Unico American Corporation is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary, Crusader Insurance Company (“Crusader”); provides property, casualty, health and life insurance through its agency subsidiaries, Unifax Insurance Systems, Inc. (“Unifax”) and American Insurance Brokers, Inc. (“AIB”); provides insurance premium financing through its subsidiary American Acceptance Company (“AAC”); and provides membership association services through its subsidiary Insurance Club, Inc., dba AAQHC, an Administrator (“AAQHC”).
The Company receives its revenue primarily from earned premium derived from the insurance company operation, commission and fee income generated from the insurance agency operations, finance fee income from the premium finance operations, and investment income from cash generated primarily from the insurance company operation. The insurance company operation generated approximately 92% of the Company’s total revenue for the years ended December 31, 2018 and 2017. The Company’s remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually not material to consolidated revenues.
On January 17, 2019, A.M. Best Company downgraded Crusader’s Financial Strength Rating to B++ (Good) from A- (Excellent) and the Long-Term Issuer Credit Rating to bbb+ from a-. The outlook of the Financial Strength Rating has been revised to stable from negative while the outlook of the Long-Term Issuer Credit Rating remains negative. The rating downgrades reflect a revision in A.M. Best’s assessment of the company’s operating performance to adequate from strong.
The property and casualty insurance business is cyclical in nature. The conditions of a “soft market” include premium rates that are stable or falling and insurance is readily available. Conversely, “hard market” conditions occur during periods in which premium rates rise and coverage may be more difficult to find. The Company believes that the California property and casualty insurance market is relatively mature and intensely competitive, with different products in different stages of the soft/hard market cycle at any given time.
The following is a reconciliation of Crusader’s underwriting loss before income taxes to the Company’s loss before taxes:
The insurance company operation combined ratio is the sum of (1) the ratio of net losses and loss adjustment expenses incurred (including a provision for IBNR) to net earned premium (loss ratio) and (2) the ratio of policy acquisition costs to net earned premium (expense ratio). If the combined ratio is below 100%, an insurance company has an underwriting profit; if it is above 100%, the company has an underwriting loss.
AAQHC’s fee income decreased $7,721 (11%) for the year ended December 31, 2018, as compared to the year ended December 31, 2017, as a result of a decrease in the number of association members enrolled in AAQHC.
The finance fees earned by AAC for the year ended December 31, 2018, increased $70,091 (94%) as compared to the year ended December 31, 2017, due primarily to the increase in earned finance charges as a result of the change in annual percentage rate charged on AAC new loans from 0% to 4.99%, effective March 1, 2018, partially offset by a decrease in late fees due to a reduction in the number of AAC loans issued. AAC issued 2,095 and 2,914 loans in 2018 and 2017, respectively. Revenue earned in 2018 consisted of earned finance charges, late fees and other miscellaneous charge. Revenue earned in 2017 consisted of late fees and other miscellaneous fees charges. The average policy premium financed by AAC was $4,395 and $4,535 in 2018 and 2017, respectively.
The Company generated revenues from its total invested assets of $90,119,542 (at amortized cost) and $88,098,898 (at amortized cost) as of December 31, 2018 and 2017, respectively. During the year ended December 31, 2017, the Company also generated revenue from two cash deposits placed with the Los Angeles Superior Court by Crusader in lieu of appeal bonds. These two deposits, totaling $13,373,793, were made on December 28, 2015, for $7,924,178, and on March 21, 2016, for $5,449,615, and their respective balances were included in “Cash, cash equivalents, and restricted cash” on the Consolidated Balance Sheets as of December 31, 2016, and were not a part of the total invested assets as of December 31, 2018 and 2017. In September 2017, both judgments were settled for a total of $7,000,000 which was paid from the two deposits, and the remaining funds on deposit with the Los Angeles Superior Court were returned to Crusader.
Due to the current interest rate environment, a current target effective duration for the Company’s investment portfolio is between 3.25 and 4.75 years. As of December 31, 2018, all of the Company’s investments are in U.S. treasury securities, corporate fixed maturity securities, agency mortgage-backed securities, Federal Deposit Insurance Corporation (“FDIC”) insured certificates of deposit, and short-term investments. The Company’s investments in U.S. treasury securities, corporate fixed maturity securities, agency mortgage-backed securities, and short-term investments are readily marketable. As of December 31, 2018, the weighted average maturity of the Company’s investments was approximately 6.5 years, and the effective duration for available-for-sale investments (investments managed under the investment guidelines approved in 2017) was 3.31 years.
