We are authorized to underwrite, and/or place through our wholly owned subsidiaries, homeowners’ multi-peril (“homeowners”), commercial general liability, federal flood, personal auto and various other lines of insurance in Florida and various other states. We market and distribute our own and third-party insurers’ products and our other services through a network of independent agents.
FNIC is licensed as a non-admitted carrier in Missouri, Nevada and South Carolina and can underwrite commercial general liability insurance in all of these states. Currently, we do not have any operations in these states. A non-admitted carrier, sometimes referred to as an “excess and surplus lines” carrier, is permitted to do business in a state and, although it is strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud, non-admitted carriers are subject to considerably less regulation with respect to policy rates and forms. Non-admitted carriers are not required to financially contribute to and benefit from the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.
We internally process claims made by our insureds through our wholly owned claims adjusting company, Federated National Adjusting, Inc. (“FNA”). Our agents have no authority to settle claims or otherwise exercise control over the claims process. Furthermore, we believe that the retention of independent adjusters, in addition to the employment of salaried claims personnel, results in reduced ultimate loss payments, lower Losses and loss adjustment expenses (“LAE”) and improved customer service for our claimants and policyholders. We also employ an in-house litigation management team to cost effectively manage claims-related litigation and to monitor our claims handling practices for efficiency and regulatory compliance.
During the years ended December 31, 2014, 2013 or 2012, we did not experience any weather-related catastrophic events such as the hurricanes that occurred in Florida during 2005 and 2004. We are not able to predict how hurricanes or other insurable events will affect our future results of operations and liquidity. Losses and LAE are affected by a number of factors, many of which are partially or entirely beyond our control, including the following.
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 us. When our estimated liabilities for unpaid losses and LAE are less than the actuarially determined amounts, we increase the expense in the current period. Conversely, when our estimated liabilities for unpaid losses and LAE are greater than the actuarially determined amounts, we decrease the expense in the current period.
Gross premiums written increased $133.8 million, or 55.0%, to $377.2 million for 2014, compared with $243.4 million for 2013. Florida homeowners’ represents 94% and Texas private passenger automobile represents the remaining 6% of the increased premium volume. We believe that our growth in 2014 reflects management’s efforts over several years. Our success today reflects our goal to be an agent-friendly carrier that provides exceptional service. We have invested in our agent relationships and our staff, created easy-to-use systems for the agent, and increased our relevance to the agents’ operations by providing insurance products that meet their market needs.
Our homeowner business contributed $126.6 million or 95.0% of the increased gross written premiums during the year ended December 31, 2014. This increase was the result of:
· a “flight to quality” in the market by agents who seek quality carriers to place their business, and
· supporting a marketing team dedicated to promoting the quality and quantity of products and services that we offer.
During 2014, approximately 88% of our policyholders renewed their Florida homeowner policies. We believe that high retention rate reflects the confidence that the policyholder and his agent have in our financial stability and strength and in our commitment to adjusting claims quickly and fairly.
The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with management’s evaluation of the determination of (i) liability for unpaid losses and LAE, (ii) the amount and recoverability of amortization of Deferred Policy Acquisition Costs (“DPAC”), and (iii) estimates for our reserves with respect to finance contracts, premiums receivable and deferred income taxes. Various assumptions and other factors underlie the determination of these significant estimates, which are described in greater detail in Footnote 2 in this Form 10-K.
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, 2014). 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.
We developed reported claim counts to ultimate levels using the development approach. The mechanics of this approach are the same as we described previously for paid and incurred losses. The validity of the results of this method depends on the stability of claim reporting and settlement rates. Then we developed accident year incurred severities (incurred losses divided by reported claim counts) to ultimate levels using the development approach.
We trended these severities to accident year 2014 levels. Trend rates were selected based on a review of historical severities. Selected severity was chosen based on judgment considering the developed severities and the trended severities, considering industry benchmarks for each segment. The loss & ALAE, claim count and severity triangles are evaluated as of 12 months, 24 months, 36 months etc. We selected loss development factors based on the loss development history, to the extent credible, and supplemented with industry data where appropriate.
Our reported results, financial position and liquidity would be affected by likely changes in key assumptions that determine our net loss reserves. The table below illustrates the change to equity that would occur as a result of a change in loss and LAE reserves, net of reinsurance.
