We also lease office space located at 7861 Woodland Center Boulevard, Tampa, Florida 33614 in a 5,880 square foot office facility, which serves as the principal office space for our subsidiary, Maison. Our lease for this office space is scheduled to expire in January 2025.
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth elsewhere in this Annual Report.
(1)Net loss ratio is calculated as losses and loss adjustment expenses divided by net premiums earned.
Total revenue increased $18.9 million, or 4.8%, to $415.0 million for the year ended December 31, 2019, as compared to $396.1 million for the year ended December 31, 2018. The increase was primarily driven by higher net premiums growth from Homeowners and higher net investment gains offset by lower net premiums earned in Automobile and commercial general liability, all of which are discussed below.
Gross premiums earned increased $2.3 million, or 0.4%, to $582.3 million for the year ended December 31, 2019, as compared to $580.0 million for the year ended December 31, 2018. Gross premiums earned increased primarily due to a 4.8% increase in earned premiums in Homeowners, which includes $7.9 million from Maison, partially offset by our decision to exit the Automobile and commercial general liability lines.
Ceded premiums earned decreased $6.1 million, or 2.7%, to $218.7 million for the year ended December 31, 2019, as compared to $224.8 million for the year ended December 31, 2018. The decrease was primarily driven by lower ceded premiums in Automobile as we have exited that line of business, partially offset by higher excess of loss reinsurance spend in Homeowners.
Net realized and unrealized investment gains (losses) increased $11.2 million, to $7.1 million for the year ended December 31, 2019, as compared to $(4.1) million for the year ended December 31, 2018. We recognized $4.1 million and $(1.2) million in unrealized investment gains (losses) for equity securities during these respective periods. Our current year net realized gains and prior year net realized losses are primarily associated with our portfolio managers, under our control, moving out of positions due to both macro and micro conditions, a typical practice each and every quarter. Our prior year net realized losses also resulted from our decision to liquidate certain bond positions, including positions related to tax-free municipal securities during the first quarter of 2018.
Direct written policy fees decreased by $3.2 million, or 23.7%, to $10.2 million for the year ended December 31, 2019, as compared to $13.4 million for the year ended December 31, 2018. The decrease in direct written policy fees is correlated to our decision to exit the Automobile line, as discussed earlier.
Losses and loss adjustment expenses ("LAE") increased $44.7 million, or 19.6%, to $273.1 million for the year ended December 31, 2019, as compared to $228.4 million for the year ended December 31, 2018. Homeowners losses increased $51.2 million during the year ended December 31, 2019 as compared to the year ended December 31, 2018, slightly offset by $6.5 million of decreases in Automobile and commercial general liability as we exit these lines, across the same period.
The net loss ratio increased 10.8 percentage points, to 75.1% in 2019, as compared to 64.3% in 2018. The higher ratio was primarily the result of $52.7 million of net losses from 2019 severe weather events in Florida and other states (of which $26.5 million relates to
General and administrative expenses increased $1.0 million, or 4.6%, to $23.2 million for the year ended December 31, 2019, as compared to $22.2 million for the year ended December 31, 2018. The increase was primarily the result of higher professional fees, including deal costs and due diligence costs relating to the acquisition of the Maison Companies, as previously discussed.
Interest expense increased $6.6 million to $10.8 million for the year ended December 31, 2019, as compared to $4.2 million for the year ended December 31, 2018. The increase in interest expense is the result of $3.6 million of prepayment fees, including the write-off of remaining debt issuance costs, and an increase in the outstanding debt as a result of our first quarter 2019 borrowing. Refer to Note 3 and 8 of the notes to our Consolidated Financial Statements included herein, for information regarding new debt issued and debt retirement that occurred in March 2019.
Income tax expense (benefit) decreased $5.8 million, or 105.4%, to $(0.3) million for the year ended December 31, 2019, as compared to $5.5 million for the year ended December 31, 2018. The decrease in income tax expense is the result of lower income during 2019, compared to 2018. Additionally, in 2019, we recognized a benefit of $0.4 million relating to an election to carry back capital losses and a benefit of $0.2 million relating to a reduction in the uncertain tax position reserve. Lastly, the State of Florida announced a reduction in its state income tax rate effective from January 1, 2019, as discussed earlier.
