We lease office space in Nashville, Tennessee for our corporate offices, claims, customer service and data center (approximately 80,000 square feet). We also lease office space for our regional claims office in Tampa, Florida and for our regional claims office and customer service center in Chicago, Illinois. Our retail locations are all leased and typically are located in storefronts in retail shopping centers, and each location typically contains approximately 1,200 square feet of space. See Note 8 to our consolidated financial statements for further information about our leases.
income (loss), income (loss) per share and other financial performance measures;
the anticipated effects on our results of operations or financial condition from recent and expected developments or events;
the financial condition of, and other issues relating to the strength of and liquidity available to, issuers of securities held in our investment portfolio;
The SEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to address situations where a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting under ASC Topic 740 for certain income tax effects of the Act for the reporting period of enactment. SAB 118 allows the Company to provide a provisional estimate of the impacts of the Act during a measurement period similar to the measurement period used when accounting for business combinations. Adjustments to provisional estimates and additional impacts from Tax Reform must be recorded as they are identified during the measurement period as provided for in SAB 118.
At December 31, 2017, we leased and operated 350 retail locations (or “stores”) and a call center staffed by employee-agents who primarily sell non-standard personal automobile insurance products underwritten by us as well as certain commissionable ancillary products. In most states, our employee-agents also sell a complementary insurance product providing personal property and liability coverage for renters underwritten by us. In addition, retail locations in some markets offer non-standard personal automobile insurance serviced and underwritten by other third-party insurance carriers for which we receive a commission.
Since August 2016, we have taken the following actions towards the goal of returning our ratio of net premiums written to statutory capital and surplus to within regulatory guidelines and improving profitability:
Reduced premium writings, through the closing of 53 poorly performing stores, by temporarily suspending or eliminating new business in selected areas of our business, and tightening our underwriting standards;
Aggressive actions have been taken in our claims-handling operations. In October 2016, we hired a new Senior Vice President and restructured claims management to include three additional functional Vice President positions. This structure makes optimal use of departmental availability and experience through redesigned workflows and increases accountability through recurring quality assurance review programs. A text message status process now allows insureds and claimants to receive updates during the life cycle of their claim, and certain auto damage claims are now eligible for submission through a smartphone photo application. Along with proper staffing and increased focus on training, these efforts are helping reduce pending claims to targeted levels.
In 2017, our insurance operations generated revenues from selling non-standard personal automobile insurance products and related products in 16 states. We currently conduct our servicing and underwriting operations in 13 states through three insurance company subsidiaries: First Acceptance Insurance Company, Inc., First Acceptance Insurance Company of Georgia, Inc. and First Acceptance Insurance Company of Tennessee, Inc., and operate only as an insurance agency in three states. Our insurance revenues were primarily generated from:
commission and fee income, including installment fees on policies written, agency fees and commissions and fees for other ancillary products and policies sold on behalf of third-party insurance carriers; and
Our insurance segment presents a combined ratio as a measure of its overall underwriting profitability. The components of the combined ratio are as follows.
The value of our consolidated available-for-sale investment portfolio was $129.9 million at December 31, 2017 and consisted of fixed maturity securities, preferred stock and investments in mutual funds, all carried at fair value with unrealized gains and losses reported as a separate component of stockholders’ equity. At December 31, 2017, we had gross unrealized gains of $2.6 million and gross unrealized losses of $2.4 million in our consolidated investments available-for-sale portfolio.
The following table summarizes our investments available-for-sale at December 31, 2017 (in thousands).
For the year ended December 31, 2017, we recognized $2.3 million of favorable prior period loss development, compared with $30.6 million of unfavorable prior period loss development for the year ended December 31, 2016. The year ended December 31, 2017 was unfavorably impacted by $2.4 million in catastrophic claims losses during the third quarter. Conversely, the year ended December 31, 2016 was favorably impacted by a $1.2 million gain on the sale of foreclosed real estate along with net realized gains
on investments of $4.8 million from the sales of fixed maturities that were sold to increase the statutory capital and surplus of our insurance company subsidiaries.
