As of December 31, 2013, we leased an aggregate of 164,331 square feet of office space in various locations throughout the United States. The office space includes a lease for 45,635 aggregate square feet of office space in a common building in Burr Ridge, Illinois which expires in November 2016. Effective November 2012, we
subleased 38,341 square feet of the common building in Burr Ridge through November 2016. We lease 56,888 square feet of office space in Addison, Texas, and our Addison lease term expires in October 2024. We also have two leases of 55,186 aggregate square feet of office space in Baton Rouge, Louisiana. One Baton Rouge lease is for 51,792 square feet of office space with a term that expires in January 2020. The second Baton Rouge lease is for 3,394 square feet of office space with a term that expires in July 2014. We also have offices in Chicago and Dallas which have 4,003 and 2,619 square feet, respectively.
As of December 31, 2013, our subsidiaries included insurance companies licensed to write insurance policies in 39 states, two underwriting agencies and a service company. We are also party to an agreement with an unaffiliated underwriting agency that distributes our policies in the state of California. We distribute and service non-standard insurance policies underwritten by a Texas county mutual insurance company. Prior to the sale of our retail agency distribution business on September 30, 2013, we also provided premium financing services and distributed third-party insurance products and services. We are currently distributing insurance policies through approximately 5,200 independent agents or brokers including the retail agency stores sold on September 30, 2013. We currently operate in seven states (Louisiana, Texas, California, Alabama, Illinois, Indiana and Missouri). In 2012, we discontinued writing business in the state of South Carolina. In 2011, we discontinued writing business in the state of Michigan.
Management has obtained sufficient quota-share reinsurance to allow us to maintain written premium capacity through 2014.
The preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires us to make estimates and assumptions when applying our accounting policies. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. Our critical accounting policies are described below. For a detailed discussion on the application of these and other accounting policies, see Note 3 of Notes to Consolidated Financial Statements which appears in Item 8 of this Annual Report.
There can be no assurance that actual future loss and LAE development, or variability in loss and LAE, will be consistent with the development or variability in our historical loss and LAE experience. We expect that the final outcome for a given accident year will be within the range of estimates if development emerges normally.
Valuation of available-for-sale investments. Our available-for-sale investment securities are recorded at fair value, which is typically based on publicly-available quoted prices. When quoted market prices in active markets are unavailable, we determine fair value based on independent external valuation sources. From time to time, the carrying value of our investments may be temporarily impaired because of the inherent volatility of publicly-traded investments. We do not adjust the carrying value of any investment unless management determines that the impairment of an investment’s value is other than temporary.
premiums and anticipated investment income. At December 31, 2013 and 2012, there were no premium deficiencies. Judgments as to the ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with unearned premiums.
Income taxes. Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities, and the valuation allowance recorded against net deferred tax assets. The process involves summarizing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. In addition, we assess whether valuation allowances should be established against deferred tax assets based on consideration of all available evidence using a “more likely than not” standard. To the extent a valuation allowance is established in a period, an expense must be recorded within the income tax provision in the consolidated statement of operations. We carry a full valuation allowance as of December 31, 2013 and 2012 that was initially established in 2009.
On September 30, 2013, we sold our retail agency distribution business to Confie Seguros (Confie). Our retail agency distribution business consisted of 195 retail locations in Louisiana, Alabama, Texas, Illinois, Indiana, Missouri, Kansas, South Carolina and Wisconsin and two premium finance companies (the retail business). Proceeds from the sale were $101.9 million in cash with the potential to receive an additional $20.0 million of cash proceeds. The cash proceeds included $20.0 million placed in an escrow account which is included in other assets on the consolidated balance sheet. The funds held in escrow will, dependent upon the risk-based capital status of Affirmative Insurance Company (AIC), be utilized to either infuse capital into AIC or pay down debt. The risk-based capital measurement will be made quarterly through June 30, 2014. As of the first measurement date of September 30, 2013, AIC met the risk-based capital target and in November 2013, $5.0 million was released from the escrow account and was used to pay down the senior secured credit facility.
We expect to pay down an additional $5.0 million of the senior secured credit facility in April 2014 based on the risk-based capital measurement as of December 31, 2013. In addition, the purchase agreement was amended in March 2014 to suspend the measurement of risk-based capital as of March 31, 2014, which determines how the remaining escrow account is utilized until the measurement date as of June 30, 2014. The initial cash proceeds also included a preliminary working capital adjustment of $1.8 million as of September 30, 2013. Upon review by the purchaser, an additional working capital adjustment of $0.1 million was received in the fourth quarter of 2013.
Total gross written premiums managed for 2012 increased $7.8 million, or 3.4%, compared with 2011. This increase was primarily due to an increase in new business policies generated in Texas from independent agencies during 2012. New business policies in Texas increased 41.4% for 2012 compared with 2011, which was comprised of a 12.6% increase from our former retail stores and a 131.3% increase from independent agents.
The following table displays our gross written premiums managed and assumed by state (in thousands):
Reinsurance. During 2011, we entered into a quota-share reinsurance arrangement effective January 1, 2011 ceding 28% of gross written premium in all states other than Michigan through December 31, 2011. This contract terminated on January 1, 2012 on a cut-off basis and resulted in the return of $11.8 million of ceded unearned premium, net of $4.3 million of deferred ceding commissions. Written premiums ceded under this agreement totaled $50.6 million.
In 2013, we entered into a new quota-share agreement with the previous third-party reinsurance company effective March 31, 2013, under which we cede 40% for the same four states as the expiring agreement. This agreement is through December 31, 2013 but had automatic one-year renewals unless either party provides notice of intent not to renew within 75 days. This agreement was amended effective June 30, 2013, under which we cede an additional 40% for the same four states for the remainder of 2013. This agreement was further amended to provide a $10.0 million reduction in ceded premiums in the fourth quarter. Written premiums ceded under this agreement totaled $145.8 million during the year ended December 31, 2013. This agreement terminated on January 1, 2014.
Effective December 31, 2013, we entered into a new reinsurance agreement with four new third-party reinsurance companies. Under this agreement, we cede 20% of premiums and losses in Alabama, Illinois, Louisiana and Texas, and 60% in California on policies in force on December 31, 2013 or written or renewed on and after that date. Written premiums ceded under this agreement totaled $22.2 million as of December 31, 2013. On January 1, 2014, the quota-share rate increases to 60% for all business in force in these same states and for new and renewal business through January 1, 2015.
The table below presents the ceded premiums written and ceded loss and loss adjustment expenses to the MCCA for the year ended December 31, 2012 and 2011(in thousands):
In February 2013, we entered into a one-year excess of loss reinsurance contract with third-party reinsurers that provides coverage for individual losses in excess of $100,000 up to $1.0 million.
In July 2013, we entered into a reinsurance agreement with third-party reinsurers which provides $7.0 million in excess of the first $3.0 million of losses coverage for catastrophic events that may involve multiple insured losses.
Commission income, fees and managing general agent revenue for 2013 increased $16.0 million, or 26.1%, compared with 2012. Policyholder fees increased $14.7 million, or 70.8%, due to the higher overall volume of premiums written and a change in mix of states. Managing general agent revenue is related to the Texas county mutual book of business that we manage, but no longer assume the underwriting risk beginning January 1, 2013. Commission income and fees for 2012 decreased $6.4 million, or 9.4%, compared with 2011. In 2012, policyholder fees decreased $3.6 million, or 15.0%, due to the lower overall volume of premiums written and a change in mix of states.
Prior to the sale of our retail agency distribution business, we earned commission income and fees in our retail distribution channel for sales of third-party insurance policies in addition to policies under our management. In 2013, commissions and fees decreased $3.0 million, or 18.8%, due to decreased third-party sales. Commissions and fees for 2012 decreased $0.2 million, or 1.0%, due to a decrease in ancillary product sales. The following represents third-party gross written premiums produced by our former retail agencies (in thousands):
Third-party policies for 2013 decreased $5.9 million, or 12.0%, compared with 2012. Retail premium volume was impacted by the sale of our retail agency distribution business effective September 30, 2013. Third-party policies for 2012 decreased $4.8 million, or 8.8%, compared with 2011.
Net Investment Income and Other Income. Net investment income includes income on our portfolio of debt securities and net rental income from our investment in real property. Net investment income for 2013 decreased $0.4 million, or 12.4%, compared with 2012. The decrease was primarily due to a 36.2% decrease in total average invested assets to $48.7 million during 2013 from $76.3 million during 2012. The annualized average investment yield was 1.4% (1.5% on a taxable equivalent basis) in 2013, compared with 1.9% (2.0% on a taxable equivalent basis) in 2012.
Our investment strategy is to conservatively manage our investment portfolio by primarily investing in readily marketable, investment-grade, fixed-income securities. We currently do not invest in common equity securities and we have no direct exposure to foreign currency risk. The Investment Committee of our Board of Directors has established investment guidelines and periodically reviews portfolio performance for compliance with our guidelines.
In 2012, the percentage of calendar year losses and loss adjustment expense to net premiums earned (the net loss ratio) was 77.8% compared with 78.0% in 2011. On an accident year basis, the net loss ratio was 74.0% in 2012 compared with 75.1% in 2011. Loss adjustment expenses include all of the business subject to the quota-share treaties with ceding commission income booked as an offset to selling, general and administrative expenses. As such, the quota-share treaties’ impact on the loss ratio was to increase it by 4.6 points for 2012 and 3.1 points for 2011. Excluding the impact of the quota-share, the net loss ratio for the 2012 accident year was 69.4% and 71.1% for the 2011 accident year. This decrease reflects the pricing, claims and underwriting actions that commenced in the second half of 2010 through 2011. Also reflected in the above numbers is the effect of catastrophes. For the 2012 accident year we have incurred catastrophes, net of reinsurance, equal to 2.0 points for 2012 compared to 1.5 points in 2011. Both of these numbers are higher than our long term average expectation of 0.5 points. The adverse prior period development taken in 2012 was primarily due to an increase in the estimated severity for Louisiana bodily injury claims in 2011.
The decrease in the 2012 accident year resulted from the confluence of a number of initiatives. During 2011, we introduced our new multi-variate pricing model in our four largest states, implemented pricing and underwriting changes and our continuing process in implementing changes to our claims process.
which such reserves are increased. The historic development of our reserves for losses and loss adjustment expenses is not necessarily indicative of future trends in the development of these amounts.
Deferred policy acquisition costs represent the deferral of expenses that we incur related to successful contract acquisition of new business or renewal of existing business. Policy acquisition costs, consisting of primarily commission expenses and premium taxes, are initially deferred and then charged against income ratably over the terms of the related policies through amortization of the deferred policy acquisition costs. Thus, the amortization of deferred acquisition costs is correlated with earned premium and the ratio of amortization of deferred acquisition costs to earned premium in an accounting period is another measurement of performance.
Amortization of deferred policy acquisition costs is a major component of selling, general and administrative expenses. The following table sets forth the impact that amortization of deferred acquisition costs had on selling, general and administrative expenses and the change in deferred acquisition costs (in thousands):
Additions to deferred acquisition costs in 2013 decreased by $10.9 million, and additions to the related amortization decreased by $3.3 million compared with 2012. The decrease in additions is primarily due to the increase of $13.1 million of deferred acquisition costs ceded to our reinsurers, partially offset by the policy acquisition expenses incurred for independent agents due to the increase in premiums written as well as the increase in policy acquisition costs in the fourth quarter of our former retail business which previously was eliminated in the consolidated financial statements. Additions to deferred acquisition costs in 2012 increased by $8.5 million, and additions to the related amortization increased by $5.0 million compared with 2011. The increase in additions is primarily due to an increase in business written by independent agents and a decrease in ceded deferred policy acquisition expenses. The increase in amortization is due to an increase in net written premium and higher policy acquisition expenses.
Interest Expense. Interest expense for 2013 increased $0.9 million, or 4.7%, compared with 2012. This increase was primarily due to an increase in amortization of debt discount, which was $4.9 million in 2013 as compared with $4.1 million for 2012 due to the incremental term loan that was borrowed in November 2012 and the new debt arrangement effective September 2013.
Interest expense for 2012 decreased $1.8 million, or 8.5%, compared with 2011. This decrease was due to decreases in the average debt outstanding, in the amortization of debt discount and in interest expense on the lease obligation entered into in May 2010. In 2012, we repaid $3.5 million of the senior secured facility. Amortization of debt discount was $4.1 million in 2012, compared with $4.5 million in 2011.
Our gross deferred tax assets prior to recognition of valuation allowance were $90.0 million and $104.9 million at December 31, 2013 and 2012, respectively. In assessing the realizability of our deferred tax assets, we considered whether it was more likely than not that our deferred tax assets will be realized based upon all available evidence, including scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the Internal Revenue Code, among others. Based on this assessment, we began recording a valuation allowance against deferred taxes in December 2009. The valuation allowance was $88.4 million and $101.9 million at December 31, 2013 and 2012, respectively.
State insurance laws restrict the ability of our insurance company subsidiaries to declare stockholder dividends. These subsidiaries may not issue an “extraordinary dividend” until 30 days after the applicable commissioner of insurance has received notice of the intended dividend and has not objected in such time or until the commissioner has approved the payment of the extraordinary dividend within the 30-day period. In most states, an extraordinary dividend is defined as any dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10.0% of the insurance company’s surplus as of the preceding year-end or the insurance company’s net income for the preceding year, in each case determined in accordance with statutory accounting practices. In addition, dividends may only be paid from unassigned earnings and an insurance company’s remaining surplus must be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. As of December 31, 2013, our insurance companies could not pay ordinary dividends to us without prior regulatory approval due to a negative unassigned surplus position of Affirmative Insurance Company. However, as mentioned previously, our non-insurance company subsidiaries provide adequate cash flow to fund their own operations.
Our insurance company subsidiaries are subject to risk-based capital standards and other minimum capital and surplus requirements imposed under applicable state laws, including the laws of their state of domicile. The risk-based capital standards, based upon the Risk-Based Capital Model Act, adopted by the National Association of Insurance Commissioners (NAIC), require our insurance company subsidiaries to report their results of risk-based capital calculations to state departments of insurance and the NAIC. Failure to meet applicable risk-based capital requirements or minimum statutory capital requirements could subject us to further examination or corrective action imposed by state regulators, including limitations on our writing of additional business, state supervision or liquidation. Any changes in existing risk-based capital requirements or minimum statutory capital requirements may require us to increase our statutory capital levels. At December 31, 2013, each of our insurance subsidiaries maintained a risk-based capital level that was in excess of an amount that would require any corrective actions. Effective January 1, 2012, the State of Illinois adopted the revised NAIC Risk-Based Capital Model Act that includes a risk-based capital trend test as another manner under which the company action level could be triggered and will be applied beginning December 31, 2012. The test is applicable when an insurance company has a risk-based capital ratio between 200% and 300% and a combined ratio of more than 120%. All of our insurance subsidiaries were in compliance with the RBC trend test as of December 31, 2013.
Debt refinancing - We used proceeds from the sale of the retail agency distribution business and two new debt arrangements to replace the existing senior secured credit facility. Our new debt arrangement consists of a $40.0 million senior secured credit facility with a maturity date of March 30, 2016, and a $10.0 million subordinated secured credit facility with a maturity date of March 30, 2017.
In December 2013, we entered into a capital lease obligation related to certain computer software, software licenses and hardware used in our insurance operations. We received cash proceeds from the financing in the amount of $4.9 million in January 2014. A receivable for settlement of this transaction was included in other assets as of December 31, 2013. The transaction proceeds, when received, will be pledged as collateral against all the Company’s obligations under the lease. The dollar amount of collateral pledged is set to decline over the term of the lease as the Company makes the scheduled lease payments. At the end of the initial term, we will have the right to purchase the software for a nominal fee, after which all rights, title and interest would transfer to us.
leases and rents on real estate located in Baton Rouge, Louisiana, which is held as investment in real property in the accompanying consolidated balance sheet. The mortgage bears interest at a per annum fixed rate of 4.95%. The mortgage requires monthly payments of principal and interest with the final payment due on the maturity date of December 15, 2015. As security for payments, we assigned rents due under the lease to a trustee. Pursuant to an escrow and servicing agreement, the trustee will receive rent due under the lease, make required payments due under the mortgage and maintain certain escrow accounts to pay for the necessary expenses of the property until the mortgage is paid in full. The principal balance of the mortgage payable was $3.6 million at December 31, 2013.
We believe that existing cash and investment balances, as well as cash flows generated from operations, and other actions taken by the Company will be adequate to meet our liquidity needs, planned capital expenditures and the debt service requirements of the senior secured credit facility and notes payable, during the 12-month period following the date of this report at both the holding company and insurance company levels. For the year ended December 31, 2013, cash and cash equivalents increased $6.4 million in 2013 as compared with an increase of $9.6 million in 2012. Our net cash used in operations was $3.1 million in 2013 as compared to net cash used in operations of $57.8 million in 2012. This decrease was primarily due to the growth in written premium volume from new business in Texas and California. Net cash provided by investing activities was $77.3 million in 2013 as compared to net cash provided by investing activities of $65.9 million in 2012. Improved operating cash flows resulted from the sale of the retail business, which was partially offset by purchases rather than sales of investment securities. Net cash used in financing activities was $67.8 million in 2013 as compared to net cash provided by financing activities of $1.5 million in the prior year period. This was due primarily to the pay off of the senior secured credit facility effective January 2007, which was partially offset by the senior secured credit facility of $38.0 million and subordinated secured credit facility of $10.0 million secured as of September 30, 2013 and $4.8 million mortgage note payable secured by commercial real estate obtained during the first quarter of 2013.
In August 2013, a new class of loans to be borrowed under the senior secured credit facility was created allowing for an additional tranche of incremental term loan (ITL B). Under the ITL B, we borrowed $12.5 million which was contributed to our subsidiary, LIFCO, LLC to pay off an intercompany note due AIC.
The following table summarizes our contractual obligations at December 31, 2013 (in thousands):
(6) On October 16, 2012, Affirmative and Accenture materially amended the Master Agreement effective September 1, 2012 (“Amended Agreement”), whereby we reassumed responsibility for managing substantially all of our IT operations, including our data center and applications management. The Amended Agreement was scheduled to terminate on October 30, 2016, subject to termination for convenience provisions that may be invoked by us at any time, subject to the payment of certain stranded costs and other termination fees. Termination costs may be incurred for early termination under other specific circumstances as well. This contract was terminated as of June 30, 2013. An early termination penalty was invoked by the third party whereby the Company will pay out $1.8 million over a twelve month period which started in July 2013. These amounts represent our minimum future IT outsourcing commitments.
Affirmative Insurance Holdings, Inc. (the Company), was incorporated in Delaware in June 1998. The Company is a provider of non-standard personal automobile insurance policies for individual consumers in targeted geographic areas. The Company is a party to an agreement with an unaffiliated underwriting agency in the state of California and provides non-standard insurance policies written by a Texas county mutual. The Company is currently distributing insurance policies through approximately 5,200 independent agents or brokers in 7 states (Louisiana, Texas, California, Alabama, Illinois, Indiana and Missouri).
The Company has taken actions to address its liquidity concerns including:
$20.0 million originally established in an escrow account on the sale date. The Company expects to pay down an additional $5.0 million of the senior secured note in April 2014 based on the risk-based capital measurement as of December 31, 2013. In addition, the purchase agreement was amended in March 2014 to suspend the measurement of risk-based capital as of March 31, 2014, which determines how the remaining escrow account is utilized until the measurement date as of June 30, 2014 (See Note 4).
Debt refinancing - The Company used proceeds from the sale of the retail agency distribution business and two new debt arrangements to replace the existing senior secured credit facility. The Company’s new debt arrangement consists of a $40.0 million senior secured credit facility with a maturity date of March 30, 2016, and a $10.0 million subordinated secured credit facility with a maturity date of March 30, 2017 (See Note 11).
Management has taken and will continue to pursue appropriate actions to improve the underwriting results; however, there can be no assurance that this will occur.
Management has obtained sufficient quota-share reinsurance to allow the Company to maintain written premium capacity through 2014.
Use of Estimates • The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. These estimates and assumptions are particularly important in determining reserves for losses and loss adjustment expenses, deferred policy acquisition costs, reinsurance receivables, valuation of investments, other intangible assets, and deferred income taxes.
Investments • Investment securities consist of debt securities, and are recorded at fair value on the consolidated balance sheet. These investments are classified as available-for-sale, based on management’s intent and ability to hold to maturity. Unrealized gains and losses are recorded in accumulated other comprehensive income (loss), a separate component of stockholders’ deficit. No income tax effect of unrealized gains and losses is reflected in other comprehensive income (loss) due to the Company carrying a full deferred tax valuation allowance. The Investment Committee periodically reviews investment portfolio results and evaluates strategies to maximize yields, to match maturity durations with anticipated needs, and to maintain compliance with investment guidelines.
Fair value is based on quoted prices in active markets or third-party valuation sources when observable market prices are not available. Gains and losses realized on the disposition of investment securities are determined on the specific-identification basis and credited or charged to income. Premium and discount on investment securities are amortized and accreted using the interest method and charged or credited to investment income.
Amounts Due from/to Reinsurers • The Company collects premiums from insureds and after deducting its authorized commissions, the Company remits these premiums to the appropriate reinsurance companies. The
Company’s obligation to remit these premiums is recorded as amounts due reinsurers in its consolidated balance sheet. The Company records the amounts it expects to receive from reinsurers for paid and unpaid losses as an asset on its consolidated balance sheet.
Property and Equipment, Net • Property and equipment is stated at cost, less accumulated depreciation. Depreciation is recognized using the straight-line method over the estimated useful lives of the Company’s assets, typically ranging from three to eight years. Leasehold improvements are depreciated over the shorter of the estimated useful lives of the assets or the remainder of the lease term.
Identifiable intangible assets consist of state insurance company licenses and brand names prior to the sale of the retail agency distribution business on September 30, 2013. The Company reviews such intangibles for impairment whenever an impairment indicator exists. Management continually monitors events and changes in circumstances that could indicate carrying amounts of long-lived assets, including intangible assets, may not be recoverable. When such events or changes in circumstances occur, management assesses recoverability by determining whether the carrying value of such assets will be recovered through the undiscounted expected future cash flows. If the future undiscounted cash flows are less than the carrying amount of these assets, an impairment loss is recognized based on the excess of the carrying amount over the fair value of the assets.
Variable Interest Entities • Affirmative Insurance Holdings Statutory Trust I (“Trust I”), is an unconsolidated trust subsidiary, for the sole purpose of issuing $30.0 million trust preferred securities in 2004. Trust I used the proceeds from the sale of these securities and the Company’s initial capital contribution to purchase $30.9 million of subordinated debt securities from the Company. The debt securities are the sole assets of Trust I, and the payments under the debt securities are the sole revenues of Trust I. The Company’s initial capital contribution consisted of the purchase of 928,000 common securities issued by Trust I for $928,000, which represented 3% of the total dollar amount of subordinated debentures issued.
The investment in the common securities totaling $1.7 million is reflected in other assets in the Company’s consolidated balance sheets. The subordinated debentures totaling $56.7 million are included in debt in the Company’s consolidated balance sheets.
Profit-sharing commissions, which enable the Company to collect commission income and fees in excess of provisional commissions, are recorded when it is probable that estimates of loss ratios will be below the levels stated in the Company’s agency contracts. Provisional commissions may be reduced when it is probable that estimates of loss ratios will be above the levels stated in the related agency contract.
Agency Fees - Represents revenues from the retail agency business prior to being sold on September 30, 2013. These fees compensated the Company for the costs of policy cancellation, policy rewrite and reinstatement and were recognized when the services were provided. Premium finance and origination fees were recognized over the term of the finance contracts.
Recently Adopted Accounting Standards • Accounting Standards Update (ASU) 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, requires disclosure of amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present either on the face of the statement of operations or in the notes to the financial statements, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. This ASU is effective prospectively for annual and interim periods beginning after December 15, 2012. The adoption of this standard did not have an impact on our consolidated financial position, results of operations or cash flows.
The Company realized a pretax gain on the sale of $65.0 million. The Company’s consolidated results of operations include the retail business’s results of operations through the date of the sale, September 30, 2013. The net assets sold consisted of (in thousands):
The Company had $10.0 million and $0 million of unsettled investment purchases as of December 31, 2013, and 2012, respectively.
Expected maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties. The Company’s amortized cost and estimated fair values of fixed-income securities at December 31, 2013 by contractual maturity were as follows (in thousands):
The Company’s portfolio contained approximately 53 and 16 individual investment securities that were in an unrealized loss position as of December 31, 2013 and 2012, respectively.
In 2013, the Company entered into a new quota-share agreement with the previous third-party reinsurance company effective March 31, 2013, under which the Company cedes 40% for the same four states as the expiring agreement. This agreement is through December 31, 2013 but has automatic one-year renewals unless either party provides notice of intent not to renew within 75 days. This agreement was amended effective June 30, 2013, under which the Company cedes an additional 40% for the same four states for the remainder of 2013. This agreement was further amended to provide a $10.0 million reduction in ceded premiums in the fourth quarter. Written premiums ceded under this agreement totaled $145.8 million during the year ended December 31, 2013. This agreement terminated on January 1, 2014.
In July 2013, the Company entered into a reinsurance agreement with third-party reinsurers that provides $7.0 million in excess of the first $3.0 million of losses coverage for catastrophic events that may involve multiple insured losses.
In February 2013, the Company entered into a one-year excess of loss reinsurance contract with third-party reinsurers that provides coverage for individual losses in excess of $100,000 up to $1.0 million.
The Michigan Catastrophic Claims Association (MCCA) is the mandatory reinsurance facility that covers no-fault medical losses above a specific retention amount in Michigan. The Company discontinued writing policies in Michigan in 2011. For policies effective in 2011 and 2010, the retention amount was $0.5 million. When the Company wrote personal automobile policies in the state of Michigan, the Company ceded premiums and claims to the MCCA. Funding for MCCA comes from assessments against active automobile insurers based upon their proportionate market share of the state’s automobile liability insurance market. Insurers are allowed to pass along this cost to Michigan automobile policyholders.
At December 31, 2013, $2.5 million was included in reserves for losses and loss adjustment expenses that represented the amounts owed by AIC under a reinsurance agreement with a VIG-affiliated company. Affirmative established a trust account to secure the Company’s obligations under this reinsurance contract, which currently holds $15.7 million in a money market cash equivalent account (the AIC Trust). The Special Deputy Receiver in Texas had cumulative withdrawals from the AIC Trust of $0.4 million through December 2013, and the Special Deputy Receiver in Hawaii had cumulative withdrawals from the AIC Trust of $1.7 million through December 2013.
In June 2006, the Texas Department of Insurance (TDI) placed VFIC, along with several of its affiliates, into rehabilitation and subsequently into liquidation (except for VIG which remains in rehabilitation). In accordance with the TDI liquidation orders, all VIG subsidiary reinsurance agreements were terminated. Prior to the termination, the Company assumed various quota-share percentages according to which managing general agents (MGAs) produced the business. With respect to business produced by certain MGAs, the Company assumed 100% of the contracts. For business produced by other MGAs, the Company’s assumption was net after
VIG cession to other reinsurers. For this latter assumed business, the other reinsurers and their participation varied by MGA. Prior to the termination of the VIG subsidiary reinsurance agreements, the agreements contained no maximum loss limit other than the underlying policy limits. The ceding company’s retention was zero and these agreements could be terminated at the end of any calendar quarter by either party with prior written notice of not less than 90 days.
Policy acquisition costs, consisting of primarily commissions and premium taxes, net of ceding commission income, are deferred and charged against income ratably over the terms of the related policies. The components of deferred policy acquisition costs and the related amortization expense were as follows (in thousands):
The Company reports no carrying value for goodwill since the impairment analysis as of September 30, 2012. The Company reports under a single reporting segment and, as such, the goodwill analysis was measured under one reporting unit. Trends and developments resulted in management concluding that it is more likely than not that a goodwill impairment existed at September 30, 2012. Specifically, operating income and cash flow was less than plan, and premium production was below forecast. Due to the Company’s negative equity position of $101.3 million as of September 30, 2012, prior to goodwill impairment, ASC 350-20-35-30 required that the Company perform step two of the goodwill impairment test.
Consistent with prior assessments, the fair value of the Company was determined using an internally developed discounted cash flow method. Management made significant assumptions and estimates about the extent and timing of future cash flows, growth rates, and discount rates that represent unobservable inputs into the valuation methodologies used to calculate fair value. A discount rate of 19% was used at September 30, 2012, which the Company believes adequately reflected an appropriate risk-adjusted discount rate based on its overall cost of capital and company-specific risk factors related to cash flow, debt covenants compliance, and regulatory risk. The cash flows were estimated over a significant future period of time, which made those estimates and assumptions subject to a high degree of uncertainty. Based upon the results of the assessment, the Company concluded that the carrying value of goodwill was fully impaired as of September 30, 2012. In step two of the goodwill impairment analysis, the Company determined the fair values of the Company’s assets and liabilities (including any unrecognized intangible assets) as if the Company had been acquired in a business combination. Determining the implied fair value of goodwill was judgmental in nature and involved the use of significant estimates and assumptions. The resulting implied fair value of goodwill was compared to the carrying value of goodwill, resulting in the write-off of the remaining goodwill balance of $23.4 million.
Changes in the carrying value of goodwill for the year ended December 31, 2012 and 2011 were as follows (in thousands):
Significant declines in the fourth quarter of 2011 in premiums written in the markets corresponding to the recorded agency relationship compared with prior periods and forecast, as well as customer attrition rates indicated that the carrying amounts of definite-lived intangible assets were not recoverable, resulting in a non-cash impairment charge of $1.7 million.
Other intangible assets at December 31, 2013 and 2012 were as follows (in thousands):
The Company transferred $12.8 million of trade name intangibles as part of the retail sale, as discussed in Note 4.
The Company’s long-term debt instruments and balances outstanding at December 31, 2013 and 2012 were as follows (in thousands):
The $30.9 million notes payable due 2035 are redeemable in whole or in part by the Company. The notes adjust quarterly to the three-month LIBOR rate plus 3.60%. The interest rate as of December 31, 2013 was 3.84%.
The $25.8 million notes payable due 2035 are redeemable in whole or in part by the Company. The notes adjust quarterly to the three-month LIBOR rate plus 3.55%. The interest rate as of December 31, 2013 was 3.79%.
The $20.1 million notes payable due 2035 are redeemable in whole or in part by the Company. The notes adjust quarterly to the three-month LIBOR rate plus 3.95%. The interest rate as of December 31, 2013 was 4.19%.
The pricing under the subordinated secured credit facility is currently subject to an adjusted LIBOR rate floor of 1.25%, plus 18.00%. The interest rate as of December 31, 2013 was 19.25%. The subordinated secured credit facility included a commitment fee of $3.0 million that was added to the principal balance outstanding. Accrued interest is added to the outstanding principal balance until the senior secured credit facility is paid. Capitalized interest totaling $0.7 million was added to the principal balance during 2013. As of December 31, 2013, the principal balance of the subordinated secured credit facility was $13.7 million.
The Company’s obligations under the credit facilities are guaranteed by its material operating subsidiaries (other than the Company’s insurance companies) and are secured by a first lien security interest on all of the Company’s assets and the assets of its material operating subsidiaries (other than the Company’s insurance companies), including a pledge of 100% of the stock of AIC.
In August 2013, a new class of loans to be borrowed under the senior secured credit facility effective January 2007 was created allowing for an additional tranche of incremental term loan (ITL B). Under the ITL B, the Company borrowed $12.5 million which was contributed to our subsidiary, LIFCO, LLC to pay off an intercompany note due AIC.
Face amount of $8.0 million with a funded amount of $5.5 million, of which the Company contributed $4.6 million to Affirmative Insurance Company.
In March 2013, the Company, through one of its indirect, wholly-owned subsidiaries, entered into a $4.8 million loan secured by commercial real estate to provide liquidity to AIC. The loan is evidenced by a promissory note secured by a mortgage security agreement and assignment of leases and rents on real estate located in Baton Rouge, Louisiana, which is held as investment in real property on the consolidated balance sheet. The mortgage bears interest at a per annum fixed rate of 4.95%. The mortgage requires monthly payments of principal and interest with the final payment due on the maturity date of December 15, 2015. As security for payments, the Company assigned rents due under the lease to a trustee. Pursuant to an escrow and servicing agreement, the trustee will receive rent due under the lease, make required payments due under the mortgage and maintain certain escrow accounts to pay for the necessary expenses of the property until the mortgage is paid in full. The principal balance of the mortgage payable was $3.6 million at December 31, 2013.
On October 17, 2012, the Company received notice from one of the lessors (Lessor) under a capital lease obligation that, based upon Lessor’s claim of an alleged default under the terms of the applicable lease and security agreements, it elected to immediately seek recovery of an amount equal to the casualty loss value of the leased property, together with all other sums allegedly due to Lessor, which Lessor calculated as $9.6 million. Lessor informed the Company that it had directed the escrow agent to redeem the CDs securing the Company’s lease payment obligation and disburse to it the approximately $8.3 million in proceeds, which Lessor received on October 15, 2012. Lessor threatened legal action against the Company to recover the remaining $1.3 million, alleged liquidated damages. The Company contests that any event of default has occurred and also disputes Lessor’s demand for payment of the casualty loss value of the leased property. On December 26, 2012, Lessor conveyed all right and interest in the leased property back to the Company, although both parties reserved all claims with respect to the disputed demands for payment. Neither party has filed suit at this time.
The remaining lease term is 17 months with monthly rental payments totaling approximately $0.3 million. Cash and securities pledged as collateral and held as available-for-sale securities were $5.9 million and $9.1 million as of December 31, 2013 and 2012, respectively.
Property under capital lease consisted of the following as of December 31, 2013 and 2012 (in thousands):
At December 31, 2013, the Company’s 2007 and prior tax years were closed by the IRS.
Affirmative Insurance Company (AIC) was party to a General Agency Agreement with United Underwriters, Inc. (United), pursuant to which United produced business and managed claims on such business in the state of Utah. The General Agency Agreement terminated in 2006. In May 2005, two of AIC’s insureds were injured in an automobile accident for which they sought personal injury protection (PIP) and underinsured motorist (UIM) benefits from AIC. United disputed the insureds’ claims and a lawsuit was filed in the Third District Court of Salt Lake County, Utah. Pursuant to the General Agency Agreement, United is responsible for all costs to defend the lawsuit and owes certain indemnification obligations to AIC. After a bench trial in September 2013, the trial court issued its Findings of Fact, Conclusions of Law and Order on December 5, 2013 (Order), finding in favor of AIC’s insureds on their claims for PIP and UIM benefits. The trial court further found that AIC breached its duty of good faith and fair dealing and awarded certain pre-judgment interest and consequential damages of attorneys’ fees and costs. The trial court directed that the parties submit evidentiary materials and briefing materials on the amount of attorneys’ fees and costs to be awarded, with a hearing to be scheduled. AIC has notified United of its intention to pursue indemnification for losses in connection with this matter. However, the Company believes that its ultimate loss will be within the limits of the policy issued to its insureds, which has been recorded in the loss and LAE reserves.
Net income (loss) per common share is based on the weighted average number of shares outstanding. Diluted weighted average shares is calculated by adjusting basic weighted average shares outstanding by all potentially dilutive stock options and restricted stock. Stock options outstanding of 323,000, 2,407,000 and 1,748,000 for the years ended December 31, 2013, 2012 and 2011, respectively, were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price of the common stock or there was a loss from continuing operations in the respective periods.
The following table sets forth the reconciliation of numerators and denominators for the basic and diluted earnings per share computation for each of the years ended December 31, 2013, 2012 and 2011 (in thousands, except per share amounts):
On September 30, 2013, the Company entered into a $10.0 million subordinated secured credit facility with JCF AFFM Debt Holdings, L.P., as Administrative Agent and Collateral Agent. JCF AFFM Debt Holdings, L.P. is an affiliate of J.C. Flowers & Co. LLC and New Affirmative LLC, the Company’s 51.0% majority shareholder.
20. Disclosures for Items Reclassified Out of Accumulated Other Comprehensive Income (Loss)
State insurance laws restrict the ability of the Company’s insurance company subsidiaries to declare stockholder dividends. These subsidiaries may not issue an “extraordinary dividend” until 30 days after the applicable commissioner of insurance has received notice of the intended dividend and has not objected in such time or until the commissioner has approved the payment of the extraordinary dividend within the 30-day period. In most states, an extraordinary dividend is defined as any dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10.0% of the insurance company’s surplus as of the preceding year-end or the insurance company’s net income for the preceding year, in each case determined in accordance with statutory accounting practices. In addition, dividends may only be paid from unassigned earnings and an insurance company’s remaining surplus must be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. As of December 31, 2013, the Company’s insurance companies could not pay ordinary dividends to the Company without prior regulatory approval due to a negative unassigned surplus position of Affirmative Insurance Company. However, as mentioned previously, the Company’s non-insurance company subsidiaries provide adequate cash flow to fund their own operations.
The Company utilizes a hierarchy of valuation techniques for the disclosure of fair value estimates based on whether the significant inputs into the valuation are observable. In determining the level of hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions. The Company measures certain assets and liabilities at fair value on a recurring basis, including investment securities classified as available-for-sale, cash equivalents and other invested assets. Following is a brief description of the type of valuation information that qualifies as a financial asset or liability for each level:
Where possible, the Company utilizes quoted market prices to measure fair value. For assets and liabilities that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. When quoted market prices in active markets are unavailable, the Company determines fair values based on independent external valuation information obtained from independent pricing services, which utilize various models and valuation techniques based on a range of inputs including pricing models, quoted market prices of publicly traded securities with similar duration and yield, time value, yield curve, prepayment speeds, default rates and discounted cash flows. In most cases, these estimates are determined based on independent third-party valuation information, and the amounts are disclosed as Level 2 or Level 3 of the fair value hierarchy depending on the level of observable market inputs.
would determine a fair value using this observable market information and disclose the occurrence of this circumstance. All of the fair values of securities disclosed in Level 2 are estimated based on independent third-party pricing services.
At December 31, 2013, the Company’s Level 3 financial assets include an investment in a hedge fund, which is presented as other invested assets in the consolidated balance sheets. The Company elected the fair value option for its investment in the hedge fund and measures the fair value of the hedge fund on the basis of the net asset value of the fund as reported by the fund manager. The hedge fund is primarily invested in residential mortgage-backed securities and other asset-backed securities which are recorded at fair value as determined by the fund manager. Such fair value determination is based on quoted marked prices, bid prices, or the fund manager’s proprietary valuation models where quoted prices are unavailable or deemed to be inadequately representative of fair value. Significant decreases in the fair value of the underlying securities in the hedge fund would result in a significantly lower fair value measurement of other invested assets as reported in the consolidated balance sheets.
The following table presents the carrying value and estimated fair value of the Company’s financial assets and liabilities disclosed, but not carried, at fair value at December 31, 2012 and the level within the fair value hierarchy (in thousands):
The Company’s insurance subsidiaries are required to file statutory-basis financial statements with state insurance departments in all states where they are licensed. These statements are prepared in accordance with accounting practices prescribed or permitted by the applicable state of domicile. Each state of domicile requires
The amount of statutory capital and surplus necessary for AIC to satisfy regulatory requirements as of December 31, 2013 was $30.5 million. The statutory capital and surplus of each of the Company’s insurance subsidiaries exceeded the highest level of minimum regulatory required capital as of December 31, 2013, 2012 and 2011.
The condensed financial information of the parent company, Affirmative Insurance Holdings, Inc. as of December 31, 2013 and 2012, and for each of the three years ended December 31, 2013, 2012 and 2011 is presented as follows (in thousands, except share data):