On September 26, 2013, Crusader purchased land and a two-story building in Calabasas, California. The Company moved its home office to this location on October 9, 2015, and has been occupying the building through the present time.
As a smaller reporting company, the Company has elected to comply with certain scaled disclosure reporting obligations, and therefore does not have to provide the information required by this Item.
The Company’s net loss was $8,724,984 and $1,404,277 for the years ended December 31, 2017 and 2016, respectively.
The Company receives its revenue primarily from earned premium derived from the insurance company operation, commission and fee income generated from the insurance agency operations, finance fee income from the premium finance operations, and investment income from cash generated primarily from the insurance company operation. The insurance company operation generated approximately 92% of the Company’s total revenue for the years ended December 31, 2017 and 2016. The Company’s remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually not material to consolidated revenues.
The following table shows the loss ratios, expense ratios, and combined ratios of Crusader as derived from data prepared in accordance with GAAP:
The Company generates investment income from its total invested assets of $96,691,616 and $90,576,445 (at amortized cost) as of December 31, 2017 and 2016, respectively, and from two cash deposits placed with the Los Angeles Superior Court by Crusader in lieu of appeal bonds. These deposits, totaling $13,373,793, were made on December 28, 2015, for $7,924,178 and on March 21, 2016, for $5,449,615, and their respective balances were included in “Cash and restricted cash” on the Consolidated Balance Sheet and were not a part of the total invested assets as of December 31, 2016. In September 2017, two judgments associated with the two cash deposits in lieu of appeal bonds were settled for a total of $7,000,000 which was paid from the two deposits, and the remaining funds on deposit with the Los Angeles Superior Court were returned to Crusader.
Investment income included in insurance company operation and other insurance operations, excluding realized investment losses, for the year ended December 31, 2017, increased $408,921 (46%) as compared to the year ended December 31, 2016. The increase in the investment income was primarily a result of a change in the investment guidelines and an increase in interest rates. The Company’s yield on average invested assets increased to 1.24% in 2017 from 0.81% in 2016 (the interest on the two cash deposits in lieu of appeal bonds is excluded from the yield computation).
The weighted average maturity of the Company’s fixed maturity investments was 6.8 years and 1.0 years as of December 31, 2017 and 2016, respectively.
The Company reported net cash used by operating activities for each of the years ended December 31, 2017 and 2016. Cash used by operating activities in 2017 was $7,022,232 compared to $1,409,242 in 2016.
Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, its reserves for loss and loss adjustment expense payments and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its investments. Cash, restricted cash, and investments (at amortized cost) of the Company at December 31, 2017, were $97,465,842 compared to $104,072,824 at December 31, 2016. Crusader's cash, restricted cash, and investments were 98% and 99% of the total cash, restricted cash, and investments held by the Company as of December 31, 2017 and 2016, respectively.
As of December 31, 2017, all of the Company’s investments are in US. Treasury securities, FDIC insured certificates of deposit, other fixed maturity securities, and short-term investments. All of the Company’s investments, except for the certificates of deposit, are readily marketable. The weighted average maturity of the Company’s investments is approximately 6.8 years.
The Company is required to classify its investment 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 and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity.
On March 24, 2017, the Company’s Board of Directors approved new investment guidelines. Those guidelines are similar to what the Company believes are general investment guidelines used by Crusader’s peers.
Under the new investment guidelines, investments may only include U.S. treasury Notes, U.S. government agency notes, mortgage-backed securities (including pass through securities and collateralized mortgage obligations) that are backed by agency and non-agency collateral, commercial mortgage-backed securities, U. S. corporate obligations, asset backed securities, (including but not limited to credit card, automobile and home equity backed securities), tax-exempt bonds, preferred stocks, common stocks, commercial paper, repurchase agreements (treasuries only), mutual funds, exchange traded funds, bank certificates of deposits and time deposits. The new investment guidelines provide for certain investment limitations in each investment category.
During the years ended December 31, 2017 and 2016, no cash dividends were declared or issued by the Company to its shareholders. Declaration of future cash dividends will be subject to the Company’s profitability and its cash requirements.
While material capital expenditures may be funded through borrowings, the Company believes that its cash and short-term investments at December 31, 2017, net of statutory deposits of $700,000 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. Trust restrictions on cash and short-term investments were $0 at December 31, 2017 and December 31, 2016.
Total revenue was $36,791,482 and $35,267,724 for the years ended December 31, 2017 and 2016, respectively. This represents an increase of $1,523,758 (4%) for the 2017 year compared to the 2016. The Company had net loss of $8,724,984 and $1,404,277 for the years ended December 31, 2017 and 2016, respectively. This represents an increase in net loss of $7,320,707 (521%) for the 2017 year compared to the 2016 year due primarily to the adverse development of insured events of prior years during the year ended December 31, 2017, primarily on long-tail claims in accident years 2016, 2015, and 2014.
Direct earned premium for the year ended December 31, 2017, increased $1,546,208 (4%) compared to the year ended December 31, 2016. The increase in the direct earned premium was due primarily to growth in the direct written premium during the year ended December 31, 2016.
Ceded earned premium for the year ended December 31, 2017, increased $559,260 (9%) compared to the year ended December 31, 2016.
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, 2017 and 2016 were $30,490,507 and $22,826,878, respectively.
The adverse development of insured events of prior years during the year ended December 31, 2017, was due primarily to higher than expected incurred losses and loss adjustment expenses on long-tail claims in accident years 2016, 2015, and 2014. The development of insured events of prior years in the above table is not necessarily indicative of the results that may be expected in future periods.
If future development ultimately results in being five percent different than Crusader’s 2017 net reserve, $2,034,172 would be reflected in future periods as an increase or decrease in the development of insured events of prior years and would be recognized in the Company’s Consolidated Statements of Operations in future periods. If future development ultimately results in being ten percent different than Crusader’s 2017 net reserve, $4,068,344 would be reflected in future periods as an increase or decrease in the development of insured events of prior years and would be recognized in the Company’s Consolidated Statements of Operations in future periods.
The finance fees earned for the year ended December 31, 2017, increased $5,934 (9%) as compared to the year ended December 31, 2016. The increase in fees earned during the years presented compared to the prior year period is primarily a result of increase in late fees over comparable periods.
(2) Investment income from insurance company operation included $133,160 and $113,394 of interest on the cash deposits in lieu of appeal bonds for the years ended December 31, 2017 and 2016, respectively.
In the year ended December 31, 2017, the Company’s average invested assets (at amortized cost) decreased $575,958 (1%) compared to the year ended December 31, 2016. The decrease in average invested assets was attributable primarily to usage of funds in operations.
The par value, amortized cost, fair value and weighted average yield of fixed maturity investments at December 31, 2017, by contractual maturity are as follows:
Other income from insurance company operation and other insurance operations increased $114,436 (51%) in the year ended December 31, 2017, when compared to the year ended December 31, 2016. The increase in the year ended December 31, 2017 from the year ended December 31, 2016, is due primarily to increase in rental income on the Calabasas building.
Policy acquisition costs consist of commissions, premium taxes, inspection fees, and certain other underwriting costs that are directly related to and vary with the production of Crusader insurance policies. These costs include both Crusader expenses and the allocated expenses of other Unico subsidiaries. Crusader's reinsurers pay Crusader a ceding commission, which is primarily a reimbursement of the acquisition cost related to the ceded premium. No ceding commission is received on facultative or catastrophe ceded premium. Policy acquisition costs, net of ceding commission, are deferred and amortized as the related premium is earned. Policy acquisition costs decreased $431,468 (6%) in the year ended December 31, 2017, compared to the year ended December 31, 2016, due primarily to lower commission expense as a result of the loss experience and higher ceding commission due to an increase in ceded earned premium for the year ended December 31, 2017.
