This overview discusses some of the relevant factors that management considers in evaluating the Company's performance, prospects and risks. It is not all inclusive and is meant to be read in conjunction with the entirety of the MD&A, the Company's consolidated financial statements and notes thereto, and all other items contained within this Annual Report on Form 10-K.
The effects of the ongoing COVID-19 pandemic were a major contributor to the variability in fair value of the Company’s fixed income and equity investments during the twelve months ended December 31, 2020, and the economic uncertainty caused by the pandemic may lead to further investment valuation volatility. In addition, the recent decline in investment yields resulted in lower reinvestment rates, compared to the previous years, which will cap the Company’s investment portfolio’s ability to generate higher levels of investment income, absent a larger invested asset base or a change in investment philosophy.
Although the COVID-19 pandemic did not have a material impact on Crusader’s overall gross written premium (direct and assumed written premium before cessions to reinsurers under reinsurance treaties) during the twelve months ended December 31, 2020, Crusader has experienced a decrease in new business submissions and renewals related to the pandemic in its Bars/Taverns market sector niche as a result of government regulations, such as shelter-in-place orders and in-door dining limitations, which had adversely impacted the gross written premium for that niche.
The Company’s financial results for the twelve months ended December 31, 2020, do not fully reflect the potential adverse impacts that the ongoing coronavirus pandemic has had or will have on its business due to a high degree of uncertainty around this relatively new and continuously evolving environment. The financial impact of these uncertainties is unknown at this time but could result in a material adverse effect on the Company’s business, results of operations, financial condition and prospects.
While the coronavirus pandemic is also affecting the Company’s internal operations, the Company implemented a plan at the onset of the COVID-19 pandemic to help its operations continue effectively during the ongoing pandemic, including processes to limit the spread of COVID-19 among employees. For example, the Company modified its business practices in accordance with social distancing and safety guidelines, allowing many employees work-from-home arrangements, flexible work schedules, and restricted business travel. The Company’s employees are following the guidelines and approximately 75% are working from their homes. The Company will follow governmental safety guidelines to determine when to remove the coronavirus-related business restrictions and to allow employees working from home to return to the workplace. At this point, the Company does not have an estimate on when these changes will occur. While the pandemic has created new challenges for the Company, the Company’s ability to maintain its operations, internal controls and relationships has not been adversely affected.
The Company’s financial performance suffered in recent years, reporting net losses for each fiscal year beginning with the year ended December 31, 2015. While losses in recent years have been driven primarily by losses from Crusader’s policies and their high loss ratios, management believes that other contributing factors include (1) the growth of some of the Company’s non-routine expenses relative to flat or declining revenues, (2) the failure to replace or upgrade the Company’s legacy IT system in order to process Crusader’s smaller premium accounts more efficiently, and (3) the failure to shift focus to larger premium accounts and fee-for-service operations.
In light of the challenges faced and operational results, the Company has taken several steps to improve its results. To improve Crusader's loss ratios, beginning in January 2017, the Company made significant changes in its staffing and in its pricing and risk selection practices. To improve revenues the Company is working to improve its sales in the markets that it has historically served, to gain access to markets that it has not previously served, and to generate new sources of revenue on a fee-for-service basis. For example, the Company also re-activated its U.S. Risk Managers, Inc. subsidiary so that it can provide claims adjustment services to non-affiliated insurers and to self-insurers on a fee-for-service basis (i.e., where Crusader will not be underwriting the risk), providing the potential for an alternative revenue source to the Company.
On November 24, 2020, USIC and U.S. Risk Managers, Inc. (“U.S. Risk”) entered into a Claims Administration Agreement, effective as of April 1, 2020 (the “Claims Administration Agreement”). Pursuant to the Claims Administration Agreement, USIC appointed U.S. Risk, which is a licensed claims adjuster in the state of California, to adjust and settle claims on its behalf in connection with the surplus lines policies issued by USIC in connection with the New Reinsurance Agreement. U.S. Risk will be paid a fee by Unifax on behalf of USIC based on a percentage of earned premium. U.S. Risk will establish an account for payment of claims by U.S. Risk (the “Loss Fund Account”) pursuant to the Claims Administration Agreement. Pursuant to the terms of the New Reinsurance Agreement, Crusader will fund the Loss Fund Account provided for in the Claims Administration Agreement on behalf of USIC.U.S. Risk has agreed to indemnify and hold USIC harmless from any losses relating to the Claims Administration Agreement. The Claims Administration Agreement may be terminated in specified events, including by any party upon 90 days written notice to the other parties and automatically upon cancellation or termination of the Broker Agreement.
In 2018, the Company determined that the cost to replace its legacy IT system would be between $4,000,000 and $8,000,000, and the installation of such a system would take between two to four years. After weighing the time and expense involved against the anticipated benefit from such an investment, the Company opted for what it then perceived to be a less expensive upgrade to its legacy system, an upgrade that then seemed to offer more incremental benefits in a shorter timeframe. While initially expected to be completed by the end of 2019, at a cost of approximately $300,000, excluding costs of Unico’s employees involved in the upgrade, the system upgrade is now expected to be completed by the end of first quarter of 2021 at a cost not to exceed $1,500,000, excluding costs of Unico’s employees involved in the upgrade, due to unexpected technical challenges. In light of the significant delays and increases in cost associated with its legacy upgrade project, the Company has deployed additional resources toward the management of this project and has renegotiated the relationship that it has with the non-affiliated vendor working on this project.
As of December 31, 2020, Crusader was licensed as an admitted insurance carrier in the states of Arizona, California, Nevada, Oregon, and Washington. From 2004 until June 2014, all of Crusader’s business was written in the state of California. Crusader’s business remains concentrated in California (99.9% of gross written premium, which represents written premium before cession to reinsurers, in the years ended 2020 and 2019)). During the years ended December 31, 2020 and 2019, 99.6% and 98.3% of Crusader’s business was CMP policies, respectively.
The insurance company operation’s underwriting profitability is defined by pre-tax underwriting gain or loss which is calculated as net earned premium less losses and loss adjustment expenses and policy acquisition costs.
(1) Loss ratio is defined as losses and loss adjustment expenses divided by net earned premium.
(2) Expense ratio is defined as a sum of policy acquisition costs and portions of indirect salaries and employee benefits and other operating expenses allocation to the insurance company operations, reduced by allocation of gross commissions and fees and other income, divided by net earned premium.
On February 5, 2021, A.M. Best Company revised the outlooks to negative from stable and affirmed the FSR of B++ (Good) and Long-Term ICR of “bbb” of Crusader. Additionally, A.M. Best has revised the outlook to negative from stable and affirmed the Long-Term ICR of “bb” of the Company. Crusader is a wholly owned subsidiary of the Company.
The negative outlooks capture A.M. Best’s concerns with Crusader’s declining underwriting performance, the Company’s overall capitalization and the execution risk associated with implementing strategic operating changes to address these conditions.
The Company’s revenues from other insurance operations consist of commissions, fees, investment and other income. Excluding investment and other income, these operations accounted for approximately 6% and 8% of total revenues for the years ended December 31, 2020 and 2019, respectively.
The Company generated revenues from its total invested assets of $83,617,720 (fixed maturities at amortized cost, equity securities at cost and short-term investments at fair value) and $84,997,226 (fixed maturities at amortized cost and short-term investments at fair value) as of December 31, 2020 and 2019, respectively.
Due to the current interest rate environment, the current target effective duration for the Company’s investment portfolio is between 2.0 and 4.0 years. As of December 31, 2020, all of the Company’s investments are in U.S. Treasury securities, corporate fixed maturity securities, agency mortgage-backed securities, equity securities, Federal Deposit Insurance Corporation (“FDIC”) insured certificates of deposit, and short-term investments. All of the Company’s investments, except for the certificates of deposit, are readily marketable. As of December 31, 2020, the weighted average maturity of the Company’s investments was approximately 8.0 years, and the effective duration for available-for-sale investments (investments managed under the investment guidelines) was 2.9 years.
The Company is required to classify its debt securities into one of three categories: held-to-maturity, available-for-sale, or trading securities. Although part of the Company's investments in fixed maturity securities is classified as available-for-sale and, while the Company may sell investment securities from time to time in response to economic, regulatory and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity.
The Company’s Board of Directors has approved investment guidelines which reflect the Company’s risk, balance sheet, and profile.
Mortgage loans, except for mortgage backed securities issued by an agency of the U.S. government.
While material capital expenditures may be funded through borrowings, the Company believes that its cash, cash equivalents, and short-term investments at December 31, 2020, net of statutory deposits of $710,000 and California insurance company statutory dividend restrictions applicable to Crusader plus the cash to be generated from operations, should be sufficient to meet its operating requirements during the next 12 months without the necessity of borrowing funds.
During the years ended December 31, 2020 and 2019, no cash dividends were declared or issued by the Company to its shareholders. Declaration of future cash dividends, if any, will be subject to the Company’s profitability, cash requirements, capital requirements, and general business conditions, among other factors.
As a California insurance company, Crusader is obligated to pay a premium tax on gross written premium in all states that Crusader is admitted. Premium taxes are deferred and amortized as the related premium is earned. The premium tax is in lieu of state franchise taxes and is not included in the provision for state taxes.
The increase in total revenues for the year ended December 31, 2020, compared to the year ended December 31, 2019, was due primarily to an increase in net earned premium of $1,430,700 (5%).
The increase in income tax expense of $3,681,785 during the twelve months ended December 31, 2020, was due primarily to an increase in the valuation allowance related to deferred tax assets on federal net operating losses.
The effect of inflation on the Company’s net loss during the years ended December 31, 2020 and 2019 was not significant.
The increase in gross written premium for the year ended December 31, 2020, was due primarily to growth in the Company’s Transportation vertical, transacted by Crusader. The Transportation vertical transacts insurance primarily for long-haul trucking operations that are domiciled in California. The growth in the Company’s Transportation vertical was partially offset by coronavirus-related contraction in the Food, Beverage & Entertainment underwriting vertical for Crusader.
Written premium is defined under GAAP in Accounting Standards Codification Topic 405, “Liabilities,” as “premiums on all policies an entity has issued in a period.” Earned premium, the most directly comparable GAAP measure to written premium, represents the portion of written premium that is recognized as income in the financial statements for the period presented and earned on a pro-rata basis over the terms of the policies. Written premium is intended to reflect production levels and is meant as supplemental information and not intended to replace earned premium. Such information should be read in connection with the Company’s GAAP financial results.
Gross earned premium (direct and assumed earned premium before cessions to reinsurers under reinsurance treaties) increased $2,306,667 (7%) to $36,264,869 for the year ended December 31, 2020, compared to $33,958,202 for the year ended December 31, 2019. The Company writes annual policies. Earned premium represents a portion of written premium that is recognized as income in the financial statements for the period presented and earned daily on a pro-rata basis over the terms of the policies, and, therefore, premiums earned in the current year are related to policies written during both the current year and immediately preceding year. The increase in gross earned premium for the year ended December 31, 2020, was due primarily to an increase in gross written premium in 2019.
Ceded earned premium (premium ceded to reinsurers under reinsurance treaties) increased $875,967 (12%) to $8,096,701 for the year ended December 31, 2020, compared to $7,220,734 for the year ended December 31, 2019. Ceded earned premium as a percentage of gross earned premium was 22% for the year ended December 31, 2020, and 21% for the year ended December 31, 2019. The increase in the ceded earned premium as a percentage of gross earned premium for the year ended December 31, 2020, compared to the year ended December 31, 2019, was due primarily to higher gross earned premium subject to reinsurance treaties and higher rates on excess of loss reinsurance treaties.
Reinsurance treaties are generally structured in layers, with different negotiated economic terms and retention of participation, or liability, in each layer. In calendar years 2020 and 2019, Crusader retained participation in its excess of loss reinsurance treaties of 0% in its 1st layer (reinsured losses between $500,000 and $1,000,000), 0% in its 2nd layer (reinsured losses between $1,000,000 and $4,000,000), and 0% in its property and casualty clash treaty.
Crusader also has catastrophe reinsurance treaties from various highly rated California authorized and California unauthorized reinsurance companies. These reinsurance treaties help protect Crusader against losses in excess of certain retentions from catastrophic events that may occur on property risks which Crusader insures. In calendar years 2020 and 2019, Crusader retained a participation in its catastrophe excess of loss reinsurance treaties of 5% in its 1st layer (reinsured losses between $1,000,000 and $10,000,000) and 0% in its 2nd layer (reinsured losses between $10,000,000 and $46,000,000).
(3) Annualized yield on average invested assets did not include the investment income from cash equivalents.
The par value, amortized cost, estimated market value and weighted average yield of fixed maturity investments at December 31, 2020, by contractual maturity are as follows:
The weighted average maturity of the Company’s investments was approximately 8.0 years as of December 31, 2020, and 7.7 years as of December 31, 2019.
While the fair value of Company’s investment portfolio at December 31, 2020, has recovered from the declines recorded for the three months ended March 31, 2020, the effects of the coronavirus pandemic were a major contributor to the variability in fair value of the Company’s fixed income and equity investments during the year ended December 31, 2020, and the economic uncertainty caused by the pandemic may lead to further investment valuation volatility. In addition, the recent decline in investment yields resulted in lower reinvestment rates, compared to the previous years, which will cap the Company’s investment portfolio’s ability to generate higher levels of investment income, absent a larger invested asset base or a change in investment philosophy
Other income included in insurance company operation and other insurance operations decreased $94,072 (70%) to $39,811 for year ended December 31, 2020, compared to $133,883 for the year ended December 31, 2019. The decrease during the year ended December 31, 2020, is due primarily to decreases in rental income of $27,277 and Crusader’s share of California FAIR Plan Equity of $58,646.
AIB markets health insurance in California through non-affiliated insurance companies for individuals and groups. For these services, AIB receives commission based on the premium that it writes. Commission income for the year ended December 31, 2020, decreased $212,174 (23%) compared to the year ended December 31, 2019. The decrease in commission income is primarily a result of a loss of a large group account.
In 2020, approximately 30% and 56% of the commission income from health insurance sales was from Guardian Life Insurance Company of America dental and group life plan programs and the Blue Shield Care Trust health and life insurance programs, respectively. In 2019, approximately 39% and 49% of the commission income from health insurance sales was from Guardian Life Insurance Company of America dental and group life plan programs and the Blue Shield Care Trust health and life insurance programs, respectively.
Crusader’s emerging loss ratios for each accident year are reviewed in detail at the end of each quarter as part of the reserve review process. Losses and loss adjustment expenses for the calendar years ended December 31, 2020 and 2019 were $34,642,920 and $22,576,127, respectively. Loss ratio, which is calculated by dividing losses and loss adjustment expenses by net earned premium, was 123% for the year ended December 31, 2020, compared to 85% for the year ended December 31, 2019.
Some lines of insurance are commonly referred to as "long-tail" lines because of the extended time required before claims are ultimately settled. Lines of insurance in which claims are settled relatively quickly are called "short-tail" lines. It is generally more difficult to estimate loss reserves for long-tail lines because of the long period of time that elapses between the occurrence of a claim and its final disposition and the difficulty of estimating the settlement value of the claim. Crusader’s short-tail lines consist of its property coverages, and its long-tail lines consist of its liability coverages. However, Crusader’s long-tail liability claims tend to be settled relatively quicker than other long-tail lines not underwritten by Crusader, such as workers’ compensation, professional liability, umbrella liability, and medical malpractice. Since trends develop over longer periods of time on long-tail lines of business, the Company generally gives credibility to those trends more slowly than for short-tail or less volatile lines of business.
The difficulty in estimating the loss and loss adjustment expense reserves contributed to adverse development of insured events of prior years in the amount of $7,959,048 which Crusader experienced in 2020. During the twelve months ended December 31, 2020, the Company reevaluated certain assumptions used in its process for estimating loss and loss adjustment reserves due to its experiences in Crusader’s Apartments & Commercial Buildings and Transportation verticals as well as changes in market conditions. This reevaluation resulted in a $9,399,547 increase in Crusader’s IBNR reserves, net of reinsurance, which was a primary contributor to the increase of $12,066,793 in losses and loss adjustment expenses from $22,576,127 recognized for the twelve months ended December 31, 2019 to $34,642,920 recognized for the twelve months ended December 31, 2020. Crusader sets loss and loss adjustment expense reserves at each balance sheet date based upon management’s best estimate of the ultimate payments that it anticipates will be made to settle all losses incurred and related loss adjustment expenses incurred as of that date for both reported and unreported losses. The ultimate cost of claims is dependent upon future events, the outcomes of which are affected by many factors. Crusader claim reserving procedures and settlement philosophy, current and perceived social and economic inflation, current and future court rulings and jury attitudes, improvements in medical technology, and many other economic, scientific, legal, political, and social factors all can have significant effects on the ultimate costs of claims. Changes in Crusader operations and management philosophy also may cause actual developments to vary from the past. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made.
Crusader has received 151 coronavirus-related business interruption claims through December 31, 2020. While the Company does not believe it is exposed to substantial risk from those claims under the insurance policies written by Crusader or USIC, the individual circumstances of each such claim are reviewed to fulfill Crusader’s obligation to its policyholders if coverage applies. Further, there may be impacts to the timing of loss emergence and ultimate loss ratios for certain Crusader’s products due to postponements of civil court cases, extensions of various statutes of limitations, changes in settlement trends and other new legislative, regulatory or judicial developments which could result in loss reserve deficiencies and negative impact on results of operations.
Repeated and sustained underwriting losses in Crusader’s Apartments & Commercial Buildings vertical and growth in Crusader’s Transportation vertical, a product which is generally known for its difficulty to be underwritten profitably, coupled with changes in the market conditions and increases in social inflation (discussed below), caused Crusader management to reevaluate the assumptions used in its process for estimating loss and loss adjustment expense reserves. This reevaluation and the use of updated assumptions led to higher estimates for expected claims frequency, claims severity and ultimate incurred losses and loss adjustment expenses during the quarterly reevaluation of the loss and loss adjustment expense reserves as of September 30, 2020. The increase in the ultimate incurred losses and loss adjustment expenses manifested primarily through higher IBNR reserves as of December 31, 2020 for 2018, 2019, and 2020 accident year claims pertaining to Apartments & Commercial Buildings and Transportation liability coverages.
Crusader attributes much of its adverse loss development experienced in the three most recent years ending December 31, 2020, to social inflation. Used here, social inflation is a term that encompasses a relatively new adverse trend related to society’s application of the law when it comes to insurance. In this context, social inflation is generally described by the rising costs of insurance claims due to societal trends which results in increased litigation, broader definitions of liability and contractual interpretations, plaintiff friendly legal decisions, larger compensatory jury awards, and larger awards for non-economic damages Crusader has experienced increased costs due to social inflation in all three of its largest market sector niches, Long-haul Transportation, Residential Apartment Buildings, and Bars/Taverns, resulting in higher-than-expected frequency and severity of third-party liability claims.
The variability of Crusader’s losses and loss adjustment expenses for the periods presented is primarily due to the small and diverse population of Crusader’s policyholders and claims, which may result in greater fluctuations in claim frequency and/or severity. In addition, Crusader’s reinsurance retention, which is relatively high in relationship to its net earned premium, can result in increased loss ratio volatility when large losses are incurred in a relatively short period of time. Nevertheless, management believes that its reinsurance retention is reasonable given the amount of Crusader’s surplus and its goal to minimize ceded premium.
When there is clear evidence that the actual claims costs emerged are different than expected for any prior accident year, the claims cost estimates for that year are revised accordingly. If the claims costs that emerge are less favorable than initially anticipated, generally, Crusader increases its loss and loss adjustment expense reserves immediately. However, if the claims costs that emerge are more favorable than initially anticipated, generally, Crusader reduces its loss and loss adjustment expense reserves over time while it continues to assess the validity of the observed trends based on the subsequent emerged claim costs.