Fluctuations in cash flows from operating activities relate to changes in loss and loss adjustment expense payments, unearned premium holdings, and the timing of the collection and the payment of insurance-related receivables and payables. The variability of the Company’s losses and loss adjustment expenses is primarily due to its small population of claims which may result in greater fluctuations in claim frequency and/or severity. Although the Consolidated Statements of Cash Flows reflect net cash used by operating activities for the years ended December 31, 2018 and 2017, the Company does not anticipate future liquidity problems, and the Company believes that it continues to be well capitalized and adequately reserved.
During the years ended December 31, 2018 and 2017, no cash dividends were declared or issued by the Company to its shareholders. Declaration of future cash dividends will be subject to the Company’s profitability and its cash requirements.
Total revenue was $33,612,796 and $36,791,482 for the years ended December 31, 2018 and 2017, respectively. This represents a decrease of $3,178,686 (9%) for the 2018 year compared to the 2017. This decrease in revenue was primarily due to a decrease in net earned premium of $3,588,409 (11%) partially offset by an increase in net investment income of $617,706 (48%).
The decrease in net earned premium for the year ended December 31, 2018, compared to the year ended December 31, 2017, was due primarily to reduction in direct written premium related to the night clubs program, and, to a lesser extent, decreases in direct written premium in other Crusader's insurance programs.
The decrease in losses and loss adjustment expenses for the year ended December 31, 2018, compared to the year ended December 31, 2017, was due primarily to lower IBNR reserves on long-tail liability current accident year claims during the year ended December 31, 2018, and to severity of claims which involved assault and battery litigation and which were settled during the year ended December 31, 2017.
The decrease in salaries and employee benefits for the year ended December 31, 2018 compared to the year ended December 31, 2017, was due primarily to costs associated with a termination of an employment agreement with an employee during the year ended December 31, 2017 coupled with a reduction in employee head count during the year ended December 31, 2018.
The effect of inflation on the Company’s net income during the years ended December 31, 2018 and 2017 was not significant.
For the year ended December 31, 2018, direct written premium, as reported on Crusader's statutory financial statement, was $32,429,735 compared to $38,393,351 for the year ended December 31, 2017, a decrease of $5,963,616 (16%). The decrease in direct written premium in 2018 compared to 2017 was due primarily to reduction in direct written premium related to the night clubs program, and, to a lesser extent, decreases in direct written premium in other Crusader's insurance programs.
Direct earned premium for the year ended December 31, 2018, decreased $3,766,417 (10%) compared to the year ended December 31, 2017. The decrease in the direct earned premium was due primarily to decrease in the direct written premium during the year ended December 31, 2018.
The ratio of ceded earned premium to direct earned premium for the year ended December 31, 2018, is relatively unchanged compared to the year ended December 31, 2017, as there were no major modifications to Crusader’s reinsurance treaties.
Crusader’s emerging loss ratios for each accident year are reviewed in detail at the end of each quarter as part of the reserve review process. Losses and loss adjustment expenses for the calendar years ended December 31, 2018 and 2017 were $23,557,743 and $30,490,507, respectively.
The adverse development of insured events of prior years during the year ended December 31, 2018, was due primarily to higher than expected incurred losses and loss adjustment expenses on long-tail claims in accident years 2017 and 2016. The development of insured events of prior years in the above table is not necessarily indicative of the results that may be expected in future periods.
Bedford stopped selling and servicing the daily automobile rental polices in 2015. As a result of this decision, the commission income from the daily automobile rental insurance program for the year ended December 31, 2018, decreased $4,375 (100%) compared to the year ended December 31, 2017.
Since 2016, all Bedford’s commission income was comprised of contingent commission on previous business written. The contingent commission Bedford received in 2017 was based on profitability of premiums written in prior years for one of the non-affiliated insurance companies it represented. The Company does not expect to receive any material daily automobile rental insurance program commission in the future.
