During the first half of 2012 we completed construction of a building containing approximately 11,000 square feet located in Fort Lauderdale, Florida, near our existing headquarters. We occupy 100% of the building and use it as additional office space.
There are no mortgages or lease arrangements for these buildings, and both buildings are adequately covered by insurance.
On July 12, 2013, UPCIC entered into a lease agreement for an office building containing 29,018 square feet adjacent to our headquarters in Fort Lauderdale, Florida. We expect to use this property for additional office and storage space. UPCIC took possession of the office building and began making monthly rental payments in October 2013. Also on July 12, 2013, UPCIC entered into a purchase agreement to acquire this property. The closing for the sale of the property is subject to certain closing conditions and will take place no later than February 5, 2015. UPCIC will receive a credit toward the purchase price of the property for a portion of the rent it pays under the lease agreement.
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand the results of operations and financial condition of UIH. MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and accompanying notes in Part II, Item 8 below.
On January 2, 2014, we repurchased an additional 675,000 shares of the Company’s Common Stock from Bradley I. Meier, the Company’s former Chief Executive Officer, at approximately $11.11 per share, in a privately negotiated transaction. The repurchase price represents a discount from the then-current market price of UIH’s common stock. The Company has a right of first refusal to purchase shares of the Company’s Common Stock offered for sale by Mr. Meier through December 31, 2014.
Below is a description of our 2013-2014 reinsurance program. Although the terms of the individual contracts vary, we believe that the overall terms of the 2013-2014 reinsurance program are more favorable than the 2012-2013 reinsurance program.
Effective June 1, 2013, UPCIC entered into two quota share reinsurance contracts, both of which provide coverage through May 31, 2014 and one of which extends and provides coverage through May 31, 2015. Under the quota share contracts, through May 31, 2014, UPCIC cedes 45% of its gross written premiums, losses and loss adjustment expenses for policies with coverage for wind risk with a ceding commission equal to 26.7% of ceded gross written premiums. In addition, the quota share contract has a limitation for any one occurrence not to exceed $125 million from losses arising out of events that are assigned a catastrophe serial number by the Property Claims Services (“PCS”) office (of which UPCIC’s net liability on the first $125 million of losses in a first, second and third event scenario is $27.5 million for events affecting Florida; $16.5 million in a first and second event scenario for events affecting Georgia, Maryland, Massachusetts, North Carolina and South Carolina; and $5.5 million in a first and second event scenario for events affecting Hawaii), and an aggregate limitation from losses arising out of events that are assigned a catastrophe serial number by the PCS office not to exceed $280 million. The contracts limit the amount of premium which can be deducted for inuring reinsurance.
Effective June 1, 2013 through May 31, 2014, UPCIC entered into a property per risk excess contract covering its policies that do not provide wind coverage. Under the property per risk excess contract, UPCIC obtained coverage of $350 thousand in excess of $250 thousand for each property loss. The contract has a limitation for any one occurrence not to exceed $1.050 million and a $1.750 million aggregate limit that applies to the term of the contract. The total cost of UPCIC’s multiple line excess and property per risk reinsurance program, effective June 1, 2013 through May 31, 2014, is $4.450 million, of which UPCIC’s cost is $2.673 million, and the quota share reinsurers’ cost is the remaining $1.778 million.
Effective June 1, 2013 through June 1, 2014, under an excess catastrophe contract specifically covering risks located in Hawaii, UPCIC obtained catastrophe coverage of 55% of $20 million in excess of $10 million covering certain loss occurrences including hurricanes. The layer of coverage has a second full limit available to UPCIC with additional premium calculated pro rata as to amount and 100% as to time, as applicable. The cost of UPCIC’s excess catastrophe contract specifically covering risks in Hawaii is $330 thousand.
UPCIC also obtained coverage from the FHCF. The approximate coverage is estimated to be 90% of $1.158 billion in excess of $423.1 million. The estimated premium that UPCIC plans to cede to the FHCF for the 2013 hurricane season is $77.993 million of which UPCIC’s cost is 55%, or $42.896 million, and the quota share reinsurers’ cost is the remaining 45%.
With the implementation of the Company’s 2013-2014 reinsurance program at June 1, 2013, the Company retains a maximum pre-tax net liability of $27.5 million for the first catastrophic event up to $1.868 billion of losses relating to the UPCIC Florida program, a maximum pre-tax net liability of $16.5 million for the first catastrophic event up to $125 million of losses relating to the UPCIC Georgia, Maryland, Massachusetts, North Carolina and South Carolina program, and a maximum pre-tax net liability of $5.5 million for the first catastrophic event up to $30 million of losses relating to the UPCIC Hawaii program.
APPCIC also obtained coverage from the FHCF. The approximate coverage is estimated to be 90% of $39.084 million in excess of $14.276 million. The estimated premium that APPCIC plans to cede to the FHCF for the 2013 hurricane season is $2.632 million.
The total cost of the APPCIC multiple line excess reinsurance program effective June 1, 2013 through May 31, 2014 is $3.3 million.
The largest private participants in APPCIC’s reinsurance program include leading reinsurance companies such as ACE Tempest Re, Everest Re, Hiscox, Odyssey Re, Hannover Ruck, Amlin Bermuda and Lloyd’s of London syndicates.
UIH owned and maintained a segregated account, Segregated Account T25 - Universal Insurance Holdings of White Rock Insurance (SAC) Ltd. (“T25”), established in accordance with Bermuda law. As part of our overall reinsurance program, T25 at times entered into underlying excess catastrophe contracts with the Insurance Entities for the purpose of assuming certain risk for specified loss occurrences, including hurricanes. The agreements between T25 and the Insurance Entities were a cost-effective alternative to reinsurance during certain years that the Insurance Entities would otherwise purchase from third-party reinsurers. While we retained the risk that otherwise would have been transferred to third-party reinsurers, these agreements provided benefits to the Insurance Entities in “no-loss” years that could not have been replicated in the open reinsurance market. These benefits include the return to the Insurance Entities of a substantial portion of the earned reinsurance premiums under the contract. All the related intercompany transactions with respect to these agreements were eliminated in consolidation.
Characteristics of Reserves. Reserves are established based on estimates of the ultimate cost to settle claims, less losses that have been paid. Claims are typically reported promptly with relatively little reporting lag between the date of occurrence and the date the loss is reported. UPCIC’s claim settlement data suggests that homeowners’ property losses have an average settlement time of less than one year, while homeowners’ liability losses generally take longer.
Reserves are the difference between the estimated ultimate cost of losses and LAE incurred and the amount of paid losses as of the reporting date. Reserves are estimated for both reported and unreported claims, and include estimates of all expenses associated with processing and settling all incurred claims. We update reserve estimates periodically as new information becomes available or as events emerge that may affect the resolution of unsettled claims. Changes in prior year reserve estimates (reserve re-estimates), which may be material, are determined by comparing updated estimates of ultimate losses to prior estimates, and the differences are recorded as losses and LAE in the Consolidated Statements of Income in the period such changes are determined. Estimating the ultimate cost of losses and LAE is an inherently uncertain and complex process involving a high degree of judgment and is subject to the evaluation of numerous variables.
The Actuarial Methods used to Develop Reserve Estimates. Reserves for losses and LAE are determined in four primary segments. These segments are the estimation of reserves for Florida non-catastrophe losses, hurricane losses, sinkhole losses, and non-Florida non-catastrophe losses. Evaluations are performed for loss and LAE separately, and on a net and direct basis for each segment. The analyses for non-catastrophe losses are further separated into data groupings of like exposure. These groups are property damage on homeowner policy forms HO-3 and HO-8 combined, property damage on homeowner policy forms HO-4 and HO-6 combined, dwelling fire property damage, all homeowner liability exposure, and other liability (the optional liability coverage offered to dwelling fire policyholders).
Reserve estimates for both losses and LAE are derived using several different actuarial estimation methods that are variations on one primary actuarial technique. That actuarial technique is known as a “chain ladder” estimation process in which historical payment and reserving patterns are applied to actual paid and reported amounts (paid losses or LAE plus individual case reserves established by claim adjusters) for an accident period to create an estimate of how losses are likely to develop over time. This technique forms the basis of the seven actuarial methods described below. An accident period refers to classifying claims based on the date in which the claims occurred, regardless of the date it was reported to the Insurance Entities. This analysis is used to prepare estimates of required reserves for payments to be made in the future. Transactions are organized into half-year accident periods for purposes of the reserve estimates. The key data elements used to determine our reserve estimates include claim counts, loss and LAE payments, case reserves, and the related development factors applicable to this data.
The third method is the paid development method, but performed using only the payment history of closed claims. This method is similar to the paid development method; however, payments that are made during the claims settlement process are not considered. While this method has the disadvantage of not recognizing the information provided by current case reserves or partial payments, it has the advantage of avoiding potential distortions in the data due to changes in settlement practices during the life of an active claim. This method’s implicit assumption is that the rate of claims closures has been relatively consistent over time.
The fourth, fifth and sixth methods are Bornhuetter-Ferguson (“B-F”) methods relating to reported, paid and closed development methods discussed above. B-F methods are essentially a blend of two other methods. The first method is an expected loss method, whereby the IBNR estimate equals the difference between predetermined estimates of expected losses and actual reported losses. The second method in each case is the development method (each described above), whereby actual losses are multiplied by an expected development factor. The B-F methods combine these two methods by setting ultimate losses equal to actual reported (or paid) losses plus expected unreported (or unpaid) losses. As an experience year matures and expected unreported (or unpaid) losses become smaller, the initial expected loss assumption becomes gradually less important. This has the advantage of stability, but it does not respond to actual results as they emerge.
A seventh method, called the Reported Counts and Averages method, is utilized for the estimate of Loss Adjustment Expenses for each segment, and also for the estimation of loss and LAE reserves for sinkhole losses. In this method, an estimate of unpaid losses or expenses is determined by separately projecting ultimate reported claim counts and ultimate reported claim severities (cost per reported claim) for each accident period. Typically, loss development methods are used to project ultimate claim counts and claim severities based on historical data using the same methodology described in the reported development method above. Estimated ultimate losses are then calculated as the product of the two items. This method is intended to avoid data distortions that may exist with the other methods for the most recent years as a result of changes in case reserve levels, settlement rates and claims handling fees. In addition, it may provide insight into the drivers of loss experience. This method is only utilized for sinkhole losses due to unique settlement patterns that have emerged since the passage of legislation that codified claim settlement practices with respect to sinkhole related claims and subsequent policy form changes implemented by the Company. Claims for sinkholes are expected to be reported and settled at different rates and ultimate values than historically observed, requiring a departure from traditional development methodologies.
How Reserve Estimates are Established and Updated. Reserve estimates are developed for both open claims and unreported claims. The actuarial methods described above are used to derive claim settlement patterns by determining development factors to be applied to specific data elements. Development factors are calculated for data elements such as claim counts reported and settled, paid losses and paid losses combined with case reserves. Historical development patterns for these data elements are used as the assumptions to calculate reserve estimates.
