Management's Discussion and Analysis of Financial Condition and Results of Opearations
We are authorized to underwrite, and/or place through our wholly owned subsidiaries, homeowners’ multi-peril (“homeowners”), commercial general liability, federal flood, personal auto and various other lines of insurance in Florida and various other states. We market and distribute our own and third-party insurers’ products and our other services through a network of independent agents. We also utilize a select number of general agents for the same purpose.
During the years ended December 31, 2012, 2011 or 2010, we did not experience any weather-related catastrophic events such as the hurricanes that occurred in Florida during 2005 and 2004. We are not able to predict how hurricanes or other insurable events will affect our future results of operations and liquidity. Loss and loss adjustment expenses (“LAE”) are affected by a number of factors, many of which are partially or entirely beyond our control, including the following.
The estimated Ultimate Loss and Defense and Cost Containment Expense (“DCCE”) is based on an analysis by line of business, coverage and by accident quarter performed using data as of December 31, 2012. The analysis relies primarily on four actuarial methods: Incurred Lossand DCCE Development Method, Paid Loss and DCCE Development Method, Bornhuetter-Ferguson Incurred Method, and Bornhuetter-Ferguson Paid Method. Each method relies on company experience, and, where relevant, the analysis includes comparisons to industry experience. The following is a description of each of these methods:
Interim - During 2012 our interim approach was very similar to the annual process noted above.
In practice there are factors that change over time; however, many (such as inflation) are intrinsically reflected in the historical development patterns, and others typically do not materially affect the estimate of the reserve for unpaid losses and LAE. Therefore, no specific adjustments have been incorporated for such contingencies projecting future development of losses and LAE. There are no key assumptions as of December 31, 2012 premised on future emergence inconsistent with historical loss reserve development patterns.
See Note 2(n), “Summary of Significant Accounting Policies - Recent Accounting Pronouncements” in the Notes to the Condensed Consolidated Financial Statements for a discussion of recent accounting pronouncements and their effect, if any, on the Company.
We account for our investment securities consistent with FASB issued guidance that requires our securities to be classified into one of three categories: (i) held-to-maturity, (ii) trading securities or (iii) available-for-sale.
Below is a summary of net unrealized gains and losses at December 31, 2012 and December 31, 2011 by category.
FASB has also issued guidance regarding when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. Factors used in such consideration include the extent and length of time over which the market value has been less than cost, the financial condition and near-term prospects of the issuer and our ability and intent to keep the investment for a period sufficient to allow for an anticipated recovery in market value. In reaching a conclusion that a security is either other-than-temporarily or permanently impaired, we also consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor’s (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”), as well as information released via the general media channels. During 2012, in connection with the process, we have charged to operations $44,000 of investment losses. During 2011, in connection with the process, we have charged to operations $0.8 million of investment losses.
As of December 31, 2012 and December 31, 2011, all of our securities are in good standing and not impaired, except as noted above.
The Company records the unrealized gains, net of estimated income taxes, that are associated with that part of our portfolio classified as available-for-sale through the shareholders' equity account titled “Other Comprehensive Income”.
The following table summarizes, by type, our investments as of December 31, 2012 and 2011.
Prepaid reinsurance premiums decreased $1.3 million, or 15.5%, to $7.0 million as of December 31, 2012, compared with $8.3 million as of December 31, 2011. We believe concentrations of credit risk associated with our prepaid reinsurance premiums are not significant.
Our commercial general liability insurance premiums receivable decreased $0.7 million, or 58.9%, to $0.5 million as of December 31, 2012, compared with $1.2 million as of December 31, 2011.
Premiums receivable in connection with our automobile line of business increased $0.9 million, or 112.2%, to $1.7 million as of December 31, 2012, compared with $0.8 million as of December 31, 2011.
Reinsurance recoverable, net, increased $1.4 million, or 67.8%, to $3.5 million as of December 31, 2012, compared with $2.1 million as of December 31, 2011. The change is due to the payment patterns by our reinsurers, as influenced by the diminishing catastrophe related claims. All amounts are current and deemed collectable. We believe concentrations of credit risk associated with our reinsurance recoverables, net, are not significant.
Income taxes receivable remained unchanged at nearly nothing as of December 31, 2012, compared with nothing as of December 31, 2011.
Property, plant and equipment, net decreased $0.2 million, or 33.0%, to $0.6 million as of December 31, 2012, compared with $0.8 million as of December 31, 2011. The change is due to our sale of a previously occupied retail facility.
Unpaid losses and LAE decreased $10.1 million, or 16.8%, to $49.9 million as of December 31, 2012, compared with $60.0 million as of December 31, 2011. The composition of unpaid losses and LAE by product line is as follows.
Please see “Liability for Unpaid Losses and LAE” under “Item 1. Business” for a discussion of the factors that affect unpaid losses and LAE.
Premium deposits and customer credit balances decreased $0.3 million, or 12.4%, to $2.5 million as of December 31, 2012, compared with $2.8 million as of December 31, 2011. Premium deposits are monies received on policies not yet in-force as of December 31, 2012.
Year Ended December 31, 2012 Compared with Year Ended December 31, 2011
These premium discounts have had a significant effect on both written and earned premium. Wind mitigation credits are 37.4% of the pre-credit premium, or $61.1 million, as of December 31, 2012, as compared with 28.6% of the pre-credit premium, or $31.5 million, as of December 31, 2011.
Our earnings can also be impacted by our ratings, such as the rating of FNIC by Demotech, Inc. (“Demotech”). FNIC’s rating as of December 31, 2012 was "A" ("Exceptional"). For more information regarding our rating and the impact of a change or withdrawal of our rating, please see “Business-Regulation-Industry Rating Services.”
The Company’s sale of commercial general liability policies decreased by $0.8 million to $9.3 million for 2012, compared with $10.1 million for 2011. The primary factor for this decrease has been improvements to our underwriting standards and our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas.
The following table sets forth the amounts and percentages of our gross premiums written in connection with our commercial general liability program by state.
The increase in unearned premiums was $11.1 million for 2012, compared with $0.8 million for 2011. The 2012 charge to written premium was due to a $10.9 million increase in unearned homeowners’ insurance premiums, a $0.5 million increase in unearned flood premiums, a $0.1 million decrease in unearned automobile premiums and a $0.2 million decrease in unearned commercial general liability premiums during 2012. These changes are a result of differences in written premium volume during this period as compared with the same period last year. See “Gross Premiums Written” above.
The $1.4 million decrease in commercial general liability net premiums earned is a result of a $0.8 million decrease in gross written premium, reflecting the impact our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas. The change is also a result of a $0.4 million increase in gross premiums ceded and a $0.2 million decrease in the net change to unearned premium.
The $1.1 million decrease in automobile net premiums earned is a result of a $0.3 million decrease in gross written premium as discussed, a $0.4 million increase in gross premiums ceded and a $0.4 million decrease in the net change to prepaid reinsurance premiums and unearned premium.
FASB has issued guidance regarding when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. During 2012, pursuant to guidelines prescribed in FASB issued guidance, we have charged to operations, realized investment losses of $44,000. The charges relate to common stock held in diverse industries; during 2011, pursuant to guidelines prescribed in FASB issued guidance, we charged to operations, realized investment losses of $0.8 million. In reaching a conclusion that a security is either other than temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as S&P and Moody’s, as well as information released via the general media channels.
Losses and LAE decreased by $0.7 million, or 2.2%, to $30.2 million for 2012, compared with $30.9 million for 2011. The overall change includes a $4.8 million increase in our homeowners’ program, a $3.4 million decrease in our commercial general liability program and a $2.1 million decrease in connection with our automobile program.
Operating and underwriting expenses increased $0.1 million, or 0.8%, to $10.0 million for 2012, compared with $9.9 million for 2011.
Salaries and wages increased $0.4 million, or 5.4%, to $8.4 million for 2012, compared with $8.0 million for 2011. The charge to operations for stock-based compensation, in accordance with FASB guidance, was approximately $0.3 million during 2012, compared with approximately $0.2 million for 2011.
Policy acquisition costs - amortization, increased $1.0 million, or 7.4%, to $13.3 million for 2012, compared with $12.3 million for 2011.
These premium discounts have had a significant effect on both written and earned premium. Wind mitigation credits are 28.6% of the pre-credit premium, or $31.5 million, as of December 31, 2011, as compared with 26.0% of the pre-credit premium, or $27.3 million, as of December 31, 2010.
Gross premiums ceded decreased to $46.3 million for 2011, compared with $53.0 million for 2010. Gross premiums ceded relating to our homeowners’, write-your-own flood and automobile programs totaled $40.3 million, $4.5 million and $1.5 million for 2011. Gross premiums ceded relating to our homeowners’, commercial general liability, write-your-own flood and automobile programs totaled $46.9 million, $0.2 million, $4.0 million and $1.9 million for 2010.
The decrease to gross premiums ceded relating to our homeowners’ program is primarily due to the reduced cost of reinsurance purchased from the FHCF. The ceded relating to our automobile program is associated with our arrangement to write nonstandard private passenger automobile insurance through a reputable managing general agent familiar with the Georgia market. A quota share treaty cedes 100% of the risk and fully collateralizes for unearned premium and unpaid loss and LAE.
The $5.7 million increase in homeowners’ net premiums earned is due to a $3.6 million increase in gross written premium as discussed, a $6.5 million decrease in gross premiums ceded and a $4.4 million decrease in the net change to prepaid reinsurance premiums and unearned premium.
The $0.4 million increase in automobile net premiums earned is a result of a $0.4 million decrease in gross written premium as discussed, a $0.3 million decrease in gross premiums ceded and a $0.5 million increase in the net change to prepaid reinsurance premiums and unearned premium.
Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, was 3.1% and 3.4%, respectively, for 2011. The primary reason for our lower investment yield in 2011 was the Company harvested gains that were a result of the Federal Reserve's activity in the bond market, which pushed up bond prices and lowered yields. Hence the proceeds from recognizing the gains were reinvested at yields that were lower than what was sold. Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, was 3.4% and 3.7%, respectively, for 2010.
FASB has issued guidance regarding when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. During 2011, pursuant to guidelines prescribed in FASB issued guidance, we have charged to operations, realized investment losses of $0.8 million. The charges relate to common stock held in diverse industries; during 2010, we did not mark any investments to market value pursuant to guidelines prescribed in FASB issued guidance. In reaching a conclusion that a security is either other than temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as S&P and Moody’s, as well as information released via the general media channels.
Please see “Liability for Unpaid Losses and LAE” under “Item 1 Business” for a discussion of the factors that affect unpaid losses and LAE.
For further discussion, see Footnote 6 to the Consolidated Financial Statements included under Part II, Item 8, of this Report.
Salaries and wages decreased $0.6 million, or 7.1%, to $8.0 million for 2011, compared with $8.6 million for 2010. The charge to operations for stock-based compensation, in accordance with FASB guidance, was approximately $0.2 million during 2011, compared with approximately $0.4 million for 2010.
The provision for income tax benefit was $0.6 million for 2011, compared with a $4.0 million for 2010. The effective rate for income taxes was 57.0% for 2011, compared with 33.1% for 2010. The 57.0% effective rate reflects the true-up of the 2010 tax return permanent differences.
A summary of long-term contractual obligations as of December 31, 2012 follows. The amounts represent estimates of gross undiscounted amounts payable over time.
In 2012, operations generated $20.8 million of gross cash flow, due to an $11.1 million increase in unearned premiums, a $2.3 million decrease in deferred income tax expense and $1.4 million of amortization of investment premium discount, net. Additional sources of cash included a $1.3 million decrease in prepaid reinsurance premiums, $0.2 million depreciation and amortization and $0.2 million non-cash compensation, all in conjunction with $4.3 million of net income.
In 2012, net cash provided by investing activities was $4.3 million. In 2011 and 2010, net cash used by investing activities was $5.2 million and $5.1 million. Our available-for-sale investment portfolio is highly liquid as it consists entirely of readily marketable securities. In 2012, investing activities generated $90.5 million and used $86.2 million.
In 2012, net cash provided by financing activities was less than $0.1 million. In 2011 and 2010, net cash provided and used by financing activities was less than $0.1 million and $0.4 million, respectively. In 2012, the sources of cash in connection with financing activities included $0.1 million from exercised stock options and a $0.1 million tax benefit related to non-cash compensation. In 2012, the use of cash in connection with financing activities was $0.2 million of dividends paid.
We offer direct billing in connection with our homeowners’, commercial general liability and automobile programs. Direct billing is an agreement in which the insurance company accepts from the insured, as a receivable, a promise to pay the premium, as opposed to requiring the full amount of the policy at policy inception, either directly from the insured or from a premium finance company. The advantage of direct billing a policyholder by the insurance company is that we are not reliant on a credit facility, but remain able to charge and collect interest from the policyholder.
As of December 31, 2012, 2011, and 2010, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “structured finance” or “special purpose” entities, which were established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. As such, management believes that we currently are not exposed to any financing, liquidity, market or credit risks that could arise if we had engaged in transactions of that type requiring disclosure herein.
Insurance premiums are established before we know the amount of losses and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate premiums, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation may also affect the market value of our investment portfolio and the investment rate of return. Any future economic changes that result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred losses and LAE and thereby materially adversely affect future liability requirements.
For the years ended December 31, 2012 and 2011, we had no off balance sheet transactions.
We have audited the accompanying consolidated balance sheets of Federated National Holding Company as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2012. Federated National Holding Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
The insurable events during 2012, 2011 and 2010 did not include any weather related catastrophic events such as the well publicized series of hurricanes that occurred in Florida during 2005 and 2004. During 2012, 2011 and 2010 we processed property and liability claims stemming from our homeowners’, commercial general liability and private passenger automobile lines of business. Our reinsurance strategy serves to smooth the liquidity requirements imposed by most severe insurable events and for all other insurable events we manage, at a micro and macro perspective, in the normal course of business.
During 2012, 85.3%, 7.8%, 4.4% and 2.5% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and personal automobile insurance, respectively. During 2011, 81.8%, 10.3%, 4.6% and 3.3% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and personal automobile insurance, respectively.
We internally process claims made by our insureds through our wholly owned claims adjusting company, FNA. Until June 2011, we offered premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium.
If all the costs substantially associated with the MGA contracts, which do not involve affiliated insurers, are incurred during the underwriting process, then the MGA fees and the related acquisition costs are recognized at the time the policy is underwritten, net of estimated cancellations. If the MGA contract requires significant involvement subsequent to the completion of the underwriting process, then the MGA fees and related acquisition costs are deferred and recognized over the life of the policy. Included in MGA Fees are policy fees charged by the insurance companies and passed through to FNU. Policy fees are discussed below.
We recognize the income and expense on reinsurance contracts principally on a pro-rata basis over the term of the reinsurance contracts or until the reinsurers maximum liability is exhausted, whichever comes first. We are reinsured under separate reinsurance agreements for the different lines of business underwritten. Reinsurance contracts do not relieve us from our obligations to policyholders. We continually monitor our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. We only cede risks to reinsurers whom we believe to be financially sound. At December 31, 2012, all reinsurance recoverables are considered current and deemed collectable.
In October 2010, the FASB issued ASU No. 2010-26: Financial Services - Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, a consensus of FASB Emerging Issues Task Force. The amendments in this update modify the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. The amendments in this update specify that the costs must be based on successful efforts (that is, acquiring a new or renewal contract). The amendments also specify that advertising costs should be included as deferred acquisition costs under certain circumstances. The amendments in this update are effective for fiscal years, and interim period within those fiscal years, beginning after December 15, 2011. The amendments in this update should be applied prospectively upon adoption. Retrospective application to all prior periods presented upon the date of adoption also is permitted. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
We face a risk of non-collectability of reinsurance, which could materially and adversely affect our business, results of operations and/or financial condition.
Nonstandard automobile insurance historically has a higher frequency of claims than standard automobile insurance, thereby increasing our potential for loss exposure beyond what we would be likely to experience if we offered only standard automobile insurance.
Current operating resources are necessary to develop future new insurance products.
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2012 and 2011 because of their short-term nature: cash and short term investments, premiums receivable, finance contracts, due from reinsurers, revolving credit outstanding, bank overdraft, accounts payable and accrued expenses.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB issued guidance using the modified-prospective-transition method. Under that transition method, compensation costs recognized during 2012, 2011 and 2010 include:
Property, plant and equipment is stated at cost less accumulated depreciation. Depreciation on property, plant and equipment is calculated on a straight-line basis over the following estimated useful lives: building and improvements - 30 years and furniture and fixtures - 7 years. We capitalize betterments and any other expenditure in excess of $1,000 if the asset is expected to have a useful life greater than one year. The carrying value of property, plant and equipment is periodically reviewed based on the expected future undiscounted operating cash flows of the related item. Based upon our most recent analysis, we believe that no impairment of property, plant and equipment exists at December 31, 2012.
The 2011and 2010 financial statement amounts have not been reclassified to conform to the 2012 presentations.
FASB issued guidance addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. The guidance requires that these securities be classified into one of three categories: Held-to-maturity, Trading, or Available-for-sale securities.
length of time and the extent to which the fair value has been less than amortized cost;
In reaching a conclusion that a security is either other-than-temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as S&P and Moody’s, as well as information released via the general media channels. During 2012, in connection with the process, we have charged to operations $44,000 of investment losses. During 2011, in connection with the process, we have charged to operations $0.8 million of investment losses.
As of December 31, 2012 and December 31, 2011, we have classified $7.4 million and $7.1 million, respectively, of our bond portfolio as held-to-maturity. We classify bonds as held-to-maturity to support securitization of credit requirements.
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of debt and equity securities at December 31, 2012 and 2011 is as follows.
United States Treasury notes with a book value of $2,004,527 and $64,438, maturing in 2012 and 2016, respectively, were on deposit with the Florida OIR as of December 31, 2011, as required by law for FNIC, and are included with other investments held until maturity.
Depreciation of property, plant, and equipment was $195,078, $167,753 and 221,494 during 2012, 2011 and 2010, respectively.
The Company holds collateral under related reinsurance agreements in the form of fully funded trust agreements totaling $4.8 million that can be drawn on for amounts that remain unpaid for more than 120 days.
As a result of our review of liability for losses and LAE, which includes a re-evaluation of the adequacy of reserve levels for prior year’s claims, we decreased the liability for losses and LAE for claims occurring in prior years by $1.4 and $1.0 million for the years ended December 31, 2012 and 2011, respectively, and we increased the liability for losses and LAE for claims occurring in prior years by $2.8 million for the year ended December 31, 2010.
We continue to revise our estimates of the ultimate financial impact of claims made resulting from past storms. The revisions to our estimates are based on our analysis of subsequent information that we receive regarding various factors, including: (i) per claim information; (ii) Company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages, and (iv) trends in general economic conditions, including the effects of inflation.
We trended these severities to accident year 2012 levels. Trend rates were selected based on a review of historical severities. Selected severity was chosen based on judgment considering the developed severities and the trended severities, considering industry benchmarks for each segment. The loss & ALAE, claim count and severity triangles are evaluated as of 12 months, 24 months, 36 months etc. We selected loss development factors based on the loss development history, to the extent credible, and supplemented with industry data where appropriate.
Based upon the results of our analysis and the application of ASC 740-10, we have determined that all material tax positions meet the recognition threshold and can be considered as highly certain tax positions. This is based on clear and unambiguous tax law, and we are highly confident that the full amount of each tax position will be sustained upon possible examination. Accordingly, the full amount of the tax positions will be recognized in the financial statements.
As part of its approval of the January 2011 merger between FNIC and American Vehicle, the Florida OIR, the Company, FNIC and American Vehicle entered into a consent order with the Florida OIR dated January 25, 2011 (the “Consent Order”), which was amended in February 2013, due to FNIC’s statutory underwriting profit during 2012. Pursuant to the amended Consent Order, the Company and the resulting company in the merger (the “Merged Company”) agreed to the following:
The Merged Company retained the following licenses: (010) Fire, (020) Allied Lines, (040) Homeowners Multi Peril, (050) Commercial Multi Peril, (090) Inland Marine, (170) Other Liability, (192) Private Passenger Auto Liability, (194) Commercial Auto Liability, (211) Private Passenger Auto Physical Damage and (212) Commercial Auto Physical Damage.
The Merged Company surrendered its surety license. The Merged Company has no surety policy premium in force.
The managing general agency fees payable by the Merged Company to Federated National Underwriters, Inc. (“FNU”), formerly known as Assurance Managing General Agents, Inc., a wholly owned subsidiary of the Company, which were traditionally 6% of gross written premium, were reduced and will not exceed 4% without prior approval from the Florida OIR. The Merged Company has lowered the fee to amounts varying between 2% and 4% of gross written to further support the FNIC results of operations. This will have no impact on the Company’s consolidated financial results.
At December 31, 2012, 2011 and 2010, FNIC’s statutory capital surplus was $52.1 million, $39.3 million and $18.7 million, respectively. At December 31, 2010, American Vehicle had statutory capital surplus of $21.9 million.
An insurance company is also required to adhere to prescribed premium-to-capital surplus ratios. As of December 31, 2012, 2011 and 2010, FNIC was in compliance with the prescribed premium-to-surplus ratio. As of December 31, 2010, American Vehicle was in compliance with the prescribed premium-to-surplus ratio.
We had bonds with a carrying value of approximately $2.2 million and $2.1 million pledged to the Florida OIR, as of December 31, 2012 and 2011, respectively, in accordance with regulatory requirements.
No dividends were paid by FNIC or American Vehicle in 2012, 2011 and 2010, and none are anticipated in 2013. Although we believe that amounts required to meet our financial and operating obligations will be available from sources other than dividends from our insurance subsidiaries, there can be no assurance in this regard. Further, there can be no assurance that, if requested, the Florida OIR will allow any dividends to be paid by FNIC to us, the parent company, in the future. The maximum dividends permitted by state law are not necessarily indicative of an insurer’s actual ability to pay dividends or other distributions to a parent company, which also may be constrained by business and regulatory considerations, such as the impact of dividends on capital surplus, which could affect an insurer’s competitive position, the amount of premiums that can be written and the ability to pay future dividends. Further, state insurance laws and regulations require that the statutory capital surplus of an insurance company following any dividend or distribution by it be reasonable in relation to its outstanding liabilities and adequate for its financial needs.
Based upon the 2012 and 2011 statutory financial statements for FNIC, statutory surplus exceeded the regulatory action levels established by the NAIC’s risk-based capital requirements.
Based on risk-based capital requirements, the extent of regulatory intervention and action increases as the ratio of an insurer’s statutory surplus to its Authorized Control Level (“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 474.4%, 409.7% and 222.8% at December 31, 2012, 2011 and 2010, respectively. American Vehicle’s ratio of statutory surplus to its ACL was 373.4% at December 31, 2010.
There was no action taken by the Florida OIR in connection with the December 31, 2010 or 2011 IRIS ratio results. We do not currently believe that the Florida OIR will take any significant action with respect to FNIC regarding the 2012 IRIS ratios, although there can be no assurance that will be the case.
The table below reflects the range and test results for FNIC for the years ended December 31, 2012 and 2011, respectively.
During December 2012, the Company was assessed $0.8 million by FIGA relating to the recent failures of Florida domestic property and casualty insurance companies. Future assessments are likely, although the impact of these assessments on our balance sheet, results of operations or cash flow are undeterminable at this time.
FNIC is also required to participate in an insurance apportionment plan under Florida Statutes Section 627.351, 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. FNIC was not assessed by the JUA Plan during 2012 or 2011. Future assessments by this association are undeterminable at this time.
Rent expense was $0.2 million in 2012 and $0.7 million in 2011 and 2010.
In 2002, we implemented the 2002 Stock Option Plan, which expired in April 2012. The purpose of this plan was to advance our interests by providing an additional incentive to attract, retain and motivate highly qualified and competent persons who are key to the Company, including employees, consultants, independent contractors, officers and directors. Our success is largely dependent upon their efforts and judgment; therefore, by authorizing the grant of options to purchase common stock, we encourage stock ownership. Options outstanding under the plan were granted at prices either equal to or above the market value of the stock on the date of grant, expire six or ten years after the grant date and have vesting periods determined by the Compensation Committee of our Board of Directors. Under this plan, we were authorized to grant options to purchase up to 1,800,000 common shares, and as of December 31, 2012 and 2011 we had outstanding exercisable options to purchase 702,597 and 624,700 shares, respectively.
In April 2012, our Board of Directors adopted, and in September 2012 our shareholders approved, the Company’s 2012 Stock Incentive Plan (the “2012 Plan”). The 2012 Plan permits the issuance of up to 1,000,000 shares of our common stock, subject to adjustment as provided for in the 2012 Plan, in connection with the grant of a variety of equity incentive awards, such as incentive stock options, non-qualified stock options, stock appreciation rights, dividend equivalent rights, restricted stock, restricted stock units, and performance shares. Officers, directors and executive, managerial, administrative and professional employees of the Company and its subsidiaries are eligible to participate in the 2012 Plan. Awards may be granted singly, in combination, or in tandem. As of December 31, 2012, no awards had been granted under the 2012 Plan. The 2012 Plan was amended and restated in March 2013 to clarify the plan administrator’s authority to permit the vesting of unvested restricted shares in the event of the death of the grantee. The 2012 Plan will expire on April 5, 2022. Please see Footnote 22 of the Notes to Consolidated Financial Statements for additional discussions regarding the granting of shares from the 2012 Plan.
Activity in our stock option plans for the period from January 1, 2009 to December 31, 2012 is summarized below.
Options outstanding as of December 31, 2012 are exercisable as follows.
As a result of adopting FASB issued guidance on January 1, 2006, the Company’s income from continuing operations before provision for income tax expense and net income for 2012 are lower by approximately $265,900 and $165,700, respectively, than if it had continued to account for share-based compensation under APB guidance.
Basic and diluted loss per share for 2011 would have been $0.03, if the Company had not adopted FASB issued guidance, compared with reported basic and diluted loss per share of $.05.
The weighted average fair value of options granted during 2012, 2011 and 2010 estimated on the date of grant using the Black-Scholes option-pricing model was $1.45, $0.72 to $0.78 and $1.54 to $1.81, respectively.
The fair value of options granted is estimated on the date of grant using the following assumptions.
We have established a profit sharing plan under Section 401(k) of the Internal Revenue Code. This plan allows eligible employees to contribute up to 100 percent of their compensation, not to exceed statutory limits. The Company match totaled $0.1 million during each of the years 2012, 2011 and 2010.
Through December 31, 2010, the Company matched 50% of the first 6% of a participant’s elective contributions. Effective January 1, 2011, the Board of Directors approved an amendment to our 401(k) plan to be a qualified automatic contribution arrangement with an employer match of 100% of the first 1% of elective contributions and an employer match of 50% of the next 2% to 6% of elective contributions, which is vested 100% after 2 years of service.
For the years ended December 31, 2012, 2011 and 2010, comprehensive income (loss) consisted of the following.
Our Amended and Restated Articles of Incorporation authorize the issuance of one million shares of preferred stock with designations, rights and preferences determined from time to time by our board of directors. Accordingly, our Board of Directors is empowered, without shareholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. We have not issued preferred shares as of December 31, 2012.
On February 15, 2013, Federated National entered into a Reimbursement Contract and Addendum No. 1 thereto (together, the “Reimbursement Contract”) with the SBA for the 2013-2014 hurricane season. This Reimbursement Contract is part of the Company’s reinsurance program and will reimburse Federated National for covered property losses under its homeowners’ insurance policies resulting from hurricanes that cause damage in the State of Florida through May 31, 2014.
Under this Reimbursement Contract, the FHCF will provide approximately $167.3 million of aggregate seasonal coverage for covered losses in excess of approximately $62.8 million, subject to a 10.0% Company participation. Federated National’s premium for the FHCF reinsurance coverage will be approximately $11.2 million payable in three installments between August 2013 and December 2013. The actual attachment point, total coverage and cost will not be finalized until December 31, 2013.