For the year ended December 31, 2012, our overall revenues increased $10.1 million, or 3.6%, to $291.6 million from $281.6 million for the same period in 2011, and include a $5.3 million increase in revenues attributable to the change in accounting estimate. This increase was also due to increased net earned premiums, ceding commissions and brokerage commissions, which was partially offset by lower net realized investment gains and net investment income.
Total expenses increased $7.0 million, or 2.7%, to $268.1 million for the year ended December 31, 2012 from $261.1 million for the same period in 2011. The majority of the increase was due to increases in commissions of $1.8 million, of which $3.9 million was from the change in accounting estimate, net losses and loss adjustment expenses of $2.3 million, and personnel costs of $4.1 million. Partially offsetting this increase was a reduction of $0.8 million in other operating expenses due to higher acquisition related charges and the loss on the sale of CIRG impacting 2011. Additionally, interest expense decreased $1.0 million due to lower borrowing costs and the effect of the swap, which was partially offset by the $0.7 million charge for previously capitalized transaction costs on the termination of the SunTrust Bank, N.A. revolving credit facility.
On December 31, 2012, we acquired a 62.4% ownership in Digital Leash, LLC, d/b/a ProtectCELL and an option to purchase the remaining 37.6% ownership interest in ProtectCELL after 2014. ProtectCELL provides membership plans that afford protection for mobile wireless devices and other benefits including data management and identity theft protection. ProtectCELL is one of the leaders in mobile device protection plans and will spearhead Fortegra's efforts to expand its warranty and service contract business in the mobile and wireless device space.
On December 31, 2012, we acquired 100% of the outstanding stock ownership of 4Warranty Corporation, a leading warranty and extended service contract administrator with extensive expertise in furniture, electronics, appliance, lawn and garden, and fitness equipment. 4Warranty complements the company's rapidly expanding warranty business within its Payment Protection segment.
We estimate the Plan pre-tax costs will range from approximately $1.3 million to $1.7 million, including approximately $1.1 million to $1.3 million of cash payments under existing employment agreements and severance arrangements and approximately $0.2 million to $0.4 million of other cash costs, such as legal, relocation and information technology. We expect that substantially all the costs will be recorded during the three months ending March 31, 2013 and paid during 2013. We also estimate that the Plan will result in annual pre-tax savings of approximately $4.0 million, a substantial majority of which is expected to commence in the first quarter of 2013.
We prepare our Consolidated Financial Statements in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP") which requires management to make significant estimates and assumptions that affect the reported amounts of our assets, liabilities, revenues and expenses. See "Use of Estimates" and "Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements, included in Item 8 of this Form 10-K for additional information.
We periodically evaluate our estimates, which are based on historical experience and on various other assumptions that management believes to be reasonable under the circumstances. Critical accounting policies are those that are most important to the portrayal of our financial condition and results of operations and require management's most difficult, subjective or complex judgments, as a result of the need to make estimates about the effect of matters that are inherently uncertain. If actual performance should differ from historical experience or if the underlying assumptions were to change, our financial condition and results of operations may be materially impacted. In addition, some accounting policies require significant judgment to apply complex principles of accounting to certain transactions, such as acquisitions, in determining the most appropriate accounting treatment. We believe that the significant accounting estimates and policies described below are material to our financial reporting and are subject to a degree of subjectivity and/or complexity. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors.
There are inherent risks and uncertainties involved in making these judgments. Changes in circumstances and critical assumptions such as a continued weak economy, a more pronounced economic downturn or unforeseen events which affect one or more companies, industry sectors or countries could result in additional impairments in future periods for other-than-temporary declines in fair value. See the Note, "Investments" in the Notes to the Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information and ITEM 1A. RISK FACTORS - "Risks Related to Our Payment Protection Business - Our investment portfolio is subject to several risks that may diminish the fair value of our invested assets and cash and may materially and adversely affect our business and profitability" and "Liquidity and Capital Resources - Liquidity" contained elsewhere in this Form 10-K.
On January 1, 2012, we adopted the new guidance for Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This guidance was adopted on a retrospective basis and has been applied to all prior period financial information contained in our Consolidated Financial Statements. See the Note, "Recent Accounting Standards" of the Notes to Consolidated Financial Statements of this Form 10-K for the effect of the retrospective application.
We defer certain costs of acquiring new business and retaining existing business in accordance with the guidance in ASU 2010-26. These costs are limited to direct costs that resulted from successful contract transactions and would not have been incurred by our insurance entities had the transactions not occurred. These capitalized costs are amortized as the related premium is earned. The amortization of deferred acquisition costs are recorded in commissions expense or other operating expense in our Consolidated Statements of Income.
We evaluate whether deferred acquisition costs-insurance related are recoverable at year-end, and periodically if deemed necessary, and consider investment income in the recoverability analysis. As a result of our evaluations, no write-offs for unrecoverable deferred acquisition costs were recognized during the years ended December 31, 2012, 2011 and 2010.
We defer certain costs of acquiring new business and retaining existing business in our Payment Protection Segment related to non-insurance subsidiary transactions. These costs are limited to direct costs, typically commissions and contract transaction fees, that resulted from successful contract transactions and would not have been incurred by us had the transactions not occurred. These capitalized costs are amortized as the related service and administrative fees are earned. The following table shows the amortization of deferred acquisition costs for our non-insurance subsidiaries:
Goodwill represents the excess cost of an acquisition over the fair value of the net assets acquired in a business combination. Our other intangible assets consist of finite-lived intangible assets including customer related and contract based assets and are comprised
primarily of client lists and non−compete arrangements and acquired software, while our indefinite-lived intangible assets consist of trademarks. Goodwill and other intangible assets are carried as assets on the Consolidated Balance Sheets. Goodwill represented $119.5 million, $104.9 million, and $75.0 million of our total assets as of December 31, 2012, 2011 and 2010, respectively while other intangible assets represented $79.3 million, $54.4 million, and $40.0 million of our total assets as of December 31, 2012, 2011 and 2010, respectively.
In accordance with applicable statutory insurance company regulations, our unpaid claims reserves are evaluated by appointed actuaries. The appointed actuaries perform this function in compliance with the Standards of Practice and Codes of Conduct of the American Academy of Actuaries. The appointed actuaries perform their actuarial analysis each year and prepare opinions, statements and reports documenting their determinations. The appointed actuaries conduct their actuarial analysis on a basis gross of reinsurance. The same estimates used as a basis in calculating the gross unpaid claims reserves are then used as the basis for calculating the net unpaid claims reserves, which take into account the impact of reinsurance.
Anticipated future loss development patterns form a key assumption underlying these analyses. Our claims are generally reported and settled quickly resulting in a consistent historical loss development pattern. From the anticipated loss development patterns, a variety of actuarial loss projection techniques are employed, such as chain ladder method, the Bornhuetter-Ferguson method and expected loss ratio method.
(1) "In Course of Settlement" represents amounts reserved to pay claims known but are not yet paid.
(2) IBNR reserves represent amounts reserved to pay claims where the insured event has occurred and has not yet been reported. IBNR reserves for credit disability also include the net present value of future claims payment of $1,243, $1,354 and $1,094 as of December 31, 2012, 2011 and 2010, respectively.
Most of our credit insurance business is written on a retrospective commission basis, which permits management to adjust commissions based on claims experience. Thus, any adjustment to prior years' incurred claims in this line of business is partially offset by a change in retrospective commissions.
While our cost of claims has not varied significantly from our reserves in prior periods, if the actual level of loss frequency and severity are higher or lower than expected, our paid claims will be different than management's estimate. We believe that, based on our actuarial analysis, an aggregate change that is greater than ± 10% (or 5% for each of loss frequency and severity) is not probable. The effect of higher and lower levels of loss frequency and severity levels on our ultimate cost for claims occurring in 2012 would be as follows (dollars in thousands):
The calculation of tax liabilities is complex, and requires the use of estimates and judgments by management since it involves application of complex tax laws. We record deferred income taxes in accordance with the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recorded based on the difference between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as temporary differences, and are based on the enacted tax laws and statutory tax rates applicable to the periods in which we expect the temporary differences to reverse.
We earn brokerage commission and fee income by providing wholesale brokerage services to retail insurance brokers and agents and insurance companies. Brokerage commission income is primarily recognized when the underlying insurance policies are issued. A portion of the brokerage commission income is derived from profit agreements with insurance carriers. These commissions are received from carriers based upon the underlying underwriting profitability of the business that we place with those carriers. Profit commission income is generally recognized as revenue on the receipt of cash based on the terms of the respective carrier contracts. In certain instances, profit commission income may be recognized in advance of cash receipt where the profit commission income due to be received has been calculated or has been confirmed by the insurance carrier. We also derive fees from master license agreements to use the eReinsure system together with fees for the transactions completed through its platform. See - "Revenues - Brokerage Commissions and Fees" in this MD&A for a discussion of various factors that impact our brokerage commissions and fees.
commissions, incurred claims and the reinsurer's fee for the coverage. See - "Revenues - Ceding Commissions" for additional information on our ceding commissions.
Net earned premium is from direct and assumed earned premium consisting of revenue generated from the direct sale of Payment Protection insurance policies by our distributors and premiums written for Payment Protection insurance policies by another carrier and assumed by us. Whether direct or assumed, the premium is earned over the life of the respective policy using methods appropriate to the pattern of losses for the type of business. Methods used include the Rule of 78's, pro rata, and actuarial methods. Management selects the appropriate method based on available information, and periodically reviews the selections as additional information becomes available. Direct and assumed premiums are offset by premiums ceded to our reinsurers, including producer owned reinsurance companies ("PORCs"), earned in the same manner. The amount ceded is proportional to the amount of risk assumed by the reinsurer.
We earn net investment income from interest payments and dividends received from our investment portfolio, and interest earned on our cash accounts and notes receivable, less portfolio management expenses. Our investment portfolio is primarily invested in fixed maturity securities which tend to produce consistent levels of investment income. The fair value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. The fair value generally increases or decreases in an inverse relationship with fluctuations in interest rates. Investment income can be significantly impacted by changes in interest rates. Interest rate volatility can increase or reduce unrealized gains or unrealized losses in our portfolios. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Fluctuations in interest rates affect our returns on, and the fair value of, fixed maturity and short-term investments.
We currently have stock options outstanding under our 2005 Equity Incentive Plan and time- and performance-based stock options and restricted stock awards outstanding under The 2010 Omnibus Incentive Plan. Time-based stock options and restricted stock awards are grants that vest based on the passage of time whereas performance-based stock options and restricted stock awards are grants that vest based on us attaining certain financial metrics. We record stock-based compensation in accordance with ASC 718, Compensation - Stock Compensation, ("ASC 718"), which addresses the accounting for share-based awards, including stock options and restricted stock. Under ASC 718, compensation expense is measured using fair value and is recorded over the requisite service or performance period of the awards. We measure stock-based compensation expense using the calculated value method. Under this method, we estimate the fair value of each stock option on the grant date using the Black-Scholes valuation model. We use historical data to estimate expected employee behavior related to stock award exercises and forfeitures. Since there is not sufficient historical market experience for shares of our stock, we have chosen to estimate volatility, by using the average volatility of a selected peer group of publicly traded companies operating in the same industry. Expected dividends are based on the assumption that no dividends are expected to be distributed in the near future. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the options. The fair value of restricted stock awards is based on the market price of our common stock at the grant date. We typically recognize stock-based compensation expense for time-based awards on a straight-line basis over the requisite service and on a graded vesting attribution model for performance-based awards. Our current policy is to issue new shares upon the exercise of stock options. Please see the Note, "Stock-Based Compensation" in the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K for additional information.
For a discussion of recently issued accounting standards see the Note "Recent Accounting Standards" of the Notes to Consolidated Financial Statements of this Form 10-K.
Payment Protection. The Payment Protection administrative service revenue is recognized consistent with the earnings recognition pattern of the underlying insurance policies, debt cancellation contracts and motor club memberships being administered, using Rule of 78's, modified Rule of 78's, pro rata, or other methods as appropriate for the contract. Management selects the appropriate method based on available information, and periodically reviews the selections as additional information becomes available.
Brokerage commissions and fees are generally affected by fluctuations in the amount of premium charged by insurance carriers. The premiums charged fluctuate based on, among other factors, the amount of capital available in the insurance marketplace, the type of risk being insured, the nature of the insured party and the terms of the insurance purchased. If premiums increase or decrease, our
Our surplus lines brokerage commission and fee revenues fluctuate seasonally based on policy renewal dates and timing of profit commissions, and have historically been higher in the first two calendar quarters compared to the last two calendar quarters. In addition, our fee revenues at eReinsure are subject to seasonal fluctuations and are generally higher in the second and fourth quarters.
Ceding Commissions. Ceding commission earned under coinsurance agreements are based on contractual formulas that take into account, in part, underwriting performance and investment returns experienced by assuming companies. As experience changes, adjustments to the ceding commissions are reflected in the period incurred. Ceding commissions are only generated by our Payment Protection segment on credit insurance products.
We elect to cede to reinsurers under coinsurance arrangements a significant portion of the credit insurance that we distribute on behalf of our clients. We continue to provide all policy administration for credit insurance that we cede to reinsurers. Ceding commissions consist of commissions paid to us by our reinsurers to reimburse us for costs related to the acquisition, administration and servicing of policies and premiums that we cede to reinsurers. In addition, a portion of the ceding commission is determined based on the underwriting profits of the ceded credit insurance. The credit insurance that we distribute has historically generated attractive underwriting profits. Furthermore, some reinsurers pay to us a portion or all of the investment income earned on reserves that are maintained in trust accounts.
Ceding commissions are generally positively correlated with our credit insurance transaction and premium volumes. The portion of our ceding commissions that is related to the underwriting profits of the ceded credit insurance also fluctuates based on the claims made on such policies. The portion of our ceding commissions that is related to investment income can be impacted by the amount of reserves that are maintained in trust accounts and changes in interest rates. Ceding commissions are earned over the life of the policy.
Net Earned Premium. Net earned premium is from direct and assumed earned premium consisting of revenue generated from the direct sale of Payment Protection insurance policies by our distributors and premiums written for Payment Protection insurance policies by another carrier and assumed by us. Whether direct or assumed, the premium is earned over the life of the respective policy using methods appropriate to the pattern of losses for the type of business. Methods used include the Rule of 78's, pro rata, and actuarial methods. Management selects the appropriate method based on available information, and periodically reviews the selections as additional information becomes available. Direct and assumed premiums are offset by premiums ceded to our reinsurers, including producer owned reinsurance companies ("PORCs"), earned in the same manner. The amount ceded is proportional to the amount of risk assumed by the reinsurer.
The principal factors affecting net earned premiums are: (i) the proportion of the risk assumed by our reinsurers as defined in the applicable reinsurance treaty; (ii) increases and decreases in written premium; (iii) increases and decreases in policy cancellation rates; (iv) the average duration of the policies written; and (v) changes in regulation that would modify the earning patterns for the policies underwritten and administered.
Net Realized Investment Gains (Losses). We realize gains when invested assets are sold for an amount greater than the amortized cost in the case of fixed maturity securities and cost basis for equity securities. We recognize realized losses for invested assets sold for an amount less than their carrying cost or when fixed maturity securities or equity securities are written down as a result of an other-than-temporary impairment ("OTTI").
such unpaid claims reserve estimates and establishing the related liabilities based on our actual experience. We have not made any changes to our methodologies for determining unpaid claims reserves in the periods presented.
Amortization of Intangibles. Amortization of finite-lived intangibles is an expense recorded to allocate the cost of finite-lived intangible assets, such as purchased customer accounts and non-compete agreements acquired as part of our business acquisitions, over their estimated useful lives.
Interest Expense. Interest expense includes interest payable on our credit facilities, notes payable and preferred trust securities, net of the impact of the interest rate swap, and is directly correlated to the balances outstanding and the prevailing interest rates on these debt instruments.
(1) - The December 31, 2011 and 2010 Consolidated Statement of Income results have been adjusted to properly reflect the retrospective adoption of ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, as described in the Note, "Restatement of the Consolidated Financial Statements," of Notes to the Consolidated Financial Statements.
Service and administrative fees for the year ended December 31, 2011 increased $38.2 million, or 67.9%, to $94.5 million from $56.3 million for the year ended December 31, 2010. The results for 2011 principally reflect the full impact of the 2011 acquisition of Auto Knight and our 2010 car club acquisitions, which mostly occurred in the latter part of 2010 and contributed $41.1 million of the increase
Brokerage commissions and fees for the year ended December 31, 2012 increased $0.9 million, or 2.6%, to $35.3 million from $34.4 million for the year ended December 31, 2011. The 2012 period includes a full year of results for eReinsure, while the same period in 2011 includes eReinsure's results from the acquisition on March 3, 2011. For the 2012 period, B&G contributed $1.3 million to the increase while eReinsure decreased $0.4 million principally due to lower license fees.
Ceding commissions for the year ended December 31, 2012 increased $5.3 million, or 18.1%, to $34.8 million from $29.5 million for the year ended December 31, 2011. This increase primarily resulted from improved underwriting results due to growth in earned premiums and favorable loss experience along with additional administrative fees earned from increased insurance production in 2012, and the change in accounting estimate which accounted for $2.8 million of the increase. For the year ended December 31, 2012, ceding commissions included $25.6 million in service and administrative fees, $8.6 million in underwriting profits and $0.6 million in net investment income.
Net investment income for the year ended December 31, 2012 decreased $0.3 million, or 8.9%, to $3.1 million compared to $3.4 million for the year ended December 31, 2011. The decrease from 2011 was principally due to lower income earned on fixed income securities and to a lesser extent a lower amount of income earned on cash. Yields on the investment portfolio decreased 21 basis points to 2.67% for the year ended December 31, 2012 from 2.88% for the year ended December 31, 2011.
Net investment income for the year ended December 31, 2011 was $3.4 million and $4.1 million for the year ended December 31, 2010. The decrease from 2010 was principally due to lower income earned on fixed income securities and to a lesser extent a lower amount of income earned on cash. Yields on the investment portfolio decreased 134 basis points to 2.88% for the year ended December 31, 2011 from 4.22% for the year ended December 31, 2010.
and assumed written premium due to new clients distributing our credit insurance and warranty products. Because of this increase, ceded earned premiums increased $9.8 million or 5.0%. On average, we maintained a 64% overall cession rate of direct and assumed earned premium for both the years ended December 31, 2011 and 2010, respectively.
Net losses and loss adjustment expenses for the year ended December 31, 2012 increased $2.3 million, or 6% to $40.2 million, from $37.9 million for the year ended December 31, 2011. Our net losses and loss adjustment expense ratio improved from 32.9% in 2011 to 31.5% in 2012, with the change in accounting estimate improving the net losses and loss adjustment expense ratio by 63 basis points. The increase in net losses and loss adjustment expenses was primarily driven by increased earned premiums and warranty claims. For the 2012 period, our direct and assumed losses increased by $4.6 million, or 5.6%, as compared with the same period in 2011. For the 2012 period, our ceded losses were higher by $2.3 million, or 5.2%, compared with the same period in 2011, partially offsetting the increase in direct and assumed losses. On average, we maintained a 53.5% and 53.6% overall cession rate of direct and assumed losses and loss adjustment expenses for the year ended December 31, 2012 and 2011, respectively.
Commissions for the year ended December 31, 2011 increased $34.3 million, or 37.0%, to $126.9 million, from $92.6 million for the year ended December 31, 2010. The increase for 2011, compared to 2010, was principally due to 2011 results containing a full year of results for Auto Knight, Continental, and United, whereas 2010 results included only eight months of activity for Continental and four months of activity for United. In addition we saw a $4.5 million increase in net commissions due to growth in net written premiums. Retrospective commission expense increased $1.3 million due to favorable underwriting results and a decrease of $2.6 million in deferred policy acquisition cost amortization.
Personnel costs for the year ended December 31, 2012 increased $4.1 million, or 9.2%, to $48.6 million from $44.5 million for the year ended December 31, 2011. The increase resulted primarily from $1.9 million for the 2011 PBG acquisition and the increased headcount across the business. Total employees at December 31, 2012 increased to 589, which excludes the employees of ProtectCELL and 4Warranty, compared to 545 at December 31, 2011. In addition, the sale of CIRG in 2011 reduced personnel costs in 2012 by $0.3 million. Stock-based compensation expense included in personnel costs totaled $0.7 million and $0.6 million for the year ended December 31, 2012 and 2011, respectively.
Personnel costs for the year ended December 31, 2011 increased $8.2 million, or 22.5%, to $44.5 million from $36.4 million for the year ended December 31, 2010. The majority of the increase resulted from our 2011 and 2010 acquisitions, which increased personnel costs by $5.7 million, and $1.1 million associated with being a public company. Total employees at December 31, 2011 increased to
Other operating expenses for the year ended December 31, 2012 decreased $0.8 million, or 2.5%, to $30.4 million from $31.1 million for the year ended December 31, 2011. Other Operating expenses declined by $2.6 million led by transaction costs and other one-time expenses decreasing $0.4 million and $1.4 million, respectively. These improvements were offset in part by the impact of a full year of other operating expenses from PBG which we acquired during the final quarter in 2011. For 2012, PBG's other operating expenses were $2.1 million compared with 2011's other operating expenses of $0.3 million.
Other operating expenses for the year ended December 31, 2011 increased $6.7 million, or 27.5%, to $31.1 million from $24.4 million for the year ended December 31, 2010. The increase in other operating expenses is primarily due to $1.9 million in non-recurring charges, which included $1.0 million in costs related to contemplated acquisitions, $0.2 million in costs for corporate governance matters, $0.2 million for office relocation expenses, and $0.1 million in non-recurring statutory audits related to expanded licensing activities. In addition, $1.5 million of the increase is attributable to public company costs, including increased auditing and professional fees, corporate insurance and director fees. Also, our 2011 and 2010 acquisitions increased other operating expenses by $3.2 million.
Depreciation and amortization expense for the year ended December 31, 2011 increased $1.7 million, or 120.4%, to $3.1 million from $1.4 million for the year ended December 31, 2010. The increase was primarily due to higher levels of depreciable and amortizable assets in service at 2011 compared to 2010.
Interest expense for the year ended December 31, 2011 decreased $0.8 million, or 9.7%, to $7.6 million from $8.5 million for the year ended December 31, 2010. Interest expense for the year ended December 31, 2011 included the write off of $0.3 million during the first quarter of 2011 for capitalized issuance costs associated with the redemption of preferred stock. Interest expense for the year ended December 31, 2011 was positively impacted by the use of proceeds of our IPO funds to eliminate higher rate debt late in 2010 and to a lesser extent the changing of our base rate for our revolving line of credit to a EURO Dollar Funding thereby reducing our interest rate from 6.00% to 4.10% on $53.0 million in outstanding borrowings during the latter part of 2011. The reduction in higher rate borrowings was partially offset by the addition of approximately $41.8 million on our credit facility to fund the Auto Knight and eReinsure acquisitions in the first quarter of 2011 and to a lesser extent an additional $7.0 million borrowed to fund the PBG acquisition in the fourth quarter of 2011.
Income taxes for the year ended December 31, 2012 increased $1.2 million, or 16.2%, to $8.3 million from $7.1 million for the year ended December 31, 2011, with the increase primarily attributable to a higher level of pretax income. Our effective tax rate was 35.2% for the year ended December 31, 2012 compared to 34.9% for the same period in 2011.
Income taxes for the year ended December 31, 2011 decreased $1.0 million, or 12.5%, to $7.1 million compared with $8.2 million for 2010 due primarily to lower income before income taxes. Our effective tax rate was 34.9% for the year ended December 31, 2011 and 2010, respectively.
We conduct our business through three business segments: (i) Payment Protection; (ii) BPO; and (iii) Brokerage. The revenue for each segment is presented to reflect the operating characteristics of the segment. We allocate certain revenues and costs to our segments. These items consist primarily of corporate-related income, transaction related costs, executive stock compensation and other overhead expenses. For additional information regarding segment net revenues and operating expenses, see the Note, "Segment Results" in the Notes to the Consolidated Financial Statements included in this Form 10-K.
In addition to the financial covenant requirements under our credit facility, management uses EBITDA and Adjusted EBITDA as financial measures of operating performance for planning purposes, which may include, but are not limited to, the preparation of budgets and projections, the determination of bonus compensation for executive officers, the analysis of the allocation of resources and the evaluation of the effectiveness of business strategies. Although we use EBITDA and Adjusted EBITDA as financial measures to assess the operating performance of our business, both measures have significant limitations as analytical tools because they exclude certain material expenses. For example, they do not include interest expense and the payment of income taxes, which are both a necessary element of our costs and operations. Since we use property and equipment to generate service revenues, depreciation expense is a necessary element of our costs. In addition, the omission of amortization expense associated with our intangible assets further limits the usefulness of this financial measure. Management believes the inclusion of the adjustments to EBITDA and Adjusted EBITDA are appropriate to provide additional information to investors about certain material non-cash items and about unusual items that we do not expect to continue at the same level in the future. Because EBITDA and Adjusted EBITDA do not account for these expenses, its utility as a financial measure of our operating performance has material limitations. Due to these limitations, management does not view EBITDA and Adjusted EBITDA in isolation or as a primary financial performance measure.
We believe EBITDA and Adjusted EBITDA are frequently used by securities analysts, investors and other interested parties in the evaluation of similar companies in similar industries and to measure the company's ability to service its debt and other cash needs. Because the definitions of EBITDA and Adjusted EBITDA (or similar financial measures) may vary among companies and industries, they may not be comparable to other similarly titled financial measures used by other companies.
The following tables present segment revenue and expense information, segment EBITDA and EBITDA margin information and a reconciliation to net income:
(1) - The December 31, 2011 and 2010 Segment results have been adjusted to properly reflect the retrospective adoption of ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, as described in the Note, "Restatement of the Consolidated Financial Statements," of Notes to the Consolidated Financial Statements.
Operating expenses for the year ended December 31, 2012 increased $2.9 million, or 8.7%, to $36.4 million from $33.5 million for the year ended December 31, 2011. The increase in 2012 resulted primarily from growth in variable expenses to expand our payment protection business while the change in accounting estimate decreased 2012 by $0.4 million.
Operating expenses for the year ended December 31, 2011 increased $8.4 million, or 33.4%, to $33.5 million from $25.1 million for the year ended December 31, 2010. This increase resulted primarily from $2.8 million in expenses associated with being a public company, $1.3 million in non-recurring expenses and additional stock-based compensation expense of $0.6 million. Also contributing to this increase was $3.2 million of expense from the acquisitions of Auto Knight, Continental and United.
The BPO segment for 2012 includes a full year of results for PBG, which was acquired in October 2011.
Operating expenses for the year ended December 31, 2012 increased $2.6 million, or 22.7%, to $14.2 million from $11.6 million for the year ended December 31, 2011. The increase resulted primarily from additional expenses of $4.4 million from our PBG acquisition, offset by a $1.4 million reduction in operating expenses resulting from lower variable costs for processing and fulfillment associated with the decline in Consecta revenue.
EBITDA for the year ended December 31, 2011 decreased $3.1 million, or 43.6%, to $4.0 million from $7.1 million for the year ended December 31, 2010. As a result, EBITDA margin for the year ended December 31, 2011 was 25.6% compared to 41.4% for the year ended December 31, 2010.
Revenues totaled $37.1 million for the year ended December 31, 2012 compared to $37.0 million for the year ended December 31, 2011 and were comprised primarily of $24.5 million in standard commissions and fees, $2.4 million in profit commissions, $2.0 million of premium financing and collateral recovery fees and $8.4 million in fees from eReinsure. Revenues for the year ended December 31, 2011 of $37.0 million were comprised primarily of $23.7 million in standard commissions and fees, $1.9 million in profit commissions, $8.8 million in fees from eReinsure, and $2.0 million of premium financing and collateral recovery fees. Revenues for the year ended December 31, 2010 were $29.2 million and were comprised primarily of $23.1 million of standard commissions and fees, $1.2 million of profit commission revenue and $4.9 million of debt collection, premium financing and collateral recovery fees.
Operating expenses for the year ended December 31, 2012 were $28.4 million, compared to $29.3 million for the same period in 2011. For the years ended December 31, 2012 and 2011, the majority of our expenses were personnel costs, which totaled $15.6 million and $14.9 million, respectively. For the year ended December 31, 2012, eReinsure accounted for $3.1 million of the personnel costs and $0.9 million of the operating expenses compared to $3.3 million and $1.4 million, respectively for the same period in 2011.
During 2012, we acquired ProtectCELL and 4Warranty and recorded preliminary goodwill amounts of $11.7 million and $2.7 million, respectively. In addition, during 2012, we determined the final valuation for eReinsure and PBG and reduced the amount of goodwill associated with these acquisitions by $2.6 million and $2.7 million, respectively, to reflect the final valuation of intangibles acquired.
The following tables present our restated results of operations for the quarters ending March 31, June 30, and September 30 for the years 2012, 2011 and 2010, respectively, as discussed in the Note, "Restatement of the Consolidated Financial Statements," of Notes to the Consolidated Financial Statements.
The following MD&A presents the discussion of the Consolidated Income Statement line items that were impacted by the restatements described in the Note, "Restatement of the Consolidated Financial Statements," of Notes to the Consolidated Financial Statements
Service and administrative fees for the three months ended March 31, 2012 increased $1.3 million, or 6.2%, to $22.5 million from $21.2 million for the same period in 2011. The increase resulted primarily from an increase of $1.0 million in Motor Clubs fees, a $0.6 million increase in our BPO segment revenues, including the benefit of a $0.9 million increase in administrative fees from our 2011 acquisition of PBG offset by decreased revenue in Consecta of $0.3 million. In addition, we had a $0.1 million increase in administrative fees in our Payment Protection segment. These increases were partially offset by a $0.5 million lower debt collection and collateral recovery fees.
Service and administrative fees for the three months ended June 30, 2012 increased $0.7 million, or 3.1%, to $21.8 million from $21.1 million for the same period in 2011. The increase resulted primarily from a $0.7 million increase in our BPO segment revenues from our 2011 acquisition of PBG in October 2011 and a $0.1 million increase in administrative fees in our Payment Protection segment. These increases were partially offset by reduction of $0.2 million in Motor Clubs revenue and debt collection and collateral recovery fees declining $0.2 million compared to the same period in 2011.
Member benefit claims for the three months ended June 30, 2012 decreased $0.2 million, or 16.1%, to $1.1 million, from $1.3 million for the same period in 2011, resulting from lower Motor Clubs claims activity.
Member benefit claims was $0.9 million for the three months ended March 31, 2011. Since the first acquisition of a motor club did not occur until the second quarter of 2010, there was no corresponding member benefit claims expense for the same period in 2010.
Commissions for the three months ended June 30, 2012 increased $2.6 million, or 8.9%, to $31.3 million, from $28.7 million for the same period in 2011.The increase in commission expense resulted from growth in Payment Protection net earned premiums and Motor Clubs Service and administrative fees.
Commissions for the three months ended September 30, 2012 decreased $0.6 million, or 1.7%, to $33.4 million, from $33.9 million for the same period in 2011. Commissions associated with Motor Clubs decreased $4.0 million consistent with the reduction in revenues for the period, offset by higher commission expense of $0.9 million which resulted from growth in net earned premiums and from the third quarter 2012 change in accounting estimate, which increased commissions in the third quarter 2012 by $2.7 million.
The following MD&A presents the discussion of the Consolidated Income Statement line items for our Payment Protection Segment impacted by the restatements described in the Note, "Restatement of the Consolidated Financial Statements," of Notes to the Consolidated Financial Statements.
Net revenues for the three months ended March 31, 2012 decreased $1.1 million, or 7.6%, to $13.1 million from $14.2 million for the three months ended March 31, 2011. Ceding commission decreased $1.1 million resulting from lower underwriting profits of $1.4 million due to unfavorable loss experience for 2012 and was partially offset by additional service and administrative fees of $0.3 million from increased insurance production in 2012. Net investment income on our portfolio decreased by $0.2 million due to lower investment yields. Net realized gains on the sale of investments decreased by $0.1 million due to the sale of assets in the first quarter of 2011 not repeated in the first quarter of 2012. These decreases were offset by additional service and administrative fee income, which was $0.1 million above prior year period and resulted from increased debt cancellation and service fees primarily in the Vacation Ownership channel. In addition, underwriting revenue was $0.1 million above the 2011 period and resulted from increased earned premiums offset by growth in commissions due to an increase in direct and assumed written premium and an increase in loss ratio in our risk retained business.
Net investment income on our portfolio decreased by $0.1 million due to lower investment yields. Net realized (losses) gains on the sale of investments decreased by $1.2 million due to the sale of investment securities in the third quarter of 2011 not repeated in the third quarter of 2012. Motor club revenue net of commission decreased overall net revenue by $1.0 million.
Operating expenses for the three months ended September 30, 2012 increased $1.1 million, or 13.2%, to $9.6 million from $8.5 million for the three months ended September 30, 2011. This increase resulted primarily from growth in variable expenses to expand the business.
EBITDA for the three months ended September 30, 2012 increased $0.6 million, or 8.2%, to $7.8 million from $7.2 million for the three months ended September 30, 2011. As a result, EBITDA margin three months ended September 30, 2012 was 44.9% compared with 46.0% for the three months ended September 30, 2011.
Operating expenses for the three months ended March 31, 2011 increased $3.0 million, or 52.5%, to $8.8 million from $5.8 million for the three months ended March 31, 2010. This increase resulted primarily from $1.5 million in expenses associated with being a public company and additional stock-based compensation expense. Also contributing to this increase was $1.0 million of expense from the acquisitions of Auto Knight, Continental Car Club and United Motor Club. In addition, we recorded $0.7 million of expense due to the amortization of previously deferred acquisition costs from additional marketing and administrative costs.
Net revenues for the three months ended June 30, 2011 increased $1.1 million, or 9.4%, to $13.4 million from $12.2 million for the three months ended June 30, 2010. The 2011 results include a full quarter of revenues from the acquisitions of Auto Knight, Continental Car Club and United Motor Club, which added $0.9 million of revenue. Realized gains on the sale if investments increased by $1.1 million. These increases were partially offset by a decrease in ceding commission revenue of $0.1 million and net underwriting revenue (net earned premium less net losses and loss adjustment expenses less commissions) of $0.5 million due to unfavorable underwriting results.
EBITDA for the three months ended June 30, 2011 decreased $1.1 million, or 19.4%, to $4.7 million from $5.8 million for the three months ended June 30, 2011. As a result, EBITDA margin of the three months ended June 30, 2012 was 35.3% compared with 47.9% for the three months ended June 30, 2010.
Operating expenses for the three months ended September 30, 2012 increased $1.1 million, or 13.2%, to $9.6 million from $8.4 million for the three months ended September 30, 2011. This increase resulted primarily from additional costs associated with being a public
company and operating expenses associated with the 2011 and 2010 acquisitions which contributed $0.4 million of personnel costs and $0.1 million of other operating expense.
EBITDA for the three months ended September 30, 2012 decreased $0.9 million, or 10.9%, to $7.2 million from $8.1 million for the three months ended September 30, 2011. As a result, EBITDA margin for the three months ended September 30, 2012 was 46.0% compared with 55.2% for the three months ended September 30, 2011.
Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of its business operations, including working capital needs, capital expenditures, debt service, acquisitions and other commitments and contractual obligations. We historically have derived our liquidity from our invested assets, cash flow from operations, ordinary and extraordinary dividend capacity from our subsidiary insurance companies, our credit facility and investments. When considering our liquidity, it is important to note that we hold cash in a fiduciary capacity as a result of premiums received from insured parties that have not yet been paid to insurance carriers. The fiduciary cash is recorded as an asset on our Consolidated Balance Sheets with a corresponding liability, net of our commissions, to insurance carriers.
Our primary sources of liquidity are our total investments, cash and cash equivalent balances, availability under our revolving credit facility and dividends and other distributions from our subsidiaries. At December 31, 2012, we had total available-for-sale and short-term investments of $118.1 million, which includes restricted investments of $17.9 million, cash and cash equivalents of $15.2 million and $35.6 million of available capacity on our credit facility. At December 31, 2011, we had total investments of $95.8 million, which included restricted investments of $18.3 million, cash and cash equivalents of $31.3 million and $12.0 million of available capacity on our revolving credit facility. Our total indebtedness was $124.4 million at December 31, 2012 compared to $108.0 million at December 31, 2011.
On August 2, 2012, we terminated our existing $85.0 million revolving credit facility with SunTrust Bank, N.A and entered into a new credit facility with Wells Fargo Bank, N.A., which is described in the sections below, "$125.0 Million Credit Facility" and "$85.0 Million Revolving Credit Facility."
On August 2, 2012, we entered into a five-year $125.0 million secured credit agreement (the "Credit Agreement") with a syndicate of lenders, including Wells Fargo Bank, N.A., who also serves as administrative agent ("Wells Fargo" or the "Administrative Agent"). The Credit Agreement provides for a $50.0 million term loan facility (the "Term Loan Facility"), as well as a $75.0 million revolving credit facility (the "Revolving Facility" and collectively with the Term Loan Facility, the "Facilities") with a sub-limit of $10.0 million for swingline loans and $10.0 million for letters of credit. Subject to earlier termination, the Credit Agreement terminates on August 2, 2017. The Credit Agreement includes a provision pursuant to which, from time to time, we may request that the lenders in their discretion increase the maximum amount of commitments under the Facilities by an amount not to exceed $50.0 million.
The Credit Agreement contains certain customary representations, warranties and covenants applicable to us for the benefit of the Administrative Agent and the lenders. We may not assign, sell, transfer or dispose of any collateral or effect certain changes to our capital structure and the capital structure of our subsidiaries without the Administrative Agent's prior consent. Our obligations under the Facilities may be accelerated or the commitments terminated upon the occurrence of an event of default under the Credit Agreement, including payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, cross defaults to other material indebtedness, defaults arising in connection with changes in control and other customary events of default. The Credit Agreement also contains the following financial covenants, which require us to maintain, as of the end of each fiscal quarter:
a maximum Total Leverage Ratio (as defined in the Credit Agreement) of 3.50:1.00, with step-downs to 3.25:1.00 on December 31, 2013 and 3.00:1.00 on December 31, 2014;
a minimum Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of 2.00:1.00;
a minimum Reinsurance Ratio (as defined in the Credit Agreement) of 50.0%; and
On August 2, 2012, we terminated the $85.0 million revolving credit facility with SunTrust Bank, N.A. and entered into a new $125.0 million credit facility, which is discussed above. In connection with the termination of the SunTrust Bank, N.A. revolving credit facility, we recorded a charge of $0.7 million to interest expense during the year ended December 31, 2012 for previously capitalized transaction costs associated with this revolving credit facility.
In connection with the Summit Partners Transactions, our subsidiary, LOTS Intermediate Co. issued $35.0 million of fixed/floating rate preferred trust securities due in 2037. The preferred trust securities accrued interest at a rate of 9.61% per annum until the June 2012 interest payment date, thereafter, interest accrues at a rate of 3-month LIBOR plus 4.10% for each interest rate period. We were not permitted to redeem the preferred trust securities until after the June 2012 interest payment date, thereafter we may redeem the preferred trust securities, in whole or in part, at a price equal to 100% of the principal amount of such preferred trust securities outstanding plus accrued and unpaid interest. Interest is payable quarterly.
In April 2011, we entered into a forward interest rate swap (the "Swap") with Wells Fargo Bank, N.A., pursuant to which we swapped the floating rate portion of our $35.0 million in outstanding preferred trust securities to a fixed rate of 3.47% per annum payable quarterly resulting in a total rate of 7.57% after adding the applicable margin of 4.10%. The Swap has a five year term, which commenced in June 2012 when the interest rate on the underlying preferred trust securities began to float and will expire in June 2017.
Our invested assets consist mainly of high quality investments in fixed maturity securities, short-term investments, and a smaller allocation of common and preferred equity securities. We believe that prudent levels of investments in equity securities within our investment portfolio are likely to enhance long-term after-tax total returns without significantly increasing the risk profile of the portfolio. We regularly review our entire portfolio in the context of macroeconomic and capital market conditions. The overall credit quality of the investment portfolio was rated A+ by Standard and Poor's Rating Service at December 31, 2012 and 2011, respectively.
As of December 31, 2012, we held 29 individual fixed maturity and 3 individual equity securities in unrealized loss positions. We do not intend to sell the investments that are in an unrealized loss position at December 31, 2012 and it is more likely than not that we will be able to hold these securities until full recovery of their amortized cost basis for fixed maturity securities or cost for equity
As of December 31, 2011, there were 35 individual fixed maturity and 5 individual equity securities in unrealized loss positions. At December 31, 2011, based on management's quarterly review, we deemed that 10 individual equity securities were other than temporarily impaired and for the year ended December 31, 2011 recorded an impairment charge of $0.2 million. Please see the Note, "Investments" in the Notes to Consolidated Financial Statements for additional information.
Net cash provided by operating activities was $32.0 million for the year ended December 31, 2012 and was primarily attributable to our net income and an increase in accrued expenses, accounts payable and other liabilities and unearned premiums, which was partially offset by increases in reinsurance receivables, accounts and premiums receivable, net, and other receivables.
Net cash provided by operating activities was $11.2 million for the year ended December 31, 2011 and was attributable to an increase in unearned premiums and net income, partially offset by payments made for accrued expenses, accounts payable and other liabilities and a decrease in deferred revenue.
Net cash used in investing activities was $45.8 million for the year ended December 31, 2011 and primarily reflected cash used for purchases of fixed maturity securities and our acquisitions of Auto Knight, eReinsure, PBG and Magna, partially offset by the sale and maturity of fixed maturity investments. Net cash used in investing activities was $29.8 million for the year ended December 31, 2010 and was primarily used for the purchase of fixed maturity securities, the acquisitions of South Bay, Continental and United and purchases of property and equipment.
Net cash provided by financing activities was $22.6 million for the year ended December 31, 2011 and primarily reflected borrowings under our lines of credit of $110.6 million, of which approximately $51.6 million was used to complete the acquisitions of Auto Knight, eReinsure and PBG, which was partially offset by $74.3 million used to pay-down our credit facilities and $11.0 million used for the redemption of our redeemable preferred stock. During 2011, we also used $2.6 million to repurchase 471,554 shares of our common stock under our share repurchase plan.
We have obligations and commitments to third parties as a result of our operations. These obligations and commitments, as of December 31, 2012, are detailed in the table below by maturity date as of the periods indicated:
For interest payable on the preferred trust securities, we used interest swap in effect of 7.57% until June 2017, subsequent to that date we utilized the contractual spread amount of 410 basis points plus the 3-month forward LIBOR curve rate.
(4) - Estimated. Net unpaid claims are: total $13,119; less than 1 year $11,426; 1-3 years $1,584; 3-5 years $101; and more than 5 years $8.
We have audited the accompanying consolidated balance sheets of Fortegra Financial Corporation ("the Company") as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2012. Our audits also included the financial statement schedules listed in Item 15. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fortegra Financial Corporation as of December 31, 2012 and 2011, and the results of its consolidated operations and its cash flows for each of the years in the three-year period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, such financial statement schedules, when considered in relation to the basic financial statements as a whole, present fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 29, 2013 expressed an adverse opinion thereon.
Fortegra Financial Corporation (Traded on the New York Stock Exchange under the symbol: FRF), including its subsidiaries ("Fortegra" or the "Company"), is a diversified insurance services company headquartered in Jacksonville, Florida that provides distribution and administration services on a wholesale basis to insurance companies, insurance brokers and agents and other financial services companies primarily in the United States. In 2008, the Company changed its name from Life of the South Corporation to Fortegra Financial Corporation. The Company was incorporated in 1981 in the State of Georgia and re-incorporated in the State of Delaware in 2010. Most of the Company's business is generated through networks of small to mid-sized community and regional banks, small loan companies and automobile dealerships. The Company's majority-owned and controlled subsidiaries, are as follows:
Life of the South Insurance Company ("LOTS") and its subsidiary, Bankers Life of Louisiana ("Bankers Life")
The Consolidated Financial Statements include the accounts of Fortegra Financial Corporation and its majority-owned and controlled subsidiaries. All material intercompany account balances and transactions have been eliminated. The third-party ownership of 15% of the common stock of SFLAC and 37.6% of the ownership interests of ProtectCELL have been reflected as non-controlling interests on the Consolidated Balance Sheets. Prior to 2011, third parties held a 52% ownership of the preferred stock of CRC Reassurance Company, Ltd. which were redeemed during the year ended December 31, 2010.
Income (loss) attributable to these non-controlling interests has been reflected on the Consolidated Statements of Income as income (loss) attributable to non-controlling interests and on the Consolidated Statements of Comprehensive Income as comprehensive income (loss) attributable to non-controlling interests.
Prior to September 30, 2012, the Company's method of estimating unearned premium reserves in relation to the loss patterns and the related recognition of income for certain types of credit property and vendor single interest payment protection products was based on the pro-rata method. The use of the pro-rata method was based on the best information available at the time the Company's financial statements were prepared.
During the past two years the Company has increased the volume of business related to these product types, thereby increasing the volume of policy and claims data specific to the Company's product types. During the three months ended September 30, 2012, the Company determined it had accumulated a sufficient volume of policy and claims data to be able to perform an actuarial analysis in order to determine the preferable estimation approach. As a result of the analysis of the recently collected additional data, the Company has gained better insight into its product loss patterns and can provide improved judgment and estimation to more accurately calculate the unearned premium reserves and the associated recognition of income. Upon completion of the analysis, Management determined that the Rule of 78s applied on a daily basis provides a more accurate representation of historical loss patterns and the recognition of the related income; as such, the estimation method was changed. The change in approach has been accounted for as a change in accounting estimate that is effected by a change in accounting principle and is justifiable in that it is the preferable approach for income recognition based on the Company's actuarial study. This change in accounting estimate was applied prospectively in accordance with ASC 250-10-45-18. Summarized below is the effect of the change in accounting estimate on the Consolidated Statement of Income for the following period:
The Company reviewed all material subsequent events that occurred up to the date the Company's Consolidated Financial Statements were issued to determine whether any event required recognition or disclosure in the financial statements and/or disclosure in the notes thereto. For more information, please see the Note, "Subsequent Events."
Fair value as defined in the ASC as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.ASC 820-10 - Fair Value Measurements established a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when available. The levels of the hierarchy and those investments included in each are as follows:
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted
prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable
Level 3 - Inputs to the valuation methodology are unobservable for the asset or liability and are significant to the fair value
measurement. These unobservable inputs are derived from the Company's internal calculations, estimates and assumptions and
Cash and cash equivalents: The estimated fair value of cash and cash equivalents approximates their carrying value.
Notes payable and preferred trust securities: The carrying amounts approximate fair value because the applicable interest rates approximate current rates offered to the Company for similar instruments.
Interest rate swap: The fair value of the interest rate swap is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of the interest rate swap. This analysis reflects the contractual terms of the interest rate swap, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.
The Company earns brokerage commission and fee income by providing wholesale brokerage services to retail insurance brokers and agents and insurance companies and is primarily recognized when the underlying insurance policies are issued. A portion of the brokerage commission income is derived from profit commission agreements with insurance carriers. These commissions are received from carriers based upon the underlying underwriting profitability of the business that the Company places with those carriers. Profit commission income is generally recognized as revenue on the receipt of cash based on the terms of the respective carrier contracts. In certain instances, profit commission income may be recognized in advance of cash receipt where the profit commission income due to be received has been calculated or has been confirmed by the insurance carrier. The Company also derives fees from master license agreements to use the eReinsure system together with fees for the transactions completed through its platform.
Ceding commissions earned under coinsurance agreements are based on contractual formulas that take into account, in part, underwriting performance and investment returns experienced by the assuming companies. As experience changes, adjustments to the ceding commissions are reflected in the period incurred and are based on the claim experience of the related policy. The adjustment is calculated by adding the earned premium and investment income from the assets held in trust for the Company's benefit less earned commissions, incurred claims and the reinsurer's fee for the coverage.
