Our executive offices are now located at 14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323 in an 18,500 square foot office facility and our telephone number is (800) 293-2532. During March 2014, we extended our lease term to expire in August 2019 and expanded the leased premises to include an additional 13,642 square feet. All of our operations are consolidated within this facility. We believe that the facilities are well maintained, in substantial compliance with environmental laws and regulations, and adequately covered by insurance. We also believe that these leased facilities are not unique and could be replaced, if necessary, at the end of the lease term.
Federated National Holding Company (“FNHC”, “Company”, “we”, “us”), formerly known as 21st Century Holding Company, is an insurance holding company that controls substantially all steps in the insurance underwriting, distribution and claims processes through our subsidiaries and our contractual relationships with our independent agents and general agents. We changed our name on September 11, 2012, pursuant to approval received at our annual shareholders’ meeting, from 21st Century Holding Company so that our parent company and other subsidiary companies’ names are consistent with our primary insurance subsidiary and the name under which we have been writing insurance for more than 23 years.
Except as described below, we believe that in 2014 there were no significant changes in those critical accounting policies and estimates. Senior management has reviewed the development and selection of our critical accounting policies and estimates and their disclosure in this Form 10-K with the Audit Committee of our Board of Directors.
The estimated Ultimate Loss and Defense and Cost Containment Expense (“DCCE”) is based on an analysis by line of business, coverage and by accident quarter performed using data as of December 31, 2014. The analysis relies primarily on four actuarial methods: Incurred Loss and DCCE Development Method, Paid Loss and DCCE Development Method, Bornhuetter-Ferguson Incurred Method, and Bornhuetter-Ferguson Paid Method. Each method relies on company experience, and, where relevant, the analysis includes comparisons to industry experience. The following is a description of each of these methods:
A key assumption underlying the estimation of the reserve for loss 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 (known or unknown) have varied over time during the experience period and / or will vary (expectedly or unexpectedly) in the future. 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. Therefore, the ultimate liability for unpaid losses and LAE will likely differ from the amount recorded at December 31, 2014.
For each class of business, expected ultimate loss ratios for each accident year are estimated based on loss reserve development patterns. 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.
Total investments increased $110.1 million, or 49.9%, to $330.8 million as of December 31, 2014, compared with $220.7 million as of December 31, 2013. This increase reflected the $133.8 million increase in gross premiums written compared with 2013 and the $43.4 million in net proceeds from the Company’s August 2014 offering. The excess cash was invested primarily in the bond portfolio.
The debt and equity securities that are available-for-sale and carried at fair value represent 98% of total investments as of December 31, 2014, compared with 97% as of December 31, 2013.
The $0.5 million of unrealized losses from equity securities is from common stocks and mutual funds held in diverse industries as of December 31, 2014. The Company evaluated the near-term prospects in relation to the severity and duration of the impairment. Based on this evaluation and the Company’s ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2014.
In reaching a conclusion that a security is either other-than-temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor’s (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”), as well as information released via the general media channels.
As December 31, 2014, the duration of the bond portfolio was approximately 3.7 years.
Two reinsurers require FNIC to maintain securities with a fair market value of $4.9 million. As of December 31, 2014 and 2013, FNIC maintained fully funded trust agreements that totaled $4.9 million in favor of the reinsurers. In addition, as of December 31, 2014 and 2013, $1.0 million is held in a fully funded trust account in favor of another reinsurer under a prior program.
Prepaid reinsurance premiums increased $46.9 million, or 618.5%, to $54.5 million as of December 31, 2014, compared with $7.6 million as of December 31, 2013 as the result of the increase in ceded unearned premiums on the Property 30% Quota Share reinsurance agreement effective July 1, 2014, in addition to the amortization of our payment patterns. We believe concentrations of credit risk associated with our prepaid reinsurance premiums are not significant.
Premiums receivable in connection with our automobile line of business increased $2.0 million, or 72.0%, to $4.8 million as of December 31, 2014, compared with $2.8 million as of December 31, 2013.
DPAC decreased $3.1 million, or 18.5%, to $13.6 million as of December 31, 2014, compared with $16.7 million as of December 31, 2013. The change reflects in part the deferral of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned associated with our increased unearned premium, which during the twelve months ended December 31, 2014 total approximately $9.3 million. The $9.3 million increase was offset by a $12.4 million reduction associated with our Property 30% Quota Share agreement effective July 1, 2014. An analysis of deferred acquisition costs follows.
The change to deferred income taxes, net is primarily due to the decrease in the reserve for claims settlements and increase in unrealized gain on investment securities as illustrated in the following table.
Contingent quota-share profit sharing totaled $14.0 million as of December 31, 2014, compared with nothing as of December 31, 2013. The $14.0 million is our current estimated profit-sharing benefit associated with our Property 30% Quota Share agreement effective July 1, 2014. The provisions of this program allow for profit-sharing up to approximately $32.0 million at the end of the two-year contract term. The ultimate benefit is based upon the occurrence of future catastrophic events and predefined non-catastrophic loss ratios.
Unearned premiums increased $64.1 million, or 49.9%, to $192.4 million as of December 31, 2014, compared with $128.3 million as of December 31, 2013. The change was due to a $61.3 million increase in unearned homeowners’ insurance premiums, a $0.8 million increase in unearned flood insurance premiums, a $1.2 million increase in unearned commercial general liability premiums and a $0.8 million increase in unearned automobile insurance premiums. Generally, as is in this case, an increase in unearned premium directly relates to an increase in written premium on a rolling twelve-month basis. The $64.1 million total increase and the $61.3 million homeowners’ increase were net of a $38.5 million reduction associated with our Property 30% Quota Share agreement effective July 1, 2014.
Premium deposits and customer credit balances increased $3.6 million, or 92.6%, to $7.4 million as of December 31, 2014, compared with $3.8 million as of December 31, 2013. Premium deposits are monies received on policies not yet in-force, the change of which is due to the increase in gross written premiums during this same period.
Income taxes payable converted to income taxes receivable of $1.8 million as of December 31, 2014, compared with income taxes payable of $2.4 million as of December 31, 2013. The change is due to estimated tax payments made in excess of the related accrued liability.
Claims payments outstanding increased $4.0 million, or 63.7%, to $10.2 million as of December 31, 2014, compared with $6.2 million as of December 31, 2013. The claims payments outstanding relate primarily to losses and LAE disbursements paid but not presented for payment by the policyholder or vendor. The change relates to the timing of presentation of claims checks to the issuing bank. Generally, the increase in claims payments outstanding directly relates to the increase in claims payments which directly relates to the increase in written premium.
Accounts payable and accrued expenses increased $4.5 million, or 69.5%, to $11.0 million as of December 31, 2014, compared with $6.5 million as of December 31, 2013. The $4.5 million change includes increases of $1.8 million for premium taxes, $0.9 million for commissions, $0.9 million for vendor accruals, $0.4 million for the remittance of recouped assessments, $0.3 million for the Homeowners Louisiana assessment and $0.2 million for dividends.
Deferred quota-share profit sharing totaled $10.5 million as of December 31, 2014, compared with nothing as of December 31, 2013, and relates to the quota-share program. The deferred quota-share profit sharing was originally recorded at $14.0 million at the program’s July 1, 2014 inception and will continue to amortize over the life of the program.
Gross premiums written increased $133.8 million, or 55.0%, to $377.2 million for 2014, compared with $243.4 million for 2013. The following table denotes gross premiums written by major product line. The increase in gross premiums written during 2014 is primarily due to the increase in the sale of homeowners’ policies. During 2014, our improved underwriting, risk management and product distribution enabled us to write more policies than in prior years.
During 2014, $39.6 million or 11.0% of the $344.9 million of homeowners’ premiums we underwrote were produced under an agency agreement with Ivantage Select Agency, Inc. (“ISA”), an affiliate of Allstate Insurance Company, that grants Allstate agents the authority to offer certain FNU products. The $39.6 million of homeowners’ premiums produced under this agreement with ISA represents 31.0% of the total increase in the sale of homeowners’ policies during 2014, compared with 2013. This network of agents began writing for FNIC in March 2013.
These premium discounts have had a significant effect on both written and earned premium. Wind mitigation credits are 50.1% of the pre-credit premium, or $336.7 million, as of December 31, 2014, as compared with 50.1% of the pre-credit premium, or $216.8 million, as of December 31, 2013.
Our in-force homeowners’ policies increased by approximately 66,200, or approximately 56.8%, to approximately 182,600 as of December 31, 2014, as compared with approximately 116,400 as of December 31, 2013.
Premium rates charged to our homeowner insurance policyholders are continually evaluated to assure that they meet the expectation that they are actuarially sound and produce a reasonable level of profit (neither excessive nor inadequate). Premium rates are regulated and approved by the Florida OIR. In 2014 our voluntary program rate study resulted in a rate decrease of 3% on our voluntary property book of homeowners’ business. In 2013 our voluntary program rate indications did not indicate the need for adjustment. In 2012 we were approved for a 4.8% and 0.9% rate increase on our voluntary property book of homeowners’ business.
Similarly, for the policies we assumed from Citizens Property Insurance Corporation (“Citizens”) in 2009, we received approval for a 14.8% increase in 2013 and a 14.1% rate increase in 2012. There was no rate change in 2014. Our voluntary program was 99.0%, 97.7%, and 90.0% of the total homeowner program, for the years ending December 31, 2014, 2013 and 2012, respectively.
The Company’s sale of commercial general liability policies increased by $2.0 million to $12.4 million for 2014, compared with $10.4 million for 2013. The primary factor for this increase has been renewal retention combined with new business growth.
The increase in unearned premiums was $64.1 million for 2014, compared with $69.3 million in 2013. The $64.1 million charge to written premium was due to a $61.3 million increase in unearned homeowners’ insurance premiums, a $0.8 million increase in unearned flood premiums, a $1.2 million increase in unearned commercial general liability premiums and a $0.8 million increase in unearned automobile insurance premiums during 2014. These changes are a result of differences in written premium volume during this period as compared with the same period last year. See “Gross Premiums Written” above. The $64.1 million total increase and the $61.3 million homeowners’ increase were net of a $38.5 million reduction associated with our Property 30% Quota Share agreement effective July 1, 2014.
The $64.4 million increase in homeowners’ net premiums earned is due to a $126.6 million increase in gross written premium as discussed, a $115.0 million increase in gross premiums ceded and a $52.9 million decrease in the net change to prepaid reinsurance premiums and unearned premium.
The $66.5 million total increase and the $64.4 million homeowners’ increase were net of a $34.6 million reduction associated with our Property 30% Quota Share agreement effective July 1, 2014.
The $1.3 million increase in commercial general liability net premiums earned is a result of a $2.1 million increase in gross written premium, a less than $0.1 million increase in gross premiums ceded and a $0.7 million increase in the net change to unearned premium.
The $0.8 million increase in automobile net premiums earned is a result of a $3.9 million increase in gross written premium as discussed, a $3.0 million increase in gross premiums ceded and a $0.2 million increase in the net change to prepaid reinsurance premiums and unearned premium.
Direct written policy fees increased $2.5 million, or 40.2%, to $8.7 million for 2014, compared with $6.2 million for 2013. The change is attributed to the increase in gross premiums written during this same period.
The table below depicts the net realized investment gains by investment category during 2014 and 2013.
Other income increased $1.1 million, or 75.1%, to $2.5 million for 2014, compared with $1.4 million for 2013. The increase is primarily due to the commission sharing agreement with our reinsurance intermediary.
Quota-share profit sharing, net totaled $2.8 million for 2014, compared with nothing for 2013. The deferred quota-share profit sharing was originally estimated and recorded at $14.0 million at the program’s July 1, 2014 inception, based upon the likely occurrence of future catastrophic events and predefined non-catastrophic loss ratios. This estimate, subject to future adjustments, will continue to be amortized over the remaining life of the quota-share program.
Favorable adjustments to the deferred quota-share profit sharing total will increase the amount we recognize over the remaining life of the program. Unfavorable adjustments to the deferred quota-share profit sharing total will decrease the amount we recognize over the remaining life of the program and could result in a current period charge to operations for some or all of the previously recognized profit sharing.
Losses and LAE increased by $24.6 million, or 43.7%, to $81.0 million for 2014, compared with $56.4 million for 2013. The overall change includes a $17.3 million increase in our homeowners’ program, a $7.1 million increase in our commercial general liability program and a $0.2 million increase in connection with our automobile program.
The $24.6 million total increase and the $17.3 million homeowners’ increase were net of a $7.7 million reduction associated with our Property 30% Quota Share agreement effective July 1, 2014.
Operating and underwriting expenses increased $5.4 million, or 37.5%, to $19.9 million for 2014, compared with $14.5 million for 2013. The change is primarily due to a $1.6 million increase in premium tax, a $0.5 million increase in surveys and underwriting reports, a $0.4 million increase in actuarial fees, a $0.4 million increase in credit card fees and a $2.5 million increase in other general expenses.
Year Ended December 31, 2013 Compared with Year Ended December 31, 2012
Similarly, for the policies we assumed from Citizens in 2009, we received approval for a 14.8% increase in 2013 and a 14.1% rate increase in 2012. In 2011 we received approval for a 13.9% increase. Our voluntary program was 97.7%, 90.0%, and 79.2% of the total homeowner program, for the years ending December 31, 2013, 2012, and 2011, respectively.
Our earnings can also be impacted by our ratings, such as the rating of FNIC by Demotech. FNIC’s rating as of December 31, 2013 was "A" ("Exceptional"). For more information regarding our rating and the impact of a change or withdrawal of our rating, please see “Business-Regulation-Industry Rating Services.”
The primary reason for our lower investment yield in 2013 pertained to selling higher yielding and longer duration bonds and purchasing shorter duration and lower yielding bonds to protect our bond portfolio against principal erosion.
See also “Analysis of Financial Condition As of December 31, 2013 Compared with December 31, 2012 - Investments” for a further discussion on our investment portfolio.
Net realized investment gains were $2.9 million for 2013, compared with $1.1 million for 2012. Specifically, net realized gains for equity securities were $2.2 million for 2013, compared with net realized losses of $0.3 million for 2012. For debt securities, net realized gains were $0.7 million for 2013, compared with $1.4 million for 2012. Our managers are authorized to sell securities at their discretion. During 2013, our equity managers took advantage of prevailing market opportunities and sold equities to lock in gains.
The table below depicts the net realized investment gains by investment category during 2013 and 2012.
Our loss ratio is computed as losses and LAE divided by net premiums earned. A lower loss ratio generally results in higher operating income. Our loss ratio for 2013 was 54.0% compared with 50.9% for the same period in 2012. The increase to our loss ratio is due to the $26.2 million increase in losses and LAE measured against the $45.0 million increase in net premium earned during 2013 as compared with the same period in 2012.
Operating and underwriting expenses increased $4.5 million, or 44.8%, to $14.5 million for 2013, compared with $10.0 million for 2012. The change is primarily due to a $2.5 million increase in premium tax expense, a $0.5 million increase in postage, a $0.9 million increase in surveys and underwriting reports and a $0.6 million increase in other general expenses.
Amortization of DPAC increased $8.1 million, or 61.8%, to $21.4 million for 2013, compared with $13.3 million for 2012, which corresponds to the increase in net premiums earned during this same period.
A summary of long-term contractual obligations as of December 31, 2014 follows. The amounts represent estimates of gross undiscounted amounts payable over time.
In 2014, operations generated $140.9 million of gross cash flow, due to a $64.1 million increase in unearned premiums, a $17.3 million increase in unpaid losses and LAE, a $4.5 million increase in accounts payable and accrued expenses, $4.2 million of amortization of investment premium discount, net and a $4.0 million increase in claims payments outstanding. Additional sources of cash included a $3.5 million increase in premium deposits and customer credit balances, a $3.1 million decrease in policy acquisition costs, net of amortization, $1.7 million non-cash compensation, a $1.2 million decrease in deferred income tax expense, net of other comprehensive income and $0.1 million depreciation and amortization, all in conjunction with $37.2 million of net income.
In 2014, net cash used by investing activities was $107.9 million. In 2013 and 2012, net cash used and provided by investing activities was $87.1 million and $4.3 million, respectively. Our available-for-sale investment portfolio is highly liquid as it consists entirely of readily marketable securities. In 2014, investing activities generated $87.2 million and used $195.1 million.
As discussed above, we have experienced significant growth, as evidenced by the 55.0% increase in gross premiums written during 2014 as compared with 2013 and the 56.8% increase in the number of our in-force homeowners’ policies during 2014.
As of December 31, 2014, 2013, and 2012, 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.
For the years ended December 31, 2014 and 2013, we had no off balance sheet transactions.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Federated National Holding Company as of December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the years in the three year period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Federated National Holdings Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Federated National Holding Company (“FNHC”, “Company”, “we”, “us”), formerly known as 21st Century Holding Company is an insurance holding company that controls substantially all steps in the insurance underwriting, distribution and claims processes through our subsidiaries and our contractual relationships with our independent agents and general agents. We changed our name on September 11, 2012, pursuant to approval received at our annual shareholders’ meeting, from 21st Century Holding Company so that our parent company and other subsidiary companies’ names are consistent with our primary insurance subsidiary and the name under which we have been writing insurance for more than 23 years.
Our insurance subsidiary is Federated National Insurance Company (“FNIC”). FNIC is licensed as an admitted carrier in Florida. An admitted carrier is an insurance company that has received a license from the state department of insurance giving the company the authority to write specific lines of insurance in that state. These companies are also bound by rate and form regulations, and are strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Admitted carriers are also required to financially contribute to the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders. Through contractual relationships with a network of approximately 3,600 independent agents, of which approximately 2,300 actively sell and service our products, FNIC is authorized to underwrite homeowners’, commercial general liability, fire, allied lines and personal and commercial automobile insurance in Florida. FNIC is licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas and underwrites commercial general liability insurance in those states. FNIC also underwrites homeowners’ insurance in Louisiana and Alabama, commencing in October 2014. Additionally, we underwrite personal automobile insurance in Georgia and Texas.
During 2014, the Florida Office of Insurance Regulation (“Florida OIR”) approved an application to allow the claims administration operations of FNA to be assumed by FedNat Underwriters, Inc. (“FNU”), formerly known as Federated National Underwriters Inc., a wholly owned subsidiary of the Company. Under the amended managing general agency agreement between FNU and FNIC, FNU will provide the same claims administration services under the same fee structure. The combination of these services in FNU had no effect on consolidated net income.
During the years ended December 31, 2014, 2013 or 2012, we did not experience any weather-related catastrophic events such as the hurricanes that occurred in Florida during 2005 and 2004. We are not able to predict how hurricanes or other insurable events will affect our future results of operations and liquidity. LAE is affected by a number of factors, many of which are partially or entirely beyond our control, including the following.
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.
Unpaid losses and LAE are determined by establishing liabilities in amounts estimated to cover incurred losses and LAE. Such liabilities are determined based upon our assessment of claims pending and the development of prior years' loss liability. These amounts include liabilities based upon individual case estimates for reported losses and LAE and estimates of such amounts that are incurred but not yet reported (“IBNR”). Changes in the estimated liability are charged or credited to operations as the losses and LAE are settled.
We do not discount unpaid losses and LAE for financial statement purposes.
In June 2014, the FASB issued Accounting Standard Update (“ASU”) No. 2014-12: Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period, a consensus of the FASB Emerging Issues Task Force. The amendments in this ASU apply to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performance target (for example, an initial public offering or a profitability target) could be achieved and still be eligible to vest in the award if and when the performance target is achieved. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Current U.S. Generally Accepted Accounting Principles (“GAAP”) does not contain explicit guidance on whether to treat a performance target that could be achieved after the requisite service period as a performance condition that affects vesting or as a non-vesting condition that affects the grant-date fair value of an award. The amendments in this ASU provide explicit guidance for those awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, and, earlier adoption is permitted. The adoption of the amendments in this ASU will not have a material impact on our financial position, results of operations or cash flows.
In September 2011, the FASB issued ASU No. 2011-08: Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which amends ASC Topic 350, Intangibles-Goodwill and Other. The guidance in this ASU permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC Topic 350. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The adoption of this ASU did not have a material impact on our financial condition, results of operations or cash flows.
In December 2011, the FASB issued ASU No. 2011-11: Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities, which requires new disclosure requirements mandating that entities disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as instruments and transactions subject to an agreement similar to a master netting arrangement. In addition, the standard requires disclosure of collateral received and posted in connection with master netting agreements or similar arrangements. This ASU is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this ASU did not have a material impact on our financial condition, results of operations or cash flows.
· Our loss reserves are estimates and may be inadequate to cover our actual liability for losses, causing our results of operations to be adversely affected.
· Our business could be materially and adversely affected by a security breach or other attack involving our computer systems or the systems of one or more of our business partners or vendors.
· Current operating resources are necessary to develop future new insurance products.
· Once Monarch is organized, we will be required to consolidate Monarch's financial results with ours. As a result, our financial results may be impacted by our percentage share of any losses that Monarch would be likely to experience in its first years of operations.
· Our participation in the Florida Property Insurance Clearinghouse may not result in an increase in our premium revenue.
· We are subject to extensive regulation and potential further restrictive regulation may increase our operating costs and limit our growth.
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, 2014 and 2013. Changes in interest rates subsequent to December 31, 2014 may affect the fair value of our investments. Refer to Footnote 21 of the Notes to Consolidated Financial Statements for details.
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2014 and 2013 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 and accrued expenses.
The 2013 and 2012 financial statement amounts have not been reclassified to conform to the 2014 presentations.
FASB issued guidance addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. We account for our investment securities consistent with FASB issued guidance that requires our securities to be classified into one of three categories: (i) held-to-maturity, (ii) trading securities or (iii) available-for-sale.
As of December 31, 2014 and 2013, our investments consisted primarily of corporate bonds held in various industries, municipal bonds and United States government bonds. As of December 31, 2014, 77% of our debt portfolio was in diverse industries and 23% is in United States government bonds. As of December 31, 2014, approximately 88% of our equity holdings were in equities related to diverse industries and 12% were in mutual funds. As of December 31, 2013, 83% of our debt portfolio was in diverse industries and 17% is in United States government bonds. As of December 31, 2013, approximately 91% of our equity holdings were in equities related to diverse industries and 9% were in mutual funds.
· rating downgrade or other credit event (eg., failure to pay interest when due);
During 2014, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity. During 2013 we reclassified $150,000 of our bond portfolio to available-for-sale from held-to-maturity.
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of debt and equity securities at December 31, 2014 and 2013 is as follows.
Below is a summary of debt securities at December 31, 2014 and 2013 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.
United States Treasury notes with a book value of $61,465 and $2,208,588, maturing in 2016 and 2022, respectively, were on deposit with the Florida OIR as of December 31, 2014, as required by law for FNIC, and are included with other investments held until maturity.
Proceeds from sales, pay downs and maturities of debt securities and proceeds from sales of equity securities in 2014, 2013 and 2012 were approximately $87.2 million, $106.2 million and $90.4 million, respectively.
As shown above, and as a result of review of 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 losses and LAE for claims occurring in prior years by $1.1 million and $0.2 million for the years ended December 31, 2014 and 2013 and decreased the liability for losses and LAE for claims occurring in prior years by $1.4 million for the year ended December 31, 2012.
We also produce an estimate of unpaid Adjusting and Other Expense (“A&O”), as a reserve is required under Statutory Accounting Principles (“SAP”) even if this expense has been pre-paid or with an unconsolidated affiliate. Although we do not prepay for A&O, the majority of the A&O incurred is with an affiliated company and eliminated under the accounting principles for consolidation. The unpaid A&O is added to unpaid losses & DCCE, resulting in total unpaid losses and LAE.
Annually - Our policy is to select a single point estimate that best reflects our in-house actuarial determination for unpaid losses and LAE. Our independent actuarial firm, examining the exact same data set, will independently select a point estimate which determines a high point and low point range. Both processes rely on objective and subjective determinations. If our point estimate falls within the range determined from the point estimate of our actuary’s opinion, then the Company’s policy has been that no adjustments by management would be required. In consideration thereof, the company does not have a policy for adjusting the liability for unpaid losses and LAE to an amount that is different than an amount set forth within the range determined by our independent actuary, although the reserve level ultimately determined by us may not be the mid-point of our independent actuary’s range. Further, there can be no assurances that our actual losses will be within our actuary’s range. Our independent actuary’s report expressly states that the report is based on assumptions developed from its own analysis and based on information provided by management and that notwithstanding its analysis, there is a significant risk of material adverse deviation from its range.
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).
The Company has adopted ASC 740-10-05, Accounting for Uncertainty in Income Taxes, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. ASC 740 provides a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company’s policy is to classify interest and penalties related to unrecognized tax positions in income before income taxes. As of December 31, 2014, 2013 and 2012, we have determined that no uncertain tax liabilities are required.
The Company has recorded a net deferred tax liability and asset of $1.3 million and $1.0 million as of December 31, 2014 and 2013, respectively. Realization of deferred tax assets is dependent on generating sufficient taxable income in future periods. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in assessing the ability to realize deferred tax assets. 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 and as such no valuation allowance has been recorded against deferred tax assets. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would record a valuation allowances as deemed appropriate in the period that the change in circumstances occurs, along with a corresponding increase or charge to net income. The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.
As of September 30, 2014, we had satisfied all applicable conditions of the Consent Order we entered into in January 2011 (the “Consent Order”) with the Florida OIR. We entered into the Consent Order in connection with the merger of our one of our wholly owned insurance subsidiaries, American Vehicle into FNIC, with FNIC continuing the operations of both entities. As of the date of this Report, the only operational restriction that remains in effect is a requirement to obtain OIR approval prior to writing commercial multi-peril business or any new commercial property business, including condo associations, under any other line of business for which FNIC is authorized. FNIC currently has no commercial multi-peril policy premium in-force and the current commercial habitation book of business is fully earned. The Consent Order required us to, among other things, limit the number of policies that we write in the Tri-County area and imposed certain other operational requirements on us, all of which we have complied with.
We had bonds with a carrying value of approximately $2.3 million pledged to the Florida OIR, as of December 31, 2014 and 2013, respectively, in accordance with regulatory requirements.
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 25.0% 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.
No dividends were paid by FNIC or American Vehicle in 2014, 2013 and 2012, and none are anticipated in 2015. 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 to be paid by FNIC to us, the parent company, 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.
Insurance holding company regulations govern the amount that non-insurance company subsidiaries (FNU, FNA and any other affiliate) may charge any of the insurance companies for service (e.g., management fees and commissions).
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 Authorized Control Level (“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. FNIC’s ratio of statutory surplus to its ACL was 534.0%, 312.1% and 474.4% at December 31, 2014, 2013 and 2012, respectively.
As of December 31, 2014, FNIC was outside NAIC’s usual range for four of thirteen IRIS ratios. These exceptions related to change in policyholder surplus growth, investment yield and estimated current reserve deficiency to policyholders’ surplus. The policyholder surplus growth exceeded the normal range due to the parent company’s surplus infusion totaling approximately $18.5 million. The increase in earned premiums during 2014 lead to the exceptional value for the Estimated Current Reserve to Deficiency to Surplus result.
FNIC is 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 automobile 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. FNIC was not assessed by the JUA Plan during 2014, 2013 or 2012. Future assessments by this association are undeterminable at this time.
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 $6,538, $36,400 and $27,175 in 2014, 2013 and 2012, respectively, and is included in LAE.
· Revenue, including unaffiliated and inter-segment sales or transfers, is 10% or more of total revenue of all operating segments.
· Operating profit or loss is 10% or more of the greater, in absolute amount, of the combined operating profit (or loss) of all industry segments with operating profits (or losses).
On September 9, 2014, a total of 130,000 restricted shares from the 2012 Plan were granted pursuant to the vesting requirements and other terms and conditions set forth in restricted stock agreements. Of the total, 45,000 shares were granted to the Company's Chief Executive Officer and President and 15,000 shares were granted to the Company's Chief Financial Officer. An aggregate of 50,000 shares were granted to the Company's directors and the remaining 20,000 shares were granted to other employees of the Company.
As a result of adopting FASB issued guidance on January 1, 2006, the Company’s income from continuing operations before provision for income tax expense and net income for 2013 are lower by approximately $447,000 and $278,600, respectively, than if it had continued to account for share-based compensation under APB guidance.
Basic and diluted earnings per share for 2014 would have been $3.15 and $3.05, respectively, if the Company had not adopted FASB issued guidance, compared with reported basic and diluted earnings per share of $3.08 and $2.99, respectively.
Summary information about the Company’s stock options outstanding at December 31, 2014 follows.
Through December 31, 2010, the Company matched 50% of the first 6% of a participant’s elective contributions. Effective January 1, 2011, the Board of Directors approved an amendment to our 401(k) plan to be a qualified automatic contribution arrangement with an employer match of 100% of the first 1% of elective contributions and an employer match of 50% of the next 2% to 6% of elective contributions, which is vested 100% after 2 years of service. Effective January 1, 2014, the Board of Directors approved the Company will match 100% of the first 6% of a participant’s elective contributions.
Securities available-for-sale: The fair value of securities available-for-sale is determined by obtaining quoted prices on nationally recognized security exchanges.
Assets measured at fair value on a recurring basis as of December 31, 2014, presented in accordance with this guidance, are as follows.
On March 4, 2015, FNHC announced that Bruce F. Simberg, Chairman and a member of the Company’s Board of Directors, has resigned for personal reasons. Michael H. Braun, the Company’s Chief Executive Officer, President, and a member of the Board, will serve as interim Chairman of the Board.
Under this Contract, the FHCF will provide about $591.4 million of aggregate seasonal coverage for covered losses in excess of approximately $222.6 million subject to a 10% Company participation. Federated National’s premium for the FHCF reinsurance coverage will be approximately $40.2 million payable in three installments between August 2015 and December 2015. The actual attachment point, total coverage and cost may vary significantly as we continue to write new business and will not be finalized until December 31, 2015.
Effective February 12, 2015, Federated National Underwriters, Inc. changed its name to FedNat Underwriters, Inc.
On January 22, 2015, the Florida OIR approved FNIC to transact business in (050) Commercial Multi-Peril, with admitted (010) Commercial Property Fire, effective 2015.