The net loss for the year ended December 31, 2017 included a reduction in the deferred tax asset of $12.5 million as a result of the enactment of legislation to reduce the corporate income tax rate.
Commission and fee income decreased by $11.0 million, or 15%, to $64.6 million for the year ended December 31, 2017, from $75.6 million for the year ended December 31, 2016. This decrease was primarily the result of a decrease in monthly billing fees as a result of the previously-mentioned decline in the number of policies in force. Additionally, we earned less commission as a result of a decline in the renewals of automobile insurance policies sold in California on behalf of third-party carriers.
In September 2016, in order to increase the statutory capital and surplus of our insurance company subsidiaries by realizing gains on fixed maturities carried at amortized cost for statutory purposes, we sold $66.9 million of available-for-sale securities yielding 3.6% and reinvested the proceeds at 2.2%. As a result, our investment income from fixed maturities in subsequent periods has declined from the reduced yield in our fixed maturities portfolio. Recent results however have been favorable as a result of increased yields on cash and cash equivalents while returns from limited partnership investments, although favorable, have fluctuated from period-to-period.
Net realized losses on investments, available-for-sale during the year ended December 31, 2017 included $3.0 thousand from redemptions. Net realized gains on investments, available-for-sale during the year ended December 31, 2016 included $4.8 million from the previously-mentioned sale of fixed maturities. Such realized gains are net of $147 thousand of charges related to other-than-temporary-impairment (“OTTI”) on a mutual fund and other net realized gains from redemptions.
The loss ratio was 79.4% for the year ended December 31, 2017, compared with 101.9% for the year ended December 31, 2016. We experienced favorable development related to prior fiscal years of $2.3 million for the year ended December 31, 2017, compared with unfavorable development of $30.6 million for the year ended December 31, 2016. The favorable loss development for the year ended December 31, 2017 was the net result of favorable LAE development related to bodily injury claims over the 2014-2016 accident years, offset by unfavorable development on losses related to bodily injury severity over the 2014-2016 accident years. The unfavorable loss development for the year ending December 31, 2016 was the result of increased losses primarily from the 2015
accident year across all major coverages. The most significant causes of the development were a greater than usual emergence of reported claims and higher bodily injury severity.
Excluding the development related to prior fiscal years and the impact of the hurricanes, the loss ratios for the years ended December 31, 2017 and 2016 were 79.3% and 91.8%, respectively. We believe that this improvement in the loss ratio was the result of our aggressive rate and underwriting actions in addition to a moderate reduction in claims frequency.
Insurance operating expenses decreased 4.5% to $111.3 million for the year ended December 31, 2017 from $116.5 million for the year ended December 31, 2016. This decrease in operating expenses was primarily due to the costs savings from the recent store closures, a reduction in advertising costs, and reduced variable expenses (e.g. underwriting reports and postage) as a result of the decline in new business written.
During 2016, we closed 53 poorly-performing stores. The cost of these closures, primarily for lease buyouts, was $1.0 million and is included in insurance operating expenses.
The expense ratio was 17.8% for the year ended December 31, 2017, compared with 14.6% for the year ended December 31, 2016. The year-over-year increase in the expense ratio was primarily due to the decrease in premiums earned which resulted in a higher percentage of fixed expenses and the previously-mentioned decline in commission and fee income, which is a component of the expense ratio.
The provision for income taxes was $15.2 million for the year ended December 31, 2017, compared with a benefit for income taxes of $15.8 million at the year ended December 31, 2016. The provision (benefit) for income taxes for the year ended December 31, 2017 includes a reduction in the deferred tax asset of $12.5 million as a result of the enactment of legislation to reduce the corporate income tax rate.
For the year ended December 31, 2016, we recognized $30.6 million of unfavorable prior period loss development. Conversely, the period was favorably impacted by a $1.2 million gain on the sale of foreclosed real estate along with net realized gains on investments of $4.8 million from the sales of fixed maturities that were sold to increase the statutory capital and surplus of our insurance company subsidiaries. The year ended December 31, 2015 included $3.7 million of costs related to a litigation settlement.
Premiums earned increased by $36.3 million, or 13.6%, to $303.3 million for the year ended December 31, 2016, from $267.0 million for the year ended December 31, 2015. This improvement was due to higher average premiums resulting from our rate increases throughout the year. While during 2016, our total policies-in-force declined 14.5%, this targeted decline was more than offset by a 13.6% year-over-year increase in our average in-force premium.
compared with unfavorable development of $0.8 million for the year ended December 31, 2015. The unfavorable loss development for the year ended December 31, 2016 was the result of increased losses primarily from the 2015 accident year across all major coverages. The most significant causes of the development were a greater than usual emergence of reported claims and higher bodily injury severity. The unfavorable loss development for the year ending December 31, 2015 was largely the result of an increase in bodily injury loss adjustment expenses (primarily outside legal costs) driven by the overall increase in claim frequency.
The benefit for income taxes was $15.8 million for the year ended December 31, 2016, compared with $0.6 million at the year ended December 31, 2015. The year ended December 31, 2016 includes an increase in the valuation allowance for deferred tax assets (“DTA”) of $0.1 million.
In assessing our ability to realize the DTA, both positive and negative evidence are used to evaluate the allowance. Although we have incurred a pre-tax loss of $45.1 million which is a source of negative evidence, we placed greater weight on our outlook for future taxable income over the allowable time period for realization of the DTA and concluded that it is more likely than not that the remaining DTA will be realized. Regarding the length of time available to realize the DTA, at December 31, 2016, $24.2 million of the DTA related to net operating loss carryforwards do not expire until 2032 through 2037 and $2.0 million in AMT (“Alternative Minimum Tax”) carryforwards have no expiration date. The DTA valuation allowance may be adjusted in future periods if management determines that it is more likely than not that some portion or all of the DTA will not be realized. In the event the DTA valuation allowance is adjusted, we would record an income tax expense for the adjustment.
Our primary sources of funds are premiums, fees and investment income from our insurance company subsidiaries and commissions and fee income from our non-insurance company subsidiaries. Our primary uses of funds are the payment of claims and operating expenses. Net cash provided by operating activities for the year ended December 31, 2017 was $9.0 million, compared with net cash used in operating activities of $13.6 million for the year ended December 31, 2016. This increase was primarily the result of the Company’s improved loss and LAE ratio. Net cash used in investing activities for the year ended December 31, 2017 was $12.3 million, compared with net cash provided by investing activities of $16.7 million for the year ended December 31, 2016. These cash flows were the result of the purchase and sale activity related to investments, available-for-sale. Investing activities for the year ended December 31, 2016 were impacted by the sale of certain fixed maturities in an unrealized gain position to increase the statutory capital and surplus of the insurance company subsidiaries and their subsequent reinvestment.
Our holding company requires cash for general corporate overhead expenses and for debt service related to our debentures and term loan payable. The holding company’s primary source of unrestricted cash to meet its obligations is the sale of ancillary products and insurance policies on behalf of third-party carriers by our agency operations. At December 31, 2016, our holding company had $2.4 million available in unrestricted cash and investments. These funds and the additional unrestricted cash from the sources noted above will be used to pay our future cash requirements outside of the insurance company subsidiaries.
We have three insurance company subsidiaries that are organized and domiciled under the insurance statutes of Texas, Georgia, and Tennessee. Our insurance company subsidiaries also operate under licenses issued by various state insurance authorities. Such licenses may be of perpetual duration or periodically renewable, provided we continue to meet applicable regulatory requirements.
The National Association of Insurance Commissioners (“NAIC”) Model Act for risk-based capital provides formulas to determine each December 31 on an annual basis the amount of statutory capital and surplus that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. Failure to meet applicable risk-based capital requirements could subject our insurance company subsidiaries to further examination or corrective action imposed by state regulators, including limitations on their writing of additional business, state supervision or even liquidation. As of December 31, 2017 the insurance company subsidiaries remain above the company action levels. There are also statutory guidelines that suggest that on an annual calendar year basis an insurance company should not exceed a ratio of net premiums written to statutory capital and surplus of 3-to-1. On a combined basis, the ratio for our insurance company subsidiaries of net premiums written for the last twelve months to statutory capital and surplus was 4.27-to-1 at December 31, 2017 which is in excess of the suggested guideline.
Management is currently operating under a business plan to reduce premium writings and increase statutory capital and surplus to address the net premiums written to statutory capital and surplus guideline. For the year ended December 31, 2017, the insurance company subsidiaries experienced an increase in statutory capital and surplus of $7.2 million and a reduction in premiums written of $16.9 million, or 6%.
Payments due by period assume a contractual variable interest rate of LIBOR plus 375 basis points, or 5.517% at January 31, 2018.
We follow the accounting guidelines, which allows companies to waive comparing the fair value of goodwill and identifiable intangible assets to their carrying amounts in assessing their recoverability if, based on qualitative factors, it is more likely than not that the fair value of goodwill and identifiable intangible assets is greater than their carrying amounts. The qualitative factors include such things as our financial performance, legal and regulatory factors, industry and market considerations, and entity-specific events, all of which are subjective. Based on review of these factors, the Company prepared a qualitative analysis for its annual impairment testing as of October 1, 2017, which did not indicate any impairment.
We believe that our estimate regarding changes in loss severity is the most significant factor that can potentially impact our IBNR reserve estimate. We believe that there is a reasonable possibility of increases or decreases in our estimated claim severities, with the largest potential changes occurring in the most recent accident years. Dependent upon the accident year, an increase in loss severity of unpaid losses, ranging from 0.5% to 4.0% would result in adverse development of net loss and loss adjustment expense reserve levels at December 31, 2017 and a decrease in income before income taxes of approximately $5.3 million. Conversely, a comparable decrease in loss severity would result in favorable development of net loss and loss adjustment expense reserve levels at December 31, 2017 and an increase in income before income taxes of approximately $5.3 million.
To the Stockholders and the Board of Directors of First Acceptance Corporation
We have audited the accompanying consolidated balance sheets of First Acceptance Corporation and subsidiaries (the Company) as of December 31, 2017 and 2016, and the related consolidated statements of operations and comprehensive loss, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and financial statement schedule listed in the Index at Item 15(a)(2) (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 6, 2018 expressed an unqualified opinion thereon.
The Company's management is responsible 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 “Management’s Annual Report on Internal Control over Financial Reporting”. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries which are all wholly-owned. The accounts of First Acceptance Statutory Trust I (“FAST I”) are not consolidated since it does not meet the requirements for consolidation of FASB ASC 810, Consolidation (see Note 10). These financial statements have been prepared in conformity with U.S. generally accepted accounting principles. All intercompany accounts and transactions have been eliminated in consolidation.
If management can assert that it does not intend to sell an impaired fixed maturity security and it is more likely than not that it will not have to sell the security before recovery of its amortized cost basis, then an entity must separate other-than-temporary impairments (“OTTI”) into the following two components: (i) the amount related to credit losses, which are charged against income, and (ii) the amount related to all other factors, which are recorded in other comprehensive (loss) income. The credit-related portion of an OTTI is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge is required to reduce the amortized cost of that security to fair value.
Cash, cash equivalents, and restricted cash consist of bank demand deposits and other highly-liquid investments. All investments with maturities of three months or less at the date of purchase are considered cash equivalents. At December 31, 2017 and December 31, 2016, the Company had restricted cash equivalents of $18.5 million and $18.6 million, respectively.
The change in net asset value of limited partnership interests and any dividends paid by the REIT are recorded in investment income in the consolidated statements of comprehensive loss.
The Company accounts for income tax uncertainties under the provisions of FASB ASC 740, Income Taxes. The Company has recognized no additional liability or reduction in deferred tax assets for unrecognized tax benefits at December 31, 2017 and 2016. Any interest and penalties incurred in connection with income taxes are recorded as a component of the provision for income taxes. The Company is generally not subject to U.S. federal, state or local income tax examinations by tax authorities for taxable years prior to 2013.
On May 4, 2016, the Company sold one tract of land resulting in a gain of $1.2 million.
Deferred acquisition costs include premium taxes and other variable underwriting and direct sales costs incurred in connection with writing successful new and renewal business. These costs are deferred and amortized over the policy period in which the related premiums are earned, to the extent that such costs are deemed recoverable from future unearned premiums and anticipated investment income. Advertising costs are expensed when incurred and are not a part of deferred acquisition costs. Amortization expense for the years ended December 31, 2017, 2016 and 2015 was $16.9 million, $18.9 million and $16.3 million, respectively, and is included within insurance operating expenses in the accompanying consolidated statements of operations and comprehensive (loss) income.
Goodwill and identifiable intangible assets are attributable to the Company’s insurance operations and were initially recorded at their estimated fair values at their dates of acquisition. Identifiable intangible assets with an indefinite life, (trade name and state insurance licenses) are not amortized for financial statement purposes while those with a definite life (policy renewal rights, customer relationships, and software licenses) are amortized in proportion to projected policy expirations or life of the asset. At December 31, 2017 and 2016, identifiable intangible assets were $6.9 million and $7.6 million, respectively, stated net of accumulated amortization expense of $2.3 million and $1.5 million, respectively. The remaining amortization expense over the five succeeding fiscal years is $0.6 million, $0.5 million, $0.4 million, $0.3 million, and $0.2 million.
The Company performs required annual impairment tests of its goodwill and identifiable intangible assets as of October 1st of each year. In the event that facts and circumstances indicate that goodwill or identifiable intangible assets may be impaired, an interim impairment test would be required. For goodwill impairment analysis purposes, the Company considers the Titan Agencies to be a separate reporting unit.
Based on our evaluation of this guidance, including contract reviews, the Company did not determine any impact to our consolidated financial statements in applying this new guidance as of January 1, 2018.
In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments - Overall (Subtopic 825-20): Recognition and Measure of Financial Assets and Financial Liabilities” which requires entities to measure many equity investments at fair value and recognize changes in fair value in net income (loss), as opposed to the current practice of other comprehensive income (loss). The change will apply to the Company’s investments in mutual funds and preferred stock. The guidance also provides a new measurement alternative for equity investments that do not have readily determinable fair values and do not qualify for the net asset value practical expedient. Under this alternative, these investments can be measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. This guidance will apply to the Company’s other investment in the common stock of a real estate investment trust. The guidance is effective for public business entities for annual periods beginning after December 15, 2017, and interim periods within those years. The Company will adopt this new guidance as of January 1, 2018.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” which requires lessees to record most leases on their balance sheets as lease liabilities with corresponding right-of-use assets, but recognize expense in a manner similar to the current accounting treatment. The guidance is effective for public business entities for annual periods beginning after December 15, 2018, and interim periods within those years. Early adoption is permitted. The Company’s lease arrangements fall under this guidance and will be required to be shown on its consolidated balance sheet. The FASB has proposed a transition option that would allow entities to not apply the new guidance in the comparative periods they present in their financial statements in the year of adoption. The Company is
currently evaluating controls and processes to ensure this guidance is reflected properly on future consolidated financial statements and expects to adopt this guidance in its consolidated balance sheet as of March 31, 2019. As detailed in Note 8, the undiscounted contractual cash payments remaining on leased properties was $17.2 million as of December 31, 2017.
In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting” which addressed the recognition, presentation and classification of awards, forfeitures and shares withheld for tax purposes. The standard was effective for fiscal periods beginning after December 15, 2016, with each provision having a different application method. The adoption of this standard effective January 1, 2017 did not have a material impact on our consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326)” which requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses will be based on relevant information, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The expected increases and decreases in the credit loss will be reflected on the consolidated statement of comprehensive income (loss). The guidance is effective for public business entities for annual periods beginning after December 15, 2019, and interim periods within those years. Early adoption is permitted. The Company has not determined the impact on future consolidated financial statements once this is adopted.
In April 2017, the FASB issued ASU No. 2017-08, “Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities” which shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date instead of the current practice of amortizing the premium as a yield adjustment over the contractual life of the security. The guidance is effective for public business entities for periods beginning after December 15, 2018. Early adoption is permitted. The guidance calls for a modified retrospective transition approach under which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company believes that it will be reasonably able to comply with these requirements and has not determined the impact on future consolidated financial statements once this is adopted.
In May 2017, the FASB issued ASU No. 2017-09, “Compensation-Stock Compensation (Topic 718), Scope of Modification Accounting” that clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. The new guidance will provide relief to entities that make non-substantive changes to their share-based payment awards. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company currently has no intentions to modify any of its currently outstanding share-based payment awards.
In February 2018, the FASB issued ASU No. 2018-02 “Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” which gave entities the option to reclassify tax effects stranded in accumulated other comprehensive income (loss) as a result of the recent tax reform, to retained earnings (accumulated deficit). The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted for reporting periods for which financial statements have not yet been issued or made available for issuance. The Company has elected to early adopt this standard and has chosen to apply this adjustment in 2017. As a result, the Company opted to reclassify a deferred tax liability of $86 thousand (based on specific identification) from accumulated other comprehensive income to accumulated deficit in the accompanying consolidated financial statements, as of and for the year ended December 31, 2017.
Basic net loss per share is computed by dividing net loss available to common shareholders by the weighted average number of common shares, while diluted net loss per share is computed by dividing net loss available to common shareholders by the weighted average number of such common shares and dilutive share equivalents. Dilutive share equivalents may result from the assumed exercise of employee stock options and restricted stock units and are calculated using the treasury stock method.
The fair values as presented represent the Company’s best estimates and may not be substantiated by comparisons to independent markets. The fair value of the debentures payable and the term loan from principal shareholder are categorized as Level 3,
The fair values of the Company’s investments are determined by management after taking into consideration available sources of data. All of the portfolio valuations classified as Level 1 or Level 2 in the above tables are priced exclusively by utilizing the services of independent pricing sources using observable market data. The Level 2 classified security valuations are obtained from a single independent pricing service. The Level 3 classified security in the table above consists of an investment in the common stock of a REIT for which fair value at December 31, 2017 has been determined using a recent observable market transaction and at December 31, 2016 using a model-driven valuation that did not have observable market data. There were no transfers between Level 1 and Level 2 for years ended December 31, 2017 and 2016. The Company’s policy is to recognize transfers between levels at the end of the reporting period based on specific identification. The Company has not made any adjustments to the prices obtained from the independent pricing source.
The following table sets forth the scheduled maturities of the Company’s fixed maturity securities based on their fair values (in thousands). Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
The following table reflects the fair value and gross unrealized losses of those fixed maturity securities in a continuous unrealized loss position for greater than 12 months as of December 31, 2017. Gross unrealized losses are further segregated by the percentage of amortized cost (in thousands, except number of securities). There were no fixed maturity securities in a continuous unrealized loss position for greater than 12 months as of December 31, 2016.
Other investments consist of the common stock of a REIT and limited partnership interests in three funds that invest in (i) commercial real estate and secured commercial real estate loans acquired from financial intuitions, (ii) undervalued international publicly-traded equities and (iii) a pre-identified pool of select buyout private equity funds. These investments have redemption and transfer restrictions. The Company withdrew from another limited partnership investment and received the final withdrawal installment in July 2016. The Company does not intend to sell any of the remaining investments, and it is more likely than not that the Company will not be required to sell them before the expiration of such restrictions. At December 31, 2017, the Company had unfunded commitments of $2.5 million with two of these investments.
At December 31, 2017, fixed maturities and cash equivalents with a fair value and amortized cost of $6.2 million were on deposit with various insurance departments as a requirement of doing business in those states. Cash equivalents with a fair value and amortized cost of $18.3 million were on deposit with another insurance company as collateral for an assumed reinsurance contract.
The following is a progression of the credit-related portion of OTTI on investments owned at December 31, 2017, 2016, and 2015 (in thousands).
The Company has issued stock options (“Stock Option Awards”) and restricted stock units (“Restricted Stock Units”) to employees and directors under its Amended and Restated First Acceptance Corporation 2002 Long Term Incentive Plan (the “Plan”) and accounts for such issuances in accordance with FASB ASC 718, Compensation - Stock Compensation. At December 31, 2017, there were 6,450,143 shares remaining available for issuance under the Plan.
Stock Option Awards were all granted with an exercise price equal to or greater than the market price of the Company’s stock at the date of grant. Stock Option Awards expire over five or ten years from the date of grant and were all fully vested as of January 2016. Compensation expense related to Stock Option Awards was calculated under the fair value method and recorded on a straight-line basis over the vesting period. No Stock Option Awards have been granted since January 2012. All 120,000 options outstanding expire on March 17, 2018 having a $3.04 exercise price.
The following table summarizes Restricted Stock Units that the Compensation Committee of the Board of Directors of the Company awarded to executive officers (in thousands, except per share data). Such Restricted Stock Units will vest, and an equal number of shares of common stock will be deliverable upon the third anniversary of the dates of grants. Compensation expense related to the units was calculated based upon the closing market prices of the common stock on the dates of grants and is recorded on a straight-line basis over the vesting period.
The Company’s Board of Directors adopted the First Acceptance Corporation Employee Stock Purchase Plan (“ESPP”) whereby eligible employees may purchase shares of the Company’s common stock at a price equal to the lower of the closing market price on the first or last trading day of a six-month period. ESPP participants can authorize payroll deductions, administered through an independent plan custodian, of up to 15% of their salary to purchase semi-annually (June 30 and December 31) up to $25,000 of the Company’s common stock during each calendar year. The Company’s Board of Directors may at any time amend the ESPP in any respect, including termination of the ESPP, without notice to the employees. The Company has reserved 600,000 shares of common stock for issuance under the ESPP. Employees purchased approximately 68,000, 64,000, and 37,000 shares during the years ended December 31, 2017, 2016 and 2015, respectively. Compensation expense attributable to subscriptions to purchase shares under the ESPP was $20 thousand, $19 thousand and $12 thousand for the years ended December 31, 2017, 2016 and 2015, respectively. At December 31, 2017, 118,456 shares remain available for issuance under the ESPP.
Depreciation expense related to property and equipment was $2.1 million, $2.5 million and $1.8 million for the years ended December 31, 2017, 2016 and 2015, respectively.
The Company is committed under various operating lease agreements for office space. Certain lease agreements contain renewal options and rent escalation clauses. Rental expense for the years ended December 31, 2017, 2016 and 2015 was $9.9 million, $11.3 million and $11.2 million, respectively, and is included within insurance operating expenses in the accompanying consolidated statements of operations and comprehensive loss. Future minimum lease payments primarily under these agreements follow (in thousands).
The favorable change in the estimate of unpaid losses and loss adjustment expenses of $2.3 million for the year ended December 31, 2017 was the net result of favorable LAE development related to bodily injury claims over the 2014-2016 accident years, offset by unfavorable development on losses related to bodily injury severity over the 2014-2016 accident years.
The unfavorable change in the estimate of unpaid losses and loss adjustment expenses of $0.8 million for the year ended December 31, 2015 was largely the result of an increase in bodily injury loss adjustment expenses (primarily outside legal costs) driven by the overall increase in claim frequency.
As of December 31, 2017, frequency of claims by accident based on number of claimants is as follows.
The obligations of the Company under the junior subordinated debentures represent full and unconditional guarantees by the Company of FAST I’s obligations for the preferred securities. Dividends on the preferred securities are cumulative, payable quarterly in arrears and are deferrable at the Company’s option for up to five years. The dividends on these securities, which have not been deferred, are the same as the interest on the debentures. The Company cannot pay dividends on its common stock during such deferments.
The Company had a valuation allowance of $1.3 and $1.9 million at December 31, 2017 and 2016, respectively, relating to certain amounts that are more likely than not to be realized. In assessing our ability to realize the deferred tax asset (“DTA”), both positive and negative evidence are used to evaluate the allowance. Although the Company incurred a pre-tax loss of $45.1 million in 2016, which is a source of negative evidence, we placed greater weight on the Company’s outlook for future taxable income over the allowable time period for realization of the DTA, the Company has concluded that it is more likely than not that the remaining DTA will be realized. Regarding the length of time available to realize the DTA, at December 31, 2017, $13.4 million of the DTA related to net operating loss carryforwards do not expire until 2032 through 2036 and $2.0 million in AMT (“Alternative Minimum Tax”) credit carryforwards are fully refundable by 2021 under the new tax legislation if not utilized. The DTA valuation allowance may be adjusted in future periods if management determines that it is more likely than not that some portion or all of the DTA will not be realized. In the event the DTA valuation allowance is adjusted, the Company would record an income tax expense for the adjustment.
For the year ended December 31, 2017, the computation of diluted net loss per share did not include restricted stock units convertible into 755 thousand shares, a dilutive effect of 103 thousand shares, since their inclusion would have been anti-dilutive. Options to purchase 120 thousand shares for the year ended December 31, 2017 were not included in the computation of diluted net loss per share as their exercise prices were in excess of the average stock prices for the year.
For the year ended December 31, 2015, the computation of diluted net loss per share did not include options to purchase approximately 825 thousand shares, a dilutive effect of 319 thousand shares, and restricted stock units convertible into 141 thousand shares, a dilutive effect of 26 thousand shares, since their inclusion would have been anti-dilutive. Options to purchase 260 thousand shares for the year ended December 31, 2015 were not included in the computation of diluted net loss per share as their exercise prices were in excess of the average stock prices for the year.
At December 31, 2017, the Company had certain concentrations of credit risk with several financial institutions in the form of cash, cash equivalents, and restricted cash, which amounted to $115.5 million. For purposes of evaluating credit risk, the stability of financial institutions conducting business with the Company and the amount of available Federal Deposit Insurance Corporation insurance is periodically reviewed. If the financial institutions failed to completely perform under terms of the financial instruments, the exposure for credit loss would be the amount of the financial instruments less amounts covered by regulatory insurance.
As further detailed in Note 10, in June 2015, the Company borrowed $30 million from Diamond Family Investments, LP, an affiliate of Gerald J. Ford, the Company’s controlling stockholder.
The Company has $70.0 million in long-term borrowings of which $40.0 million matures in 2037 and $30.0 million matures in 2025. At December 31, 2017, the Company was in compliance with the covenants related to these borrowings. Such borrowings are not obligations of the Company’s regulated insurance company subsidiaries who at December 31, 2017 had combined statutory capital and surplus of $66.1 million. The Company believes that it has sufficient liquidity to meet its current obligations in the foreseeable future, including the payment of interest on its long-term borrowings which it currently funds through the cash flows of its agency operations which are generated outside the Company’s regulated insurance company subsidiaries and are not subject to any limitation on the payment of dividends to the holding company.
Interim results are not necessarily indicative of fiscal year performance because of the impact of seasonal and short-term variations. Selected quarterly financial data is summarized as follows (in thousands, except per share data).
Net (loss) income for the quarter ended December 31, 2017 included a reduction in the deferred tax asset of $12.5 million as a result of the enactment of legislation to reduce the corporate income tax rate.