Properties ---------- The Company presently occupies a 46,000 square foot office building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2012. Erwin Cheldin, the Company's president, chairman, and principal stockholder, is the owner of the building. The Company signed an extension to the lease with a 4% increase in rent effective April 1, 2007. The lease provides for an annual gross rent of $1,025,952 through March 31, 2007 and $1,066,990 from April 1, 2007 through March 31, 2012. In addition, the lease extension provides for two, five-year options with a rent increase of 5% for each option period. The Company believes that at the inception of the lease agreement and at each subsequent extension, the terms of the lease 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.
Overview -------- General - ------- 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, insurance premium financing, and membership association services.
The Company's net income was $11,794,241 in 2006, $6,715,004 in 2005, and $5,681,500 in 2004.
Insurance Company Operation - --------------------------- The property and casualty insurance industry is highly competitive and includes many insurers, ranging from large companies offering a wide variety of products worldwide to smaller, specialized companies in a single state or region offering only a single product. Many of the Company's existing or potential competitors have considerably greater financial and other resources, have a higher rating assigned by independent rating organizations such as A.M. Best Company, have greater experience in the insurance industry and offer a broader line of insurance products than the Company. Crusader is writing primarily Commercial Multiple Peril business only in the state of California. Crusader's financial strength rating has been upgraded by A.M. Best Company from B+ (Good) to B++ (Good), effective January 2, 2007, with a rating outlook of stable.
The property and casualty insurance industry is characterized by periods of soft market conditions, in which premium rates are stable or falling and insurance is readily available, and by periods of hard market conditions, in which premium rates rise, coverage may be more difficult to find and insurers' profits increase. The Company believes that the California property and casualty insurance market has transitioned to a "soft market" in the last few years The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change. Despite the increased competition in the property and casualty marketplace, the Company believes that rate adequacy is more important than premium growth, and that underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) is its primary goal. For the year ended December 31, 2006, gross written premium was $51,913,967, a decrease of $8,354,817 (14%) compared to 2005.
For the twelve months ended December 31, 2006, losses and loss adjustment expenses for insured events of the current year were $29,997,662, offset by $12,170,683 of favorable development for events of prior years. For the twelve months ended December 31, 2005, losses and loss adjustment expenses for insured events of the current year were $35,338,196, offset by $3,824,464 of favorable development for events of prior years. The favorable developments resulted from settling or re-estimating claims for lesser amounts than they were previously forecast.
AIB sells and services health insurance policies for individual/family and small business groups and receives commissions based on the premiums that it writes. Commissions remained relatively comparable in the year ended December 31, 2006, compared to 2005.
AAC provides premium financing for Crusader policies that are produced by Unifax in California. Finance charges and fees earned by AAC during 2006 decreased 10% as compared to 2005. The decrease is primarily a result of a 17% decrease in the number of loans issued in 2006 compared to 2005. Average premium financed increased 8% to $2,758 in 2006 from $2,557 in 2005.
As of December 31, 2006, the weighted average maturity of the Company's fixed maturity investments was 1.3 years compared to 1.2 years and 1.4 years as of December 31, 2005, and December 31, 2004, respectively.
The cash flow provided by operations in the year ended December 31, 2006, was $6,297,894, a decrease in cash flow of $3,500,448 compared to the cash flow for the year ending December 31, 2005. Cash flow provided by operations for the year ended December 31, 2005, was $9,798,342, a decrease of $5,025,495 in cash provided compared to the year ended December 31, 2004. The Company has utilized the cash provided from operating activities and from the maturity of its fixed maturity investments primarily to purchase $68.9 million of fixed maturity securities in 2006.
The most significant liquidity risk faced by the Company is adverse development of the insurance company's loss and loss adjustment expense reserves. Based on the Company's current loss and loss expense reserves and expected current and future payments, the Company believes that there are no current liquidity issues. However, no assurance can be given that the Company's estimate of ultimate loss and loss adjustment expense reserves will be sufficient.
Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, its reserves for loss payments, and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its
investments. Cash and investments (excluding net unrealized gains or losses) at December 31, 2006, were $147,346,870 compared to $140,617,062 at December 31, 2005, a 5% increase. Crusader's cash and investments at December 31, 2006, was $144,120,695 or 98% of the total held by the Company, compared to $137,990,174 or 98% of the total held by the Company at December 31, 2005.
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 investment securities into one of three categories: held-to-maturity, available-for-sale, or trading securities. Although all of the Company's investment in fixed maturity securities 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.
The Company's investment guidelines on equity securities limit investments in equity securities to an aggregate maximum of $2,000,000. The Company's investment guidelines on fixed maturities limit those investments to high-grade obligations with a maximum term of eight years. The maximum investment authorized in any one issuer is $2,000,000 and the maximum in any one U.S. government agency or U.S. government sponsored enterprise is $3,000,000. This dollar limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues. Investments in municipal securities are primarily pre-refunded and secured by U.S. treasury securities. The short-term investments are either U.S. government obligations, FDIC insured, or are in an institution with a Moody's rating of P2 and/or a Standard & Poor's rating of A1. All of the Company's fixed maturity securities are rated and readily marketable and could be liquidated without any materially adverse financial impact.
No dividends were declared or paid by Crusader to Unico in 2006, 2005 or 2004. Based on Crusader's statutory net income for the year ended December 31, 2005, the maximum dividend that could be made by Crusader to Unico without prior regulatory approval in 2007 is $13,396,732.
The Company has certain obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2006, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
For the year ended December 31, 2006, the Company had income before taxes of $18,153,986 compared to income before taxes of $10,466,430 in the year ended December 31, 2005, an increase in income before taxes of $7,687,556. The increase in pre-tax income was primarily due to an increase of $7,404,321 in the underwriting profit from Crusader.
The effect of inflation on the net income of the Company during the years ended December 31, 2006, 2005, and 2004 was not significant.
Crusader's primary line of business is commercial multiple peril policies. This line of business represented approximately 97% of Crusader's total written premium for the year ended December 31, 2006, 97% for the year ended December 31, 2005, and 98% for the year ended December 31, 2004.
The Company's future writings and growth are dependent on market conditions, competition, and upon the Company's ability to introduce new marketing channels and profitable products. The Company continues to believe that it can compete effectively and profitably by offering better service and by focusing its marketing efforts upon independent agents. Historically, most of Crusader's marketing was aimed at independent insurance brokers, representatives of the consumer. With the relatively recent advent of heightened competition and of declining sales, in 2007 Crusader adopted a plan to supplement its marketing efforts with independent agents, representatives of the Company. The Company believes that those agents will be particularly effective and that their efforts will not diminish the business historically produced by independent brokers. Crusader expects to begin making those agency appointments during 2007.
The Company writes annual policies and, therefore, earns written premium daily over the one-year policy term. Premium earned before reinsurance decreased $8,020.551 (12%) in the year ended December 31, 2006, compared to the year ended December 31, 2005, and decreased $3,178,044 (5%) in the year ended December 31, 2005, compared to the year ended December 31, 2004. The decrease in earned premium before reinsurance in 2006 and 2005 is a direct result of the decrease in written premium in 2006 and 2005, respectively.
Earned ceded premium for the 12 months ended December 31, 2006, decreased $476,420 (3%) to $13,758,424 compared to $14,234,844 for the 12 months ended December 31, 2005. Earned ceded premiums as a percentage of direct earned premiums were 24% and 22% for 2006 and 2005, respectively. Earned ceded premium for the 12 months ended December 31, 2005, decreased $3,594,396 (20%) to $14,234,844 compared to $17,784,240 for the 12 months ended December 31, 2004. Earned ceded premiums as a percentage of direct earned premiums were 22% and 26% for 2005 and 2004, respectively.
Losses and Loss Adjustment Expenses ----------------------------------- Losses and loss adjustment expenses and loss ratio are as follows:
Expected losses and loss adjustment expenses are determined based on earned premiums. The portion of the premium dollar expected to pay claims costs is referred to as the expected loss and loss adjustment expense ratio. Accident years 2004 through 2006 has substantially the same expected loss and loss adjustment expense ratio. The Company's emerging loss and loss adjustment expense ratios for each accident year are reviewed in detail at the end of each quarter as part of the reserve diagnostics testing.
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Loss ratio 41.5% 62.4% 68.8% Expense ratio 21.5% 20.8% 20.6% ---- ---- ---- Combined ratio 63.0% 83.2% 89.4% ==== ==== ====
As indicated in the above table, the loss ratio for the year ended December 31, 2006, decreased to 41.5% from 62.4% in 2005 and 68.8% in 2004. The continuous decrease in the loss ratio 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.
Any reduction in losses and loss adjustment expenses from redundancies in the Company's December 31, 2006, reserves over actual future payments, and/or any additional losses and loss adjustment expenses from actual
future payments that exceed the Company's reserves, will be recognized in the consolidated statements of operations of future accounting periods. The Company's current expected loss and loss adjustment expense ratio assumption closely approximates the Company's historical average loss and loss adjustment expense ratio. A difference between the Company's current expected loss and loss adjustment expense ratio assumption and the actual loss and loss adjustment expense ratio for a given accident year will ultimately result in a dollar change (either higher or lower) that is a multiple of the earned premium for that year. The actual loss and loss adjustment expense ratio has been within five percentage points of the current expected loss and loss adjustment expense ratio in four of the Company's twenty-two years. Since the Company's net earned premium in 2006 was $42,933,789, a difference between the accident year 2006 actual and current expected loss and loss adjustment expense ratios of only five percentage points will ultimately impact losses and loss adjustment expenses by $2,146,689. The actual loss and loss adjustment expense ratio has been within ten percentage points of the current expected loss and loss adjustment expense ratio in nine of the Company's twenty-two years. A difference of ten percentage points on accident year 2006 will ultimately impact losses and loss adjustment expenses by $4,293,379. The actual loss and loss adjustment expense ratio has been within twenty percentage points of the current expected loss and loss adjustment expense ratio in fifteen of the Company's twenty-two years. A twenty percentage point difference between the accident year 2006 actual and the current expected loss and loss adjustment expense ratios will ultimately impact losses and loss adjustment expenses by $8,586,758. In addition, accident years 2005 and prior are still developing. Future development on those years might either offset or add to any future development that emerges on accident year 2006.
Reserves for Losses and Loss Adjustment Expenses ------------------------------------------------ The Company's liability for unpaid loss and loss adjustment expense (reserves) consists of case reserves and reserves for incurred but not reported (IBNR) claims. Case reserves are established by claims personnel based on a review of the facts known at the time the claim is reported and are subsequently revised as more information about a claim becomes known. IBNR is computed using various actuarial methods and techniques and includes (1) reserves for losses and loss adjustment expenses on claims that have occurred but for which claims have not yet been reported to the Company, and (2) a provision for expected future development on case reserves for information not currently known.
The Company`s consolidated financial statements include estimated reserves for unpaid losses and related loss adjustment expenses of the insurance company operation. The Company sets loss and loss adjustment expense reserves at each balance sheet date at management's best estimate of the ultimate payments that it anticipates will be made to settle all losses incurred and all related loss adjustment expenses incurred as of that date, for both reported and unreported claims.
Analysis of the roll forward of reserves for losses and loss adjustment expenses - -------------------------------------------------------------------------------- The following table provides an analysis of the roll forward of Crusader's losses and loss adjustment expenses, including a reconciliation of the ending balance sheet liability for the periods indicated:
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Membership and fee income $300,527 $318,349 $333,470
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Commission income $1,634,438 $1,628,061 $2,156,924
AIB markets health and life insurance in California through non-affiliated insurance companies for individuals and groups. For these services, AIB receives commission based on the premiums that it writes. Commission income remained relatively comparable in the year ended December 31, 2006, compared to 2005. Commission income decreased $528,863 (25%) in the year ended December 31, 2005, compared to 2004. The decrease in commission in 2005 was primarily due to the discontinuance of CIGNA's individual and family health insurance program in the state of California. Commissions from carriers other than CIGNA for the year ended December 31, 2006, remained relatively comparable to 2005 and 2004.
Policy fee income for the year ended December 31, 2005, decreased $392,817 (12%) as compared to the year ended December 31, 2004. The 12% decrease in policy fee income is primarily a result of a 2,958 (14%) decrease in the number of policies issued during 2005 as compared to 2004 offset, by the increase in policy fee from $165 per policy to $178 per policy effective on and after August 2005.
The daily automobile rental insurance program commission and fee income decreased $135,714 (27%) from $511,066 in 2005 to $375,352 in 2006. Commission and fee income decreased $54,386 (10%) from $565,452 in 2004 to $511,066 in 2005. The daily automobile rental insurance program commission and fee income excluding claim administration fee and contingent commission decreased $93,510 (23%) from $411,189 in 2005 to $317,679 in 2006. Commission and fee income excluding claim administration fee and contingent commission decreased $144,775 (26%) from $555,964 in 2004 to $411,189 in 2005. Premium written in 2006 decreased 25% compared to premium written in 2005, and premium written in 2005 decreased 24% compared to premium written in 2004. The decrease in written premium in 2006 and 2005 is primarily due to the continued intense price competition in the daily automobile rental insurance program, which is causing these reductions in the Company's written premium and related commission income. The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change. 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.
Primarily due to declining sales, in April 2006 Bedford hired a new general manager who has substantial experience in the daily automobile rental insurance business. Future sales growth of the Bedford program is also currently dependent on the non-affiliated insurance company approving and implementing various product enhancements that Bedford recommends. Bedford is currently working with the non-affiliated insurance company to obtain their approval of the recommended program enhancements.
The Company's subsidiary U.S. Risk Managers, Inc., (U.S. Risk) ceased providing insurance claim administration services to the non-affiliated daily automobile insurer as of December 31, 2003; and it is currently inactive. As of December 31, 2003, the non-affiliated insurer 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. During 2004 and 2005, the Company did not receive any claim administration fees and did not incur any future internal claim administration costs. During 2005, the Company recognized an additional amount of $70,000 of the $100,000 claim administration fees that were unearned as of December 31, 2004. As of December 31, 2006, the non-affiliated insurer had billed the Company for the final claim administration costs due and the Company recognized the remaining balance in the amount of $4,035 as a claim administration fee income.
Other commission and fee income are as follows: Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Earthquake program commission income $37,914 $48,519 $53,140 Miscellaneous commission and fee income 116 70 111 ------ ------ ------ Total other commission and fee income $38,030 $48,589 $53,251 ====== ====== ======
Premium Finance Program ----------------------- Premium finance charges and late fees earned from financing policies are as follows: Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Premium finance charges and fees earned $678,740 $758,325 $933,529 New loans 3,596 4,200 5,156
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Average Invested Assets at amortized cost $143,957,963 $136,355,683 $125,331,342
Interest income Insurance company operations $5,906,079 $4,248,399 $4,204,573 Other operations 100,955 68,828 38,250 --------- --------- --------- Total investment income and realized gains $6,007,034 $4,317,227 $4,242,823 ========= ========= =========
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 assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, and the Company's intent to hold the investment for a period of time sufficient to allow the Company to recover its costs. The Company has concluded that the gross unrealized losses of $474,493 at December 31, 2006, were temporary in nature. However, facts and circumstances may change which could result in a decline in market value considered to be other than temporary. The Company sold one fixed maturity investment in the year ended December 31, 2006, with net
realized gain in the amount of $2,617. The Company did not sell any fixed maturity investment in the year ended December 31, 2005.
Policy acquisition costs consist of commissions, premium taxes, inspection fees, and certain other underwriting costs that are directly related to and vary with the production of Crusader insurance policies. These costs include both Crusader expenses and allocated expenses of other Unico subsidiaries. On certain reinsurance treaties, Crusader receives a ceding commission from its reinsurer that represents a reimbursement of the acquisition costs related to the premium ceded. No ceding commission is received on facultative, catastrophe, or provisionally rated ceded premium. Policy acquisition costs, net of ceding commission, are deferred and amortized as the related premiums are earned. No significant change in the ratio of policy acquisition cost to net earned premium was noted for the years ended December 31, 2006, 2005 and 2004.
OTHER OPERATING EXPENSES are as follows: Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Other operating expenses $3,012,678 $2,874,025 $2,657,310
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. In 2004, 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 is obligated to establish a state deferred tax liability which represents the Company's future state tax liability for all undistributed earnings of Crusader since January 1, 1993, in accordance with FASB 109.
Recently Issued Accounting Standards - ------------------------------------ In June 2006, the Financial Accounting Standards Board (FASB) issued an interpretation of FASB Statement No. 109, "Accounting for Uncertainty in Income Taxes" (FIN 48). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation will be effective January 1, 2007. The Company is currently assessing the effect of implementing FIN 48, and does not expect any material impact from the implementation of FIN 48.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measures" (SFAS 157). SFAS 157 provides guidance for using fair value to measure assets and liabilities and applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently reviewing the provisions of SFAS 157 to determine the impact on our financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 ("SAB 108"). SAB 108 requires registrants to quantify misstatements by using both the balance-sheet and income-statement approaches and to determine whether financial statement restatement is necessary. SAB 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006. The Company's adoption of SAB 108 did not have an effect on its results of operations or financial positions.
In October 2005, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 05-1, "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts" ("SOP 05-1"). SOP 05-1 provides accounting guidance for deferred policy acquisition costs associated with internal replacements of insurance and investment contracts other than those already described in SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. The provisions of SOP 05-1 are effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The Company is currently assessing the impact of SOP 05-1 on its results of operations and financial position. The Company does not expect the impact of the adoption to have a material effect on its results of operations or financial position.
Losses and Loss Adjustment Expenses ----------------------------------- The preparation of the Company's financial statements requires judgments and estimates. The most significant is the estimate of loss reserves as required by Statement of Financial Accounting Standards No. 60 (SFAS No. 60), "Accounting and Reporting by Insurance Enterprises" and Statement of Financial Accounting Standards No. 5 (SFAS No. 5), "Accounting for Contingencies."
Management makes its best estimate of the liability for unpaid claims costs as of the end of each fiscal quarter. Due to the inherent uncertainties in estimating the Company's unpaid claims costs, actual loss and loss adjustment expense payments should be expected to vary, perhaps significantly, from any estimate made prior to the settling of all claims. Variability is inherent in establishing loss and loss adjustment expense reserves, especially for a small insurer like the Company. For any given line of insurance, accident year, or other group of claims, there is a continuum of possible reserve estimates, each having its own unique degree of propriety or reasonableness. Due to the complexity and nature of the insurance claims process, there are potentially an infinite number of reasonably likely scenarios. The Company does not specifically identify reasonably likely scenarios other than utilizing management's best estimate. In addition to applying the various standard methods to the data, an extensive series of diagnostic tests of the resultant reserve estimates are applied to determine management's best estimate of the unpaid claims liability. Among the statistics reviewed for each accident year are loss and loss adjustment expense development patterns, frequencies (expected claim counts), severities (average cost per claim), loss and loss adjustment expense ratios to premium, and loss adjustment expense ratios to loss. When there is clear evidence that the actual claims costs emerged are different than expected for any prior accident year, the claims cost estimates for that year are revised accordingly.
Some lines of insurance are commonly referred to as "long-tail" lines because of the extended time required before claims are ultimately settled. Lines of insurance in which claims are settled relatively quickly are called "short-tail" lines. It is generally more difficult to estimate loss reserves for long-tail lines because of the long
At the end of each fiscal quarter, the Company's reserves are re-evaluated for each accident year (i.e., for all claims incurred within each year) by a committee consisting of the Company's executive vice president, the Company's chief financial officer, and an independent consulting actuary. The Company uses the loss ratio method to estimate ultimate claims costs on the current accident year. The current accident year IBNR reserves are initially determined by multiplying earned premiums for the year by the expected loss and loss adjustment expense ratio, then subtracting the current accident year's cumulative incurred (paid plus case reserves) to date. This method is subject to adjustment based upon actual results incurred during the reporting period. This initial IBNR reserve is adjusted as subsequent development of that accident year takes place.
The Company's actuarially based loss and loss adjustment expense reserve methodology does not include an implicit or explicit provision for uncertainty. Insurance claims costs are inherently uncertain. There is not a precise means of quantifying a provision for uncertainty when determining an appropriate liability for unpaid claims costs. Rather, the potential for claims costs being less than estimated and the potential for claims costs being more than estimated are considered when selecting the parameters to be used in the application of the actuarial methods and when testing the estimates for reasonableness. Management believes that its recorded loss and loss adjustment expense reserve makes reasonable provision for its liability for unpaid claims costs.
Reinsurance ----------- The Company's receivable from reinsurers represents an estimate of the amount of future loss and loss adjustment expense payments that will be recoverable from the Company's reinsurers. These estimates are
based upon estimates of the ultimate losses and loss adjustment expenses that the Company expects to incur and the portion of those losses that are expected to be allocable to reinsurers based upon the terms of the reinsurance agreements. Given the uncertainty of the ultimate amounts of losses and loss adjustment expenses, the estimates may vary significantly from the eventual outcome. The Company's estimate of the amounts receivable from reinsurers is regularly reviewed and updated by management as new data becomes available. The Company's assessment of the collectibility of the recorded amounts receivable from reinsurers is based primarily upon public financial statements and rating agency data. Any adjustments necessary are reflected in then current operations. We evaluate each of our ceded reinsurance contracts at their inception to determine if there is sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting literature. At December 31, 2006, all such ceded contracts are accounted for as risk transfer reinsurance.
The following tables provide the effect of reinsurance on the Company's financial statements:
The Company's reinsurance strategy is to reduce volatility in its expected loss and loss adjustment expense results by protecting the Company 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 it insures. On an annual basis, or sooner if warranted, the Company evaluates whether any changes to its retention, participation, or retained limits are necessary. The most significant change to the Company's reinsurance program during the three years ended December 31, 2006, was increasing its catastrophic reinsurance in 2005 from $15 million to $35 million.
The Company currently only writes business in the state of California. The types of businesses and the coverage limits written by the Company are not considered difficult lines for obtaining reinsurance. In addition, because the major catastrophe exposure is primarily from riots and fire following earthquakes, the Company does not anticipate significant limitations on its ability to cede future losses on a basis consistent with its historical results.
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.
Related Party Transactions - -------------------------- The Company presently occupies a 46,000 square foot office building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2012. Erwin Cheldin, the Company's president, chairman, and principal stockholder, is the owner of the building. The Company signed an extension to the lease with a 4% increase in rent effective April 1, 2007. The lease provides for an annual gross rent of $1,025,952 through March 31, 2007 and $1,066,990 from April 1, 2007 through March 31, 2012. In addition, the lease extension provides for two five year options with a rent increase of 5% for each option period. The Company believes that at the inception of the lease agreement and at each subsequent extension, the terms of the lease 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.
Consolidated Balance Sheets as of December 31, 2006, and 2005 40
Consolidated Statements of Comprehensive Income for the years ended December 31, 2006, 2005, and 2004 42
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2006, 2005, and 2004 43
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005, and 2004 44
We have audited the accompanying consolidated balance sheets of Unico American Corporation and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31,
Reclassifications - ----------------- Certain reclassifications have been made to prior year balances to conform to the current year presentation.
Property and Equipment - ---------------------- Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight line methods over the estimated useful lives of the related assets.
o Cash and Short-Term Investments - The carrying amounts reported in the balance sheet for these instruments approximate their fair values.
o Premiums and Notes Receivable - The carrying amounts reported in the balance sheet for these instruments approximate their fair values.
Earnings Per Share - ------------------ Basic earnings per share exclude the impact of common share equivalents and are based upon the weighted average common shares outstanding. Diluted earnings per share utilize the average market price per share when applying the treasury stock method in determining common share dilution. When dilutive, outstanding stock options are treated as common share equivalents for purposes of computing diluted earnings per share and represent the difference between basic and diluted weighted average shares outstanding. In loss periods, options are excluded from the calculation of diluted earnings per share, as the inclusion of such options would have an anti-dilutive effect.
There is a high level of uncertainty inherent in the evaluation of the required loss and loss adjustment expense reserves for the Company. The long-tailed nature of liability claims and the volatility of jury awards exacerbate that uncertainty. The Company sets loss and loss adjustment expense reserves at each balance sheet date at 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. The ultimate cost of claims is dependent upon future events, the outcomes of which are affected by many factors. Company claim reserving procedures and settlement philosophy, current and perceived social and economic inflation, current and future court rulings and jury attitudes, improvements in medical technology, and many other economic, scientific, legal, political, and social factors all can have significant effects on the ultimate costs of claims. Changes in Company operations and management philosophy also may cause actual developments to vary from the past. 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.
Premium trust funds (1) $933,053 $265,668 Cash deposited in lieu of bond (2) - 200,000 Assigned to state agencies (3) 700,000 700,000 --------- --------- Total restricted funds $1,633,053 $1,165,668 ========= =========
(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.
Segment Reporting - ----------------- Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" establishes standards for the way information about operating segments is reported in financial statements. The Company has identified its insurance company operation as its primary reporting segment. Revenues from this segment comprised 89% of consolidated revenues for the year ended December 31, 2006, 90% of consolidated revenues for the year ended December 31, 2005, and 88% for the year ended December 31, 2004. The Company's remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually insignificant to consolidated revenues.
At December 31, 2006, the Company's reinsurance recoverable on paid and unpaid losses and loss adjustment expenses of $23,788,042 were as follows:
Stock-Based Compensation - ------------------------ Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"), using the modified prospective transition method and therefore has not restated results from prior periods. Under this transition method, share-based compensation expense for 2006 includes compensation expense for all share-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." Share-based compensation expense for all share-based payment awards granted or modified on or after January 1, 2006 is based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R.
Recently Issued Accounting Standards - ------------------------------------ In June 2006, the Financial Accounting Standards Board (FASB) issued interpretation of FASB Statement No. 109, "Accounting for Uncertainty in Income Taxes" (FIN 48). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation will be effective January 1, 2007. The Company is currently assessing the effect of implementing FIN 48, and does not expect any material impact from the implementation of FIN 48.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measures" (SFAS 157). SFAS 157 provides guidance for using fair value to measure assets and liabilities and applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods
within those fiscal years. The Company is currently reviewing the provisions of SFAS 157 to determine the impact on our financial statements.
In October 2005, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 05-1, "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts" ("SOP 05-1"). SOP 05-1 provides accounting guidance for deferred policy acquisition costs associated with internal replacements of insurance and investment contracts other than those already described in SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. The provisions of SOP 05-1 are effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The Company is currently assessing the impact of SOP 05-1 on its results of operations and financial position. The Company does not expect the impact of the adoption to have a material effect on its results of operations or financial position.
NOTE 2 - ADVANCE PREMIUM AND PREMIUM DEPOSITS ------------------------------------ The insurance company operation records a liability for advance premium that represents the written premium on policies that have been submitted to the Company and are bound, billed, and recorded prior to their effective date of coverage. These advance premiums are not included in written premium or the liability for unearned premium.
NOTE 3 - INVESTMENTS - -------------------- The amortized cost and estimated fair values of investments in fixed maturities by categories are as follows:
Amortized Estimated Cost Fair Value ---- ---------- Due in one year or less $70,219,895 $69,923,874 Due after one year through five years 70,272,433 70,241,068 Due after five years through ten years - - ----------- ----------- Total fixed maturities $140,492,328 $140,164,942 =========== ===========
At December 31, 2006, the fixed maturity investments with a gross unrealized loss for continuous periods of 0 to 6 months consisted of U.S. treasury securities. The fixed maturity investments with a gross unrealized loss position for continuous periods of 7 to 12 months consisted both U.S. treasury securities and investment grade industrial securities. The fixed maturity investments with a gross unrealized loss position for a continuous period over 12 months consisted of U.S. treasury securities, investment grade industrial securities, and pre-refunded municipal bonds. The unrealized loss is primarily due to rising interest rates.
At December 31, 2005, the fixed maturity investments with a gross unrealized loss for continuous periods of 0 to 6 months and 7 to 12 months both consisted of U.S. treasury securities and investment grade industrial securities. The fixed maturity investments with a gross unrealized loss position for a continuous period over 12 months consisted of U.S. treasury securities, U.S. government sponsored enterprise securities, and pre-refunded municipal bonds. The unrealized loss is primarily due to rising interest rates.
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 assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, and the Company's intent to hold the investment for a period of time sufficient to allow the Company to recover its costs. The Company has concluded that the gross unrealized losses of $474,493 at December 31, 2006, were temporary in nature. However, facts and circumstances may change which could result in a decline in fair value considered to be other than temporary. The Company sold one fixed maturity investment in the year ended December 31, 2006, with net realized gain in the amount of $2,617. The Company did not sell any fixed maturity investment in the year ended December 31, 2005.
Short-term investments have an initial maturity of one year or less and consist of the following: Year ended December 31 ---------------------- 2006 2005 ---- ---- Short-term U.S. treasury bill $4,322,048 - Certificates of deposit 200,000 $100,000 Cash deposited in lieu of bond* - 200,000 Commercial paper 1,665,000 1,830,000 Bank money market accounts 210,270 182,673 U.S. government obligation money market fund 411,206 2,150,671 Bank savings accounts 11,483 11,818 --------- --------- Total short-term investments $6,820,007 $4,475,162 ========= =========
*Deposit with superior court to stay execution of judgment pending appeal of Crusader claim.
NOTE 4 - PROPERTY AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION) -------------------------------------------------------- Property and equipment consist of the following:
Reserves net of reinsurance Case reserves $18,776,430 $19,135,467 $17,879,989 IBNR reserves 51,300,000 57,100,000 49,470,000 ---------- ---------- ---------- Total net reserves $70,076,430 $76,235,467 $67,349,989 ========== ========== ==========
The Company's net losses and loss adjustment expenses for the calendar year ended December 31, 2006, were $17,826,979. This amount is comprised of accident year 2006 net losses and loss adjustment expenses of $29,997,662 and favorable development of prior accident years of $12,170,683. The Company's net losses and loss adjustment expenses for the calendar year ended December 31, 2005, were $31,513,732. This amount is comprised of accident year 2005 net losses and loss adjustment expenses of $35,338,196 and favorable development of prior accident years of $3,824,464. The Company's net losses and loss adjustment expenses for the calendar year ended December 31, 2004, were $34,450,738. This amount is comprised of accident year
The following table provides an analysis of the roll forward of Crusader's deferred policy acquisition costs:
Year ending ----------- December 31, 2007 1,056,731 December 31, 2008 1,066,990 December 31, 2009 1,066,990 December 31, 2010 1,066,990 December 31, 2011 1,066,990 December 31, 2012 (through March 31, 2012) 266,747 --------- Total minimum payments $5,591,438 =========
NOTE 10 - COMMITMENT AND CONTINGENCIES ---------------------------- The Company, by virtue of the nature of the business conducted by it, becomes involved in numerous legal proceedings as either plaintiff or defendant. The Company is also required to resort to legal proceedings from time to time in order to enforce collection of premiums, commissions, or fees for the services rendered to customers or to their agents. These routine items of litigation do not materially affect the Company and are handled on a routine basis by the Company through its general counsel.
Crusader's primary excess of loss reinsurance agreements since January 1, 1998, are as follows:
Prior to January 1, 1998, National Reinsurance Corporation (acquired by General Reinsurance Corporation in 1996) charged a provisional rate on exposures up to $500,000 that was subject to adjustment and was based on the amount of losses ceded, limited by a maximum percentage that could be charged. That provisionally rated treaty was cancelled on a runoff basis and replaced by a flat rated treaty on January 1, 1998.
In 2006 and 2005 Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($700,000 in excess of $300,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2004 Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2003 Crusader retained a participation in its excess of loss reinsurance treaties of 5% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties.
Crusader's 2006 1st layer primary excess of loss treaty provides for a contingent commission equal to 20% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2006, through December 31, 2006. The Company will calculate and report to the reinsurer its net profit, if any, within 90 days after 36 months following the end of the first accounting period, and within 90 days after the end of each 12 month period thereafter until all losses subject to the agreement have been finally settled. Based on losses and loss adjustment expenses ceded (including incurred but not reported losses) as of December 31, 2006, no contingent commission has been accrued. The 2005 1st layer primary excess of loss treaties do not provide for a contingent commission. Crusader's 2004 and 2003 1st layer primary excess of loss treaty provides for a contingent commission to the Company equal to 45% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2003, through December 31, 2004. The Company will calculate and report to the reinsurer its net profit, if any, within 90 days after 36 months following the end of the first accounting period, and within 90 days after the end of each 12 month period thereafter until all losses subject to the agreement have been finally settled. Based on losses and loss adjustment expenses ceded (including incurred but not reported losses) as of December 31, 2006, no contingent commission has been accrued.
Crusader also has catastrophe reinsurance from various highly rated California authorized 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.
On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays a commission to Crusader that includes a reimbursement of the cost of acquiring the portion of the premium that is ceded. Crusader does not currently assume any reinsurance. Ceding commission was $4,376,474 in 2006, $4,647,748 in 2005, and $6,031,987 in 2004. The Company intends to continue obtaining reinsurance although the availability and cost may vary from time to time. The unpaid losses ceded to the reinsurer are recorded as an asset on the balance sheet.
Reinsurance ceded premium as a percentage of direct earned premium was 24% in 2006, 22% in 2005 and 26% in 2004. The decrease in the ratio is primarily the result of rate decreases by the Company's reinsurers due to the Company's improving ceded loss experience.
Money Purchase Plan - ------------------- During the year ended December 31, 1999, the Company adopted the Unico American Corporation Money Purchase Plan. This plan covers the present executive officers of the Company. Pursuant to the terms of such Plan, the Company annually contributes to the account of each participant an amount equal to a percentage of the participant's eligible compensation as determined by the Board of Directors. However, amounts contributed to the Unico American Corporation Profit Sharing Plan will be considered first in determining the actual amount available under the Internal Revenue Service maximum contribution limits. Participants must be employed by the Company on the last day of the plan year to be eligible for contribution. Participants are entitled to receive distribution of benefits under the Plan upon retirement, termination of employment, death or disability.
NOTE 13 - 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 fair 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 U.S. 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, 2006 $50,023,768 As of December 31, 2005 $36,586,441
Year ended December 31, 2006 $13,396,732 Year ended December 31, 2005 $6,817,451 Year ended December 31, 2004 $3,343,859
report on the examination was issued by the department of insurance on May 10, 2006. No significant issues were reported in the final report.
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. Based on Crusader's statutory net income for the year ended December 31, 2006, the maximum dividend that could be made by Crusader to Unico without prior regulatory approval in 2007 is $13,396,732. There were no dividends paid by Crusader to Unico in 2006, 2005, or in 2004.
NOTE 17 - EARNINGS PER SHARE ------------------- A reconciliation of the numerator and denominator used in the basic and diluted earnings per share calculation is presented below: