· Our primary insurance subsidiary is Federated National Insurance Company (“Federated National”). Federated National is licensed as an admitted carrier in Florida. An admitted carrier is an insurance company that has received a license from the state department of insurance giving the company the authority to write specific lines of insurance in that state. Through contractual relationships with a network of approximately 3,000 independent agents, of which approximately 600 actively sell and service our products, Federated National is authorized to underwrite homeowners’, fire, allied lines and personal and commercial automobile insurance in Florida. Federated National is also licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas, and underwrites commercial general liability insurance in those states. Federated National operated as a non-admitted carrier in Arkansas, California, Kentucky, Maryland, Missouri, Nevada, Oklahoma, South Carolina, Tennessee and Virginia, and could underwrite commercial general liability insurance in all of these states. A non-admitted carrier is allowed to do business in that state and is strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Sometimes, non-admitted carriers are referred to as “excess and surplus” lines carriers. Non-admitted carriers are subject to considerably less regulation with respect to policy rates and forms. Non-admitted carriers are not required to financially contribute to and benefit from the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.
Assurance MGA earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. Assurance MGA earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliates Federated National and American Vehicle. During the fourth quarter of 2010, Assurance MGA, pursuant to the Consent Order as discussed in “Regulation - Consent Order” reduced its fee, to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date with approval from the Florida OIR. A formal agreement reflecting this fee modification was executed during January 2011.
Although we are authorized to underwrite the various lines described above, our business is primarily underwriting homeowners’ policies. During 2011, 81.8%, 10.3%, 4.6% and 3.3% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and personal automobile insurance, respectively. During 2010, 79.7%, 12.3%, 4.1% and 3.9% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and personal automobile insurance, respectively.
During the years ended December 31, 2011, 2010 or 2009, we did not experience any weather-related catastrophic events such as the hurricanes that occurred in Florida during 2005 and 2004. We are not able to predict how hurricanes or other insurable events will affect our future results of operations and liquidity. Loss and loss adjustment expenses (“LAE”) are affected by a number of factors, many of which are partially or entirely beyond our control, including the following.
The preparation of financial statements in conformity with Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
The estimated Ultimate Loss and Defense and Cost Containment Expense (“DCCE”) is based on an analysis by line of business, coverage and by accident quarter performed using data as of December 31, 2011. The analysis relies primarily on four actuarial methods: Incurred Loss and DCCE Development Method, Paid Loss and DCCE Development Method, Bornhuetter-Ferguson Incurred Method, and Bornhuetter-Ferguson Paid Method. Each method relies on company experience, and, where relevant, the analysis includes comparisons to industry experience. The following is a description of each of these methods:
We also produce an estimate of unpaid Adjusting and Other Expense (“A&O”), as a reserve is required under Statutory Accounting Principles ("SAP") even if this expense has been pre-paid or with an unconsolidated affiliate. Although we do not prepay for A&O, the majority of the A&O incurred is with an affiliated company and eliminated under the accounting principles for consolidation. The unpaid A&O is added to unpaid losses & DCCE, resulting in total unpaid losses and LAE.
Frequency / Severity Method - This method separately estimates the two components of ultimate losses (the frequency, or number of claims and the severity, or cost per claim) and then combines the resulting estimates in a multiplicative fashion to estimate ultimate losses. The approach is valuable because sometimes there is more inherent stability in the frequency and severity data when viewed separately than in the total losses.
Interim - During 2011 our interim approach was very similar to the annual process noted above.
We account for our investment securities consistent with FASB-issued guidance that requires our securities to be classified into one of three categories: (i) held-to-maturity, (ii) trading securities or (iii) available-for-sale.
Below is a summary of net unrealized gains and losses at December 31, 2011 and December 31, 2010 by category.
The $2.0 million of unrealized losses from equity securities is from common stocks and mutual funds held in diverse industries as of December 31, 2011. The Company evaluated the near-term prospects in relation to the severity and duration of the impairment. Based on this evaluation and the Company’s ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2011.
The $0.4 million of unrealized losses from debt securities is related to both corporate and US government bonds. The Company does not expect to settle at prices less than the amortized cost basis. The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2011 because we neither currently intend to sell these investments nor consider it likely that we will be required to sell these investments before recovery of the amortized cost basis; additionally, at least 74% of these bonds had at least an “A” rating.
The Company records the unrealized losses, net of estimated income taxes, that are associated with that part of our portfolio classified as available-for-sale through the shareholders' equity account titled “Other Comprehensive Income”.
Debt securities are carried on the balance sheet at market. At December 31, 2011 and 2010, debt securities had the following quality ratings by S&P and for securities not assigned a rating by S&P, Moody’s or Fitch ratings were used.
The following table summarizes, by maturity, the debt securities as of December 31, 2011 and 2010.
At December 31, 2011, the weighted average maturity of the debt portfolio was approximately 7.5 years.
As of December 31, 2011 and December 31, 2010, Federated National maintained fully funded trust agreements that totaled $4.6 million in favor of two of its reinsurers.
During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic Underwriters Insurance Company (“Republic”) which was terminated in April 2007. During 2010, the letter of credit in favor of Republic was replaced by a fully funded trust agreement. As of December 31, 2011 and 2010 respectively, the amount held in trust was $1.0 million.
Cash and short-term investments, which include cash, certificates of deposits, and money market accounts, decreased $1.0 million, or 6.2%, to $15.2 million as of December 31, 2011, compared with $16.2 million as of December 31, 2010. The decrease in cash and short-term investments resulted from portfolio reallocation based on improving risk profiles; wherein we decided to increase our exposure to corporate bonds. We evaluate our asset class allocation on an ongoing basis continually adjust based on economic and business risk.
Our homeowners’ insurance premiums receivable increased $0.2 million, or 6.6%, to $3.7 million as of December 31, 2011, compared with $3.5 million as of December 31, 2010.
Premiums receivable in connection with our automobile line of business remained unchanged at $0.8 million as of December 31, 2011, compared with $0.8 million as of December 31, 2010.
Our allowance for credit losses remained unchanged at $0.1 million as of December 31, 2011, compared with $0.1 million as of December 31, 2010.
Reinsurance recoverable, net, decreased $5.9 million, or 74.0%, to $2.1 million as of December 31, 2011, compared with $8.0 million as of December 31, 2010. The change is due to the payment patterns by our reinsurers, as influenced by the diminishing catastrophe related claims. All amounts are current and deemed collectable. We believe concentrations of credit risk associated with our reinsurance recoverables, net, are not significant.
DPAC decreased $0.2 million, or 2.0%, to $7.7 million as of December 31, 2011, compared with $7.9 million as of December 31, 2010. The change is due to the deferral of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned. An analysis of deferred acquisition costs follows.
Unpaid losses and LAE decreased $6.5 million, or 9.8%, to $60.0 million as of December 31, 2011, compared with $66.5 million as of December 31, 2010. The composition of unpaid losses and LAE by product line is as follows.
Unearned premiums increased $0.8 million, or 1.7%, to $47.9 million as of December 31, 2011, compared with $47.1 million as of December 31, 2010. The change was due to a $1.5 million increase in unearned homeowners’ insurance premiums, a $0.3 million increase in unearned flood insurance premiums, a $0.6 million decrease in unearned commercial general liability premiums, and a $0.4 million decrease in unearned automobile insurance premiums. Generally, as is in this case, a increase in unearned premium directly relates to a increase in written premium on a rolling twelve-month basis. Competition could negatively affect our unearned premium.
Premium deposits and customer credit balances increased $0.4 million, or 18.6%, to $2.8 million as of December 31, 2011, compared with $2.4 million as of December 31, 2010. Premium deposits are monies received on policies not yet in-force as of December 31, 2011.
Bank overdraft increased $0.5 million, or 6.7%, to $7.9 million as of December 31, 2011, compared with $7.4 million as of December 31, 2010. The bank overdraft relates primarily to losses and LAE disbursements paid but not presented for payment by the policyholder or vendor. The change relates to the timing of presentation of claims checks to the issuing bank.
Accounts payable and accrued expenses increased $0.9 million, or 44.4%, to $3.1 million as of December 31, 2011, compared with $2.2 million as of December 31, 2010. The change from prior year includes increases of $0.2 million for premium taxes payable and $0.1 million for homeowners’ commission payable, as well as the impact of the timing of payments with our trade vendors.
Gross premiums written increased $1.9 million, or 1.9%, to $98.3 million for 2011, compared with $96.4 million for 2010. The following table denotes gross premiums written by major product line. This increase reflected primarily an increase in the sale of homeowners’ policies.
The increase in the sale of homeowners’ policies by $3.6 million, or 4.6%, to $80.4 million in 2011, compared with $76.8 million in 2010, is gross of reinsurance costs and net of Florida’s mandated homeowners’ wind mitigation discounts. We offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. As of December 31, 2011, 63.5% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $31.5 million (a 28.6% reduction of in-force premium), while 60.1% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $27.3 million, (a 26.0 % reduction of in-force premium), as of December 31, 2010.
We received approval from the Florida OIR in 2009 and 2010 for a premium rate increases for our voluntary homeowners’ program within the State of Florida. These premium rate increases averaged approximately 19% in 2009 and 20.2% in 2010 and were implemented for policies with effective dates as soon as permitted following approval. In addition, in 2010 we received approval from the Florida OIR for a premium rate increase of approximately 15% for homeowners policies assumed from Citizens Property Insurance Corporation ("Citizens") in Florida beginning July 2010. In February 2012, we received approval from the Florida OIR of a 14.1% rate increase. That rate increase, together with our 2011 rate increases for our voluntary property book of homeowners’ business, averaging 20.2% statewide, and our assumed property book of homeowners’ business, averaging 13.9% statewide, are expected to gain momentum and accrete throughout 2012.
The Company’s sale of auto insurance policies decreased to $3.3 million for 2011, compared with $3.7 million 2010. The Company’s sale of auto insurance included only renewal policies in 2011 , and new and renewal policies in 2010.
The $2.7 million decrease in commercial general liability net premiums earned is a result of a $1.8 million decrease in gross written premium, reflecting the impact our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas. The change is also a result of a $0.2 million decrease in gross premiums ceded and a $1.1 million decrease in the net change to unearned premium.
FASB has issued guidance regarding when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. During 2011, pursuant to guidelines prescribed in FASB issued guidance, we have charged to operations, realized investment losses of $0.8 million. The charges relate to common stock held in diverse industries; during 2010, we did not mark any investments to market value pursuant to guidelines prescribed in FASB issued guidance. In reaching a conclusion that a security is either other than temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor’s and Moody’s, as well as information released via the general media channels.
Losses and LAE decreased by $9.2 million, or 22.9%, to $30.9 million for 2011, compared with $40.1 million for 2010. The overall change includes a $7.0 million decrease in our homeowners’ program due to favorable experience based in part on enhanced underwriting and claim processing techniques. The overall change also includes a $2.8 million decrease in our commercial general liability program and a $0.6 million increase in connection with our automobile program.
Our loss ratio is computed as losses and LAE divided by net premiums earned. A lower loss ratio generally results in higher operating income. Our loss ratio for 2011 was 63.7% compared with 89.0% for the same period in 2010. The favorable decrease to our loss ratio is due to the $9.2 million decrease in losses and LAE measured against the $3.5 million increase in net premium earned during 2011 as compared with the same period in 2010.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
As a result of the foregoing, the Company’s net loss for 2011was $0.4 million, compared with $8.0 million for 2010.
During 2010 and 2009, the change to the cumulative wind mitigation credits afforded our policyholders totaled ($0.3) million and $9.8 million, respectively.
These premium discounts have had a significant effect on both written and earned premium. Wind mitigation credits are 26.0% of the pre-credit premium, or $27.3 million, as of December 31, 2010, as compared with 24.2% of the pre-credit premium, or $27.6 million, as of December 31, 2009.
We received approval from the Florida OIR in 2009 and 2010 for a premium rate increases for our voluntary homeowners’ program within the State of Florida. These premium rate increases averaged approximately 19% in 2009 and 20.2% in 2010 and were implemented for policies with effective dates as soon as permitted following approval.
Gross premiums ceded decreased to $53.0 million in 2010, compared with $56.2 million in 2009, due to our decreased cost of reinsurance. Gross premiums ceded under our catastrophe reinsurance program totaled $46.9 million, gross premiums ceded to the write-your-own flood program totaled $4.0 million, gross premiums ceded relating to our commercial automobile program totaled $1.9 million and gross premiums ceded relating to our commercial general liability program totaled $0.2 million in 2010.
The decrease in prepaid reinsurance premiums was $2.1 million in 2010, compared with a $10.2 million increase in 2009. The increased charge to written premium is associated with the timing of our reinsurance payments measured against the term of the underlying reinsurance policies.
The decrease in unearned premiums was $3.7 million in 2010, compared with a $10.3 million increase in 2009. The change was due to a $3.1 million decrease in unearned homeowners’ insurance premiums, a $1.6 million decrease in unearned commercial general liability premiums, a $0.8 million increase in unearned automobile premiums, net of a $0.2 million increase in unearned flood premiums in 2010. These changes are a result of differences in written premium volume during this period as compared with the same period last year. See “Gross Premiums Written” above.
Net premiums earned decreased $2.9 million, or 6.1%, to $45.1 million for in 2010, compared with $48.0 million in 2009. The following table denotes net premiums earned by product line.
Commission income remained unchanged at $1.4 million in 2010, compared with $1.4 million in 2009. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link.
Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, were 3.4% and 3.7%, respectively, in 2010. Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, were 3.5% and 3.7%, respectively, in 2009.
Losses and LAE decreased by $3.6 million, or 8.3%, to $40.1 million in 2010, compared with $43.7 million in 2009. The overall change includes a $1.5 million increase in our homeowners’ program and a $6.3 million decrease in our commercial general liability program; these decreases are due to favorable experience in these markets based in part on enhanced underwriting and claim processing techniques. The overall increase also includes a $1.2 million increase in connection with our re-launched automobile program which has experienced adverse development in its initial phase.
Based on our review as discussed above, reserves were decreased by approximately $4.1 million in 2010. This overall change includes a $5.3 million decrease in our homeowners’ program and a $1.2 million decrease in our commercial general liability program; these decreases are due to favorable experience in these markets based in part on enhanced underwriting and claim processing techniques. The overall decrease also includes a $2.4 million increase in connection with our re-launched automobile program which has experienced adverse development in its initial phase.
Our loss ratio, which is computed as losses and LAE divided by net premiums earned, in 2010 was 89.0% compared with 91.1% for the same period in 2009.
The charge to operations for stock-based compensation, in accordance with FASB issued guidance, remained unchanged at approximately $0.4 million in 2010 compared with approximately $0.4 million in 2009.
The provision for income tax benefit was $4.0 million in 2010, compared with $5.9 million in 2009. The effective rate for income taxes was 33.1% in 2010 and 36.5% in 2009.
A summary of long-term contractual obligations as of December 31, 2011 follows. The amounts represent estimates of gross undiscounted amounts payable over time.
In 2011, operations generated $15.1 million of gross cash flow, due to a $6.0 million decrease in reinsurance recoverable, a $2.4 million decrease in income taxes recoverable, a $2.1 million decrease in prepaid reinsurance premiums, $1.3 million of amortization of investment discount, net, a $1.0 million increase in accounts payable and accrued expenses, a $0.8 million increase in unearned premiums, a $0.5 million increase in bank overdraft, a $0.4 million increase in premium deposits and customer credit balances, $0.3 million of non-cash compensation, $0.2 million of depreciation and amortization and a $0.1 million decrease in policy acquisition costs, net of amortization.
In 2011, operations used $10.9 million of gross cash flow primarily due to a $6.5 million decrease in unpaid losses and LAE, $2.7 million of net realized investment gains, a $0.9 million increase in deferred income tax expense, a $0.3 million increase in various other assets and a less than $0.1 million decrease in the provision for uncollectible premiums receivable, all in conjunction with a net loss of $0.4 million.
As of December 31, 2011, 2010, and 2009, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “structured finance” or “special purpose” entities, which were established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. As such, management believes that we currently are not exposed to any financing, liquidity, market or credit risks that could arise if we had engaged in transactions of that type requiring disclosure herein.
For the years ended December 31, 2011 and 2010, we had no off balance sheet transactions.
We have audited the accompanying consolidated balance sheets of 21st Century Holding Company as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2011. 21st Century Holding Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
The insurable events during 2011, 2010 and 2009 did not include any weather related catastrophic events such as the well publicized series of hurricanes that occurred in Florida during 2005 and 2004. During 2011, 2010 and 2009 we processed property and liability claims stemming from our homeowners’, commercial general liability and private passenger automobile lines of business. Our reinsurance strategy serves to smooth the liquidity requirements imposed by most severe insurable events and for all other insurable events we manage, at a micro and macro perspective, in the normal course of business.
American Vehicle, prior to the January 2011 merger, was licensed as an admitted carrier in Florida, and underwrote commercial general liability, and personal and commercial automobile insurance. American Vehicle was also licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas, and underwrote commercial general liability insurance in those states. American Vehicle operated as a non-admitted carrier in Arkansas, California, Kentucky, Maryland, Missouri, Nevada, Oklahoma, South Carolina, Tennessee and Virginia, and could underwrite commercial general liability insurance in all of these states. Subsequent to the merger, these operations may continue under the newly formed Federated National.
Assurance MGA earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. Assurance MGA earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliates Federated National and American Vehicle. During the fourth quarter of 2010, Assurance MGA, pursuant to the Consent Order as discussed in “Footnote 8 - Regulation - Consent Order” reduced its fee, to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date with approval from the Florida OIR. A formal agreement reflecting this fee modification was executed during January 2011.
The homeowner policy provides Assurance MGA the right to cancel any policy within a period of 90 days from the policy's inception with 25 days’ notice, or after 90 days from policy inception with 95 days’ notice, even if the risk falls within our underwriting criteria.
If all the costs substantially associated with the MGA contracts, which do not involve affiliated insurers, are incurred during the underwriting process, then the MGA fees and the related acquisition costs are recognized at the time the policy is underwritten, net of estimated cancellations. If the MGA contract requires significant involvement subsequent to the completion of the underwriting process, then the MGA fees and related acquisition costs are deferred and recognized over the life of the policy. Included in MGA Fees are policy fees charged by the insurance companies and passed through to Assurance MGA. Policy fees are discussed below.
In December 2011, the FASB issued Accounting Standard Update (“ASU”) No. 2011-12: Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The guidance defers certain provisions contained in ASU No. 2011-05 requiring the requirement to present components of reclassifications of other comprehensive income on the face of the income statement or in the notes to the financial statements. However, this deferral does not impact the other requirements contained in the new standard on comprehensive income as described above. This ASU is effective during interim and annual periods beginning after December 15, 2011. The adoption of this ASU will not have a material impact on our financial condition, results of operations or cash flows.
In December 2010, the FASB issued ASU No. 2010-29: Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations a consensus of the FASB Emerging Issues Task Force. The objective of this update is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. Paragraph 805-10-50-2(h) requires a public entity to disclose pro forma information for business combinations that occurred in the current reporting period. The disclosures include pro forma revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma revenue and earnings of the combined entity for the comparable prior reporting period should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. In practice, some preparers have presented the pro forma information in their comparative financial statements as if the business combination that occurred in the current reporting period had occurred as of the beginning of each of the current and prior annual reporting periods. Other preparers have disclosed the pro forma information as if the business combination occurred at the beginning of the prior annual reporting period only, and carried forward the related adjustments, if applicable, through the current reporting period. The amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The adoption of this update did not have a material impact on the Company’s financial statements.
We are subject to certain risks in our business operations which are described below. Careful consideration of these risks should be made before making an investment decision. The risks and uncertainties described below are not the only ones facing 21st Century. Additional risks and uncertainties not presently known or currently deemed immaterial may also impair our business operations.
Adverse ratings by insurance rating agencies may adversely impact our ability to write new policies, renew desirable policies or obtain adequate insurance, which could limit or halt our growth and harm our business.
Our senior management team is critical to the strategic direction of our company. If there were an unplanned loss of service by any of our officers our business could be harmed.
During the year ended December 31, 2011, the Company had two stock-based employee compensation plans, which are described later in Footnote 14, Stock Compensation Plans. Prior to January 1, 2006, we accounted for the plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by the Accounting Principles Board (“APB”) and related Interpretation, as permitted by FASB issued guidance. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB issued guidance using the modified-prospective-transition method. Under that transition method, compensation costs recognized during 2011, 2010 and 2009 include:
Certain 2010 and 2009 financial statement amounts have been reclassified to conform to the 2011 presentations.
During 2009, the Company purchased one intangible asset totaling $0.1 million. In accordance with FASB issued guidance, the accounting for the recognized intangible asset was based on its useful life to the Company. The useful life of the intangible asset was the period over which it was expected to contribute directly or indirectly to the future cash flows of the Company. The intangible asset had a definite finite life ranging from six to twelve months, and was amortized accordingly.
In reaching a conclusion that a security is either other-than-temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor’s and Moody’s, as well as information released via the general media channels. During 2011, in connection with this process, we charged to operations $0.8 million of investment losses. During 2010, in connection with this process, we have not charged any net realized investment loss to operations.
As of December 31, 2011 and December 31, 2010, respectively, all of our securities are in good standing and not impaired, except as noted above, as defined by FASB-issued guidance.
As of December 31, 2011 and 2010, our investments consisted primarily of corporate bonds held in various industries, municipal bonds and United States government bonds. As of December 31, 2011, 61% of our debt portfolio was in diverse industries and 39% is in United States government bonds. As of December 31, 2011, approximately 83% of our equity holdings were in equities related to diverse industries and 17% were in mutual funds. As of December 31, 2010, 72% of our debt portfolio was in diverse industries and 28% was in United States government bonds. As of December 31, 2010, approximately 77% of our equity holdings were in equities related to diverse industries and 23% were in mutual funds.
The following table shows the realized gains (losses) for debt and equity securities for the years ended December 31, 2011 and 2010.
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of debt and equity securities at December 31, 2011 and 2010 is as follows.
Below is a summary of debt securities at December 31, 2011 and 2010 by contractual or expected maturity periods. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
United States Treasury notes with a book value of $1,036,000 and $1,041,000, both maturing in 2012, were on deposit with the Florida OIR as of December 31, 2010, as required by law for American Vehicle and Federated National respectively, and are included with other investments held until maturity.
Proceeds from sales, pay downs and maturities of debt securities and proceeds from sales of equity securities in 2011, 2010 and 2009 were approximately $108.3 million, $149.0 million and $59.2 million, respectively.
A summary of net realized investment gains and increases in net unrealized gains follows.
As a result of our review of liability for losses and LAE, which includes a re-evaluation of the adequacy of reserve levels for prior year’s claims, we decreased the liability for losses and LAE for claims occurring in prior years by $1.0 million for the year ended December 31, 2011, compared with the increase of $2.8 million and $1.7 million for the years ended December 31, 2010 and 2009, respectively.
For the year ended December 31, 2011, our actuarial firm determined range of statutory loss and LAE reserves on a net basis range from a low of $51.5 million to a high of $65.2 million, with a best estimate of $55.4 million. The Company’s net loss and LAE reserves are carried on a statutory basis at $55.6 million, and on a GAAP consolidated basis at $60.0 million which when netted with our $2.1 million reinsurance recoverable totals $57.9 million. The Company’s point estimate for its reserves as of December 31, 2011 is 0.3% above our actuary’s best estimate, which reflects management’s current analysis of the status and expected timing of our anticipated claims, our analysis of expected weather patterns in the regions in which we sell policies, our re-focus of our business growth efforts to areas outside of South Florida, and other factors.
We trended these severities to accident year 2011 levels. Trend rates were selected based on a review of historical severities. Selected severity was chosen based on judgment considering the developed severities and the trended severities, considering industry benchmarks for each segment. The loss & ALAE, claim count and severity triangles are evaluated as of 12 months, 24 months, 36 months etc. We selected loss development factors based on the loss development history, to the extent credible, and supplemented with industry data where appropriate.
A summary of the provision for income tax benefit is as follows.
The actual income tax benefit differs from the "expected" income tax benefit (computed by applying the combined applicable effective federal and state tax rates to income before provision for income tax benefit) as follows.
The Company has recorded a net deferred tax asset of $8.6 million and $7.9 million as of December 31, 2011 and 2010, respectively. Realization of net deferred tax asset is dependent on generating sufficient taxable income in future periods. Management believes that it is more likely than not that the deferred tax assets will be realized and as such no valuation allowance has been recorded against the net deferred tax asset. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2011 and 2010, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would record valuation allowances as deemed appropriate in the period that the change in circumstances occurs, along with a corresponding increase or charge to net income. The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.
The Company’s consolidated federal and state income tax returns for 2005-2010 are open for review by the Internal Revenue Service (“IRS”) and various state taxing authorities. The federal income tax returns for 2003 and 2002 have been examined by the IRS. The IRS concluded its examination for 2003 and 2002 and there were no material changes in the tax liability for those years. The 2005 and 2006 income tax returns and net operating loss carry-back from tax year 2009 have been reviewed by the Joint Committee on Taxation. The Joint Committee on Taxation completed its consideration in September 2011 and took no exception to the conclusions reached by the IRS regarding the net operating loss carry-back from tax year 2009.
At December 31, 2011, 2010 and 2009, Federated National’s statutory capital surplus was $39.3 million, $18.7 million and $21.0 million, respectively. At December 31, 2010 and 2009, American Vehicle had statutory capital surplus of $21.9 million and $25.8 million, respectively.
An insurance company is also required to adhere to prescribed premium-to-capital surplus ratios. As of December 31, 2011, 2010 and 2009, Federated National was in compliance with the prescribed premium-to-surplus ratio. As of December 31, 2010 and 2009, American Vehicle was in compliance with the prescribed premium-to-surplus ratio.
In order to enhance the regulation of insurer solvency, the National Association of Insurance Commissioners (“NAIC”) established risk-based capital requirements for insurance companies that are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policy holders. These requirements measure three major areas of risk facing property and casualty insurers: (i) underwriting risks, which encompass the risk of adverse loss developments and inadequate pricing; (ii) declines in asset values arising from credit risk; and (iii) other business risks from investments. Insurers having less statutory surplus than required will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The Florida OIR, which follows these requirements, could require Federated National to cease operations in the event they fail to maintain the required statutory capital.
Based upon the 2011 statutory financial statements for Federated National, statutory surplus exceeded the regulatory action levels established by the NAIC’s risk-based capital requirements.
Based upon the 2010 statutory financial statements for Federated National and American Vehicle, statutory surplus exceeded the regulatory action levels established by the NAIC’s risk-based capital requirements.
As of December 31, 2010, American Vehicle was outside NAIC’s usual range for four of thirteen IRIS ratios. These exceptions related to two-years overall operating ratio, investment yield, gross change in policyholders’ surplus and change in adjusted policyholders’ surplus.
There was no action taken by the Florida OIR in connection with the December 31, 2010 IRIS ratio results. We do not currently believe that the Florida OIR will take any significant action regarding the 2011 IRIS ratios, although there can be no assurance that will be the case.
GAAP differs in some respects from reporting practices prescribed or permitted by the Florida OIR. Federated National's statutory capital and surplus was $39.3 million and $18.7 million as of December 31, 2011 and 2010, respectively.
The Company’s subsidiaries are, from time to time, named as defendants in various lawsuits incidental to their insurance operations. Legal actions relating to claims made in the ordinary course of seeking indemnification for a loss covered by the insurance policy are considered by the Company in establishing loss and LAE reserves.
We operate in a regulatory environment where certain entities and organizations have the authority to require us to participate in assessments. Currently these entities and organizations include, but are not limited to, FIGA, Citizens, FHCF and JUA.
As a direct premium writer in the state of Florida, we are required to participate in certain insurer solvency associations under Florida Statutes Section 631.57(3) (a), administered by FIGA. Participation in these pools is based on our written premium by line of business to total premiums written statewide by all insurers. Participation has resulted in assessments against us, as it had in 2006 and 2007, and again on October 30, 2009. There were no assessments made during the years ended December 31, 2008, 2010 or 2011. Through 2007, we were assessed $6.6 million and in 2009 we were assessed an additional $0.6 million in connection with the insolvencies of domestic insurance companies. For statutory accounting these assessments were not charged to operations, in contrast, GAAP treatment was to charge current operations for the assessments. If new assessments occur, we will be required to treat these assessments consistent with GAAP since accounting difference with Statutory accounting no longer exists as of January 1, 2011. Through policyholder surcharges, as approved by the Florida OIR, we have since fully recouped $7.2 million in connection with these assessments.
The Florida OIR issued Information Memorandum OIR-06-008M, titled Notice of Anticipated Florida Hurricane Catastrophe Fund Assessment, and dated May 4, 2006, to all property and casualty insurers, surplus lines insurers, and surplus lines agents in the state of Florida placing them on notice of an anticipated FHCF assessment. Sighting the unprecedented hurricane seasons of 2004 and 2005, the FHCF exhausted nearly all of the $6 billion in reserves it had accumulated since its inception in 1993. The Florida SBA issued its directive to levy an emergency assessment upon all property and casualty business in the state of Florida. There is no statutory requirement that policyholders be notified of the FHCF assessment. The FHCF and Florida OIR are, however, recommending that insurers include the FHCF assessment in a line item on the declaration page for two reasons: (1) this is a multi-year assessment and (2) there may be concurrent assessments and the insureds should know what amount is for which assessment. The assessment became effective on all policies effective after January 1, 2007 and was remitted to the administrator of the assessment as collected.
Florida OIR issued an Order April 29, 2010, levying an increase to the emergency assessment to 1.3% from 1.0%, of direct written premium on all property and casualty lines of business written in the state of Florida for the benefit of the FHCF. The assessment was approved by the Florida SBA to fund FHCF losses stemming from the 2005 hurricane season. This order requires insurers to begin collecting the emergency assessment for policies issued or renewed on or after January 1, 2011. The FHCF emergency assessment is being remitted to the administrator of the assessment as collected and therefore accounted for in a manner such that amounts collected or receivable are not recorded as revenues and amounts due or paid are not expensed. Previously and still in effect, the Florida OIR issued a similar order dated January 11, 2007, levying an emergency assessment of 1.4% of direct written premium on all property and casualty lines of business written in the state of Florida for the benefit of Citizens’ High Risk Account. This order requires insurers to collect the emergency assessment for policies issued or renewed on or after July 1, 2007. Similar to the FHCF assessment discussed above, the Citizens emergency assessment is remitted to the administrator of the assessment as collected and therefore accounted for in a manner such that amounts collected or receivable are not recorded as revenues and amounts due or paid are not expensed.
The Company has recorded a net deferred tax asset of $8.6 million and $7.9 million as of December 31, 2011 and 2010, respectively. Realization of net deferred tax asset is dependent on generating sufficient taxable income in future periods. Management believes that it is more likely than not that the deferred tax assets will be realized and as such no valuation allowance has been recorded against the net deferred tax asset. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2011, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would record valuation allowances as deemed appropriate in the period that the change in circumstances occurs, along with a corresponding increase or charge to net income. The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.
Our executive offices are now located at 14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323 in an 18,500 square feet office facility. All of our operations are consolidated within this facility. We believe that the facilities are well maintained, in substantial compliance with environmental laws and regulations, and adequately covered by insurance. We also believe that these leased facilities are not unique and could be replaced, if necessary, at the end of the lease term. Our lease for this office space will expire in May 2017.
Rent expense was $0.7 million in 2011 and 2010, and $0.6 million in 2009.
One of our directors is a partner at a law firm that handles some of the Company’s claims litigation. Fees paid to this law firm amounted to approximately $3,349, $40,000 and $90,000 in 2011, 2010 and 2009, respectively, and is included in LAE.
Net loss per share is computed by dividing net loss by the weighted average number of shares of common stock and common stock equivalents outstanding during the periods presented. In accordance with GAAP, net loss per share is antidilutive; therefore the basic and diluted loss per share is the same.
In 2001, we implemented a franchisee stock option plan that was terminated during September 2008, and provided for the granting of stock options to individuals purchasing Company owned agencies that were then converted to franchised agencies. The purpose of the plan was to advance our interests by providing an additional incentive to encourage managers of Company owned agencies to purchase the agencies and convert them to franchises. Options outstanding under the plan were granted at prices, which were above the market value of the stock on the date of grant, vested over a ten-year period, and expired ten years after the grant date. Under this plan, we were authorized to grant options to purchase up to 988,500 common shares, and, as of December 31, 2011 and December 31, 2010, we had no outstanding exercisable options to purchase shares.
Activity in our stock option plans for the period from January 1, 2009 to December 31, 2011 is summarized below.
Compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair-value estimated in accordance with the provisions of FASB issued guidance. Results for prior periods have not been restated, as they are not required to be by the pronouncement.
The weighted average fair value of options granted during 2011, 2010 and 2009 estimated on the date of grant using the Black-Scholes option-pricing model was $0.72 to $0.78; $1.54 to $1.81and $0.61 to $1.29, respectively.
Summary information about the Company’s stock options outstanding at December 31, 2011 follows.
For the years ended December 31, 2011, 2010 and 2009, comprehensive loss consisted of the following.
Our Amended and Restated Articles of Incorporation authorize the issuance of one million shares of preferred stock with designations, rights and preferences determined from time to time by our board of directors. Accordingly, our Board of Directors is empowered, without shareholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. We have not issued preferred shares as of December 31, 2011.
21st Century (the parent company only) has no long term obligations, guarantees or material contingencies as of December 31, 2011. The following summarizes the major categories of the parent company’s financial statements.
In September 2006, FASB issued accounting guidance that defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants on the measurement date. This guidance also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance also categorizes assets and liabilities at fair value into one of three different levels depending on the observation of the inputs employed in the measurement, as follows.