For the year ended December 31, 2014, our actuarial firm determined range of statutory loss and LAE reserves on a net basis range from a low of $61.7 million to a high of $72.2 million, with a best estimate of $66.2 million. The Company’s net loss and LAE reserves are carried on a statutory basis at $68.2 million, and on a GAAP consolidated basis at $61.0 million which when netted with our $2.7 million reinsurance recoverable totals $58.3 million. The Company’s statutory point estimate for its reserves as of December 31, 2014 is 3.0% above our actuary’s best estimate, which reflects management’s current analysis of the status and expected timing of our anticipated claims, our analysis of expected weather patterns in the regions in which we sell policies, our re-focus of our business growth efforts to areas outside of South Florida, and other factors.
Below is a summary of net unrealized gains at December 31, 2014 and December 31, 2013 by category.
The net unrealized gain of $12.4 million is inclusive of $1.0 million of unrealized losses. The $1.0 million of unrealized losses is inclusive of $0.5 million unrealized losses from equity securities and $0.5 million unrealized losses from debt securities.
The $0.5 million of unrealized losses from debt securities is primarily related to Corporate obligations. The Company does not expect to settle at prices less than the amortized cost basis. The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2014 because we neither currently intend to sell these investments nor consider it likely that we will be required to sell these investments before recovery of the amortized cost basis.
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 temporarily 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.
Debt securities are carried on the balance sheet at market. At December 31, 2014 and 2013, debt securities had the following quality ratings by S&P and for securities not assigned a rating by S&P, Moody’s or Fitch ratings were used.
The following table summarizes, by maturity, the debt securities as of December 31, 2014 and 2013.
Premiums receivable, net of allowance for credit losses, increased $4.8 million, or 21.5%, to $27.2 million as of December 31, 2014, compared with $22.4 million as of December 31, 2013.
Our homeowners’ insurance premiums receivable increased $3.0 million, or 15.0%, to $22.4 million as of December 31, 2014, compared with $19.4 million as of December 31, 2013, resulting from the increase to gross premiums written during 2014 compared with 2013.
Our allowance for credit losses remained unchanged at $0.1 million as of December 31, 2014, compared with $0.1 million as of December 31, 2013.
Reinsurance recoverable, net, increased $9.8 million, or 358.5%, to $12.5 million as of December 31, 2014, compared with $2.7 million as of December 31, 2013. The change is due to the payment patterns by our reinsurers, as influenced by the diminishing catastrophe related claims and to the Property 30% Quota Share agreement effective July 1, 2014. All amounts are current and deemed collectable. We believe concentrations of credit risk associated with our reinsurance recoverables, net, are not significant.
Deferred income taxes, net, converted to a $1.3 million liability as of December 31, 2014, compared with a $1.0 million asset as of December 31, 2013.
Deferred income taxes, net, is comprised of approximately $9.7 million and $11.0 million of deferred tax assets, net of approximately $11.0 million and $10.0 million of deferred tax liabilities as of December 31, 2014 and December 31, 2013.
Income taxes receivable totaled $1.8 million as of December 31, 2014, compared with income taxes payable of $2.4 million as of December 31, 2013. The change is due to estimated tax payments made in excess of the related accrued liability.
Property, plant and equipment, net increased $0.8 million, or 88.3%, to $1.7 million as of December 31, 2014, compared with $0.9 million as of December 31, 2013. The change is due primarily to investments in information technology.
Other assets increased $4.0 million, or 126.4%, to $7.2 million as of December 31, 2014, compared with $3.2 million as of December 31, 2013. Major components of other assets are shown in the following table; the accrued interest income receivable is primarily investment related.
The increase in the sale of homeowners’ policies by $126.6 million, or 58.0%, to $344.9 million in 2014, compared with $218.3 million in 2013, is gross of reinsurance costs and net of Florida’s mandated homeowners’ wind mitigation discounts. We offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. As of December 31, 2014, 76.4% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $336.7 million (a 50.1% reduction of in-force premium), while 80.3% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $216.8 million, (a 50.1% reduction of in-force premium), as of December 31, 2013.
During 2014 and 2013, the change to the cumulative wind mitigation credits afforded our policyholders totaled $119.9 million and $155.7 million, respectively.
The Company’s sale of auto insurance policies increased by $4.0 million to $12.4 million for 2014, compared with $8.4 million for 2013. The primary factor for this increase was due to the new Texas private passenger automobile business for which 2013 was the first full year of operations.
Gross premiums ceded increased to $202.0 million for 2014, compared with $82.7 million for 2013. Gross premiums ceded relating to our homeowners’, commercial general liability, write-your-own flood and automobile programs totaled $184.8 million, $0.5 million, $7.4 million and $9.3 million for 2014. Gross premiums ceded relating to our homeowners’ includes $73.0 million associated with our Property 30% Quota Share agreement effective July 1, 2014 and was also impacted by an additional 165.0% of reinsurance coverage purchased for the 2014-2015 season as compared with the 2013-2014 season.
