Assurance MGA, a wholly owned subsidiary, acts as Federated National’s and American Vehicle’s exclusive managing general agent. Assurance MGA currently provides all underwriting policy administration, marketing, accounting and financial services to Federated National and American Vehicle, and participates in the negotiation of reinsurance contracts. Assurance MGA generates revenue through policy fee income and other administrative fees from the marketing of companies’ products through our distribution network.
Our business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on our business, results of operations and financial condition. Also, if our estimated liabilities for unpaid losses and LAE are less than actual losses and LAE, we will be required to increase reserves with a corresponding reduction in our net income in the period in which the deficiency is identified.
The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with management’s evaluation of the determination of liability for unpaid loss and LAE. In addition, significant estimates form the basis for our reserves with respect to finance contracts, premiums receivable and deferred income taxes. Various assumptions and other factors underlie the determination of these significant estimates.
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.
historical experience of each material short-tail and long-tail line of business. The Incurred and Paid Cape Cod Methods reflect similar historical development unique to each material short-tail and long-tail line of business.
The calculations underlying the Paid Cape Cod method are similar to the Reported Cape Cod method calculations with the exception that paid losses, unpaid percentages, and loss payment patterns replace reported losses, unreported percentages, and loss reporting patterns.
The Cape Cod method is most useful as an alternative to other models for immature accident years. For these immature years, the amounts reported or paid may be small and unstable and therefore not predictive of future development. Therefore, future development is assumed to follow an expected pattern that is supported by more stable historical data or by emerging trends. This method is also useful when changing reporting patterns or payment patterns distort the historical development of losses.
Reserves are estimates because there are uncertainties inherent in the determination of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends.
Interim - During 2007 for Federated National’s homeowners program, our selection of loss reserves was weighted more to the Paid Loss Development Method and the Incurred Loss Development Method. American Vehicle’s commercial general liability program relied upon the Cape Cod Method on both a paid and incurred basis as well as the Paid Loss Development Method and the Incurred Loss Development Method. During 2006 our selection of loss reserves were weighted more to the short-tail targeted loss ratio methods employing loss ratio factors from prior accident year indications. During the year-end process for 2007, we were able to employ long-tail methodologies to our commercial general liability program’s loss reserve process based on no specific event other than newly available in-house resources. The estimated pretax charge to operations in connection with the change in methods for estimating commercial general liability unpaid loss and loss adjustment totaled approximately $2.0 million.
A key assumption underlying the estimation of the reserve for losses and LAE is that past experience serves as the most reliable estimator of future events. This assumption may materially affect the estimates when the insurance market, the regulatory environment, the legal environment, the economic environment, the book of business, the claims handling department, or other factors have varied (known or unknown) over time during the experience period and / or will vary (expectedly or unexpectedly) in the future.
A number of other actuarial assumptions are generally made in the review of reserves for each class of business. For the long-tail classes of business, other actuarial assumptions generally are made with respect to the following:
· Expected loss ratios for the latest accident year and, in some cases for accident years prior to the latest accident year. The expected loss ratio generally reflects the projected loss ratio from prior accident years, adjusted for the loss trend and the effect of rate changes and other quantifiable factors on the loss ratio.
For the year ended December 31, 2007 our actuarial firm determined range of loss and LAE reserves on a net basis range from a low of $37.9 million to a high of $45.6 million, with a best estimate of $42.1 million. The Company’s net loss and LAE reserves are carried at $40.0 million. Management’s point estimate of reserves are 5.2% below our actuary’s best estimate in recognition of the inherent uncertainty in assessing the potential ultimate liabilities given legal developments as well as evolution in its operations.
We are required to review the contractual terms of all our reinsurance purchases to ensure compliance with SFAS 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts”. The statement establishes the conditions required for a contract with a reinsurer to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. Contracts that do not result in the reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed generally do not meet the conditions for reinsurance accounting and must be accounted for as deposits. SFAS 113 also requires us to disclose the nature, purpose and effect of reinsurance transactions, including the premium amounts associated with reinsurance assumed and ceded. It also requires disclosure of concentrations of credit risk associated with reinsurance receivables and prepaid reinsurance premiums.
financial condition and near term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology or discontinuance of a business segment;
The Company evaluates its investments in securities to determine other than temporary impairment, no less than quarterly. Investments that are deemed other than temporarily impaired are written down to their estimated net fair value and the related losses recognized in operations in the period of determination.
Cash and short term investments, which include cash, certificates of deposits, and money market accounts increased $4.6 million, or 25.7%, to $22.5 million as of December 31, 2007, compared to $17.9 million as of December 31, 2006. These balances are held primarily in money market accounts at amounts deemed sufficient to meet short-term cash requirements. Our excess cash and short term investments are invested in accordance with our liquidity requirements.
Receivable for investments sold increased to $6.4 million, as of December 31, 2007, compared to nothing as of December 31, 2006. The increase is a result of investment trading activity that occurred in late December and did not settle until early January 2008.
Finance contracts receivable, net of allowance for credit losses, decreased $1.4 million, or 77.1%, to $0.4 million as of December 31, 2007, compared to $1.8 million as of December 31, 2006. The decrease is primarily due to our sale in December 2004 of our assets related to our non-standard automobile insurance agency business in Florida and the associated financed contracts. We anticipate a continued decline in the financed contracts receivable, net over the future short term and its related conversion to cash and short term investments and investments.
Our homeowners’ insurance premiums receivable decreased $2.3 million, or 55.1%, to $1.9 million as of December 30, 2007, compared to $4.2 million as of December 31, 2006. The change can be attributed to a decrease in written premiums.
Our commercial general liability insurance premiums receivable decreased $0.1 million, or 5.2%, to $2.6 million as of December 30, 2007, compared to $2.7 million as of December 31, 2006.
Premiums receivable in connection with our automobile line of business decreased $0.8 million, or 69.2%, to $0.4 million as of December 31, 2007, compared to $1.2 million as of December 31, 2006. The decrease in automobile related premiums receivable is associated with our current policy to underwrite renewal policies only and not take any new policy applicants.
Property, plant and equipment, net, decreased $0.2 million, or 19.3%, to $1.0 million as of December 31, 2007, compared to $1.3 million as of December 31, 2006. The decrease is primarily due to depreciation and amortization of our existing property, plant and equipment.
Unpaid losses and LAE increased $20.1 million, or 50.7%, to $59.7 million as of December 31, 2007, compared to $39.6 million as of December 31, 2006. The increase in unpaid losses and LAE relates primarily to our loss reserve strengthening relative to the commercial general liability and property lines of business. The composition of unpaid loss and LAE by product line is as follows:
Factors that affect unpaid losses and LAE include the estimates made on a claim-by-claim basis known as “case reserves” coupled with bulk estimates known as incurred but not yet reported (“IBNR”). Periodic estimates by management of the ultimate costs required to settle all claim files are based on the Company’s analysis of historical data and estimations of the impact of numerous factors such as (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. Management revises its estimates based on the results of its analysis. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors.
Income taxes payable increased to $4.2 million as of December 31, 2007, compared to nothing as of December 31, 2006. The change is due to tax payment patterns in connection with our tax liabilities.
Deferred gain from sale of property decreased $0.5 million, or 19.0%, to $2.0 million as of December 31, 2007, compared to $2.5 million as of December 31, 2006. In accordance with the provisions of SFAS 13, we are amortizing the deferred gain over the term of the leaseback, which is scheduled to end in December 2011.
Year Ended December 31, 2007 Compared to Year Ended December 31,
Gross premiums written decreased $19.1 million, or 12.5%, to $133.6 million for the year ended December 31, 2007, compared to $152.7 million for year ended December 31, 2006. The following table denotes gross premiums written by major product line.
The following table sets forth the amounts and percentages of our gross premiums written in connection with our commercial general liability program by state:
The Company’s sale of homeowners’ policies decreased $14.9 million, or 13.0% to $99.5 million for the year ended December 31, 2007, compared to $114.4 million for the year ended December 31, 2006. The decrease is primarily due to the soft market conditions prevailing in the State of Florida. The soft market conditions are lead by Citizens, the state run insurance company. We believe that the competition in this market is based primarily on pricing insurance products at rates that do not reflect current economic conditions. We do not intend to compete with others solely on the basis of pricing mechanisms. Where our rates are competitive (and there are territories in Florida that so exist) we will continue to market our property insurance product.
The Company’s sale of auto insurance policies decreased by $4.2 million, or 69.2%, to $1.9 million for the year ended December 31, 2007, compared to $6.1 million for the year ended December 31, 2006.
The (decrease) increase in prepaid reinsurance premiums was ($11.3) million for the year ended December 31, 2007, compared to $20.2 million for year ended December 31, 2006. The change in this account is primarily associated with the timing of our reinsurance payments measured against the term of the underling reinsurance policies.
Net premiums earned increased $9.9 million, or 11.1%, to $99.2 million for the year ended December 31, 2007, compared to $89.3 million for year ended December 31, 2006. The following table denotes net premiums earned by major product line.
As noted above, the Company’s efforts to expand its commercial general liability lines of insurance products is coming to fruition, as reflected by increased net premiums earned of $5.1 million, or 18.4 % to $32.7 million for the year ended December 31, 2007, compared to $27.7 million for the year ended December 31, 2006.
Commission income increased $5.5 million, to $7.2 million for the year ended December 31, 2007, compared to $1.7 million for the year ended December 31, 2006. Recurring components of our commission income totaled $1.4 million. Non-reoccurring components of our commission income totaled $5.8 million stemming from two separate events. First and pursuant to provisions contained in the three-year reinsurance treaties, we were afforded the right to cancel the remaining two years and be entitled to receive a no loss experience commission. In connection with this treaty, we reported approximately $2.8 million during the year ended December 31, 2007. The second non-reoccurring operating event was in connection with commission income totaling approximately $3.0 million in connection with our participation in a Citizens take out program in 2004, wherein the commission was earned by us upon the successful retention of the policyholder for thirty-six months.
Finance revenue decreased $1.1 million, or 67.7%, to $0.5 million for the year ended December 31, 2007, compared to $1.7 million for year ended December 31, 2006. The change is primarily due to the Company’s decreased emphasis on automobile insurance and the finance revenue derived there-from.
The following table reflects the changes during the year ended December 31, 2007 in connection with the four hurricanes that occurred in August and September of 2004. A charge of $1.2 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, 2007 was 48.0%, compared to 49.7% for the year ended December 31, 2006. The table below reflects the loss ratios by product line.
Operating and underwriting expenses decreased $0.5 million, or 3.6%, to $12.7 million for the year ended December 31, 2007, compared to $13.2 million for the year ended December 31, 2006. The change is primarily due to a $2.3 million aggregate decrease in boards bureaus and associations, bad debts, real estate taxes, motor vehicle reports, telephone, temporary employment, postage and bank fees, offset by a $1.8 million aggregate increase in legal fees, building rent, premium taxes, consulting fees, licensing, accounting fees and a one time settlement payment to State National.
Salaries and wages decreased $0.3 million, or 4.0%, to $6.7 million for the year ended December 31, 2007, compared to $7.0 million for the year ended December 31, 2006.
Interest expense decreased $0.5 million, or 73.6%, to $0.2 million for the year ended December 31, 2007, compared to $0.7 million for year ended December 31, 2006. The decrease results from our subordinated debt retirement on September 30, 2007.
The provision for income tax expense increased $3.8 million, or 51.8%, to $11.2 million for the year ended December 31, 2007, compared to $7.4 million for the year ended December 31, 2006. The effective rate for income tax expense is 34.5% for the year ended December 31, 2007, compared to 34.7% for the year ended December 31, 2006.
Gross premiums written increased $33.2 million, or 27.8%, to $152.7 million for the year ended December 31, 2006, compared to $119.4 million for the year ended December 31, 2005. The following table denotes gross premiums written by major product line.
As noted above, the Company’s efforts to expand commercial general liability lines of insurance products are coming to fruition, as reflected by increased premiums written of $9.6 million, or 42.6 % to $32.2 million for the year ended December 31, 2006, compared to $22.6 million for the year ended December 31, 2005.
The Company’s sale of homeowners’ policies increased $38.2 million, or 50.2%, to $114.4 million for the year ended December 31, 2006, as compared to $76.2 million for year ended December 31, 2005. The increase in homeowners’ gross premiums written was primarily due to the Company’s rate increase, with only a slight increase in the number of policy holders.
Net premiums earned increased $6.4 million, or 7.7%, to $89.3 million for the year ended December 31, 2006, compared to $83.0 million for year ended December 31, 2005. The following table denotes net premiums earned by major product line.
Managing general agent fees increased $0.2 million, or 8.5%, to $2.6 million for the year ended December 31, 2006, compared to $2.4 million for year ended December 31, 2005.
Loss and LAE decreased by $3.9 million, or 8.1%, to $44.4 million for the year ended December 31, 2006, compared to $48.3 million for year ended December 31, 2005. The decrease was attributable to the increase in loss and LAE incurred during the year ended December 31, 2005 which was in connection with the adverse development associated with the 2004 hurricanes.
Salaries and wages increased $0.6 million, or 9.8%, to $7.0 million for the year ended December 31, 2006, compared to $6.4 million for year ended December 31, 2005. As a result of the adoption of SFAS 123R on January 1, 2006, salaries and wages for the year ended December 31, 2006 included a $0.5 million charge, representing approximately 85.9% of the 2006 overall increase. The remaining increase in salaries and wages was due in part to the increased labor costs in connection with additional claims loss adjusters added to our staff. We believe that salaries and wages are consistent with retaining quality management and increased premium production.
For the year ended December 31, 2007, operations provided net operating cash flow of $32.8 million, as compared to $27.5 million and $19.4 million for the years ended December 31, 2006 and 2005, respectively.
For the year ended December 31, 2007, net financing activities used $9.2 million, as compared to provided $4.1 million and used $4.0 million for the years ended December 31, 2006 and 2005, respectively. For the year ended December 31, 2007, the sources of cash in connection with financing activities included $2.0 million from the exercise of warrants, a $0.2 million tax benefit related to non-cash compensation and $0.2 million of exercised stock options. The uses of cash in connection with financing activities included $5.8 million in dividends paid, $3.8 million for the purchase of treasury stock and $2.1 million for the regularly scheduled principal and interest payments on our Notes.
Federated National’s and American Vehicle’s statutory capital surplus levels as of December 31, 2007 were approximately $32.3 million and $27.6 million, respectively, and their statutory net income for the year ended December 31, 2007 were $15.3 million and $1.3 million, respectively.
As of December 31, 2007, 2006, and 2005, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “structured finance” or “special purpose” entities, which were established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. As such, management believes that we currently are not exposed to any financing, liquidity, market or credit risks that could arise if we had engaged in transactions of that type requiring disclosure herein.
On September 30, 2007, we made the final principal payment of $1,041,667 on the September 2004 notes and the September 2004 warrants expired. Of the 1,019,608 shares that could have been issued in connection with the September 2004 warrants, 911,270 were exercised and 108,338 were unexercised. The unexercised warrants were cancelled as of September 30, 2007.
Insurance premiums are established before we know the amount of loss and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate premiums, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation also affects the market value of our investment portfolio and the investment rate of return. Any future economic changes which result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred loss and LAE and thereby materially adversely affect future liability requirements.
21st Century is an insurance holding company, which, through our subsidiaries and our contractual relationships with our independent agents and general agents controls substantially all aspects of the insurance underwriting, distribution and claims process. We are authorized to underwrite homeowners’ property and casualty insurance, commercial general liability insurance, personal automobile insurance and commercial automobile insurance in various states with various lines of authority through our wholly owned subsidiaries, Federated National and American Vehicle.
Insurable events during 2007 and 2006 were more normal in nature as compared to 2005 and 2004. 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 property and liability claims stemming from our homeowners’, commercial general liability and private passenger automobile lines 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 homeowners’ 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.
American Vehicle is authorized as either an admitted or surplus lines carrier to underwrite commercial general liability coverage. American Vehicle has either ongoing operations or operations expected to commence this year in several states. The table below denotes by state American Vehicle’s authority, status of operations and where new applications are pending. We may not receive authority to write in every state we request due to state specific guidelines.
Additionally, both Federated National and American Vehicle are authorized to underwrite personal automobile insurance in Florida as an admitted carrier.
During 2007 American Vehicle applied for and was granted, by the State of Florida in 2008, a license to underwrite commercial multiple peril, inland marine and surety lines of business as an admitted carrier. We believe theses new lines of authority will bode well with American Vehicle’s existing customers. Operations under American Vehicle’s newly granted line of authority are expected to begin during 2008.
Assurance MGA, a wholly owned subsidiary, acts as Federated National’s and American Vehicle’s exclusive managing general agent in the state of Florida. As American Vehicle continues its expansion into other states we shall contract with general agents to market our commercial general liability insurance product beyond the state of Florida. Assurance MGA currently provides underwriting policy administration, marketing, accounting and financial services to Federated National and American Vehicle, and participates in the negotiation of reinsurance contracts. Assurance MGA generates revenue through a 6% commission fee from the insurance companies’ gross written premium, policy fee income of $25 per policy and other administrative fees from the marketing of company products through the Company’s distribution network. The 6% commission fee from Federated National and American Vehicle was made effective January 1, 2005. Assurance MGA plans to establish relationships with additional carriers and servicing additional insurance products in the future.
Our investment securities have been classified as either available-for-sale or held to maturity in response to our liquidity needs, changes in market interest rates and asset-liability management strategies, among other reasons. Investments available-for-sale are stated at fair value on the balance sheet. Investments designated as held to maturity are stated at amortized cost on the balance sheet. Unrealized gains and losses are excluded from earnings and are reported as a component of other comprehensive income within shareholders' equity, net of related deferred income taxes.
A decline in the fair value of an available-for-sale security below cost that is deemed other than temporary results in a charge to income, resulting in the establishment of a new cost basis for the security. Premiums and discounts are amortized or accreted, respectively, over the life of the related fixed maturity security as an adjustment to yield using a method that approximates the effective interest method. Dividends and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific-identification method for determining the cost of securities sold.
Premium revenue on all lines are earned on a pro-rata basis over the life of the policies. Unearned premiums represent the portion of the premium related to the unexpired policy term.
In September 2006, FASB issued SFAS 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect any impact upon the adoption of SFAS 157 on our consolidated financial statements.
In September 2006, FASB issued SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” This statement requires an employer to recognize the overfunded or underfunded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through comprehensive income. SFAS 158 is effective for years ending after December 15, 2006. There was no impact on our consolidated financial statements with respect to the adoption of SFAS 158.
In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108 to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that registrants quantify the impact on the current year’s financial statements of correcting all misstatements, including the carryover and reversing effects of prior years’ misstatements, as well as the effects of errors arising in the current year. SAB 108 is effective as of the first fiscal year ending after November 15, 2006, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006, for errors that were not previously deemed material, but are material under the guidance in SAB No. 108. There was no impact on our consolidated financial statements with respect to the adoption of SAB No. 108.
In February 2006, FASB issued SFAS 155, “Accounting for Certain Hybrid Financial Instruments”. This accounting standard permits fair value re-measurement for any hybrid financial instrument containing an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; establishes a requirement to evaluate interests in securitized financial assets to identify them as freestanding derivatives or as hybrid financial instruments containing an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends SFAS 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument pertaining to a beneficial interest other than another derivative financial instrument. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year beginning after September 15, 2006. There was no impact on our consolidated financial statements with respect to the adoption of SFAS 155.
Our revenues and operating performance will fluctuate due to statutorily approved assessments that support property and casualty insurance pools and associations.
Our business is heavily regulated, and changes in regulation may reduce our profitability and limit our growth.
Our largest shareholders currently control approximately 10% of the voting power of our outstanding common stock, which could discourage potential acquirers and prevent changes in management.
We have authorized but unissued preferred stock, which could affect rights of holders of common stock.
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2007 and 2006 because of their short-term nature: cash and short term investments, premiums receivable, finance contracts, due from reinsurers, revolving credit outstanding, bank overdraft, accounts payable, accrued expenses and subordinated debt.
Certain 2006 and 2005 financial statement amounts have been reclassified to conform to the 2007 presentations.
intent and ability of the Company to retain the investment for a period of time sufficient to allow for anticipated recovery in market value.
The fixed maturities and the equity securities that are available for sale and carried at fair value represent 85.2% of total investments as of December 31, 2007, as compared to 84.2% as of December 31, 2006. The investments held at December 31, 2007 and December 31, 2006 were comprised mainly of United States government and agency bonds as well as municipal bonds which are viewed by the Company as conservative and less risky holdings, though sensitive to interest rate changes. There is a smaller concentration of corporate bonds predominantly held in the financial and conglomerate industries. Our equity holdings held at December 31, 2007 were primarily in trust companies, financial companies and mutual funds; and our equity holdings at December 31, 2006 were primarily in trust companies and mutual funds.
We determined that one of our securities qualified for other than temporary impairment status during the three months ended September 30, 2007. In connection with this process we charged to operations a net realized investment loss that totaled approximately $797,000, net of an estimated provisional tax effect of approximately $481,000. This investment was subsequently sold during the three months ended December 31, 2007, and we recognized an additional $200,000 loss, net of an estimated tax benefit of approximately $122,000 in connection with this security.
There were no impaired investments written down as of December 31, 2007, 2006 and 2005.
The following table summarizes, by type, our investments as of December 31, 2007 and 2006.
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of fixed maturities and equity securities at December 31, 2007 and 2006 is as follows:
At December 31, 2007 prepaid reinsurance premiums were nothing, compared to $6.6 million as of December 31, 2006. These prepaid reinsurance premiums were associated with a single reinsurer and returned pursuant to provisions contained in the three-year reinsurance treaties, in which we were afforded the right to cancel the remaining two years and be entitled to receive a no loss experience commission. In connection with the cancellation of this treaty, we reported approximately $2.8 million commission income during the year ended December 31, 2007.
Federated Premium’s operations were funded by the revolving loan agreement with FlatIron. The Revolving Agreement is structured as a sale of contracts receivable under a sale and assignment agreement with WPAC, which gives them the right to sell or assign these contracts receivable. Federated Premium, which services these contracts, has recorded transactions under the Revolving Agreement as secured borrowings. There were no outstanding borrowings under the Revolving Agreement as of December 31, 2007. Outstanding borrowings under the Revolving Agreement as of December 31, 2006 and 2005 were approximately $0.01 million and $0.20 million, respectively. This credit facility terminated, at our request, during 2007.
The actual income tax expense differs from the "expected" income tax expense (computed by applying the combined applicable effective federal and state tax rates to income before provision for income tax expense) as follows:
In assessing the net realizable value of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2007 and 2006, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences.
To retain our certificate of authority, the Florida Insurance Code (the "Code") requires Federated National and American Vehicle to maintain capital and surplus equal to the greater of 10% of their liabilities or a statutory minimum capital and surplus as defined in the Code. Federated National and American Vehicle are required to have a minimum capital surplus of $4.0 million. At December 31, 2007, 2006 and 2005, Federated National’s statutory capital surplus was $32.3 million, $19.5 million and $11.2 million, respectively. At December 31, 2007, 2006 and 2005, American Vehicle had statutory capital surplus of $27.6 million, $26.7 million and $18.0 million, respectively.
As of December 31, 2007, to meet regulatory requirements, we had bonds with a carrying value of approximately $2.2 million pledged to the Insurance Commissioner of the State of Florida.
Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its shareholders except out of that part of its available and accumulated capital surplus funds which is derived from realized net operating profits on its business and net realized capital gains. A Florida domestic insurer may not make dividend payments or distributions to shareholders without prior approval of the Florida OIR if the dividend or distribution would exceed the larger of (i) the lesser of (a) 10.0% of its capital surplus or (b) net income, not including realized capital gains, plus a two-year carryforward, (ii) 10.0% of capital surplus with dividends payable constrained to unassigned funds minus 25% of unrealized capital gains or (iii) the lesser of (a) 10.0% of capital surplus or (b) net investment income plus a three-year carryforward with dividends payable constrained to unassigned funds minus 25.0% of unrealized capital gains.
We may be the subject of additional targeted examinations or analysis. These examinations or analysis may result in one or more corrective orders being issued by the Florida OIR. Federated National anticipates a regularly scheduled statutory triennial examination by the Florida OIR to occur during 2008 for the three years ended December 31, 2007 however we have not yet received any notice of such examination.
As of December 31, 2007, American Vehicle was outside NAIC’s usual range for two of thirteen ratios. The exceptions were in connection with reserve development in connection with our Commercial General Liability program.
We do not currently believe that the Florida OIR will take any significant action with respect to Federated National or American Vehicle regarding the 2007 IRIS ratios, although there can be no assurance that will be the case.
GAAP differs in some respects from reporting practices prescribed or permitted by the Florida OIR. Federated National's statutory capital and surplus was $32.3 million and $19.5 million as of December 31, 2007 and 2006, respectively. Federated National's statutory net income (loss) was $15.3 million, $1.7 million and ($2.2) million for the years ended December 31, 2007, 2006 and 2005, respectively. Federated National’s statutory non-admitted assets were approximately $1.2 million and $11.0 million as of December 31, 2007 and 2006, respectively.
The 2004, 2003 and 2002 consolidated Federal Income Tax Returns filed by the Company have been examined by the IRS during 2006 and 2005. We have concurred with certain IRS conclusions and have appealed other conclusions. Irrespective of the ongoing appellate process, we do not believe that a material adjustment will occur. Income taxes receivable are net of $160,000 reserve established in conjunction with this process.
Pursuant to Section 627.3512, Florida Statutes, insurers are permitted to recoup the assessment by adding a surcharge to policies in an amount not to exceed the amount paid by the insurer to Citizens. Federated National is currently underwriting the recoupment in connection with this assessment and has recouped approximately $0.4 million and $1.2 million during 2007 and 2006, respectively. As noted above, Federated National has subrogated $1.5 million to our reinsurers.
Federated National and American Vehicle are also required to participate in an insurance apportionment plan under Florida Statutes Section 627.351, which is referred to as a JUA Plan. The JUA Plan provides for the equitable apportionment of any profits realized, or losses and expenses incurred, among participating motor vehicle insurers. In the event of an underwriting deficit incurred by the JUA Plan which is not recovered through the policyholders in the JUA Plan, such deficit shall be recovered from the companies participating in the JUA Plan in the proportion that the net direct written premiums of each such member during the preceding calendar year bear to the aggregate net direct premiums written in this state by all members of the JUA Plan. During the year ended December 31, 2007 Federated National was assessed $7,470 and American Vehicle recovered $842, by and from the JUA Plan based on its December 2007 Cash Activity Report. During the year ended December 31, 2006 Federated National and American Vehicle were assessed $221,765 and $1,579, respectively. These charges are contained in Operating and Underwriting Expenses in the Statement of Operations. Future assessments by this association are undeterminable at this time.
A summary of the numerator and denominator of the basic and fully diluted 2007, 2006 and 2005 net income per share is presented below:
We implemented a stock option plan in November 1998 that provides for the granting of stock options to officers, key employees and consultants. The objectives of this plan includes attracting and retaining the best personnel, providing for additional performance incentives, and promoting our success by providing employees the opportunity to acquire common stock. Options outstanding under this plan have been granted at prices, which are either equal to or above the market value of the stock on the date of grant, typically vest over a four-year period, and expire six or ten years after the grant date. Under this plan, we are authorized to grant options to purchase up to 900,000 common shares, and, as of December 31, 2007, we had outstanding exercisable options to purchase 152,599 shares.
Compensation cost for all share-based payments 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 123, and
Because the change in income taxes payable includes the effect of excess tax benefits, those excess tax benefits also must be shown as a separate operating cash outflow so that operating cash flows exclude the effect of excess tax benefits. SFAS 123R requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement to options granted under our stock option plans in the period presented. For purposes of this provision disclosure and comparability, the value of the options were estimated using the Black-Scholes option-pricing model and amortized to expense over the options vesting periods.
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. Unrealized loss in connection with the 2006 reclassification totaled $0.26 million, net of a $0.16 income tax effect.
21st Century Holding Company (the parent company only) has no long term obligations, guarantees or material contingencies as of December 31, 2007. The following summarizes the major categories of the parent company’s financial statements:
The September 2004 Notes paid interest at the annual rate of 6%, mature on September 30, 2007, and ranked pari passu in terms of payment and priority to the July 2003 Notes. Quarterly payments of principal and interest due on the September 2004 Notes, like 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.
As indicated on the table below, we paid, pursuant to the terms of the September 2004 Notes and in accordance with the contractual computations, selected quarterly payments of principal and interest due in shares of our Common Stock.
For the September 2004 Notes, the quarterly principal and interest payments, totaling approximately $1.1 million per payment, were due quarterly with the last installment paid in cash on September 30, 2007.
Assets and liabilities, including goodwill, that were sold totaled approximately $2.1 million on December 31, 2004.