Based on the loss and loss adjustment expense reserve estimates as of December 31, 2020, the estimated ultimate loss ratio is within five percentage points of the initial expected loss ratio in 8 of Crusader’s 36 years. Since Crusader’s net earned premium in 2020 was $28,168,168, a difference between the accident year 2020 actual and initial expected loss ratios of five percentage points will or may ultimately impact losses and loss adjustment expenses by $1,408,408. The estimated ultimate loss ratio is within ten percentage points of the initial expected loss ratio in 13 of Crusader’s 36 years. A ten percentage point difference between the accident year 2020 actual and the initial expected loss ratios will or may ultimately impact losses and loss adjustment expenses by $2,816,817. The estimated ultimate loss ratio is within twenty percentage points of the initial expected loss ratio in 28 of Crusader’s 36 years. A twenty percentage point difference between the accident year 2020 actual and the initial expected loss ratios will or may ultimately impact losses and loss adjustment expenses by $5,633,634.
Crusader's liability for unpaid loss and loss adjustment expense reserves consists of case reserves and reserves for IBNR claims. Case reserves are established by claims personnel based on a review of the facts known at the time the claim is reported and are subsequently revised as more information about a claim becomes known. IBNR is estimated using various actuarial methods and techniques and includes (1) reserves for losses and loss adjustment expenses on claims that have occurred but for which claims have not yet been reported to Crusader, and (2) a provision for expected future development on case reserves for information not currently known.
Policy acquisition costs decreased in the year ended December 31, 2020, compared to the year ended December 31, 2019, due primarily to increase of ceding commission that Crusader received as a result of increase in premium ceded to its reinsurers.
Total salaries and employee benefits incurred increased $2,334,794 (30%) to $10,058,536 for the year ended December 31, 2020, compared to $7,723,742 for the year ended December 31, 2019.
Other operating expenses increased $1,658,331 (58%) to $4,502,414 for the year ended December 31, 2020, compared to $2,844,083 for the year ended December 31, 2019. The increase in other operating expenses for the year ended December 31, 2020, compared to the year ended December 31, 2019, was due primarily to increases in legal, depreciation and communication expenses, fees associated with the reinsurance arrangement with USIC, and higher board of director fees.
Income tax expense was $3,547,598 (-20% of pre-tax loss) for the twelve months ended December 31, 2020 and income tax benefit was $134,187 (4% of pre-tax loss) for the twelve months ended December 31, 2019. The fluctuation in the income tax rate as a percentage of pre-tax loss for the twelve months ended December 31, 2020, when compared to the twelve months ended December 31, 2019, is primarily due to an increase in the valuation allowance related to deferred tax assets on federal net operating losses.
Crusader underwrites three statutory annual statement lines of business: (1) CMP, (2) liability other than automobile and products, and (3) fire. CMP policies comprised 99.6% and 98.3% of Crusader’s 2020 and 2019 gross written premium, respectively. CMP policies include both property and liability coverages. For all of Crusader’s coverages and lines of business, Crusader’s actuarial loss and loss adjustment expense reserving methods require assumptions that can be grouped into two key categories: (1) expected loss and loss adjustment expense development patterns and (2) expected loss and loss adjustment expense per premium dollar.
Each year, management compares the actual claims costs that emerge to the claims costs that were expected to emerge and evaluates whether any observed significant differences are due to normal variances in the development process that occur from time to time, particularly in an insurer the size of Crusader, or if they are an indication that changes in the key reserve assumptions or methodologies are appropriate. Repeated and sustained underwriting losses in Crusader’s Apartments & Commercial Buildings vertical and growth in Crusader’s Transportation vertical, a product which is generally known for its difficulty to be underwritten profitably, coupled with changes in the market conditions and increases in social inflation caused Crusader management to reevaluate the assumptions used in its process for estimating loss and loss adjustment expense reserves during the year ended December 31, 2020.
The Company must estimate its ultimate losses and loss adjustment expenses using a very small claim population size. At the beginning of 2020, Crusader had 510 open claim files. During 2020, 793 new claim files were opened and 811 claim files were closed, leaving 492 open claim files at the end of 2020. Due to the small size of Crusader and the related small population of claims, Crusader’s losses and loss adjustment expenses for any accident year can vary significantly from the initial expectations. Due to the small number of claims, changes in claim frequency and/or severity can materially affect Crusader’s reserve estimate. The potential variability from management’s best estimate cannot be measured from any meaningful statistical basis due to the numerous uncertainties in the claims reserving process and the small population of claims.
There were no losses subject to catastrophe reinsurance treaties coverage incurred during the years ended December 31, 2020 and 2019.
Crusader’s reinsurance strategy is to protect Crusader against liabilities in excess of certain retentions, including major or catastrophic losses that may occur from any one or more of the property and/or casualty risks which it insures. On an annual basis, or sooner if warranted, Crusader evaluates whether any changes to its retention, participation, or retained limits are necessary. Loss and loss adjustment expense reserves are determined separately on both a direct basis and a net of reinsurance basis, and the ceded reserves are determined by subtraction. Therefore, reinsurance recoverable is determined in a manner consistent with the associated loss reserves. There have been no recent changes in key assumptions underlying the estimation of loss and loss adjustment expense reserves, and no changes are anticipated. Ceded paid losses and loss adjustment expenses are determined by the terms of the individual treaties. The Company continually monitors and evaluates the collectability of reinsurance recoverable to determine if any allowance is necessary.
For years ended December 31, 2020 and 2019, Crusader wrote 99.9% of its business in the state of California. The types of businesses and the coverage limits written by Crusader are not considered difficult lines for obtaining reinsurance. In addition, because the major catastrophe exposure is primarily from riots and from fire following earthquakes, Crusader does not anticipate significant limitations on its ability to cede future losses on a basis consistent with its historical results.
We identified the evaluation of loss reserves as a critical audit matter due to the complexity and subjective judgment required to audit management’s best estimate, which required assessing the selected methods and assumptions, such as paid and incurred loss development factors, used to estimate loss reserves. Specialized actuarial skills, training, and knowledge were needed to evaluate the Company’s actuarial methodologies and the estimate of future claim payment and reporting patterns.
We tested the completeness of the underlying data generated from the Company’s policy administration system by reconciling it to the data used by the Company’s actuary. We tested the accuracy of the data on a sample basis by tracing it to source documents. Furthermore, we engaged an independent actuary with specialized skills, training, and knowledge to assist in assessing management’s methodologies used to estimate loss reserves by comparing it to generally accepted actuarial methods; evaluating management’s estimates by lines of business by performing independent analysis of loss reserves using the Company’s underlying historical claims data; and developing a reserve range based on actuarial methodologies and comparing it to the Company’s total recorded loss reserves.
The Company has a comprehensive portfolio monitoring process to identify and evaluate each fixed income security whose carrying value may be other-than-temporarily impaired. For each fixed income security in an unrealized loss position, the Company assesses whether it is more likely than not that the Company will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes, or the credit quality of the underlying security. If a security meets this criteria, the security's decline in fair value is considered other than temporary and is recorded as a net realized investment loss in the Consolidated Statements of Operations and in the Consolidated Statements of Comprehensive Income (Loss) based on the specific identification method. There were no realized investments gains (losses) from other than temporary impairments for any of the periods presented in the accompanying Consolidated Statements of Operations. For each fixed income security that the Company does not intend to sell or for which it is more likely than not that the Company would not be required to sell before an anticipated recovery in value, the Company separates the credit loss component of the impairment, if any, from the amount related to all other factors and reports the credit loss component in net realized investment gains (losses). There was no credit loss component for any of the periods presented in the accompanying Consolidated Statements of Operations.
Depreciation on Crusader Insurance Company (“Crusader”), the Company’s subsidiary, owned building, located at 26050 Mureau Road, Calabasas, California, is computed using the straight-line method over 39 years. Improvements to the building structure are amortized over the useful life of the improvements. Depreciation on furniture, fixtures and equipment in the Calabasas building is computed using the straight-line method over 3 to 15 years. Amortization of tenant improvements in the Calabasas building was being computed using the shorter of the useful life of the tenant improvements or the remaining years of the lease.
The Company and its subsidiaries file consolidated federal and state income tax returns. Pursuant to the tax allocation agreement, Crusader and American Acceptance Corporation (“AAC”), a subsidiary of Unico, are allocated taxes or tax credits in the case of losses, at current corporate rates based on their own taxable income or loss. The Company files income tax returns under U.S. federal and various state jurisdictions. The Company is subject to examination by U.S. federal income tax authorities for tax returns filed starting at taxable year 2017 and California state income tax authorities for tax returns filed starting at taxable year 2016. There are no ongoing examinations of income tax returns by federal or state tax authorities.
The provision for federal income taxes is computed on the basis of income as reported for financial reporting purposes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and are measured using the enacted tax rates and laws expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Income tax expense provisions increase or decrease in the same period in which a change in tax rates is enacted.
At each balance sheet date, management assesses the need to establish a valuation allowance that reduces deferred tax assets when it is more-likely-than-not that any portion of the deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon generating sufficient taxable income of the appropriate character within the carryback and carryforward periods available under the tax law. Management considers the reversal of deferred tax liabilities, projected future taxable income of an appropriate nature and tax-planning strategies when making this assessment. In connection with preparation of its consolidated financial statements, the Company periodically performs an analysis of future income projections to determine the adequacy of the valuation allowance. In light of the net losses that were generated in recent years, for the twelve months ended December 31, 2020, the Company has established a valuation allowance for the aggregate amount of the federal and state net operating losses and other deferred tax assets in the amount of $10,557,080 that, in management’s judgment, are not more-likely-than-not to be realized. For the year ended December 31, 2019, the Company carried a valuation allowance on deferred tax assets generated from federal and state net operating losses in the amount of $600,000 and $1,931,665, respectively.
(1) As required by law, the Company segregates from its operating accounts the premium collected from insureds that are payable to insurance companies into separate trust accounts.
Crusader’s reinsurance recoverable on paid and unpaid losses and loss adjustment expenses is as follows:
In June 2016, the FASB issued ASU 2016-13 “Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 replaces the current incurred loss methodology for recognizing credit losses with a current expected credit loss model, which requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. ASU 2016-13 also requires enhanced disclosures for better understanding of significant estimates and judgments used in estimating credit losses. The Company is currently evaluating the effect ASU 2016-13 will have on the Company's consolidated financial statements, but expects the primary changes to be (i) the use of the expected credit loss model for its premium receivables and reinsurance recoverables and (ii) the presentation of credit losses within the available-for-sale fixed maturities portfolio through an allowance method rather than as a direct write-down. ASU 2016-13 will primarily impact the Company’s available-for-sale fixed maturities portfolio and reinsurance recoverables. In November 2019, the FASB issued ASU 2019-10 “Financial Instruments - Credit Losses, Derivatives and Hedging, and Leases.” ASU 2019-10 updated the effective date for implementing ASU 2016-13 for smaller reporting entities, and that effective date will be for fiscal years beginning after December 15, 2022. Since the Company’s fixed income portfolio is invested primarily in higher rated bonds and the reinsurance is purchased from financially strong reinsurers, the Company believes the adoption of ASU 2016-13 will not have a material impact to the Consolidated Statements of Operations and the Consolidated Balance Sheets.
In December of 2019, the FASB issued Accounting Standards Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes or ASU 2019-12. ASU 2019-12 is expected to reduce the cost and complexity related to the accounting for income taxes. The ASU removes specific exceptions to the general principles in Topic 740 and improves the financial statement preparer's application of income tax related guidance. The ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.
Cash equivalents were comprised of highly liquid investments with initial maturity of 90 days or less. As of December 31, 2020 and 2019, cash equivalents included custodial trust, bank money market accounts, and a bank savings account.
A summary of investment income, net of investment expenses, net realized gains, and net unrealized investment gains on equity securities is as follows:
The amortized cost and estimated fair value of fixed maturity investments at December 31, 2020, by contractual maturity are as follows:
The amortized cost and estimated fair values of investments in fixed maturities by category are as follows:
As of December 31, 2020, one corporate security, included in available-for-sale fixed maturities, was held as collateral with Comerica, pursuant to the reinsurance trust agreement among Crusader, USIC and Comerica to secure payment of Crusader’s liabilities and performance of its obligations under the reinsurance arrangement with USIC. The estimated fair value and amortized cost of that security was $824,500 and $787,653 on December 31, 2020, respectively.
The Company started investing in common stock equity securities during the year ended December 31, 2020. The Company’s equity securities allocation is intended to enhance the return of and provide diversification for the total investment portfolio. A summary of equity securities is shown below:
The Company’s investment in certificates of deposit included $598,000 of brokered certificates of deposit as of December 31, 2020 and 2019. All of the Company’s certificates of deposit are within the Federal Deposit Insurance Corporation (“FDIC”) insured permissible limits. Due to the nature of the Company’s business, certain bank accounts may exceed FDIC insured permissible limits.
Fair value measurements are not adjusted for transaction costs. The Company recognizes transfers between levels at either the actual date of the event or a change in circumstances that caused the transfer. The Company did not have any transfers between Levels 1, 2 and 3 of the fair value hierarchy during the years ended December 31, 2020 and 2019.
NOTE 6 - REAL ESTATE HELD FOR SALE, NET AND PROPERTY AND EQUIPMENT, NET
The Company capitalizes certain computer software costs purchased from outside vendors for internal use or incurred internally to upgrade the existing systems. These costs also include configuration and customization activities, coding, testing and installation. Training costs and maintenance are expensed as incurred, while upgrade and enhancements are capitalized if it is probable that such expenditure will result in additional functionality. The capitalized costs are not depreciated until the software is placed into production.
At each review period, actual claims costs that emerge are compared with the claims costs that were expected to emerge during that development period. Sometimes the previous claims costs estimates prove to have been too high; sometimes they prove to have been too low. The fluctuation in development of insured events of prior years’ underscores the inherent uncertainty in insurance claims costs, especially for a relatively small insurer, such as Crusader. Management reviews claims costs that appear to be different from the historical claims costs to determine whether those differences are a normal part of the process or an indication that a change in reserve assumptions is appropriate. Management concluded that the differences noted above are differences between actual and expected claims costs that emerge from time to time, particularly in an insurer the size of Crusader.
Deferred policy acquisition costs consist of commissions (net of ceding commission), premium taxes, inspection fees, and certain other underwriting costs, which are related to and vary with the production of Crusader policies. Policy acquisition costs are deferred and amortized as the related premium is earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future income on insurance policies generated from these costs, including investment income. The Company recognized a premium deficiency of $150,000 as of December 31, 2020. The Company did not carry a premium deficiency reserve as of December 31, 2019.
Crusader is also subject to regulatory and governmental examinations, requests for information, inquiries, investigations, and threatened legal actions and proceedings by state regulators and others. Crusader receives numerous requests, orders for documents, and information in connection with various aspects of its regulated activities. Regulatory and governmental requests for information, inquires, certain examinations and investigations are routinely handed by Crusader. Crusader may involve outside counsel in regulatory matters depending on the nature of the matter.
On November 24, 2020, as a result of such negotiations with the DOI, Crusader, Unifax and USIC agreed to rescind certain agreements by and among USIC, Crusader and Unifax. The effect of such rescissions was that the rescinded agreements were deemed never to have existed and no insurance policies were deemed issued, and no premium deemed written, collected or reported with respect to those agreements. Further, on November 24, 2020, the parties entered into various restructured arrangements in order to address the issues raised by the DOI with respect to California insurance laws. In particular, the parties eliminated all intercompany duties so that the arrangement would not require prior approval by the DOI under the Insurance Act. Details of the restructured arrangements with USIC include the following:
Ceded earned premium as a percentage of gross earned premium (direct and assumed earned premium) was 22% in 2020 and 21% in 2019.
Crusader is required to file statutory financial statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities. Statutory accounting practices differ in certain respects from GAAP. The more significant of the differences for statutory accounting practices are (a) policy acquisition and commission costs are expensed when incurred rather than over the periods covered by the policies; (b) fixed maturity securities are reported at amortized cost, or the lower of amortized cost or fair value, depending on the quality of the security as specified by the National Association of Insurance Commissioners (“NAIC”); (c) non-admitted assets are charged directly against surplus; (d) loss and loss adjustment expense reserves and unearned premium reserves are stated net of reinsurance; (e) federal income taxes are recorded when payable and deferred taxes, subject to limitations, are recognized but only to the extent that they do not exceed a specified percentage of statutory surplus; and (f) changes in deferred taxes are recorded directly to surplus as regards policyholders. Additionally, the cash flow presentation is not consistent with GAAP and reconciliation from net income to cash provided by operations is not presented. Comprehensive income is not presented under statutory accounting practices.
The California Department of Insurance (“CA DOI”) conducts periodic financial examinations of Crusader. During 2017, the CA DOI completed a financial examination of Crusader’s December 31, 2015, statutory financial statements. On June 23, 2017, a report of examination was officially filed and became part of the records of the CA DOI. The Company has complied with all comments and recommendations identified in the report of examination, and none of the issues in that report of examination had any material effect on Crusader.
The NAIC uses a Risk-Based Capital (“RBC”) Model Law for property and casualty companies. The RBC Model Law is intended to provide standards for calculating a variable regulatory capital requirement related to a company’s current operations and its risk exposures (asset risk, underwriting risk, credit risk and off-balance sheet risk). These standards are intended to serve as a diagnostic solvency tool for regulators that establishes uniform capital levels and specific authority levels for regulatory intervention when an insurer falls below minimum capital levels. The RBC Model Law specifies four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer if its RBC is equal to or less than 200% of its computed authorized control level RBC. A company’s RBC is required to be disclosed in its statutory annual statement. The RBC is not intended to be used as a rating or ranking tool nor is it to be used in premium rate making or approval. Crusader’s adjusted capital at December 31, 2020, was 278% of authorized control level RBC.
Crusader’s adjusted capital below 300% as of December 31, 2020, and combined loss ratio in excess of 120% for the year ended December 31, 2020, triggered a company action level event. Crusader has submitted to the insurance commissioner of the CA DOI a comprehensive plan to increase the adjusted capital above 300% to resolve the company action level event and is awaiting response from the CA DOI.
The income tax provision reflected in the Consolidated Statements of Operations is different than the expected federal income tax rate of 21% on income as shown in the following table:
The Company recognizes deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases, and for tax credits. The Company evaluates its deferred tax assets for recoverability based on available evidence, including assumptions about future profitability, reversal patterns of recorded deferred tax assets and deferred tax liabilities, and capital gain generation. Some or all of the Company’s deferred tax assets could expire unused if the Company is unable to generate taxable income of a sufficient nature in the future to utilize them.
As of December 31, 2020, the Company had no unrecognized tax benefits, no unrecognized additional liabilities or reduction in deferred tax asset, and no uncertain tax positions. In addition, the Company had not accrued interest and penalties related to unrecognized tax benefits. However, if interest and penalties would need to be accrued related to unrecognized tax benefits, such amounts would be recognized as a component of federal income tax expense.
As of December 31, 2020 and 2019, the Company had no common share equivalents that were excluded in the diluted loss per share calculation for years ended December 31, 2020 and 2019.
On February 12, 2021, the Company, through Crusader, completed the sale of the Company’s headquarters at 26050 Mureau Road, Calabasas, California 91302, for approximately $12,695,000 (the “Sale”) to Mureau Road, LLC (“Mureau Road”), a subsidiary of Alliant Capital, Ltd. (“Alliant”). Mureau Road and Alliant do not have any material relationship with the Company or its subsidiaries, other than through the Sale and the Lease (as defined below) transactions. The Company recognized a gain of $4,359,982 and incurred selling costs of $666,124 on the sale of the building.