Effective March 1, 2005, Federated National sold its interest in the Lauderdale Lakes property to 21st Century at the property’s net book value of approximately $2.9 million. Effective on or about March 1, 2006, 21st Century sold the property to an unrelated party for approximately $5.0 million cash and a $0.9 million six year 5% note. As part of the transaction, 21st Century has agreed to lease the same facilities for a six year term. Our lease for this office space expires in December 2011.
The insurable events during 2009, 2008 and 2007 did not include any weather related catastrophic events such as the well publicized series of hurricanes that occurred in Florida during 2005 and 2004. During 2009, 2008 and 2007 we processed property and liability claims stemming from our homeowners’, commercial general liability and private passenger automobile lines of business. Our reinsurance strategy serves to smooth the liquidity requirements imposed by the most severe insurable events and for all other insurable events we manage, at a micro and macro perspective, in the normal course of business.
We are not certain how hurricanes and other insurable events will affect our future results of operations and liquidity. Loss and loss adjustment expenses (“LAE”) are affected by a number of factors including:
Despite the effects of Florida’s mandated homeowners’ rate reductions and wind mitigation discounts, the Company’s sale of homeowners’ policies increased $24.0 million, or 39.5%, to $84.7 million in 2009, compared with $60.7 million in 2008. Included in our sale of homeowners’ policies during 2009, is $17.9 million from policies we assumed from Citizens Property Insurance Corporation (“Citizens”). The primary factor for the decrease in commercial general liability production is a slowdown in the economy which has a dramatic impact on the artisan contractor portfolio written by American Vehicle.
Our business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on our business, results of operations and financial condition. In addition, if our estimated liabilities for unpaid losses and LAE are less than actual losses and LAE, we will be required to increase reserves with a corresponding reduction in our net income in the period in which the deficiency is identified. We internally process claims made by our insureds through our wholly owned claims adjusting company, Superior Adjusting, Inc. (“Superior”).
Bornhuetter-Ferguson Paid Method - This method is similar to the Bornhuetter-Ferguson Incurred Method only paid loss & DCCE and paid patterns are substituted for the incurred loss & DCCE and incurred patterns.
We select an estimate of ultimate loss & DCCE for each accident quarter after considering the results of each projection method for the quarter and the relative maturity of the quarter (the time elapsed between the start of the quarter and December 31, 2009). Reserves for unpaid losses & DCCE for each quarter are the differences between these ultimate estimates and the amount already paid. The reserves for each quarter and each coverage are summed, and the result is the overall estimate of unpaid losses & DCCE liability for the company.
The following describes the extent of our procedures for determining the reserve for loss and LAE on both an annual and interim reporting basis:
Interim - During 2009 our interim approach was very similar to the annual process noted above.
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, 2009 premised on future emergence inconsistent with historical loss reserve development patterns.
See Note 2(n), “Summary of Significant Accounting Policies - Recent Accounting Pronouncements” in the Notes to the Condensed Consolidated Financial Statements for a discussion of other recent accounting pronouncements and their effect, if any, on the Company.
Investments classified as held-to-maturity include debt securities wherein the Company’s intent and ability are to hold the investment until maturity. The accounting treatment for held-to-maturity investments is to carry them at amortized cost without consideration to unrealized gains or losses. Investments classified as trading securities include debt and equity securities bought and held primarily for sale in the near term. The accounting treatment for trading securities is to carry them at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments. The accounting treatment for available-for-sale securities is to carry them at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, namely “Other Comprehensive Income”.
Total Investments increased $88.1 million, or 338.2%, to $114.2 million as of December 31, 2009, compared with $26.1 million as of December 31, 2008. Our debt portfolio contained callable features exercised in 2008. The proceeds from our called securities were in cash and short-term investments as of December 31, 2008. During 2008, the Company engaged an outside investment advisor and during 2009 the funds were invested in long and short term investments with yields that best match our liquidity needs.
Below is a summary of net unrealized gains and losses at December 31, 2009 and December 31, 2008 by category. The $0.1 million unrealized losses for debt securities is related to United States Treasury obligations. The unrealized losses on the Company’s investments in United States Treasury obligations were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporary impaired at December 31, 2009.
In reaching a conclusion that a security is either other than temporary or permanently impaired, we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor’s and Moody’s Investors Service, Inc. (“Moody’s”), as well as information released via the general media channels. During 2009, in connection with this process, we have not charged any net realized investment loss to operations.
As of December 31, 2009, 36.9% of the investment portfolio is in corporate bonds, 34.4% is in obligations of states and political subdivisions, and 11.2% is in United States government bonds.
As of December 31, 2009 and 2008 we have classified $2.7 million and $13.5 million, respectively, of our bond portfolio as held-to-maturity. We only classify bonds as held to maturity to support collateralized letters of credit. Outstanding irrevocable letters of credit, used for such purposes, total $2.8 million and $3.0 million for the period ended December 31, 2009 and December 31, 2008, respectively.
During 2009, we reclassified $5.0 million of amortized cost to available-for-sale from held-to-maturity because a collaterized requirement was reduced.
During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic Underwriters Insurance Company (“Republic”) which was terminated in April 2007. As of December 31, 2007 the letter of credit in favor of Republic totaled $10.0 million. As of December 31, 2008 the letter of credit in favor of Republic totaled $3.0 million. As of December 31, 2009 the letter of credit in favor of Republic totaled $1.0 million.
Cash and short-term investments, which include cash, certificates of deposits, and money market accounts, decreased $96.4 million, or 77.4%, to $28.2 million as of December 31, 2009, compared with $124.6 million as of December 31, 2008.
Our debt portfolio contained callable features exercised in 2008. The proceeds from our called securities were in cash and short-term investments as of December 31, 2008. During 2008, the Company engaged an outside investment advisor and during 2009 the funds were invested in long and short term investments with yields that best match our liquidity needs.
Premiums receivable, net of allowance for credit losses, increased $6.9 million, or 207.5%, to $10.3 million as of December 31, 2009, compared with $3.4 million as of December 31, 2008.
Our homeowners’ insurance premiums receivable increased $7.3 million, to $9.0 million as of December 31, 2009, compared with $1.7 million as of December 31, 2008. The increased homeowners’ insurance premiums receivable includes $5.4 million assumed premiums receivable in connection with our citizens take-out. Our commercial general liability insurance premiums receivable decreased $0.8 million, or 47.7%, to $0.9 million as of December 31, 2009, compared with $1.7 million as of December 31, 2008. Premiums receivable in connection with our automobile line of business increased $0.4 million, or 308.3%, to $0.5 million as of December 31, 2009, compared with $0.1 million as of December 31, 2008. Our allowance for credit losses decreased $0.1 million, or 79.9%, to less than $0.1 million as of December 31, 2009, compared with more than $0.1 million as of December 31, 2008.
The activity in the allowance for credit losses for premiums receivable was as follows.
Reinsurance recoverable, net, decreased $1.6 million, or 9.39%, to $15.3 million as of December 31, 2009, compared with $16.9 million as of December 31, 2008. The change is due to payment patterns by our reinsurers. All amounts are current and deemed collectable. We believe concentrations of credit risk associated with our reinsurance recoverables, net are not significant.
Property, plant and equipment, net, remained unchanged at $0.9 million as of December 31, 2009 and December 31, 2008.
Unpaid losses and LAE increased $5.8 million, or 9.0%, to $70.6 million as of December 31, 2009, compared with $64.8 million as of December 31, 2008. The composition of unpaid losses and LAE by product line is as follows.
Premium deposits and customer credit balances increased $0.4 million, or 25.3%, to $2.1 million as of December 31, 2009, compared with $1.7 million as of December 31, 2008. Premium deposits are monies received on policies not yet in-force as of December 31, 2009.
Bank overdraft decreased $0.4 million, or 5.1%, to $8.3 million as of December 31, 2009, compared with $8.7 million as of December 31, 2008. The bank overdraft relates primarily to losses and LAE disbursements paid but not presented for payment by the policyholder or vendor. The change relates to our payment patterns in relationship to the rate at which those cash disbursements are presented to the bank for payment.
Accounts payable and accrued expenses decreased $1.1 million, or 29.9%, to $2.6 million as of December 31, 2009, compared with $3.7 million as of December 31, 2008. This change is due to the timing of payments with our trade vendors.
Gross premiums written increased $16.2 million, or 18.3%, to $104.4 million for the year ended December 31, 2009 (“2009”), compared with $88.2 million for the year ended December 31, 2008 (“2008”). The following table denotes gross premiums written by major product line.
We continue to afford premium discounts in response to wind mitigation efforts by policyholders. Such discounts, which were required by the Florida Legislature and became effective on December 15, 2007 for new business and renewal business, have also had a significant effect on both written and earned premium. During 2009 and 2008 wind mitigation credits totaling $9.8 million and $15.3 million were afforded our policyholders, respectively. As of December 31, 2009, 56.8% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $27.6 million, (a 24.2% reduction of in-force premium), while 52.1% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $17.8 million, (a 22.2% reduction of in-force premium), as of December 31, 2008.
Despite the effects of Florida’s mandated homeowners’ rate reductions and wind mitigation discounts the Company’s sale of homeowners’ policies increased $24.0 million, or 39.5%, to $84.7 million in 2009, compared with $60.7 million in 2008. Included in our sale of homeowners’ policies during 2009, is $17.9 million from policies we assumed from Citizens.
Federated National and American Vehicle are currently rated by Demotech as "A" ("Exceptional"), which is the third of seven ratings, and defined as “Regardless of the severity of a general economic downturn or deterioration in the insurance cycle, insurers earning a Financial Stability Rating (“FSR”) of “A” possess “Exceptional” financial stability related to maintaining surplus as regards to policyholders”. Demotech’s ratings are based upon factors of concern to agents, reinsurers and policyholders and are not primarily directed toward the protection of investors. However, our Demotech rating could be jeopardized by such other factors including adverse development and various surplus related ratio exceptions. On June 11, 2009, Demotech reaffirmed Federated National’s FSR of “A” (“Exceptional”).
The Company’s sale of auto insurance policies increased by $0.3 million to $0.8 million in 2009, compared with $0.5 million in 2008.
Commission income decreased $0.2 million, or 15.5%, to $1.4 million in 2009, compared with $1.6 million in 2008. The primary sources of our commission income are in connection with our managing general agent services and our independent insurance agency, Insure-Link, Inc. (“Insure-Link”).
Managing general agent fees decreased $0.1million, or 7.2%, to $1.6 million in 2009, compared with $1.7 million in 2008.
Net investment income decreased $3.1 million to $3.4 million for 2009, compared with $6.5 million for 2008. Our investment yield net and gross of investment expenses were 2.1% and 2.3% respectively for 2009, compared with 4.1% net of investment expenses for 2008. Our investment yield net and gross of investment expenses measured against debt securities, excluding cash were 3.5% and 3.7% respectively for 2009. Our net investment income and yield were adversely affected by having an average cash balance of $55.0 million in the prime money market account that provided less than a 1% yield during 2009.
Dividend income decreased $0.3 million to $0.5 million for 2009, compared with $0.8 million for 2008. Short-term income decreased $0.9 million to $0.2 million for 2009, compared with $1.1 million for 2008.
Losses and LAE increased by $1.8 million, or 4.4%, to $43.7 million for 2009, compared with $41.9 million for 2008. The overall change includes a $4.5 million increase in our homeowners’ program, a $6.0 million decrease in our commercial general liability program and a $3.3 million increase in connection with our automobile program.
The change is partially due to the addition of Insure-Link, created to serve as an independent insurance agency, for which operating and underwriting expenses increased to $1.1 million for the twelve months ended December 31, 2009, compared with $0.1 million for the twelve months ended December 31, 2008. Additionally, assessments paid, investment fees and bad debt expense increased a net total $1.5 million for the twelve months ended December 31, 2009, compared with the twelve months ended December 31, 2008.
The effective rate for income taxes was 36.5% for 2009, compared with 34.8% for 2008.
Gross premiums written decreased $45.4 million, or 33.9%, to $88.2 million for the year ended December 31, 2008 (“2008”), compared with $133.6 million for year ended December 31, 2007 (“2007”). The following table denotes gross premiums written by major product line.
Federated National and American Vehicle are currently rated by Demotech as "A" ("Exceptional"), which is the third of seven ratings, and defined as “Regardless of the severity of a general economic downturn or deterioration in the insurance cycle, insurers earning a FSR of “A” possess “Exceptional” financial stability related to maintaining surplus as regards to policyholders”. Demotech’s ratings are based upon factors of concern to agents, reinsurers and policyholders and are not primarily directed toward the protection of investors. See “Industry Rating Services”. However, our Demotech rating could be jeopardized by such other factors including the letter we received from Demotech on March 22, 2010, adverse development and various surplus related ratio exceptions.
The Company’s sale of commercial general liability policies decreased by $8.4 million to $23.8 million in 2008, compared with $32.2 million in 2007. This decrease is due to increased competition in the commercial general liability market. The following table sets forth the amounts and percentages of our gross premiums written in connection with our commercial general liability program by state.
Finance revenue decreased $0.1 million, or 35.7%, to $0.4 million in 2008, compared with $0.5 million in 2007. The change was primarily due to the Company’s decreased emphasis on automobile insurance and the finance revenue derived there-from.
In 2008 we marked certain equity investments to market value pursuant to guidelines prescribed in FASB issued guidance. In reaching a conclusion that a security is either other than temporary or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor’s and Moody’s, as well as information released via the general media channels. The pretax charge to operations was approximately $9.9 million in connection with our estimates of the net realizable value of these investments. A significant number of these investments were subsequently sold in 2008, and we recognized an additional pretax charge to operations of $0.2 million.
Losses and LAE decreased by $5.7 million, or 12.1%, to $41.9 million in 2008, compared with $47.6 million in 2007. The overall change includes a $1.0 million decrease in our homeowners’ program, a $2.3 million increase in our commercial general liability program and a $7.0 million decrease in connection with our automobile program.
Management revises its estimates based on the results of its analysis. This process assumes that past 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 $5.1 million in 2008.
In accordance with GAAP, 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 in 2008 was 64.3% compared with 48.0% for the same period in 2007. The table below reflects the loss ratios by product line.
The provision for income tax benefit was $1.3 million in 2008, compared with an income tax expense of $11.2 million in 2007. The effective rate for income taxes was 34.8% in 2008, compared with 34.5% in 2007.
As a result of the foregoing, the Company’s net loss in 2008 was $2.5 million compared with net income of $21.3 million in 2007.
In 2009, net financing activities used $2.0 million, as compared with $4.3 million and $9.2 million in 2008 and 2007, respectively. In 2009, the sources of cash in connection with financing activities included a $0.2 million tax benefit related to non-cash compensation. The uses of cash in connection with financing activities included $1.9 million in dividends paid and $0.3 million for the purchase of treasury stock.
We offer direct billing in connection with our automobile and homeowner programs. Direct billing is an agreement in which the insurance company accepts from the insured, as a receivable, a promise to pay the premium, as opposed to requiring the full amount of the policy at policy inception, either directly from the insured or from a premium finance company. The advantage of direct billing a policyholder by the insurance company is that we are not reliant on a credit facility, but remain able to charge and collect interest from the policyholder.
As of December 31, 2009, 2008, and 2007, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “structured finance” or “special purpose” entities, which were established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. As such, management believes that we currently are not exposed to any financing, liquidity, market or credit risks that could arise if we had engaged in transactions of that type requiring disclosure herein.
Insurance premiums are established before we know the amount of losses and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate premiums, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation also affects the market value of our investment portfolio and the investment rate of return. Any future economic changes that result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred losses and LAE and thereby materially adversely affect future liability requirements.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of 21st Century Holding Company as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, 21st Century Holding Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We are not certain how hurricanes and other insurable events will affect our future results of operations and liquidity. Loss and LAE are affected by a number of factors including:
Despite the effects of Florida’s mandated homeowners’ rates reduction and wind mitigation discounts the Company’s sale of homeowners’ policies increased $24.0 million, or 39.5%, to $84.7 million in 2009, compared with $60.7 million in 2008. Included in our sale of homeowners’ policies during 2009, is $17.9 million from policies we assumed from Citizens. The primary factor for the decrease in commercial general liability production is a slowdown in the economy, which has a dramatic impact on the artisan contractor portfolio written by American Vehicle.
A decline in the fair value of an available-for-sale security below cost that is deemed other than temporary results in a charge to income, resulting in the establishment of a new cost basis for the security. Premiums and discounts are amortized or accreted, respectively, over the life of the related debt security as an adjustment to yield using a method that approximates the effective interest method. Dividends and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific-identification method for determining the cost of securities sold.
Accounting for loss contingencies pursuant to FASB issued guidance involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur. Additionally, accounting for a loss contingency requires management to assess each event as probable, reasonably possible or remote. Probable is defined as the future event or events are likely to occur. Reasonably possible is defined as the chance of the future event or events occurring is more than remote but less than probable, while remote is defined as the chance of the future event or events occurring is slight. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: First, the amount can be reasonably estimated, and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements. It is implicit in this condition that it is probable that one or more future events will occur confirming the fact of the loss or incurrence of a liability.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss, capital loss and tax-credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income or expense in the period that includes the enactment date.
In June 2009, the FASB issued new accounting guidance related to accounting standards codification and the hierarchy of GAAP. This guidance provides for the FASB Accounting Standards Codification (the “Codification”) to become the single official source of authoritative, nongovernmental United States GAAP. The Codification did not change GAAP but reorganized the literature. The guidance is effective for interim and annual periods ending after September 15, 2009.
In May 2009, FASB issued guidance related to subsequent events. The objective of the guidance is to establish general standards of accounting for disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. In particular, the guidance sets forth:
the disclosures that an entity should make about events or transactions that occurred after the balance sheet date.
In April 2009, the FASB issued new accounting guidance related to the recognition and presentation of other-than-temporary impairments. In April 2009, the SEC also adopted similar guidance with Staff Accounting Bulletin (“SAB”) No. 111 (“SAB 111”) on Other-Than Temporary Impairment. This new accounting guidance establishes a new method of recognizing and reporting other-than-temporary impairments of debt securities and contains additional disclosure requirements related to debt and equity securities. For debt securities, the “ability and intent to hold” provision is eliminated, and impairment is considered to be other-than-temporary if an entity (i) intends to sell the security, (ii) more likely than not will be required to sell the security before recovering its cost, or (iii) does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). This new framework does not apply to equity securities (i.e., impaired equity securities will continue to be evaluated under previously existing guidance). The “probability” standard relating to the collectability of cash flows is eliminated, and impairment is now considered to be other-than-temporary if the present value of cash flows expected to be collected from the debt security is less than the amortized cost basis of the security. The accounting guidance provides that for debt securities which (i) an entity does not intend to sell and (ii) it is not more likely than not that the entity will be required to sell before the anticipated recovery of its remaining amortized cost basis, the impairment is separated into the amount related to estimated credit losses and the amount related to all other factors. The amount of the total impairment related to all other factors is recorded in other comprehensive loss and the amount related to estimated credit loss is recognized as a charge against current period earnings. The new guidance expands disclosure requirements for both debt and equity securities and requires a more detailed, risk-oriented breakdown of security types and related information, and requires that the annual disclosures be made in interim periods. The accounting guidance is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. At the time of adoption, the Company did not have any Other Than Temporary Impairments for debt securities, and, the adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
In October 2008, the FASB issued new accounting guidance related to determining the fair value of a financial asset when the market for that asset is not active. The purpose of the guidance was to clarify the application of previous accounting guidance. The guidance allows for the use of management’s internal assumptions about future cash flows with appropriately risk-adjusted discount rates when relevant observable market data does not exist. The guidance was effective upon issuance, including prior periods for which financial statements had not been issued. The adoption of this guidance did not have a material impact on the Company’s financial statements or condition.
In April 2009, the FASB issued further accounting guidance related to determining fair value when the volume and level of activity for an asset or liability have significantly decreased and identifying transactions that are not orderly. The guidance indicates that if an entity determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. The guidance is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted and must be applied prospectively. The adoption of this guidance did not have a material impact on the Company’s financial statements or condition.
In February 2007, FASB issued new accounting guidance related to the fair value option for financial assets and financial liabilities. This guidance permits an entity to measure many financial assets and financial liabilities at fair value that are not currently required to be measured at fair value. Entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected on an instrument-by-instrument basis, with a few exceptions. This guidance amends previous guidance to extend the use of the fair value option to available-for-sale and held-to-maturity securities. The guidance also establishes presentation and disclosure requirements to help financial statement users understand the effect of the election. We adopted this guidance on its effective date, January 1, 2008. The Company did not elect to measure any financial assets and liabilities, and accordingly, to date, there is no impact on our consolidated financial statements.
Our financial condition could be adversely affected by the occurrence of natural and man-made disasters.
We have used 99.2% of the reinsurance coverage available for Hurricane Wilma and if any claims exceed this coverage amount, it could adversely impact our business, results of operations and/or financial condition.
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 loss reserves may be inadequate to cover our actual liability for losses, causing our results of operations to be adversely affected.
Our investment portfolio may suffer reduced returns or losses, which would significantly reduce our earnings.
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.
As a holding company, we depend on the earnings of our subsidiaries and their ability to pay management fees and dividends to the holding company as the primary source of our income.
During the year ended December 31, 2009, the Company had two stock-based employee compensation plans, which are described later in Footnote 16, 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.
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 the nine months ended September 30, 2009 and 2008 include:
Certain 2008 and 2007 financial statement amounts have been reclassified to conform to the 2009 presentations.
During 2009, the Company purchased one intangible asset totaling $0.1 million. In accordance with FASB issued guidance, the accounting for the recognized intangible asset is based on its useful life to the Company. The useful life of the intangible asset is the period over which it is expected to contribute directly or indirectly to the future cash flows of the Company. The intangible asset has a definite finite life ranging from six to twelve months, and is amortized accordingly.
Additional provisions contained in FASB issued guidance address the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. The Company’s policy for the valuation of temporary impaired securities is to determine impairment based on the analysis of the following factors:
Pursuant to FASB issued guidance, the Company records the unrealized losses, net of estimated income taxes that are associated with that part of our portfolio classified as available for sale through the shareholders' equity account titled “Other Comprehensive Income”. Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other than temporary or permanently impaired. Factors used in such consideration include, but are not limited to, the extent and length of time over which the market value has been less than cost, the financial condition and near-term prospects of the issuer and our ability and intent to keep the investment for a period sufficient to allow for an anticipated recovery in market value.
During 2008 we charged to operations a net realized investment loss that totaled approximately $9.9 million, net of an estimated provisional tax effect of approximately $3.7 million. Most of these investments were subsequently sold during the third and fourth quarter of the year, and, we recognized an additional $0.2 million loss, net of an estimated tax benefit of approximately $0.1 million.
The investments held as of December 31, 2009, were comprised mainly of corporate bonds held in various industries and municipal and United States government bonds. The investments held as of December 31, 2008, were comprised mainly of United States government and agency bonds, as well as municipal bonds and corporate bonds held in the financial and conglomerate industries. As of December 31, 2009, 89% of the debt portfolio is in diverse industries and 11% is in United States government bonds. As of December 31, 2009, approximately 89% of the equity holdings are in equities related to diverse industries and 11% are in mutual funds.
During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic which was terminated in April 2007. As of December 31, 2007 the letter of credit in favor of Republic totaled $10.0 million. As of December 31, 2008 the letter of credit in favor of Republic totaled $3.0 million. As of December 31, 2009 the letter of credit in favor of Republic totaled $1.0 million.
The following table summarizes, by type, our investments as of December 31, 2009 and 2008.
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of debt and equity securities at December 31, 2009 and 2008 is as follows.
Below is a summary of debt securities at December 31, 2009 and 2008 by contractual or expected maturity periods. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
United States Treasury notes with a book value of $1,039,000 and $1,045,000, both maturing in 2012, were on deposit with the Florida OIR as of December 31, 2009, as required by law for American Vehicle and Federated National respectively, and are included with other investments held until maturity.
A summary of realized investment gains (losses) and increases in net unrealized gains follows.
As security, Federated Premium Finance, Inc. (“Federated Premium”) retains a contractual right, if a premium installment is not paid when due, to cancel the insurance policy and to receive the unearned premium from the insurer.
The impact of the excess of loss reinsurance treaties on the financial statements is as follows.
The impact of the quota-share reinsurance treaties on the financial statements is as follows.
Based upon the results of our analysis and the application of the provisions of FIN 48, we have determined that all material tax positions meet the recognition threshold and can be considered as highly certain tax positions. This is based on clear and unambiguous tax law, and we are highly confident that the full amount of each tax position will be sustained upon possible examination. Accordingly, the full amount of the tax positions will be recognized in the financial statements.
In 2008, approximately $30,000 penalties and interest were paid in conjunction with our 2007 Federal Income Tax Return and were included within our provision for income tax benefit.
As of December 31, 2009, to meet regulatory requirements, we had bonds with a carrying value of approximately $2.0 million pledged to the Florida OIR.
While the non-insurance company subsidiaries (Assurance MGA, Superior and any other affiliate) are not subject directly to the dividend and other distribution limitations, insurance holding company regulations govern the amount that any affiliate within the holding company system may charge any of the insurance companies for service (e.g., management fees and commissions).
Federated National anticipates a regularly scheduled statutory examination by the Florida OIR to occur during April 2010 for the five years ended December 31, 2009. American Vehicle anticipates a regularly scheduled statutory examination by the Florida OIR to occur during 2011 for the five years ended December 31, 2010. We have not received any notice of such examinations for American Vehicle.
As of December 31, 2009, Federated National was outside NAIC’s usual range for four of thirteen IRIS ratios. Three exceptions related to underwriting operations and one related to lower than expected investment yields. The operations ratios relate to the timing of premium rate corrections and elevated reinsurance costs. The Florida OIR granted Federated National an average statewide increase of 19.0% for policies that went into effect November 1, 2209 and December 1, 2009 for new and renewed homeowner insurance policies, respectively. As of December 31, 2008, Federated National was outside NAIC’s usual ranges with respect to its tests on two out of thirteen IRIS ratios. There was one exception in connection with change in net written premium and one in connection with two year reserve development to policyholders’ surplus.
The table below reflects the range and test results for both Federated National and American Vehicle for the years ended December 31, 2009 and 2008, respectively.
We are involved in claims and legal actions arising in the ordinary course of business. Revisions to our estimates are based on our analysis of subsequent information that we receive regarding various factors, including: (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages, and (iv) trends in general economic conditions, including the effects of inflation. 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. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, results of operations, or liquidity.
The Company's subsidiaries are, from time to time, named as defendants in various lawsuits incidental to their insurance operations. Legal actions relating to claims made in the ordinary course of seeking indemnification for a loss covered by the insurance policy are considered by the Company in establishing loss and LAE reserves.
The Company also faces, in the ordinary course of business, lawsuits that seek damages beyond policy limits, commonly known as bad faith claims. 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.
We operate in a regulatory environment where certain entities and organizations have the authority to require us to participate in assessments. Currently these entities and organizations include, but are not limited to, Florida Insurance Guaranty Association (“FIGA”), Citizens, Florida Hurricane Catastrophe Fund (“FHCF”) and Florida Joint Underwriters Insurance Company (“JUA”).
As a direct premium writer in the state of Florida, we are required to participate in certain insurer solvency associations under Florida Statutes Section 631.57(3) (a), administered by FIGA. Participation in these pools is based on our written premium by line of business to total premiums written statewide by all insurers. Participation has resulted in assessments against us, as it has in 2006 and 2007, and again on October 30, 2009. There were no assessments made for the year ended December 31, 2008. Through 2007, we have been assessed $6.7 million and in 2009 we were assessed an additional $0.6 million in connection with the insolvencies of domestic insurance companies. For statutory accounting these assessments are not charged to operations, in contrast, GAAP treatment is to charge current operations for the assessments. Through policyholder surcharges, as approved by the Florida OIR, we have since recouped $6.2 million in connection with these assessments.
The State Board of Administration ("SBA") and the FHCF Financing Corporation are considering a resolution that would authorize the issuance and sale of FHCF post-event revenue bonds not to exceed $710 million. The proceeds of the bonds would be used for the reimbursement of insurance companies for additional claims due to hurricanes during the 2005 season. These bonds will have fixed interest rates, be exempt from federal income taxes and be secured by not yet implemented emergency assessments and reimbursement premiums. The inability to issue these bonds could result in the FHCF's need to accelerate additional assessments. We have not recorded any liability in connection with this initiative.
During a subsequent regularly scheduled meeting on or about December 18, 2006, Citizens Board determined an additional 2004 plan year deficit existed in the High Risk Account. Citizens decided that a $515 million Regular Assessment was in the best interest of Citizens and consistent with Florida Statutes. On this basis, Citizens certified for a Regular Assessment. Federated National’s participation in this assessment totaled $0.3 million. Provisions contained in our excess of loss reinsurance policies provided for participation of our reinsurers totaling $1.8 million of the $2.3 million in assessments. There was no assessment made for 2008 or 2009.
Federated National and American Vehicle are also required to participate in an insurance apportionment plan under Florida Statutes Section 627.351, which is referred to as a JUA Plan. The JUA Plan provides for the equitable apportionment of any profits realized, or losses and expenses incurred, among participating automobile insurers. In the event of an underwriting deficit incurred by the JUA Plan which is not recovered through the policyholders in the JUA Plan, such deficit shall be recovered from the companies participating in the JUA Plan in the proportion that the net direct written premiums of each such member during the preceding calendar year bear to the aggregate net direct premiums written in this state by all members of the JUA Plan. Neither Federated National nor American Vehicle was assessed by the JUA Plan during either 2009 or 2008. Future assessments by this association are undeterminable at this time.
The Company’s consolidated federal income tax returns for 2008, 2007, 2006 and 2005 are open for review by the IRS. The federal income tax returns for 2003 and 2002 have been examined by the IRS. The IRS concluded its’ examination for 2003 and 2002 and there were no material changes in the tax liability for those years. The 2004 income tax return remains open due to net operating loss carryforward to open years.
The Company records valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. 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 adjust related valuation allowances 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 is also involved in various legal actions arising in the ordinary course of business and not related to the insured claims activity.
On November 7, 2008, the District Court granted in part and denied in part the Company's motion to dismiss the consolidated class complaint with leave to amend by December 8, 2009 or the allegations dismissed would be deemed dismissed with prejudice without further order of the Court. Lead plaintiffs did not seek to amend the consolidated complaint and the defendants have answered. On July 29, 2008, the District Court granted the defendant’s motion to dismiss the plaintiff’s shareholder derivative complaint without prejudice. On August 27, 2009, the derivative plaintiff filed an amended shareholder derivative complaint. On March 30, 2009, following various motions by the parties, the Court entered an order granting defendant’s renewed motion to stay the shareholder derivative action pending resolution of the class action.
Effective on or about March 1, 2006, the Company sold its interest in the property located at 3661 West Oakland Park Boulevard, Lauderdale Lakes, Florida to an unrelated party for approximately $5.0 million cash and a $0.9 million six year 5% note. As part of the transaction, the Company agreed to lease the same facilities for a six year term; in accordance with FASB issued guidance, the lease will be treated as an operating lease. The expected future payout schedule is as follows.
In accordance with GAAP, net (loss) per share is antidilutive, therefore the basic and diluted (loss) per share is the same.
FASB issued guidance requires that the amount reported for each segment item be based on what is used by the chief operating decision maker in formulating a determination as to how many resources to assign to a segment and how to appraise the performance of that segment. The term chief operating decision maker may apply to the chief executive officer or chief operating officer or to a group of executives. Note: The term of chief operating decision maker may apply to a function and not necessarily to a specific person. This is a management approach rather than an industry approach in identifying segments. The segments are based on the Company’s organizational structure, revenue sources, nature of activities, existence of responsible managers, and information presented to the Board of Directors.
Activity in our stock option plans for the period from January 1, 2007 to December 31, 2009 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 2009 and 2008 include:
As a result of adopting FASB issued guidance on January 1, 2006, the Company’s income from continuing operations before provision for income taxes and net income for 2009 are lower by approximately $425,000 and $265,000, respectively, than if it had continued to account for share-based compensation under ABP guidance.
Summary information about the Company’s stock options outstanding at December 31, 2009 follows.
We have established a profit sharing plan under Section 401(k) of the Internal Revenue Code. This plan allows eligible employees, except key and highly compensated employees, to contribute up to 100 percent of their compensation not to exceed statutory limits. We contributed $0.1 million and $0.1 million in 2009 and 2008, respectively. In 2007 we did not contribute to the plan. The Company matches 50% up to 6% of employee contributions which vest incrementally over five years of service.
For the years ended December 31, 2009, 2008 and 2007, comprehensive (loss) income consisted of the following.
The 2004 Warrants issued to the purchasers of the September 2004 Notes and to the placement agent in the offering, J. Giordano Securities Group (“J. Giordano”), each entitled the holder to purchase one share of our Common Stock at an exercise price of $12.75 per share and was exercisable until September 30, 2007. The number of shares issued upon exercise of the 2004 Warrants to purchasers equaled $12.5 million divided by the exercise price of the warrants, and totaled 980,392. The number of shares issued upon exercise of the 2004 Warrants to J. Giordano equaled $500,000 divided by the exercise price of the warrants, and totaled 39,216. GAAP required that detachable warrants be valued separately from debt and included in paid-in capital. Based on the terms of the purchase agreement with the investors in the private placement, management determined that the September 2004 Warrants had zero value at the date of issuance.
On March 19, 2010, the Company entered into an agreement in principle to acquire Homewise Insurance Company and other insurance related businesses from Homewise. The proposed transaction is subject to customary definitive documentation, regulatory approval and the completion of satisfactory due diligence. There can be no assurances that the Company will close the proposed acquisition.
On March 22, 2010, Federated National received notice from Demotech that it would require a capital infusion of $10 million by March 31, 2010 in order for Federated National to maintain its’ “A” rating with the agency. We are working to comply with this requirement; however there can be no assurance that we will be able to do so. Any additional capital contribution to Federated National must be approved by the Florida OIR.