Our insurance subsidiary is Federated National Insurance Company (“FNIC”). FNIC is licensed as an admitted carrier in Florida. An admitted carrier is an insurance company that has received a license from the state department of insurance giving the company the authority to write specific lines of insurance in that state. These companies are also bound by rate and form regulations, and are strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Admitted carriers are also required to financially contribute to the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders. Through contractual relationships with a network of approximately 3,600 independent agents, of which approximately 1,800 actively sell and service our products, FNIC is authorized to underwrite homeowners’, commercial general liability, fire, allied lines and personal and commercial automobile insurance in Florida. FNIC is licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas and underwrites commercial general liability insurance in those states, homeowners’ insurance in Louisiana and personal automobile insurance in Georgia and Texas.
Our homeowner business contributed $116.5 million or 94.0% of the increased gross written premiums during the year ended December 31, 2013. This increase was the result of:
· a “flight to quality” in the market by agents who seek quality carriers to place their business,
During 2013, approximately 85% of our policyholders renewed their policies. This high retention rate reflects the confidence that the policyholder and his agent have in our financial stability and strength. Additionally, policyholders have told agents that our professional staff adjusts claims quickly and fairly.
The estimated Ultimate Loss and Defense and Cost Containment Expense (“DCCE”) is based on an analysis by line of business, coverage and by accident quarter performed using data as of December 31, 2013. The analysis relies primarily on four actuarial methods: Incurred Loss and DCCE Development Method, Paid Loss and DCCE Development Method, Bornhuetter-Ferguson Incurred Method, and Bornhuetter-Ferguson Paid Method. Each method relies on company experience, and, where relevant, the analysis includes comparisons to industry experience. The following is a description of each of these methods:
Annually - Our policy is to select a single point estimate that best reflects our in-house actuarial determination for unpaid losses and LAE. Our independent actuarial firm, examining the exact same data set, will independently select a point estimate which determines a high point and low point range. Both processes rely on objective and subjective determinations. If our point estimate falls within the range determined from the point estimate of our actuary, then the Company’s policy has been that no adjustments by management would be required. In consideration thereof, the company does not have a policy for adjusting the liability for unpaid losses and LAE to an amount that is different than an amount set forth within the range determined by our independent actuary, although the reserve level ultimately determined by us may not be the mid-point of our independent actuary’s range. Further, there can be no assurances that our actual losses will be within our actuary’s range. Our independent actuary’s report expressly states that the report is based on assumptions developed from its own analysis and based on information provided by management and that notwithstanding its analysis, there is a significant risk of material adverse deviation from its range.
For the year ended December 31, 2013, our actuarial firm determined range of statutory loss and LAE reserves on a net basis range from a low of $51.5 million to a high of $60.9 million, with a best estimate of $55.5 million. The Company’s net loss and LAE reserves are carried on a statutory basis at $54.0 million, and on a GAAP consolidated basis at $61.0 million which when netted with our $2.7 million reinsurance recoverable totals $58.3 million. The Company’s statutory point estimate for its reserves as of December 31, 2013 is 2.6% below our actuary’s best estimate, which reflects management’s current analysis of the status and expected timing of our anticipated claims, our analysis of expected weather patterns in the regions in which we sell policies, our re-focus of our business growth efforts to areas outside of South Florida, and other factors.
The debt and equity securities that are available for sale and carried at fair value represent 97% of total investments as of December 31, 2013, compared with 94% as of December 31, 2012.
Below is a summary of net unrealized gains at December 31, 2013 and December 31, 2012 by category.
The net unrealized gain of $9.6 million is inclusive of $1.6 million of unrealized losses. The $1.6 million of unrealized losses is inclusive of $0.1 million unrealized losses from equity securities and $1.5 million unrealized losses from debt securities.
The $1.5 million of unrealized losses from debt securities is primarily related to US government obligations and obligations of states and political subdivisions. The Company does not expect to settle at prices less than the amortized cost basis. The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2013 because we neither currently intend to sell these investments nor consider it likely that we will be required to sell these investments before recovery of the amortized cost basis.