The number of loans issued decreased by 819 (28%) during 2018 when compared to 2017. The average premium financed by AAC was $4,395 and $4,535 in 2018 and 2017, respectively. During 2018, 39% of all Unifax policies were financed and 74% of those policies were financed by AAC. During 2017, 40% of all Unifax policies were financed and 80% of those policies were financed by AAC.
(2) Investment income from invested assets included $0 and $133,160 of interest on the cash deposits in lieu of appeal bonds for the years ended December 31, 2018 and 2017, respectively. Investment income from invested assets included $114,232 of investment expense for the year ended December 31, 2018, compared to $47,824 for the year ended December 31, 2017.
The par value, amortized cost, fair value and weighted average yield of fixed maturity investments at December 31, 2018, by contractual maturity are as follows:
The Company closely monitors its investments. If an unrealized loss is determined to be other-than-temporary, it is written off as a realized loss through the Consolidated Statements of Operations. The Company’s methodology of assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near-term prospects of the issuer, and whether the debtor is current on its contractually obligated interest and principal payments. The unrealized losses as of December 31, 2018, and December 31, 2017, were determined to be temporary.
Policy acquisition costs consist of commissions, premium taxes, inspection fees, and certain other underwriting costs that are directly related to and vary with the production of Crusader insurance policies. These costs include both Crusader expenses and the allocated expenses of other Unico subsidiaries. Crusader's reinsurers pay Crusader a ceding commission, which is primarily a reimbursement of the acquisition cost related to the ceded premium. No ceding commission is received on facultative or catastrophe ceded premium. Policy acquisition costs, net of ceding commission, are deferred and amortized as the related premium is earned. Policy acquisition costs decreased $554,850 (9%) in the year ended December 31, 2018, compared to the year ended December 31, 2017, due primarily to the decrease in premium.
Also contributing to the decrease in the net amount of salaries and employee benefits charged to operating expenses for the year ended December 31, 2018, compared to the year ended December 31, 2017, was a decrease in support personnel, the net effect of which was a reduction in employee headcount.
Other operating expenses decreased $403,693 (11%) for the year ended December 31, 2018, compared to the year ended December 31, 2017. The decrease in other operating expenses for the year ended December 31, 2018, compared to the year ended December 31, 2017, was related primarily to fees paid to the California Department of Insurance for their tri-annual financial examination of Crusader and consulting expenses incurred during the year ended December 31, 2017. There were no financial examination expenses incurred during the year ended December 31, 2018, and Crusader’s next tri-annual financial examination by the California Department of Insurance is expected to start in 2019. The decrease in other operating expenses for the year ended December 31, 2018 was partially offset by an increase in other individually insignificant expenses.
Income tax benefit for the year ended December 31, 2018, decreased $398,004 (34%) compared to the year ended December 31, 2017. The decrease in the income tax benefit is related primarily to the $3,926,792 loss before taxes for the year ended December 31, 2018, compared to the $9,880,221 loss before taxes for the year ended December 31, 2017.
As of December 31, 2018, the Company has $16,739,147 of federal net operating loss carryforwards that will begin to expire in 2035. As of December 31, 2018, the Company had deferred tax assets of $1,850,934 generated from state net operating loss carryforwards. For the years ended December 31, 2018 and December 31, 2017, a valuation allowance was established in the amount of $1,850,934 and $1,258,753, respectively, as the Company does not expect to realize a tax benefit from its state net operating losses in future years. For the years ended December 31, 2018 and December 31, 2017 the amount of state net operating losses that expired were $0 and $1,209,784, respectively. The remaining $1,850,934 of state tax carryforwards expire between 2028 and 2038. In light of the net operating losses that were generated in recent years, the Company periodically performs an analysis of future income projections to determine the adequacy of the valuation allowance. As a result of that analysis at December 31, 2018, the Company believes it is more likely than not that it will be able to utilize the net operating loss carryforwards before they expire and the valuation allowance is adequate. Additionally, a component of the loss generated in 2018 is subject to an indefinite carryforward period.
At the end of each fiscal quarter, Crusader’s reserves for each accident year (i.e., for all claims occurring within each year) are re-evaluated independently by the Company’s president, the Company’s chief financial officer and by an independent consulting actuary. Generally accepted actuarial methods, including the widely used Bornhuetter-Ferguson and loss development methods, are employed to estimate ultimate claims costs. An actuarial central estimate of the ultimate claims costs and IBNR reserves is ultimately determined by management and tested for reasonableness by the independent consulting actuary.
Each year, management compares the actual claims costs that emerge to the claims costs that were expected to emerge and evaluates whether any observed significant differences are due to normal variances in the development process that occur from time to time, particularly in an insurer the size of Crusader, or if they are an indication that changes in the key reserve assumptions or methodologies are appropriate. As of December 31, 2018, management concluded that no changes in Crusader’s key reserve assumptions or methodologies are appropriate.
Crusader’s actuarially based loss and loss adjustment expense reserve methodology does not include an implicit or explicit provision for uncertainty. Insurance claims costs are inherently uncertain. There is not a precise means of quantifying in advance a provision for uncertainty when determining an appropriate liability for unpaid claims costs. Rather, the potential for claims costs being less than estimated and the potential for claims costs being more than estimated are considered when selecting the parameters to be used in the application of the actuarial methods and when testing the estimates for reasonableness. Management believes that its recorded loss and loss adjustment expense reserves make reasonable provision for its liability for unpaid claims costs.
At each quarterly review, actual claims costs that emerge are compared with the claims costs that were expected to emerge during that development period. Sometimes the previous claims costs estimates prove to have been too high; sometimes they prove to have been too low. The fluctuation in development of insured events of prior years underscores the inherent uncertainty in insurance claims costs, especially for a relatively small insurer, such as Crusader. While the Company believes the reserves were adequate at December 31, 2018 and 2017, adverse or (favorable) development may emerge in the future.
There have been no changes in key assumptions of estimating future loss and loss adjustment expense payments. The changes in estimates of prior accident year incurred losses and loss adjustment expenses are attributed to the passage of time and the greater amount of actual loss data available for each accident year.
Crusader’s recoverable from reinsurers represents an estimate of the amount of future loss and loss adjustment expense payments that will be recoverable from Crusader’s reinsurers. These estimates are based upon estimates of the ultimate losses and loss adjustment expenses that Crusader expects to incur and the portion of those losses that are expected to be allocable to reinsurers based upon the terms of the reinsurance agreements. Given the uncertainty of the ultimate amounts of losses and loss adjustment expenses, the estimates may vary significantly from the eventual outcome. Crusader’s estimate of the amounts recoverable from reinsurers is regularly reviewed and updated by management as new data becomes available. Crusader’s assessment of the collectability of the recorded amounts recoverable from reinsurers is based primarily upon public financial statements and rating agency data. Any adjustments necessary are reflected in the current operations. Crusader evaluates each of its ceded reinsurance contracts at its inception to determine if there is sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting literature. At December 31, 2018, all such ceded contracts are accounted for as risk transfer reinsurance.
There were no catastrophe losses incurred during the years ended December 31, 2018 and 2017.
The Company has a comprehensive portfolio monitoring process to identify and evaluate each fixed income security whose carrying value may be other-than-temporarily impaired. For each fixed income security in an unrealized loss position, the Company assesses whether it is more likely than not that the Company will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes, or the credit quality of the underlying security. If a security meets this criteria, the security's decline in fair value is considered other than temporary and is recorded as a net realized investment loss in the Consolidated Statements of Operations and in the Consolidated Statements of Comprehensive Income (Loss) based on the specific identification method. There were no realized investments gains (losses) from other than temporary impairments for any of the periods presented in the accompanying Consolidated Statements of Operations. For each fixed income security that the Company does not intend to sell or for which it is more likely than not that the Company would not be required to sell before an anticipated recovery in value, the Company separates the credit loss component of the impairment, if any, from the amount related to all other factors and reports the credit loss component in net realized investment gains (losses). There was no credit loss component for any of the periods presented in the accompanying Consolidated Statements of Operations. The unrealized gains or losses from fixed maturities are reported as “Accumulated other comprehensive income (loss),” which is a separate component of stockholders’ equity, net of any deferred tax effect.
Cash, cash equivalents, and restricted cash - The carrying amounts reported in the Consolidated Balance Sheets approximate their fair values given the short-term nature of these instruments.
Receivables, net - The carrying amounts reported in the Consolidated Balance Sheets approximate their fair values given the short-term nature of these instruments.
The Company and its subsidiaries file consolidated federal and state income tax returns. Pursuant to the tax allocation agreement, Crusader and American Acceptance Corporation (“AAC”), a subsidiary of Unico, are allocated taxes or tax credits in the case of losses, at current corporate rates based on their own taxable income or loss. The Company files income tax returns under U.S. federal and various state jurisdictions. The Company is subject to examination by U.S. federal income tax authorities for tax returns filed starting at taxable year 2015 and California state income tax authorities for tax returns filed starting at taxable year 2014. There are no ongoing examinations of income tax returns by federal or state tax authorities.
Commissions from sales of health insurance are earned in income based on the satisfaction of a single performance obligation. Marketing, selling, billing, collecting, and administering health insurance policies are a series of distinct services combined as a one performance obligation, which is recognized in income monthly over the policy period. Premiums are collected upon the initial sale of health insurance policies and then monthly upon each subsequent periodic payment. As a result there are limited accounts receivable. Policy fee income is recognized on a pro-rata basis over the terms of the policies.
Premium is earned on a pro-rata basis over the terms of the policies. Premium applicable to the unexpired terms of policies in force are recorded as unearned premium.
(1) As required by law, the Company segregates from its operating accounts the premium collected from insureds that are payable to insurance companies into separate trust accounts. These amounts are included in cash and short-term investments.
(2) $510,000 and $500,000 included in fixed maturity investments as of December 31, 2018 and 2017, respectively, and $200,000 and $200,000 included in short-term investments as of December 31, 2018 and 2017, respectively, are statutory deposits assigned to and held by the California State Treasurer and the Insurance Commissioner of the State of Nevada. These deposits are required for writing certain lines of business in California and for admission in states other than California.
Crusader employs reinsurance to provide greater diversification of business allowing management to control exposure to potential losses arising from large risks by reinsuring certain levels of risk in various areas of exposure, to reduce the loss that may arise from catastrophes, and to provide additional capacity for growth. Prepaid reinsurance premium and reinsurance receivables are reported as assets and represent ceded unearned premium and reinsurance recoverable on both paid and unpaid losses and loss adjustment expenses, respectively. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. Crusader evaluates each of its ceded reinsurance contracts at its inception to determine if there is sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting literature. As of December 31, 2018, all such ceded contracts are accounted for as risk transfer reinsurance.
Crusader evaluates and monitors the financial condition of its reinsurers and factors such as collection periods, disputes, applicable coverage defenses and other factors to assess the need for any allowance against anticipated reinsurance recoveries. No such allowance was considered necessary at December 31, 2018 or 2017.
The Company has identified its insurance company operation as its primary reporting segment. Revenues from this segment comprised 92% of consolidated revenues for the years ended December 31, 2018 and 2017. The Company’s remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually insignificant to consolidated revenues.
(1) Intersegment revenue eliminations reflect rents paid by Unico to Crusader for space leased in the Calabasas building and commissions paid by Crusader to Unifax Insurance Systems, Inc. (“Unifax”), a subsidiary of Unico.
(2) Intersegment asset eliminations reflect the elimination of Crusader receivables from Unifax and Unifax payables to Crusader.
99.8%, and 99.7% of Crusader’s direct written premium was derived from California during the years ended December 31, 2018 and 2017, respectively. In 2018, approximately 37% and 46% of the $958,495 commission income from the Company’s health insurance program was from Guardian Life Insurance Company of America dental and group life plan programs and the Blue Shield Care Trust health and life insurance programs, respectively. In 2017, approximately 42% and 45% of the $1,047,593 commission income from the Company’s health insurance program was from Guardian Life Insurance Company of America dental and group life plan programs and the Blue Shield Care Trust health and life insurance programs, respectively.
In February 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” ASU 2018-02 was issued as a result of the enactment of the Tax Cuts and Jobs Act of 2017 (“TCJA”) on December 22, 2017. Accounting guidance required deferred tax items to be revalued based on the new tax laws (the most significant of which reduced the corporate tax rate to 21% percent from 34% percent) and to include the change in income from continuing operations. ASU 2018-02 is effective for annual and interim reporting periods beginning after December 15, 2018, with early adoption permitted. The Company adopted ASU 2018-02 for the year ended December 31, 2017 (see Note 16 for impact of ASU 2018-02 adoption to the Company’s consolidated financial statements).
In May 2017, FASB issued ASU 2017-09, "Compensation - Stock Compensation (Topic 718), Scope of Modification Accounting." ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 became effective for the Company beginning January 1, 2018. ASU 2017-09 does not have a material impact on the Company’s consolidated financial statements and related disclosures.
Cash equivalents were comprised of highly liquid investments with initial maturity of 90 days or less. As of December 31, 2018 and 2017, cash equivalents included custodial trust, bank money market accounts, and a bank savings account.
The restricted cash was represented by two cash deposits placed by Crusader with the Los Angeles Superior Court in lieu of appeal bonds. In December 2015, a judgment was finalized on a Crusader policy liability claim. Crusader appealed the judgment. As a part of the appeal, Crusader deposited $7,924,178 in cash with the Los Angeles Superior Court on December 28, 2015, in lieu of an appeal bond. This cash deposit was required to appeal the judgment. In March 2016, an additional judgment for plaintiff’s attorney fees and costs on this Crusader policy liability claim was finalized. Crusader appealed this additional judgment. That additional appeal required an additional $5,449,615 cash deposit, which was made on March 21, 2016, in lieu of an appeal bond. In September 2017, the two judgments were settled between the parties thereto for a total of $7,000,000 which was paid from the two deposits, and the remaining funds on deposit with the Los Angeles Superior Court for the two appeals in the amount of $6,373,793 were returned to Crusader and were invested in fixed maturities, short-term investments, and cash equivalents.
A summary of total investment income, net of investment expenses, and net realized gains is as follows:
All of the Company’s brokered and non-brokered certificates of deposit are within the FDIC insured permissible limits. Due to nature of the Company’s business, certain bank accounts may exceed FDIC insured permissible limits.
Depreciation on the Calabasas building is computed using the straight line method over 39 years. Improvements to the building structure are amortized over the useful life of the improvements. Depreciation on furniture, fixtures and equipment in the Calabasas building is computed using the straight line method over 3 to 15 years. Amortization of tenant improvements in the Calabasas building is being computed using the shorter of the useful life of the tenant improvements or the remaining years of the lease.
For the years ended December 31, 2018 and 2017, the Calabasas building has generated rental revenue in the amount of $1,150,428 and $1,065,104, and incurred operating expenses in the amount of $774,663 and $796,270, which included depreciation, respectively. These amounts are included in “Other income” from insurance company operation and other operating expenses, respectively, in the Company’s Consolidated Statements of Operations.
The total square footage of the Calabasas building is 46,884, including common areas. As of December 31, 2018, 14,481 square feet of the Calabasas building was leased to non-affiliated entities. As of December 31, 2018, the Calabasas building was fully occupied.
The Company‘s consolidated financial statements include estimated reserves for unpaid losses and related loss adjustment expenses of the insurance company operation. Crusader sets loss and loss adjustment expense reserves at each balance sheet date based upon management’s best estimate of the ultimate payments that it anticipates will be made to settle all losses incurred and all related loss adjustment expenses incurred as of that date for both reported and unreported claims.
At each review period, actual claims costs that emerge are compared with the claims costs that were expected to emerge during that development period. Sometimes the previous claims costs estimates prove to have been too high; sometimes they prove to have been too low. The fluctuation in development of insured events of prior years underscores the inherent uncertainty in insurance claims costs, especially for a relatively small insurer, such as Crusader. Management reviews claims costs that appear to be different from the historical claims costs to determine whether those differences are a normal part of the process or an indication that a change in reserve assumptions is appropriate. Management concluded that the differences noted above are differences between actual and expected claims costs that emerge from time to time, particularly in an insurer the size of Crusader.
The Company establishes reserves for lawsuits, regulatory actions and other contingencies for which the Company is able to estimate its potential exposure and believes a loss is probable. For loss contingencies believed to be reasonably possible, the Company discloses the nature of the loss contingency, an estimate of the possible loss, a range of loss, or a statement that such an estimate cannot be made.
Crusader’s primary excess of loss reinsurance agreements during the years ended December 31, 2018 and 2017 are as follows:
On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays a commission to Crusader that includes a reimbursement of the cost of acquiring the portion of the premium that is ceded. Crusader does not currently assume any reinsurance. Crusader intends to continue obtaining reinsurance although the availability and cost may vary from time to time. The unpaid losses and loss adjustment expenses ceded to the reinsurer are recorded as an asset on the Consolidate Balance Sheets.
Ceded earned premium as a percentage of direct earned premium was 18% in 2018 and 17% in 2017. Crusader did not assume any premium or losses during the years ended December 31, 2018 and 2017.
The Unico American Corporation Profit Sharing Plan (“Plan”) covers Company’s employees who are at least 21 years of age and have met certain service and eligibility requirements. Unico American Corporation is the Plan sponsor and the Plan administrator. Fidelity Management Trust Company is the Plan trustee. The Plan is intended to be a qualified retirement plan under the Internal Revenue Code. As required by the Plan, on an annual basis, the Company must contribute 3% of participants’ eligible compensation to the account of each participant. In addition, pursuant to the terms of the Plan, the Company may contribute to participants an amount determined by the Board of Directors. Under the Plan, participants have the option to make 401(k) and/or Roth 401(k) deferral contributions which are not matched by the Company. Participants must be employed by the Company on the last day of the Plan year and must have met certain service and eligibility requirements to be eligible for a contribution. Participants are eligible to request a distribution of their vested account balance upon death, retirement, minimum required distributions and termination of employment.
The Unico American Corporation 2011 Incentive Stock Plan (“2011 Plan”) covers 200,000 shares of the Company’s common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.) and was approved by shareholders on May 26, 2011. Options to purchase 8,760 and 91,240 shares of common stock were granted under the 2011 Plan to one non-executive employee during the years ended December 31, 2012 and 2011, respectively. Due to termination of the employee during 2017, all options granted under the 2011 Plan became null and void. As of December 31, 2018, there are no outstanding options under the 2011 Plan.
As of December 31, 2018, the Company has $16,739,147 of federal net operating loss carryforwards that will begin to expire in 2035. As of December 31, 2018, the Company had deferred tax assets of $1,850,934 generated from state net operating loss carryforwards. For the years ended December 31, 2018 and December 31, 2017, a valuation allowance was established in the amount of $1,850,934 and $1,258,753, respectively, as the Company does not expect to realize a tax benefit from its state net operating losses in future years. For the years ended December 31, 2018 and December 31, 2017 the amount of state net operating losses that expired were $0 and $1,209,784, respectively. The remaining $1,850,934 of state tax carryforwards, expire between 2028 and 2038. The current federal effected state tax rate is 6.98%.
The Company and its subsidiaries file consolidated federal and state income tax returns. Pursuant to the tax allocation agreement, Crusader and AAC are allocated taxes, or tax credits in the case of losses, at current corporate rates based on their own taxable income or loss. The Company files income tax returns under U.S. federal and various state jurisdictions. The Company is subject to examination by U.S. federal income tax authorities for tax returns filed starting at taxable year 2015 and California state income tax authorities for tax returns filed starting at taxable year 2014. There are no ongoing examinations of income tax returns by federal or state tax authorities.
As a California insurance company, Crusader is obligated to pay a premium tax on direct written premium in all states where Crusader is admitted. Premium taxes are deferred and amortized as the related premium is earned. The premium tax is in lieu of state franchise taxes and is not included in the provision for state taxes.
A reconciliation of the numerator and denominator used in the basic and diluted loss per share calculation is presented as follows:
As of December 31, 2018 and 2017, the Company had 0 common share equivalents that were excluded in the diluted loss per share calculation for years ended December 31, 2018 and 2017.
(1) The information for the years 2009 through 2016 is presented as unaudited required supplementary information.
The following table presents average annual percentage payout of incurred claims by age, net of reinsurance, as of December 31, 2018: