policyholders may choose not to renew their Garage insurance with the other insurer.
On September 30, 2008, in a cash and stock transaction, we completed the acquisition of 100% of the ownership interests in UIH and merged UIH with a transitory, wholly-owned subsidiary created specifically for that purpose. As consideration for the Merger, we paid members of UIH an aggregate of $25 million in cash and we issued 8,929,819 shares of our common stock and granted warrants to purchase 1,273,569 shares of our common stock. The cash consideration for the Merger was funded with cash held in our trust account established in connection with our initial public offering, as well as the net proceeds of the debt financing which closed on September 29, 2008. Former members of UIH may receive additional cash consideration of up to $5 million, in the aggregate, based on our achievement of certain net income targets.
The underwriter for our initial public offering (“IPO”) surrendered 100,000 of the 450,000 unit purchase options it owned. They also agreed to accelerate the expiration date of their remaining 350,000 unit purchase options to October 4, 2010. Each unit purchase option consists of a share of common stock and a warrant to purchase a share of common stock. The unit purchase options are exercisable beginning October 4, 2008, at an exercise price of $10.00 per unit.
iii) INTEREST RATE RISK - the risk that interest rates will change and cause a decrease in the value of our investments. To the extent liabilities come due more quickly than assets mature, we might have to sell assets prior to maturity and potentially recognize a gain or a loss. We manage this risk by having our management, our investment committee and our outside investment manager monitor our investment portfolio.
iv) GEOGRAPHIC RISK - the risk of currently writing all of our policies in the State of Florida. We minimize this risk by entering into reinsurance agreements with financially sound reinsurers and through our underwriting, diversifying our concentration of policies throughout Florida.
v) CATASTROPHIC AND/OR SEVERE EVENT RISK - the risk associated with writing insurance policies that cover losses resulting from catastrophes and/or severe events, including hurricanes, tropical storms, tornadoes or other weather-related events. We mitigate our risk of these events through the use of reinsurance, forecast-modeling techniques and the monitoring of concentrations of risk, all designed to protect our statutory surplus.
When we prepare our consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”), we are required to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying notes. Certain of these estimates result from judgments that can be subjective and complex. Consequently, our actual results may differ, perhaps substantially, from the estimates.
The most significant accounting estimate inherent in the preparation of our financial statements is our evaluation and determination of the liability for unpaid losses and loss adjustment expenses (“LAE”).
We establish reserves for unpaid losses and LAE which are comprised of reserves on known claims (“case reserves”) and reserves for IBNR claims. These reserves represent our best estimate of our liability for losses and LAE and are based on the application of various actuarial reserve estimation techniques as well as the consideration of other material facts and circumstances known at the balance sheet date. The process of establishing our reserves is complex and necessarily imprecise, as it involves using judgment that is affected by many variables. Due to the uncertain nature of any projection of the future, including the estimation of loss and LAE reserves, the ultimate loss and LAE payments made by us may be different from the recorded reserves.
We determine our ultimate loss and LAE reserves by selecting an estimated amount within a range of indications that is calculated by our financial analysts using generally accepted actuarial techniques. Our selection of this estimate is influenced by the analysis of our paid losses and incurred losses since inception. For each accident year, our financial analysts estimate the ultimate incurred losses and LAE for both known and unknown claims. In establishing this estimate, our financial analysts will calculate the high, low, and average range from the distribution of ultimate losses and LAE estimates compiled from the results of the Paid and Incurred Loss Development models discussed below. Our total reserves are the difference between the estimated ultimate incurred losses and LAE and the cumulative loss and LAE payments made to date. We establish two categories of loss reserves as follows:
Paid Loss Development - Under this version of the Loss Development model, ultimate losses are estimated based on the historical development patterns of paid losses by accident year.
The strengths and weaknesses of this method are identical to the Incurred Loss Development model.
Incurred Bornhuetter-Ferguson Severity - Under this version of the Bornhuetter-Ferguson model, ultimate losses are estimated as the sum of cumulative incurred losses and estimated IBNR losses. The IBNR losses are estimated based on expected average severity, estimated ultimate claim counts and the historical development patterns on incurred losses. Historical loss severities are adjusted to current levels using severity on-level factors which include a provision for the notable change in average claim costs between accident years 2003 and 2004.
Incurred Bornhuetter-Ferguson Loss Ratio - Under this version of the Bornhuetter-Ferguson model, ultimate losses are estimated as the sum of cumulative incurred losses and estimated IBNR losses. IBNR losses are estimated based on level earned premium, expected loss ratios and the historical development patterns of incurred losses.
All four of the models described above produce substantially similar results in our case. While our independent actuary uses all four models, we rely heavily on our Loss Development models when calculating our estimate of ultimate losses and LAE. Our focus on the two Loss Development models is justified because of the short-tailed nature of our book of business, the relative responsiveness of the Loss Development models, and the fact the Bornhuetter-Ferguson models are not expected to produce materially different results. Ultimately, this means the main assumptions of the Loss Development methods, the selected loss development factors, represent the most critical aspect of our loss reserving process. We use the same set of loss development factors in the models during our loss reserving process that we also use to calculate the premium necessary to ensure we are always earning enough premiums to pay expected ultimate losses and LAE.