· length of time and the extent to which the fair value has been less than amortized cost;
· financial condition and near term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology or discontinuance of a business segment;
· intent and ability of the Company to retain the investment for a period of time sufficient to allow for anticipated recovery in market value;
The following table summarizes, by maturity, the debt securities as of December 31, 2013 and 2012.
Two reinsurers require FNIC to maintain securities with a fair market value of $4.6 million. As of December 31, 2013, FNIC maintained fully funded trust agreements that totaled $4.9 million in favor of the reinsurers. As of December 31, 2012, FNIC maintained fully funded trust agreements that totaled $4.8 million in favor of the reinsurers.
Our allowance for credit losses remained unchanged at $0.1 million as of December 31, 2013, compared with $0.1 million as of December 31, 2012.
Reinsurance recoverable, net, decreased $0.8 million, or 21.7%, to $2.7 million as of December 31, 2013, compared with $3.5 million as of December 31, 2012. The change is due to the payment patterns by our reinsurers, as influenced by the diminishing catastrophe related claims. All amounts are current and deemed collectable. We believe concentrations of credit risk associated with our reinsurance recoverables, net, are not significant.
DPAC increased $8.2 million, or 97.0%, to $16.7 million as of December 31, 2013, compared with $8.5 million as of December 31, 2012. The change is due to the deferral of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned, in conjunction with the increase to gross premiums written during 2013 compared with 2012. An analysis of deferred acquisition costs follows.
Deferred income taxes, net, decreased $3.3 million, or 76.8%, to $1.0 million as of December 31, 2013, compared with $4.3 million as of December 31, 2012. Deferred income taxes, net, is comprised of approximately $11.0 million and $10.0 million of deferred tax assets, net of approximately $10.0 million and $5.7 million of deferred tax liabilities as of December 31, 2013 and December 31, 2012. The change in the net deferred tax asset is primarily due to the increase in the deferred tax liability related to deferred acquisition costs, net.
Property, plant and equipment, net increased $0.3 million, or 64.8%, to $0.9 million as of December 31, 2013, compared with $0.6 million as of December 31, 2012. The change is due primarily to investments in information technology.
Unearned premiums increased $69.3 million, or 117.5%, to $128.3 million as of December 31, 2013, compared with $59.0 million as of December 31, 2012. The change was due to a $68.0 million increase in unearned homeowners’ insurance premiums, a $0.4 million increase in unearned flood insurance premiums, a $0.5 million increase in unearned commercial general liability premiums and a $0.4 million increase in unearned automobile insurance premiums. Generally, as is in this case, an increase in unearned premium directly relates to an increase in written premium on a rolling twelve-month basis.
Income taxes payable increased to $2.4 million as of December 31, 2013, compare with nothing as of December 31, 2012, in conjunction with the increase to income before provision for income tax expense, net of estimated tax payments made during 2013.
Accounts payable and accrued expenses increased $3.9 million, or 146.7%, to $6.5 million as of December 31, 2013, compared with $2.6 million as of December 31, 2012. The $3.9 million change includes increases of $1.6 million for commissions, $0.8 million for the remittance of recouped assessments, $0.6 million for payroll, $0.6 million for premium taxes and $0.3 million for dividends.
During 2013, $29.7 million or 13.6% of the $218.3 million of homeowners’ premiums we underwrote were produced under an agency agreement with Ivantage Select Agency, Inc. (“ISA”), an affiliate of Allstate Insurance Company, that grants Allstate agents the authority to offer certain FNU products. The $29.7 million of homeowners’ premiums produced under this agreement with ISA represents 25.5% of the total increase in the sale of homeowners’ policies during 2013, compared with 2012. This network of agents began writing for FNIC in March 2013.
Premium rates charged to our homeowner insurance policyholders are continually evaluated to assure that they meet the expectation that they are actuarially sound and produce a reasonable level of profit (neither excessive nor inadequate). Premium rates are regulated and approved by the Florida OIR. In 2013 our voluntary program rate indications did not indicate the need for adjustment. In 2012 we were approved for a 4.8% and 0.9% rate increase on our voluntary property book of homeowners’ business. In 2011 our voluntary rate increase of 20% was approved.
The increase in unearned premiums was $69.3 million for 2013, compared with $11.1 million in 2012. The 2013 charge to written premium was due to a $68.0 million increase in unearned homeowners’ insurance premiums, a $0.4 million increase in unearned flood premiums, a $0.5 million increase in unearned commercial general liability premiums and a $0.4 million increase in unearned automobile insurance premiums during 2013. These changes are a result of differences in written premium volume during this period as compared with the same period last year. See “Gross Premiums Written” above.
The $0.2 million increase in commercial general liability net premiums earned is a result of a $1.0 million increase in gross written premium, a less than $0.1 million decrease in gross premiums ceded and a $0.8 million increase in the net change to unearned premium.
The $1.2 million increase in automobile net premiums earned is a result of a $5.5 million increase in gross written premium as discussed, a $4.3 million increase in gross premiums ceded and a less than $0.1 million decrease in the net change to prepaid reinsurance premiums and unearned premium.
Commission income increased $1.2 million, or 92.2%, to $2.6 million for 2013, compared with $1.4 million for 2012. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link, Inc. (“Insure-Link”).
Other income increased $0.9 million, or 177.3%, to $1.4 million for 2013, compared with $0.5 million for 2012. The increase is primarily due to the recoupment of assessments previously expensed in connection with the Florida Insurance Guaranty Association (“FIGA”).
Losses and LAE, our most significant expense, represent 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 analysis of estimated future payments to be made. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events.
Losses and LAE increased by $26.2 million, or 86.7%, to $56.4 million for 2013, compared with $30.2 million for 2012. The overall change includes a $26.7 million increase in our homeowners’ program, a $2.5 million decrease in our commercial general liability program and a $2.0 million increase in connection with our automobile program.
Please see “Liability for Unpaid Losses and LAE” under “Item 1 Business” for a further discussion of the factors that affect unpaid losses and LAE.
Management revises its estimates based on the results of its analysis. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors. Because of our process, reserves were increased by approximately $11.1 million during 2013. This overall change includes a $16.1 million increase in reserves for our homeowners’ program, a $3.5 million increase in reserves for our automobile program and an $8.5 million decrease in reserves for our commercial general liability program.
Amortization of deferred policy acquisition costs increased $8.1 million, or 61.8%, to $21.4 million for 2013, compared with $13.3 million for 2012, which corresponds to the increase in net premiums earned during this same period.
Amortization of deferred policy acquisition costs, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned.
Our earnings can also be impacted by our ratings, such as the rating of FNIC by Demotech. FNIC’s rating as of December 31, 2012 was "A" ("Exceptional"). For more information regarding our rating and the impact of a change or withdrawal of our rating, please see “Business-Regulation-Industry Rating Services.”
Net premiums earned increased $10.9 million, or 22.3%, to $59.4 million for 2012, compared with $48.5 million for 2011. The following table denotes net premiums earned by product line.
Commission income increased $0.4 million, or 38.5%, to $1.4 million for 2012, compared with $1.0 million for 2011. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link.
Direct written policy fees increased $0.4 million, or 26.8%, to $2.0 million for 2012, compared with $1.6 million for 2011. The change is attributed to the increase in gross premiums written during this same period.
Net investment income decreased $0.3 million, or 6.4%, to $3.8 million for 2012, compared with $4.1 million for 2011. Our investment yield, net and gross of investment expenses, excluding equities and including cash, was 2.5% and 2.8%, respectively, for 2012. Our investment yield, net and gross of investment expenses, excluding equities and including cash, was 2.9% and 3.1%, respectively, for 2011.
The table below depicts the net realized investment gains by investment category during 2012 and 2011.
Management revises its estimates based on the results of its analysis. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors. Because of our process, reserves were decreased by approximately $10.1 million during 2012. This overall change includes a $4.5 million decrease in reserves for our homeowners’ program, a $6.7 million decrease in reserves for our commercial general liability program and a $1.1 million increase in reserves for our automobile program. The decreases are due to favorable experience based in part on enhanced underwriting and claim processing techniques.
Our loss ratio is computed as losses and LAE divided by net premiums earned. A lower loss ratio generally results in higher operating income. Our loss ratio for 2012 was 50.9% compared with 63.7% for the same period in 2011. The favorable decrease to our loss ratio is due to the $0.7 million decrease in losses and LAE measured against the $10.9 million increase in net premium earned during 2012 as compared with the same period in 2011.
Amortization of deferred policy acquisition costs, increased $1.0 million, or 7.4%, to $13.3 million for 2012, compared with $12.3 million for 2011. Policy acquisition costs - amortization, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned.
In 2013, operations generated $106.3 million of gross cash flow, due to a $69.3 million increase in unearned premiums, an $11.1 million increase in unpaid losses and LAE, a $3.8 million increase in accounts payable and accrued expenses, a $2.4 million increase in income taxes payable and a $2.2 million decrease in deferred income tax expense. Additional sources of cash included $1.8 million of amortization of investment premium discount, net, a $1.4 million increase in premium deposits and customer credit balances, a $0.8 million decrease in reinsurance recoverable, net, $0.3 million non-cash compensation, $0.3 million depreciation and amortization and a $0.2 million increase in bank overdraft, all in conjunction with $12.7 million of net income.
In 2013, net cash used by investing activities was $87.1 million. In 2012 and 2011, net cash provided and used by investing activities was $4.3 million and $5.2 million, respectively. Our available-for-sale investment portfolio is highly liquid as it consists entirely of readily marketable securities. In 2013, investing activities generated $106.2 million and used $193.3 million.
For the years ended December 31, 2013 and 2012, we had no off balance sheet transactions.
Federated National Holding Company (“FNHC”, “Company”, “we”, “us”), formerly known as 21st Century Holding Company is an insurance holding company that controls substantially all steps in the insurance underwriting, distribution and claims processes through our subsidiaries and our contractual relationships with our independent agents and general agents. We changed our name on September 11, 2012, pursuant to approval received at our annual shareholders’ meeting, from 21st Century Holding Company so that our parent company and other subsidiary companies’ names are consistent with our primary insurance subsidiary and the name under which we have been writing insurance for more than 20 years.
We internally process claims made by our insureds through our wholly owned claims adjusting company, Federated National Adjusting, Inc. (“FNA”). Our agents have no authority to settle claims or otherwise exercise control over the claims process. Furthermore, we believe that the retention of independent adjusters, in addition to the employment of salaried claims personnel, results in reduced ultimate loss payments, lower LAE and improved customer service for our claimants and policyholders. We also employ an in-house Litigation Manager to cost effectively manage claims-related litigation and to monitor our claims handling practices for efficiency and regulatory compliance.
Until June 2011, we offered premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc. (“Federated Premium”).
FNU earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. FNU earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliate, FNIC. During the fourth quarter of 2010, FNU, pursuant to the Consent Order as discussed above, reduced its fee to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date with approval from the Florida OIR. A formal agreement reflecting this fee modification was executed during January 2011.
We have entered into a Coexistence Agreement effective August 30, 2013 (the “Coexistence Agreement”) with Federated Mutual Insurance Company (“Federated Mutual”) in response to correspondence received from Federated Mutual’s counsel alleging that our use of the name “Federated” infringed certain federal trademarks held by Federated Mutual. Although we believe that we have meritorious defenses to this allegation, we sought to avoid litigation and therefore negotiated and entered into the Coexistence Agreement. Under the Coexistence Agreement, among other things, we may continue to use “Federated” until at least August 30, 2020, after which time we have agreed to either cease using “Federated” in commerce or otherwise adopt and use trade names that are not confusingly similar to Federated Mutual’s trademarks. During this period, we continue to develop our brand under the “FedNat” name, which is the name by which agents generally know us.
Policy fees represent a $25 non-refundable application fee for insurance coverage, which are intended to reimburse us for the costs incurred to underwrite the policy. The fees and related costs are recognized when the policy is underwritten. These fees are netted against underwriting costs and are included as a component of deferred acquisition costs.
