The stores also offered automobile club services for roadside assistance and some of our franchise locations offered income tax preparation services.
Net investment income and net realized gains (losses) on investments. We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, short term investments, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets, less investment expenses. Net realized gains and losses on our investments are reported separately from our net investment income. Net realized gains occur when our investment securities are sold for more than their costs or amortized costs, as applicable. Net realized losses occur when our investment securities are sold for less than their costs or amortized costs, as applicable, or are written down as a result of other-than-temporary impairment. We classify equity securities and our fixed maturity securities as available-for-sale. Net unrealized gains (losses) on those securities classified as available-for-sale are reported separately within accumulated other comprehensive income on our balance sheet.
Interest expense - mandatorily redeemable preferred stock. Interest expense on mandatorily redeemable preferred stock represents amounts we incurred on our previously outstanding preferred stock at the then-applicable dividend rates.
Gain on acquisition of Kingstone Insurance Company. Gain on acquisition represents the excess of the fair market value of the net assets acquired compared to the acquisition cost.
Income tax expense (benefit). We incur federal income tax expense (benefit) on our consolidated operations as well as state income tax expense for our non-insurance underwriting subsidiaries
We believe that the most critical accounting policies relate to the reporting of reserves for loss and LAE, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third party reinsurers, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities, intangible assets and the valuation of stock based compensation (see Note 2 to the Consolidated Financial Statements - “Accounting Policies”).
We completed the acquisition of KICO on July 1, 2009. Accordingly, our consolidated revenues and expenses reflect significant changes as a result of this acquisition particularly through the addition of our insurance underwriting business that now includes all of the operations of KICO.
Due to the acquisition of KICO and the commencement of our insurance underwriting business on July 1, 2009, and the discontinuance of all business operations previously in place before the acquisition date, the comparability of information between quarters and years is less meaningful. A separate discussion has been provided to compare the results of operations from KICO for the six months ended December 31, 2010 to the six months ended December 31, 2009.
In December 2008, due to declining revenues and profits, we made a decision to restructure our network of retail offices (the “Retail Business”). The plan of restructuring called for the closing of seven of our least profitable locations during December 2008 and the sale of the remaining 19 Retail Business locations. On April 17, 2009, we sold substantially all of the assets, including the book of business, of the 16 remaining Retail Business locations that we owned in New York State (the “New York Sale”). Effective June 30, 2009, we sold all of the outstanding stock of the subsidiary that operated our three remaining Retail Business locations in Pennsylvania (the “Pennsylvania Sale”). As a result of the restructuring in December 2008, the New York Sale on April 17, 2009 and the Pennsylvania Sale effective June 30, 2009, our Retail Business has been presented as discontinued operations and prior periods have been restated.
Effective May 1, 2009, we sold all of the outstanding stock of the subsidiaries that operated our DCAP franchise business. As a result of the sale, our franchise business has been presented as discontinued operations and prior periods have been restated.
During the year ended December 31, 2010 (“2010”), revenues from continuing operations were $21,596,000, as compared to $8,390,000 for the year ended December 31, 2009 (“2009”). The increase in total revenues was due to the increases in all sources of revenue stemming from the acquisition of KICO that occurred on July 1, 2009.
The decrease in revenue and expenses in our discontinued operations in 2010 as compared to 2009 was attributable to: (i) the cessation of operations in our Retail Business of the 16 remaining stores located in New York as a result of the sale of their assets on April 17, 2009, and the sale of our Pennsylvania stores on June 30, 2009, and (ii) in our discontinued Franchise Business, the sale on May 1, 2009 of all of the outstanding stock of the subsidiaries that operated our DCAP franchise business. In 2010 we received $38,000, which represents the balance of contingent consideration due to us from the New York Sale.
Net written premium increased $2,252,000, or 51.2%, to $6,652,000 in 2010 from $4,400,000 in 2009. The increase in net written premium resulted from an increase of gross written premium in 2010 compared to gross written premium in 2009. Net written premiums grew at a greater rate than gross written premiums (51.2 % compared to 22.7%) due to the elimination of our commercial auto quota share treaty effective January 1, 2010 and a reduction of our ceding percentage in the other commercial lines quota share treaty from 85% to 75% effective July 1, 2010.
Net earned premium increased $1,769,000, or 31.2%, to $6,296,000 in 2010 from $4,526,000 in 2009. As premiums written earn ratably primarily over a twelve month period, the increase was a result of higher net written premium for the twelve months ended December 31, 2010 compared to the twelve months ended December 31, 2009.
Ceding commission revenue was $4,401,000 in 2010 compared to $2,939,000 in 2009. The increase of $1,769,000 or 39.1% was due to the increase in the amount of premiums ceded and more favorable ceding commission rates. Ceding commission revenue also increased as a result of decreases in ceded loss ratios on prior year’s quota share treaties.
Net investment income was $336,000 in 2010 compared to $226,000 in 2009. The increase of $110,000 or 48.8% was due to an increase in average invested assets in 2010 as compared to 2009. The increase in cash and invested assets resulted primarily from increased operating cash flows.
Net loss and loss adjustment expenses were $3,815,000 in 2010 compared to $2,035,000 in 2009. The net loss ratio was 60.6% in 2010 compared to 45.0% in 2009. The increase of 15.6 percentage points in our net loss ratio for 2010 as compared to 2009 is primarily due to an increase in losses incurred and a decrease in ceded losses as a percent of total losses. Our net loss incurred resulting from two fires in 2010 added 3.1 percentage points to our net loss ratio in 2010.
Other underwriting expenses were $3,247,000 in 2010 compared to $2,368,000 in 2009. The $464,000 increase in other underwriting expenses was primarily due expenses directly related to the increase in gross premiums written, additional employment costs due to the hiring of additional staff needed to service our growth in written premiums and an increase in professional fees due to increased compliance costs. The gross underwriting expense ratio was 3.4% in 2010 as compared to 11.5% in 2009. The net underwriting expense ratio was 8.7% in 2010 as compared to 33.8% in 2009.
The following table presents a breakdown of the amortized cost, aggregate fair value and unrealized gains and losses by investment type as of December 31, 2010 and 2009:
The table below summarizes the average duration by type of fixed-maturity security as well as detailing the average yield as of December 31, 2010 and 2009:
As disclosed in Note 5 to the Consolidated Financial Statements, with respect to “Fair Value Measurements,” effective January 1, 2008, we adopted new GAAP guidance, which provides a revised definition of fair value, establishes a framework for measuring fair value and expands financial statements disclosure requirements for fair value. Under this guidance, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an “exit price”). The statement establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy in GAAP prioritizes fair value measurements into three
levels based on the nature of the inputs. Quoted prices in active markets for identical assets have the highest priority (“Level 1”), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities (“Level 2”), and unobservable inputs, including the reporting entity’s estimates of the assumption that market participants would use, having the lowest priority (“Level 3”). As of December 31, 2010 and December 31, 2009, 100% of the investment portfolio recorded at fair value was priced based upon quoted market prices.
Notes payable with an outstanding principal balance of $1,450,000 bear interest at the rate of 12.625% and are to mature on July 10, 2011. The noteholders have expressed the desire to amend and extend the notes at maturity, many having invested on these same terms with similar notes beginning in 2003. As of December 31, 2010 the related party holders represent $785,000 or 54% of the principal amount. Prior to the scheduled maturity date, our Board of Directors will consider our options, as they have repeatedly done since the original issuance of $3,500,000 of similar notes in 2003. We will attempt to reduce the outstanding principal balance and will offer to extend the due date of the remaining principal for an added period of time, which we anticipate to be from three to five years. Consideration will also be given to a significant reduction in the interest rate to 9-10%, reflecting our current financial condition as compared to our financial condition when the notes were issued in 2009.
Our reconciliation of net income to cash provided by (used in) operations is generally influenced by the collection of premiums in advance of paid losses, the timing of reinsurance, issuing company settlements and loss payments.
Net cash provided by financing activities increased as a result of the $1,434,000 decrease in principal payments of long-term debt in 2010 as compared to 2009, offset by a decrease in proceeds from long term debt in 2010. The acquisition of KICO on July 1, 2009 had no effect on our financing activities.
From June 2009 through December 2009, we borrowed an aggregate of $1,050,000 (including $585,000 payable from related parties) and issued promissory notes in such aggregate principal amount (the “2009 Notes”). The 2009 Notes provide for interest at the rate of 12.625% per annum and are payable on July 10, 2011. The 2009 Notes are prepayable by us without premium or penalty; provided, however, that, under any circumstances, the holders of the 2009 Notes are entitled to receive an aggregate of six months interest from the issue date of the 2009 Notes with respect to the amount prepaid. Between January 2010 and March 26, 2010, we borrowed an additional $400,000 (including $200,000 from related parties) on the same terms as provided for in the 2009 Notes.
Our reinsurance treaties for both its Personal Lines business, which primarily consists of homeowners’ policies, and Commercial Lines business, other than commercial auto were renewed as of July 1, 2010. The terms of the renewed treaties follow:
Changes in the severity or frequency of claims may affect our profitability. Changes in homeowners claim severity are driven by inflation in the construction industry, in building materials and in home furnishings, and by other economic and environmental factors, including increased demand for services and supplies in areas affected by catastrophes. Changes in bodily injury claim severity are driven primarily by inflation in the medical sector of the economy and litigation. Changes in auto physical damage claim severity are driven primarily by inflation in auto repair costs, auto parts prices and used car prices. However, changes in the level of the severity of claims are not limited to the effects of inflation and demand surge in these various sectors of the economy. Increases in claim severity can arise from unexpected events that are inherently difficult to predict, such as a change in the law. Although we pursue various loss management initiatives to mitigate future increases in claim severity, there can be no assurances that these initiatives will successfully identify or reduce the effect of future increases in claim severity, and a significant increase in claim frequency could have an adverse effect on our operating results and financial condition.
We are exposed to significant financial and capital markets risk, including changes in interest rates, equity prices, market volatility, the performance of the economy in general, the performance of the specific obligors included in our portfolio and other factors outside our control. Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. A rise in interest rates will increase the net unrealized loss position of our investment portfolio. Our investment portfolio contains interest rate sensitive instruments, such as fixed income securities, which may be adversely affected by changes in interest rates from governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A rise in interest rates would increase the net unrealized loss position of our investment portfolio, which would be offset by our ability to earn higher rates of return on funds reinvested. Conversely, a decline in interest rates would decrease the net unrealized loss position of our investment portfolio, which would be offset by lower rates of return on funds reinvested.
Regulation requiring us to underwrite business and participate in loss sharing arrangements may adversely affect our operating results and financial condition.
Our future success will depend, in part, upon the efforts of Barry Goldstein, our President and Chief Executive Officer, and John Reiersen, President and Chief Executive Officer of KICO. The loss of Messrs. Goldstein and/or Reiersen or other key personnel could prevent us from fully implementing our business strategies and could materially and adversely affect our business, financial condition and results of operations. As we continue to grow, we will need to recruit and retain additional qualified management personnel, but we may not be able to do so. Our ability to recruit and retain such personnel will depend upon a number of factors, such as our results of operations and prospects and the level of competition then prevailing in the market for qualified personnel. KICO and Mr. Reiersen have agreed that, effective January 1, 2012, he will become Executive Vice President of KICO and shall provide, in a part-time capacity, advice and assistance to the President and Chief Executive Officer of KICO, and other management personnel, with regard to the management and operation of KICO. It is contemplated that Mr. Goldstein will assume the duties and responsibilities of President and Chief Executive Officer of KICO effective January 1, 2012. Although Mr. Goldstein has served as our President and Chief Executive Officer since 2001, as KICO’s Chairman of the Board and Chairman of the Executive Committee since 2006 and as KICO’s Chief Investment Officer since 2008, he has never served as President and Chief Executive Officer of an insurance company.