As previously noted, we evaluate several factors when exercising our judgment in the selection of the loss development factors that ultimately drive the determination of our loss and LAE reserves. We believe a reasonably likely change in almost any of these aforementioned factors could have an impact on our reported results, financial position and liquidity. However, we do not believe any reasonably likely changes in the frequency or severity of claims would have a material impact on us unless the changes in frequency and severity were far in excess of our ten-year historical trend for frequency and severity.
As discussed in Note 5 to our consolidated financial statements, certain of our investments are valued at fair market value using a level 2 input. A level 2 input is a valuation based on observable inputs that are not quoted prices in an active market, but are, for example, quoted prices in an inactive market or quoted prices in active markets for similar, but not identical instruments. The fair value for our fixed-maturity securities is largely determined by one of two primary pricing methods: third-party pricing service market prices or independent broker quotations. Prices from third-party pricing services are often unavailable for securities that are rarely traded or are traded only in privately negotiated transactions and as a result, certain of our securities are priced via broker quotations. The fair market value prices and/or quotations could vary from one third-party pricing service/broker to another. Any change in the estimated fair market value of our securities could impact the amount of unrealized gain or loss we have recorded, which could change the amount we have recorded for our investments and comprehensive income on our Consolidated Balance Sheets.
Any change in the estimation of loss and LAE could change the amount of deferred policy acquisition costs we expense each period.
The fixed-maturity securities and the equity securities that are available for sale and carried at fair value represent 99.8% of total investments as of December 31, 2008, compared to 99.7% as of December 31, 2007.
We have determined none of our securities reflect an impairment that qualifies as other than temporary per SFAS No. 115. See Note 5 to our consolidated financial statements for a discussion of how we determine an impairment, if any.
During 2008, we increased our gross reserves for unpaid losses and LAE by $4.1 million. The $4.1 million increase is comprised of an increase of $6.5 million for estimated losses and LAE that are ceded (our reinsurance recoverable asset for unpaid losses and LAE also increased $6.5 million) and a decrease of $2.4 million for non-ceded losses and LAE. During 2008, we increased our loss and LAE reserves by $6.5 million for reinsured claims related to Hurricane Wilma which occurred during 2005 as we are experiencing unfavorable loss development from claims being re-opened and new claims being opened due to public adjusters encouraging policyholders to file new claims.
The $2.4 million decrease in unpaid losses and LAE is comprised of a decrease of $5.1 million for reduced estimated loss and LAE reserves offset by an increase of $2.7 million in estimated losses and LAE for the policies we assumed from Citizens during 2008. The $5.1 million of reduced estimated loss and LAE is due primarily to a $4.0 million reduction in IBNR reserves; which reflects the favorable development of our main line of business. Claims originating in prior accident years are another year older; therefore, most losses and LAE has 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.
On August 27, 2008, we entered into an agreement with Citizens to take-out up to 75,000 policies from them. During October and December of 2008, we assumed approximately 7,000 policies from Citizens. These policies increased our gross premiums written by approximately $5.7 million during 2008. By Florida law, policyholders may choose to “opt out” of the assumption and keep their Citizens policy; therefore, the number of policies we assumed could decrease. During February 2009, we assumed from Citizens approximately 2,200 additional policies based upon our disciplined underwriting criteria and do not anticipate assuming any additional policies from Citizens until October or December 2009. See Note 22 to our consolidated financial statements for a discussion of the additional polices we assumed from Citizens during February 2009.
Net unearned premiums increased $1.2 million during 2008 and 2007. The table below reflects the decrease/(increase) in gross unearned premiums and the increase/(decrease) in ceded unearned premiums that comprise the increase in net unearned premiums for 2008 compared to 2007:
The $7.9 million decrease in gross unearned premiums is a result of the decrease in gross premiums written as discussed above.
Loss and LAE, our most significant expense, represents actual payments made and changes in estimated future payments to be made to or on behalf of our policyholders, including expenses required to settle claims and losses. We revise our estimates based on the results of our analysis of estimated future payments to be made. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events.
The largest factor that can impact our losses and LAE are catastrophes. Catastrophes can be caused by various natural events, including hurricanes, windstorms, earthquakes, hail, severe winter weather and fires. Catastrophes can also be man made, such as terrorist attacks or consequences of war or political instability. Catastrophes are an inherent risk of the property-liability insurance business, especially in the State of Florida which may contribute to material year-to-year fluctuations in our results of operations and financial position.
In addition to catastrophes, the accumulation of losses from smaller weather-related events in a fiscal quarter or year could materially and adversely impact our results of operations in those periods. While we believe our underwriting strategies as well as our reinsurance program limit the severity of future losses, we continue to be exposed to catastrophic losses that may exceed the limits of our reinsurance program.
Policy acquisition costs consist of agents’ commissions, policy administration fees and premium taxes. Policy acquisition costs increased $0.6 million, or 3.5%, to $17.6 million for 2008 compared to $17 million for 2007 due primarily to an increase in policy administration fees and an overall increase in the rate we paid to agents for their commissions. We amortize agents’ commissions over the 12-month period related to the policies written and we anticipate our policy acquisition costs will continue to increase slightly during 2009.
Operating and underwriting expenses decreased $2.9 million or 31.3%, to $6.5 million during 2008 compared to 2007. During 2007, UPCIC was assessed $3.1 million by the Florida Insurance Guaranty Association (“FIGA”); however, we did not have any assessments during 2008. Our premium taxes decreased $0.8 million during 2008 compared to 2007. These decreases totaling $3.9 million were offset by increases of $0.3 million in premium write-offs and $0.7 million in other operating and underwriting expense categories that were individually insignificant.
Since the Merger has been consummated and we are no longer a blank-check company, during 2009, we will incur additional compliance costs we have not incurred in the past. Specifically, we will incur compliance costs to document and test our internal control procedures as well as having management perform an assessment of our internal controls to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002.
Interest expense related to the Columbus Bank and Trust (“CB&T”) note decreased by $2.2 million, attributable to a decrease in the outstanding loan balance as a result of normal principal repayments as well as the application of the $13.1 million balance in the escrow account, which we were previously required to maintain, against the outstanding principal balance.
During the fourth quarter of 2008, we recorded $0.5 million of interest expense related to the five notes we issued prior to the consummation of the Merger.
During 2008 and 2007, our effective tax rate was 19.7% and 17.3%, respectively. The 2.4% increase in our effective tax rate (even though the income before taxes decreased $6.3 million from 2007 to 2008) is due to our recording of corporate taxes on all of our entities during the fourth quarter of 2008; however, during 2007, and during the first nine months of 2008, only one of our subsidiaries, UPCIC, recorded a provision for income taxes as the other subsidiaries were treated as partnerships for income tax purposes. Since the other subsidiaries were partnership entities, no provision for income taxes was required to be recorded on our Consolidated Statements of Income for those entities. Effective October 1, 2008, all of our subsidiaries are required to record a provision for income taxes as all of our subsidiaries are part of a consolidated C-corporation return.
See our Consolidated Statements of Income for a pro forma calculation of the estimated corporate income taxes we would have recorded for 2008 and 2007 if all of our subsidiaries had recorded corporate income taxes at the beginning of January 1, 2006.
to implement a wind mitigation credit during the fourth quarter of 2007 that had been enacted by the Florida Legislature.
Gross premiums ceded decreased to $58.5 million for 2007 as compared to $78.0 million for 2006. Our reinsurance premiums resulting from our contracts with private reinsurance companies are based mainly on the total insured value and the projected maximum loss of the underlying reinsured policies. Those premiums are also based on the amount of coverage the private reinsurance contracts must offer related to the portion of potential catastrophe losses not covered by our contract with the Florida Hurricane Catastrophe Fund. The decrease in gross premiums ceded resulted from a lower TIV and PML in the current year compared to the prior year, as well as from an increase in the coverage provided by the FHCF contract over the prior year’s FHCF contract.
Losses and LAE is our most significant expense and represents actual claims and estimated future payments to be made for
Insurable events during 2007 and 2006 were more normal in nature as compared to 2005 and 2004. During 2007 and 2006, there were no catastrophic weather events such as the series of hurricanes that occurred in Florida during 2005 and 2004.
Losses and LAE decreased by $9.7 million, or 27.4%, to $25.7 million for 2007, compared to $35.4 million for 2006. The $9.7 million decrease is comprised of the $4.6 million decrease in the current year incurred as compared to the current year incurred in 2006 and the $5.1 million decrease in the adjustment to the reserves for prior years for unpaid losses and LAE. We also attribute current year improvement in incurred losses as a result of disciplined underwriting with a focus on agency management. We also have inspections on all of our new business policies to ensure we use complete and accurate data in our underwriting process. Furthermore, business-mapping services are used to automatically populate critical property details used in our underwriting process. We use this information not only for rating purposes, but to also ensure it does not have unacceptable concentrations in any one particular geographic area.
Policy acquisition costs increased $1.5 million, or 9.5%, to $17 million for 2007, as compared to $15.5 million for 2006. Policy acquisition costs consist of agents’ commissions, policy administration fees and premium taxes. The increase in policy acquisition costs is primarily attributable to a $2.9 million increase in agents’ commissions to $14.9 million in 2007 compared to $12.0 million in 2006.
Interest expense increased $2 million, or 48.9%, to $6.1 million for the year ended December 31, 2007, as compared to $4.1 million for the year ended December 31, 2006. The change is primarily attributed to our refinancing of our note payable to York during 2007, which accelerated the amortization of the participation fee and original issue discount related to the York note.
Other income (expenses) increased $0.7 million or 73.3% to $1.6 million due to the projected increase in the value of the 4.75% equity interest in UIH that York received in connection with the financing transaction entered into with UIH in 2006. York entered into a Put agreement with UIH that provided York with an option to sell its entire interest back to UIH at any time (i) between September 15, 2009 and September 15, 2010, and (ii) between September 15, 2011 and September 15, 2012. At December 31, 2006, UIH recorded a charge of $0.9 million for the value of the York equity interest in UIH.
The provision for income tax increased $12.3 million to $8.3 million for 2007, compared to income tax benefit of $4.0 million for 2006. The change in income tax year over year is attributable to the profitability of the insurance subsidiary. The effective income tax rate for the insurance subsidiary was 37.6% for 2007, compared to an income tax benefit for 2006.
As a result of the foregoing, our net income for 2007 was $39.6 million, compared to net income of $17.2 million for 2006.
The $38.9 million of net cash provided by operating activities resulted primarily from cash inflows from our generation of $33.4 million of net income, a $5.8 million increase in amounts payable to reinsurers, a $4.1 million increase in unpaid loss and LAE and a $4.6 million decrease in other assets, and was offset by cash outflows resulting mainly from a $5.8 million increase in reinsurance recoverable.
We recorded an unrealized loss on our investments available for sale of $3.6 million during 2008 and the interest income we earned on our cash and cash equivalents was $0.9 million lower during 2008 compared to 2007, partly due to lower interest rates. The lower interest rate environment affects the interest income we earn on our cash and cash equivalents and the bonds we may purchase during 2009.
Subject to catastrophic or severe weather related occurrences, net operating cash flow is currently expected to be positive in both the short-term and the reasonably foreseeable future. During 2008, we did not have any hurricanes in the territories we insure. Florida did have Tropical Storm Fay which caused damage in some of the territories we insure and we recorded $3.3 million of loss and LAE of which $2.2 million was paid during 2008. At December 31, 2008, our estimated loss and LAE reserve increased $6.5 million compared to December 31, 2007. This was a result of increased claims from Hurricane Wilma which occurred in 2005. Since all of the claims relating to the 2004 and 2005 hurricanes are 100% ceded, these ceded claims will ultimately not affect our cash flow as we will get reimbursed by our reinsurers for any claims that we pay.
For 2008, we used $17.8 million of cash in our net investing activities compared to providing $18.7 million during 2007. Our available-for-sale investment portfolio is highly liquid as it consists entirely of readily marketable securities. For 2008, we generated $56.2 million from the sale of investments available-for-sale and we used $72.4 million for the purchase of investments available-for-sale.
We used $46.3 million of cash in our net financing activities during 2008 compared to $26.3 million during 2007. During 2008, we paid $19.5 million of principal payments on our CB&T note. At December 31, 2008, the interest rates on our notes were 3.6% for the SBA note, 3.5% for the CB&T note and 11% for the Merger notes. On August 11, 2008, we amended our CB&T note agreement whereby the principal payments to CB&T ceased after our July 2008 installment and will recommence with our April 2009 installment. During 2009, we expect to pay the remaining $4.3 million principal to CB&T in accordance with the amended note terms.
Prior to the recently completed Merger, we issued five notes (“Merger Notes”) with a combined principal of $18.3 million; however, no principal payments are required until the Merger Notes mature on September 29, 2011. Interest payments are payable semi-annually beginning April, 1, 2009.
The ability of our parent company to meet its debt payment obligations and pay our general and administrative expenses is largely dependent on cash dividends or inter-company loans from UIM. UIM’s primary source of revenue, from which dividends to us have been paid, is the management fee and commissions UIM receives from our insurance company, UPCIC, pursuant to a management agreement in effect between those entities. UPCIC is subject to extensive regulation by the OIR, including approval of any management fee UPCIC pays to UIM for services rendered.
The primary sources of cash flow for UPCIC are gross premiums written, loss reimbursements by our reinsurers, investment income, and proceeds from the sale or maturity of investments. Funds are used by UPCIC for ceded premium payments to reinsurers, loss and LAE payments, other underwriting expenses, purchases of investments and fee payments to UIM. Any dividends from UPCIC are regulated by the OIR.
We paid tax distributions of $16.2 million to the former members of UIH during 2008 to allow them to pay federal income taxes which may be owed by them due to the income attributable to them as members of UIH, which was a partnership for income tax purposes. During 2008, we paid a $2.0 million non-tax related distribution which was authorized under the Merger agreement. We will not have any tax payments to our former UIH members during 2009; however, we will make quarterly federal and state income tax payments directly to the Internal Revenue Service and the Florida Department of Revenue on behalf of our consolidated entities.
As consideration for the Merger, we paid an aggregate of $25 million of cash to the former members of UIH along with issuing 8,929,819 shares of our common stock and granting warrants to purchase 1,273,569 shares of our common stock. The $25 million cash consideration for the Merger was funded with cash held in our trust account established in connection with our initial public offering, as well as the net proceeds of the financing which closed on September 29, 2008. There is a provision in the Amended and Restated Agreement and Plan of Merger, dated August 15, 2008, as amended on September 23, 2008, which provides for potential additional consideration to be paid of up to $5 million to the former UIH members. The former UIH members will be paid $2.00 in cash for each dollar exceeding UIHC’s net income (as defined in the Merger Agreement) of $25 million during either of the periods of (i) July 1, 2008 through June 30, 2009, and (ii) January 1, 2009 through December 31, 2009. We paid $5.7 million to FMG prior to the Merger, which FMG used to repurchase some of our common stock, and we incurred $2.9 million of Merger costs which were recorded to our retained earnings account on the Merger date.
GAAP differs in some respects from reporting practices prescribed or permitted by the OIR. To retain our certificate of authority, the Florida insurance laws and regulations require UPCIC maintain capital and surplus equal to the statutory minimum capital and surplus requirement which Florida Statutes define as the greater of 10% of the insurer’s total liabilities or $4 million. UPCIC’s statutory capital surplus was $54.7 million at December 31, 2008, and exceeded the minimum capital and surplus requirements. UPCIC is also required to adhere to prescribed premium-to-capital surplus ratios, with which we were in compliance at December 31, 2008.
We do not believe we will have any significant capital purchases during 2009. We believe our current capital resources, together with cash flow from operations, will be sufficient to meet currently anticipated working capital requirements. There can be no assurance, however, that such will be the case in the future.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of United Insurance Holdings Corp. and subsidiaries as of December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America.
During 2008, we sold an investment available-for-sale for $1,133 in exchange for a note receivable in the same amount. We recorded a deferred gain of $133 on the sale.
Through our wholly-owned UIH subsidiary, and UIH’s three wholly-owned subsidiaries, UIHC is engaged in the property and casualty insurance business in the State of Florida. The three subsidiaries of UIH include United Property & Casualty Insurance Company (“UPCIC”), United Insurance Management, L.C. (“UIM”) and Skyway Claims Services, LLC (“Skyway”). We operate under one business segment.
UIM is a managing general agent (“MGA”) formed in 1999 under the laws of the State of Florida. UIM manages all aspects of UPCIC’s operations, including underwriting, policy administration, collections and disbursements, accounting and claims processes.
Skyway was formed in 2004 under the laws of the State of Florida to provide claims appraisal services. Skyway is currently one of several companies that provide such services to UPCIC, and it mainly provides appraisal services for claims arising from Dade, Broward and Palm Beach counties.
We account for our investments in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Per SFAS No. 115, investments in debt and equity securities are classified as either held-to-maturity, available-for-sale or trading. We currently classify all securities as available-for-sale and report them at fair value, with subsequent changes in value reported as unrealized holding gains and losses, net of tax, as a separate component of other comprehensive income included in stockholders’ equity. We include realized gains and losses, which we derive using the specific-identification method for determining the cost of securities sold, in earnings. We recognize dividends and interest income when earned.
When we determine a decline in the fair value of an available-for-sale security below its cost to be other-than-temporary, we record a charge to income, resulting in the establishment of a new cost basis for the security.
We record premiums as earned using the daily pro rata method over the contract period of the related policies that are in force, and we record a liability, called unearned premiums, for any portion of premiums not earned at the end of the reporting period.
Premiums receivable represents amounts due from our policyholders for billed premiums and related policy fees. We perform a policy-level evaluation to determine the extent to which the balance of premium receivable exceeds the balance of unearned premium. We then age any resulting exposure based on the last date the policy was billed to the policyholder, and we establish an allowance for credit losses for any amounts outstanding for more than 90 days. When we receive payments on amounts previously written off, we credit bad debt expense in the period we receive the payment. As of December 31, 2008 and 2007, we had allowances for credit losses totaling $305 and $160, respectively.
We amortized $53 of capitalized software during the year ended December 31, 2008, and none in prior years. The estimated amortization of capitalized software will be $214 in each of the next five years, with the remaining $162 to be amortized thereafter.
We did not recognize any impairment of long-lived assets during the years ended December 31, 2008 and 2007.
Our reserves for unpaid losses and loss adjustment expense (“LAE”) represent the estimated ultimate cost of all unreported and reported unpaid losses and LAE. We estimate our reserves for unpaid losses and LAE using individual case-basis estimates for reported losses and actuarial estimates for losses incurred but not yet reported. Our estimated losses are subject to the effects of trends in loss severity and frequency, and we continually review and adjust our estimated losses as necessary based on our historical experience and as new information becomes known. We include any adjustments to our estimated losses and LAE in current operations. The ultimate settlement of losses and LAE may vary significantly from the estimated amounts included in our consolidated financial statements.
If our unpaid loss and LAE reserves prove to be inadequate, we will increase the liability, thereby reducing net income, in the period in which we identify the deficiency. Future loss experience substantially in excess of the established unpaid losses and LAE could have a material adverse effect on our business, results of operations and financial condition.
UIM records managing general agent fee revenue from two sources: UPCIC and policyholders. UIM provides various insurance-related services to UPCIC, including but not limited to, policy administration, underwriting and general and administrative activities, for which UPCIC pays UIM 31.5% of gross earned premium. The MGA fees UIM receives from UPCIC are eliminated in consolidation and, therefore, do not appear in our consolidated financial statements. UIM also collects a per policy MGA fee from policyholders.
Our policy fees consist of the MGA fee, a pay-plan fee and an inspection fee. Florida law allows managing general agents to charge policyholders a $25 fee on each policy written. We record our MGA fees as income on a pro rata basis over the term of the underlying policies. We record our pay-plan fees, which we charge to all policyholders that pay their premium in more than one installment, as income when collected. We record our inspection fees as income when the inspection is performed. We report all policy fees in Commissions and fees on our Consolidated Statements of Income.
We account for our reinsurance contracts in accordance with SFAS No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. Our reinsurance agreements are short-term, prospective contracts. We record both an asset called Prepaid reinsurance premiums and a liability called Reinsurance payable for the entire contract amount upon commencement of our new reinsurance agreements. We amortize our prepaid reinsurance premiums over the 12-month contract period, and we record the amortization in Decrease (increase) in net unearned premiums on our Consolidated Statements of Income.
We disclose the fair values of our financial instruments in accordance with SFAS No. 107, Disclosures About Fair Value of Financial Instruments and SFAS No. 157, Fair Value Measurements.
SFAS No. 157 provides a revised definition of fair value, establishes a hierarchy for measuring fair value and expands financial statement disclosure requirements for fair value information. Under SFAS No. 157, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price). The fair value hierarchy established by SFAS No. 157 distinguishes between inputs based on market data from independent sources (observable inputs) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (unobservable inputs).
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2008 and 2007 because of their short-term nature: cash and cash equivalents, accrued investment income, premiums receivable, reinsurance receivable, reinsurance payable and accounts payable and accrued expenses.
We file a consolidated tax return and each of our subsidiaries are a party to our tax sharing agreement under which the taxes are allocated to each subsidiary in proportion to the amount of taxable income that each subsidiary contributes to the consolidated taxable income.
We record any income tax penalties and/or income-tax-related interest as income tax expense in the period incurred. We did not incur any tax penalties or income-tax-related interest during the years ended 2008, 2007 or 2006.
Additionally, all of our cash is on deposit at three financial institutions, all of which are subsidiaries of a company that is our largest shareholder. We have $7,648 on deposit at these institutions in excess of the FDIC-insured amount.
We ultimately base our liability for unpaid losses and LAE on our reasoned expectations of future events, though we also support the liability with actuarial projections and other data. Although these estimates have considerable inherent variability, we believe that this liability is reasonable. Since our estimate of reinsurance recoverable is a function of our estimate of unpaid losses and LAE, estimated amounts recoverable from reinsurers will change in conjunction with any changes to our estimate of unpaid losses and LAE. We review these and other estimates regularly, make adjustments as necessary, and reflect such adjustments in current operations. In addition, the realization of our deferred income tax assets is dependent upon generating sufficient future taxable income. A reasonable possibility exists that the expectations associated with these accounts could change in the near term and that the effect of such changes could be material to our consolidated financial statements.
Since we accounted for the Merger as a reverse acquisition and recapitalization, we have retroactively restated certain equity accounts for periods prior to the Merger. Also, certain amounts in the 2007 and 2006 financial statements have been reclassified to conform to the 2008 presentation. These reclassifications had no impact on our consolidated financial position, results of operations or cash flows as previously reported.
On September 30, 2008, UIHC completed the acquisition of UIH and merged UIH with a transitory, wholly-owned subsidiary created specifically for that purpose. We accounted for the transaction as a reverse acquisition and recapitalization with UIH being the surviving entity. In exchange for 100% of the membership units in UIH, we paid the members of UIH $25,000 cash, we issued 8,929,819 shares of our common stock at a quoted market value of $7.91 per share on September 29, 2008, and we granted warrants to purchase 1,273,569 shares of our common stock at a quoted market value of $0.35 per warrant on September 29, 2008. If certain income targets are met, we will also pay up to $5,000 in cash of additional consideration to the former members of UIH. The warrants are exercisable at $6.00 per share beginning October 4, 2008, and expire on October 4, 2011.
We did not present in our footnotes any pro forma information regarding the effects of the Merger as if the Merger occurred on January 1, 2006, because UIHC was a blank-check company with no material operations prior to the Merger.
The following table details our realized gains (losses) by major investment category for the years ended December 31, 2008, 2007 and 2006:
The table below is a summary of fixed maturities at December 31, 2008 by contractual maturity periods. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
We evaluated the declines in the fair values of our available-for-sale securities and determined that none were other-than-temporary; therefore, we recorded no impairment charges during the years ended 2008, 2007 or 2006.
The following table presents our fair value measurements of investments by level:
The table below reflects the diluted weighted average number of common stock shares outstanding using the treasury stock method:
For the policy year beginning June 1, 2008, we have a private catastrophe reinsurance contract with four schedules; these schedules divide the coverage into layers. For example, the coverage provided by the second schedule picks up, or “attaches”, at the point where coverage under the first schedule ends. Our contract with the
For our Garage program, we entered into a quota share reinsurance contract. Per the contract, which has an effective date of August 1, we cede 50% of the premiums written on subject policies and the reinsurer provides us 50% coverage for losses and LAE on subject policies up to the greater of $4,000 or 130% of premium ceded under the contract. The reinsurer pays us a commission ranging from 21% to 43.5% based on the loss ratio of the program. We record the commission revenue at the minimum percentage and, per the contract terms, we recalculate the commission annually after the contract expires until all claims on subject policies have been finally settled. We recognized commission revenue totaling $606, $392 and $349, for the years ended December 31, 2008, 2007 and 2006, respectively. The 2008 and 2007 commission revenue includes immaterial commission recalculations from prior contracts.
escrowed bonus amounts. During the years ended 2008, 2007 and 2006, we recognized policy assumption bonus income of $6,493, $13,556 and zero, respectively, which included $791, $1,238 and zero of interest income, respectively, from the 2004 and 2005 assumption periods.
The liability for unpaid losses and LAE is determined on an individual-case basis for all incidents reported. The liability also includes amounts for claims incurred but not reported.
Activity in our unpaid losses and LAE liability is summarized as follows:
(a) Note Payable to the State Board of Administration (“SBA”) of Florida
We agreed to certain covenants, the violation of which could cause an event of default. Among others, these covenants include: i) maintaining statutory surplus above $50,000, ii) refraining from the payment of dividends when principal and/or interest payments related to the note are past due, and iii) maintaining a Minimum Writing Ratio (“Writing Ratio”). The amended note permits us to meet either of the following ratios:
Beginning on January 1, 2010, if our Writing Ratio based on net written premium to surplus falls below 1:1, and if our Writing Ratio based on gross written premium to surplus falls below 3:1 for three consecutive quarters, we will be obligated to repay a portion of the SBA note such that the Writing Ratio will be obtained for the following quarter provided that we are capable of repayment without creating a financially hazardous condition at UPCIC. In addition, if we default on any covenant, the SBA may, at its sole discretion, increase the interest rate to 25%, which is the maximum interest rate permitted by law; accelerate the repayment of principal and interest; shorten the term of the note or call the note and demand full repayment. As of December 31, 2008, we were in compliance with each of the loan covenants, as amended.
During the first three quarters of 2008, we incurred an additional 450 basis points of interest expense as we did not meet the Writing Ratio as stated in the initial note agreement with the SBA during the fourth quarter of 2007 and the first two quarters of 2008. We did not incur any additional interest rate charge during the fourth quarter of 2008, and at December 31, 2008, we met the Writing Ratio as defined in the amended agreement, so we will not incur an additional interest rate charge for the first quarter of 2009.
In March 2008, we amended the CB&T note to reduce the interest rate to the 30-day LIBOR rate plus 300 basis points, which represented a 100 basis point reduction from the originally agreed-upon interest rate.
Prior to September 30, 2008, UIH had elected to be treated as a partnership for income tax purposes. The taxable income and all tax credits of UIH and its two limited liability company subsidiaries, UIM and Skyway, were reportable by the entities’ members on their individual tax returns. UPCIC was taxed as a C-corporation from its inception.
In assessing the net realizable value of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. We have no loss carryforwards available to offset future taxable income at December 31, 2008.
Our insurance subsidiary is subject to assessments by Citizens, the FHCF and the Florida Insurance Guaranty Association (“FIGA”). Citizens and the FHCF may levy assessments against all assessable insurers that write premiums in the State of Florida to cover operating deficiencies related to windstorm catastrophes. FIGA may levy assessments against all assessable insurers that write premiums in the State of Florida to cover the claims of policyholders of insurance companies in the State of Florida that have become insolvent.
Assessments implemented by Citizens are calculated by multiplying the ratio of our direct written premium on the subject lines of business to the total direct written premium on the subject lines of business of all assessable Florida insurance companies (“participation ratio”) by Citizens’ total operating deficit in its High Risk Account. By Florida statute, assessments implemented by either the FHCF or FIGA are capped annually at a flat percentage of 1% for FHCF and 2% for FIGA multiplied by our direct written premium on subject lines of business.
As described in Note 2(k), we expense assessments when they are imposed upon us; therefore, expected recoveries in the table above are not assets and will be recorded as income when collected. We are also currently collecting assessments upon policyholders on behalf of Citizens in the amount of 1.4%, and on behalf of FHCF in the amount of 1.0%. The premium written on each policy, except our flood policies, is multiplied by these assessment percentages to determine the amount to be remitted to the assessing agencies.
Our insurance subsidiary’s assets, liabilities and results of operations have been reported in accordance with GAAP, which varies from SAP prescribed or permitted by the NAIC, state laws and regulations, as well as by general industry practices. The following items are principal differences between SAP and GAAP:
SAP require that we exclude certain assets, called non-admitted assets, from the balance sheet.
We calculate deferred income taxes differently under SAP than we would under GAAP.
SAP require that we establish valuation allowances with regard to investments.
The table below reconciles our consolidated GAAP stockholders’ equity to the surplus as regards policyholders of UPCIC:
information; (ii) company and industry historical loss experience; (iii) judicial decisions and legal developments in the awarding of damages, and (iv) trends in general economic conditions, including the effects of inflation. Management revises the estimates based on the results of their analysis. We are not currently involved in any material non-claims-related litigation.
Prior to consummation of the Merger on September 30, 2008, the owner of two independent insurance agencies that write our policies, Alpha Insurance Management and Comegy’s Insurance Corner, served on the Board of Directors of UIH. During 2008, 2007, and 2006, we paid board fees and agents’ commissions to the aforementioned agencies totaling $679, $715, and $600, respectively. The commissions paid were determined in accordance with industry rates. As of September 30, 2008, the owner of the aforementioned insurance agencies no longer serves as a director of UIH, but remains a common stockholder.
We place private reinsurance through BMS Group, Ltd., a broker that employs a person that served as a UIH
During 2008, 2007 and 2006, we held various secured note agreements with CB&T. CB&T is a subsidiary of Synovus. The amount outstanding on the note at December 31, 2008 and 2007 was $4,327 and $23,833, respectively. Total interest incurred related to the CB&T note agreements totaled $754, $2,956 and $741 for the years ended December 31, 2008, 2007 and 2006, respectively. The interest rates charged and earned were determined in accordance with industry rates.
From December 2005 through the close of the Merger, we had an agreement with Raymond James Financial, Inc. (“RJF”) to provide us with investment banking services. A person that served as a director of UIH prior to the Merger, and who remains a common stockholder after the Merger, works for RJF as a managing director. During 2008, we incurred fees of $1,646 under the agreement that were related to the Merger; therefore, those fees were a portion of the amount by which we reduced equity for direct costs of the Merger. In 2006, we incurred fees of $965 under the agreement that were related to a debt financing; therefore, we recorded that amount as interest expense. We incurred no fees in 2007 under the agreement.
During the first quarter of 2008, UIH’s Chairman of the Board of Directors exercised an option for $63 to purchase 258 additional membership units of UIH. No further UIH equity purchase options exist.
On September 29, 2008, we issued notes payable with a total face amount of $7,527 to two of our former stockholders. These notes are part of the note agreement we entered into on August 15, 2008, with various accredited investors (see Note 11). In exchange for these two notes, we received 869,565 shares of UIHC common stock, with a total value of $6,878 at the time the notes were issued. We recorded a discount on these two notes of $649 which will be amortized to interest expense over the three-year term of the notes. The notes bear interest at 11% per annum, and require semi-annual interest-only payments each April 1 and October 1. The entire principal balance is due and payable on September 29, 2011.
On September 29, 2008, we issued a note payable with a total face amount of $538 to two of our directors, through United Noteholders, LLC, in exchange for cash. This note was issued under the note agreement we entered into on August 15, 2008 (see Note 11).
The balance of comprehensive income (loss) is as follows at year end:
During the first quarter of 2008, UIH’s Chairman of the Board of Directors exercised an option for $63 to purchase 258 additional membership units of UIH.
On September 29, 2008, we increased the number of authorized shares of our common stock from 20,000,000 to 50,000,000 with a $0.0001 par value per share.
We issued 8,929,819 shares of our common stock to the members of UIH, as well as warrants to purchase 1,273,569 shares of our common stock. Each common stock warrant allows the holder to purchase one share of our common stock at an exercise price of $6.00 per share. The warrants are exercisable beginning October 4, 2008, and expire on October 4, 2011.
We have a right to redeem the warrants if the last sales price of the common stock equals or exceeds $11.50 per share, for any 20 trading days within a 30 trading day period ending on the third business day prior to the notice of redemption to warrant holders. If we call the warrants for redemption, our management will have the option to require any holder that wishes to exercise his, her or its warrant to do so on a “cashless basis.” If our management takes advantage of this option, all holders of warrants would pay the exercise price by surrendering his, her or its warrants for that number of shares of common stock equal to the quotient obtained by dividing (x) the product of the number of shares of common stock underlying the warrants, multiplied by the difference between the exercise price of the warrants and the “fair market value” by (y) the fair market value. If we call our warrants for redemption and our management does not take advantage of this option, Pali Capital would still be entitled to exercise its 350,000 warrants for cash or on a cashless basis. The right of redemption does not apply to the private warrants held by FMGI, as discussed below.
Currently, an escrow agent, pursuant to an escrow agreement, is holding 945,181 shares of our common stock until 12 months after the Merger date. FMGI, the initial sponsor of FMG prior to our initial public offering, owns 865,181 of the escrowed shares, while other investors own the remaining escrowed shares.
FMGI holds warrants to purchase 1,070,181 shares of our common stock. As long as these warrants are held by FMGI or certain permitted assigns, they are non-redeemable and can be exercised on a “cashless” basis.
At December 31, 2008, we had warrants outstanding to purchase shares of our common stock with the following terms:
* This warrant is part of a unit purchase option. See discussion above regarding unit purchase options.
UIHC is a legal entity separate and distinct from its subsidiaries. As a holding company, the primary sources of cash needed to meet UIHC’s obligations are distributions, dividends, and other permitted payments from its subsidiaries. While there are no restrictions on distributions from UIHC, dividends from UPCIC have certain restrictions (see Note 13).
Prior to the recently completed Merger, and in accordance with the UIH Members Agreement, UIH provided cash distributions to each of its members on an annual basis to allow each member to pay any federal income tax which may have been owed on the taxable income attributable to the person/entity as a member of UIH. During 2008 and 2007, UIH paid tax distributions to its members totaling $16,225 and $8,281, respectively. During 2008 and 2007, UIH declared and paid $2,000 and $10,000 of non-tax-related distributions to UIH members. The $2,000 non-tax-related distribution in 2008 was authorized under the Merger agreement.
On February 17, 2009, UPCIC assumed approximately two thousand two hundred policies from Citizens. We recognized $3,058 in premium from this assumption, as well as commission expense of $489. The policies were removed from Citizens pursuant to the 2008 Agreement.
On March 1, 2009, UIHC entered into a non-binding letter of intent to acquire substantially all of the assets and assume certain liabilities of Coral Enterprises, LLC, and/or its subsidiaries (“Coral LLC”). Coral LLC is engaged in the business of providing property and casualty insurance in the State of Florida. Consummation of any transaction is subject to the receipt of required regulatory approvals, UIHC’s completion of due diligence, negotiation and execution of definitive agreements and other customary conditions to closing. There can be no assurance that the acquisition contemplated by the letter of intent or any similar transaction will ever be consummated.