The insurable events during 2007 and 2006 did not include any weather related catastrophic events such as the well publicized series of hurricanes that occurred in Florida during 2005 and 2004. During 2007 and 2006 we processed liability claims stemming from our automobile and commercial general liability lines of business and physical damage claims in connection with our homeowners’ line of business and to a much less extent our automobile physical damage line of business. Our automobile claims generally will exceed commercial general liability and homeowners’ claims with respect to frequency of claimant activity, however the per-claim severity in connection with our commercial general liability and homeowner lines would be expected to exceed the automobile line. Our reinsurance strategy serves to smooth the liquidity requirements imposed by the most severe insurable events and for all other insurable events we manage, at a micro and macro perspective, in the normal course of business.
Accounting for loss contingencies pursuant to Statements of Financial Accounting Standards (“SFAS”), 5 involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur. Additionally, accounting for a loss contingency requires management to assess each event as probable, reasonably possible or remote. Probable is defined as the future event or events are likely to occur. Reasonably possible is defined as the chance of the future event or events occurring is more than remote but less than probable, while remote is defined as the chance of the future event or events occurring is slight. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: First, the amount can be reasonably estimated, and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements. It is implicit in this condition that it is probable that one or more future events will occur confirming the fact of the loss or incurrence of a liability.
The methods we use for our short-tail business do not differ from the methods we use for our long-tail business. The Incurred and Paid Development Methods intrinsically recognize the unique development characteristics contained within the
The Paid Loss Development method is mechanically identical to the Incurred Loss Development method described above. The paid method does not rely on case reserves or claim reporting patterns in making projections.
The validity of the results from using a loss development approach can be affected by many conditions, such as internal claim department processing changes, a shift between single and multiple claim payments, legal changes, or variations in a company’s mix of business from year to year. Also, since the percentage of losses paid for immature years is often low, development factors are volatile. A small variation in the number of claims paid can have a leveraging effect that can lead to significant changes in estimated ultimates. Therefore, ultimate values for immature accident years are often based on alternative estimation techniques such as Cape Cod.
The Reported Cape Cod method is based on reported loss data and relies on the assumption that remaining unreported losses are a function of the total expected losses. The total expected losses used in this analysis are calculated as earned premium multiplied by the ratio of reported losses during the experience period to a percentage of earned premium. This percentage of earned premium is based on the historical loss reporting patterns and represents the amount of earned premium that has been "used" when compared to reported losses. The total expected losses are multiplied by the unreported percentage to produce expected unreported losses. The unreported percentage is calculated as one minus the reciprocal of the selected reported loss development factors. Finally, the expected unreported losses are added to the current reported losses to produce ultimate loss estimations.
We compute our estimated ultimate liability using the most appropriate principles and procedures applicable to the lines of business written. However, because the establishment of loss reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss reserves and have a material adverse effect on our results of operations and financial condition. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made. Accordingly, the ultimate liability for unpaid losses and loss settlement expenses will likely differ from the amount recorded at December 31, 2007.
In practice there are factors that change over time; however, many (such as inflation) are intrinsically reflected in the historical development patterns, and others typically do not materially affect the estimate of the reserve for losses and LAE. Therefore, no specific adjustments have been incorporated for such contingencies projecting future development of losses and LAE. There are no key assumptions as of December 31, 2007 premised on future emergence inconsistent with historical loss reserve development patterns.
For the year ended December 31, 2006 our actuarial firm determined range of loss and LAE reserves on a net basis range from a low of $27.2 million to a high of $34.7 million. The Company’s net loss and LAE reserves are carried at $27.3 million. Management’s point estimate of reserves is at the lowest end of its actuarially determined range in recognition of the inherent uncertainty in assessing the potential ultimate liabilities given legal developments as well as evolution in its operations.
In June 2006, the Financial Accounting Standards Board (“FASB”) issued interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes” which clarifies the accounting for income tax reserves and contingencies recognized in an enterprise’s financial statements in accordance with SFAS 109, Accounting for Income Taxes. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation was effective for fiscal years beginning after December 15, 2006. The Company evaluated the impact that FIN will have on its Consolidated Financial Statements. Additionally, we have developed a process to capture and quantify any such effect that FIN 48 could have on the Company and concluded there was no impact on our consolidated financial statements for the year ended December 31, 2007.
As of December 31, 2007 and 2006 we have classified $20.2 million and $19.7 million, respectively, of our bond portfolio as held-to-maturity. The decision to classify this layer of our bond portfolio as held-to-maturity was predicated on our intention and ability to hold these securities until maturity. Additionally, we have and may continue to use this position to secure irrevocable letters of credit to facilitate business opportunities in connection with our commercial general liability program. During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic which was terminated in April 2007. As of December 31, 2007 the letter of credit in favor of Republic totaled $10.0 million. During January 2008 this letter of credit was reduced to $3.0 million.
Total Investments increased $11.4 million, or 9.1%, to $136.2 million as of December 31, 2007, compared to $124.8 million as of December 31, 2006. The increase is primarily in connection with decreased prepaid reinsurance requirements and deferred policy acquisition costs.
Below is a summary of net unrealized gains and (losses) at December 31, 2007 and December 31, 2006 by category.
Premiums receivable, net of allowance for credit losses, decreased $3.4 million, or 47.4%, to $3.8 million as of December 31, 2007, compared to $7.2 million as of December 31, 2006.
Reinsurance recoverable, net increased $2.7 million, or 13.4%, to $22.9 million as of December 31, 2007, compared to $20.2 million as of December 31, 2006. The increase is due to payment patterns by our reinsurers. All amounts are current and deemed collectable. We have not recorded a valuation allowance in connection with our reinsurance recoverable, net.
Deferred policy acquisition costs decreased $2.2 million, or 19.7%, to $9.0 million as of December 31, 2007, compared to $11.2 million as of December 31, 2006. The change in this asset is due to the decrease in our homeowners’ insurance production volume.
Deferred income taxes, net, increased $2.0 million, or 56.2%, to $5.6 million as of December 31, 2007, compared to $3.6 million as of December 31, 2006. The increase is comprised primarily of $0.9 million related to unrealized losses on investment securities, $0.8 million in connection with deferred policy acquisition costs, $0.7 million related to unpaid losses and LAE, and $0.7 million related to regulatory assessments, offset by $0.8 million related to unearned premiums, $0.2 million in connection with the sale of our property in Lauderdale Lakes and $0.2 million related to unearned commissions.
Unearned premiums decreased $21.4 million, or 27.5%, to $56.4 million as of December 31, 2007, compared to $77.8 million as of December 31, 2006. The decrease was due to a $19.4 million decrease in unearned homeowners’ insurance premiums, a $0.5 million decrease in unearned commercial general liability premiums, and a $1.5 million decrease in unearned automobile premiums. Generally, as is in this case, a decrease in unearned premium directly relates to a decrease in written premium on a rolling twelve-month basis. Conversely, in periods of increased written premium on a rolling twelve-month basis, unearned premium generally would be expected to rise.
Premium deposits and customer credit balances decreased $1.0 million, or 27.2%, to $2.8 million as of December 31, 2007, compared to $3.8 million as of December 31, 2006. Premium deposits are monies received on policies not yet in force as of December 31, 2007.
Bank overdraft increased $0.6 million, or 7.2%, to $8.7 million as of December 31, 2007, compared to $8.1 million as of December 31, 2006. The bank overdraft relates primarily to loss and LAE disbursements paid but not yet presented for payment by the policyholder or vendor. The increase relates to our payment patterns in relationship to the rate at which those cash disbursements are presented to the bank for payment.
Subordinated Debt decreased to nothing as of December 31, 2007, compared to $4.2 million as of December 31, 2006. The decrease is due to the maturity of the notes issued in the 2004 private placement on September 30, 2007 and our final principal and interest payment on these notes.
Accounts payable and accrued expenses decreased $1.4 million, or 24.1%, to $4.3 million as of December 31, 2007, compared to $5.7 million as of December 31, 2006. This decrease is due to our cash management efforts and timing of payments with our trade vendors.
Gross premiums ceded decreased $23.0 million, or 34.0%, to $44.6 million for the year ended December 31, 2007, compared to $67.5 million for the year ended December 31, 2006.
The decrease (increase) in unearned premiums was $21.4 million for the year ended December 31, 2007, compared to ($16.0) million for year ended December 31, 2006. The change was due to a $19.4 million decrease in unearned homeowners’ insurance premiums, a $0.5 million decrease in unearned commercial general liability premiums, and a $1.5 million decrease in unearned automobile premiums. These changes are a result of our decreased premium volume during this period. See Gross Premiums Written.
Managing general agent fees decreased $0.6 million, or 22.5%, to $2.0 million for the year ended December 31, 2007, compared to $2.6 million for year ended December 31, 2006.
Net investment income increased $2.0 million, or 34.2%, to $8.0 million for the year ended December 31, 2007, compared to $5.9 million for the year ended December 31, 2006. The increase in investment income is primarily a result of the additional amounts of invested assets. Also affecting our net investment income was an increase in overall yield to 6.10 % for the year ended December 30, 2007 compared to a yield of 5.28 % for the year ended December 31, 2006.
Net realized investment (losses) gains were ($0.1) million for the year ended December 31, 2007, compared to $1.1 for the year ended December 31, 2006. The table below depicts (losses) gains by investment category.
Other income increased $0.7 million, or 45.2%, to $2.3 million for the year ended December 31, 2007, compared to $1.6 million for the year ended December 31, 2006. Major components of other income for the year ended December 31, 2007 included approximately $1.7 million in connection with FIGA recoupment, $0.5 million in partial recognition of our gain on the sale of our Lauderdale Lakes property and $0.1 million of rental income, interest income and miscellaneous income.
The table below reflects no impact to operations during the year ended December 31, 2007 from the four hurricanes that occurred in July, August, September and October of 2005.
Policy acquisition costs, net of amortization, increased $2.0 million, or 11.6%, to $19.4 million for the year ended December 31, 2007, compared to $17.4 million for year ended December 31, 2006. The increase is primarily in connection with a more generous commission structure during 2007. Policy acquisition costs, net of amortization, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned.
As a result of the foregoing, the Company’s net income for the year ended December 31, 2007 was $21.3 million compared to net income of $13.9 million for year ended December 31, 2006.
The (increase) in unearned premiums was ($16.0) million for the year ended December 31, 2006, compared to ($11.7) million for year ended December 31, 2005. The change was due to an $18.9 million increase in unearned homeowners’ insurance premiums, a $4.6 million increase in unearned commercial general liability premiums, and a $7.4 million decrease in unearned automobile premiums. These changes reflect our continued growth along our homeowners’ and commercial general liability lines of business. For further discussion, see “Analysis of Financial Condition - Unearned Premiums” on page 49.
As noted above, the Company’s efforts to expand commercial general liability lines of insurance products are coming to fruition, as reflected by increased net premiums earned of $9.4 million, or 51.9 % to $27.7 million for the year ended December 31, 2006, compared to $18.2 million for the year ended December 31, 2005.
Finance revenue decreased $1.9 million, or 52.7%, to $1.7 million for the year ended December 31, 2006, compared to $3.6 million for year ended December 31, 2005. The decrease was primarily due to the sale in December 2004 of our assets related to our non-standard automobile insurance agency business in Florida and the finance revenue derived there from. We expect a continuing decline in finance revenue over the near future.
Net investment income increased $2.1 million, or 54.5%, to $5.9 million for the year ended December 31, 2006, compared to $3.8 million for year ended December 31, 2005. The increase in investment income was primarily a result of the additional amounts of invested assets. Also affecting our net investment income was an increase in overall yield to 5.28% for the year ended December 31, 2006 compared to a yield of 4.66% for the year ended December 31, 2005.
Other income increased $0.6 million, or 56.5%, to $1.6 million for the year ended December 31, 2006, compared to $1.0 million for year ended December 31, 2005. Major components of other income for the year ended December 31, 2006 included $0.5 million in partial recognition of our gain on the sale of our Lauderdale Lakes property, $0.2 million in connection with a legal settlement, $0.2 million of business interruption recovery, $0.1 million in connection with FIGA fees, $0.1 million of rental income and $0.2 million of miscellaneous other sources.
The following table reflects the changes during the year ended December 31, 2006 in connection with the four hurricanes that occurred in August and September of 2004. A charge of $5.5 million occurred during the year ended December 31, in connection with these storms.
Our loss ratio, as determined in accordance with GAAP, for the year ended December 31, 2006 was 49.7%, compared to 58.3% for the year ended December 31, 2005. The table below reflects the loss ratios by product line.
Operating and underwriting expenses increased $4.9 million, or 60.1%, to $13.2 million for the year ended December 31, 2006, compared to $8.2 million for year ended December 31, 2005. The change was primarily due to a charge to operations of $3.9 million in connection with a FIGA assessment and premium tax expense which increased $1.0 million. Approvals by the OIR to recoup the assessment through an average 1.0% policy surcharge on all of our policies written in Florida over a twelve month period for new and renewal business have been granted. Premium tax expense is directly correlated to written premium, which experienced an increase in 2006.
Policy acquisition costs, net of amortization, increased $2.8 million, or 19.5%, to $17.4 million for the year ended December 31, 2006, compared to $14.6 million for year ended December 31, 2005. Policy acquisition costs, net of amortization, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned.
The provision for income tax expense for continuing and discontinued operations increased $2.1 million, or 39.9%, to $7.4 million for the year ended December 31, 2006, compared to $5.3 million for the year ended December 31, 2005. The effective rate for income tax expense is 34.7% for the year ended December 31, 2006, compared to 30.4% for the year ended December 31, 2005.
A summary of long-term contractual obligations as of December 31, 2007 follows. The amounts represent estimates of gross undiscounted amounts payable over time.
For the year ended December 31, 2007, our primary sources of capital were revenues generated from operations, including increased unpaid losses and LAE, decreased prepaid reinsurance premiums, increased income taxes payable, decreased premiums receivable, decreased policy acquisition costs, net of amortization, decreased premium finance contracts receivable, decreased other assets, decreased income taxes recoverable and increased bank overdrafts. Operational sources of capital also included non-cash compensation, depreciation and amortization, provision for uncollectible premiums receivable and common stock issued for interest on notes. Also contributing to our liquidity were proceeds from the sale of investment securities, exercised warrants, a tax benefit related to non-cash compensation and exercised employee stock options. Because we are a holding company, we are largely dependent upon fees and commissions from our subsidiaries for cash flow.
For the year ended December 31, 2007, operations generated $62.0 million of gross cash flow, due to a $20.1 million increase in unpaid losses and LAE, a $6.0 million decrease in prepaid reinsurance premiums, a $3.3 million increase in income taxes payable, a $4.2 million decrease in premiums receivable, a $2.2 million decrease in policy acquisition costs, net of amortization, a $1.4 million decrease in premium finance contracts receivable, a $1.2 million decrease in other assets, a $0.8 million decrease in income taxes recoverable and a $0.6 million increase in bank overdrafts. Operational sources of capital also included $0.4 million of non-cash compensation, $0.3 million of depreciation and amortization, $0.2 million in the provision for uncollectible premiums receivable and $0.1 million of common stock issued for interest on notes, all in conjunction with net income of $21.3 million.
For the year ended December 31, 2007, operations used $29.1 million of gross cash flow primarily due to a $21.4 million decrease in unearned premiums, a $2.7 million increase in reinsurance recoverable, net, a $2.0 million increase in deferred income tax expense, a $1.4 million decrease in accounts payable and accrued expenses and a $1.0 million decrease in premium deposits and customer credit balances. Additional operational uses of cash include $0.4 million of amortization of investment discount and $0.2 million of net realized investment losses.
For the year ended December 31, 2007, net investing activities used $19.0 million, as compared to $19.7 million and $15.5 million for the years ended December 31, 2006 and 2005, respectively. Our available for sale investment portfolio is highly liquid as it consists entirely of readily marketable securities. For the year ended December 31, 2007, investing activities generated $153.6 million and used $172.6 million from the maturity several times over of our very short municipal portfolio.
We believe that our current capital resources, together with cash flow from operations, will be sufficient to meet currently anticipated working capital requirements. There can be no assurances, however, that such will be the case.
The July 2003 Notes paid interest at the annual rate of 6%, were subordinated to senior debt of the Company, and matured on July 31, 2006. Quarterly payments of principal and interest due on the July 2003 Notes were made in cash or, at our option, in shares of our Common Stock. When paid in shares of Common Stock, the number of shares issued was determined by dividing the payment due by 95% of the weighted-average volume price for the Common Stock on Nasdaq as reported by Bloomberg for the 20 consecutive trading days preceding the payment date.
For the years ended December 31, 2007 and 2006, there were no off balance sheet transactions.
We have audited the accompanying balance sheets of 21st Century Holding Company as of December 31, 2007 and 2006, and the related statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited 21st Century Holding Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 21st Century Holding Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Certification Report included in the Company’s 2007 Form 10-K. Our responsibility is to express an opinion on these financial statements and an opinion on the company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of 21st Century Holding Company as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, 21st Century Holding Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
· legal and political factors such as legislative initiatives and public opinion.
Federated National is authorized to underwrite homeowners’ property and casualty insurance in Florida as an admitted carrier.
During the year ended December 31, 2007, 74.5%, 24.1% and 1.4% of the premiums we underwrote were for homeowners’ property and casualty insurance, commercial general liability insurance and personal automobile insurance, respectively. During the year ended December 31, 2006, 74.9%, 21.1% and 4.0% of the premiums we underwrote were for homeowners’ property and casualty insurance, commercial general liability insurance and personal automobile insurance, respectively. We internally process claims made by our insureds through our wholly owned claims adjusting company, Superior.
There can be no assurance that our unpaid losses and LAE reserves will be adequate to cover actual losses. If our unpaid losses and LAE prove to be inadequate, we will be required to increase the liability with a corresponding reduction in our net income in the period in which the deficiency is identified. Future loss experience substantially in excess of the established unpaid losses and LAE could have a material adverse effect on our business, results of operations and financial condition.
Accounting for loss contingencies pursuant to SFAS 5 involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur. Additionally, accounting for a loss contingency requires management to assess each event as probable, reasonably possible or remote. Probable is defined as the future event or events are likely to occur. Reasonably possible is defined as the chance of the future event or events occurring is more than remote but less than probable, while remote is defined as the chance of the future event or events occurring is slight. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: First, the amount can be reasonably estimated; and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements. It is implicit in this condition that it is probable that one or more future events will occur confirming the fact of the loss or incurrence of a liability.
If substantially all the costs associated with the MGA contracts which do not involve affiliated insurers are incurred during the underwriting process, then the MGA fees and the related acquisition costs are recognized at the time the policy is underwritten, net of estimated cancellations. If the MGA contract requires significant involvement subsequent to the completion of the underwriting process, then the MGA fees and related acquisition costs are deferred and recognized over the life of the policy. Included in Managing General Agent Fees are policy fees charged by the insurance companies and passed through to Assurance MGA. Policy fees are discussed below.
We recognize the income and expense on reinsurance contracts principally on a pro-rata basis over the term of the reinsurance contracts or until the reinsurers maximum liability is exhausted, whichever comes first. We are reinsured under separate reinsurance agreements for the different lines of business underwritten. Reinsurance contracts do not relieve us from our obligations to policyholders. We continually monitor our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. We only cede risks to reinsurers whom we believe to be financially sound. At December 31, 2007, all reinsurance recoverables are considered collectible.
The fair value option established by SFAS 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the business entity does not report earnings) at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments.
SFAS is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first days of that fiscal year and also elects to apply the provisions of SFAS 157, Fair Value Measurements. We will adopt SFAS 159 on its effective date, January 1, 2008. We do not expect the adoption of SFAS 159 to have a material impact, if any, on our financial position or results of operations.
In June 2006, FASB issued interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes” which clarifies the accounting for income tax reserves and contingencies recognized in an enterprise’s financial statements in accordance with SFAS 109, Accounting for Income Taxes. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation was effective for fiscal years beginning after December 15, 2006. The Company evaluated the impact that FIN will have on its Consolidated Financial Statements. Additionally, we have developed a process to capture and quantify any such effect that FIN 48 could have on the Company and concluded there was no impact on our consolidated financial statements for the year ended December 31, 2007.
Our revenues and operating performance may fluctuate with business cycles in the property and casualty insurance industry.
We are named as a defendant in a securities class action lawsuit and it may have an adverse impact on our business.
Our business strategy is to avoid competition based on price to the extent possible. This strategy, however, may result in the loss of business in the short term.
The fair value of our investments is estimated based on prices published by financial services or quotations received from securities dealers and is reflective of the interest rate environment that existed as of the close of business on December 31, 2007 and 2006. Changes in interest rates subsequent to December 31, 2007 may affect the fair value of our investments. Refer to Note 3(a) of the Notes to Consolidated Financial Statements for details.
At December 31, 2007, the Company has two stock-based employee compensation plans and one stock-based franchise compensation plan, which are described later in footnote 8, Stock Compensation Plans. Prior to January 1, 2006, we accounted for those plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by SFAS 123, Accounting for Stock-Based Compensation. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations for the year ended December 31, 2005 as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.
Property, plant and equipment is stated at cost less accumulated depreciation. Depreciation on property, plant and equipment is calculated on a straight-line basis over the following estimated useful lives: building and improvements - 30 years and furniture and fixtures - 7 years. We capitalize betterments and any other expenditure in excess of $500 if the asset is expected to have a useful life greater than one year. The carrying value of property, plant and equipment is periodically reviewed based on the expected future undiscounted operating cash flows of the related item. Based upon our most recent analysis, we believe that no impairment of property, plant and equipment exists at December 31, 2007.
SFAS addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. SFAS 115 requires that these securities be classified into one of three categories, Held-to-maturity, Trading securities or Available-for-sale. Investments classified as held-to-maturity include debt securities wherein the Company’s intent and ability are to hold the investment until maturity. The accounting treatment for held-to-maturity investments is to carry them at amortized cost without consideration to unrealized gains or losses. Investments classified as trading securities include debt and equity securities bought and held primarily for the sale in the near term. The accounting treatment for trading securities is to carry them at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments. The accounting treatment for available-for-sale securities is to carry them at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, namely “Other Comprehensive Income”. We did not hold any non-traded investment securities during 2007 or 2006.
Additional provisions contained in SFAS 115 address the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. The Company’s policy for the valuation of temporarily impaired securities is to determine impairment based on the analysis of the following factors:
The following table shows the realized (losses) gains for fixed and equity securities for the years ended December 31, 2007 and 2006.
The table below reflects the aging of our unrealized investment losses by investment class.
Below is a summary of fixed maturities at December 31, 2007 and 2006 by contractual or expected maturity periods. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of fixed maturities and equity securities for the years ended December 31, 2007, 2006 and 2005 were approximately $202.2 million, $271.3 million and $122.5 million, respectively.
A summary of realized investment (losses) gains and (increases) in net unrealized losses follows:
Depreciation of property, plant, and equipment was $316,525, $342,108, and $444,744 during 2007, 2006 and 2005, respectively.
The impact of the excess of loss reinsurance treaties on the financial statements is as follows:
The impact of the quota-share reinsurance treaties on the financial statements is as follows:
As a result of our review of our liability for losses and LAE, which includes a re-evaluation of the adequacy of reserve levels for prior year’s claims, we increased the liability for loss and LAE for claims occurring in prior years by $9,166,491, $9,294,096 and $6,094,843 for the years ended December 31, 2007, 2006 and 2005, respectively. The adjustments in the liability were primarily attributable to loss development in connection with the four hurricanes of There can be no assurance concerning future adjustments of reserves, positive or negative, for claims through December 31, 2007.
Finance contracts receivable decreased $1.4 million, or 77.0%, to $0.4 million as of December 31, 2007, compared to $1.8 million as of December 31, 2006. We anticipate a continued decline in the short-term in connection with premiums financed contracts. The Company anticipates continued use of the direct bill feature associated with the two insurance companies and their automobile lines of business.
The insurance companies are also required to adhere to prescribed premium-to-capital surplus ratios. As of December 31, 2007, 2006 and 2005, both Federated National and American Vehicle were in compliance with the prescribed premium-to-surplus ratio.
Alternatively, a Florida domestic insurer may pay a dividend or distribution without the prior written approval of the Florida OIR (i) if the dividend is equal to or less than the greater of (a) 10.0% of the insurer’s capital surplus as regards policyholders derived from realized net operating profits on its business and net realized capital gains or (b) the insurer’s entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, (ii) the insurer will have policy holder capital surplus equal to or exceeding 115.0% of the minimum required statutory capital surplus after the dividend or distribution, (iii) the insurer files a notice of the dividend or distribution with the Florida OIR at least ten business days prior to the dividend payment or distribution and (iv) the notice includes a certification by an officer of the insurer attesting that, after the payment of the dividend or distribution, the insurer will have at least 115% of required statutory capital surplus as to policyholders. Except as provided above, a Florida domiciled insurer may only pay a dividend or make a distribution (i) subject to prior approval by the Florida OIR or (ii) 30 days after the Florida OIR has received notice of such dividend or distribution and has not disapproved it within such time.
No dividends were paid by Federated National or American Vehicle in 2007, 2006 or 2005, and none are anticipated in 2008. Although we believe that amounts required to meet our financial and operating obligations will be available from sources other than dividends from our insurance subsidiaries, there can be no assurance in this regard. Further, there can be no assurance that, if requested, the Florida OIR will allow any dividends in excess of the amount available, to be paid by Federated National and American Vehicle to us in the future. The maximum dividends permitted by state law are not necessarily indicative of an insurer’s actual ability to pay dividends or other distributions to a parent company, which also may be constrained by business and regulatory considerations, such as the impact of dividends on capital surplus, which could affect an insurer’s competitive position, the amount of premiums that can be written and the ability to pay future dividends. Further, state insurance laws and regulations require that the statutory capital surplus of an insurance company following any dividend or distribution by it be reasonable in relation to its outstanding liabilities and adequate for its financial needs.
Based upon the 2007 statutory financial statements for Federated National and American Vehicle, statutory surplus exceeded all regulatory action levels established by the NAIC’s risk-based capital requirements. Based upon the 2006 statutory financial statements for American Vehicle, statutory surplus exceeded all regulatory action levels established by the NAIC’s risk-based capital requirements. Based upon the 2006 statutory financial statements for Federated National, statutory surplus did not exceed company action levels established by the NAIC. Federated National’s results required us to submit a plan containing corrective actions.
Based on Risk Based Capital requirements, the extent of regulatory intervention and action increases as the ratio of an insurer’s statutory surplus to its ACL, as calculated under the NAIC’s requirements, decreases. The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200.0% of the ACL amount. The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150.0% of the ACL amount. The third action level, ACL, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70.0% of the ACL amount. Federated National’s ratio of statutory surplus to its ACL was 653.0%, 165.4 % and 154.0% at December 31, 2007, 2006 and 2005, respectively. American Vehicle’s ratio of statutory surplus to its ACL was 448.5%, 444.2% and 329.7% at December 31, 2007, 2006 and 2005, respectively.
As of December 31, 2007, Federated National was outside NAIC’s usual ranges with respect to its IRIS tests on three out of thirteen ratios. There were two exceptions in connection with surplus growth and one exception in connection with adverse homeowner claims in connection with the hurricanes of 2004 and 2005.
The table below reflects the range and test results for both Federated National and American Vehicle for the years ended December 31 2007 and 2006, respectively.
American Vehicle’s statutory capital and surplus was $27.6 million and $26.7 million as of December 31, 2007 and 2006, respectively. American Vehicle’s statutory net income was approximately $1.3 million, $6.2 million and $2.9 million for the years ended December 31, 2007, 2006 and 2005 respectively. American Vehicle’s statutory non-admitted assets were approximately $0.9 million and $0.4 million as of December 31, 2007 and 2006, respectively.
Bonds totaling $17.7 million secure a $10.0 million irrevocable letter of credit in order to facilitate business opportunities in connection with our commercial general liability program.
Effective on or about March 1, 2006, the Company sold its interest in the property located at 3661 West Oakland Park Boulevard, Lauderdale Lakes, Florida to an unrelated party for approximately $5.0 million cash and a $0.9 million six year 5% note. As part of the transaction, the Company agreed to lease the same facilities for a six year term; in accordance with SFAS 13, the lease will be treated as an operating lease. The expected future payout schedule is as follows:
One of our directors is a partner at a law firm that handles some of the Company’s claims litigation. Fees paid to this law firm amounted to approximately $80,000, $258,000 and $192,000 for the years ended December 31, 2007, 2006 and 2005, respectively, and is included in LAE.
Net income per share is computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding during the periods presented.
SFAS 131, Disclosures About Segments of an Enterprise and Related Information, requires that the amount reported for each segment item be based on what is used by the chief operating decision maker in formulating a determination as to how many resources to assign to a segment and how to appraise the performance of that segment. The term chief operating decision maker may apply to the chief executive officer or chief operating officer or to a group of executives. Note: The term of chief operating decision maker may apply to a function and not necessarily to a specific person. This is a management approach rather than an industry approach in identifying segments. The segments are based on the Company’s organizational structure, revenue sources, nature of activities, existence of responsible managers, and information presented to the Board of Directors.
In 2001, we implemented a franchisee stock option plan that provides for the granting of stock options to individuals purchasing Company owned agencies which are then converted to franchised agencies. The purpose of the plan is to advance our interests by providing an additional incentive to encourage managers of Company owned agencies to purchase the agencies and convert them to franchises. Options outstanding under the plan have been granted at prices, which are above the market value of the stock on the date of grant, vest over a ten-year period, and expire ten years after the grant date. Under this plan, we are authorized to grant options to purchase up to 988,500 common shares, and, as of December 31, 2007, we had no outstanding exercisable options to purchase shares.
In 2002, we implemented the 2002 Option Plan. The purpose of this Plan is to advance our interests by providing an additional incentive to attract, retain and motivate highly qualified and competent persons who are key to the Company, including key employees, consultants, independent contractors, Officers and Directors, upon whose efforts and judgment our success is largely dependent, by authorizing the grant of options to purchase Common Stock to persons who are eligible to participate hereunder, thereby encouraging stock ownership by such persons, all upon and subject to the terms and conditions of the Plan. Options outstanding under the plan have been granted at prices which are above the market value of the stock on the date of grant, vest over a five-year period, and expire six years after the grant date. Under this plan, we are authorized to grant options to purchase up to 1,800,000 common shares, and, as of December 31, 2007, we had outstanding exercisable options to purchase 660,309 shares.
Activity in our stock option plans for the period from January 1, 2005 to December 31, 2007 is summarized below:
At December 31, 2007, the Company has two stock-based employee compensation plans and one stock-based franchise compensation plan, which are described above. Prior to January 1, 2006, we accounted for those plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by SFAS 123, Accounting for Stock-Based Compensation. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations for the year ended December 31, 2005 as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.
Effective January 1, 2006, the Company adopted the fair value recognitions provisions of SFAS 123R using the modified-prospective-transition method. Under that transition method, compensation cost recognized during the years ended December 31, 2007 and 2006 includes:
Compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair-value estimated in accordance with the provisions of SFAS 123R. Results for prior periods have not been restated, as not required to by the pronouncement.
Basic and diluted earnings per share for the year ended December 31, 2007 and 2006 would have been $2.74 and 2.70, and $1.85 and $1.73, respectively, if the Company had not adopted SFAS 123R, compared to reported basic and diluted earnings per share of $2.69 and $2.65, and $1.84 and $1.72, respectively.
The weighted average fair value of options granted during 2007, 2006 and 2005 estimated on the date of grant using the Black-Scholes option-pricing model was $2.92 to $5.59; $3.62 to $5.73 and $2.81 to $10.75, respectively.
The fair value of options granted is estimated on the date of grant using the following assumptions:
Reclassification adjustments related to the investment securities sold and previously included in comprehensive income (loss) for the years ended December 31, 2007, 2006 and are as follows:
Our Amended and Restated Articles of Incorporation authorize the issuance of one million shares of preferred stock with designations, rights and preferences determined from time to time by our board of directors. Accordingly, our board of directors is empowered, without shareholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. We have not issued preferred shares as of December 31, 2007.
The Warrants issued to the purchasers of the September 2004 Notes and to the placement agent in the offering, J. Giordano, each entitled the holder to purchase one share of our Common Stock at an exercise price of $12.75 per share and was exercisable until September 30, 2007. The number of shares issued upon exercise of the 2004 Warrants to purchasers equaled $12.5 million divided by the exercise price of the warrants, and totaled 980,392. The number of shares issued upon exercise of the 2004 Warrants to J. Giordano equaled $500,000 divided by the exercise price of the warrants, and totaled 39,216. GAAP required that detachable warrants be valued separately from debt and included in paid-in capital. Based on the terms of the purchase agreement with the investors in the private placement, management determined that the September 2004 Warrants had zero value at the date of issuance.
For the July 2003 Notes, the quarterly principal and interest payments totaling approximately $0.6 million per payment were due quarterly with the last installment paid in cash on July 31, 2006.