In addition, we lease approximately 100,000 square feet of office space in approximately 20 locations throughout the United States. Most of our leases have lease terms of three to five years with provisions for renewals. We believe our properties are adequate for our business as presently conducted. Please refer to the footnotes, "Property and Equipment" and "Leases", in the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report for additional information.
The following table sets forth our consolidated selected financial data for the periods and as of the dates indicated and are derived from our audited consolidated financial statements. On June 20, 2007, affiliates of Summit Partners acquired a majority of our capital stock. All periods prior to June 20, 2007 are referred to as "Predecessor," and all periods including and after such date are referred to as "Successor." The consolidated financial statements for all Successor periods are not comparable to those of the Predecessor periods. The following consolidated financial data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") in Part II,
Management's Discussion and Analysis represents an overview of our results of operations and financial condition. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Part II, Item 8 of this Annual Report.
We are an insurance services company that provides distribution and administration services and insurance-related products to insurance companies, insurance brokers and agents and other financial services companies in the United States. We sell our services and products directly to businesses rather than directly to consumers.
We began nearly 30 years ago as a provider of credit insurance products and, through our transformational efforts, have evolved into a diversified insurance services company. We now leverage our proprietary technology infrastructure, internally developed best practices and access to specialty insurance markets to provide our clients with distribution and administration services and insurance-related products. Our services and products complement consumer credit offerings, provide outsourcing solutions designed to reduce the costs associated with the administration of insurance and other financial products and facilitate the distribution of excess and surplus lines insurance products through insurance companies, brokers and agents. These services and products are designed to increase revenues, improve customer value and loyalty and reduce costs for our clients.
We operate in three business segments: Payment Protection, BPO and Wholesale Brokerage.
Our Payment Protection segment, marketed under our Life of the South, Continental Car Club and United Motor Club brands, delivers credit insurance, debt protection, warranty and service contracts and car club solutions to consumer finance companies, regional banks, community banks, retailers, small loan companies, warranty administrators, automobile dealers, vacation ownership developers and credit unions. Our clients then offer these products to their customers in conjunction with consumer finance transactions. Our Payment Protection segment specializes principally in providing products that protect consumer lenders and their borrowers from death, disability or other events that could otherwise impair their borrowers' ability to repay a debt. We typically maintain long-term business relationships with our clients.
Our BPO segment, marketed under the Consecta brand, provides a broad range of administrative services tailored to insurance and other financial services companies. Our BPO business is our most technology-driven segment. Through our operating platform, which utilizes our proprietary technology, we provide sales and marketing support, premium billing and collections, policy administration, claims adjudication and call center management services on behalf of our clients.
We were incorporated in 1981 and initially provided credit life and disability insurance for financial institutions, primarily small community banks in Georgia, and their customers under our Life of the South brand. From 1994 to 2003, through a series of strategic acquisitions and organic growth, we expanded our payment protection client or producer base to include consumer finance companies, retailers, automobile dealers, credit card issuers, credit unions and regional and community banks throughout the United States. During this period, we expanded our product and service offerings to include credit property, debt cancellation and warranty products. In 2008, we changed our name from Life of the South Corporation to Fortegra Financial Corporation.
providing fulfillment of life and health insurance products. We previously operated our BPO business under the LOTSolutions brand. In 2007, we expanded our BPO segment to provide services to finance companies owned by industrial equipment manufacturers. We entered into the asset recovery business in December 2008 through our acquisition of CIRG, a third-party administrator serving commercial lending institutions for pre-collections, recovery, deficiency collections, dealer inventory seizures and management of asset portfolio run-off. Our asset recovery business is part of our BPO segment.
In 2010, we commenced marketing our BPO segment under the Consecta brand. Through our February 2010 acquisition of South Bay Acceptance Corporation, we expanded into premium finance to support our Wholesale Brokerage segment. In May 2010, we acquired Continental Car Club, which provides car club memberships through consumer finance companies, to enable our Payment Protection segment to expand into the roadside assistance market. In September 2010, we acquired United Motor Club, which also provides car club memberships through consumer finance companies.
In June 2007, entities affiliated with Summit Partners, a global growth equity investment firm, acquired 91.2% of our capital stock. The acquisition was financed through (i) $20.0 million of subordinated debentures maturing in 2013 issued to affiliates of Summit Partners, (ii) $35.0 million of preferred trust securities maturing in 2037 and (iii) an equity investment of $43.1 million by affiliates of Summit Partners. In connection with the acquisition, all of our $11.5 million of redeemable preferred stock outstanding prior to the acquisition remained outstanding and certain stockholders prior to the acquisition continued to hold such shares after the acquisition. In addition to acquiring our capital stock in the acquisition, the proceeds from the equity and debt financings were used to repay pre-transaction indebtedness of $10.1 million and pay transaction costs of $5.8 million. We refer to the foregoing transactions collectively as the "Summit Partners Transactions."
In April 2009, in connection with our acquisition of Bliss and Glennon, Inc., affiliates of Summit Partners acquired additional shares of our capital stock for $6.0 million. In connection with the IPO, Summit Partners sold 1,548,675 shares of stock. At December 31, 2010, affiliates of Summit Partners beneficially owned 61.4% of our common stock.
The preparation of our consolidated financial statements in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP") requires management to make estimates that affect the reported amounts of our assets, liabilities, revenues and expenses. Please see the footnote, "Summary of Significant Accounting Policies" in the Notes to the Consolidated Financial Statements, including the use of estimates, included in Item 8 of this Annual Report for additional information.
We periodically evaluate our estimates, which are based on historical experience and on various other assumptions that management believes to be reasonable under the circumstances. Critical accounting policies are those that are most important to the portrayal of our financial condition and results of operations and require management's most difficult, subjective or complex judgments, as a result of the need to make estimates about the effect of matters that are inherently uncertain. If actual performance should differ from historical experience or if the underlying assumptions were to change, our financial condition and results of operations may be materially impacted. In addition, some accounting policies require significant judgment to
We regularly monitor our investment portfolio to ensure investments that may be other-than-temporarily impaired are identified in a timely fashion, properly valued, and charged against earnings in the proper period. The determination that a security has incurred an other-than-temporary decline in value requires the judgment of management. The analysis takes into account relevant factors, both quantitative and qualitative in nature. Among the factors considered are the following: the length of time and the extent to which fair value has been less than cost; issuer-specific considerations, including an issuer's short-term prospects and financial condition, recent news that may have an adverse impact on its results, and an event of missed or late payment or default; the occurrence of a significant economic event that may affect the industry in which an issuer participates; and for loan-backed and structured securities, the undiscounted estimated future cash flows as compared to the current book value. When such impairments occur, the decrease in fair value is reported in net income as a realized investment loss and a new cost basis is established.
Reinsurance receivables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims, future policyholder benefits and policyholder contract deposits. The cost of reinsurance is accounted for over the terms of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves and are reported in our consolidated balance sheets.
We capitalize internally developed software costs on a project-by-project basis in accordance with Accounting Standards Codification ("ASC") 350-40, Intangibles - Goodwill and Other: Internal-Use Software. All costs to establish the technological feasibility of computer software development is expensed to operations when incurred. Internally developed software development costs are carried at the lower of unamortized cost or net realizable value and are amortized based on the current and estimated useful life of the software. Amortization over the estimated useful life of five years begins when the software is ready for its intended use.
Amortization of deferred acquisition costs for the years ended December 31, 2010, 2009 and 2008, totaled $57.3 million, $57.7 million and $60.6 million, respectively. We consider investment income in determining whether deferred acquisition costs are recoverable at year-end. No write-offs for unrecoverable deferred acquisition costs were recognized during the years ended December 31, 2010, 2009 and 2008.
We review our goodwill annually in the fourth quarter for impairment or more frequently if indicators of impairment exist. We regularly assess whether any indicators of impairment exist. Such indicators include, but are not limited to, a sustained significant decline in our market value or a significant decline in our expected future cash flows due to changes in company-specific factors or the broader business climate. The evaluation of such factors requires considerable judgment by management. Any adverse change in these factors could have a significant impact on the recoverability of goodwill and could have a material impact on our consolidated financial statements. Goodwill and other intangible assets represented $113.7 million, $93.6 million, and $57.7 million of our total assets as of December 31, 2010, 2009 and 2008, respectively.
The following table provides unpaid claims reserve information by Payment Protection product line: (in thousands)
Prior years' incurred claims increased $0.1 million during 2010 due to the unfavorable development in payment patterns for the credit property lines of business. Incurred claims decreased $0.6 million during 2009 due to the favorable development in payment patterns for the credit property lines of business in 2009. The $2.3 million decrease in 2008 primarily resulted from a single bank customer that assumed the exposure on their block of business during that period.
Premiums written are earned over the period that coverage is provided. Unearned premiums represent the portion of premiums that will be earned in the future and are generally calculated using the pro-rata method. A premium deficiency reserve is
recorded if anticipated losses, loss adjustment expenses and maintenance costs exceed the recorded unearned premium reserve and anticipated investment income. As of December 31, 2010, 2009 and 2008, no such reserve was recorded.
The calculation of tax liabilities is complex, and requires the use of estimates and judgments by management since it involves application of complex tax laws. We record our income taxes in accordance with the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recorded based on the difference between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as temporary differences, and are based on the enacted tax laws and statutory tax rates applicable to the periods in which we expect the temporary differences to reverse.
Under ASC Topic 740, a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. In determining whether our deferred tax asset is realizable, we considered all available evidence, including both positive and negative evidence. The realization of deferred tax assets depends upon the existence of sufficient taxable income of the same character during the carry-back or carry-forward period. We considered all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing temporary differences, future taxable income exclusive of reversing temporary differences and carry forwards, taxable income in carry-back years and tax-planning strategies.
We earn service and administrative fees for a variety of activities. This includes providing administrative services for other insurance companies, debt cancellation programs, collateral tracking, and asset recovery services.
We earn wholesale brokerage commission and fee income by providing wholesale brokerage services to retail insurance brokers and agents and insurance companies. Wholesale brokerage commission income is primarily recognized when the underlying insurance policies are issued. A portion of the wholesale brokerage commission income is derived from profit agreements with insurance carriers. These commissions are received from carriers based upon the underlying underwriting profitability of the business that we place with those carriers. Profit commission income is generally recognized as revenue on the receipt of cash based on the terms of the respective carrier contracts. In certain instances, profit commission income may be recognized in advance of cash receipt where the profit commission income due to be received has been calculated or has been confirmed by the insurance carrier. We had profit commissions of $1.4 million and $1.3 million for the years ended December 31, 2010 and 2009, respectively. See - "Revenues - Wholesale Brokerage Commissions and Fees" for a discussion
Ceding commissions earned under coinsurance agreements are based on contractual formulas that take into account, in part, underwriting performance and investment returns experienced by the assuming companies. As experience changes, adjustments to the ceding commissions are reflected in the period incurred.
See - "Revenues - Ceding Commissions" for additional information on our ceding commissions.
Direct and assumed earned premium consists of revenue generated from the direct sale of Payment Protection insurance policies by our distributors or premiums written for Payment Protection insurance policies by another carrier and assumed by us. Whether direct or assumed, the premium is earned over the life of the respective policy. Direct and assumed earned premium are offset by premiums ceded to our reinsurers, including producer owned reinsurance companies ("PORCs"). The amount ceded is proportional to the amount of risk assumed by the reinsurer.
The fair market value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. The fair market value generally increases or decreases in an inverse relationship with fluctuations in interest rates. We also have investments that carry prepayment risk, such as mortgage-backed and asset-backed securities. Actual net investment income and/or cash flows from investments that carry prepayment risk may differ from estimates at the time of investment as a result of interest rate fluctuations. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities, commercial mortgage obligations and bonds are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates. Therefore, we may be required to reinvest those funds in lower interest-bearing investments.
We currently have outstanding stock options under its Key Employee Stock Option Plan (1995), 2005 Equity Incentive Plan and The 2010 Omnibus Incentive Plan.
The Key Employee Stock Option Plan (1995), which was effective January 26, 1995, permits awards of incentive stock options and non-qualified stock options. We are permitted to issue up to 1,102,500 shares under this plan. Each option granted under
this plan has a maximum contractual term of 10 years. The 1995 plan (but not the outstanding options granted under the plan) terminated on January 25, 2005. As of December 31, 2010, there were 258,300 options outstanding under the 1995 plan.
The 2005 Equity Incentive Plan was established on October 18, 2005 and permits awards of (i) Incentive Stock Options, (ii) Non-qualified Stock Options, (iii) Stock Appreciation Rights, (iv) Restricted Stock and (v) Restricted Stock Units. We are permitted to issue up to 1,312,500 shares under this plan. Each option granted under this plan has a maximum contractual term of 10 years. As of December 31, 2010, there were 1,312,500 options outstanding under the 2005 plan.
The 2010 Omnibus Incentive Plan was established on December 13, 2010 and permits awards of (i) Incentive Stock Options, (ii) Non-qualified Stock Options, (iii) Stock Appreciation Rights, (iv) Restricted Stock, (v) Other Stock-Based Awards, and (vi) Performance-Based Compensation Awards. We are permitted to issue up to 4,000,000 shares under this plan. Each option granted under this plan has a maximum contractual term of 10 years. As of December 31, 2010, there were 88,268 options and 160,000 restricted shares outstanding under the 2010 plan.
We measure stock-based compensation related to options using the calculated value method. Under that method, we estimate the fair value of each option on the grant date using the Black-Scholes valuation model incorporating the assumptions noted in the following table. We used historical data to estimate expected employee behavior related to stock award exercises and forfeitures. Since there is not sufficient historical market experience for shares of the our stock, we have chosen to estimate its volatility, by using the average volatility of our peers. Expected dividends are based on the assumption that no dividends were expected to be distributed in the near future. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the options. Assumptions related to stock option awards:
A summary of options granted, exercised and canceled under these agreements for the years ended December 31, 2010 and 2009 are as follows:
Our policy is to issue new shares upon the exercise of stock options. Shares of our stock issued upon the exercise of stock options in 2010, 2009, and 2008, were 44,185, 15,750 and 551,250, respectively.
Stock-based compensation cost is measured at the grant date based on the fair value of the award, and is typically recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. Total stock-based compensation recognized on the consolidated statements of income was as follows:
Total unrecognized compensation cost related to non-vested share based compensation at December 31, 2010 was $0.4 million with a weighted-average recognition period of 1.4 years.
Service and Administrative Fees. We earn service and administrative fees from two of our business segments. Such fees are typically positively correlated with transaction volume and are recognized as revenue as they become both realized and earned. See "- Critical Accounting Policies - Service and Administrative Fees."
clients. Our clients own PORCs that assume the credit insurance premiums and associated risk that they originate in exchange for fees paid to us for ceding the premiums. In addition, our Payment Protection revenue includes administrative fees charged by us under retrospective commission arrangements with producers, where the commissions paid are adjusted based on actual losses incurred compared to premium earned after a specified net allowance retained by us. Under these arrangements, our insurance companies receive the insurance premiums and administer the policies that are distributed by our clients. The producer of the credit insurance policies receives a retrospective commission if the premium generated by that producer in the accounting period exceeds the costs associated with those polices, which includes our administrative fees, incurred claims, reserves and premium taxes. If the net result is negative, we either offset that negative amount against future retrospective commission payments, reduce the producer's up-front commission on a prospective basis to increase the likelihood that it will return to a positive position or request payment of the negative amount from the producer. Revenues in our Payment Protection business may fluctuate seasonally based on consumer spending trends, where consumer spending has historically been higher in April, September and December, corresponding to Easter, back-to-school and the holiday season. Accordingly, our Payment Protection revenues may reflect higher second, third and fourth quarters than in the first quarter.
BPO. Our BPO revenues consist exclusively of service and administrative fees for providing a broad set of administrative services tailored to insurance and other financial services companies including ongoing sales and marketing support, premium billing and collections, policy administration, claims adjudication and call center management services. Our BPO revenues are based on the volume of business that we manage on behalf of our clients. Our BPO segment typically charges fees on a per-unit of service basis as a percentage of our client's insurance premiums.
Gross commission rates for the products that we distribute in our Wholesale Brokerage segment, whether acting as a wholesale broker or as a Managing General Agent ("MGA"), generally range from 15% to 25% of the annual premium for the policy. Wholesale brokerage commissions and fees net of commissions paid to our retail insurance agent and broker clients are typically approximately 10%.
Net Earned Premium. Net earned premium consists of revenue generated from the direct sale of Payment Protection insurance policies by our distributors or premiums written for Payment Protection insurance policies by another carrier and assumed by us. Whether direct or assumed, the premium is earned over the term of the respective policy. Premiums earned are offset by earned premiums ceded to our reinsurers, including PORCs. The amount ceded is proportional to the amount of risk assumed by the reinsurer.
We also have investments that carry prepayment risk, such as mortgage-backed and asset-backed securities. Actual net investment income and/or cash flows from investments that carry prepayment risk may differ from estimates at the time of investment as a result of interest rate fluctuations. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities, commercial mortgage obligations and bonds are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates. Therefore, we may be required to reinvest those funds in lower interest-bearing investments.
We earn realized gains when invested assets are sold for an amount greater than the amortized cost in the case of fixed maturity securities and recognize realized losses when investment securities are written down as a result of an other-than-temporary impairment or sold for an amount less than their carrying cost.
Net losses and loss adjustment expenses include actual paid claims and the change in unpaid claim reserves, net of reinsurance. Our profitability depends in part on accurately predicting net loss and loss adjustment expenses. Incurred claims are impacted by loss frequency, which is the measure of the number of claims per unit of insured exposure, and loss severity, which is based on the average size of claims. Factors affecting loss frequency and loss severity include changes in claims reporting patterns, claims settlement patterns, judicial decisions, legislation, economic conditions, morbidity patterns and the attitudes of claimants towards settlements.
Unpaid claims are reserve estimates that are established in accordance with GAAP using generally accepted actuarial methods. Credit life, credit disability and AD&D unpaid claims reserves include claims in the course of settlement and IBNR. For all other product lines, unpaid claims reserves are bulk reserves and are entirely IBNR. We use a number of algorithms in establishing our unpaid claims reserves. These algorithms are used to calculate unpaid claims as a function of paid losses, earned premium, target loss ratios, in force amounts, unearned premium reserves, industry recognized morbidity tables or a combination of these factors. The factors used to develop the IBNR reserves vary by product line. However, in general terms, the primary factor used to develop IBNR reserves for credit life insurance is a function of the amount of life insurance in force. This factor can vary from $0.60 to $1.00 per $1,000 of in force coverage. The primary factor used to develop IBNR reserves for credit disability is a function of the pro-rata unearned premium reserve and is typically 5% of unearned premium reserve. Finally, IBNR reserves for AD&D policies is a function of in force coverage and is currently $0.11 per $1,000 of in force coverage.
Our unpaid claims reserves do not represent an exact calculation of exposure, but instead represent our best estimates, generally involving actuarial projections at a given time. The process used in determining our unpaid claims reserves cannot be exact since actual claim costs are dependent upon a number of complex factors such as changes in doctrines of legal liabilities and damage awards. These factors are not directly quantifiable, particularly on a prospective basis. We periodically review and update our methods of making such unpaid claims reserve estimates and establishing the related liabilities based on our actual experience. We have not made any changes to our methodologies for determining unpaid claims reserves in the periods presented.
In addition to our general personnel costs, some of the employees in our Wholesale Brokerage segment are paid a percentage of commissions and fees they generate. Accordingly, compensation for brokers in our Wholesale Brokerage segment is
predominantly variable. Bonuses for the remaining employees are discretionary and are based on an evaluation of their individual performance and the performance of their particular business segment, as well as our entire firm.
Other operating expenses consist primarily of rent, insurance, investigation fees, transaction expenses, professional fees, technology costs, travel and entertainment and advertising, and they are also a significant portion of our expenses. In addition, we have variable costs that are based on the volume of business we process.
Ceding commission earned under coinsurance agreements are based on contractual formulas that take into account, in part, underwriting performance and investment returns experienced by assuming companies. As experience changes, adjustments to the ceding commissions are reflected in the period incurred. Ceding commissions increased $4.7 million, or 19.5%, to $28.8 million for the year ended December 31, 2010 from $24.1 million for the year ended December 31, 2009. This increase was due to additional service and administrative fees of $2.3 million from increased insurance production in 2010. Underwriting profits increased $1.2 million due to positive underwriting performance. In addition, net investment income from assets held in trust by our reinsurers increased $1.1 million during the period. Pursuant to the existing treaties our reinsurer holds assets in trust related to our credit insurance program. If the reinsurers divest these assets our proportional share of the gains or losses flows through the ceding commission. For the year ended December 31, 2010, ceding commissions included $19.6 million in service and administrative fees, $6.0 million in underwriting profits from positive underwriting performance and $3.1 million in net investment income.
Ceding commissions decreased $2.1 million, or 8.2%, to $24.1 million for the year ended December 31, 2009 from $26.2 million for the year ended December 31, 2008. This decrease primarily resulted from lower credit insurance premium production in 2009. In 2008, we assumed two blocks of credit insurance business that increased credit insurance premiums during that period. No such transaction was completed in 2009. For the year ended December 31, 2009, ceding commissions included $17.3 million in service and administrative fees, $4.8 million in underwriting profits from positive underwriting performance and $2.0 million in net investment income.
We earn net investment income from interest payments and dividends received from our investment portfolio, and interest earned on our cash accounts and notes receivable, less portfolio management expenses. Our investment portfolio is primarily invested in fixed maturity securities which tend to produce consistent levels of investment income. Investment income can be significantly impacted by changes in interest rates. Interest rate volatility can increase or reduce unrealized gains or unrealized losses in our investment portfolio. The fair market value generally increases or decreases in an inverse relationship with fluctuations in interest rates. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Fluctuations in interest rates affect our returns on, and the market value of, fixed maturity and short-term investments.
We also have investments that carry prepayment risk, such as mortgage-backed and asset-backed securities. Actual net investment income and/or cash flows from investments that carry prepayment risk may differ from estimates at the time of investment as a result of interest rate fluctuations. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities, commercial mortgage obligations and bonds are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates. Therefore, we may be required to reinvest those funds in lower interest-bearing investments. Conversely, in times of rising interest rates, prepayments slow as borrowers tend to be less likely to refinance borrowings at higher interest rates, which tends to increase the duration of our investment holdings. With the increase in investment duration, we will have less cash flows from prepayments to invest at higher prevailing market rates.
Net investment income decreased $0.8 million, or 14.4%, to $4.8 million for the year ended December 31, 2009 from $5.6 million for the year ended December 31, 2008. The decrease resulted from lower prevailing interest rates on our cash and cash equivalents, which decreased our overall yield by 93 basis points to 3.19% for the year ended December 31, 2009 from 4.12% for the year ended December 31, 2008.
We realize gains when invested assets are sold for an amount greater than the amortized cost in the case of fixed maturity securities and recognize realized losses for invested assets sold for an amount less than their carrying cost or when investment securities are written down as a result of an other-than-temporary impairment, ("OTTI"). Net realized gains were $0.7 million for the year ended December 31, 2010 compared with $0.1 million for the year ended December 31, 2009. The primary increase in net realized gains for 2010 was due to a lower level of realized losses on the sale of fixed maturity securities.
Direct and assumed earned premiums consist of revenue generated from the direct sale of Payment Protection insurance policies by our distributors or premiums written for Payment Protection insurance policies by another carrier and assumed by us. Net earned premium increased $3.7 million, or 3.4%, to $111.8 million for the year ended December 31, 2010 from $108.1 million for the year ended December 31, 2009. Direct and assumed earned premium increased $7.7 million resulting from growth in net written premium due to new customers distributing our credit insurance and warranty products. Because of this increase, ceded earned premiums increased $4.0 million or 2.1%. On average, we maintained a 64% overall cession rate of direct and assumed earned premium for the years ended December 31, 2010 and 2009.
Other income increased $0.8 million to $1.0 million for the year ended December 31, 2009 from $0.2 million for the year ended December 31, 2008. The main increase in other income for 2009 was due to a non-recurring reserve reduction of $0.5 million associated with the Bliss & Glennon acquisition in April 2009.
Net losses and loss adjustment expenses include actual claims paid and the change in unpaid claim reserves and consist of direct and assumed losses less ceded losses. Net losses and loss adjustment expense increased $3.5 million, or 10.7% to $36.0 million for the year ended December 31, 2010 from $32.6 million for the year ended December 31, 2009. For the year ended December 31, 2010, our direct and assumed losses decreased by $1.0 million, or 1.2%, as compared with the year ended December 31, 2009, due to slightly more favorable loss development. However, for the year ended December 31, 2010, our ceded losses, which serve to decrease our net losses, were lower by $4.4 million, or 9.3%, as compared with the year ended December 31, 2009, thereby increasing our net losses and loss adjustment expenses by the corresponding amount. On average, we maintained a 55% overall cession rate of direct and assumed losses and loss adjustment expenses for the year ended December 31, 2010 and 59% for the year ended December 31, 2009.
Net losses and loss adjustment expense increased $2.7 million, or 9.1%, to $32.6 million for the year ended December 31, 2009 from $29.9 million for the year ended December 31, 2008. Direct and assumed losses and loss adjustment expenses increased $4.3 million, or 5.7%, resulting primarily from the unfavorable loss development in the involuntary unemployment insurance programs ($5.7 million). Ceded losses and loss adjustment expenses increased $1.5 million, or 3.5%. On average, we maintained a 59% overall cession rate of direct and assumed losses and loss adjustment expenses in 2009 as compared with a 61% rate in 2008.
Commissions include the commissions paid to distributors selling credit insurance policies. Commission rates, in many instances, are set by state regulators and are also impacted by market conditions and in certain instances, commissions are subject to retrospective adjustment based on the profitability of the related policies. Commissions increased $0.6 million, or 0.8%, to $71.0 million for the year ended December 31, 2010 from $70.4 million for the year ended December 31, 2009. The increase in commission expense resulted from a $0.5 million increase in commissions paid for the increase in production of credit insurance policy premiums. Retrospective commission expense decreased $0.7 million due to unfavorable underwriting results. This decrease was offset in part by a $0.8 million increase in deferred policy acquisition cost amortization.
Commissions decreased $10.8 million, or 13.3%, to $70.4 million for the year ended December 31, 2009 from $81.2 million for the year ended December 31, 2008. The decrease resulted from a $8.1 million decrease in our commission expense that resulted from a decline in net written credit insurance premium and unfavorable underwriting results that decreased our retrospective commission expense by $7.4 million to $9.8 million in 2009 from $17.2 million in 2008. These decreases were offset in part by a $4.7 million increase in deferred policy acquisition cost amortization.
Other operating expenses consist primarily of rent, insurance, investigation fees, transaction expenses, professional fees, technology costs, travel and entertainment and advertising, and may include variable costs based on the volume of business we process. Other operating expenses increased $0.6 million, or 2.6%, to $22.9 million for the year ended December 31, 2010 from $22.3 million for the year ended December 31, 2009. In 2010, the acquisition of South Bay Acceptance Corporation added $0.2 million to other operating expenses while the Continental Car Club and United Motor Club acquisitions added $0.6 million. A full year of Bliss & Glennon expenses accounted for $1.9 million of the 2010 increase. The increase for 2010 was offset principally by a $1.2 million reduction in the BPO segment for processing, policy fulfillment and reduced call center expenses and a $1.1 million decline in corporate expenses.
Depreciation and amortization increased $0.9 million, or 33.4%, to $3.5 million for the year ended December 31, 2009, from $2.6 million for the year ended December 31, 2008. This increase resulted primarily from the amortization of other intangible assets of $1.0 million related to the acquisition of Bliss & Glennon.
Interest expense increased $0.5 million, or 7.5%, to $7.8 million for the year ended December 31, 2009, from $7.3 million for the year ended December 31, 2008. This increase was driven by $11.5 million of increased indebtedness incurred in connection with our acquisition of Bliss & Glennon, which was offset in part by lower interest rates on our indebtedness.
We conduct our business through three business segments: (i) Payment Protection; (ii) BPO; and (iii) Wholesale Brokerage. The revenue for each segment is presented to reflect the operating characteristics of the segment. We do not allocate certain revenues and costs to our segments. These items primarily consist of corporate-related income, transaction related costs, executive stock compensation and other overhead expenses, which are reflected as “Corporate” in the following table. We measure the profitability of our business segments without allocation of Corporate income and expenses and without taking into account amortization, depreciation, interest expense and income taxes. We refer to these performance measures as segment EBITDA (earnings before interest, taxes, depreciation and amortization) and segment EBITDA margin (segment EBITDA divided by segment net revenues). Our measures of segment EBITDA and segment EBITDA margin, meet the definition of Non-GAAP financial measures. These measures are not in accordance with, or an alternative to, the GAAP information provided in this annual report. We believe that these presentations provide useful information to management, analysts and investors regarding financial and business trends relating to our results of operations and financial condition. Our industry peers provide similar supplemental non-GAAP information, although they may not use the same or comparable terminology and may not make identical adjustments. The non-GAAP information we provide should be used in addition to, but not as a substitute for, the GAAP information provided. The variability of our segment EBITDA and segment EBITDA margin is significantly affected by our segment net revenues because a large portion of our operating expenses are fixed. For additional information regarding segment net revenues and operating expenses, please see the footnote, "Segment Results" in the Notes to the Consolidated Financial Statements included in this Annual Report.
EBITDA and Adjusted EBITDA are not recognized terms under accounting principles generally accepted in the United States, or GAAP. Accordingly, they should not be used as an indicator of, or alternative to, net income as a measure of operating performance. Although we use EBITDA and Adjusted EBITDA as measures to assess the operating performance of our business, EBITDA and Adjusted EBITDA have significant limitations as analytical tools because they exclude certain material costs. For example, they do not include interest expense, which has been a necessary element of our costs. Since we use capital assets, depreciation expense is a necessary element of our costs and ability to generate service revenues. In addition, the omission of the substantial amortization expense associated with our intangible assets further limits the usefulness of this measure. EBITDA and Adjusted EBITDA also do not include the payment of taxes, which is also a necessary element of our operations. Because EBITDA and Adjusted EBITDA do not account for these expenses, its utility as a measure of our operating performance has material limitations. Due to these limitations, management does not view EBITDA and Adjusted EBITDA in isolation or as a primary performance measure and also uses other measures, such as net income. Because the definitions of EBITDA and Adjusted EBITDA (or similar measures) may vary among companies and industries, they may not be comparable to other similarly titled measures used by other companies.
Revenues increased $0.7 million, or 1.7% to $42.8 million for the year ended December 31, 2009 from $42.1 million for the year ended December 31, 2008. The increase was due to increased net underwriting revenue of $3.4 million and a positive change in realized gains of $2.0 million, offset by lower service and administrative fees of $2.0 million, ceding commissions of $2.1 million and investment income of $0.8 million. The improvement in net underwriting revenue was primarily due to reduced commissions resulting from a change in product mix sold by our clients. The increase in realized gains resulted from one time write-downs in 2008 of a $1.2 million bond investment and 15 equity securities of $0.7 million that were classified as other than-temporarily impaired securities. There were no such write-downs in 2009. The service and administrative fee decline was due, in part, to lower credit insurance premium production in 2009. In 2008, we assumed two blocks of credit insurance business that increased credit insurance premium during that period. No such transaction was completed in 2009. The investment income decline was due to lower yields on our investment portfolio.
Operating expenses decreased $0.9 million, or 3.5%, to $23.8 million for the year ended December 31, 2009 from $24.7 million for the year ended December 31, 2008. The decrease primarily resulted from a $2.8 million reduction in personnel costs and other operating expenses due to cost cutting initiatives and a $0.3 million tax savings related to the re-domestication to Delaware of one of our P&C insurance companies. The savings was offset by an increase in the amortization of deferred acquisition costs of $1.6 million which was caused by an increase in marketing and sales expenses in prior periods.
EBITDA increased $8.3 million, or 43.5%, to $27.3 million for the year ended December 31, 2010 from $19.0 million for the year ended December 31, 2009. As a result, EBITDA margin for our Payment Protection segment was 53.6% for the year ended December 31, 2010 compared with 44.4% for the year ended December 31, 2009.
EBITDA increased $1.6 million, or 9.0%, to $19.0 million for the year ended December 31, 2009 from $17.4 million for the year ended December 31, 2008.
Revenues increased $9.6 million, or 69.2%, to $23.5 million for the year ended December 31, 2009 from $13.9 million for the year ended December 31, 2008. The increase was due to incremental growth in our administrative services for insurance companies of $6.3 million and administrative fees for asset recovery services of $3.3 million.
EBITDA increased $3.0 million, or 44.3%, to $9.8 million for the year ended December 31, 2009 from $6.8 million for the year ended December 31, 2008.
We acquired our Wholesale Brokerage segment in April 2009, and therefore, 2010 to 2009 comparisons are not meaningful.
Operating expenses for the year ended December 31, 2010 were $19.9 million. The majority of our expenses in this segment were personnel costs, which totaled $15.4 million, or 77.4%, of total operating expenses. For the year ended December 31, 2009. The majority of our operating expenses in our Wholesale Brokerage segment were personnel costs, which totaled $10.3 million or 80% of total operating expenses.
Our primary cash requirements include the payment of our operating expenses, interest and principal payments on our debt, and capital expenditures. We also have used cash for acquisitions and to make dividend payments and tax-related distributions to our equity holders. We may also incur unexpected costs and operating expenses related to any unforeseen disruptions to our facilities and equipment, the loss of key personnel or changes in the credit markets and interest rates, which could increase our
Our primary sources of liquidity are our invested assets, our cash and cash equivalent balances and availability under our revolving credit facilities. At December 31, 2010, we had invested assets of $88.9 million, cash and cash equivalents of $43.4 million and $18.3 million of availability under our revolving credit facility. Our total indebtedness and redeemable preferred stock was $82.8 million at December 31, 2010. At December 31, 2009, we had total invested assets of $84.4 million, cash and cash equivalents of $29.9 million and $18.5 million of availability under our two revolving credit facilities. Our total indebtedness and redeemable preferred stock was $78.0 million at December 31, 2009. We believe that our cash flow from operations and our availability under our credit facilities combined with our low capital expenditure requirements will provide us with sufficient capital to continue to grow our business, but we will use a portion of our cash flow to pay interest on our outstanding debt, limiting the amount available for working capital, capital expenditures and other general corporate purposes. As we continue to expand our business and make acquisitions, we may in the future require additional working capital to meet our future business needs.
We are a holding company and have limited direct operations. Our holding company assets consist primarily of the capital stock of our subsidiaries. Accordingly, our future cash flows depend upon the availability of dividends and other payments from our subsidiaries, including statutorily permissible payments from our insurance company subsidiaries, as well as payments under our tax allocation agreement and management agreements with our subsidiaries. The ability of our insurance company subsidiaries to pay such dividends and to make such other payments will be limited by applicable laws and regulations of the states in which our subsidiaries are domiciled, which vary from state to state and by type of insurance provided by the applicable subsidiary. These laws and regulations require, among other things, our insurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay to the holding company. Along with solvency regulations, the primary factor in determining the amount of capital available for potential dividends is the level of capital needed to maintain desired financial strength ratings from A.M. Best for our insurance company subsidiaries. Given recent economic events that have affected the insurance industry, both regulators and rating agencies could become more conservative in their methodology and criteria, including increasing capital requirements for our insurance subsidiaries which, in turn, could negatively affect our capital resources. The following table sets forth the dividends paid to us by our insurance company subsidiaries for the years ended December 31, 2010, 2009 and 2008:
In the case of base rate loans, borrowings under the revolving credit facility bear interest at the highest of (i) the per annum rate announced by the administrative agent as its prime lending rate, (ii) the federal funds rate plus 0.50% per annum and (iii) the adjusted LIBO rate (as defined below) for a period of one month plus 1.00% per annum, in each case, plus the applicable margin. The applicable margin for base rate loans is 3.00% per annum when our total leverage ratio (as defined in the revolving credit agreement) is greater than or equal to 2.50 to 1.00 ("leverage level 1"), 2.75% per annum when our total leverage ratio is less than 2.50 to 1.00 but greater than or equal to 2.00 to 1.00 ("leverage level 2"), 2.50% per annum when our total leverage ratio is less than 2.00 to 1.00 but greater than or equal to 1.50 to 1.00 ("leverage level 3") and 2.25% per annum when our total leverage ratio is less than 1.50 to 1.00 ("leverage level 4").
In the case of Eurodollar loans, borrowings under the revolving credit facility bear interest at a rate (the "adjusted LIBO rate") determined by dividing (i) LIBOR for such period by (ii) a percentage equal to 1.00 minus the Eurodollar reserve percentage, plus 4.00% per annum in the case of leverage level 1, 3.75% per annum in the case of leverage level 2, 3.50% per annum in the case of leverage level 3 and 3.25% per annum in the case of leverage level 4. If we default on the payment of any amounts due under our revolving credit facility, or another event of default has occurred and is continuing, we will be obligated to pay default interest on all outstanding obligations. The default interest rate will equal the interest rate then in effect with respect to the applicable loan or, in the case of obligations other than loans, base rate loans plus 2.00% per annum.
In addition, we are required to pay a commitment fee at a rate equal to 0.60% per annum in the case of leverage level 1, 0.55% per annum in the case of leverage level 2, 0.50% per annum in the case of leverage level 3 and 0.45% per annum in the case of leverage level 4 on the unused commitments available to be drawn under the facility.
We are generally required to prepay borrowings under the revolving credit facility with (i) 100% of net cash proceeds from certain asset sales or insurance proceeds as a result of casualty or condemnation and (ii) 50% of the net cash proceeds from issuances of debt or equity securities (other than proceeds of certain issuances permitted under the revolving credit agreement, including proceeds from the issuance of equity securities that are applied to repayment of the subordinated debentures and redeemable preferred stock described below). Notwithstanding the foregoing, we are not required to make mandatory prepayments with proceeds from issuances of debt or equity securities if our total leverage ratio, on a pro forma basis after giving effect to the use of proceeds from such issuance, is less than or equal to 2.50 to 1.00.
The revolving credit facility requires us and LOTS Intermediate Co. to maintain certain financial ratios, including a total leverage ratio (based upon the ratio of consolidated total debt to consolidated adjusted EBITDA, in each case of us, LOTS Intermediate Co. and our restricted subsidiaries (as defined in the revolving credit agreement)), a senior leverage ratio (based upon the ratio of consolidated senior debt to consolidated adjusted EBITDA, in each case of us, LOTS Intermediate Co. and our restricted subsidiaries), a fixed charge coverage ratio (based upon consolidated adjusted EBITDA less the actual amount paid in cash on account of capital expenditures, less cash taxes, to consolidated fixed charges, in each case of us, LOTS
Our obligations under the revolving credit facility may be accelerated or the commitments terminated upon the occurrence of an event of default under the revolving credit facility, including payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, cross defaults to other material indebtedness, defaults arising in connection with changes in control and other customary events of default.
On June 10, 2010, our subsidiary South Bay Acceptance Corporation entered into a loan and security agreement with Wells Fargo Capital Finance, LLC, for a $40.0 million revolving credit facility. The loan and security facility was guaranteed by us, but only to the extent of losses incurred by Wells Fargo as a result of fraudulent activity by South Bay Acceptance Corporation or any of its affiliates, and was secured by substantially all of South Bay Acceptance Corporation's tangible and intangible assets, subject to exceptions. The loan and security facility bore interest, with respect to LIBOR rate loans, at a rate determined by reference to the LIBOR rate plus 3.0% and, with respect to base rate loans, at a rate equal to, the greatest of (i) the federal funds rate plus 0.50%, and (ii) the rate of interest announced by Wells Fargo as its prime rate plus 3.0%. The default interest rate applicable to the obligations outstanding under the facility will equal the interest rate applicable to the relevant obligation plus 2.0% per annum. Under the loan and security agreement, South Bay Acceptance Corporation was generally prohibited from making dividend payments or other distributions. However, South Bay Acceptance Corporation was permitted to make quarterly distributions on its stock if (i) both prior to and after such payment no default or event of default has occurred or is continuing or would result from such payment and (ii) it has provided the lender under such facility its financial statements for the most recently completed quarter and certified to the lender that condition (i) above is satisfied.
The Wells Fargo Capital Finance, LLC credit facility was not drawn during 2010. Subsequent to year end 2010, the line was terminated.
The indenture governing the preferred trust securities contains various affirmative and negative covenants, including limitations on the sale of capital stock of our significant subsidiaries, mergers and consolidations and the ability to grant a lien on the
In connection with the Summit Partners Transactions, LOTS Intermediate Co. also issued $20.0 million of subordinated debentures to affiliates of Summit Partners, maturing December 2013 with an interest rate of 14% per annum on the principal amount of such subordinated debentures. In December 2010, we utilized a portion of the proceeds from the IPO to repay the entire $20.0 million of subordinated debentures for $20.6 million, which included accrued but unpaid interest to the redemption date.
At December 31, 2010 and 2009, we had $11.0 million and $11.5 million outstanding of each of our Series A, B and C redeemable preferred stock, respectively. Our Series A and C redeemable preferred stock each accrue cumulative cash dividends at a rate of 8.25% per annum of the liquidation preference of $1,000 per share of such series of redeemable preferred stock. Our Series B redeemable preferred stock accrues cash dividends at a rate per annum of 4.0% plus 90 day LIBOR times the liquidation preference of $1,000 per share of Series B redeemable preferred stock. As of December 31, 2010 and 2009, the dividend rate on our Series B redeemable preferred stock was 4.29% and 4.29%, respectively, of the liquidation preference. We pay dividends on our Series A, B and C stock quarterly in arrears. Any outstanding Series A and B redeemable preferred stock must be redeemed in full on December 31, 2034 and any outstanding Series C redeemable preferred stock must be redeemed in full on December 31, 2035.
The following table summarizes our invested assets at fair value by asset category:
The following table summarizes our allocation of fixed maturities by maturity date:
As of December 31, 2010, there were 21 fixed maturity and 13 equity securities in unrealized loss positions. We do not intend to sell these investments and it is more likely than not that we will be able to hold these securities until full recovery of their amortized cost basis for fixed maturity securities or cost for equity securities. During 2010, based on our quarterly review, 8 equity securities were deemed to be other-than-temporarily impaired and an impairment charge of $0.1 million was recorded.
As of December 31, 2009, there were 13 fixed maturity and 21 equity securities in unrealized loss positions. We did not record any OTTIs during 2009. In 2008, we determined the decline in fair value of 1 fixed maturity security and 15 equity securities to be OTTI. This resulted in an impairment write-down of $1.2 million on the fixed maturity security and $0.8 million on the equity securities.
On January 1, 2008, we adopted accounting guidance for reporting fair values in accordance with ASC 820-10 - Fair Value Measurements. There were no adjustments required to the fair value of investments as a result of adopting the new guidance. The market approach was the valuation technique used to measure fair value of the investment portfolio. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets.
The financial instruments guidance, ASC Topic 825-The Fair Value Option for Financial Assets and Financial Liabilities, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The guidance requires disclosure of fair value information about financial instruments for which it is practicable to estimate such fair value along with the significant assumptions used to estimate the fair value.
The following table presents our investment securities within the fair value hierarchy, and the related inputs used to measure those securities at December 31, 2010 and 2009:
We monitor cash flows at the consolidated, holding company and subsidiary levels. Cash flow forecasts at the consolidated and subsidiary levels are provided on a monthly basis using trend and variance analysis to project future cash needs, with adjustments made as needed. The table below shows our cash flows for the periods presented:
Net cash used in investing activities was $29.8 million for the year ended December 31, 2010 and $26.5 million for the year ended December 31, 2009. For the year ended December 31, 2010, net cash used in investing activities primarily reflected cash used for purchases of fixed maturity securities, the acquisitions of South Bay Acceptance Corporation, Continental Car Club and United Motor Club and purchases of property, equipment and other non-operating assets and change in restricted cash. For the year ended December 31, 2009, net cash used in investing activities primarily reflected the use of cash for acquisitions and change in restricted cash offset in part by cash from the sale or maturity of investments. For the year ended December 31, 2008, net cash used in investing activities totaled $26.1 million and primarily reflected the increased purchases of investment securities that was only partially offset by the receipt of proceeds from the maturity of investment securities and change in restricted cash.
We have obligations and commitments to third parties as a result of our operations. These obligations and commitments, as of December 31, 2010, are detailed in the table below by maturity date as of the dates indicated (in thousands):
(2) Estimated. See "-Unpaid Claims." Net unpaid claims are: total $12,441; less than 1 year $11,414; 1-3 years $955; 3-5 years $66; and more than 5 years $6.
On December 31, 2009, we adopted the new guidance on U.S. GAAP, which is within ASC Topic 105, GAAP. The new guidance establishes a single source of authoritative accounting and reporting guidance recognized by the FASB for nongovernmental entities (the "Codification"). The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered non-authoritative. The adoption of the new guidance did not have an impact on our financial position, results of operations or cash flows. References to accounting guidance contained in the our consolidated financial statements and disclosures have been updated to reflect terminology consistent with the Codification. Plain English references to the accounting guidance have been made along with references to the number and name.
In January 2010, the FASB issued revised guidance intended to improve disclosures related to fair value measurements. This guidance requires new disclosures and clarifies certain existing disclosure requirements. New disclosures under this guidance require separate information about significant transfers into and out of Level 1 and Level 2 and the reasons for such transfers, and also require purchases, sales, issuances, and settlements information for Level 3 measurements to be included in the rollforward of activity on a gross basis. The guidance also clarifies the requirement to determine the level of disaggregation for fair value measurement disclosures and the requirement to disclose valuation techniques and inputs used for both recurring and nonrecurring fair value measurements in either Level 2 or Level 3. This accounting guidance became effective for us beginning in the second quarter of fiscal 2010, except for the rollforward of activity on a gross basis for Level 3 fair value measurements, which will be effective for us in the first quarter of fiscal 2012. The adoption of this accounting guidance is reflected in the Footnote, "Fair Value of Financial Instruments" and did not have a material impact on our financial statement disclosures.
On December 31, 2009, we adopted the new guidance on measuring the fair value of liabilities. When the quoted price in an active market for an identical liability is not available, this new guidance requires that either the quoted price of the identical or similar liability when traded as an asset or another valuation technique that is consistent with the fair value measurements and disclosures guidance be used to fair value the liability. The adoption of this new guidance did not have an impact on our financial position, results of operations or cash flows.
In December 2009, the FASB issued revised guidance for the accounting of variable interest entities. The revised guidance replaces the quantitative-based risks and rewards approach with a qualitative approach that focuses on which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance. The accounting guidance also requires an entity to perform an ongoing analysis to determine whether the entity’s variable interest or interests give it a controlling financial interest in a variable interest entity. This accounting guidance is effective for us beginning in fiscal 2011 and is not expected to have a material impact on our consolidated financial statements.
In September 2009, the FASB issued new guidance on multiple deliverable revenue arrangements. This new guidance requires entities to use their best estimate of the selling price of a deliverable within a multiple deliverable revenue arrangement if the entity and other entities do not sell the deliverable separate from the other deliverables within the arrangement. This new guidance requires both qualitative and quantitative disclosures. This new guidance will be effective for new or materially modified arrangements in fiscal years beginning on or after June 15, 2010. Earlier application is permitted as of the beginning of a fiscal year. Assuming we do not apply the guidance early, we are required to adopt this new guidance on January 1, 2011. We are currently evaluating the requirements of this new guidance and the potential impact, if any, on our financial position, results of operations or cash flows.
In January 2009, we adopted the revised business combinations guidance, which is within ASC Topic 805, Business Combinations. The revised guidance retains the fundamental requirements of the previous guidance in that the acquisition method of accounting is used for all business combinations, that an acquirer be identified for each business combination and for goodwill to be recognized and measured as a residual. The revised guidance expands the definition of transactions and events that qualify as business combinations to all transactions and other events in which one entity obtains control over one or more other businesses. The revised guidance broadens the fair value measurement and recognition of assets acquired, liabilities assumed and interests transferred as a result of business combinations. It also increases the disclosure requirements for business combinations in the consolidated financial statements. The adoption of the revised guidance did not have an impact on our financial position, results of operations or cash flows. However, for any business combination in 2010 or beyond, our financial position, results of operations or cash flows could incur a significantly different impact than had it recorded the acquisition under the previous business combinations guidance. Earnings volatility could result depending on the terms of the acquisition.
In January 2009, we adopted the new consolidations guidance. The new guidance requires that a non-controlling interest in a subsidiary be separately reported within equity and the amount of consolidated net income attributable to the non-controlling interest be presented in the statements of income. The new guidance also calls for consistency in reporting changes in the parent's ownership interest in a subsidiary and necessitates fair value measurement of any non-controlling equity investment retained in a de-consolidation. The adoption of the new guidance did not have an impact on tour financial position, results of operations or cash flows.
We have audited the accompanying consolidated balance sheets of Fortegra Financial Corporation and Subsidiaries (the "Company") as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders' equity and cash flows for the years ended December 31, 2010, 2009 and 2008. Our audits also included the financial statement schedule listed in Item 15. The financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
Life of the South Insurance Company and its subsidiary, Bankers Life of Louisiana
The Company operates in three business segments: (i) Payment Protection, (ii) Business Process Outsourcing ("BPO") and (iii) Wholesale Brokerage. Payment Protection specializes in protecting lenders and their consumers from death, disability or other events that could otherwise impair their ability to repay a debt. BPO provides an assortment of administrative services tailored to insurance and other financial services companies through a virtual insurance company platform. Wholesale Brokerage uses a pure wholesale sell-through model to sell specialty casualty and surplus lines insurance.
These consolidated financial statements reflect the consolidated financial statements of Fortegra Financial Corporation and its subsidiaries. The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America ("U.S. GAAP") promulgated by the Financial Accounting Standards Board Accounting Standards Codification ("ASC" or "the guidance").
The Company has reviewed all material events that occurred up to the date the Company's consolidated financial statements were issued to determine whether any event required recognition or disclosure in the financial statements.
The Company revised its consolidated financial statements to correct errors related to other-than-temporary impairments, stock options and other items for the years ending December 31, 2009 and December 31, 2008. Certain items in prior financial statements have been reclassified to conform to the current presentation, which had no impact on net income, comprehensive
income or loss, net cash provided by operating activities or stockholders' equity.
On December 13, 2010, the Board of Directors approved a 5.25 for one split of the Company's common stock in the form of a 100 percent stock dividend payable. All common shares and per share data have been retroactively adjusted to reflect the stock split. Also effective November 23, 2010, the Company changed the par value of its common stock from $0.331/3 per share to $0.01 per share and increased the number of authorized common shares to 150,000,000 and also authorized 10,000,000 shares of preferred stock with a par value of $0.01 per share.
On January 1, 2008, the Company adopted accounting guidance for reporting fair values in accordance with ASC 820-10 - Fair Value Measurements. There were no adjustments required to the fair value of investments as a result of adopting the new guidance. The market approach was the valuation technique used to measure fair value of the investment portfolio. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets.
quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs.
Level 3 - Inputs to the valuation methodology are unobservable for the asset or liability and are significant to the fair value measurement. These unobservable inputs are derived from the Company's internal calculations, estimates and assumptions and require significant management judgment or estimation.
The Company's revenues are primarily derived from service and administrative fees, wholesale brokerage commissions and related fees, ceding commissions and net investment income.
Service and Administrative Fees - The Company earns service and administrative fees for a variety of activities. This includes providing administrative services for other insurance companies, debt cancellation programs, collateral tracking and asset recovery services. The Payment Protection administrative service revenue is recognized consistent with the earnings recognition pattern of the underlying insurance policy or debt cancellation contract being administered. The BPO service fee revenue is recognized as the services are performed. These services include fulfillment, BPO software development, and claims handling for the Company's customers. Collateral tracking fee income is recognized when the service is performed and billed. Asset recovery service revenue is recognized upon the location of a recovered unit and or the location and delivery of a unit. Management reviews the financial results under each significant BPO contract on a monthly basis. Any losses that may occur due to a specific contract would be recognized in the period in which the loss occurs. During the years ended December 31, 2010, 2009 and 2008, the Company has not incurred a loss with respect to a specific significant BPO contract.
Wholesale Brokerage Commissions and Fees - The Company earns wholesale brokerage commission and fee income by providing wholesale brokerage services to retail insurance brokers and agents and insurance companies and is primarily recognized when the underlying insurance policies are issued. A portion of the wholesale brokerage commission income is derived from profit commission agreements with insurance carriers. These commissions are received from carriers based upon the underlying underwriting profitability of the business that the Company places with those carriers. Profit commission income is generally recognized as revenue on the receipt of cash based on the terms of the respective carrier contracts. In certain instances, profit commission income may be recognized in advance of cash receipt where the profit commission income due to be received has been calculated or has been confirmed by the insurance carrier.
Ceding Commissions - Ceding commissions earned under coinsurance agreements are based on contractual formulas that take into account, in part, underwriting performance and investment returns experienced by the assuming companies. As experience changes, adjustments to the ceding commissions are reflected in the period incurred and are based on the claim experience of the related policy. The adjustment is calculated by adding the earned premium and investment income from the assets held in trust for the Company's benefit less earned commissions, incurred claims and the reinsurer's fee for the coverage.
Net Investment Income - The Company recognizes investment income as it is earned from interest payments and dividends on its investment securities portfolio and interest earned on its cash accounts and notes receivable, less related portfolio management expenses. Investment income also includes any amortization of premiums and accretion of discounts on securities acquired at other than par value.
Net Earned Premium - Direct and assumed earned premium consists of revenue generated from the direct sale of Payment Protection insurance policies by the Company's distributors or premiums written for Payment Protection insurance policies by another carrier and assumed by the Company. Whether direct or assumed, the premium is earned over the life of the respective policy. Direct and assumed earned premium are offset by premiums ceded to the Company's reinsurers, including producer owned reinsurance companies ("PORCs"). The amount ceded is proportional to the amount of risk assumed by the reinsurer.
Both fixed maturity securities and equity securities are classified as available-for-sale and carried at fair value with unrealized gains and losses reflected in other comprehensive income, net of tax. The cost of investments sold and any resulting gain or loss, is based on the specific identification method and recognized as of the trade date.
the length of time and the extent to which fair value has been less than cost;
if an investment's fair value declines below cost, the Company determines if there is adequate evidence to overcome the presumption that the decline is other-than-temporary. Supporting evidence could include a recovery in the investment's fair value subsequent to the date of the statement of financial position, a return of the investee to profitability and the investee's improved financial performance and future prospects (such as earnings trends or recent dividend payments), or the improvement of financial condition and prospects for the investee's geographic region and industry;
with regards to commercial mortgage-backed securities ("CMBS"), the Company also evaluates key statistics such as breakeven constant default rates and credit enhancement levels. The breakeven constant default rate indicates the percentage of the pool's outstanding loans that must default each and every year with 40 percent loss severity (i.e., a recovery rate of 60 percent) for a CMBS class/tranche to experience its first dollar of principal loss. Credit enhancements indicate how much protection, or “cushion,” there is to absorb losses in a particular deal before an actual loss would impact a specific security.
The new guidance required that, at the date of adoption, the Company record a cumulative effect of change in accounting principle to reclassify the non-credit component of a previously recognized OTTI from retained earnings to accumulated other comprehensive income. Based on its review, the Company had no OTTI losses to reclassify.
Cash and cash equivalents consist primarily of highly liquid investments, with original maturities of three months or less when purchased. At various times throughout the year, the Company has cash deposited with financial institutions that exceed the federally insured deposit amount. Management reviews the financial viability of these institutions on a periodic basis and does not anticipate nonperformance by the financial institutions.
Other receivables consist primarily of advance commissions and agents' balances in course of collection and billed but not collected policy premium. For policy premiums that have been billed but not collected, the Company records a receivable on its balance sheet for the full amount of the premium billed, with a corresponding liability, net of its commission, to insurance
carriers. The Company earns interest on the premium cash during the period of time between receipt of the funds and payment of these funds to insurance carriers.
Balances recoverable from reinsurers and amounts ceded to reinsurers relating to the unexpired portion of reinsured policies are presented as assets. Experience refunds from reinsurers are recognized based on the underwriting experience of the underlying contracts.
Property and equipment are carried at cost, net of accumulated depreciation. Gains and losses on sales and disposals of property and equipment are based on the net book value of the related asset at the disposal date using the specific identification method and are charged to operations when incurred. Maintenance and repairs, which do not materially extend asset useful life and minor replacements, are charged to income when incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets with three years for computers and five years for furniture, fixtures, equipment and software. Leasehold improvements and capitalized leases are depreciated over the remaining life of the lease.
The Company evaluates the impact of rent escalation clauses, lease incentives, including rent abatements included in its operating leases. Rent escalation clauses and lease incentives are considered in determining total rent expense to be recognized during the term of the lease, which begins on the date the Company takes control of the leased space. Rent expense related to lease agreements which contain escalation clauses are recorded on a straight-line basis. Renewal options are considered by evaluating the overall term of the lease.
Goodwill represents the excess cost of an acquisition over the fair value of the net assets acquired in a business combination.
The Company's goodwill is not amortized but is reviewed annually for impairment or more frequently if certain indicators arise. The goodwill impairment review is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount. An impairment loss may be recognized if the review indicates that the carrying value of a reporting unit exceeds its fair value. Estimates of fair value are primarily determined by using discounted cash flows. If the carrying amount of a reporting unit exceeds its fair value, step two requires the fair value of the reporting unit to be allocated to the underlying assets and liabilities of that reporting unit, resulting in an implied fair value of goodwill. If the carrying amount of the goodwill of the reporting unit exceeds the implied fair value, an impairment charge is recorded equal to the excess.
The Company's reporting units for impairment testing purposes are identical to our operating segments. The Company calculated the fair value of each reporting unit at December 31, 2010 and 2009 utilizing a discount rate of 10%, projected earnings and a forecasted annual growth rate of 4%. The calculations resulted in a fair value for each of our operating segments which exceeded their respective carrying values. Therefore, step two of the impairment test was not necessary and an
Other intangible assets include trademarks, customer related and contract based assets representing primarily client lists and non−compete arrangements and acquired software. These intangible assets, with the exception of trademarks, are amortized over periods ranging from 1 to 10 years. Trademarks are not amortized since these assets have been determined to have indefinite useful lives. Intangible assets are tested at least annually, or whenever events or circumstances indicate that their carrying amount may not be recoverable or impairments using an analysis of expected future cash flows.
Management believes that such liabilities are adequate to cover the estimated cost of the related benefits. When management determines that changes in estimates are required, such changes are included in current operations.
The Company files a consolidated federal income tax return with all majority owned subsidiaries. The Company has a tax sharing agreement with its subsidiaries where each company is apportioned the amount of tax equal to that which would be reported on a separate company basis. The components of other comprehensive income or loss included in the consolidated statements of stockholders' equity have been computed based upon the 35% tax rate.
FASB ASC subtopic 740-10, "Income Taxes-Overall" ("ASC 740-10") prescribes a comprehensive model for the financial statement recognition, measurement, classification, and disclosure of uncertain tax positions. ASC 740-10 contains a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, based on the technical merits of the position. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.
Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Basic earnings per share exclude the effect of potentially dilutive options. Diluted earnings per share reflect potential dilution that could occur if stock options were exercised and excludes anti-dilutive shares. Earnings per share is calculated as follows:
Company estimates the fair value of each option on the grant date using the Black-Scholes valuation model. The Company used historical data to estimate expected employee behavior related to stock award exercises and forfeitures. Since there is not an active internal market for shares of our stock, the Company has chosen to estimate its volatility by using the volatility of a similar publicly traded company operating in the same industry. Expected dividends are based on the assumption that no dividends were expected to be distributed in the near future. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the options. Stock-based compensation cost is measured at the grant date based on the fair value of the award and is typically recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.
In September 2009, the FASB issued new guidance on multiple deliverable revenue arrangements. This new guidance requires entities to use their best estimate of the selling price of a deliverable within a multiple deliverable revenue arrangement if the entity and other entities do not sell the deliverable separate from the other deliverables within the arrangement. This new guidance requires both qualitative and quantitative disclosures. This new guidance will be effective for new or materially modified arrangements in fiscal years beginning on or after June 15, 2010. Earlier application is permitted as of the beginning of a fiscal year. Assuming the Company does not apply the guidance early, the Company is required to adopt this new guidance on January 1, 2011. The Company is currently evaluating the requirements of this new guidance and the potential impact, if any, on the Company's financial position, results of operations and cash flows.
In April 2009, the Company adopted the new other-than-temporary impairments guidance. This new guidance amends the previous guidance for debt securities and modifies the presentation and disclosure requirements for debt and equity securities. In addition, it amends the requirement for an entity to positively assert the intent and ability to hold a debt security to recovery to determine whether an OTTI exists and replaces this provision with the assertion that an entity does not intend to sell or it is not more likely than not that the entity will be required to sell a security prior to recovery of its amortized cost basis. Additionally, this new guidance modifies the presentation of certain OTTI debt securities to only present the impairment loss within the results of operations that represents the credit loss associated with the OTTI with the remaining impairment loss being presented within other comprehensive income (loss) ("OCI"). At adoption, there was no cumulative effect adjustment to reclassify the non-credit component.
In January 2009, the Company adopted the revised business combinations guidance, which is within ASC Topic 805, Business Combinations. The revised guidance retains the fundamental requirements of the previous guidance in that the acquisition method of accounting is used for all business combinations, that an acquirer be identified for each business combination and for goodwill to be recognized and measured as a residual. The revised guidance expands the definition of transactions and events that qualify as business combinations to all transactions and other events in which one entity obtains control over one or more other businesses. The revised guidance broadens the fair value measurement and recognition of assets acquired, liabilities assumed and interests transferred as a result of business combinations. It also increases the disclosure requirements for business combinations in the consolidated financial statements. The adoption of the revised guidance did not have an impact on the Company's financial position, results of operations or cash flows. However, for any business combination in 2010 or beyond, the Company's financial position, results of operations or cash flows could incur a significantly different impact than had it recorded the acquisition under the previous business combinations guidance. Earnings volatility could result depending on the terms of the acquisition.
In January 2009, the Company adopted the new consolidation guidance. The new guidance requires that a non-controlling interest in a subsidiary be separately reported within equity and the amount of consolidated net income attributable to the non-controlling interest be presented in the statements of income. The new guidance also calls for consistency in reporting changes in the parent's ownership interest in a subsidiary and necessitates fair value measurement of any non-controlling equity investment retained in a de-consolidation. The adoption of the new guidance did not have a material impact on the Company's financial position, results of operations or cash flows.
In October 2010, the FASB issued new guidance concerning the accounting for costs associated with acquiring or renewing insurance contracts. This guidance generally follows the model of that for loan origination costs. Under the new guidance, only direct incremental costs associated with successful insurance contract acquisitions or renewals would be deferrable. The guidance also states that advertising costs and indirect costs should be expensed as incurred. Although this guidance states that certain advertising costs that meet current accounting guidance could be deferred and treated as deferred acquisition costs ("DAC"), the Company does not currently record any advertising costs in DAC. This guidance will be effective for fiscal years beginning after December 15, 2011 with earlier adoption permitted as of the first day of a company's fiscal year. The Company is currently evaluating the requirements of the amendments and the potential impact, if any, on the Company’s financial position and results of operations.
The following table presents assets acquired, liabilities assumed and goodwill recorded for acquisitions made during the years ended December 31, 2010, 2009 and 2008 based on their fair values as of respective acquisition date:
Fixed maturity and equity securities are regularly assessed for other-than-temporarily impairment when the decline in fair value is below the cost basis or amortized cost for the security and determined to be other-than-temporary by management. When, in the opinion of management, a decline in the estimated fair value of an investment is considered to be other-than-temporary, the investment is written down to its estimated fair value with the impairment loss included in net realized gains(losses). OTTI losses related to the credit component of the impairment on fixed maturity securities and equity securities are recorded in the consolidated statements of income as realized losses on investments and result in a permanent reduction of the cost basis of the underlying investment. Losses relating to the non-credit component of OTTI losses on fixed maturity securities are recorded in other comprehensive income. The determination of OTTI is a subjective process, and different judgments and assumptions could affect the fair value determination and the timing of loss realization.
As of December 31, 2010, there were 21 fixed maturity and 13 equity securities in unrealized loss positions. The Company does not intend to sell these investments and it is more likely than not that the Company will be able to hold these securities until full recovery of their amortized cost basis for fixed maturity securities or cost for equity securities. During 2010, based on its quarterly review, 8 equity securities were deemed to be other-than-temporarily impaired and an impairment charge of $65 was recorded. As of December 31, 2009, there were 13 fixed maturity and 21 equity securities in unrealized loss positions. During 2009, no OTTIs were recorded. In 2008, the Company determined the decline in fair value of 1 fixed maturity security and 15 equity securities to be OTTI. This resulted in an impairment write-down of $1,153 on the fixed maturity security and $797 on the equity securities.
The Company has various reinsurance agreements in place whereby the amount of risk in excess of the Company's retention is reinsured by unrelated domestic and foreign insurance companies. The Company remains liable to policyholders in the event that the assuming companies are unable to meet their obligations.
Excess of loss arrangements - The Company seeks to protect itself from the financial impact of large individual claims by reinsuring credit life exposures in excess of $45 and forced placed mortgage insurance exposures in excess of $150.
Included within software in the table above is internally developed software not yet placed in service totaling $5.1 million and $1.0 million at December 31, 2010 and 2009, respectively.
The following reflects depreciation on our property and equipment and amortization expense related to capitalized software costs:
In 2008, the amount of goodwill recognized as part of the Summit Partners acquisition was $31.7 million. In December 2008, the Company completed the acquisition of Darby & Associates, Inc. for approximately $0.6 million, recording goodwill of $0.6 million. The Company also completed the acquisition of CIRG in December 2008 for $1.2 million and recorded goodwill of $1.3 million.
The following unaudited pro forma summary presents the Company's consolidated financial information as if Bliss and Glennon had been acquired on January 1, 2009. These amounts have been calculated after applying the Company's accounting policies and adjusting the results of Bliss and Glennon to reflect the additional amortization that would have been charged assuming the intangible assets would have existed on January 1, 2009 and excluding the transaction costs, together with the consequential tax effect.
South Bay Acceptance Corporation, Continental Car Club and United Motor Club financial results have been included in the Company's results beginning February 1, 2010, May 15, 2010 and September 1, 2010, respectively. Revenue and net income since the respective acquisition dates included in the Company's consolidated statement of income for the year ended December 31, 2010 are as follows:
have been calculated after applying the Company's accounting policies and adjusting the results of each acquired company to reflect the additional amortization that would have been charged assuming the intangible assets would have existed on January 1, 2010 and excluding the transaction costs, together with the consequential tax effect.
Other intangible assets and their respective amortization period are as follows:
The Company recognized amortization on other intangibles of $3,232, $2,706, and $2,097 during the years ended December 31, 2010, 2009 and 2008. The estimated amortization of intangible assets for each of the next five years ending December 31 is as follows:
Sun Trust Line of Credit - In June 2010, the Company entered into a $35.0 million revolving credit facility with SunTrust Bank, which matures in June 2013 (the "Facility"). The Facility bears interest at a variable rate determined based upon the higher of (i) the prime rate, (ii) the federal funds rate plus 0.50% or (iii) LIBOR plus 1%, plus a margin tied to the Company's leverage ratio. The Company is required to pay a commitment fee of between 0.45% and 0.60% (based upon the Company's leverage ratio) on the unused portion of the Facility. The purpose of the line is for working capital and acquisitions. Interest on the line of credit is payable monthly. The Company's obligations under the Facility are guaranteed by substantially all of its domestic subsidiaries, other than South Bay Acceptance Corporation and the regulated insurance subsidiaries.
At December 31, 2010, the Company is in compliance with the above covenants on its line of credit.
Columbus Bank & Trust Lines of Credit - On November 30, 2010, Columbus Bank & Trust, a division of Synovus Bank, entered into a joinder agreement to the revolving credit facility and became a new lender under the revolving credit facility with a revolving commitment of $20.0 million, bearing interest at 6.00%, maturing June 2013, which increased the revolving credit facility with Sun Trust to $55.0 million. Upon entering into the above joinder agreement, the Company paid off and terminated both $15.0 million lines of credit with Columbus Bank & Trust. The line of credit is secured with pledges of stock
of various subsidiaries. Under the line of credit, the Company may not assign, sell, transfer or dispose of any collateral or effect certain changes to its capital structure and the capital structure of its subsidiaries without Columbus Bank & Trust's prior consent.
Wells Fargo Capital Finance, LLC - On June 10, 2010, the Company's subsidiary, South Bay Acceptance Corporation entered into a loan and security agreement with Wells Fargo Capital Finance, LLC, for a $40.0 million revolving credit facility. The loan and security facility is guaranteed by the Company, but only to the extent of losses incurred by Wells Fargo as a result of fraudulent activity by South Bay Acceptance Corporation or any of its affiliates, and is secured by substantially all of South Bay Acceptance Corporation's tangible and intangible assets, subject to exceptions. The loan and security facility bears interest, with respect to LIBOR rate loans, at a rate determined by reference to the LIBOR rate plus 3.0% and, with respect to base rate loans, at a rate equal to, the greatest of (i) the federal funds rate plus 0.50%, and (ii) the rate of interest announced by Wells Fargo as its prime rate plus 3.0%. The default interest rate applicable to the obligations outstanding under the facility will equal the interest rate applicable to the relevant obligation plus 2.0% per annum. Under the loan and security agreement, South Bay Acceptance Corporation is generally prohibited from making dividend payments or other distributions. However, South Bay Acceptance Corporation is permitted to make quarterly distributions on its stock if (i) both prior to and after such payment no default or event of default has occurred or is continuing or would result from such payment and (ii) it has provided the lender under such facility its financial statements for the most recently completed quarter and certified to the lender that condition (i) above is satisfied. The line was not drawn upon during the year ended December 31, 2010.
On February 7, 2011, the Company terminated the revolving credit facility with Wells Fargo Capital Finance, LLC.
In June 2010, the Company amended the maturity date of the subordinated debentures from June 2012 to December 2013.
Interest expense paid to the related party on these debentures was $2,769, $2,839, and $2,847 for the years ended December 31, 2010, 2009 and 2008, respectively.
The interest rates on notes payable at the end of the respective year is as follows:
The Company's outstanding Series A and Series B redeemable preferred stocks were issued in 2005, and the Series C redeemable preferred stock was issued in 2006. The Company's Series A and C redeemable preferred stock each accrue cumulative cash dividends at a fixed rate of 8.25% per annum and have a liquidation preference of $1,000 per share, while the Series B redeemable preferred stock accrues cash dividends at a variable rate of 4.0% plus 90 day LIBOR, which resets quarterly, and have a liquidation preference of $1,000 per share. The Company pays dividends on its Series A, B and C redeemable preferred stock quarterly in arrears. Any outstanding Series A and B redeemable preferred stock must be redeemed in full on December 31, 2034, and any outstanding Series C redeemable preferred stock must be redeemed in full on December 31, 2035. In addition, the Series A, B and C redeemable preferred stock have optional redemption provisions for the holders upon the death of the holder or if a change in control of the Company occurs.
Beginning on January 1, 2010, the Company had the right to redeem the Series A and Series B redeemable preferred stock, in whole or in part, based on the following time frames at the redemption prices set forth below (expressed in percentages of the liquidation amount), plus accumulated and unpaid dividends to the redemption date:
On or after January 1, 2011, the Company may redeem the Series C redeemable preferred stock, in whole or in part, based on the following time frames at the redemption prices set forth below (expressed in percentages of the liquidation amount), plus accumulated and unpaid dividends to the redemption date:
The Company leases certain office space and equipment under operating leases. Rent expense for the years ended December 31, 2010, 2009 and 2008 was $2,997, $2,753 and $1,724, respectively. The future minimum lease payments under operating leases with initial or remaining non-cancelable lease terms in excess of one year at December 31, 2010 are as follows:
Short-term investments: The carrying amounts approximate fair value because of the short maturities of these instruments.
Fixed maturity securities: Fair values of fixed maturity securities were obtained from market value quotations provided by an independent pricing service.
The following table summarizes changes in Level 3 assets measured at fair value:
The carrying value and fair value of financial instruments as of December 31, 2010 and December 31, 2009 are presented in the following table:
The reconciliation of the income tax expense at the federal statutory income tax rate of 35% in 2010 and 2009 and 34% in 2008 is as follows:
The Company had no unrecognized tax benefits for the years ended December 31, 2010, 2009 and 2008.
The Company has reviewed its uncertain tax positions and has concluded that they are immaterial and that they did not require an adjustment to equity upon adoption of ASC 740-10.
The Company is no longer subject to U.S. federal or state tax examinations by tax authorities for 2006 or prior years.
At December 31, 2010, the Company had $408 of non-life regular tax operating loss carryforwards available to offset future non-life federal taxable income and life federal taxable income with certain limitations under Internal Revenue Code Section 1503(c)(6)(1).
Performance-Based Compensation Awards. The Company is permitted to issue up to 4,000,000 shares under this plan. Each option granted under this plan has a maximum contractual term of 10 years. As of December 31, 2010, there were 88,268 options and 160,000 restricted shares outstanding under the 2010 plan.
The intrinsic value reported above is calculated as the difference between the market value as of the exercise date and the exercise price of the shares.
The Company's policy is to issue new shares upon the exercise of stock options. Shares of Company stock issued upon the exercise of stock options in 2010, 2009 and 2008, were 44,185, 15,750 and 551,250, respectively.
Stock-based compensation cost is measured at the grant date based on the fair value of the award and is typically recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. Total stock-based compensation recognized on the consolidated statements of income was as follows:
Total unrecognized compensation cost related to non-vested share based compensation at December 31, 2010 was $378 with a weighted-average recognition period of 1.4 years.
The following table summarizes information concerning the Company's outstanding stock options at December 31, 2010:
As of December 31, 2010, there was $1,754 of unrecognized compensation cost related to outstanding restricted stock. The cost is expected to be recognized over a weighted-average period of 2.4 years.
The Company's insurance subsidiaries may pay dividends to the Company, subject to statutory restrictions. Payments in excess of statutory restrictions (extraordinary dividends) to the Company are permitted only with prior approval of the insurance departments of the applicable states of domicile. In 2010, Life of the South Insurance Company received approval from the insurance department of their state of domicile to pay extraordinary dividends of $1,308 to the Company. Also in 2010, Insurance Company of the South received approval from the insurance department of their state of domicile to pay an extraordinary dividend of $1,665, 30% to Life of the South Insurance Company and 70% to the Company. All dividends were eliminated in the consolidated financial statements.
statutory capital and surplus requirements. The required statutory capital and surplus totaled $13,000 and $13,000 for the years ended December 31, 2010 and 2009, respectively.
In its Payment Protection business, the Company is currently a defendant in lawsuits which relate to marketing and/or pricing issues that involve claims for punitive, exemplary or extracontractual damages in amounts substantially in excess of the covered claim. Management considers such litigation customary in the Company's line of business. In management's opinion, the ultimate resolution of such litigation, which the Company is vigorously defending, will not be material to the consolidated financial position, results of operations or cash flows of the Company.
Prior years' incurred claims increased $115 during 2010 due to the unfavorable development in payment patterns for the credit property lines of business. Prior years' incurred claims decreased $620 during 2009 due to the favorable development in payment patterns for the credit property lines of business in 2009.
In December 2010, the Company utilized a portion of the proceeds received from its IPO to pay off the entire $20.0 million of outstanding subordinated debentures for $20.6 million, which included accrued but unpaid interest to the redemption date.
The Company has a 401(k) plan that is available to employees upon meeting certain eligibility requirements. The Plan allows employees to contribute, at their discretion, a percentage of their pre-tax annual compensation and allows for employees to select from various investment options based on their individual investment goals and risk tolerances. Under the terms of the Plan, the Company will match 100% of each dollar of the employee contribution up to the maximum of 5% of the employee's annual compensation. The contributions of the Plan are invested at the election of the employee in one or more investment options by a third party plan administrator. The Company's matching contributions to the plan are as follows:
In July 2009, the Company suspended the matching contribution. The matching contribution was reinstated in January 2010 and subsequently suspended in August 2010.
A summary of selected quarterly information for 2010 and 2009 is as follows: