HAHC is a property and casualty insurance holding company incorporated in Delaware in 2005. In May 2006, we began selling property and casualty insurance products in Texas through our subsidiary, HAIC. HAIC began offering property and casualty insurance products in Arizona in 2014, and South Carolina and Virginia in 2015. HAHC's subsidiary, HAMGA provides marketing services in Texas and claims administration services in all other markets in which the Company does business. Through the use of highly automated underwriting tools, we currently offer homeowners, dwelling fire and extended coverage, tenant and condominium owner's policies within market segments which we believe have been historically profitable. Using internet-enabled applications, our products are offered to the public through independent insurance agents.
● Single family home sales were up 5.0% year over year as of December month end.
● exas' nonfarm employment rate increased 1.4% at December month end, as compared to an 1.9% increase of the national U.S. rate.
The Texas Department of Insurance ("TDI") reported in its second quarter 2015 report to the Texas Legislature that we are the 15th largest homeowners company in Texas. TDI also reported we are one of the fastest growing companies in Texas among the top 15 and the only company in the top 15 to show an underwriting profit in the second quarter of 2015, despite the active springtime convectional thunderstorm season which occurred during the second quarter of 2015. As of December 31, 2015, our property insurance policy in force count of 94,982 represented annualized premiums of approximately $98.5 million as compared to the same time last year when our policy in force count was 74,698, and our in force premium was approximately $74.4 million as of December 31, 2014. Our policy growth year over year was 27.2 %, while our in force premium grew 32.5 %.
Our net cash provided by operations of $12.7 million for the year ended December 31, 2015 was the primary source of our increase in net invested assets, which includes cash and cash equivalents. Our primary investment vehicle is certificates of deposit of varying terms.
Our net invested assets for the year ended December 31, 2015 increased $12.5 million, or 97.7%. As of December 31, 2015, the Company had invested approximately $4.2 million, or 16.6%, of its total invested assets in fixed maturity obligations and $21.1 million, or 83.4%, of its total invested assets in certificates of deposit.
Our increases in ceded reinsurance premiums payable, unearned premiums, and unearned ceding commissions were all directly related to increased business volume during the year ended December 31, 2015, resulting in our customer base increasing by 27.2% and our in force premium increasing by 32.5% during the same period, as well as our purchase of additional quota share reinsurance for named windstorms.
Our general and accrued expenses increased by $3.0 million, or 132.5%, primarily the result of reclassification of checks issued, not yet presented for payment, which includes both claim and general operating expenses. The majority of these unpresented checks were a result of increased claim activity.
Year Ended December 31, 2015 compared to Year Ended December 31, 2014
In support of our expansion in the Houston metropolitan area, commencing June 1, 2015, we entered into a property quota share reinsurance treaty with a third party reinsurer specifically to mitigate losses from named tropical cyclone storm risk. The treaty covers 90% of our risk under property coverage on any named hurricane or tropical storm system which affects certain geographical areas in the Houston metropolitan area, not to exceed the lesser of $75,000,000 or a 250-year return period. This reinsurance coverage is in addition to the reinsurance programs described below.
Due to our increased exposure to casualty risk, we entered into a per risk casualty excess of loss reinsurance program, beginning April 1, 2015. The program covers losses in excess of $100,000, with an occurrence limit of $650,000. The program permits ten reinstatements of coverage during the treaty period, with an annual loss limit of $7,150,000.
Property catastrophe treaties, which went into effect on April 1, 2015, develop over four layers with a gross loss of $175,000,000 excess of $5,000,000 per occurrence. Together, the property catastrophe treaties and our main quota share program, leaves us with a net retention of $500,000 per loss occurrence. At the last program renewal date, we entered into a mixture of 12 and 24-month treaty periods to take advantage of low catastrophe reinsurance pricing in the marketplace. Our higher limit catastrophe coverage is placed for 12 months, as we believe this level of coverage has less price volatility than lower limits and feel we can acquire this type of coverage at competitive prices going forward.
Premium production for the year ended December 31, 2015 was $97.5 million, an increase of $23.9 million, or 32.4 %, over the same period in 2014. This growth was due to an increase in insured properties in 2015, achieved through improved closing ratios on new policies and maintaining persistency on policies subject to renewal in its target markets.
The following is a reconciliation of our total net premiums written to net premiums earned for the year ended December 31, 2015 and 2014 (values in thousands):
Our Losses and Loss Adjustment Expenses amounted to $5.2 million and $2.9 million, respectively, for the years ended December 31, 2015 and 2014. This increase was directly attributable to increased business volume and increased catastrophic and other weather-related events occurring during the year ended December 31, 2015 as compared to the same period in 2014. During the year ended December 31, 2015, we sustained gross losses (losses prior to reinsurance recoveries) totaling $37.7 million from ten PCS designated CAT events. During the same period in 2014, we incurred gross losses (losses prior to reinsurance recoveries) of $14.3 million from seven PCS designated CAT events. Our liability for losses and loss adjustment expense ("Reserves") is more fully described below under "Critical Accounting Policies and Estimates." These Reserves include both case reserves on reported claims and our reserves for incurred but not reported ("IBNR") losses. At each period-end date, the balance of our Reserves is based on our best estimate of the ultimate cost of each claim for those known cases and the IBNR loss reserves are estimated based primarily on our historical experience.
General and Administrative Expenses for the years ended December 31, 2015 and 2014 were $6.8 million and $5.5 million, respectively. The $1.3 million increase was primarily attributable to increases in compensation and compensation-related costs of $0.9 million, a direct result of our increase in head count from 43 employees at December 31, 2014 to 56 employees as of December 31, 2015, as well as increases in other administrative costs of $0.4 million, which include a variety of professional service fees, contract labor, and other general expenses to support our premium growth.
Our expenses (policy acquisition, underwriting, and other operating expenses), as a percentage of direct earned premium was 32.4 % for the year ended December 31, 2015, compared to 33.9 % for the year ended December 31, 2014. The decrease in our expense ratio was primarily attributable to our ability to control acquisition and operating costs during the continued expansion of our business.
Trends within our insurance business are seasonal, both as they relate to premium production and as they relate to incurred losses. Premium production tends to increase during the late spring and summer due to increased home purchases, while our claims activity increases with the occurrence of convectional springtime thunderstorms producing strong winds, tornados and hail typically during the period from March 1 through June 30 each year. Due to our heavy reliance on reinsurance, we have moved the commencement of our reinsurance treaty year from April 1 to December 31 for the majority of its reinsurance programs in order to include only one treaty year's potential impact from a variance in reinsurance costs and profit share adjustments in a calendar year.
In the insurance industry cash collected for premium from policies written is invested and interest and dividends are earned thereon. Our primary cash outflows are claim payments and operating expenses. In regard to claim payments, while the substantial portion of our claims are paid out within 90 - 180 days, the period of time payments are made varies by the circumstances of the claim, and loss settlement expenses can be paid over periods of more than one year. Additional cash outflow occurs through payments of underwriting costs such as commissions, taxes, payroll, and overhead expenses.
The credit risk we are exposed to on ceded premium and losses recoverable from reinsurers is managed through the careful selection of reinsurance companies. When selecting reinsurance coverage, we consider the financial strength and stability of the providers, their history of responding to claims, and their overall reputation. We require that all reinsurers have an A.M. Best rating of A- (Excellent), or better, or an S&P rating of AA- or better, in order to minimize the risk of uncollectable balances. HAIC continually monitors the financial condition of its reinsurers with the aid of AON Benfield, its reinsurance broker. As of December 31, 2015, no reinsurance recoverable balance is outstanding beyond 30 days. We do not use credit default swaps to mitigate our credit exposure from either investments or counterparties.
Assisting us in setting the case reserves, after first reviewing the elements of the claim and the coverage afforded under the policy, we use a damage estimating software package called Xactimate, developed and owned by the industry leader, Insurance Service Office. The estimating software researches and reports on estimates of structural repair pricing and compares it to actual completed bids and market surveys. The research includes over 40,000 providers of materials, equipment and labor and over 80,000 surveys each year.
We maintain IBNR reserves to provide for incurred claims that have not yet been reported as well as development on reported claims. The IBNR reserve is determined by estimating our ultimate net liability for both reported and IBNR claims and then subtracting the case reserves and payments made to date for reported claims. IBNR reserves are developed separately for non-catastrophe losses and catastrophe based claims. Catastrophe based IBNR reserves factors project the ultimate incurred loss from a specific event. Non-catastrophe IBNR reserves include case development for IBNR claims.
For each of the above bands, the losses incurred and percentage of total losses incurred from claims reported during those time frames is calculated by accident year, as are cumulative values. This data is then spread out into days from the event (so that 1-5 band become individual days 1, 2, 3, 4, 5 and so on for the other bands) on a graduated basis, which is then adjusted to scale over the time period so that claim reporting is greater earlier in the bands than later in the bands (so for the 1-5 band, is proportionally more was reported on day 1 than day 2, etc.). Initially, this was done on a daily basis for days 0-30, with subsequent periods grouped broken into bands of 5, 15 and 30 days. Data can be pulled in by event and by accident period. However, since events have individual reporting patterns, data is pulled on an accident year basis (so that variability could be reviewed), and rolled up to an ITD basis for this evaluation.
Factor changes for the periods under review, from period to period, are considered to be within reasonable ranges. Therefore, the methodology used is considered to be consistent from period to period.
Realization of any carry forward component of deferred tax assets depends upon our generation of sufficient taxable income in the future to recover tax benefits that cannot be recovered from taxes paid in the carryback period, generally two years.
We have audited the accompanying consolidated balance sheets of Homeowners of America Holding Corporation and Subsidiaries (the Company) as of December 31, 2015 and 2014, and the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows for each of the years in the two year period ended December 31, 2015. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Homeowners of America Holding Corporation and Subsidiaries as of December 31, 2015 and 2014, and the consolidated results of their operations and their cash flows for each of the years in the two year period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
Cash and cash equivalents include cash and highly liquid short-term investments, with original maturities of three months or less. The amount is carried at cost, which approximates fair value. At December 31, 2015 and 2014, cash and cash equivalents consist of cash on deposit with financial institutions, as well as money market mutual funds.
General and other accrued expenses payable as of December 31, 2015 and December 31, 2014, include $4.5 million and $1.7 million, respectively, of both claim and general operating expense checks issued in excess of cash book balances, not yet presented for payment.
Long-lived assets, such as property, equipment and software, are reviewed for impairment whenever business events or circumstances could lead to or indicate that the value of the asset may not be recoverable. The assessment of possible impairment is based on whether the carrying amount of the assets exceeds its fair value. The Company uses estimates of undiscounted future cash flows in determining the recoverability of long-lived assets. As of December 31, 2015 and 2014, no impairment has been recorded.
In the normal course of business, the Company seeks to reduce the overall exposure to losses that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk with other insurance enterprises or reinsurers. The Company uses only quality, financially rated reinsurers and continually monitors the financial ratings of these companies through its brokers. The amount and type of reinsurance purchased each year is based on management's analysis of liquidity and its estimate of its probable maximum loss and the conditions within the reinsurance market. The Company continually monitors its risk exposure through the use of the AIR modeling system and other modeling tools provided by its reinsurance brokers. Reinsurance premiums, expense reimbursements, and reserves related to reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums paid for reinsurance are reported as reductions of earned premium income.
The Company's fixed-maturity securities held as available-for-sale are carried at fair value as of December 31, 2015 and 2014. Fair value for securities are based on the framework for measuring fair value established by FASB ASC Topic 820, Fair Value Measurements and Disclosures.
Diluted earnings (loss) per share of common stock is computed by dividing net income or loss attributable to common stockholders, adjusted for the effect of potentially dilutive securities, by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued using the treasury stock method. Potentially dilutive securities include convertible notes payable, outstanding convertible preferred stock and common stock options.
On February 25, 2016, the FASB issued Accounting Standards Update No. 2016-02 ("ASU 2016-02"), Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. Lessees (for capital and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees may not apply a full retrospective transition approach. The Company is currently evaluating the impact of adopting this guidance.
On November 20, 2015, the FASB issued Accounting Standards Update No. 2015-17 ("ASU 2015-17"), Income Taxes (Topic 740), Balance Sheet Classification Deferred Taxes. ASU 2015-17 simplifies the presentation of deferred income taxes. ASU 2015-17 require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendment applies to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendment. ASU 2015-17 is effective for annual periods beginning after December 15, 2016, and interim periods within annual periods for public business entities. For all other entities, ASU 2015-17 is effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. The amendments in ASU 2015-17 may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company presents an unclassified statement of financial position, therefore there will be no impact to the Company's consolidated financial statements.
For the year ended December 31, 2015, the Company incurred an expense of $450,000 (of which $150,000 is represented by the issuance of 227,273 shares of common stock) for services performed under the Advisory Agreement.
Investment income, net of investment expenses totaled $138,517 and $43,603 for the years ended December 31, 2015 and 2014, respectively.
For the years ended December 31, 2015 and 2014, there were $10,851 and $73, respectively, in unrealized gains/(losses) on fixed-maturity securities held as available-for-sale.
The following table provides the Company's short-term, restricted and long-term investment holdings by type of financial instruments that were used to estimate the fair value disclosures for financial instruments:
The following table provides the Company's fixed-maturity securities classified as available-for-sale which are carried at fair value as of December 31, 2015 and December 31, 2014:
● the financial condition and near-term prospects of the issuer, including any specific events that may affect its operations or earnings;
Securities with gross unrealized loss positions at December 31, 2015 and December 31, 2014, aggregated by investment category and length of time the individual securities have been in a continuous loss position, are as follows:
At December 31, 2014, there were 31 securities in an unrealized loss position. The Company began its investment in these securities in June 2014, therefore none of these securities had been in an unrealized loss position for 12 months or greater at December 31, 2014.
The Company believes there were no fundamental issues such as credit losses or other factors with respect to any of its available-for-sale securities. The unrealized losses on investments in fixed-maturity securities were caused primarily by interest rate changes. It is expected that the securities would not be settled at a price less than par value of the investments. Because the declines in fair value are attributable to changes in interest rates or market conditions and not credit quality, and because the Company has the ability and intent to hold its available-for-sale investments until a market price recovery or maturity, the Company does not consider any of its investments to be other-than-temporarily impaired at December 31, 2015 and 2014.
The fair value hierarchy is used to prioritize valuation inputs into three levels:
● Level 1 - unadjusted quoted prices in active markets for identical assets or liabilities. These inputs are considered to be the most reliable evidence of fair value.
● Level 2 - quoted prices for similar assets in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the investment. Such inputs include market interest rates and volatilities, spreads and yield curves.
● Level 3 - termed unobservable inputs which are utilized in situations where there is little or no market activity for the asset or liability at the measurement date. The approach typically involves a significant subjective management judgment toward the pricing of the security.
Depreciation and amortization expense for property, equipment and software totaled $147,314 and $128,107 for the years ended December 31, 2015 and 2014, respectively.
As a result of additional information on claims occurring in prior years becoming available to management, changes in estimates of provisions of claims and claim adjustment expenses were made resulting in an increase of $224,455 and $48,000 for the years ended December 31, 2015 and 2014, respectively.
The Company's 2013 Equity Compensation Plan (the "2013 Plan") provides for granting of stock options, incentive stock options, stock awards, and restricted stock units to enable the Company to obtain and retain the services of selected persons, both employees and directors, considered to be essential to the long-range success of the Company. Under the 2013 Plan, options may be granted to purchase a total not to exceed 2,925,000 shares of common stock, made up of original issue shares, treasury shares or a combination of the two. At December 31, 2015, options to purchase 1,965,000 shares of common stock and 3,000 shares of common stock in the form of a stock award had been granted under the 2013 Plan. At December 31, 2014, options to purchase 1,965,000 shares of common stock and 39,000 shares of common stock in the form of a stock award have been granted under the 2013 Plan.
There were no stock options granted in 2015. Stock options granted in 2014 had a weighted average grant date fair value of $0.02.
The Company records stock-based compensation expense related to granting stock options in general and administrative expenses. The Company recognized compensation expense as follows for the year ended December 31, 2015 and 2014:
Certain premiums and benefits are ceded to other insurance companies under various reinsurance agreements. The reinsurance agreements provide HAIC with increased capacity to write larger risks and maintain its exposure to loss within its capital resources. Ceded reinsurance contracts do not relieve HAIC from its obligations to policyholders. HAIC remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreements. To minimize its exposure to significant losses from reinsurer insolvencies, HAIC evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers.
Commencing April 1, 2014 and ending March 31, 2015, the Company reinsured its property and casualty risk under quota share reinsurance treaties with third party reinsurers. The treaties cover 80 % of its risk under property coverage on any one loss occurrence not to exceed $110 million; 10 % of its risk under property coverage on any one loss occurrence not to exceed $4 million and approximately 64 % of its risk under casualty coverage.
Property catastrophe treaties, which went into effect on the same day and having the same term as the quota share treaties, develop over four layers and 20 % of our risk on property coverage on a gross loss of $110 million excess of $4 million per occurrence. The Company's net retention is $400,000 per loss occurrence.
The Company also purchases reinsurance covering non-weather losses (two occurrences) in excess of a gross loss of $500,000 per occurrence for all coverage lines (a net loss of $50,000). This coverage, which was in force during 2014 had been obtained principally to protect the Company in the event of a large fire loss.
The following is a summary of the names of each of HAIC's significant reinsurer and the amount due from each for paid losses, LAE and unearned premium.
Financial instruments which potentially subject the Company to credit risk consist principally of cash, money market accounts on deposit with financial institutions, money market funds, certificates of deposit and fixed-maturity securities, as well as premium balance in the course of collection. At times, the Company's bank deposits may exceed the FDIC limit.
Rent expense under such leases in the year ended December 31, 2015 and December 31, 2014 was $182,624 and $167,119, respectively.
HAIC is subject to the laws and regulations of the State of Texas and the regulations of any other states in which HAIC conducts business. State regulations cover all aspects of HAIC's business and are generally designed to protect the interests of insurance policyholders, as opposed to the interests of stockholders. The Texas Insurance Code requires all property and casualty insurers to have a minimum of $2.5 million in capital stock and $2.5 million in surplus. HAIC has capital and surplus in excess of this requirement.
As of December 31, 2015, HAIC's total statutory surplus was $15,081,420 (capital stock of $3,000,000 and surplus of $12,081,420).
HAIC prepares its statutory-based financial statements in conformity with accounting practices prescribed or permitted by the Texas Department of Insurance. Prescribed statutory accounting practices primarily include those published as statements of SAP by the NAIC, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practice not so prescribed. As of December 31, 2015 and 2014, there were no material permitted statutory accounting practice utilized by HAIC.
On February 1, 2016, the Company issued 164,836 shares of common stock at $0.91 a share to Inter-Atlantic Management, Inc. or "Inter-Atlantic". A number of our directors are among the beneficial owners of Inter-Atlantic. Per the terms of the Advisory Agreement dated August 1, 2013, Inter-Atlantic Management, Inc. will be issued annually on February 1st , a grant of the Company's common stock which in aggregate will have a fair market value of $150,000 at the time of grant.