Net losses and loss adjustment expenses include actual claims paid and the change in unpaid claim reserves. The Company's profitability depends in part on accurately predicting net loss and loss adjustment expenses. Incurred claims are impacted by loss frequency, which is the measure of the number of claims per unit of insured exposure, and loss severity, which is based on the average size of claims. Factors affecting loss frequency and loss severity include changes in claims reporting patterns, claims settlement patterns, judicial decisions, legislation, economic conditions, morbidity patterns and the attitudes of claimants towards settlements.
Unpaid claims are reserve estimates that are established in accordance with U.S. GAAP using generally accepted actuarial methods. Credit life and AD&D unpaid claims reserves include claims in the course of settlement and incurred but not reported ("IBNR").
Member Benefit Claims represent claims paid on behalf of contract holders directly to third parties providers for roadside assistance and for the repair or replacement of covered products. Claims can also be paid directly to contract holders as a reimbursement payment provided supporting documentation of loss is submitted to the Company. Claims are recognized as expense when incurred.
the occurrence of a significant economic event that may affect the industry in which an issuer participates, including a change that might adversely impact the investee's ability to achieve profitability in its operations;
with regards to commercial mortgage-backed securities ("CMBS"), the Company also evaluates key statistics such as breakeven constant default rates and credit enhancement levels. The breakeven constant default rate indicates the percentage of the pool's outstanding loans that must default each and every year with 40 percent loss severity (i.e., a recovery rate of 60 percent) for a CMBS class/tranche to experience its first dollar of principal loss. Credit enhancements indicate how much protection, or "cushion," there is to absorb losses in a particular deal before an actual loss would impact a specific security.
When, in the opinion of management, a decline in the estimated fair value of an investment is considered to be other-than-temporary or management intends to sell or is required to sell the investment prior to the recovery of cost, the investment is written down to its estimated fair value with the impairment loss included in net realized gains (losses) in the Consolidated Statements of Income. OTTI losses on equity securities and losses related to the credit component of the impairment on fixed maturity securities are recorded in the Consolidated Statements of Income as realized losses on investments and result in a permanent reduction of the cost basis of the underlying investment. Losses relating to the non-credit component of OTTI losses on fixed maturity securities are recorded in accumulated other comprehensive income (loss) ("AOCI") in the Consolidated Balance Sheets. The determination of
Cash and cash equivalents consist primarily of highly liquid investments, with original maturities of three months or less when purchased. At various times throughout the year, the Company may have cash deposited with financial institutions that exceed the federally insured deposit amount. Management reviews the financial viability of these financial institutions on a periodic basis and does not anticipate nonperformance by the financial institutions. The Company had approximately $8.2 million and $9.0 million of cash in interest bearing money market accounts at December 31, 2012 and 2011, respectively, that exceeded the FDIC insurance limit of $250,000.
Other receivables primarily represent amounts due to the Company from its business partners for retrospective commissions and for motor club fees.
The Company evaluates whether deferred acquisition costs-insurance related are recoverable at year-end, and considers investment income in the recoverability analysis. As a result of the Company's evaluations, no write-offs for unrecoverable deferred acquisition costs were recognized during the years ending December 31, 2012, 2011 and 2010.
The Company defers certain costs of acquiring new business and retaining existing business in its Payment Protection Segment related to non-insurance subsidiary transactions. These costs are limited to direct costs, typically commissions and contract transaction fees, that resulted from successful contract transactions and would not have been incurred by the Company had the transactions not occurred. These capitalized costs are amortized as the related service and administrative fees are earned. The following table shows the amortization of deferred acquisition costs for the Company's non-insurance subsidiaries:
The Company evaluates whether deferred acquisition costs - non-insurance related are recoverable at year-end. As a result of the Company's evaluations, no write-offs for unrecoverable deferred acquisition costs were recognized during the years ending December 31, 2012, 2011 and 2010.
Property and equipment is carried at cost, net of accumulated depreciation and amortization of capitalized software. Gains and losses on sales and disposals of property and equipment are based on the net book value of the related asset at the disposal date using the specific identification method with the corresponding gain or loss recorded to operations when incurred. Maintenance and repairs, which do not materially extend asset useful life and minor replacements, are charged to earnings when incurred. Depreciation expense is computed using the straight-line method over the estimated useful lives of the respective assets with three years for computers and five years for furniture, fixtures and equipment. Leasehold improvements are depreciated over the remaining life of the lease.
The Company leases certain equipment under a single capital lease. The assets and liabilities under the capital lease are recorded at the lower of the present value of the minimum lease payments or the fair value of the asset. The assets under the capital lease are depreciated over the remaining life of the lease or their estimated productive lives.
The Company capitalizes internally developed software costs on a project-by-project basis in accordance with ASC 350-40, Intangibles - Goodwill and Other: Internal-Use Software. All costs to establish the technological feasibility of computer software development are expensed to operations when incurred. Internally developed software development costs are carried at the lower of unamortized cost or net realizable value and are amortized based on the current and estimated useful life of the software. Amortization is computed using the straight-line method over the estimated useful life of 5 years and begins when the software is ready for its intended use.
The Company completed its annual assessment of goodwill for the years December 31, 2012, and 2011 in December of each respective year and concluded that the value of its goodwill was not impaired as of December 31, 2012 and 2011, respectively.
The Company has acquired significant other intangible assets through business acquisitions. The Company's other intangible assets consist of finite-lived intangibles, including customer related and contract based assets representing primarily client lists and non−compete arrangements and acquired software while the Company's indefinite-lived intangible assets consist of trademarks. Finite-
Unpaid claims include estimates for losses reported prior to the close of the accounting period and other estimates, including amounts for incurred but not reported claims. These liabilities are continuously reviewed and updated by management. Management believes that such liabilities are adequate to cover the estimated cost of the related claims. When management determines that changes in estimates are required, such changes are included in current operations.
The liability for unpaid claims includes estimates of the ultimate cost of known claims plus supplemental reserves calculated based upon loss projections utilizing certain actuarial assumptions and historical and industry data. In establishing its liability for unpaid claims, the Company utilizes the findings of actuaries.
Premiums written are earned over the life of the respective policy using the Rule of 78's, pro rata, or other actuarial method as appropriate for the type of business. Unearned premiums represent the portion of premiums that will be earned in the future. A premium deficiency reserve is recorded if anticipated losses, loss adjustment expenses, deferred acquisition costs and policy maintenance costs exceed the recorded unearned premium reserve and anticipated investment income. As of December 31, 2012, and 2011, no deficiency reserve was recorded.
Commissions include the commissions paid to distributors selling credit insurance policies, motor club memberships, and warranty service contracts. Credit insurance commission rates, in many instances, are set by state regulators and are also impacted by market conditions. In certain instances, credit insurance commissions are subject to retrospective adjustment based on the profitability of the related policies. Under these retrospective commission arrangements, the producer of the credit insurance policies receives a retrospective commission if the premium generated by that producer in the accounting period exceeds the costs associated with those policies, which includes the Company's administrative fees, claims, reserves, and premium taxes. The Company analyzes the retrospective commission calculation on a monthly basis for each producer and, based on the analysis associated with each such producer, the Company records a liability for any positive net retrospective commission earned and due to the producer or, conversely, records a receivable amount due from such producer for instances where the net result of the retrospective commission calculation is negative.
Deferred revenues represent the portion of income that will be earned in the future attributable to motor club memberships, mobile device protection plans, and other non-insurance service contracts that are earned over the respective contract periods using Rule of
Under Internal Revenue Code Section 1501, the Company files a consolidated federal income tax return with its affiliates which are at least 80% owned by the group. The Company has a tax sharing agreement with its subsidiaries where each company is apportioned the amount of tax equal to that which would be reported on a separate company basis. The components of other comprehensive income or loss included on the Consolidated Statements of Comprehensive Income and on the Consolidated Statements of Stockholders' Equity have been computed based upon the 35% federal tax rate.
All repurchased common shares are recorded as treasury stock and are accounted for under the cost method.
Advertising and promotional costs are expensed as incurred. Advertising expense for the following periods is presented below:
The Company has restated its previously issued Consolidated Balance Sheets, Consolidated Statements of Income and Consolidated Statements of Cash Flows as of and for the years ended December 31, 2011 and 2010, to correct for an error in the presentation of revenue and expense for the Motor Clubs division within the Payment Protection Segment, and errors in accounting as discussed in further detail below.
The Notes "Segment Results," "Quarterly Information - Restated (Unaudited)," and "Quarterly Segment Results - Restated (Unaudited)" disclose the material effects of these restatements by segment, by quarter, and by segment by quarter, respectively.
Due to the increased growth in and significance of this division to the Company and the Payment Protection segment, the Company reviewed its revenue presentation for service and administrative fees generated by the Motor Clubs division during the fourth quarter of 2012. The Company performed this analysis based on the guidance in ASC 605, Revenue Recognition, to determine the proper presentation of revenues for the Motor Clubs division. Based on its analysis, the Company determined that presentation of gross revenue and expense is most appropriate because the Company was and is the principal in transactions with motor club members, and was and is responsible for future claims and services to be provided to those members.
Concurrent with its review of Motor Clubs revenue presentation, the Company also reviewed its method of Motor Clubs revenue recognition and identified errors in revenue recognition for some of its product lines for the year ended December 31, 2011 and for the nine months ended September 30, 2012, and associated errors in purchase accounting related to deferred revenues and deferred acquisition costs on these products. Management evaluated the materiality of the errors from qualitative and quantitative perspectives and concluded that the errors were immaterial to the periods affected. The immaterial purchase accounting impacts, included in final purchase accounting amounts disclosed in Note "Business Combinations," were increases in deferred revenue liability of $0.7 million, deferred acquisition costs of $0.1 million, and goodwill of $0.4 million, and a decrease in deferred tax liabilities of $0.3 million. For the year ended December 31, 2011, this immaterial correction reduced retained earnings by $0.5 million. In this Form 10-K, the Consolidated Statement of Income, Consolidated Balance Sheet, and Consolidated Statement of Cash Flows as of and for the year ended December 31, 2011 have been restated to reflect the immaterial corrections.
As reported in the Company's Quarterly Report on Form 10-Q ("Form 10-Q") for September 30, 2012, during the third quarter 2012 the Company identified errors related to the purchase accounting adjustments for the 2011 acquisition of Auto Knight and the April 2009 acquisition of B&G. As a result, the Company's historical balances for goodwill, property and equipment and deferred taxes were incorrectly reported in prior period filings for the years ended December 31, 2011, 2010 and 2009, respectively. Management evaluated the materiality of the errors from qualitative and quantitative perspectives and concluded that the errors were immaterial to each of the prior periods noted above.
As more fully disclosed in Note "Recent Accounting Standards," the Company adopted ASU 2010-26, Accounting for the Costs Associated with Acquiring or Renewing Insurance Contracts, on a retrospective basis as permitted. This is not a correction of an error. However, in order to show all the effects of adjustments and restatements to the prior period financial statements in one set of schedules, the effects of this retrospective adoption are displayed in the schedules below.
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards ("IFRS"), which provides a consistent definition of fair value and ensures that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. The guidance changes certain fair value measurement principles and expands the disclosure requirements particularly for Level 3 fair value measurements. The guidance became effective for the Company beginning January 1, 2012 and was applied prospectively. The adoption of this guidance, which primarily relates to disclosure, did not impact the Company’s consolidated financial position, results of operations or cash flows.
On December 31, 2012, the Company acquired a 62.4% ownership interest of Digital Leash, LLC, d/b/a ProtectCELL and an option to purchase the remaining 37.6% ownership interest in ProtectCELL after 2014. ProtectCELL provides membership plans that afford protection for mobile wireless devices and other benefits including data management and identity theft protection. ProtectCELL is one of the leaders in mobile device protection plans and will spearhead Fortegra's efforts to expand its warranty and service contract business in the mobile and wireless device space. ProtectCELL's results will be included in the Company's Payment Protection segment.
During 2012, the Company received the final valuation studies for identifiable intangible assets to determine the final valuation for the 2011 acquisitions of eReinsure and PBG. Accordingly, the Consolidated Balance Sheet at December 31, 2011 has been retrospectively adjusted to include the effect of the measurement period adjustments as required under ASC 805. Please see the Notes, "Goodwill," and "Other Intangible Assets," for more information on the retrospective measurement period adjustments made in 2012.
(1) The amount of goodwill attributable to acquisitions that is expected to be tax deductible for acquisitions completed in 2011 has been revised from the amount presented in the 2011 Annual Report on Form 10-K resulting from adjustments to goodwill for final valuations obtained in 2012 for the 2011 acquisitions.
In 2012, the Company recorded goodwill in conjunction with the ProtectCELL and 4Warranty acquisitions. During 2012, the Company determined the final valuations for the 2011 acquisitions of eReinsure, included in the Brokerage Segment and PBG, included in the BPO segment.
The following table shows the retrospective adjustments made to the balance of goodwill at December 31, 2011 to reflect the effect of these measurement period adjustments made in accordance with accounting requirements under ASC 805 and the adjustments made to goodwill for the immaterial error corrections under ASC 250, that impacted balances prior to January1, 2011, that are discussed in the Note, "Restatement of the Consolidated Financial Statements," of Notes to the Consolidated Financial Statements.
Estimated amortization of finite-lived other intangible assets for the next five years and thereafter ending December 31 is presented below:
The following table summarizes the Company's available-for-sale fixed maturity and equity securities:
At December 31, 2012, the three unrelated reinsurers are: London Life Reinsurance Company (A. M. Best Rating-A); London Life International Reinsurance Corporation (A. M. Best Rating-NR-3) and Spartan Property Insurance Company (A. M. Best Rating - Non-rated). Because Spartan Property Insurance Company does not maintain an A.M. Best rating, the related receivables are collateralized by assets held in trust accounts. At December 31, 2011, the three unrelated reinsurers are: Munich American Reassurance Company (A. M. Best Rating-A+); London Life Reinsurance Company (A. M. Best Rating-A); and London Life International Reinsurance Corporation (A. M. Best Rating-NR-3). Because London Life International Reinsurance Corporation does not maintain an A.M. Best rating, the related receivables are collateralized by assets held in trust accounts and letters of credit. At December 31, 2012, the Company does not believe there is a risk of loss as a result of the concentration of credit risk in the reinsurance program.
The Company also leases equipment and software under a single capital lease expiring in 2014. The capital lease was assumed by the Company in conjunction with the 2012 acquisition of ProtectCELL. The following table shows the Company's future minimum lease payments for its capital lease at December 31, 2012:
Aggregate maturities for the Company's note payable at December 31, 2012 are as follows:
At December 31, 2012, the Company had a $125.0 million secured credit agreement (the "Credit Agreement"), entered into on August 2, 2012, with a syndicate of lenders, among them Wells Fargo Bank, N.A., who also serves as administrative agent ("Wells Fargo" or the "Administrative Agent"). The Credit Agreement has a five year term and provides for a $50.0 million term loan facility (the "Term Loan Facility"), as well as a $75.0 million revolving credit facility (the "Revolving Facility" and collectively with the Term Loan Facility, the "Facilities"). Subject to earlier termination, the Credit Agreement terminates on August 2, 2017. The Credit Agreement includes a provision pursuant to which, from time to time, the Company may request that the lenders in their discretion increase the maximum amount of commitments under the Facilities by an amount not to exceed $50.0 million.
The adjusted LIBO rate is the rate per annum obtained by dividing (i) the London interbank offered rate ("LIBOR") for such interest period by (ii) a percentage equal to 1.00 minus the Eurodollar Reserve Percentage (as defined in the Credit Agreement). The interest margin over the adjusted LIBO rate, initially set at 2.75%, may increase (to a maximum amount of 3.0%) or decrease (to a minimum amount of 2.0%) based on changes in our leverage ratio. The interest margin over the base rate, initially set at 1.75%, may increase (to a maximum amount of 2.0%) or decrease (to a minimum amount of 1.0%) based on changes in our leverage ratio.
In addition to interest payable on the principal amount of indebtedness outstanding from time to time under the Credit Agreement, the Company is required to pay a commitment fee, initially equal to 0.40% per annum of the unused amount of the Revolving Facility. The percentage rate of such fee may increase (to a maximum amount of 0.45%) or decrease (to a minimum amount of 0.25%) based on changes in the Borrowers' leverage ratio. The amount of outstanding swingline loans is not considered usage of the Revolving Facility for the purpose of calculating the commitment fee. The Company is also required to pay letter of credit participation fees on the undrawn amount of all outstanding letters of credit. The Company paid fees of approximately $1.7 million to Wells Fargo in connection with the execution of the Credit Agreement, which have been capitalized and are being amortized over the life of the Credit Agreement.
At December 31, 2011, the Company had an $85.0 million revolving credit facility with SunTrust Bank, N.A.,(the "Facility"). The Facility had an original maturity of June 2013. The Facility bore interest at a variable rate determined based upon the higher of (i) the prime rate, (ii) the federal funds rate plus 0.50% or (iii) LIBOR plus 1%, plus a margin tied to the Company's leverage ratio. The Company could select at its discretion to convert the interest rate for all or a portion of the outstanding balance for a period of up to six months to a fixed EURO Dollar Funding rate which is equal to the adjusted LIBOR rate for the elected interest period in effect at the time of election, plus a margin tied to the Company's leverage ratio.
At December 31, 2012 and 2011, respectively, the Company had to comply with various financial covenants set forth in the Credit Agreement and the Facility, respectively. The following describes the Credit Agreement's more significant financial covenants in effect at December 31, 2012 and the calculations used to arrive at each ratio:
The following is a summary of the Credit Agreement's more significant financial covenants calculated at December 31, 2012:
The following describes the Facility's more significant financial covenants in effect at December 31, 2011 and the calculations used to arrive at each ratio:
Fixed charge coverage ratio - is the ratio of Consolidated Adjusted EBITDA less the actual amount paid by the Company and its Subsidiaries in cash on account of Capital Expenditures less cash taxes to the Consolidated Fixed Charges, in each case measured for the four consecutive Fiscal Quarters ending on or immediately prior to such date.
Reinsurance ratio - is the ratio (expressed as a percentage) of, as of any date of determination, of the aggregate amounts recoverable by the Company and its Restricted Subsidiaries from reinsurers divided by the sum of (i) policy and claim liabilities plus (ii) unearned premiums, in each case of the Company and its Restricted Subsidiaries determined in accordance with GAAP.
The following table summarizes the fair value (including accrued interest) and related outstanding notional amounts of derivative instruments and indicates where within the Consolidated Balance Sheets each is reported:
The table below shows the estimated amount to be reclassified to earnings from AOCI during the next 12 months. These net losses reclassified into earnings are expected to primarily increase net interest expense related to the respective hedged item.
Additional information on time- and performance-based options granted, vested and exercised is presented below:
(1) Calculated as the difference between the market value at the exercise date and the exercise price of the shares.
A summary of the Company's time- and performance-based restricted stock award activity is presented below:
The Company has a nonqualified deferred compensation plan for certain officers. Provision has been made for the compensation which is payable upon their retirement or death. The deferred compensation is to be paid to the individual or their beneficiaries over a period of ten years commencing with the first year following retirement or death. As of December 31, 2012, there were no further payments required under the plan.
The Company also has deferred bonus agreements with several key executives whereby funds are contributed to "rabbi" trusts held for the benefit of the executives. The funds held in the rabbi trusts are included in cash and cash equivalents and the corresponding deferred compensation obligation is included in the line item, "Accrued expenses, accounts payable and other liabilities," on the Consolidated Balance Sheets. Pursuant to U.S. GAAP, the portion of the rabbi trusts invested in shares of the Company has been reflected in the treasury stock balance on the Consolidated Balance Sheets at December 31, 2012 and 2011.
The reconciliation of the income tax expense at the federal statutory income tax rate of 35% is as follows for the:
In addition, the Company has research and experimentation (research) tax credit carry forwards for federal and state income tax purposes in the amount of $0.5 million and $0.2 million, respectively. The federal research credit is also subject to certain limitations under IRC Section 382. The research credit carry forwards will begin to expire in 2019. As part of the valuation determinations of the subsidiary in which the research credit was generated, the Company recorded a $0.2 million liability against the research credit carryforward deferred tax asset.
As of December 31, 2012, the Company was under examination by the Internal Revenue Service ("IRS") for the 2009 and 2010 tax years. In February 2013, the IRS completed its field audit for those tax years and presented preliminary findings. The Company has agreed to those findings and paid $57.0 thousand, an amount considered immaterial to the consolidated group as of December 31, 2012. In March 2013, the Company received notice from the IRS that the audit report has been fully approved. The assessment will be expensed in the first quarter of 2013.
The following table details the combined statutory capital and surplus of the Company's insurance subsidiaries, the required minimum statutory capital and surplus, as required by the laws of the states in which they are domiciled and the combined amount available for ordinary dividends of the Company's insurance subsidiaries for the following periods:
The benefits of such additional funding would inure to the Company and to the non-controlling ownership interest of ProtectCell, in proportion to their respective ownership interests. However, in return for each $1,000 of Additional Fortegra Capital Contributions, the Fortegra Members shall receive one Series A Preferred Unit. Any unreturned Series A Preferred contribution is deducted from ProtectCELL's valuation in determining the option price.
The Company is a party to claims and litigation in the normal course of its operations. Management believes that the ultimate outcome of these matters will not have a material adverse effect on the consolidated financial condition, results of operations or cash flows of the Company.
In the Payment Protection segment, the Company is currently a defendant in lawsuits that relate to marketing and/or pricing issues that involve claims for punitive, exemplary or extra-contractual damages in amounts substantially in excess of the covered claim. Such litigation includes Lawson v. Life of the South Insurance Co., which was filed on March 13, 2006, in the Superior Court of Muscogee County, Georgia, and later moved to the United States District Court for the Middle District of Georgia, Columbus Division. The allegations involve the Company's alleged duty to refund unearned premiums on credit insurance policies, even when the Company has not been informed of the payoff of the underlying finance contract. The action seeks an injunction requiring remedial action, as well as a variety of damages, including punitive damages and attorney fees and costs. The action was brought as a class action, however the Company's May 11, 2012 Motion to Strike or Dismiss Plaintiffs' Class Action Allegations, or in the Alternative, to Deny Class Certification was granted on September 28, 2012. Plaintiff's appeal of such ruling was denied on December 7, 2012. The merits discovery phase continues in the individual, underlying case.
Also in the Payment Protection segment, the Company is currently a defendant in Mullins v. Southern Financial Life Insurance Co., which was filed on February 2, 2006, in the Pike Circuit Court, in the Commonwealth of Kentucky. A class was certified on June 25, 2010. At issue is the duration or term of coverage under certain policies. The action alleges violations of the Consumer Protection Act and certain insurance statutes, as well as common law fraud. The action seeks compensatory and punitive damages, attorney fees and interest. The parties are currently involved in the merits discovery phase and discovery disputes have arisen. Plaintiffs filed a Motion for Sanctions on April 5, 2012 in connection with the Company's efforts to locate and gather certificates and other documents from the Company's agents. While the court did not award sanctions, it did order the Company to subpoena certain records from its agents. The Company filed an appeal of this order, which was denied on August 31, 2012. The Company is currently appealing the denial in the Kentucky Supreme Court. To date, no trial date has been set.
In the Motor Clubs business in the Payment Protection segment, the Company is currently a Defendant in Dill and Thurman v. Continental Car Club, Inc. and Fortegra Financial Corp., which was filed on August 18, 2011 in the Tennessee Chancery Court, Rhea County. The Plaintiffs assert claims for breach of their employment and non-competition agreements, among other claims, and seek injunctive relief and damages in connection with the Company's purchase of Continental Car Club, Inc. from Plaintiffs in May 2010. The trial court ruled in November 2012 that Plaintiffs resigned for good reason from the Company, the result of which is that the Company can enforce the non-competition and non-solicitation provisions contained in the Plaintiffs' employment agreements for a period of up to two years, but that the Company is required to pay Plaintiffs base salary and accrued benefits during such period. As of December 31, 2012, the value of such salary and benefits is $0.4 million; the value would increase over time through the two-year period to an estimated maximum of approximately $0.8 million. The Company has filed for an appeal of this ruling and will vigorously defend its position. The Company believes that it is not probable that the judgment will be upheld through the appeal process, and that reasonably possible outcomes range from $0 to the amount of the judgment. Accordingly, the Company has not recorded a charge with respect to this loss contingency as of December 31, 2012.
The Company believes that this Non-GAAP financial measure provides useful information to management, analysts and investors regarding financial and business trends relating to the Company's results of operations and financial condition. The variability of the Company's segment EBITDA is significantly affected by segment net revenues because a large portion of the Company's operating expenses are fixed. The Company's industry peers may also provide similar supplemental Non-GAAP financial measures, although they may not use the same or comparable terminology and may not make identical adjustments.
In conjunction with the December 31, 2012 acquisition of ProtectCELL, the Company assumed an office space lease between ProtectCELL and 39500 High Pointe, LLC, ("High Pointe"). The ownership of High Pointe includes three members who were the founding members and are currently employees of ProtectCELL. The Company did not make any lease payments to High Pointe for the year ended December 31, 2012.
In addition, ProtectCELL holds a $6.1 million note receivable carrying an interest rate of 8.00% from High Pointe, which is fully secured by a mortgage on the office building owned by High Pointe. For the year ending December 31, 2012, the Company did not receive payments from High Pointe on the note receivable.
An executive officer of ProtectCELL owns multiple wireless retail locations, which sell ProtectCELL protection plans to wireless retail customers. For the year ending December 31, 2012, the Company did not record income related to this related party arrangement.
In December 2011, the Company entered into an information technology support services agreement (the "IT Agreement") with a company for which a member serving on the Company's Board of Directors also serves on the board of the company receiving the information support services. The IT Agreement has no set term and calls for a total of $0.3 million plus reimbursement of expenses to be received by the Company over the duration of the agreement.
In connection with the Summit Partners acquisition of the Company on June 20, 2007, $20.0 million of subordinated debentures were issued to affiliates of Summit Partners, a related party, and reported in the notes payable line of the Consolidated Balance Sheets. The subordinated debentures had an original maturity of June 20, 2012, which was subsequently amended to mature in June 2013, and bore interest at 14% per annum on the principal amount of such subordinated debentures, payable quarterly. In December 2010, the Company paid off the entire $20.0 million of outstanding subordinated debentures for $20.6 million, which included accrued but unpaid interest to the redemption date.
The following table details the amounts recorded on the Company's Consolidated Balance Sheets and Consolidated Statements of Income resulting from related party transactions:
On January 1, 2013, the Company granted 228,981 performance-based stock options and 76,326 performance-based restricted stock awards under the Company's Long-Term Incentive Plan ("LTIP").
The performance-based awards will vest, if at all, should the Company achieves three-year performance goals on or before December 31, 2015 for (i) net revenue (Compound Annual Growth Rate), (ii) earnings growth (Net Income) and (iii) profitable growth (Return on Average Equity). The performance metrics are equally weighted such that achievement of any one target results in vesting of one-third of the total equity award. If any of the target(s) are not attained by December 31, 2015, the award(s) associated with the unattained targets will be canceled.
On January 2, 2013, U.S. tax law was enacted which extends, through 2013, several expired or expiring temporary business tax provisions. The Company is still quantifying the impact of this law change; however, it is not expected to have a material impact on the Company's Consolidated Financial Statements.
As disclosed on January 18, 2013 in the Company's Current Report on Form 8-K, effective January 14, 2013, the Company committed to a plan to consolidate the Company's fulfillment, claims administration and information technology functions for all its insurance related products (the "Plan"). Prior to the Plan, such functions resided in the Company's individual business units. The decision is part of the Company's efforts to streamline its operations, focus its resources and provide first in class service to its customers. When fully implemented, approximately 40 employee and contract positions will be eliminated.
force. All remaining claim liabilities for previously issued policies are fully reinsured by Kemper's subsidiary, Trinity Universal Insurance Company.
The quarters ending March 31, 2012, June 30, 2012 and September 30, 2012 and the quarters ending March 31, 2011, June 30, 2011, September 30, 2011 and December 31, 2011 presented in the tables below have been restated as discussed in the Note, "Restatement," of the Consolidated Financial Statements and have been adjusted to reflect the retrospective adoption of ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. See the Note, "Quarterly Information - Restated (Unaudited)," of the Notes to Consolidated Financial Statements for additional information on the line items impacted for the for the above noted periods.
The following tables present the Company's restated quarterly Segment Results for the quarters ending March 31, 2012, June 30, 2012 and September 30, 2012 and for the quarters ending March 31, June 30, September 30, and December 31, 2011 and 2010, respectively.
The following table reconciles the restated segment information to the Company's Consolidated Statements of Income and provides a summary of other key financial information for each segment, as restated, for the quarters ending March 31, 2012, June 30, 2012 and September 30, 2012 and for the quarters ending March 31, June 30, September 30, and December 31, 2011 and 2010, respectively.
Reconciliation of Segment Net Revenue to Total Revenue and EBITDA to Net Income