We recognize the income and expense on reinsurance contracts principally on a pro-rata basis over the term of the reinsurance contracts or until the reinsurers maximum liability is exhausted, whichever comes first. We are reinsured under separate reinsurance agreements for the different lines of business underwritten. Reinsurance contracts do not relieve us from our obligations to policyholders. We continually monitor our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. We only cede risks to reinsurers whom we believe to be financially sound. At December 31, 2013, all reinsurance recoverables are considered current and deemed collectable.
FNU earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. FNU earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliates FNIC and American Vehicle. During the fourth quarter of 2010, FNU, pursuant to the Consent Order as discussed in “Regulation - Consent Order” reduced its fee, to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date with approval from the Florida OIR. A formal agreement reflecting this fee modification was executed during January 2011.
In February 2013, the FASB issued ASU No. 2013-02: Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The objective of this ASU is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. Generally Accepted Accounting Principles (“GAAP”) to be reclassified in its entirety in net income. For other amounts that are not required to be reclassified to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments in the ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. The ASU is effective prospectively for reporting periods beginning after December 15, 2012. The adoption of these amendments did not have a material impact on our financial condition, results of operations or cash flows.
· Although we follow the industry practice of reinsuring a portion of our risks, our costs of obtaining reinsurance fluctuates and we may not be able to successfully alleviate risk through reinsurance arrangements.
· Our business is heavily regulated, and changes in regulation may reduce our profitability and limit our growth.
· Our revenues and operating performance may fluctuate with business cycles in the property and casualty insurance industry.
· Adverse ratings by insurance rating agencies may adversely impact our ability to write new policies, renew desirable policies or obtain adequate insurance, which could limit or halt our growth and harm our business.
· We rely on independent and general agents to write our insurance policies, and if we are not able to attract and retain independent and general agents, our revenues would be negatively affected.
· Increased competition, competitive pressures, industry developments and market conditions could affect the growth of our business and adversely impact our financial results.
· Our participation in the new Florida Property Insurance Clearinghouse may not result in an increase in our premium revenue.
· Our senior management team is critical to the strategic direction of our company. If there were an unplanned loss of service by any of our officers our business could be harmed.
· New homeowners’ insurance operations outside of the State of Florida may not be profitable.
· Provisions in our articles of incorporation and our bylaws, as amended, and the Florida Business Corporation Act could make it more difficult to acquire us and may reduce the market price of our common stock.
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2013 and 2012 because of their short-term nature: cash and short term investments, premiums receivable, finance contracts, due from reinsurers, revolving credit outstanding, bank overdraft, accounts payable and accrued expenses.
During the year ended December 31, 2013, the Company had three stock-based employee compensation plans, which are described later in Footnote 14, Stock Compensation Plans. Prior to January 1, 2006, we accounted for the plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by the Accounting Principles Board (“APB”) and related Interpretation, as permitted by FASB issued guidance. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.
Property, plant and equipment is stated at cost less accumulated depreciation. Depreciation on property, plant and equipment is calculated on a straight-line basis over the following estimated useful lives: building and improvements - 30 years and furniture and fixtures - 7 years. We capitalize betterments and any other expenditure in excess of $1,000 if the asset is expected to have a useful life greater than one year. The carrying value of property, plant and equipment is periodically reviewed based on the expected future undiscounted operating cash flows of the related item. Based upon our most recent analysis, we believe that no impairment of property, plant and equipment exists at December 31, 2013.
Total investments increased $90.6 million, or 69.7%, to $220.7 million as of December 31, 2013, compared with $130.1 million as of December 31, 2012. This increase reflected the $123.9 million increase in gross premiums written compared with 2012 and the $28.1 million in net proceeds from the Company’s November 2013 offering. The excess cash was invested primarily in the bond portfolio.
The following table shows the realized gains (losses) for debt and equity securities for the years ended December 31, 2013 and 2012.
Proceeds from sales, pay downs and maturities of debt securities and proceeds from sales of equity securities in 2013, 2012 and 2011 were approximately $106.1 million, $90.4 million and $108.3 million, respectively.
The Company holds collateral under related reinsurance agreements in the form of fully funded trust agreements totaling $4.9 million that can be drawn on for amounts that remain unpaid for more than 120 days.
Based upon consultations with our independent actuarial consultants and their statement of opinion on losses and LAE, we believe that the liability for unpaid losses and LAE is adequate to cover all claims and related expenses which may arise from incidents reported.
We trended these severities to accident year 2013 levels. Trend rates were selected based on a review of historical severities. Selected severity was chosen based on judgment considering the developed severities and the trended severities, considering industry benchmarks for each segment. The loss & ALAE, claim count and severity triangles are evaluated as of 12 months, 24 months, 36 months etc. We selected loss development factors based on the loss development history, to the extent credible, and supplemented with industry data where appropriate.
In practice there are factors that change over time; however, many (such as inflation) are intrinsically reflected in the historical development patterns, and others typically do not materially affect the estimate of the reserve for unpaid losses and LAE. Therefore, no specific adjustments have been incorporated for such contingencies projecting future development of losses and LAE. There are no key assumptions as of December 31, 2013 premised on future emergence inconsistent with historical loss reserve development patterns.
A summary of the provision for income tax expense (benefit) is as follows.
The actual income tax expense (benefit) differs from the "expected" income tax expense (benefit) (computed by applying the combined applicable effective federal and state tax rates to income before provision for income tax expense (benefit) as follows.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our net deferred tax asset are as follows.
The Company has recorded a net deferred tax asset of $1.0 million and $4.3 million as of December 31, 2013 and December 31, 2012, respectively. Realization of net deferred tax asset is dependent on generating sufficient taxable income in future periods. Management believes that it is more likely than not that the deferred tax assets will be realized and as such no valuation allowance has been recorded against the net deferred tax asset. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2013, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would record valuation allowances as deemed appropriate in the period that the change in circumstances occurs, along with a corresponding increase or charge to net income. The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.
The Company files federal income tax returns as well as multiple state and local tax returns. The Company’s consolidated federal and state income tax returns for 2010 - 2012 are open for review by the Internal Revenue Service (“IRS”) and the various state taxing authorities. The Company’s 2011 federal tax return is currently under review by the IRS. The 2012 federal and state income tax returns were filed by the extended due date in the third quarter of 2013. The 2013 federal and state income tax returns have been extended as of March 2014 and will be timely filed in the third quarter of 2014.
· The Merged Company retained the following licenses: (010) Fire, (020) Allied Lines, (040) Homeowners Multi Peril, (050) Commercial Multi Peril, (090) Inland Marine, (170) Other Liability, (192) Private Passenger Auto Liability, (194) Commercial Auto Liability, (211) Private Passenger Auto Physical Damage and (212) Commercial Auto Physical Damage.
At December 31, 2013, 2012 and 2011, FNIC’s statutory capital surplus was $76.9 million, $52.1 million and $39.3 million, respectively.
Based upon the 2013 and 2012 statutory financial statements for FNIC, statutory surplus exceeded the regulatory action levels established by the NAIC’s risk-based capital requirements.
Based on risk-based capital requirements, the extent of regulatory intervention and action increases as the ratio of an insurer’s statutory surplus to its Authorized Control Level (“ACL”), as calculated under the NAIC’s requirements, decreases. The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200.0% of the ACL amount. The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150.0% of the ACL amount. The third action level, ACL, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70.0% of the ACL amount. FNIC’s ratio of statutory surplus to its ACL was 312.1%, 474.4% and 409.7% at December 31, 2013, 2012 and 2011, respectively.
As of December 31, 2012, FNIC was outside NAIC’s usual range for three of thirteen IRIS ratios. These exceptions related to investment yield, net change in adjusted policyholders’ surplus and estimated current reserve deficiency to policyholders’ surplus.
The Company also faces, in the ordinary course of business, lawsuits that seek damages beyond policy limits. The Company continually evaluates potential liabilities and reserves for litigation of these types using the criteria established by FASB issued guidance. Under this guidance, reserves for a loss are recorded 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 make an estimate of a possible range of loss or state that an estimate cannot be made. Management considers each legal action using this guidance and records reserves for losses as warranted.
The Company files federal income tax returns as well as multiple state and local tax returns. The Company’s consolidated federal and state income tax returns for 2010 - 2012 are open for review by the IRS and the various state taxing authorities. The Company’s 2011 federal tax return is currently under review by the IRS. The 2012 federal and state income tax returns were filed by the extended due date in the third quarter of 2013. The 2013 federal and state income tax returns have been extended as of March 2014 and will be timely filed in the third quarter of 2014.
Our executive offices are located at 14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323 in an 18,500 square foot office facility. All of our operations are consolidated within this facility. We believe that the facilities are well maintained, in substantial compliance with environmental laws and regulations, and adequately covered by insurance. We also believe that these leased facilities are not unique and could be replaced, if necessary, at the end of the lease term. Our lease for this office space will expire in May 2017.
One of our directors is a partner at a law firm that handles some of the Company’s claims litigation. Fees paid to this law firm amounted to approximately $30,500, $27,175 and $3,349 in 2013, 2012 and 2011, respectively, and is included in LAE.
A summary of the numerator and denominator of the basic and fully diluted 2013, 2012 and 2011 net income (loss) per share is presented below.
We implemented a stock option plan in 1998 (the “1998 Plan”), which expired in September 2008. Under this plan, we were authorized to grant options to purchase up to 900,000 common shares, and as of December 31, 2013 and December 31, 2012, we had outstanding exercisable options to purchase 3,000 and 78,500 shares, respectively.
On August 5, 2013, a total of 150,000 restricted shares from the 2012 Plan were granted pursuant to the vesting requirements and other terms and conditions set forth in restricted stock agreements. Of the total, 100,000 shares were granted to the Company's Chief Executive Officer and President and 50,000 shares were granted to the Company's Chief Financial Officer.
Activity in our stock option and incentive plans for the period from January 1, 2011 to December 31, 2013 is summarized below.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB issued guidance using the modified-prospective-transition method. Under that transition method, compensation costs recognized during 2013 and 2012 include the following.
Basic and diluted income per share for 2012 would have been $0.55, if the Company had not adopted FASB issued guidance, compared with reported basic and diluted income per share of $0.53.
Because the change in income taxes receivable includes the effect of excess tax benefits, those excess tax benefits also must be shown as a separate operating cash outflow so that operating cash flows exclude the effect of excess tax benefits. FASB issued guidance requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.
FASB issued guidance requires that when valuing an employee stock option under the Black-Scholes option pricing model, the fair value be based on the option’s expected term and expected volatility rather than the contractual term. The estimate of the fair value on the grant date should reflect the assumptions marketplace participants now use on the date of the measurement (i.e. grant date). During 2011, management changed the expected term in the Black -Scholes option pricing model from four years to two years for new options granted. Management believes that share price volatility over the last two years is more indicative of future share price volatility. The change has had an immaterial impact on the financial statements.
We have established a profit sharing plan under Section 401(k) of the Internal Revenue Code. This plan allows eligible employees to contribute up to 100 percent of their compensation, not to exceed statutory limits. The Company match totaled $0.2 million during 2013 and $0.1 million during each of the years 2012 and 2011.
Our Amended and Restated Articles of Incorporation authorize the issuance of one million shares of preferred stock with designations, rights and preferences determined from time to time by our board of directors. Accordingly, our Board of Directors is empowered, without shareholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. We have not issued preferred shares as of December 31, 2013.
In April 2009, the FASB issued accounting guidance that if an entity determines that either the volume and/or level of activity for an investment security has significantly decreased (from normal conditions for that investment security) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. This guidance was effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. This guidance was applied prospectively. The adoption of this guidance did not have an impact on our financial condition, results of operations or cash flows.
Under this Reimbursement Contract, the FHCF will provide approximately $531.0 million of aggregate seasonal coverage for covered losses in excess of approximately $225.0 million, subject to a 10.0% Company participation. Federated National’s premium for the FHCF reinsurance coverage will be approximately $41.4 million payable in three installments between August 2014 and December 2014. The actual attachment point, total coverage and cost will not be finalized until December 31, 2014.