Reserves are re-estimated periodically by combining historical payment and reserving patterns with current actual results. When actual development of claims reported, paid losses or case reserve changes are different than the historical development pattern used in a prior period reserve estimate, and as actuarial studies validate new trends based on indications of updated development factor calculations, new ultimate loss and LAE predictions are determined. This process incorporates the historic and latest trends, and other underlying changes in the data elements used to calculate reserve estimates. The difference between indicated reserves based on new reserve estimates and the previously recorded estimate of reserves is the amount of reserve re-estimates. The resulting increase or decrease in the reserve re-estimates is recorded and included in “Losses and loss adjustment expenses” in the Consolidated Statements of Income. Total reserve re-estimates in 2013, 2012 and 2011, expressed as a percent of the net losses and LAE liability balance as of the beginning of each year, were (2.6%), 6.8%, and 14.4%, respectively. There are inherent uncertainties associated with this estimation process, especially for a company with limited development history. However, with the passing of each year, the Company’s own historical trends have become more reliable for use in predicting future results.
Factors Affecting Reserve Estimates. Reserve estimates are developed based on the processes and historical development trends as previously described. These estimates are considered in conjunction with known facts and interpretations of circumstances and factors including our experience with similar cases, actual claims paid, differing payment patterns and pending levels of unpaid claims, loss management programs, product mix and contractual terms, changes in law and regulation, judicial decisions, and economic conditions. When these types of changes are experienced, actuarial judgment is applied in the determination and selection of development factors in order to better reflect new trends or expectations. For example, if a law change is expected to have a significant impact on the development of claim severity, actuarial judgment is applied to determine appropriate development factors that will most accurately reflect the expected impact on that specific estimate. This example appropriately describes the reserving methodology selection for use in estimating sinkhole liabilities after the passing of legislation, as noted above. Another example would be when a change in economic conditions is expected to affect the cost of repairs to property; actuarial judgment is applied to determine appropriate development factors to use in the reserve estimate that will most accurately reflect the expected impacts on severity development.
As loss experience for the current year develops for each type of loss, it is monitored relative to initial assumptions until it is judged to have sufficient statistical credibility. From that point in time and forward, reserves are re-estimated using statistical actuarial processes to reflect the impact loss trends have on development factors incorporated into the actuarial estimation processes. Statistical credibility is usually achieved by the end of the first calendar year; however, when trends for the current accident year exceed initial assumptions sooner, they are usually given credibility, and reserves are adjusted accordingly.
Causes of Reserve Estimate Uncertainty. Since reserves are estimates of the unpaid portions of claims and claims expenses that have occurred, the establishment of appropriate reserves, including reserves for catastrophes, requires regular reevaluation and refinement of estimates to determine ultimate loss and LAE estimates.
In selecting the RTR development factors described above in the section titled The Actuarial Methods Used to Develop Reserve Estimates, due consideration is given to how the RTR development factors change from one year to the next over the course of several consecutive years of recent history. In addition to the loss development triangles cited above, various diagnostic triangles, such as triangles showing historical patterns in the ratio of paid to reported losses and paid to reported claim counts, are typically prepared as a means of determining the stability of various determinants of loss development, such as consistency in claims settlement and case reserving.
On an annual basis, the Company’s appointed independent actuary provides a Statement of Actuarial Opinion (“SAO”) that certifies the carried reserves make a reasonable provision for all of the Insurance Entities’ unpaid loss and LAE obligations under the terms of contracts and agreements with our policyholders. The SAO is reviewed and projected ultimate losses and LAE amounts per the SAO are compared to the Company’s own projection of ultimate losses and LAE to ensure that loss and LAE reserves recorded at each annual balance sheet date are based upon an analysis of all internal and external factors related to known and unknown claims against the Insurance Entities. Recorded reserves are compared to the indicated range provided in the report accompanying the SAO. At December 31, 2013, the recorded amount for net loss and LAE falls within the range determined by the appointed independent actuaries and approximates their best estimate.
Potential Reserve Estimate Variability. The methods employed by actuaries include a range of estimated unpaid losses reflecting a level of uncertainty. Projections of loss and LAE liabilities are subject to potentially large errors of estimation since the ultimate disposition of claims incurred prior to the financial statement date, whether reported or not, is subject to the outcome of events that have not yet occurred. Examples of these events include jury decisions, court interpretations, legislative changes, public attitudes, and social/economic conditions such as inflation. Any estimate of future costs is subject to the inherent limitation on one’s ability to predict the aggregate course of future events. It should therefore be expected that the actual emergence of losses and LAE will vary, perhaps materially, from any estimate.
In selecting the range of reasonable estimates, the range of indications produced by the various methods is inspected, the relative strengths and weaknesses of each method are considered, and from those inputs a range of estimates can be selected. For reasons cited above, this range of estimated ultimate losses is typically smaller for older, more mature accident periods and greater for more recent, less mature accident periods. The greatest level of uncertainty is associated with the most recent accident years, and particularly years in during which catastrophe events occurred.
Provision for Premium Deficiency. Our policy is to evaluate and recognize losses on insurance contracts when estimated future claims and maintenance costs under a group of existing policy contracts will exceed anticipated future premiums and investment income. The determination of the provision for premium deficiency requires estimation of the costs of losses, catastrophic reinsurance and policy maintenance to be incurred and investment income to be earned over the remaining policy period. Management has determined that a provision for premium deficiency was not warranted as of December 31, 2013.
Downes and Associates, a multi-line insurance adjustment corporation based in Deerfield Beach, Florida performed certain claims adjusting work for the Insurance Entities. Downes and Associates is owned by Dennis Downes, who is the father of Sean P. Downes, our President and Chief Executive Officer. During 2013, 2012 and 2011, we paid claims adjusting fees of $477 thousand, $623 thousand, $753 thousand, respectively, to Downes and Associates. Our agreement with Downes and Associates was terminated effective November 30, 2013 and on December 1, 2013 Dennis Downes became an employee of the Company.
Net investment income for the year ended December 31, 2013 was $1.9 million, compared to $441 thousand for the same period in the prior year. The increase in net investment income of $1.5 million reflects an increase in the amount of interest earning and dividend paying securities held in the investment portfolio partially offset by an increase in investment expenses associated with asset management fees charged by our investment advisers to manage certain segments of the available for sale portfolio. When the portfolio was classified as trading, all fees were paid in the form of commission on investment trades and reflected in net realized gains and losses on investments and changes in unrealized gains and losses on investments.
The reduction in the net losses and LAE ratio reflects an increase in net premiums earned and a decrease in losses and LAE. The increase in net earned premium is attributable to an increase in direct earned premium as described above. The decrease in losses and LAE expenses is primarily attributable to a reduction in losses and LAE for the current accident year combined with favorable development during 2013 related to prior accident years, compared to unfavorable development recorded during 2012.
General and administrative expenses were $92.0 million for the year ended December 31, 2013, compared to $91.2 million for 2012. The increase in general and administrative expenses of $0.8 million, or 0.9% was due to several offsetting factors including an increase of $3.5 million in performance bonuses, an increase of $3.9 million in amortization of deferred policy acquisition costs, an increase in stock-based compensation of $2.6 million, an increase in insurance department fines of $1.3 million and an increase of
$1.1 million in other general and administrative expenses. These increases were offset by a reduction in general and administrative expenses of $11.6 related to mandatory assessments by the FIGA. FIGA assessments are initially charged to insurance companies and ultimately recovered from policyholders. The charges of $6.3 million recorded during the year ended December 31, 2012 reflect an assessment received in the fourth quarter of 2012 followed by recoveries of $5.4 million recorded during the year ended December 31, 2013.
Comprehensive income includes net income and other comprehensive income (loss). The other comprehensive loss of $376 thousand for the year ended December 31, 2013, reflects after-tax changes in fair value of securities held in our investment portfolio of securities available for sale net of reclassifications out of cumulative other comprehensive income (loss) for securities sold during the period. See “Item 8 - Note 14 (Other Comprehensive Income (Loss)). There was no other comprehensive income (loss) for the year ended December 31, 2012.
Net income increased by $10.2 million, or 50.7%, primarily attributable to an increase in net premiums earned and improved performance in the investment portfolio, partially offset by an increase in general and administrative expenses. The increase in net premiums earned in 2012 outpaced the increase in total operating costs and expenses. The rate increases which have taken effect over the past 24 months are providing positive results that somewhat offset the negative effect of wind mitigation credits.
The following discussion provides comparative information for significant changes to the components of net income and comprehensive income for 2012 compared to 2011.
The increase in net earned premiums of $32.1 million, or 16.1% compared to the prior year, reflects an increase in direct earned premiums of $61.9 million partially offset by an increase in ceded earned premiums of $29.8 million. The increase in direct earned premiums is due primarily to rate increases over the past 24 months. These rate increases, along with strategic initiatives we have undertaken to manage our exposure such as the decision not to renew certain policies we believe have inadequate premiums relative to projected risks and expenses, have resulted in a moderate reduction in the number of policies in force even as the amount of direct written premiums have increased. The benefit from the rate increases continued to be partially offset by wind mitigation credits within the state of Florida. The increase in ceded earned premiums of $29.8 million is attributable to an increase in quota-share ceded premiums in proportion to the growth in direct written premiums, a $5.4 million increase related to the settlement of a dispute with our predecessor quota-share reinsurer and $4.4 million in 2012 relating to an underlying property catastrophe excess of loss reinsurance contract with an unaffiliated third-party reinsurer that did not exist during 2011. The after-tax effect of the settlement with our predecessor quota share reinsurer was $0.08 per diluted share. These increases were partially offset by a reduction in the quota-share cession rate from 50% for the 2011-2012 reinsurance program to 45% for the 2012-2013 reinsurance program.
The net loss and LAE ratios, or net losses and LAE as a percentage of net earned premiums, were 54.6% and 62.5% during years ended December 31, 2012, and 2011, respectively, and were comprised of the following components (in thousands):
The increase in general and administrative expenses of $23.4 million was due to several factors including $10.8 million of charges related to net deferred policy acquisition costs. The reduction in the amount of ceding commissions received from the quota share reinsurer under the 2012-2013 reinsurance program, effectively increased the amount of net deferred policy acquisition costs and related amortization. In addition, we are charging certain costs directly to earnings that were previously capitalized under the superseded FASB guidance which governed how we accounted for deferred policy acquisition costs until January 1, 2012. Charges of $6.3 million were recorded in the latter part of 2012 as a result of a mandatory assessment by the Florida Insurance Guaranty Association (“FIGA”). FIGA assessments are ultimately passed down to policyholders. We will recover these charges over a twelve-month period beginning February 1, 2013. There were also increases in salaries, bonuses, stock-based compensation and insurance, of $1.6 million, $1.6 million, $1.0 million and $2.5 million, respectively offset partially by a decrease in insurance department fees of $1.0 million.
During the first quarter of 2013, we liquidated our trading portfolio and reinvested proceeds and excess cash in a portfolio of securities available for sale.
Reinsurance receivable, net, represents inuring premiums receivable, net of ceded premiums payable with our quota share reinsurer. The decrease of $24.1 million during 2013 was due to the timing of settlements of offsetting balances with our quota-share reinsurers.
Our income taxes recoverable as of December 31, 2013 were $8.2 million compared to $2.6 million as of December 31, 2012. The majority of the increase reflects a recoverable recorded for realized losses generated upon the liquidation of our trading portfolio during the first quarter of 2013, which will be carried back and applied to realized gains generated in previous tax years for federal income taxes.
See Item 8 - Note 12 (Income Taxes) for a schedule of deferred income taxes as of December 31, 2013 and 2012, which shows the components of deferred tax assets and liabilities as of both balance sheet dates.
Advance premium represents premium payments made by policyholders ahead of the effective date of the policies. The increase of $7.9 million to $22.9 million reflects an increase in renewals taking place subsequent to year end for 2013 compared to 2012 combined with rate increases that went into effect during 2013.
The maximum amount of dividends which can be paid by Florida insurance companies without prior approval of the Commissioner of the OIR is subject to restrictions relating to statutory surplus. The maximum dividend that may be paid by the Insurance Entities to UIH without prior approval is limited to the lesser of statutory net income from operations of the preceding calendar year or statutory unassigned surplus as of the preceding year end. During the years ended December 31, 2013 and 2012, the Insurance Entities did not pay dividends to UIH.
The Insurance Entities are responsible for losses related to catastrophic events with incurred losses in excess of coverage provided by our reinsurance programs and for losses that otherwise are not covered by the reinsurance programs, which could have a material adverse effect on the Insurance Entities’ and our business, financial condition, results of operations and liquidity. See “Item 7. Management’s Discussion of Financial Condition and Results of Operations - 2013-2014 Reinsurance Program” for a discussion of our reinsurance programs.
On December 14, 2012, we filed a shelf registration statement on Form S-3 with the SEC, registering (i) for issuance up to $100 million of Common Stock, preferred stock, debt securities, warrants, rights or depositary shares, or units consisting of any combination thereof and (ii) for resale up to 7 million shares of Common Stock owned by our former Chairman, President and Chief Executive Officer, Bradley I. Meier. The shelf registration statement is intended to give UIH additional flexibility to finance future business opportunities and support our insurance subsidiaries by accessing the capital markets in an efficient and cost effective manner. However, we have no present intention of offering any securities pursuant to this registration statement. We will not receive any proceeds from the sale of shares of Common Stock by Mr. Meier.
We are required to periodically estimate and reflect on our balance sheet the amount needed to pay losses and related loss adjustment expenses on reported and unreported claims. See Item 1, Business-“Liability for Unpaid Losses and LAE” for a description of this process. The following table sets forth a reconciliation of beginning and ending liability for unpaid losses and LAE as shown in our consolidated financial statements for the periods indicated (in thousands):
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 currently adequate to cover all claims and related expenses which may arise from incidents reported and IBNR. Favorable development for 2013 was primarily the result of loss settlements lower than anticipated on 2004 and 2005 catastrophe claims which were recognized during the calendar year, and favorable development of accident year 2011 and 2012 non-catastrophe loss estimates which were recognized at year end 2013 after a detailed actuarial analysis. Favorable reserve development in 2013 was somewhat offset by increases in loss adjustment expense estimates on non-catastrophe claims for 2010 through 2012 accident years that were recognized at year end.
The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to that reserve liability.
The Liability for Unpaid Losses and LAE re-estimates tables are cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years. Unfavorable reserve re-estimates are shown in parentheses.
The following Liability for Unpaid Losses and LAE re-estimates table illustrates the change over time of the reserves, net of reinsurance with separate disclosure of the related re-estimated reinsurance recoverable, established for unpaid losses and LAE for the Insurance Entities at the end of the last eleven calendar years through December 31, 2013 (in thousands):
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Universal Insurance Holdings, Inc. and Subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in the 1992 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have audited the accompanying consolidated statements of income, stockholders’ equity and cash flows of Universal Insurance Holdings, Inc. and Subsidiaries (the “Company”) for the year ended December 31, 2011. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Universal Insurance Holdings, Inc. and Subsidiaries for the year ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
Investment Securities, Trading. Investment securities held in the Company’s trading portfolio consisted of both debt and equity securities. Investment securities held in trading were recorded at fair value on the consolidated balance sheet, with unrealized gains and losses reported in current period earnings. All investment securities held by the Company as of December 31, 2012 were held in the trading portfolio. The Company liquidated its trading portfolio of equity securities and transferred the fixed maturities that were outstanding at December 31, 2012 into its portfolio of securities available for sale effective March 1, 2013.
Gains and losses realized on the disposition of investment securities held in trading were determined on the FIFO basis and credited or charged to income. Premium and discount on investment securities held in trading were amortized and accreted using the interest method and charged or credited to investment income.
Premiums Receivable. Generally, premiums are collected prior to providing risk coverage, minimizing the Company’s exposure to credit risk. The Company performs a policy level evaluation to determine the extent the premiums receivable balance exceeds the unearned premiums balance. The Company then ages this exposure to establish an allowance for doubtful accounts based on prior experience. As of December 31, 2013 and 2012, the Company had recorded allowances for doubtful accounts in the amounts of $446 thousand and $530 thousand, respectively.
Leases. The Company has operating leases that are subject to annual increases and amortizes the scheduled annual rental increases over the term of the leases.
Reinsurance. In the normal course of business, the Company seeks to reduce the risk of loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring (ceding) certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. The Company remains responsible for insured losses in the event of the failure of any reinsurer to make payments otherwise due to the Company. Amounts recoverable from reinsurers are estimated in a manner consistent with the provisions of the reinsurance agreement and consistent with the establishment of the liability of the Company. Allowances are established for amounts deemed uncollectible if any.
Income (Loss) Per Share of Common Stock. Basic earnings per share is computed by dividing the Company’s net income (loss), less preferred stock dividends, by the weighted-average number of shares of Common Stock outstanding during the period. Diluted earnings per share is computed by dividing the Company’s net income (loss) by the weighted average number of shares of Common Stock outstanding during the period and the impact of all dilutive potential common shares, primarily preferred stock, unvested shares, options and warrants. The dilutive impact of stock options, unvested shares and warrants is determined by applying the treasury stock method and the dilutive impact of the preferred stock is determined by applying the “if converted” method.
Concentrations of Credit Risk. The Company is exposed to concentrations of credit risk, consisting principally of cash and cash equivalents, restricted cash and cash equivalents, debt securities, premiums receivable, prepaid reinsurance premiums, reinsurance receivable and reinsurance recoverable.
The following table presents current ratings for each of these financial institutions from various rating agencies:
The following table presents current ratings from rating agencies and the unsecured amounts due from the Company’s reinsurers whose aggregate balance exceeded 3% of the Company’s stockholders’ equity as of the periods presented (in thousands):
(1) Amounts represent prepaid reinsurance premiums, reinsurance receivables, and net recoverables for paid and unpaid losses, including incurred but not reported reserves, loss adjustment expenses, and offsetting reinsurance payables. n/a-No rating available
In May 2011, the FASB updated its guidance related to the Fair Value Measurement, Topic 820 of the ASC, to achieve common fair value measurement and disclosure requirements with International Financial Reporting Standards. The amendments change the wording used to describe many of the requirements under U.S. GAAP, to clarify the intent of application of existing fair value measurement and disclosure requirements, and to change particular principles or requirements for measuring and disclosing fair value measurements. The amendments are to be applied prospectively to interim and annual reporting periods beginning after December 15, 2011. The Company adopted this guidance effective January 1, 2012. The adoption of this guidance resulted in additional disclosure but did not impact the Company’s results of operations, cash flows or financial position.
(1) Cash and cash equivalents include money market accounts consisting of or collateralized by short-term U.S. Treasury securities and other U.S. government guaranteed securities.
(3) Derivatives are included in Other assets and Other liabilities and accrued expenses in the Consolidated Balance Sheets.
(4) Other investments represent physical metals held by the Company and are included in Other assets in the Consolidated Balance Sheets.
The following table presents the amortized cost and fair value of fixed maturities available for sale by contractual maturity as of December 31, 2013 (in thousands):
Amounts recoverable from reinsurers are estimated in a manner consistent with the reinsurance contracts. Reinsurance premiums, losses and LAE are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Deferred ceding commissions are netted against policy acquisition costs and amortized over the effective period of the related insurance policies.
The Company’s primary product is homeowners insurance currently offered by APPCIC in one state (Florida) and by UPCIC in seven states, including Florida.
The following table provides the percentage of concentrations with respect to the Insurance Entities’ nationwide policies-in-force as of the periods presented:
As discussed in Note 2 - SIGNIFICANT ACCOUNTING POLICIES, the Company prospectively adopted new accounting guidance effective January 1, 2012 related to accounting for costs associated with acquiring or renewing insurance contracts. This guidance resulted in a 13% reduction of our net deferred policy acquisition costs as of December 31, 2011, and a corresponding pre-tax charge of $1.6 million against earnings during the first quarter of 2012. This charge represents a charge-off of capitalized costs existing at December 31, 2011, which would have been amortized to earnings within a twelve-month period under the old guidance. In the period of adoption (three months ended March 31, 2012), approximately $9 million of net costs would have been deferred under the old guidance compared to the $5.6 million under the new guidance. Future expenses will be accelerated with the adoption of this guidance, as the amounts being deferred have decreased, partially offset by less amortization. The effect of this change in periods subsequent to March 31, 2012, on income and per share amounts is not determinable as the historical methodology will have been discontinued after adoption.
The Insurance Entities establish liabilities for unpaid losses and loss adjustment expenses on reported and unreported claims of insured losses. These liability estimates are based on known facts and interpretation of factors such as claim payment patterns, loss payments, pending levels of unpaid claims, product mix and industry experience. The establishment of appropriate liabilities, including liabilities for catastrophes, is an inherently uncertain process. Management regularly updates its estimates as new facts become known and further events occur which may impact the resolution of unsettled claims.
Based on the 2012 statutory net income and statutory capital and surplus levels, UPCIC and APPCIC did not have the capacity to pay ordinary dividends during 2013. No dividends were paid from UPCIC or APPCIC to UIHCF during the years ended December 31, 2013, 2012 and 2011. Dividends paid to the shareholders of UIH are paid from the equity of UIH not from the surplus of the Insurance Entities.
Through UIHCF, the Insurance Entities’ parent company, UIH recorded capital contributions for the periods presented (in thousands):
In November 2012, the Florida Insurance Guaranty Association (“FIGA”) Board of Directors determined the need for an emergency assessment upon its member companies. The assessment was 0.9% of each respective member’s Florida net direct premiums for calendar year 2011. The Insurance Entities’ participation in this assessment totaled $6.3 million based on 2011 net direct premiums generated in Florida of approximately $704.8 million. Pursuant to Florida statutes, insurers are permitted to recoup the assessment by adding a surcharge to policies in an amount not to exceed the amount paid by the insurer to FIGA. As a result, the Insurance Entities recorded this assessment as an expense during the year ended December 31, 2012 and began to recoup the assessment on February 1, 2013. The Company has recouped the majority of this assessment as of December 31, 2013.
In May 2008, the Florida Legislature passed a law providing participants in the Program an opportunity to amend the terms of their surplus notes based on law changes. The new law contains methods for calculating compliance with the writing ratio requirements that are more favorable to UPCIC than prior law and the prior terms of the existing surplus note. On November 6, 2008, UPCIC and the SBA executed an addendum to the surplus note that reflects these law changes. The terms of the addendum were effective July 1, 2008. In addition to other less significant changes, the addendum modifies the definitions of Minimum Required Surplus, Minimum Writing Ratio, Surplus, and Gross Written Premium, respectively, as defined in the original surplus note.
The original surplus note provided for increases in interest rates for failure to meet the Minimum Writing Ratio. Under the terms of the surplus note agreement, at December 31, 2007, the interest rate on the note was increased by 450 basis points. As of June 30, 2008, the additional interest rate on the note was decreased from 450 basis points to 25 basis points. Under the terms of the surplus note, as amended, the net written premium to surplus requirement and gross written premium to surplus requirement have been modified. Further, UPCIC will be subject to increases in interest rates if it drops below a net written premium to surplus of 1:1 below a gross written premium to surplus ratio of 3:1 for three consecutive quarters beginning January 1, 2010. As of December 31, 2013, UPCIC’s net written premium to surplus ratio and gross written premium to surplus ratio were in excess of the required minimums and, therefore, UPCIC is not subject to increases in interest rates.
On May 23, 2013, UIH entered into a $20 million unsecured term loan agreement and related term note (“Term Loan”) with RenaissanceRe Ventures Ltd. (“RenRe Ventures”). See Note 11 - RELATED PARTY TRANSACTIONS, for a discussion of a series of agreements entered into with RenRe Ventures and its affiliate Renaissance Reinsurance Ltd. (“RenRe”).
The stated interest rate of the Term Loan of 0.50% is below the Company’s borrowing rate resulting in imputed interest and an original issue discount computed by calculating the present value of the future principal and interest payments utilizing the Company’s borrowing rate. Concurrent with the establishment of the original issue discount, the Company recorded a deferred credit, a component of other liabilities and accrued expenses, for an equal amount against premium payments the Company will make in connection with a catastrophe risk-linked transaction contract entered into with RenRe on the same date and with the same maturity date as the Term Loan. The original issue discount will be amortized to interest expense over the life of the Term Loan and the deferred credit will be amortized as a reduction in insurance expense, a component of general and administrative expenses, over the life of a covered loss index swap with RenRe.
The following table provides the principal amount and unamortized discount of the Term Loan for the period presented (in thousands):
Through the interest rate payment of 0.50% per annum and the amortization of the discount, the effective interest rate on the Term Loan is 5.99%. Amortization of the discount is included in interest expense, a component of general and administrative expenses, in the Consolidated Statements of Income and was $601 thousand for the twelve months ended December 31, 2013.
(1) Differs from amount presented in the Balance Sheet as of December 31, 2013 due to unamortized discount as presented in the table above.
Interest expense was $1.2 million, $414 thousand, and $856 thousand for the years ended December 31, 2013, 2012 and 2011, respectively.
As of December 31, 2013 and 2012, the Company had shares outstanding of Series A Preferred Stock and Series M Preferred Stock. Each share of Series A Preferred Stock and Series M Preferred Stock is convertible by the Company into shares of Common Stock.
The Series A Preferred Stock pays a cumulative dividend of $0.25 per share per quarter. During 2013 and 2012, respectively, the Company declared and paid aggregate dividends of $20 thousand to holders of record of the Company’s Series A Preferred Stock.
The Series M Preferred Stock pays a cumulative dividend of $0.20 per share per year. The Company declared and paid aggregate dividends to holders of record of the Company’s Series M Preferred Stock of $9 thousand and $267 thousand for the years ended December 31, 2013 and 2012, respectively.
During the year ended December 31, 2013, shareholders converted 77,740 shares of Series M Preferred Stock into 388,700 shares of Common Stock. There were no conversions of Series M Preferred Stock in 2012.
On August 1, 2013, UIH entered into a third repurchase agreement with Bradley I. Meier to repurchase an additional 350 thousand shares of UIH’s common stock owned by Mr. Meier. The repurchase of 350 thousand of Mr. Meier’s shares occurred on August 1, 2013 for a repurchase price of $7.02 per share, representing a discount from the then-current market price of UIH’s common stock.
At the 2011 Annual Meeting of Shareholders held on May 11, 2011, shareholders voted to approve the recommendation of the Company’s Board of Directors to amend the Incentive Plan. The Incentive Plan allows for amendments which are intended for the plan to remain a flexible and effective source of incentive compensation in terms of the number of shares of stock available for awards, in terms of its design, as well as whether it generally conforms with the best practices in today’s business environment. Significant aspects of the amendment include: an increase of 2.4 million shares in the shares reserved for grant, an adjustment to the annual maximum awards limits, a prohibition against re-pricing of options and stock appreciation rights without shareholder approval, and an addition of specific elements to the performance goals.
As of December 31, 2013, 1,947 thousand shares remained reserved for issuance and were available for new awards under the Incentive Plan.
The following table provides certain information related to stock options and restricted stock during the year ended December 31, 2013 (in thousands, except per share data):
(1) Unless otherwise specified, such as in the case of the exercise of stock options, the per share prices were determined using the closing price of the Company’s Common Stock as quoted on the exchanges on which the Company was listed. Shares issued upon exercise of options represent original issuances in private transactions pursuant to Section 4(2) of the Securities Act of 1933, as amended or issuances under the Company’s 2009 Omnibus Incentive Plan.
(2) All shares outstanding as of December 31, 2013 are expected to vest.
On September 4, 2012, the Company granted stock options for an aggregate 500 thousand shares of Common Stock to the Company’s COO in consideration for services rendered pursuant to terms of an employment agreement and to provide the COO with a continued incentive to share in the success of the Company. The options have an exercise price of $3.51, expire on September 4, 2019 and vest over two years as follows: options for 250 thousand shares on the one year anniversary of the grant date and options for 250 thousand shares on the two year anniversary of the grant date.
On November 12, 2013, the Company granted the Chief Administrative Officer (“CAO”) a stock option to purchase 200 thousand shares of common stock. The Company also granted the CEO a stock option to purchase 300 thousand shares of common stock. Both option grants have an exercise price of $8.01 per share, expire on November 12, 2020 and vest over three years as follows: one third on the one (1) year anniversary of the date of grant, one third on the two (2) year anniversary of the date of grant and one third on the three (3) year anniversary of the date of grant.
Restricted stock grants are awarded to certain employees in consideration for services rendered pursuant to terms of employment agreements and or to provide to those employees with a continued incentive to share in the success of the Company. Non-vested shares (“restricted stock”) generally vest over a three year service period commencing on the grant date. The prices discussed below reflect the market price of UIH’s common stock on the grant date.
The Company issued 600 thousand shares of performance-based restricted Common Stock at a price of $5.61 per share to its COO. Shares of 200 thousand vest on each of the first, second and third anniversary of the grant date which was March 28, 2011, subject to shareholder approval and annual performance criteria. This grant was not effective until shareholder approval which took place May 11, 2011.
Effective August 8, 2013, the Company issued 150 thousand shares of restricted Common Stock at a price of $8.55 per share to its CFO. The stock vests cumulatively over a two-year period as follows: 50 percent and 50 percent, respectively, on October 1, 2014 and October 1, 2015.
The plan titled the “Universal Property & Casualty 401(K) Profit Sharing Plan and Trust” (“401(k) Plan”) is a defined contribution plan that allows employees to defer compensation through contributions to the 401(k) Plan. The contributions are invested on the employees’ behalf, and the benefits paid to employees are based on contributions and any earnings or loss. The 401(k) Plan includes a Company contribution of 100 percent of each eligible participant’s contribution that does not exceed five percent of their compensation during the 401(k) Plan year. The Company may make additional profit-sharing contributions. However, no additional profit-sharing contribution was made during the years ended December 31, 2013, 2012 and 2011.
There were no amounts due to Downes and Associates and SPC Global RE Advisors LLC as of December 31, 2013 and 2012. Payments due to Downes and Associates and SPC Global RE Advisors LLC were generally made in the month the services were provided.
Deferred income taxes represent the temporary differences between the GAAP and tax basis of the Company’s assets and liabilities. The tax effects of temporary differences are as follows as of the periods presented (in thousands):
The Company filed a consolidated federal income tax return for the fiscal years ended December 31, 2012, 2011, and 2010 and intends to file the same for the year ended December 31, 2013. The tax allocation agreements between the Company and the Insurance Entities provide that they will incur income taxes based on a computation of taxes as if they were stand-alone taxpayers. The computations are made utilizing the financial statements of the Insurance Entities prepared on a statutory basis of accounting and prior to consolidating entries which include the conversion of certain balances and transactions of the statutory financial statements to a U.S. GAAP basis.
(1) Represents the dilutive effect of unvested restricted stock and unexercised stock options.
The Company purchased 7.257 million shares of UIH’s common stock during the twelve months ended December 31, 2013, which decreased weighted average common shares outstanding and weighted average diluted common shares outstanding for these periods. The effect was to increase diluted earnings per common share by $0.17 for the twelve month period ended December 31, 2013. There were no repurchases of UIH’s common stock during 2012 and 2011. See “-Note 8 (Stockholders’ Equity)” for details on the repurchases of UIH’s common stock.
The following table provides the reclassifications out of accumulated other comprehensive income for the period presented (in thousands):
Also on July 12, 2013, UPCIC entered into a purchase agreement to acquire the Property (“Purchase Agreement”). The Purchase Agreement provides that the closing for the sale of the Property will take place no later than February 5, 2015. The closing for the sale of the Property is subject to certain closing conditions. The purchase price for the Property is $5.99 million, and UPCIC will receive a credit toward the purchase price for a portion of the rent it pays under the Lease Agreement.
Total rental expense was $423 thousand, $286 thousand and $451 thousand in 2013, 2012 and 2011, respectively.
Certain lawsuits have been filed against the Company. These lawsuits involve matters that are routine litigation incidental to the claims aspect of the Company’s business for which estimated losses are included in Unpaid Losses and Loss Adjustment Expenses in the Company’s Consolidated Financial Statements. In the opinion of management, these lawsuits are not material individually or in the aggregate to the Company’s financial position or results of operations. Accruals made or assessments of materiality of disclosure related to probable or possible losses do not consider any anticipated insurance proceeds.
Corporate Bonds: Comprise investment-grade fixed maturity securities. The primary inputs to the valuation include quoted prices for identical assets in inactive markets or similar assets in active or inactive markets, contractual cash flows, benchmark yields and credit spreads.
Mortgage-backed and asset-backed securities: Comprise securities that are collateralized by mortgage obligations and other assets. The primary inputs to the valuation include quoted prices for identical assets in inactive markets or similar assets in active or inactive markets, contractual cash flows, benchmark yields, collateral performance, prepayment speeds and credit spreads.
The Company utilizes third-party independent pricing services that provide a price quote for each fixed maturity, equity security and derivative. Management reviews the methodology used by the pricing services. If management believes that the price used by the pricing service does not reflect an orderly transaction between participants, management will use an alternative valuation methodology. There were no adjustments made by the Company to the prices obtained from the independent pricing source for any fixed maturities, equity securities or derivatives included in the tables above.
The fair value of the Term Loan approximates the carrying value given the original issue discount which was calculated based on the present value of future cash flows using the Company’s effective borrowing rate for similar instruments.
The Company performed an evaluation of subsequent events through the date the financial statements were issued and determined there were no recognized or unrecognized subsequent events that would require an adjustment or additional disclosure in the consolidated financial statements as of December 31, 2013 except for the following.
On January 30, 2014, the Company declared a dividend of $0.10 per share on its outstanding common stock payable on March 3, 2014, to shareholders of record on February 19, 2014.