Income tax was a benefit for the year ended December 31, 2017, increased $445,276 (63%) compared to the year ended December 31, 2016. The effective income tax rates for the years ended December 31, 2017 and 2016 were 12% and 34%, respectively. The increase in the income tax benefit is related primarily to the $9,880,221 loss before taxes for the year ended December 31, 2017, compared to the $2,114,238 loss before taxes for the year ended December 31, 2016.
The TCJA, signed into law on December 22, 2017, reduced the corporate Federal income tax rate from 34% to 21%, effective for years beginning after December 31, 2017. As a result of the TCJA, the Company had recognized a decrease to its net deferred asset as of December 31, 2017 in the amount of $2,176,862 and a one-time income tax charge of $2,137,385 for the year ended December 31, 2017. This one-time income tax charge partially offset income tax benefit due to the $9,880,221 loss before taxes for the year ended December 31, 2017.
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. Management concluded that no changes in Crusader’s key reserve assumptions or methodologies are appropriate.
The differences between actual and expected claims costs are typically not due to one specific factor but to a combination of many factors such as the period of time between the initial occurrence and the final settlement of the claim, current and perceived social and economic inflation, and many other economic, legal, political, and social factors. The information that management uses to arrive at its booked reserve estimate comes from many sources within the Company, including its accounting, legal, claims, and underwriting departments. Informed managerial judgment is applied throughout the reserving process. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount will tend to be. Accordingly, short-tail claims, such as the emergence of property damage claims costs, tend to be subject to less variability than the emergence of long-tail liability claims costs. The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates based on experience and industry data for development of case estimates and for unreported losses and loss adjustment expenses. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims should be expected to vary, perhaps 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. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.
At each quarterly review, 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. While the Company believes the reserves were adequate at December 31, 2017 and 2016, adverse or (favorable) development may emerge in the future.
Crusader’s recoverable from reinsurers represents an estimate of the amount of future loss and loss adjustment expense payments that will be recoverable from Crusader’s reinsurers. These estimates are based upon estimates of the ultimate losses and loss adjustment expenses that Crusader expects to incur and the portion of those losses that are expected to be allocable to reinsurers based upon the terms of the reinsurance agreements. Given the uncertainty of the ultimate amounts of losses and loss adjustment expenses, the estimates may vary significantly from the eventual outcome. Crusader’s estimate of the amounts recoverable from reinsurers is regularly reviewed and updated by management as new data becomes available. Crusader’s assessment of the collectability of the recorded amounts recoverable from reinsurers is based primarily upon public financial statements and rating agency data. Any adjustments necessary are reflected in the current operations. Crusader evaluates each of its ceded reinsurance contracts at its inception to determine if there is sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting literature. At December 31, 2017, all such ceded contracts are accounted for as risk transfer reinsurance.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Unico American Corporation (the “Company” or “Unico”) is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary; provides property, casualty, and health insurance through its agency subsidiaries; and provides insurance premium financing and membership association services through its other subsidiaries. References to Unico or the Company include both the corporation and its subsidiaries, all of which are wholly owned. Unico was incorporated under the laws of Nevada in 1969.
2. Long-term certificates of deposit - The carrying amounts reported at cost in the Consolidated Balance Sheets for these instruments approximate their fair values.
As of December 31, 2017, the Company had no unrecognized tax benefits or liabilities. In addition, the Company had not accrued interest and penalties related to unrecognized tax benefits or liabilities. However, if interest and penalties would need to be accrued related to unrecognized tax benefits or liabilities, such amounts would be recognized as a component of federal income tax expense.
Crusader employs reinsurance to provide greater diversification of business allowing management to control exposure to potential losses arising from large risks by reinsuring certain levels of risk in various areas of exposure, to reduce the loss that may arise from catastrophes, and to provide additional capacity for growth. Prepaid reinsurance premium and reinsurance receivables are reported as assets and represent ceded unearned premium and reinsurance recoverable on both paid and unpaid losses and loss adjustment expenses, respectively. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. Crusader evaluates each of its ceded reinsurance contracts at its inception to determine if there is sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting literature. As of December 31, 2017, all such ceded contracts are accounted for as risk transfer reinsurance.
ASC Topic 280, “Segment Reporting,” establishes standards for the way information about operating segments are reported in financial statements. The Company has identified its insurance company operation as its primary reporting segment. Revenues from this segment comprised 92% of consolidated revenues for the years ended December 31, 2017 and 2016. The Company’s remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually insignificant to consolidated revenues.
The insurance company operation is conducted through Crusader, which as of December 31, 2017, was licensed as an admitted insurance carrier in the states of Arizona, California, Nevada, Oregon, and Washington. Crusader is a multiple line property and casualty insurance company, which began transacting business on January 1, 1985. For the years ended December 31, 2017 and 2016, 99% and 98% of Crusader’s business was commercial multiple peril (“CMP”) insurance policies, respectively. CMP policies provide a combination of property and liability coverage for businesses. Commercial property coverage insures against loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, hail, water, explosions, severe winter weather, and other events such as theft and vandalism, fires and storms and financial loss due to business interruption resulting from covered property damage. However, Crusader does not write earthquake coverage. Commercial liability coverage insures against third party liability from accidents occurring on the insured’s premises or arising out of its operations, such as injuries sustained from products sold or the operation of the insured’s premises. In addition to CMP policies, Crusader also writes separate policies to insure commercial property and commercial liability risks on a mono-line basis which provides either commercial property or commercial liability coverage, but not both.
Share-based compensation expense for all share-based payment awards granted or modified on or after January 1, 2006, is based on the grant-date fair value estimated in accordance with the provisions of ASC Topic 718, “Compensation - Stock Compensation” using the modified prospective transition method.
In November 2016, the FASB issued ASU 2016-18 “Statement of Cash Flows: Restricted Cash.” ASU 2016-18 requires that a statement of cash flows explain the change during the period of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statements of cash flows. The Company early adopted ASU 2016-18 as of December 31, 2016, and ASU 2016-18 was applied using a retrospective approach for each period presented. Upon adoption of ASU 2016-18, the Company's consolidated statements of cash flows included restricted cash in the beginning-of-period and end-of-period total amounts for cash and restricted cash. ASU 2016-18 did not have a material impact on the Company’s consolidated financial statements, but ASU 2016-18 required additional disclosures in “Note 2 - Cash and Restricted Cash” to these consolidated financial statements.
The restricted cash is represented by two cash deposits placed by Crusader with the Los Angeles Superior Court in lieu of appeal bonds. In December 2015, a judgment was finalized on a Crusader policy liability claim. Crusader appealed the judgment. As a part of the appeal, Crusader deposited $7,924,178 in cash with the Los Angeles Superior Court on December 28, 2015, in lieu of an appeal bond. This cash deposit was required to appeal the judgment. In March 2016, an additional judgment for plaintiff’s attorney fees and costs on this Crusader policy liability claim was finalized. The Company also appealed this additional judgment. That additional appeal required an additional $5,449,615 cash deposit which was made on March 21, 2016, in lieu of an appeal bond. In September 2017, both judgments were settled for a total of $7,000,000 which was paid from the two deposits, and the remaining funds on deposit with the Los Angeles Superior Court were returned to Crusader.
A summary of total investment income, net of investment expenses, and net realized gains and losses is as follows:
(1) Investment income from fixed maturities included $133,160 and $113,394 of interest on the restricted cash for the years ended December 31, 2017 and 2016, respectively.
A summary of the unrealized gains (losses) on investments carried at fair value and the applicable deferred federal income taxes is shown below:
The Company monitors its investments closely. If an unrealized loss is determined to be other-than-temporary, it is written off as a realized loss through the Consolidated Statements of Operations. The Company’s methodology of assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near-term prospects of the issuer, and whether the debtor is current on its contractually obligated interest and principal payments. The unrealized losses as of December 31, 2017, and December 31, 2016, were determined to be temporary.
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, 2017 and 2016.
Depreciation and amortization expense on all property and equipment for the years ended December 31, 2017 and 2016 were $517,199 and $483,580, respectively.
For the years ended December 31, 2017 and 2016, the Calabasas building has generated rental revenue in the amount of $1,065,104 and $990,013, and incurred operating expenses in the amount of $796,270 and $722,442, which included depreciation, respectively. These amounts are included in “Other income” from insurance company operation and other operating expenses, respectively, in the Company’s Consolidated Statements of Operations.
The total square footage of the Calabasas building is 46,884, including common areas. As of December 31, 2017, 14,481 square feet of the Calabasas building was leased to non-affiliated entities. As of December 31, 2017, the Calabasas building was fully occupied.
While the Company’s existing policy acquisition system (“PAS”) continues to support the Company’s current operations, the Company believes it would realize more competitive parity with respect to product and service by replacing its existing PAS with a more contemporary platform. The Company is currently evaluating its alternatives.
The following table presents loss development information by accident year, including cumulative incurred and paid losses and allocated loss adjustment expenses (“ALAE”), net of reinsurance, as well as cumulative claim frequency and the total of incurred but not reported liabilities plus expected development on reported claims as of December 31, 2017:
At the end of each fiscal quarter, Crusader’s reserves for each accident year (i.e., for all claims occurring within each year) are re-evaluated independently by the Company’s president, the Company’s chief financial officer, and an independent consulting actuary. Generally accepted actuarial methods, including the widely used Bornhuetter-Ferguson and loss development methods, are employed to estimate ultimate claims costs. An actuarial central estimate of the ultimate claims costs and IBNR reserves is ultimately determined by management and tested for reasonableness by the independent consulting actuary.
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. For the year ended December 31, 2017, the Company recognized $45,000 premium deficiency reserve; there was no such reserve for the year ended December 31, 2016.
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 2017 and 2016, 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).
The Company believes that Crusader’s statutory capital and surplus are sufficient to support the written premium guidelines established by the NAIC.
Crusader is restricted in the amount of dividends it may pay to its parent in any 12-month period without prior approval of the CA DOI. Presently, without prior regulatory approval, Crusader may pay a dividend in any 12-month period to Unico up to the greater of (a) 10% of its statutory surplus or (b) its statutory net income for the preceding calendar year. Based on Crusader’s statutory surplus for the year ended December 31, 2017, the maximum dividend that could be made by Crusader to Unico without prior regulatory approval in 2018 is $5,044,689. In the years ended December 31, 2017 and 2016, Crusader paid to Unico cash dividends in the amount of $3,000,000 and $2,000,000, respectively.
The Company recognized stock-based compensation expense in the amount of $11,552 and $23,104 for all awards issued under the 2011 Plan in the “Salaries and employee benefits” line item in the Consolidated Statements of Operations in each year ended December 31, 2017 and 2016, respectively. As of December 31, 2017, there was no unrecognized compensation cost.
TCJA, signed into law on December 22, 2017, reduced the corporate Federal income tax rate from 34% to 21%, effective for years beginning after December 31, 2017. As a result of the TCJA, the Company has recognized a decrease to its net deferred asset as of December 31, 2017 in the amount of $2,176,862. The Company has determined that no other changes are required to the deferred tax asset (liability), and the current income tax expense is unaffected by this change in the law.
The Company and its subsidiaries file consolidated federal and state income tax returns. Pursuant to the tax allocation agreement, Crusader and AAC 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 2014 and California state income tax authorities for tax returns filed starting at taxable year 2013. There are no ongoing examinations of income tax returns by federal or state tax authorities.
As of December 31, 2017, 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.
A reconciliation of the numerator and denominator used in the basic and diluted earnings (loss) per share calculation is presented below:
As of December 31, 2017 and 2016, the Company had 0 and 574 common share equivalents that were excluded in the diluted loss per share calculation for years ended December 31, 2017 and 2016, respectively.
(1) The information for the years 2008 through 2016 is presented as unaudited required supplementary information.
The following table presents average annual percentage payout of incurred claims by age, net of reinsurance, as of December 31, 2017: