Properties - ------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin Cheldin, the Company's president, chairman and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties.
The Company's net income was $5,681,500 in 2004, $1,068,650 in 2003, and a net loss of $3,224,689 in 2002.
Over the past few years, the insurance industry has seen some difficult times as a result of September 11, industry-wide underwriting losses, decreases in investment yield, and increases in reinsurance cost that have all contributed to the change from a "soft market" to a "hard market." Although the Company increased its rates and adopted more restrictive underwriting guidelines, the beneficial market changes contributed to an 8% increase in direct written premium in the year ended December 31, 2004, compared to the year ended December 31, 2003. The Company's future writings and growth are dependent upon, among other things, market conditions, competition, and the Company's ability to introduce new and profitable products. The Company believes that rate adequacy is more important than premium growth and that underwriting profit is the Company's primary goal. Management's assessment of trends and underwriting results is a primary factor in its decisions to expand or contract its business. In 2002, primarily as a result of losses from liquor and premises liability coverages which had rendered much of the Company's business outside of California unprofitable, the Company began placing moratoriums on non-California business on a state-by-state basis. By July 2003, the Company had placed moratoriums on all non-California business. The Company has no plan to expand into additional states or to expand its marketing channels. Instead, the Company intends to allocate its resources toward improving its California business rates, rules, and forms.
The Company incurred underwriting losses in 2000, 2001, and 2002. As a result of these underwriting losses, management analyzed and acted upon various components of its underwriting activity. The Company believes that the implementation of these actions contributed to the improved underwriting results. This is reflected in the decrease in the Company's ratio of losses and loss adjustment expenses to net earned premium from 139% in 2001, to 98% in 2002, to 85% in 2003, and to 69% in 2004.
AAC provides premium financing for Crusader policies that are produced by Unifax in California. Finance charges and fees earned by AAC during 2004 decreased 2% as compared to 2003. The decrease is a result of a 14% decrease in the number of loans issued in 2004 compared to 2003, offset by a 13% increase in the average premium financed from $2,309 in 2003 to $2,606 in 2004.
Primarily as a result of the Company's growth in premiums in 2004 and 2003, the Company generated positive cash flows from operations, which was approximately $14.8 million in 2004 and $15.5 million in 2003. The increased cash flows from operations contributed to the increase in the Company's investment portfolio.
The cash flow provided by operations in the year ended December 31, 2004, was $14,823,837, a decrease in cash flow of $701,549 compared to the cash flow for the year ending December 31, 2003. Cash flow provided by operations for the year ended December 31, 2003, was $15,525,386, an increase of $7,512,162 in cash provided compared to the year ended December 31, 2002. The Company has utilized the cash provided from operating activities and from the maturity of its long and short-term investment primarily to purchase $51.4 million of fixed maturity securities.
The tax-exempt interest income earned (net of bond premium and discount amortization) during the year ended December 31, 2004, was $36,719 compared to $117,892 in the year ended December 31, 2003. In the year ended December 31, 2002, tax-exempt interest income earned totaled $283,856.
The Company's investment policy limits investments in any one company to $2,000,000 and any one U.S. government agency or U.S. government sponsored enterprise to $3,000,000. This limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues. The Company's investment guidelines on equity securities limit investments in equity securities to an aggregate maximum of $2,000,000. As of December 31, 2004, all of the Company's fixed maturity investments were investment grade, the Company held no non-traded fixed maturity or equity securities, all state and municipal tax exempt fixed maturity investments were pre-refunded issues, and all certificates of deposit were FDIC insured.
In 2003, Unico made capital contributions totaling $3,000,000 to its Crusader subsidiary. The contributions were made to ensure that Crusader maintained its A.M. Best Financial Size Category VI rating, which requires capital of a least $25,000,000. The funding of Unico's capital contribution to Crusader was derived from available cash from the Company's other operations and the proceeds of two notes. On September 29, 2003, the Company borrowed $1,000,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer, and $500,000 from The Cary and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the Company's executive vice president. As of December 31, 2004, the Company repaid the note from The Cary and Danielle Cheldin Family Trust in full and repaid $500,000 of the Erwin Cheldin note. On January 31, 2005, the Company repaid an additional $250,000 of the Erwin Cheldin note. The note from Erwin Cheldin is unsecured and it is payable upon demand of lender (on no less than fourteen days' notice) and, if no demand is made, then it is payable in full on September 28, 2007. The note may be prepaid at any time without penalty. The note bears an adjustable interest of 5.5% as of December 31, 2004. The interest is payable monthly and is adjustable every third month by adding a margin of one percentage point to the prime rate.
The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company (see Note 17 of Notes to Consolidated Financial Statements). During the year ended December 31, 2004, the Company did not repurchase any shares of the Company's common stock. As of December 31, 2004, the Company has purchased and retired under the Board of Directors' authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.
In the year ended December 31, 2003, the Company recognized an income tax expense of $287,000 resulting from an assessment for the years 1999 and 2000 from the California Franchise Tax Board. The assessment resulted from a court ruling in Ceridian vs. Franchise Tax Board that held that the California statute permitting the tax deductibility of dividends received from a wholly owned insurance subsidiary was unconstitutional because it discriminated against out-of-state holding companies and thus was in violation of the interstate commerce clause of the United States Constitution. The ruling concluded that the discriminatory sections of the statute are not severable and the entire statute was invalid and unenforceable. California law provides that the proper remedy in such circumstances is to disallow the deduction to those taxpayers that benefited from the deduction. As a result of the court ruling, in February 2003, the Franchise Tax Board (FTB) notified the Company that it would issue a Notice of Proposed Assessment (NPA) for tax years 1999 and 2000 of approximately $287,000 representing California state franchise taxes plus related interest of approximately $80,000. In September 2004, California enacted legislation (AB 263) that addresses many aspects of the tax treatment of insurance company owners, including holding companies such as Unico. The legislation provides for an election, applicable if made to all tax years ending after December 1, 1997, and before January 1, 2005, under which a dividend-received deduction of up to 80% of dividends paid by an insurer to a non-insurer parent is allowed. The Company made the election authorized by AB 263 and, therefore, has reversed 80% of the $287,000 income tax expense. The Company has also reversed 80% of the interest accrued at December 31, 2003, on the $287,000 assessment. In addition, as a result of AB 263, the Company recognized a state deferred tax liability of $157,249 in accordance with FASB 109. This deferred tax liability represents the Company's future state tax liability for all undistributed earnings of Crusader since January 1, 1993. The federal tax benefit resulting from AB 263 as of December 31, 2004, is $53,465. Thus, the net deferred tax liability as of December 31, 2004, is $103,784.
The Company has certain obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2004, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
* On January 31, 2005 the Company repaid $250,000 in advance of the contractual due date of the note.
**Unlike many other forms of contractual obligations, loss and loss adjustment expense reserves do not have definitive due dates and the ultimate payment dates are subject to a number of variables and uncertainties. As a result, the total loss and loss adjustment expense reserve payments to be made by period, as shown above, are estimates.
Results of Operations --------------------- General - ------- The Company had a net income of $5,681,500 for the year ended December 31, 2004, compared to net income of $1,068,650 for the year ended December 31, 2003, and a net loss of $3,224,689 for the year ended December 31, 2002. Total revenue for the year ended December 31, 2004, was $61,903,310 compared to $51,130,439 for the year ended December 31, 2003, and $46,028,642 for the year ended December 31, 2002.
Crusader's primary line of business is commercial multiple peril business package policies. This line of business represented approximately 98% of Crusader's total written premium for the year ended December 31, 2004, 97% for the year ended December 31,2003, and 96% for the year ended December 31, 2002.
As of December 31, 2004, Crusader was licensed as an admitted insurance company in the states of Arizona, California, Idaho, Montana, Nevada, Ohio, Oregon, and Washington and is approved as a non-admitted surplus lines writer in other states.
Year Ended Direct Written Policies Average December 31 Premium Issued Premium ----------- ------- ------ ------- 2004 $68,872,021 20,885 $3,298 2003 $64,047,717 21,425 $2,989 2002 $45,622,280 18,603 $2,452
Beginning July 1, 2003, the Company had placed moratoriums on all non-California business, primarily due to the fact that much of the Company's business outside of California has not been profitable. The Company has no short-term plan to expand into additional states or to expand its marketing channels. Instead, the Company intends to allocate its resources toward improving its California business rates, rules, and forms.
The Company continues to believe that it can compete effectively and profitably by offering better service and by marketing its policies through its current independent agents and brokers.
Earned ceded premiums for the 12 months ended December 31, 2004, increased $1,136,220 (7%) to $17,784,240 compared to $16,648,020 for the 12 months ended December 31, 2003. Earned ceded premiums as a percentage of direct earned premiums were 26% and 31% for 2004 and 2003, respectively. Although direct earned premiums in 2004 increased 26% as compared to 2003, earned ceded premiums increased only 7% primarily as a result of a rate decrease by the Company's reinsurers effective January 1, 2004. Earned ceded premiums for the 12 months ended December 31, 2003, increased $9,438,447 (131%) to $16,648,020 compared
The combined ratio is the sum of (1) the net ratio of losses and loss adjustment expenses incurred (including a provision for incurred-but-not-reported losses "IBNR") to net premiums earned (loss ratio) and (2) the ratio of policy acquisition costs to net premiums earned (expense ratio). The following table shows the loss ratios, expense ratios, and combined ratios of Crusader as derived from data prepared in accordance with GAAP.
As indicated in the above table, loss ratio for the year ended December 31, 2004, decreased to 68.8% from 85.5% in 2003 and 98.1% in 2002. The decrease in the loss ratio since 2002 was primarily due to improvements in the provision for prior years' incurred losses. Generally, if the combined ratio is below 100%, an insurance company has an underwriting profit; if it is above 100%, a company has an underwriting loss.
The Company`s consolidated financial statements include estimated reserves for unpaid losses and related claim settlement or loss adjustment expenses of the insurance company operation. Crusader sets loss and loss adjustment expense reserves at each balance sheet date as management's best estimate of the ultimate payments that it anticipates will be made to settle all losses incurred and related expenses incurred as of that date for both reported and unreported losses. Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates based on experience and industry data for development of case estimates and for unreported losses and loss adjustment expenses. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.
2004 losses and loss adjustment expenses - ---------------------------------------- Losses and loss adjustment expenses were $34,450,738 or 69% of net premium earned for the year ended December 31, 2004, compared to $31,720,533 or 85% of net premium earned for the year ended December 31, 2003. Incurred losses of prior years were approximately $835,434 (favorable development) for the year ended December 31, 2004, compared to an incurred losses of prior years of $2,751,585 (adverse development) for the year ended December 31, 2003.
1. Business Outside of California 2. Habitability Exposure 3. Construction Defect Exposure 4. Special Risk Class of Business 5. Increased Cost of Settling Claims, Indemnity and Expense 6. Increased Cost of Reinsurance 7. Mold Exposure 8. Terrorism Exposure
The following is a discussion of the above items. The Company believes that except for one aberrational claim previously discussed under the 2003 adverse development, the implementation of the above items have contributed to improved operating results in 2003 and 2004.
1. Business Outside of California: Collectively, the insurance underwritten by the Company outside of California has been very unprofitable, particularly with respect to the Liquor and Premises types of liability coverage. The Company adopted substantial rate increases and coverage restrictions beginning in June of 2001 for all Liquor Liability written outside of California and Nevada. The rate increases caused a dramatic decline in sales, causing the Company to be concerned about adverse selection. The Company determined that under current market conditions, it could not sell its policies at an adequate rate outside of California and ceased writing in those states.
Non-California Non-California Accident Direct Written Direct Earned Year Premium Premium ---- ------- ------- 1997 $9,464,473 $9,287,644 1998 $5,813,949 $8,085,720 1999 $4,429,266 $4,783,426 2000 $4,746,126 $4,473,864 2001 $5,263,039 $5,112,715 2002 $3,031,606 $4,431,289 2003 $18,224 $1,198,006 2004 ($404) $19,862
5. Increased Cost of Settling Claims: In 2002 the Company noticed a trend of increasing costs in settling claims but does not believe that the trend reflects operational changes. The Company believes that the trend is most likely attributable to several changes in the law, including an increased propensity for trial courts to award large plaintiff verdicts. However, several favorable decisions were recently published, including the U.S. Supreme Court's limitation on punitive damages (see Campbell vs. State Farm, 2003), and the California Supreme Court's limitation on public policy reformations (see Rosen vs. State Farm, 2003). It is difficult to quantify and predict the continuation of this trend. In 2003, an outside actuary was engaged to assist the Company in reviewing the premium rate adequacy of certain key Crusader programs and to assist in the regulatory rate filings. Crusader raises its premium rates whenever the adequacy is in doubt.
6. Increased Cost of Reinsurance: In 2003, the cost of reinsurance significantly increased primarily as a result of losses sustained outside of California that the Company no longer underwrites. The Company received a slight decrease in its reinsurance rates in 2004.
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Commission income $2,156,924 $3,312,715 $2,741,672
AIB markets health and life insurance in California through non-affiliated insurance companies for individuals and groups and receives commission and fee income based on the premiums that it writes.
Commission and fee income for the year ended December 31, 2003 increased $571,043 (21%) compared to the year ended December 31, 2002. The increase in health and life insurance program commission and fee income was primarily due to an increase in premium written. This increase was primarily due to the fact that in November 2002 CIGNA terminated their contract with another administrator and approximately 2,000 affected members were transitioned into the Company's health and life insurance program effective January 1, 2003. Approximately 65% were enrolled in the CIGNA individual health and family program and 35% were enrolled in CIGNA's small group program.
Policy fee income for the year ended December 31, 2003, increased $1,216,676 (54%) as compared to the year ended December 31, 2002. The increase in policy fee income was due to an increase in the fee from $100 to $165 per policy written in California effective on and after the latter part of August 2002 and due to the 2,822 (15%) increase in the number of policies written by Unifax during 2003 as compared to 2002.
Commission and fee income during the year ended December 31, 2004, were $565,452, a decrease of $250,173 (31%) as compared to the year ended December 31, 2003. Commission and fee income for the year ended December 31, 2003, increased by $26,142 (3%) compared to the year ended December 31, 2002.
The daily automobile rental insurance program commission income (excluding contingent commission) decreased $18,233 (3%) in 2004 compared to 2003. The daily automobile rental insurance program commission income (excluding contingent commission) decreased $67,808 (11%) in 2003 compared to 2002. Premium written in 2004 decreased 6% compared to premium written in 2003, and premium written in 2003 increased 11% compared to premium written in 2002. The decrease in written premium in 2004 and 2003 is primarily due to the continued intense price competition in the daily automobile rental insurance program, which is causing these fluctuations in the Company's written premium and related commission income. To avoid underwriting losses for the non-affiliated insurance Company that it represents, Bedford continues to produce business only at rates that it believes to be adequate. The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change.
The decrease in claim administration fee income is due to the fact that the Company's subsidiary U.S. Risk Managers, Inc., (U.S. Risk) ceased providing insurance claim administration services to a non-affiliated property and casualty insurance as of December 31, 2003, and it is currently inactive. As of December 31, 2003, the non-affiliated insurance company assumed the claim administration responsibility for all outstanding and IBNR claims. During 2003, the Company recognized $200,000 of claim administration fees that were unearned as of December 31, 2002. Although U.S. Risk is inactive, the Company is still responsible for all claim administration cost arising from losses covered by premiums for which it received a claim administration fee. As of December 31, 2003, the non-affiliated insurer assumed the claim administration for the remaining outstanding and IBNR claims. During 2004, the Company did not receive any claim administration fees and will not incur any future internal claim administration costs. The unearned claim administration reserve as of December 31, 2004, is in the amount of $100,000 and it reflects the estimated costs to complete the claim administration by the non-affiliated insurer. The non-affiliated insurer will bill the Company for these costs as they are incurred.
The increase in membership and fee income for the year ended December 31, 2003, as compared to 2002 is primarily a result of the fact that in November 2002 CIGNA terminated its contract with another administrator and approximately 2,000 affected members were transitioned into the Company's health and life insurance program effective January 1, 2003.
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Premium finance charges and fees earned $933,529 $952,543 $878,316 New loans 5,156 6,216 6,340
Premium finance charges and fees earned for the year ended December 31, 2003, increased $74,227 (8%) as compared to 2002. The increase in revenues despite the 124 (2%) decrease in the number of new loans in 2003 was primarily due to a 23% increase in the average policy premium financed as compared to 2002.
The amortized cost and estimated market value of fixed maturity investments at December 31, 2004, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
(Amounts in Thousands) As of December 31, 2004 ----------------------- Amortized Market Fixed maturities due Cost Value - -------------------- ---- ----- Within 1 year $50,772 $50,712 Beyond 1 year but within 5 years 78,218 78,848 Beyond 5 years but within 10 years - - ------- ------- Total $128,990 $129,560 ======= =======
Total salaries and employee benefits incurred for the year ended December 31, 2003, increased $932,463 (12%) compared to the year ended December 31, 2002. Factors that affected the 12% increase include the hiring of higher-level employees, general salary increases (less than 6%), and increases in employee benefits costs.
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Other operating expenses $2,657,310 $2,897,886 $3,248,227
Income Taxes - ------------ Income tax expense for the year ended December 31, 2004, was $2,990,958 compared to an income tax expense of $1,080,721 for the year ended December 31, 2003. The effective combined income tax rates for 2004 and 2003 were 34% and 50%, respectively. The pre-tax income increased $6,523,087 for the year ended December 31, 2004, compared to the year ended December 31, 2003, which resulted in an increased income tax expense in 2004. The income tax expense for the year ended December 31, 2003, was $1,080,721 compared to an income tax benefit of $1,589,370 for the year ended December 31, 2002. The effective combined income tax rates for 2003 and 2002 were 50% and 33%, respectively.
In the year ended December 31, 2003, the Company recognized an income tax expense of $287,000 resulting from an assessment for the years 1999 and 2000 from the California Franchise Tax Board. The assessment resulted from a court ruling in Ceridian vs. Franchise Tax Board that held that the California statute permitting the tax deductibility of dividends received from a wholly owned insurance subsidiary was unconstitutional because it discriminated against out-of-state holding companies and thus was in violation of the interstate commerce clause of the United States Constitution. The ruling concluded that the discriminatory sections of the statute are not severable and the entire statute was invalid and unenforceable. California law provides that the proper remedy in such circumstances is to disallow the deduction to those taxpayers that benefited from the deduction. As a result of the court ruling, in February 2003, the Franchise Tax Board (FTB) notified the Company that it would issue a Notice of Proposed Assessment (NPA) for tax years 1999 and 2000 of approximately $287,000 representing California state franchise taxes plus related interest of approximately $80,000. In September 2004, California enacted legislation (AB 263) that addresses many aspects of the tax treatment of insurance company owners, including holding companies such as Unico. The legislation provides for an election, applicable if made to all tax years ending after December 1, 1997, and before January 1, 2005, under which a dividend-received deduction of up to 80% of dividends paid by an insurer to a non-insurer parent is allowed. The Company made the election authorized by AB 263 and, therefore, has reversed 80% of the $287,000 income tax expense and 80% of the interest accrued thereon. In addition, as a result of AB 263, the Company recognized a state deferred tax liability of $157,249 in accordance with FASB 109. This deferred tax liability represents the Company's future state tax liability for all undistributed earnings of Crusader since
January 1, 1993. The federal tax benefit resulting from AB 263 as of December 31, 2004, is $53,465. Thus, the net deferred tax liability as of December 31, 2004, is $103,784.
There were no other accounting standards issued during 2004 that are expected to have a material impact on the Company's consolidated financial statements.
Investments ----------- In accordance with Statement of Financial Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities, the Company is required to classify its investments in debt and equity securities into one of three categories: held-to-maturity, available-for-sale or trading securities.
Related Party Transactions - -------------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin Cheldin, the Company's president, chairman and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties. The Company utilizes for its own operations approximately 100% of the space it leases.
Forward Looking Statements - -------------------------- Certain statements contained herein, including the Sections entitled "Business," "Legal Proceedings" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," that are not historical facts are forward looking. These statements, which may be identified by forward looking words or phrases such as "anticipate," "appears," "believe," "estimates," "expect," "intend," "may," "should," and "would," involve risks and uncertainties, many of which are beyond the control of the Company. Such risks and uncertainties could cause actual results to differ materially from these forward looking statements. Factors which could cause actual results to differ materially include those described under Item 1 - Business - Competition; premium rate adequacy relating to competition or regulation; actual versus estimated claim experience; success of the Company's underwriting and pricing actions that it believes addressed the adverse development on its construction defect, apartment house habitability, special risk class of business, and non-California liquor liability claims; the outcome of existing and planned filings with regulatory authorities seeking rate increases; acceptance by insureds of rate increases; adequacy of rate increases; possible reductions in Crusader's A.M. Best rating; regulatory changes or developments; the outcome of regulatory proceedings; unforeseen calamities; general market conditions; and the Company's ability to introduce new profitable products.
Page Number ------ Report of Independent Registered Public Accounting Firm 35
Consolidated Statements of Operations for the years ended December 31, 2004, December 31, 2003, and December 31, 2002 37
Consolidated Statements of Comprehensive Income for the years ended December 31, 2004, December 31, 2003, and December 31, 2002 38
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Unico American Corporation and subsidiaries as of December 31, 2004 and 2003, and the results of its their operations and its their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------- Nature of Business - ------------------ Unico American Corporation is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary; provides property, casualty, health and life insurance through its agency subsidiaries; and provides insurance premium financing, claim administration services, and membership association services through its other subsidiaries. Unico American Corporation is referred to herein as the "Company" or "Unico" and such references include both the corporation and its subsidiaries, all of which are wholly owned, unless otherwise indicated. Unico was incorporated under the laws of Nevada in 1969.
Use of Estimates - ---------------- The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While every effort is made to ensure the integrity of such estimates, actual results could differ.
Investments - ----------- All of the Company's fixed maturity investments are classified as available-for-sale and are stated at market value. Although all of the Company's investments are classified as available-for-sale and the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates market value. Investments in equity securities are carried at market value. The unrealized gains or losses from fixed maturities and equity securities are reported as "accumulated other comprehensive income (loss)," which is a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses are included in the consolidated statements of operations based on the specific identification method.
b. Insurance Company Operations -------------------------------- Premiums are earned on a pro-rata basis over the terms of the policies. Premiums applicable to the unexpired terms of policies in force are recorded as unearned premiums. The Company earns a commission on policies that are ceded to its reinsurers. This commission is considered earned on a pro-rata basis over the terms of the policies.
(2) Included in short-term investments are two deposits assigned and held by Travis County and the Los Angeles Superior courts. These deposits are filed with the superior courts in lieu of a bond in order to stay execution of judgments and to allow the Company to appeal the judgment in these matters. . (3) Included in fixed maturity investments are statutory deposits assigned to and held by the California State Treasurer and the Insurance Commissioner of the State of Nevada. These deposits are required for writing certain lines of business in California and for admission in states other than California.
Reinsurance - ----------- The Company cedes reinsurance to provide for greater diversification of business, to allow management to control exposure to potential losses arising from large risks by reinsuring certain levels of risk in various areas of exposure, to reduce the loss that may arise from catastrophes, and to provide additional capacity for growth. Prepaid reinsurance premiums and reinsurance receivables are reported as assets and represent ceded unearned premiums and reinsurance recoverable on both paid and unpaid losses, respectively. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies.
Concentration of Risks - ---------------------- In 2004 100% of Crusader's gross premium written was derived from California. In 2004 approximately 78% of the $2,156,924 commission and fee income from the Company's health and life insurance program was from CIGNA HealthCare medical and dental plan programs.
NOTE 2 - ADVANCE PREMIUM AND PREMIUM DEPOSITS - --------------------------------------------- Some of the Company's health and life programs require payments of premium prior to the effective date of coverage; and, accordingly, invoices are sent out as early as two months prior to the coverage effective date. Insurance premiums received for coverage months effective after the balance sheet date are recorded as advance premiums. The Company received deposits to guarantee the payment of premiums for past coverage months on its daily automobile rental program. These deposits are required when information such as gross receipts or number of rental cars is required to compute the actual premium due, but is not available until after the coverage month.
Gross realized gains on fixed maturities: - - $3,906 Gross realized (losses) on equity securities: - - (216) ----- Net realized investment gains (losses) - - $3,690 =====
Amortized Estimated Cost Market Value ---- ------------ Due in one year or less $50,771,462 $50,711,703 Due after one year through five years 78,218,196 78,847,912 Due after five years through ten years - - ----------- ----------- Total fixed maturities $128,989,658 $129,559,615 =========== ===========
The Company monitors its investments closely. If an unrealized loss is determined to be other than temporary it is written off as a realized loss through the Consolidated Statements of Operations. The Company's methodology of
*Deposited with superior courts to stay execution of judgments pending appeal of two Crusader claims.
Year ended December 31 ---------------------- 2004 2003 ---- ---- Furniture, fixtures, computer, office, and transportation equipment $1,599,077 $1,570,716 Accumulated depreciation 1,320,673 1,247,626 --------- --------- Net property and equipment $278,404 $323,090 ======= =======
NOTE 5 - PREMIUMS, COMMISSIONS AND NOTES RECEIVABLE, NET - -------------------------------------------------------- Premiums and notes receivable are substantially secured by unearned premiums and funds held as security for performance.
Year ended December 31 ---------------------- 2004 2003 ---- ---- Premiums and commission receivable $2,947,130 $2,851,189 Premium finance notes receivable 4,843,060 5,457,797 --------- --------- Total premiums and notes receivable 7,790,190 8,308,986 Less allowance for doubtful accounts 19,630 18,817 --------- --------- Net premiums and notes receivable $7,770,560 $8,290,169 ========= =========
NOTE 6 - NOTES PAYABLE - RELATED PARTIES - ---------------------------------------- In 2003, Unico made capital contributions totaling $3,000,000 to its Crusader subsidiary. The contributions were made to ensure that Crusader's capital remained above $25,000,000. The funding of Unico's capital contribution to Crusader was derived from available cash from the Company's other operations and the proceeds of two notes. On September 29, 2003, the Company borrowed $1,000,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer, and $500,000 from The Cary and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the Company's executive vice president. As of December 31, 2004, the Company repaid the note from The Cary and Danielle Cheldin Family Trust in full and repaid $500,000 of the Erwin Cheldin note. On January 31, 2005, the Company repaid an additional $250,000 of the Erwin Cheldin note. The note from Erwin Cheldin is unsecured and it is payable upon demand of lender (on no less than fourteen days' notice) and, if no demand is made, then it is payable in full on September 28, 2007. The note may be prepaid at any time without penalty. The note bears an adjustable interest of 5.5% as of December 31, 2004. The interest is payable monthly and it is adjustable every third month by adding a margin of one percentage point to the prime rate.
Note payable - Erwin Cheldin $500,000 $1,000,000 Note payable - The Cary and Danielle Cheldin Family Trust - 500,000 ------- --------- Notes payable - related parties $500,000 $1,500,000 ======= =========
Loss and loss adjustment expense reserves by line of business before reinsurance are as follows:
NOTE 8 - DEFERRED POLICY ACQUISITION COSTS - ------------------------------------------ Deferred policy acquisition costs consist of commissions (net of ceding commission), premium taxes, inspection fees, and certain other underwriting costs, which are related to and vary with the production of Crusader policies. Policy acquisition costs are deferred and amortized as the related premiums are earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future income, including investment income.
Year ending ----------- December 31, 2005 $1,025,952 December 31, 2006 1,025,952 December 31, 2007 (through March 31, 2007) 256,488 --------- Total minimum payments $2,308,392 =========
NOTE 12 - REINSURANCE - --------------------- A reinsurance transaction occurs when an insurance company transfers (cedes) a portion of its exposure on business written by it to a reinsurer that assumes that risk for a premium (ceded premium). Reinsurance does not legally discharge the Company from primary liability under its policies. If the reinsurer fails to meet its obligations, the Company must nonetheless pay its policy obligations. In 2004, Crusader's primary excess of loss reinsurance agreements were with Platinum Underwriters Reinsurance, Inc. (A.M. Best Rating A) and Hannover Ruckversicherungs AG (A.M. Best Rating A). In 2003, Crusader's primary excess of loss reinsurance agreements were with Platinum Underwriters Reinsurance, Inc., Hannover Ruckversicherungs AG, QBE Reinsurance Corporation (A.M. Best Rating A). From 2000 through 2002 Crusader had its primary excess of loss reinsurance agreements with Partner Reinsurance Company of the U.S. (A.M Best Rating A+). In 1999, Crusader had its primary excess of loss reinsurance agreements with General Reinsurance Corporation (A.M. Best Rating A++). Crusader also has catastrophe reinsurance from various highly rated California admitted and Bermuda reinsurance companies. These reinsurance agreements help protect Crusader against liabilities in excess of certain retentions, including major or catastrophic losses that may occur from any one or more of the property and/or casualty risks which Crusader insures. The Company has no reinsurance recoverable balances in dispute.
The increase in earned ceded premiums in 2004 and 2003 were primarily the result of rate increases by the Company's reinsurers and the increase in the related direct earned premiums on which those rates were based. The rate increases are primarily due to the Company's ceded loss experience and the hardening of the reinsurance marketplace.
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Premiums written: Direct business $68,872,021 $64,047,717 $45,622,280 Reinsurance assumed - - - Reinsurance ceded (17,782,448) (16,627,560) (7,259,079) ---------- ---------- ---------- Net premiums written $51,089,573 $47,420,157 $38,363,201 ========== ========== ==========
Premiums earned: Direct business $67,890,808 $53,754,119 $40,568,845 Reinsurance assumed - - - Reinsurance ceded (17,784,240) (16,648,020) (7,209,573) ---------- ---------- ---------- Net premiums earned $50,106,568 $37,106,099 $33,359,272 ========== ========== ==========
NOTE 14 - STATUTORY CAPITAL AND SURPLUS - --------------------------------------- Crusader is required to file an annual statement with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory). Statutory accounting practices differ in certain respects from GAAP. The more significant of these differences for statutory accounting are (a) premium income is taken into earnings over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) fixed maturity securities are reported at amortized cost, or the lower of amortized cost or market value, depending on the quality of the security as specified by the NAIC; (c) equity securities are valued by the NAIC as required by Statutory Accounting Principles; d) non-admitted assets are charged directly against surplus; (e) loss reserves and unearned premium reserves are stated net of reinsurance; and (f) federal income taxes are recorded when payable and deferred taxes, subject to limitations, are recognized but only to the extent that they do not exceed 10% of statutory surplus; changes in deferred taxes are recorded directly to surplus as regards policyholders. Additionally, the cash flow presentation is not consistent with generally accepted accounting principles and reconciliation from net income to cash provided by operations is not presented. Comprehensive income is not presented under statutory accounting.
As of December 31, 2004 $29,436,343 As of December 31, 2003 $26,103,440
Year ended December 31, 2004 $3,343,859 Year ended December 31, 2003 $(3,106,103) Year ended December 31, 2002 $(5,331,777)
Crusader is restricted in the amount of dividends it may pay to its parent in any twelve (12) month period without prior approval of the California Department of Insurance. Presently, without prior approval, Crusader may pay a dividend in any twelve (12) month period to its parent equal to the greater of (a) 10% of Crusader's statutory policyholders' surplus or (b) Crusader's statutory net income for the preceding calendar year. There were no dividends paid by Crusader to Unico in 2004, 2003, or in 2002. Based on Crusader's statutory surplus as regards policyholders as of December 31, 2004, the maximum dividend that could be made by Crusader to Unico without prior regulatory approval in 2005 is $2,943,634.
serve as a diagnostic solvency tool for regulators that establishes uniform capital levels and specific authority levels for regulatory intervention when an insurer falls below minimum capital levels. The RBC Model Law specifies four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer if its RBC is equal to or less than 200% of its computed authorized control level RBC. A company's RBC is required to be disclosed in its statutory annual statement. The RBC is not intended to be used as a rating or ranking tool nor is it to be used in premium rate making or approval. Crusader's adjusted capital at December 31, 2004, was 301% of authorized control level risk-based capital.
An unusual range of ratio results has been established from studies of the ratios of companies that have become insolvent or have experienced financial difficulties. In the analytical phase, companies that receive four or more financial ratio values outside the usual range are analyzed in order to identify those companies that appear to require immediate regulatory action. Subsequently, a more comprehensive review of the ratio results and an insurer's annual statement are performed to confirm that an insurer's situation calls for increased or closer regulatory attention.
NOTE 15 - STOCK PLANS - --------------------- The Company's 1999 Omnibus Stock Plan that covers 500,000 shares of the Company's common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.) was approved by shareholders June 4, 1999. On August 26, 1999, the Company granted 135,000 incentive stock options of which 40,000 were terminated and 95,000 were outstanding and exercisable as of December 31, 2004. These options expire 10 years from the date of the grant.
January 1, 2004 54,500 January 1, 2005 55,000 January 1, 2006 37,500 January 1, 2007 30,000 ------- Total 177,000 =======
Options exercisable were 149,500 at December 31, 2004, at a weighted average exercise price of $7.01; 95,000 at December 31, 2003, at a weighted average exercise price of $9.25; 92,500 at December 31, 2002, at a weighted average exercise price of $9.25.
Computed tax expense (benefit) $2,948,636 $730,786 $(1,636,780) Tax effect of: Tax exempt income (10,612) (34,071) (82,034) State tax, net of federal tax benefit 65,237 370,784 114,413 Other (12,303) 13,222 15,031 --------- --------- --------- Tax per financial statements $2,990,958 $1,080,721 $(1,589,370) ========= ========= =========
Year ended December 31 ---------------------- 2004 2003 ---- ---- Deferred tax assets: Discount on loss reserves $2,368,238 $2,246,793 Unearned premiums 2,418,595 2,351,751 AMT credit - 203,340 State income tax deductible in future periods 152,306 121,278 Other 104,644 89,499 --------- --------- Total deferred tax assets $5,043,783 $5,012,661 --------- ---------
NOTE 17 - REPURCHASE OF COMMON STOCK - EFFECT ON STOCKHOLDERS' EQUITY - --------------------------------------------------------------------- The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company. During the year ended December 31, 2004, the Company did not purchase any shares of the Company's common stock. As of December 31, 2003, the Company had purchased and retired under the Board of Directors authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.
*In loss periods, options are excluded from the calculation of diluted EPS, as the inclusion of such options would have an antidilutive effect. Therefore, 1,428 options were excluded from the calculation of diluted EPS for the year ended December 31, 2002.