Operating Results Overview - Year Ended December 31, 2018 Compared to Year Ended December 31, 2017
Gross premiums earned decreased $23.2 million, or 3.8%, to $580.0 million for the year ended December 31, 2018, as compared to $603.2 million for the year ended December 31, 2017. The results are a reflection of our decision to exit the Automobile and commercial general liability lines, as discussed earlier, and were partially offset by a 3.4% increase in earned premiums in Homeowners. Additionally, in homeowners Florida, our August 1, 2017 10.0% rate increase is fully reflected in earned premiums as of the end of the
Net realized and unrealized investment gains (losses) declined $12.6 million, to $(4.1) million for the year ended December 31, 2018, as compared to $8.5 million for the year ended December 31, 2017. During the year ended December 31, 2018, we recognized $1.2 million in unrealized investment losses for equity securities and $2.9 million in net realized losses primarily due to the decision to liquidate certain bond positions, including positions related to tax-free municipal securities. This liquidation was done to reduce exposure in certain bond types as well as consolidate our investment strategy between MNIC's investment securities and the rest of the Company's investment securities, which resulted in us selling out of certain bond and equity positions. We also experienced losses associated with our portfolio managers, under our control, moving out of positions due to both macro and micro conditions, a typical practice each and every quarter. Our prior year investment gains of $8.5 million were driven by a decision to re-deploy approximately $30.6 million of equities into fixed-income securities during the third quarter of 2017 in order to reduce the Company’s exposure to the equity markets.
The decline in other income was driven by lower commission income and financing and other revenue partially offset by higher brokerage revenue. The year over year decreases were driven by lower fee income from Automobile and other fees across the business. The lower fee income from Automobile was due to the reduction in premiums earned for the year ended December 31, 2018, as compared to December 31, 2017.
Losses and LAE decreased $19.2 million, or 7.7%, to $228.4 million for the year ended December 31, 2018, as compared to $247.6 million for the year ended December 31, 2017. The lower loss ratio was the result of the decrease in the size of Automobile ($21.2 million lower losses, including adverse development) driven by exiting the line of business.
The expense was also impacted from severe weather ($31.5 million in the year ended December 31, 2018, impacts of Hurricane Michael, Hurricane Florence and Tropical Storm Gordon, as compared to $30.4 million in the year December 31, 2017, impacts of Hurricane Irma and Hurricane Harvey).
Income taxes increased $1.9 million, or 53.4%, to $5.5 million for the year ended December 31, 2018, as compared to $3.6 million for the year ended December 31, 2017. The increase in income tax expense is the result of higher taxable income during the year ended December 31, 2018, as compared to the year ended December 31, 2017, partially offset by the decrease in the federal corporate tax rate from 35% to 21%, effective January 1, 2018. Refer to Note 9 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information on federal income tax reform.
As described more fully in Part I, Item 1. Business, Regulation of this Annual Report, our insurance operations are subject to the laws and regulations of the states in which we operate. The Florida OIR and their regulatory counterparts in other states utilize the NAIC RBC requirements, and the resulting RBC ratio, as a key metric in the exercise of their regulatory oversight. The RBC ratio is a measure of the sufficiency of an insurer’s statutory capital and surplus. In addition, the RBC ratio is used by insurance industry ratings services in the determination of the financial strength ratings (i.e. claims paying ability) they assign to insurance companies. As of December 31, 2019, FNIC’s statutory surplus, which includes MNIC, was $141.8 million. As of December 31, 2019, MIC’s, statutory surplus was $50.7 million.
Based upon the 2019, 2018 and 2017 statutory financial statements for FNIC, MIC and MNIC, statutory surplus exceeded the regulatory action levels established by the NAIC’s RBC requirements.
