Our executive offices are located at 14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323 in an 18,554 square foot office facility. Our original lease for this office space was scheduled to expire in May 2017. During March 2014, we extended our lease term to expire in August 2019 and expanded the leased premises to include an additional 13,642 square feet. During September 2015, we extended our lease term to expire in December 2022 and expanded the leased premises to include an additional 10,048 square feet. We also lease office space in Bonita Springs, Florida. Refer to note 8 set forth in Part II, Item 8 “Financial Statements and Supplemental Data” of this Form 10-K for further information about our leases.
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report on Form 10-K.
· Net income attributable to FNHC shareholders totaled $40.9 million in 2015, compared with $37.2 million in 2014 and $12.7 million in 2013.
· Total investments increased $53.5 million, to $384.3 million as of December 31, 2015, compared with $330.8 million as of December 31, 2014.
· Cash and cash equivalents increased $12.8 million, to $53.0 million as of December 31, 2015, compared with $40.2 million as of December 31, 2014.
· Combined ratio was 87.9% in 2015, compared with 83.9% in 2014 and 98.2% in 2013. The combined ratio is calculated by dividing net premiums earned by losses and LAE plus all other costs and expenses.
Other income increased $9.0 million, or 45.0%, to $29.0 million for the year ended December 31, 2015, compared with $20.0 million for the year ended December 31, 2014. The following table represents the other income detail as follows:
The increase in policy fees and brokerage revenue is directly related to the increase in gross written premiums and ceded premiums over the prior year. Additionally, the change in commission income is related to continued growth in our book of business.
Losses and LAE increased $23.3 million, or 28.8%, to $104.3 million during the year ended December 31, 2015, compared with $81.0 million during the year ended December 31, 2014. The increase to losses and LAE’s is directly related to an increase in net premiums earned and an increase in our loss ratio year over year. Our loss ratio for 2015 was 49.7% compared with 47.4% for the same period in 2014. The increase in the ratio is the result of an unfavorable development from assignment of benefits and the temporary discontinuation of the underwriting analytics. The underwriting analytics were not used for several months in the second and third quarter of 2015, due to our compliance with a cease and desist order from the Florida OIR requiring us to obtain approval of these analytics without prior approval from them. The temporary discontinuation of the underwriting analytics caused us to underwrite polices outside of our standard process.
Commissions and other underwriting expenses increased $13.2 million, or 25.4%, to $65.3 million for the year ended December 31, 2015, compared with $52.1 million for the year ended December 31, 2014. The increase is directly related to the significant increase in net premiums written and earned during the same period.
General and administrative expenses increased $4.7 million, or 46.3%, to $15.0 million for the year ended December 31, 2015, compared with $10.3 million for the year ended December 31, 2014. The change is due to an increase in salaries and benefits, including share-based compensation, legal and professional fees, including $0.9 million of start-up costs related to the organization of Monarch. Professional fees include audit, tax and actuarial fees. The increased costs are in support of the significant growth in our gross and net premiums written in 2015 as compared to 2014.
Income taxes increased $4.7 million, or 23.1%, to $24.8 million for the year ended December 31, 2015, compared with $20.1 million for the year ended December 31, 2014. The change was due to an increase in taxable income and an increase in our effective tax rate. Our effective tax rate was 38.0% for the year ended December 31, 2015, compared with 35.1% for the year ended December 31, 2014. The increase in the effective tax rate is the result of having less permanent items and true up adjustments in 2015 as compared to 2014.
Net premiums earned increased $66.5 million, or 63.7%, to $170.9 million during the year ended December 31, 2014, compared with $104.4 million during the year ended December 31, 2013. This increase was primarily due to an increase in our homeowners’ in-force policy count to 182,557 as of December 31, 2014, compared with 116,401 as of December 31, 2013. Additionally, the growth in the policy count is driven by management’s strategy to grow market share by providing exceptional service to our customers, partner agents and obtaining the Allstate relationship during 2013.
The increase in policy fees is directly related to the increase in gross written premiums over the prior year. Additionally, the change in commission increase is related to continued growth in our book of business as well as entering into a commission sharing agreement with our reinsurance intermediary.
Losses and LAE increased by $24.6 million or 43.6%, to $81.0 million for the year ended December 31, 2014, compared with $56.4 million for the year ended December 31, 2013. The increase reflects a significant increase in net premiums earned, offset by a decrease in the loss ratio to 47% during the year ended December 2014 from 54% during the year ended December 31, 2013, which was primarily driven by an increase in the amount of ceded premiums year over year.
Commissions and other underwriting expenses increased $13.5 million, or 35.0%, to $52.1 million for the year ended December 31, 2014, compared with $38.6 million for the year ended December 31, 2013. The increase is directly related to the significant increase in net premiums written and earned during the same period.
Income taxes increased $13.6 million, to $20.1 million for the year ended December 31, 2014, compared with $6.5 million for the year ended December 31, 2013. The change was due to an increase in taxable income and an increase in our effective tax rate. Our effective tax rate was 35.1% for the year ended December 31, 2014, compared with 33.8% for the year ended December 31, 2013.
Net cash provided by financing activities for the year ended December 31, 2015 was $23.6 million, compared to net cash provided by financing activities for the year ended December 31, 2014 of $43.5 million. This decrease was primarily due to $43.1 million related to issuance of common stock in public offering during the year ended December 31, 2014 offset by $18.7 million related to the noncontrolling interest equity investment and $5.0 million related to the issuance of debt in our consolidated VIE during the year ended December 31, 2015.
We believe that existing cash and investment balances, when combined with anticipated cash flows as noted above, will be adequate to meet our expected liquidity needs in both the short-term and the reasonably foreseeable future. Any future growth strategy may require external financing, and we may from time to time seek to obtain external financing. We cannot assure that additional sources of financing will be available to us on favorable terms, or at all, or that any such financing would not negatively impact our results of operations.
Insurance premiums are established before we know the amount of losses and LAE’s 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’s and thereby materially adversely affect future liability requirements.
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
The fair value is the price that would be received to sell an asset or paid to transfer a liability between market participants in the principal market or in the most advantageous market when no principal market exists. Adjustments to transaction prices or quoted market prices may be required in illiquid or disorderly markets in order to estimate fair value. Alternative valuation techniques may be appropriate under the circumstances to determine the value that would be received to sell an asset or paid to transfer a liability in an orderly transaction. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. Our nonperformance or credit risk is considered in determining the fair value of liabilities. Considerable judgment may be required in interpreting market data used to develop the estimates of fair value. Accordingly, estimates of fair value presented herein are not necessarily indicative of the amounts that could be realized in a current or future market exchange.
Our insurance companies use a variety of techniques that employ significant judgments and assumptions to establish the liabilities for unpaid loss and LAE recorded at the balance sheet date. These techniques include detailed statistical analyses of past claims reporting, settlement activity, claims frequency, internal loss experience, changes in pricing or coverages and severity data when sufficient information exists to lend statistical credibility to the analyses. More subjective techniques are used when statistical data is insufficient or unavailable. These liabilities also reflect implicit or explicit assumptions regarding the potential effects of future inflation, judicial decisions, changes in laws and recent trends in such factors, as well as a number of actuarial assumptions that vary across our reinsurance and insurance subsidiaries and across lines of business. This data is analyzed by line of business, coverage, accident year or underwriting year and reinsurance contract type, as appropriate.
Our insurance companies continually evaluate the potential for changes, both favorable and unfavorable, in their estimates of their loss and LAE liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid loss and LAE established in prior years, these liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect favorable or unfavorable development in loss experience and new information, including, for certain catastrophe events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid loss and LAE, both favorable and unfavorable, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior accident year reserve development. We adjusted our prior year loss and LAE reserve estimates during 2015, 2014 and 2013 based on current information that differed from previous assumptions made at the time such loss and LAE reserves were previously estimated.
We have audited the accompanying consolidated balance sheet of Federated National Holding Company and subsidiaries as of December 31, 2015 and the related consolidated statements of operations, comprehensive income, changes in shareholders' equity and cash flows for the year ended December 31, 2015. Our audit also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.
We have audited the accompanying consolidated balance sheets of Federated National Holding Company as of December 31, 2014 and 2013, 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, 2014. In connection with our audits of the financial statements, we have also audited the financial statement schedules listed in the accompanying index. We also have audited Federated National Holdings Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Federated National Holdings Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A Controls and Procedures. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the company’s internal control over financial reporting based on our audits.
March 16, 2015, except for Schedule II dated March 14, 2016
Our wholly owned insurance subsidiary is Federated National Insurance Company (“FNIC”), which is licensed as an admitted carrier in Florida. We also serve as managing general agent for Monarch National Insurance Company (“MNIC”), which was founded in 2015 through the joint venture, described below. An admitted carrier is an insurance company that has received a license from the state department of insurance giving the company the authority to write specific lines of insurance in that state. These companies are also bound by rate and form regulations, and are strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Admitted carriers are also required to financially contribute to the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.
The accompanying consolidated financial statements include the accounts of FNHC and all other entities in which we have a controlling financial interest and any variable interest entities (“VIE”) in which we are the primary beneficiary. All material inter-company accounts and transactions have been eliminated in consolidation.
A VIE is an entity that does not have sufficient equity to finance its own activities without additional financial support or where investors lack certain characteristics of a controlling financial interest. We assess our contractual, ownership or other interests in a VIE to determine if our interest participates in the variability the VIE was designed to absorb and pass onto variable interest holders. We perform an ongoing qualitative assessment of our variable interests in VIEs to determine whether we have a controlling financial interest and would therefore be considered the primary beneficiary of the VIE. If we determine we are the primary beneficiary of a VIE, we consolidate the assets and liabilities of the VIE in our consolidated financial statements.
The fair value is the price that would be received to sell an asset or paid to transfer a liability between market participants in the principal market or in the most advantageous market when no principal market exists. Adjustments to transaction prices or quoted market prices may be required in illiquid or disorderly markets in order to estimate fair value. Alternative valuation techniques may be appropriate under the circumstances to determine the value that would be received to sell an asset or pay to transfer a liability in an orderly transaction. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. Our nonperformance or credit risk is considered in determining the fair value of liabilities. Considerable judgment may be required in interpreting market data used to develop the estimates of fair value. Accordingly, estimates of fair value presented herein are not necessarily indicative of the amounts that could be realized in a current or future market exchange.
Deferred Acquisition Costs (“DAC”) represent those costs that are incremental and directly related to the successful acquisition of new or renewal of existing insurance contracts. The Company defers incremental costs that result directly from, and are essential to, the acquisition or renewal of an insurance contract. Such DAC generally include agent or broker commissions, premium taxes, medical and inspection fees that would not have been incurred if the insurance contract had not been acquired or renewed. Each cost is analyzed to assess whether it is fully deferrable.
The Company accounts for internal-use software development costs in accordance with accounting guidelines which state that software costs, including internal payroll costs, incurred in connection with the development or acquisition of software for internal use is charged to expense as incurred until the project enters the application development phase. Costs incurred in the application development phase are capitalized and are depreciated using the straight-line method over an estimated useful life of 5 years, beginning when the software is ready for use.
The Company accounts for share-based compensation based on the estimated grant date fair value. The Company grants awards with service only conditions and generally amortizes them on a straight-line over the requisite service period of the award, which is the vesting term. The fair value of the restricted stock grants is determined based on the closing market price on the date of grant. Non-employee directors are treated as employees for accounting purposes.
The adjustments to our accounting for the July 1, 2014 quota share reinsurance treaty, inclusive of other adjustments, are not material in any prior quarter or annual period based on an analysis of quantitative and qualitative factors in accordance with SEC Guidance.
As a result, we recorded these adjustments during the year ended December 31, 2015. The adjustments increased net income by $0.6 million for the year ended December 31, 2015.
Certain amounts in prior year’s consolidated financial statements have been reclassified to conform to the 2015 presentation. These reclassifications had no effect on the reported results of operations, financial condition, and cash flows. In the current period, the Company concluded it was appropriate to classify accounts on the consolidated balance sheets that do not have material balances in the periods being presented, such as contingent quota-share profit sharing, deferred quota-share profit sharing, and accounts payable and accrued expenses. These prior year accounts are included within other assets and other liabilities on the consolidated balance sheets. We have also reclassified certain revenue accounts that do not have material balances and included them within other income in the consolidated statements of operations. In addition, during the current period, we reclassify certain costs and expenses, principally, operating and underwriting expenses, salaries and wages and amortization of deferred policy acquisition costs. These respective account balances are now included in commissions and other underwriting expenses and general and administrative expenses in the consolidated statements of operations. The Company believes this reclassification provide greater clarity and insight into the consolidated financial statements for the periods presented.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in United States Generally Accepted Accounting Principles when it becomes effective. In July 2015, the FASB voted to delay the effective date of ASU 2014-09 by one year, making it effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted as of the original effective date. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures.
In May 2015, the FASB issued ASU 2015-09, Financial Services - Insurance (Topic 944): Disclosures about Short-Duration-Contracts. The amendments in this ASU apply to all insurance entities that issue short-duration contracts as defined in Topic 944, Financial Services-Insurance. The amendments require insurance entities to disclose for annual reporting periods information on the liability for unpaid claims and claim adjustment expenses. The amendments in this ASU are effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016. This new guidance affects disclosures only and will have no impact on the Company’s consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most notably, this new guidance requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. This new guidance is effective for annual reporting periods beginning after December 15, 2017. We are currently evaluating the impact the adoption of this standard would have on our consolidated financial statements.
Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities. An active market is defined as a market where transactions for the financial statement occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
The Company’s financial instruments measured at fair value and the level of the fair value hierarchy of inputs used were as follows:
The amortized cost and the fair value of debt and equity securities as of December 31, 2015 and 2014 are summarized as follows:
During the years ended December 31, 2015, 2014 and 2013, the proceeds from sales of investment securities were $157.2 million, $81.5 million and $100.1 million, respectively.
As of December 31, 2015, investments with fair values of $6.6 million, the majority of which were debt securities, were deposited with governmental authorities as required by law.
The Company reinsures (cedes) a portion of written premiums on an excess of loss or a quota-share basis to nonaffiliated insurance companies in order to limit our loss exposure. To the extent that reinsuring companies are unable to meet their obligations assumed under these reinsurance agreements, we remain primarily liable to our policyholders.
The Company’s reinsurance program, which generally runs from July 1 to June 30 of the following year, consists of excess of loss, Florida Hurricane Catastrophe Fund (“FHCF”) and quota share, which is a form of proportional reinsurance, treaties which insure the homeowners’ property lines from catastrophes in Florida and other states. The excess of loss and FHCF treaties, which became effective on July 1, 2015, insures for approximately $1.82 billion of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $1.26 billion, with the Company retaining the first $12.9 million in Florida and $5.0 million in Louisiana, Alabama and South Carolina for losses and LAE from each event. The FHCF treaty only affords coverage for losses sustained in Florida and represents only a portion of the reinsurance coverage in Florida.
The Company’s quota share treaties, which are included in the reinsurance program, runs from July 1 to June 30 of the following year. The quota share treaties consist of two different treaties, one for 30% which became effective July 1, 2014 and the other for 10% which became effective July 1, 2015. The combined treaties provide a 40% quota share reinsurance treaty on the first $100 million of covered losses for the homeowners’ insurance program in Florida.
The liability for loss and LAE reserves is determined on an individual-case basis for all incidents reported. The liability also includes amounts for unallocated expenses, anticipated future claim development and IBNR.
The Company is committed under various operating lease agreements for office space. Rental expense for the years ended December 31, 2015, 2014 and 2013 was $0.7 million, $0.5 million and $0.4 million, respectively. As of December 31, 2015, the future minimum lease payments under these agreements are as follows:
The following table provides certain information in connection with the Company’s share-based compensation arrangements as follows:
The unamortized share-based compensation expense is $6.9 million for the year ended December 31, 2015, which will be recognized over the remaining weighted average vesting period of approximately 3.21 years.
A summary of the Company’s stock option activity for the period from January 1, 2013 to December 31, 2015 is as follows:
The weighted average grant date fair value is measured at the closing price of FNHC common stock on the grant date, as reported on the NASDAQ Global Select Market.
The following is a summary of the related party transactions entered into by the Company for the years ended December 31, 2015, 2014 and 2013.
The Company entered into catastrophe excess of loss reinsurance agreements with TransRe. For the years ended December 31, 2015, 2014 and 2013, the Company ceded premiums related to these agreements totaling $4.1 million, $1.2 million and $0, respectively. There have not been any ceded losses relating to these agreements.
The Company’s Chairman of the Board of Directors is a partner at a law firm that handles certain litigation claims for FNHC. Fees paid to the law firm amounted to $26,151, $6,538 and $36,400 for the years ended December 31, 2015, 2014, and 2013, respectively.
As of December 31, 2015 and 2014, on a consolidated statutory basis, the capital and surplus of the Company’s insurance companies was $175.9 million and $125.3 million, respectively. For the years ended December 2015, 2014 and 2013, consolidated statutory net income of the Company’s insurance companies was $23.9 million, $29.3 million and $3.6 million, respectively. Statutory capital and surplus significantly exceeds amounts necessary to satisfy regulatory requirements.
On March 10, 2016, the Company’s Board of Directors granted 128,472 of restricted shares to the Company’s Directors, Executives and other employees. The restricted shares vest over three or five years.
In our opinion, Federated National Holding Company and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015 based on the COSO criteria.