Gross premiums ceded relating to our homeowners’, commercial general liability, write-your-own flood and automobile programs totaled $69.7 million, $0.5 million, $6.2 million and $6.3 million for 2013.
The increase in prepaid reinsurance premiums was $59.8 million in 2014, compared with $13.1 million in 2013. The increased benefit to written premium is associated with the timing of our reinsurance payments measured against the term of the underlying reinsurance policies.
Net premiums earned increased $66.5 million, or 63.7%, to $170.9 million for 2014, compared with $104.4 million for 2013. The following table denotes net premiums earned by product line.
Commission income increased $1.9 million, or 70.7%, to $4.5 million for 2014, compared with $2.6 million for 2013. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link, Inc. (“Insure-Link”).
Finance revenue increased $0.6 million, or 69.2%, to $1.5 million 2014, compared with $0.9 million for 2013. The primary source of finance revenue is service fees and interest income from our direct billing program, in which we allow our insureds to pay premiums over a stated number of months.
Net investment income increased $2.1 million, or 61.6%, to $5.4 million for 2014, compared with $3.3 million for 2013.
Our investment yield, net of and including investment expenses, excluding equities and including cash, was 2.7% and 3.0%, respectively, for 2014. Our investment yield, net of and including investment expenses, excluding equities and including cash, was 2.1% and 2.3%, respectively, for 2013.
Our investment yield, net of and including investment expenses measured against debt securities, excluding equities and cash, was 2.8% and 3.2%, respectively, for 2014. Our investment yield, net of and including investment expenses measured against debt securities, excluding equities and cash, was 2.4% and 2.7%, respectively, for 2013. The 2013 investment yields have been recalculated in conformity with the 2014 computations, which are on a taxable equivalent basis and more adequately distinguish between taxable and non-taxable income. Our lower investment yield in 2013 primarily resulted from selling higher yielding and longer duration bonds and purchasing shorter duration and lower yielding bonds to protect our bond portfolio against principal erosion, and our average cash holdings were much higher in 2013.
See also “Analysis of Financial Condition As of December 31, 2014 Compared with December 31, 2013 - Investments” for a further discussion on our investment portfolio.
Net realized investment gains were $4.4 million for 2014, compared with $2.9 million for 2013. Specifically, net realized gains for equity securities were $3.8 million for 2014, compared with of $2.9 million for 2013. For debt securities, net realized gains were $0.7 million for 2014, compared with $0.7 million for 2013. Our managers are authorized to sell securities at their discretion. During 2014, our equity managers took advantage of prevailing market opportunities and sold equities to lock in gains.
FASB has issued guidance regarding when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. 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 temporarily or permanently impaired. During 2014 and 2013, pursuant to guidelines prescribed in FASB issued guidance, we have not charged to operations any investment losses. During 2012, in connection with the process, we have charged to operations $44,000 of investment losses. In reaching a conclusion that a security is either other-than-temporarily 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 S&P and Moody’s, as well as information released via the general media channels.
The $2.8 million, net total includes a $3.5 million benefit associated with our Property 30% Quota Share agreement effective July 1, 2014 and a $0.7 charge associated with our profit sharing agreement with SageSure.
The increase to losses and LAE for 2014, compared with 2013, also reflects the additional reserves we added in response to the substantial increase in the number of policies we wrote during 2014. The increase to losses and LAE was more than offset by the increase to net premiums earned during this same period.
Management revises its estimates based on the results of its analysis. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors. Because of our process, reserves were increased by approximately $17.3 million during 2014. This overall change includes a $18.4 million increase in reserves for our homeowners’ program, a $2.5 million decrease in reserves for our automobile program and a $1.4 million increase in reserves for our commercial general liability program.
Salaries and wages increased $4.8 million, or 46.9%, to $15.0 million for 2014, compared with $10.2 million for 2013 and is primarily due to the increased number of employees which totaled 219 as of December 31, 2014, compared with 153 as of December 31, 2013. The charge to operations for stock-based compensation, in accordance with FASB guidance, was approximately $1.3 million during 2014, compared with approximately $0.4 million for 2013, for which the increased charge is primarily attributed to the higher fair market value per share at grant during 2014 compared with 2013.
The change to amortization of DPAC typically corresponds to the change in net premiums earned during the same period, and consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned, which for 2014 totaled approximately $18.4 million. The $18.4 million was offset by a $12.3 million benefit associated with our Property 30% Quota Share agreement effective July 1, 2014.
The provision for income tax expense was $20.1 million for 2014, compared with $6.5 million for 2013. The effective rate for income taxes was 35.1% for 2014, compared with 33.8% for 2013.
Net income increased $24.5 million, or 192.3%, to $37.2 million for 2014, compared with $12.7 million for 2013.
Gross premiums written increased $123.9 million, or 103.7%, to $243.4 million for 2013, compared with $119.5 million for 2012. The following table denotes gross premiums written by major product line. The increase in gross premiums written during 2013 is primarily due to the increase in the sale of homeowners’ policies. During 2013, our improved underwriting, risk management and product distribution enabled us to write more policies than in prior years.
The increase in the sale of homeowners’ policies by $116.5 million, or 114.4%, to $218.3 million in 2013, compared with $101.8 million in 2012, is gross of reinsurance costs and net of Florida’s mandated homeowners’ wind mitigation discounts. We offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. As of December 31, 2013, 80.3% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $216.8 million (a 50.1% reduction of in-force premium), while 72.7% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $61.1 million, (a 37.4 % reduction of in-force premium), as of December 31, 2012.
During 2013 and 2012, the change to the cumulative wind mitigation credits afforded our policyholders totaled $155.7 million and $29.6 million, respectively.
These premium discounts have had a significant effect on both written and earned premium. Wind mitigation credits are 50.1% of the pre-credit premium, or $216.8 million, as of December 31, 2013, as compared with 37.4% of the pre-credit premium, or $61.1 million, as of December 31, 2012.
Gross premiums ceded increased to $82.7 million for 2013, compared with $51.1 million for 2012. Gross premiums ceded relating to our homeowners’, commercial general liability, write-your-own flood and automobile programs totaled $69.7 million, $0.5 million, $6.2 million and $6.3 million for 2013. Gross premiums ceded relating to our homeowners’, commercial general liability, write-your-own flood and automobile programs totaled $43.3 million, $0.5 million, $5.3 million and $2.0 million for 2012.
The increase in prepaid reinsurance premiums was $13.1 million in 2013, compared with $2.1 million in 2012. The benefit to written premium is associated with the timing of our reinsurance payments measured against the term of the underlying reinsurance policies.
The $43.6 million increase in homeowners’ net premiums earned is due to a $116.5 million increase in gross written premium as discussed, a $26.4 million increase in gross premiums ceded and a $46.5 million increase in the net change to prepaid reinsurance premiums and unearned premium.
Commission income increased $1.2 million, or 92.2%, to $2.6 million for 2013, compared with $1.4 million for 2012. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link.
Direct written policy fees increased $4.2 million, or 208.8%, to $6.2 million for 2013, compared with $2.0 million for 2012. The change is attributed to the increase in gross premiums written during this same period.
Net investment income decreased $0.5 million, or 12.7%, to $3.3 million for 2013, compared with $3.8 million for 2012.
Our investment yield, net and of and including investment expenses, excluding equities and including cash, was 2.1% and 2.3%, respectively, for 2013. Our investment yield, net of and including investment expenses, excluding equities and including cash, was 2.5% and 2.8%, respectively, for 2012.
FASB has issued guidance regarding when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. 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 temporarily or permanently impaired. During 2013, pursuant to guidelines prescribed in FASB issued guidance, we have not charged to operations any investment losses. During 2012, pursuant to guidelines prescribed in FASB issued guidance, we charged to operations, realized investment losses of $44,000. In reaching a conclusion that a security is either other-than-temporarily 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 S&P and Moody’s, as well as information released via the general media channels.
The provision for income tax expense was $6.5 million for 2013, compared with $2.4 million for 2012. The effective rate for income taxes was 33.8% for 2013, compared with 36.1% for 2012.
In 2014, our primary sources of capital included proceeds from the sale of investment securities, increased unearned premiums, issuance of common stock, increased unpaid losses and LAE, increased accounts payable and accrued expenses, amortization of investment premium discount, net and increased claims payments outstanding. Additional sources of capital included increased premium deposits and customer credit balances, decreased policy acquisition costs, net of amortization, non-cash compensation, exercised stock options, decreased deferred income tax expense, net of other comprehensive income and a tax benefit related to non-cash compensation. Because we are a holding company, we are largely dependent upon fees and commissions from our subsidiaries for cash flow.
In 2014, operations used $77.7 million of gross cash flow primarily due to a $46.9 million increase in prepaid reinsurance premiums, a $9.8 million increase in reinsurance recoverable, net, a $4.9 million increase in premiums receivable, $4.4 million in net realized investment gains and a $4.0 million increase in other assets. Additional uses of cash included a $3.5 increase in contingent quota-share profit sharing, a $2.4 million decrease in income taxes payable and a $1.8 million increase in income taxes recoverable.
We have audited the accompanying consolidated balance sheets of Federated National Holding Company as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three year period ended December 31, 2014. We also have audited Federated National Holdings Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Federated National Holdings Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A Controls and Procedures. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the company’s internal control over financial reporting based on our audits.
FNIC is licensed as a non-admitted carrier in Missouri, Nevada and South Carolina and can underwrite commercial general liability insurance in all of these states. Currently, we do not have any operations in these states. A non-admitted carrier, sometimes referred to as a “excess and surplus lines” carrier, is permitted to do business in a state and, although it is strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud, non-admitted carriers are subject to considerably less regulation with respect to policy rates and forms. Non-admitted carriers are not required to financially contribute to and benefit from the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.
We internally process claims made by our insureds through our wholly owned claims adjusting company, Federated National Adjusting, Inc. (“FNA”). Our agents have no authority to settle claims or otherwise exercise control over the claims process. Furthermore, we believe that the retention of independent adjusters, in addition to the employment of salaried claims personnel, results in reduced ultimate loss payments, lower Loss and loss adjustment expenses (“LAE”) and improved customer service for our claimants and policyholders. We also employ an in-house litigation management team to cost effectively manage claims-related litigation and to monitor our claims handling practices for efficiency and regulatory compliance.
We previously entered into a Coexistence Agreement effective August 30, 2013 (the “Coexistence Agreement”) with Federated Mutual Insurance Company (“Federated Mutual”) pursuant to which, among other things, we may continue to use “Federated” until at least August 30, 2020, after which time we have agreed to either cease using “Federated” in commerce or otherwise adopt and use trade names that are not confusingly similar to Federated Mutual’s trademarks. We continue to develop our brand under the “FedNat” name, which is the name by which agents generally know us.
We are focusing our marketing efforts on continuing to expand our distribution network while maintaining our commitment to long-term relationships. We market our products and services throughout Florida and in other states by establishing relationships with additional independent agents and general agents. There can be no assurance, however, that we will be able to obtain the required regulatory approvals to offer additional insurance products or expand into other states.
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.
Policy fees range from $25 to $55 and represent a non-refundable application fee for insurance coverage, which are intended to reimburse us for the costs incurred to underwrite the policy. The fees and related costs are recognized when the policy is underwritten. These fees are netted against underwriting costs and are included as a component of deferred acquisition costs.
We recognize the income and expense on reinsurance contracts principally on a pro-rata basis over the term of the reinsurance contracts or until the reinsurers maximum liability is exhausted, whichever comes first. We are reinsured under separate reinsurance agreements for the different lines of business underwritten. Reinsurance contracts do not relieve us from our obligations to policyholders. We continually monitor our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. We only cede risks to reinsurers whom we believe to be financially sound. At December 31, 2014, all reinsurance recoverables are considered current and deemed collectable.
FNU earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. FNU earns a per policy fee which ranges from $25 to $55 and a commission fee from its affiliate, FNIC, which totaled 4% during 2014. The Florida OIR periodically reviews our managing general agent’s fee structure to ensure that it is neither excessive nor inadequate to operate.
In February 2013, the FASB issued ASU No. 2013-02: Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The objective of this ASU is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety in net income. For other amounts that are not required to be reclassified to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments in the ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. The ASU is effective prospectively for reporting periods beginning after December 15, 2012. The adoption of these amendments did not have a material impact on our financial condition, results of operations or cash flows.
In January 2013, the FASB issued ASU No. 2013-01: Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. The objective of this ASU is to clarify the scope of offsetting disclosures and to address implementation issues with ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments clarify that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions. An entity is required to apply the amendments for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods. The adoption of these amendments did not have a material impact on our financial condition, results of operations or cash flows.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
· If we are unable to continue our growth because our capital must be used to pay greater than anticipated claims, our financial results may suffer.
· We may require additional capital in the future which may not be available or only available on unfavorable terms.
· Our revenues and operating performance may fluctuate due to statutorily approved assessments that support property and casualty insurance pools and associations.
· Our investment portfolio may suffer reduced returns or losses, which would significantly reduce our earnings.
· The failure of any of the loss limitation methods we employ could have a material adverse effect on our financial condition or our results of operations.
· The effects of emerging claim and coverage issues on our business are uncertain.
· Our failure to pay claims accurately could adversely affect our business, financial results and capital requirements.
· We rely on our information technology and telecommunications systems, and the failure of these systems could disrupt our operations.
· Our success depends on our ability to accurately price the risks we underwrite.
· We may not obtain the necessary regulatory approvals to organize the new property and casualty insurer in Florida that is the subject of our previously announced joint venture.
· We anticipate that Monarch will initially focus on the Florida homeowners' insurance market, which will increase our exposure to the factors that impact the Florida insurance market generally, such as the occurrence of hurricanes, trends in claims experience, and the impact of changes in Florida insurance law and regulations.
· We face risks in connection with potential material weakness resulting from our Sarbanes-Oxley Section 404 management report and any related remedial measures that we undertake.
· We have authorized but unissued preferred stock, which could affect rights of holders of common stock.
· Future sales of our common stock may depress our stock price.
During the year ended December 31, 2014, the Company had three stock-based employee compensation plans, which are described later in Footnote 14, Stock Compensation Plans. Prior to January 1, 2006, we accounted for the plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by the Accounting Principles Board (“APB”) and related Interpretation, as permitted by FASB issued guidance. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.
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 2014, 2013 and 2012 include:
Property, plant and equipment is stated at cost less accumulated depreciation. Depreciation on property, plant and equipment is calculated on a straight-line basis over the following estimated useful lives: building and improvements - 30 years, furniture and fixtures - 7 years and computer equipment - 5 years. We capitalize betterments and any other expenditure in excess of $1,000 if the asset is expected to have a useful life greater than one year. The carrying value of property, plant and equipment is periodically reviewed based on the expected future undiscounted operating cash flows of the related item. Based upon our most recent analysis, we believe that no impairment of property, plant and equipment exists at December 31, 2014.
As of December 31, 2014 and December 31, 2013, respectively, all of our securities are in good standing and not impaired as defined by FASB issued guidance.
As of December 31, 2014 and December 31, 2013, we have classified $7.4 million and $7.2 million, respectively, of our bond portfolio as held-to-maturity. We classify bonds as held-to-maturity to support securitization of credit requirements.
The following table summarizes, by type, our investments as of December 31, 2014 and 2013.
The following table shows the realized gains (losses) for debt and equity securities for the years ended December 31, 2014 and 2013.
Depreciation of property, plant, and equipment was $482,750, $263,334 and $195,078 during 2014, 2013 and 2012, respectively.
For the year ended December 31, 2014, our actuarial firm determined range of statutory loss and LAE reserves on a net basis range from a low of $61.7 million to a high of $72.3 million, with a best estimate of $66.2 million. The Company’s net loss and LAE reserves are carried on a statutory basis at $68.2 million, and on a GAAP consolidated basis at $78.3 million which when netted with our $12.5 million reinsurance recoverable totals $65.8 million. The Company’s statutory point estimate for its reserves as of December 31, 2014 is 3.0% above our actuary’s best estimate, which reflects management’s current analysis of the status and expected timing of our anticipated claims, our analysis of expected weather patterns in the regions in which we sell policies, our re-focus of our business growth efforts to areas outside of South Florida, and other factors.
Additionally, the different methodologies are utilized the same, regardless of the line of business. However, the final selection of ultimate loss and LAE is certain to vary by both line of business and by accident period maturity. There is no prescribed combination of line of business, accident year maturity, and methodologies; consistency in results of the different methodologies and reasonableness of the result are the primary factors that drive the final selection of ultimate loss and LAE.
Interim - During 2014 our interim approach was very similar to the annual process noted above.
For each line of business, expected ultimate loss ratios for each accident year are estimated based on loss reserve development patterns. The expected loss ratio generally reflects the projected loss ratio from prior accident years, adjusted for the loss trend and the effect of rate changes and other quantifiable factors on the loss ratio.
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, 2014 premised on future emergence inconsistent with historical loss reserve development patterns.
A summary of the provision for income tax expense is as follows.
In September 2013, the Internal Revenue Service (“IRS”) released final tangible property regulations under Sections 162(a) and 263(a) of the Internal Revenue Code regarding the deduction and capitalization of expenditures related to tangible property as well as dispositions of tangible property. These regulations are effective for our tax year beginning January 1, 2014. The adoption of these regulations is not expected to have a material impact on our consolidated financial position, results of operations, or cash flows.
During 2014, the Company recorded tax benefits of $0.9 million from the exercise of non-qualifying stock options, restricted stock and disqualifying dispositions of incentive stock options as a reduction of the Company's income tax liability and an increase in equity. Additionally, in 2014 the Company recorded deferred tax liabilities of $1.0 million related to unrealized gains on investments as a decrease to equity.
At December 31, 2014, 2013 and 2012, FNIC’s statutory capital surplus was $125.3 million, $76.9 million and $52.1 million, respectively.
An insurance company is also required to adhere to prescribed premium-to-capital surplus ratios. As of December 31, 2014, 2013 and 2012, FNIC was in compliance with the prescribed premium-to-surplus ratio.
In order to enhance the regulation of insurer solvency, the National Association of Insurance Commissioners (“NAIC”) established risk-based capital requirements for insurance companies that are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policy holders. These requirements measure three major areas of risk facing property and casualty insurers: (i) underwriting risks, which encompass the risk of adverse loss developments and inadequate pricing; (ii) declines in asset values arising from credit risk; and (iii) other business risks from investments. Insurers having less statutory surplus than required will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The Florida OIR, which follows these requirements, could require FNIC to cease operations in the event they fail to maintain the required statutory capital.
Based upon the 2014 and 2013 statutory financial statements for FNIC, statutory surplus exceeded the regulatory action levels established by the NAIC’s risk-based capital requirements.
Most recently the Florida OIR subjected FNIC to a balance sheet audit as of December 31, 2010. There were no material findings by the independent auditors in connection with this examination. FNIC also experienced a regularly scheduled statutory examination by the Florida OIR which occurred during 2010 for the five years ended December 31, 2010. There were no material findings in connection with this examination. The previous regulatory examination conducted by the Florida OIR on FNIC covered the three-year period ended on December 31, 2004.
As of December 31, 2013, FNIC was outside NAIC’s usual range for three of thirteen IRIS ratios. These exceptions related to change in net writings, investment yield and estimated current reserve deficiency to policyholders’ surplus.
As of December 31, 2012, NAIC’s usual range for three of thirteen IRIS ratios. These exceptions related to investment yield, net change in adjusted policyholders’ surplus and estimated current reserve deficiency to policyholders’ surplus.
There was no action taken by the Florida OIR in connection with the December 31, 2013 or 2012 IRIS ratio results. We do not currently believe that the Florida OIR will take any significant action with respect to FNIC regarding the 2014 IRIS ratios, although there can be no assurance that will be the case.
The table below reflects the range and test results for FNIC for the years ended December 31, 2014 and 2013, respectively.
GAAP differs in some respects from reporting practices prescribed or permitted by the Florida OIR. FNIC’s statutory capital and surplus was $125.3 million and $76.9 million as of December 31, 2014 and 2013, respectively. FNIC’s statutory net income was $29.2 million, $3.6 million and $6.6 million for 2014, 2013 and 2012, respectively. FNIC’s statutory non-admitted assets were $0.1 million and nearly nothing as of December 31, 2014 and 2013, respectively.
The Company files a federal income tax return and various state and local tax returns. The Company’s consolidated federal and state income tax returns for 2012 - 2013 are open for review by the IRS and various state taxing authorities. The Company’s 2011 federal tax return was under review by the IRS and in 2014 the audit was closed with a no change report.
The Company is not currently involved in any material legal actions arising from the ordinary course of business that are not related to insured claims activity.
Included in this year’s reinsurance program is a 30% quota share reinsurance treaty for the Company’s in-force new and renewal homeowners’ insurance program in the State of Florida. This two-year quota share reinsurance treaty provides 30% of $200 million of aggregate catastrophe coverage per year with maximum single event coverage of 30% of $100 million per year. The approximate cost of this quota share is projected to be $6.7 million per year, net of ceding commissions, and it is included in the $117.0 million amount referenced above. The quota share treaty contains commutation provisions for the Company to share profits based on loss experience during the term of the treaty.
The 30% quota share reinsurance treaty described above contains profit sharing provisions that will adjust over its two-year term depending on the Company’s loss experience from catastrophic and non-catastrophic events during the term. The frequency and severity of catastrophic events, coupled with non-catastrophic loss experience, will determine the ultimate profit share, if any. In accordance with GAAP, the Company will initially recognize an asset and liability and the resultant net income or loss. For example, deferred quota-share profit sharing totaled $10.5 million as of December 31, 2014. The deferred quota-share profit sharing was originally recorded at $14.0 million at the program’s July 1, 2014 inception and will continue to amortize over the life of the program. Subsequently, the Company will adjust the value of the asset and liability based on information available at the time of valuation. Upward and downward adjustments to the asset’s value will affect the Company’s results of operations by increasing or decreasing net income in the period of the adjustment.
Our executive offices are located at 14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323 in an 18,500 square foot office facility. Our original lease for this office space was scheduled to expire in May 2017. During March 2014, we extended our lease term to expire in August 2019 and expanded the leased premises to include an additional 13,642 square feet. All of our operations are consolidated within these facilities. We believe that the facilities are well maintained, in substantial compliance with environmental laws and regulations, and adequately covered by insurance. We also believe that these leased facilities are not unique and could be replaced, if necessary, at the end of the lease term.
Rent expense was $0.5 million, $0.4 million and $0.2 million in 2014, 2013 and 2012, respectively.
Net income per share is computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding during the periods presented. In accordance with GAAP, net loss per share would be antidilutive; therefore the basic and diluted loss per share is the same.
A summary of the numerator and denominator of the basic and fully diluted 2014, 2013 and 2012 net income (loss) per share is presented below.
· Identifiable assets are 10% or more of total assets of all operating segments.
We implemented a stock option plan in 2002 (the “2002 Plan”), which expired in April 2012. Under this plan, we were authorized to grant options to purchase up to 1,800,000 common shares, and as of December 31, 2014 and December 31, 2013, we had outstanding exercisable options to purchase 219,285 and 523,521 shares, respectively.
On March 4, 2013, a total of 100,000 restricted shares from the 2012 Plan were granted pursuant to the vesting requirements and other terms and conditions set forth in restricted stock agreements. Of the total, 25,000 shares were granted to the Company's Chief Executive Officer and President and 15,000 shares were granted to the Company's Chief Financial Officer. An aggregate of 20,000 shares were granted to the Company's directors and the remaining 40,000 shares were granted to other employees of the Company.
On March 4, 2014, a total of 88,648 restricted shares from the 2012 Plan were granted pursuant to the vesting requirements and other terms and conditions set forth in restricted stock agreements. Of the total, 43,997 shares were granted to the Company's Chief Executive Officer and President and 16,341 shares were granted to the Company's Chief Financial Officer. An aggregate of 15,710 shares were granted to the Company's directors and the remaining 12,600 shares were granted to other employees of the Company.
On December 9, 2014, a total of 50,000 restricted shares from the 2012 Plan were granted to the Company’s Chief Executive Officer and President pursuant to the vesting requirements and other terms and conditions set forth in the restricted stock agreement.
Activity in our stock option and incentive plans for the period from January 1, 2011 to December 31, 2014 is summarized below.
Options outstanding as of December 31, 2014 are exercisable as follows.
As a result of adopting FASB issued guidance on January 1, 2006, the Company’s income from continuing operations before provision for income tax expense and net income for 2014 are lower by approximately $1,272,500 and $800,000, respectively, than if it had continued to account for share-based compensation under APB guidance.
Because the change in income taxes receivable (payable) includes the effect of excess tax benefits, those excess tax benefits also must be shown as a separate operating cash outflow so that operating cash flows exclude the effect of excess tax benefits. FASB issued guidance requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.
The weighted average fair value of options granted during 2012 estimated on the date of grant using the Black-Scholes option-pricing model was $1.45; no options were granted during 2013 or 2014.
We have established a profit sharing plan under Section 401(k) of the Internal Revenue Code. This plan allows eligible employees to contribute up to 100 percent of their compensation, not to exceed statutory limits. The Company match totaled $0.4 million, $0.2 million and $0.1 million during the years 2014, 2013 and 2012, respectively.
For the years ended December 31, 2014, 2013 and 2012, comprehensive income consisted of the following.
Our Amended and Restated Articles of Incorporation authorize the issuance of one million shares of preferred stock with designations, rights and preferences determined from time to time by our board of directors. Accordingly, our Board of Directors is empowered, without shareholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. We have not issued preferred shares as of December 31, 2014.
FNHC (the parent company only) has no long term obligations, guarantees or material contingencies as of December 31, 2014. The following summarizes the major categories of the parent company’s financial statements.
Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs are observable for an asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
On March 10, 2015, a total of 66,140 restricted shares from the 2012 Plan were granted pursuant to the vesting requirements and other terms and conditions set forth in Restricted Stock Agreements. Of the total, 32,997 shares were granted to the Company's Chief Executive Officer and President and 9,551 shares were granted to the Company's Chief Financial Officer. An aggregate of 6,252 shares were granted to the Company's directors and the remaining 17,340 shares were granted to other employees of the Company.
On February 17, 2015, Federated National entered into a Reimbursement Contract with the SBA for the 2015-2016 hurricane season. This Reimbursement Contract is part of the Company’s reinsurance program and will reimburse Federated National for covered property losses under its homeowners’ insurance policies resulting from hurricanes that cause damage in the State of Florida through May 31, 2016.