Based on RBC requirements, the extent of regulatory intervention and action increases as the ratio of an insurer’s statutory surplus to its ACL, as calculated under the NAIC’s requirements, decreases. The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200.0% of the ACL amount. The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150.0% of the ACL amount. The third action level, ACL, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70.0% of the ACL amount. FNIC’s ratio of statutory surplus to its ACL was 323.9% and 329.9% as of December 31, 2019 and 2018, respectively. MNIC’s ratio of statutory surplus to its ACL was 1,128.7% and 774.4% as of December 31, 2019 and 2018, respectively. MIC’s ratio of statutory surplus to its ACL was 305.7% as of December 31, 2019.
We believe that existing cash and investment balances, when combined with anticipated cash flows and the proceeds of our debt offering as described above, will be adequate to meet our expected liquidity needs in both the short-term and the reasonably foreseeable future. We believe the combined balances will be sufficient to meet our ongoing operating requirements and anticipated cash needs, and satisfy the covenants in our senior notes. Future growth strategies may require additional external financing and we may from time to time seek to obtain external financing. We cannot assure that additional sources of financing will be available to us on favorable terms, or at all, or that any such financing would not negatively impact our results of operations. We expect to continue declaring and paying dividends at comparable levels, subject to our future liquidity needs and reserve requirements.
The table sets forth a summary of long-term contractual obligations as of December 31, 2019, and includes amounts that represent estimates of gross undiscounted amounts payable over time, as follows:
When we invest in certain companies, such as limited partnerships and limited liability companies, and if we determine we are not the primary beneficiary, we account for them using the equity method to determine the carry value, which is included in other assets on our Consolidated Balance Sheets. Our maximum exposure to loss is limited to the capital we invest.
Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. Reinsuring loss exposures does not relieve a ceding entity from its obligations to policyholders and cedants. Reinsurance recoverables (including amounts related to claims incurred but not reported) and ceded unearned premiums are reported as assets. To minimize exposure to losses from a reinsurer’s inability to pay, the financial condition of such reinsurer is evaluated initially upon placement of the reinsurance and periodically thereafter. In addition to considering the financial condition of the reinsurer, the collectability of the reinsurance recoverables is evaluated (and where appropriate, whether an allowance for estimated uncollectible reinsurance recoverables is to be established) based upon a number of other factors. Such factors include the amounts outstanding, length of collection periods, disputes, any collateral or letters of credit held and other relevant factors.
The acquisition costs are deferred and amortized over the period in which the related premiums written are earned, generally 12 months. It is grouped consistent with the manner in which the insurance contracts are acquired, serviced and measured for profitability and is reviewed for recoverability based on the profitability of the underlying insurance contracts. Investment income is anticipated in assessing the recoverability of deferred acquisition costs. We assess the recoverability of deferred acquisition costs on an annual basis or more frequently if circumstances indicate impairment may have occurred.
Value of business acquired (‘VOBA”) is an asset that reflects the estimated fair value of in-force contracts in an acquisition and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the business in-force at the acquisition date. VOBA is amortized over the period in which the related premiums written are earned, generally twelve months or less for property insurance business. VOBA amortization is reported within commissions and other underwriting expenses on our consolidated statements of operations. VOBA is reviewed to ensure that the unamortized portion does not exceed the expected recoverable amount as of October 1, each year, and more frequently if circumstances indicate impairment may have occurred.
Refer to Note 3 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for information regarding VOBA from the acquisition during the fourth quarter of 2019.
Goodwill and identifiable intangible assets with indefinite lives are not amortized but are reviewed for impairment annually as of October 1 and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value below its associated carrying value. Identifiable intangibles that do not have indefinite lives are amortized on a straight-line basis over their estimated useful lives.
We apply significant judgment when determining the estimated fair values discussed above. Factors that can influence these values include any items that can directly or indirectly affect future production levels, profitability and cash flows. Examples of unfavorable changes to assumptions or factors that could result in future impairment include, but are not limited to, the following:
•Valuations of significant mergers or acquisitions of companies or blocks of business that would provide relevant market-based inputs for our impairment assessment that could support less favorable conclusions regarding the estimated fair value of our reporting unit.
Estimates of fair value are inherently uncertain and represent only management’s reasonable expectation regarding future developments.
Refer to Note 3 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for our goodwill and identifiable intangible assets acquired during the fourth quarter of 2019.
In conformity with GAAP, our insurance companies are not permitted to establish reserves for catastrophe losses that have not occurred. Therefore, losses related to a significant catastrophe, or accumulation of catastrophes, in any reporting period could have a material adverse effect on our results of operations and financial condition during that period.
We believe that the reserves for unpaid losses and LAE established by our insurance companies are adequate as of December 31, 2019; however, additional reserves, which could have a material impact upon our financial condition, results of operations and cash flows, may be necessary in the future.
between the occurrence of a loss and the date the loss is reported to our insurance companies. The length of the loss reporting lag affects their ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags), as well as the amount of reserves needed for IBNR. If the actual level of loss frequency and severity is higher or lower than expected, the ultimate losses will be different than management’s estimates.
Refer to Note 1 and Note 7 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information regarding our losses and LAE.
For the years ended December 31, 2019 and 2018, we did not have any off balance sheet transactions.
We have audited the accompanying consolidated balance sheets of FedNat Holding Company and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income (loss), changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and the financial statement schedules listed in the index at Item 15 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 6, 2020 expressed an unqualified opinion thereon.
FedNat Holding Company (“FNHC,” the “Company,” “we,” “us,” or “our”) is a regional insurance holding company that controls substantially all aspects of the insurance underwriting, distribution and claims processes through our subsidiaries and contractual relationships with independent agents and general agents. We, through our wholly-owned subsidiaries, are authorized to underwrite, and/or place homeowners multi-peril (“homeowners”), federal flood and other lines of insurance in Florida and other states. We market, distribute and service our own and third-party insurers’ products and other services through a network of independent and general agents.
FedNat Insurance Company (“FNIC”), our largest wholly-owned insurance subsidiary, is licensed as an admitted carrier to write homeowners property and casualty insurance by the state’s insurance departments in Florida, Louisiana, Texas, Georgia, South Carolina, Alabama and Mississippi.
The Company prepares the accompanying consolidated financial statements in accordance with GAAP, which requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results may materially differ from those estimates.
Similar to other property and casualty insurers, the Company’s liability for loss and loss and adjustment expenses ("LAE") reserves, although supported by actuarial projections and other data, is ultimately based on management’s reasoned expectations of future events. Although considerable variability is inherent in these estimates, the Company believes that the liability and LAE reserve is adequate. The Company reviews and evaluates its estimates and assumptions regularly and makes adjustments, reflected in current operations, as necessary, on an ongoing basis.
Investments consist of debt and equity securities. Debt securities consist of securities with an initial fixed maturity of more than three months, including corporate bonds, municipal bonds and United States government bonds. Equity securities generally consist of securities that represent ownership interests in an enterprise. The Company determines the appropriate classification of investments in debt and equity securities at the acquisition date and re-evaluates the classification at each balance sheet date.
Held-to-maturity debt securities are recorded at the amortized cost, reflecting the ability and intent to hold the securities to maturity. All other debt securities are classified as available-for-sale and recorded at fair value. Unrealized gains and losses during the year, net of the related tax effect applicable to available-for-sale and periods prior to January 1, 2018 for equity securities, are excluded from
Ceded commissions reduce commissions and other underwriting expenses and ceded losses incurred reduce net losses and LAE incurred over the applicable periods of the various reinsurance contracts with third party reinsurers. If premiums or commissions are subject to adjustment (for example, retrospectively-rated or experience-rated), the Company records adjustments to the premiums or ceding commission in the period that changes in the estimated losses are determined.
Refer to Note 3 below for information regarding VOBA from the acquisition during the fourth quarter of 2019.
Other assets consist primarily of identifiable intangible assets, property and equipment owned, right-of-use assets for our long-term leases, receivables resulting from sales of securities that had not yet settled as of the balance sheet date and prepaid expenses.
We recognize the estimated fair value of identifiable intangibles such as trade names and non-compete agreements acquired through a business combination at the acquisition date. Identifiable intangible assets are amortized on a straight-line basis over their identified useful life, if applicable. The carrying values of identifiable intangible assets are reviewed at least annually for indicators of impairment in value that are other-than-temporary, including unexpected or adverse changes in the following: the economic or competitive environments in which the company operates; profitability analysis; cash flow analysis; and the fair value of the relevant business operation. If there is an indication of impairment, then the discounted cash flow method would be used to measure the impairment, and the carrying value would be adjusted as necessary and reported in impairment of intangibles on our consolidated statements of operations.
Refer to Note 3 below for information regarding identifiable intangible assets acquired during the fourth quarter of 2019.
Policy fees represent a non-refundable application fee for insurance coverage. These policy fees are deferred over the related policy term in a manner consistent with how the related premiums are earned.
Other income represents brokerage, commission related income from the Company’s agency operations, fees generated from the personal automobile line of business as well as recognition of equity method investment results. Brokerage income is recognized over the term of the reinsurance period, typically one year. Commission income from agency operations are recognized up-front upon policy inception. The fees associated with the personal automobile line of business are recognized ratably over the related policy term, generally six months. In applying the equity method, the Company records its initial investment at cost, and subsequently increases or decreases the carrying amount of the investment by its proportionate share of the net earnings or losses with any dividends or distributions received are recorded as a decrease in the carrying value of the investment.
The reserves for losses and LAE represent management’s best estimate of the ultimate cost of all reported and unreported losses incurred through the balance sheet date. Such liabilities are determined based upon the Company’s assessment of claims pending and the development of prior years’ loss liability, including liabilities based upon individual case estimates for reported losses and LAE and estimates of such amounts that are incurred but not yet reported ("IBNR”). Changes in the estimated liability are charged or credited to operations as the losses and LAE are settled.
The Company’s management makes assumptions, estimates and judgments, which are subject to change, in accounting for income taxes. The Company’s management also considers events and transactions on an on-going basis and the laws enacted as of the Company’s reporting date. The U.S. Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was signed into law on December 22, 2017, and the effect of changes in federal tax law and applicable statutory rates is recorded in the consolidated financial statements in the period of enactment. As such, the Tax Act affected the Company’s deferred income tax provision in the consolidated statement of operations for the year ended December 31, 2017 and the deferred income tax assets and liabilities balances in the consolidated balance sheet as of December 31, 2017. Both the current and deferred income tax provisions are affected for 2019 and 2018. Refer to Note 9 below for further information regarding income taxes.
In January 2016, the FASB issued ASU 2016-01, which addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. Most notably, the combined new guidance required equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. The Company adopted the guidance effective January 1, 2018, by reflecting a cumulative adjustment, which increased retained earnings and decreased accumulated other comprehensive income by $1.0 million. This adjustment represented the level of net unrealized gains and losses associated with our equity investments with readily determinable market values as of January 1, 2018. The adoption also resulted in the recognition of $(1.2) million in our consolidated statements of operations and statements of comprehensive income (loss), which represented the change in net unrealized gains and losses on our equity securities for 2018. This new guidance increases our earnings volatility compared to the prior accounting rules.
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ASU 2018-15 requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in Accounting Standards Codification 350-40 to determine which implementation costs to defer and recognize as an asset. The Company completed the analysis and has concluded that the implementation did not have any impact on the Company’s consolidated financial condition or results of operations.
In addition to the purchase price, PIH received five-year right of first refusal to provide reinsurance of up to 7.5% of any layer in FedNat’s catastrophe reinsurance program. PIH also agreed to a non-compete for five years following the closing with respect to residential property insurance in Alabama, Florida, Georgia, Louisiana, South Carolina and Texas.
Since the effective acquisition date the revenues and net income of the business acquired have been $4.4 million and $1.4 million, respectively. We recognized $1.3 million of acquisition-related costs, pre-tax, for the twelve months ended December 31, 2019. These costs are included in the general and administrative expenses line item of the consolidated statement of operations. We also capitalized $0.5 million in application development costs to property and equipment included in the other asset line item on the consolidated balance sheet.
The acquisition date fair values of certain assets and liabilities, including VOBA and intangible assets, are provisional and subject to revision within one year of the acquisition date. As such, our estimates of fair values are pending finalization, which may result in adjustments to goodwill. The following presents (in thousands) the preliminary acquisition date fair values of the net assets acquired related to the Maison Companies as of December 2, 2019:
The goodwill recorded as part of the acquisition includes the expected synergies and other benefits that management believes will result from the acquisition including reinsurance savings and reduction in operating and general and administrative expenses.
The entire $8.7 million acquired VOBA balance will be amortized by December 31, 2020.
The following presents the fair value of identifiable intangible assets acquired as of the acquisition date:
The following unaudited pro forma condensed consolidated statements of operations of the Company assume that the acquisition of the Maison Companies was completed on January 1, 2018:
•Corporate and International Securities: In determining the fair value for corporate securities the Company uses the market approach utilizing primary valuation inputs including reported trades, dealer quotes for identical or similar assets in markets that are not active, benchmark yields, credit spreads (for investment grade securities), observations of equity and credit default swap curves (for high-yield corporates), reference data and industry and economic events.
As of December 31, 2019, the Company held a total of 203 debt securities that were in an unrealized loss position, of which 24 securities were in an unrealized loss position continuously for 12 months or more. As of December 31, 2018, the Company held a total of 1,222 debt securities that were in an unrealized loss position, of which 371 securities were in an unrealized loss position continuously for 12 months or more. The unrealized losses associated with these securities consisted primarily of losses related to corporate securities.
As discussed in Note 2 above, beginning January 1, 2018, the Company’s equity investments are measured at fair value through net income (loss). The Company did not have any OTTI losses on its equity securities for the year ended December 31, 2017.
Cash and cash equivalents and investments, the majority of which were debt securities, with fair values of $11.2 million and $10.3 million were deposited with governmental authorities and into custodial bank accounts as required by law or contractual obligations, as of December 31, 2019 and 2018, respectively.
Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. The Company reinsures (cedes) a portion of written premiums on an excess of loss or a quota-share basis in order to limit the Company’s loss exposure. To the extent that reinsuring companies are unable to meet their obligations assumed under these reinsurance agreements, the Company remains primarily liable to its policyholders.
The Company is selective in choosing reinsurers and considers numerous factors, the most important of which is the financial stability of the reinsurer or capital specifically pledged to uphold the contract, its history of responding to claims and its overall reputation. In an effort to minimize the Company’s exposure to the insolvency of a reinsurer, the Company evaluates the acceptability and review the financial condition of the reinsurer at least annually with the assistance of the Company’s reinsurance broker.
The combined FNIC and MNIC private market excess of loss treaties, covering both Florida and non-Florida exposures, became effective July 1, 2018 and all private layers have prepaid automatic reinstatement protection, which afforded the Company additional coverage for subsequent events. These private market excess of loss treaties structure coverage into layers, with a cascading feature such that substantially all layers attach after $20.0 million in losses for FNIC and after $3.0 million in losses for MNIC. If the aggregate limit of the preceding layer is exhausted, the next layer drops down (cascades) in its place. Additionally, any unused layer protection drops down for subsequent events until exhausted. Given market conditions, FNIC elected not to purchase any multiple year protection and terminated the second year of the $89.0 million of multiple year protection that FNIC purchased in 2017 on a two-year basis. FNIC also had $156.0 million of multiple year protection that expired on June 30, 2018. The overall reinsurance programs are with reinsurers that currently have an A.M. Best or Standard & Poor’s rating of “A-” or better, or have fully collateralized their maximum potential obligations in dedicated trusts.
FNIC’s non-Florida excess of loss reinsurance treaty affords us an additional $18 million of coverage for a second event, which applies to hurricane losses only. The result is a non-Florida retention of $20 million for FNIC for the first event and $2 million for the second event, although these retentions are reduced to $10 million and $1 million after taking into account the profit-sharing agreement that FNIC has with the non-affiliated managing general underwriter that writes FNIC’s non-Florida property business. FNIC’s non-Florida reinsurance program cost for the above specific coverage approximates $1.8 million for this private reinsurance.
FNIC's reinsurance programs also include quota-share treaties. One such treaty for 30% became effective July 1, 2014, and another for 10% became effective on July 1, 2015 with each running for two years. The combined treaties provided up to a 40% quota-share reinsurance on covered losses for the homeowners’ property and liability insurance program in Florida. The treaties are accounted for
On July 1, 2018, FNIC renewed the quota-share treaty on its Florida homeowners book of business, on an in-force, new and renewal basis, excluding named storms, which was initially set at a 2% cession, and is subject to certain limitations. In addition, this quota-share allowed FNIC to prospectively increase or decrease the cession percentage up to three times during the term of the agreement. Effective October 1, 2018, FNIC elected to increase the cession percentage from 2% to 10% on an in-force, new and renewal basis.
On July 1, 2019, FNIC renewed the quota-share treaty on its Florida homeowners book of business, on an in-force, new and renewal basis, excluding named storms, which was set at a 10% cession and is subject to certain limitations. In addition, this quota-share allows FNIC the flexibility to prospectively increase or decrease the cession percentage up to three times during the term of the agreement.
Certain reinsurance agreements require FNIC to secure the credit, regulatory and business risk. Fully funded trust agreements securing these risks totaled less than $0.1 million as of December 31, 2019 and 2018.
(3)Reflects losses ceded under retrospective reinsurance treaties to the extent there is an offsetting experience account adjustment, such that there is no impact on pre-tax net income (loss).
During the year ended December 31, 2018, the Company experienced $2.2 million of unfavorable loss and LAE reserve development on prior accident years, primarily in our personal automobile and homeowners line of business. The unfavorable automobile
The following table provides supplementary information about the average annual percentage payout of incurred losses and ALAE, net of reinsurance, for automobile policies, as of December 31, 2019:
•Expected Loss Ratio Method: Expected loss ratios are applied to premiums earned, based on historical company experience, or historical insurance industry results when company experience is deemed not to be sufficient; and
On March 5, 2019, the Company completed a private placement offering and issued $100.0 million in principal amount of Senior Unsecured Fixed Rate Notes due 2029 (the "Notes"), pursuant to an indenture dated as of March 5, 2029 (the "Indenture"). The Notes mature on March 15, 2029 and bear interest at a fixed rate of 7.5% per year, payable semi-annually in arrears, subject to increases in the interest rate payable in the event of a downgrade in the credit rating assigned to the Notes. The Notes are not convertible or exchangeable for any equity securities, other securities or assets of the Company or any subsidiary. A portion of the cash from the offering was used to redeem all $45.0 million of the Company's Senior Unsecured Fixed Rate Notes Due 2022 and the Company's Senior Notes Due 2027. We recognized $3.6 million as interest expense in our consolidated statements of operations for the year ended 2019, for prepayment fees, including the write-off unamortized debt issuance costs on the repayment.
On and after March 15, 2024, the Company may redeem the Notes, in whole or in part, at 103.750% in 2024, 101.875% in 2025, and 100% in 2026 and thereafter, together with any accrued and unpaid interest on the Notes being redeemed to but excluding the date of redemption.
We recognize accrued interest and penalties related to unrecognized tax benefits in income tax expense (benefit) in the consolidated statements of operations and statements of comprehensive income (loss). A reconciliation of these uncertain tax positions was as follows:
The deferred income tax asset (liability), net is included in income taxes, net on our Consolidated Balance Sheets along with income tax receivable, net.
The Company reviews the outstanding matters, if any, on a quarterly basis. The Company accrues for estimated losses and contingent obligations in the consolidated financial statements if and when the obligation or potential loss from any litigation, legal proceeding or claim is considered probable and the amount of the potential exposure is reasonably estimable. The Company records such probable and estimable losses, through the establishment of legal expense reserves. As events evolve, facts concerning litigation and contingencies become known and as additional information becomes available, the Company’s management reassesses its potential liabilities related to pending claims and litigation and may revise its previous estimates and make appropriate adjustment to the financial statements. Estimates that require judgment are subject to change and are based on management’s assessment, including the
Regarding the matter involving the Co-Existence Agreement effective as of August 30, 2013 with Federated Mutual Insurance Company ("Mutual") and the related arbitration (please see Note 9 of our 2018 Form 10-K for more information), the Company and Mutual have exchanged releases and all remaining pending proceedings have been resolved by an agreed order entered by the U.S. District Court for the Northern District of Illinois on November 22, 2019.
In connection with its automobile line of business, which is currently winding down, FNIC is also required to participate in an insurance apportionment plan under Florida law, which is referred to as a JUA Plan. The JUA Plan provides for the equitable apportionment of any profits realized, or losses and expenses incurred, among participating automobile insurers. In the event of an underwriting deficit incurred by the JUA Plan, which is not recovered through the policyholders in the JUA Plan, such deficit shall be recovered from the companies participating in the JUA Plan in the proportion that the net direct written premiums of each such member during the preceding calendar year bear to the aggregate net direct premiums written in this state by all members of the JUA Plan. There were no material assessments by the JUA Plan as of December 31, 2019. Future assessments by the JUA and the JUA Plan are indeterminable at this time.
The Company is committed under various operating lease agreements for office space. FNHC and its subsidiaries lease certain facilities, furniture and equipment under long-term lease agreements. Rental expense for the years ended December 31, 2019, 2018 and 2017 was $1.0 million, $0.7 million and $0.6 million, respectively.
In June 2018, the Company filed with the SEC on Form S-8, a registration statement registering 800,000 shares of common stock reserved for issuance under the Company’s 2018 Omnibus Incentive Compensation Plan (the “2018 Plan”). The 2018 Plan, which was approved by the Company’s shareholders at the 2018 annual meeting is an equity compensation plan that may be used for our employees, non-employee directors, consultants and advisors.
Stock options outstanding and exercisable in a select price range is as follows:
The Company sponsors a profit sharing plan under Section 401(K) of the Internal Revenue Code, which is a defined contribution plan that allows employees to defer compensation through contributions to the 401(K) Plan. This plan covers substantially all employees who meet specified service requirements and includes a 100% match up to the first 6% of an employee’s salary, not to exceed statutory limits. Additionally, the Company may make additional profit-sharing contributions.
For the years ended December 31, 2019 and 2018, the Company made no additional profit-sharing contribution.
In May 2019, our Board of Directors declared a $0.08 per common share dividend, payable in June 2019, to shareholders of record on May 14, 2019. amounting to $1.1 million.
The Company’s insurance companies are subject to regulations and standards of the Florida Office of Insurance Regulation (the "Florida OIR") and Louisiana Department of Insurance (the "LDI"). These standards require that insurance companies prepare statutory-basis financial statements in accordance with the National Association of Insurance Commissioners (“NAIC”) Accounting Practices and Procedures Manual. The Company did not use any prescribed or permitted statutory accounting practices that differed from the NAIC’s statutory accounting practices as of December 31, 2019.
The Company’s insurance companies are required to report their risk-based capital (“RBC”) each December 31. Failure to maintain an adequate RBC could subject the Company to regulatory action and could restrict the payment of dividends. As of December 31, 2019, the RBC levels of the Company’s insurance companies did not subject them to any regulatory action.
whether a dividend or distribution is extraordinary, an insurer may carry forward net income from the previous two calendar years that has not already been paid out as dividends. This carryforward shall be computed by taking the net income from the second and third preceding calendar years, not including realized capital gains, less dividends paid in the second and immediate preceding calendar years. Notwithstanding the foregoing, an insurer may declare an extraordinary dividend or distribution which is conditional upon regulatory approval. and the declaration shall confer no rights upon shareholders until either the payment is approved or has not been disapproved within the 30-day period referred to above.
The Company applied for and was approved by the Florida OIR for a statewide average rate increase of 5.1% for FNIC Florida dwelling fire insurance policies, which became effective for new policies on February 25, 2020 and is expected to become effective for renewal policies on April 1, 2020.
We have audited FedNat Holding Company and subsidiaries’ internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, FedNat Holding Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on the COSO criteria.