We, through Skye Lane, our wholly-owned subsidiary, own a two-building 13-acre campus located in Clearwater, Florida. Approximately 80% of the property is occupied by unaffiliated tenants.
There were 257,131 policies in-force at December 31, 2015, of which approximately 74.6% were assumed from Citizens, 9.8% were assumed from SSIC and 15.6% were from voluntary sales
Retroactive reinsurance income. Retroactive reinsurance income represents the income, net of associated losses and loss adjustment expenses, arising from the retroactive reinsurance agreement we entered in connection with our assumption of approximately 39,000 policies from Citizens in June 2013. Under this retroactive reinsurance agreement, we realized income equal to the earned premiums, net of associated losses and loss adjustment expenses, from such polices for the period from January 1, 2013 through May 31, 2013 with no corresponding reinsurance costs. The earned premiums for the period from June 1, 2013 through June 27, 2013 (the date the assumption agreement) are effective) are included in gross premiums written for the year ended December 31, 2013. The retroactive reinsurance agreement, which was a key element of our decision to enter into an assumption transaction at the outset of hurricane season, is not typical of our assumption transactions with Citizens. The typical assumption transaction with Citizens provides for the assumption of unearned premiums as of the effective date of the transaction, and does not result in the transfer of earned premiums and losses and loss adjustment expenses for prior periods. We do not expect to enter into similar retroactive arrangements with Citizens in connection with future policy assumptions.
Other revenue. Other revenue represents rental income due under non-cancelable leases for space at the Company’s commercial property in Clearwater, Florida that we acquired in April 2013, and all policy and pay-plan fees. Florida law allows insurers to charge policyholders a $25 policy fee on each policy written; these fees are not subject to refund, and the Company recognizes the income immediately when collected. The Company also charges pay-plan fees to policyholders that pay its premiums in more than one installment and record the fees as income when collected. In addition, the Company records revenue earned from its restoration subsidiary for non-insurance construction as services performed using the percentage of completion method. We do not expect the revenue generated from non-insurance contracts to be material in nature.
Policy acquisition costs. Policy acquisition costs consist of the following items: (i) commissions paid to outside agents at the time of policy issuance, (ii) policy administration fees paid to a third-party administrator at the time of policy issuance, (iii) premium taxes and (iv) inspection fees. We recognize policy acquisition costs ratably over the term of the underlying policy. Until renewed, policies assumed from Citizens have no associated policy acquisition costs. Policy acquisition costs also include the costs to acquire the SSIC policies. We recognize these costs ratably over the term of the unearned premium acquired in the transaction.
Provision for income taxes. Provision for income taxes historically consisted of income taxes associated with our subsidiaries that are taxed as corporations. On May 22, 2014, we converted from a limited liability company to a corporation. As a corporation, we are subject to typical corporate U.S. federal and state income tax rates which we expect to result in a statutory tax rate of approximately 38.575% under current tax law.
Gross premiums earned increased from $311.5 million for the year ended December 31, 2014 to $524.7 million for the year ended December 31, 2015. Our policies in force as of December 31, 2014 and 2015 were approximately 209,400, and 257,100, respectively, and this increase had a favorable impact on our gross premiums earned. Additionally, we experienced significant growth
during the second half of 2014, including the acquisition of SSIC policies in June 2014 and the introduction of commercial residential business during the fourth quarter of 2014. This business generated earned premiums for the full year for 2015, while only generating earned premiums for partial year of 2014. Gross earned premiums from commercial residential was $97.2 million for 2015, as compared to $18.9 million for 2014.
Net premiums earned increased from $223.6 million for the year ended December 31, 2014 to $376.3 million for the year ended December 31, 2015. The increase in net premiums earned in the comparable periods is primarily attributable to the increase in the number of policies in force during the year ended December 31, 2015 as compared to the year ended December 31, 2014, the growth in policy count experienced in the second half of 2014, partially offset by increased ceded earned premiums.
Net investment income, inclusive of net realized investment gains and losses, increased from $4.2 million for the year ended December 31, 2014 to $8.9 million for the year ended December 31, 2015. The increase in net investment income is due to the increase in invested assets from $331.2 million at December 31, 2014 to $400.1 million at December 31, 2015. The increase resulted primarily from policy growth and an increase in net realized gains from $0.3 million in 2014 to $1.5 million in 2015, resulting from the Company being reactive to market conditions.
Total revenue increased from $233.8 million for the year ended December 31, 2014 to $394.8 million for the year ended December 31, 2015. The increase in total revenue was due primarily to the growth in net premiums earned resulting from the significant increase in the number of policies in force throughout the year ended December 31, 2015 as compared to the prior year.
Policy acquisition costs increased from $36.5 million for the year ended December 31, 2014 to $57.2 million for the year ended December 31, 2015. The increase is primarily attributable to the significant increase in new and renewed policies, which have associated commissions and administration fees paid to outside agents and administrators at the time of policy issuance, premium
taxes and inspection fees, none of which are associated with policies assumed from Citizens prior to their renewal. This was partially offset by the fact that, $7.6 million of the $10 million SSIC policy acquisition fee was amortized during the year ended December 31, 2014, compared to only $2.4 million during the year ended December 31, 2015.
General and administrative expenses increased from $33.5 million for the year ended December 31, 2014 to $46.1 million for the year ended December 31, 2015. The increase in 2015 was due primarily to the growth in our infrastructure resulting in greater costs associated with our personnel, facilities and overall business activity.
Provision for income taxes was $27.2 million and $57.8 million for the years ended December 31, 2014 and 2015, respectively. Our effective tax rates for the years ended December 31, 2014 and 2015 were 36.6% and 38.6%, respectively. The increase in the effective tax rate is a result of prior period adjustments and more favorable permanent differences in 2014.
For the year ended December 31, 2014 we generated net income of $47.1 million, or $1.82 earnings per diluted common share, compared to net income of $92.5 million, or $3.05 earnings per diluted common share, for the year ended December 31, 2015. The weighted average shares outstanding on a diluted basis increased from 25.8 million shares to 30.3 million shares as of December 31, 2015, primarily due to the issuance of IPO shares mid-year 2014 causing 2014 diluted shares to be lower.
Ratios - Year Ended December 31, 2014 Compared to Year Ended December 31, 2015
Our gross loss ratio decreased from 28.7% for the year ended December 31, 2014 to 26.9% for the year ended December 31, 2015, primarily due to the introduction of commercial residential business during the quarter ended December 31, 2014, which has a significantly lower loss ratio then personal residential. Commercial residential represented 18.5% of total gross earned premiums in 2015 compared to 6.1% in 2014.
Results of Operations - Year Ended December 31, 2013 Compared to Year Ended December 31, 2014
Gross premiums written increased from $218.5 million for the year ended December 31, 2013 to $436.4 million for the year December 31, 2014. The increase in gross premiums written was due to the renewal of a significant number of policies previously assumed from Citizens and SSIC, the growing number of new voluntary policies written and the assumption of approximately 55,000 personal residential policies from Citizens and 32,000 from SSIC, as well as approximately 2,200 commercial residential policies from Citizens in 2014. Of our gross premiums written for the year December 31, 2014, $283.3 million represents direct premiums written and $153.1 million represents assumed premiums written. Of the $283.3 million of direct premiums written, renewals of policies previously assumed from Citizens accounted for $217.1 million and renewals of policies previously assumed from SSIC accounted for $23.9 million, while voluntary business accounted for $42.2 million. The assumed premiums written of $153.1 million were comprised of $124.5 million from policies assumed from Citizens and $28.6 million from policies assumed from SSIC.
Gross premiums earned increased from $140.0 million for the year ended December 31, 2013 to $311.5 million for the year ended December 31, 2014. Our policies in force as of December 31, 2013 and 2014 were approximately 85,100, and 209,400, respectively, and this increase had a favorable impact on our gross premiums earned. Approximately $28.5 million of gross premiums earned during the year ended December 31, 2014 was attributable to the SSIC policies acquired on June 27, 2014, and $17.0 million was attributable to our entrance into the commercial residential line of business during the fourth quarter of 2014 via assumptions from Citizens and new voluntary writings.
Policy acquisition costs increased from $6.2 million for the year ended December 31, 2013 to $36.5 million for the year ended December 31, 2014. The increase is primarily attributable to the significant increase in new and renewed policies, which have associated commissions and administration fees paid to outside agents and administrators at the time of policy issuance, premium taxes and inspection fees, none of which are associated with policies assumed from Citizens prior to their renewal. In addition, $7.6 million of the $10 million SSIC policy acquisition fee was amortized during the year ended December 31, 2014.
General and administrative expenses increased from $24.7 million for the year ended December 31, 2013 to $33.5 million for the year ended December 31, 2014. The increase in 2014 was due primarily to the growth in our infrastructure resulting in greater costs associated with our personnel, facilities and overall business activity.
Our net loss ratio decreased from 40.5% for the year ended December 31, 2013 to 40.1% for the year ended December 31, 2014, primarily as a result of the improvement of the ceded premium ratio to gross earned premiums.
Our gross expense ratio increased modestly from 22.1% for the year ended December 31, 2013 to 22.5% for the year ended December 31, 2014, primarily as a result of the acquisition costs associated with the SSIC book of business that was acquired on June 27, 2014.
Our net expense ratio decreased from 32.4% for the year ended December 31, 2013 to 31.3% for the year ended December 31, 2014, primarily as a result of the improvement of the ceded premium ratio to gross earned premiums.
As of December 31, 2015, we had 30,441,410 shares of common stock outstanding, options to purchase 1,149,923 shares of common stock, and 1,125,0000 shares of restricted common stock, reflecting total paid-in capital of $202.6 million as of such date.
Net cash provided by operating activities for December 31, 2014 was $194.2 million as compared to $153.9 million cash provided during the year ended December 31, 2015. The decrease resulted primarily from the timing of assumed premium payments from Citizens and tax deposit payments.
On May 22, 2014, Heritage Insurance Holdings, Inc. was converted from a limited liability company to a corporation. As a limited liability company, Heritage Insurance was treated as a partnership for tax purposes, and accordingly was not subject to entity-level federal or state income taxation. Our income tax provision generally consists of income taxes payable by our separate subsidiaries that are taxed as corporations and which have been taxed as such since our inception. As such, our effective tax rate as a limited liability company has historically been driven primarily by the taxable income recognized by our subsidiaries. As a corporation, we are subject to typical corporate U.S. federal and state income tax rates which we expect to result in a statutory tax rate of approximately 38.575% under current tax law.
Premiums receivable represents amounts due from our policyholders for billed premiums and related policy fees. We perform a policy-level evaluation to determine the extent to which the balance of the premium receivable exceeds the balance of the unearned premium. We then age any resulting exposure based on the last date the policy was billed to the policyholder, and we establish an allowance account for credit losses for any amounts outstanding for more than 90 days. When we receive payments on amounts previously charged off, we credit bad debt expense in the period we receive the payment. Balances in premiums receivable and the associated allowance account are removed upon cancellation of the policy due to non-payment. We recorded an allowance of $0 and $250,000 for uncollectible premiums at December 31, 2015 and 2014, respectively.
Case reserves-When a claim is reported, we establish an initial estimate of the losses that will ultimately be paid on the reported claim. Our initial estimate for each claim is based upon the judgment of our claims professionals who are familiar with property and liability losses associated with the coverage offered by our policies. Then, our claims personnel perform an evaluation of the type of claim involved, the circumstances surrounding each claim and the policy provisions relating to the loss and adjust the reserve as necessary. As claims mature, we increase or decrease the reserve estimates as deemed necessary by our claims department based upon additional information we receive regarding the loss, the results of on-site reviews and any other information we gather while reviewing the claims.
IBNR reserves-Our IBNR reserves include true IBNR reserves plus “bulk” reserves. True IBNR reserves represent amounts related to claims for which a loss occurred on or before the date of the financial statements but which have not yet been reported to us. Bulk reserves represent additional amounts that cannot be allocated to particular claims, but which are necessary to estimate ultimate losses on known claims. We estimate our IBNR reserves by projecting our ultimate losses using industry accepted actuarial methods and then deducting actual loss payments and case reserves from the projected ultimate losses. We review and adjust our IBNR reserves on a quarterly basis based on information available to us at the balance sheet date.
Our Chief actuary evaluated the adequacy of our reserves as of December 31, 2015 and concluded that total reserves ranging from a low of $78.6 million to a high of $91.7 million would meet the requirements of the insurance laws of Florida, be consistent with reserves computed in accordance with accepted loss reserving standards and principles, and make a reasonable provision for all unpaid loss and loss adjustment expense obligations under the terms of our contracts and agreements. In addition to $36.9 million of recorded case reserves, we recorded $46.8 million of IBNR reserves as of December 31, 2015 to achieve overall reserves of $83.7 million.
The following table quantifies the pro forma impact of hypothetical changes in our loss reserves on our net income, stockholders’ equity and liquidity as of and for the year ended December 31, 2015 (in thousands).
Reinsurance. We follow industry practice of reinsuring a portion of our risks. Reinsurance involves transferring, or “ceding”, all or a portion of the risk exposure on policies we write to another insurer, known as a reinsurer. To the extent that our reinsurers are unable to meet the obligations they assume under our reinsurance agreements, we remain liable for the entire insured loss.
Investments. We currently classify all of our investments in fixed maturity securities and equity securities as available-for-sale, and report them at fair value. We classified our investment in a mortgage loan as held to maturity and report it at amortized cost.
Level 3-Assets and liabilities with values that are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Unobservable inputs reflect the Company’s estimates of the assumptions that market participants would use in valuing the assets and liabilities.
Stock-Based Compensation. We recognize compensation expense under ASC 718 for stock-based payments based on the fair value of the awards. The Company grants stock options at exercise prices equal to the fair market value of the Company’s stock on the dates the options are granted. The options have a maximum term of ten years from the date of grant and vest primarily in equal annual
We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant taxing authority.
We record any income tax penalties and income tax-related interest as income tax expense in the period incurred. We did not incur any material tax penalties or income tax-related interest during the years ended December 31, 2015, 2014 and 2013.
Our insurance business is seasonal as hurricanes typically occur during the period from June 1 through November 30 each year. With our reinsurance program effective on June 1 each year, any variation in the cost of our reinsurance, whether due to changes to reinsurance rates or changes in the total insured value of our policy base will occur and be reflected in our financial results beginning June 1 of each year, subject to certain adjustments.
We obtained a $10 million irrevocable letter of credit from a financial institution to secure Osprey’s obligations arising from our reinsurance program. We collateralized this letter of credit facility with otherwise unencumbered real estate. The letter of credit terminates on May 31, 2016.
The consolidated financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Our primary assets are monetary in
nature. As a result, interest rates have a more significant impact on our performance than the effects of the general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the cost of paying losses and LAE.
Consolidated Balance Sheets as of December 31, 2015 and December 31, 2014
Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2015, 2014 and 2013
We have audited the accompanying consolidated balance sheets of Heritage Insurance Holdings, Inc. (a Delaware Corporation) and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
Our insurance subsidiary is Heritage Property & Casualty Insurance Company (“Heritage P&C”). Our other subsidiaries include: Heritage MGA, LLC (“MGA”), the managing general agent that manages substantially all aspects of our insurance subsidiary’s business; Contractors’ Alliance Network, LLC, our vendor network manager, which includes BRC Restoration Specialists, Inc., our restoration service; Skye Lane Properties, LLC, our property management subsidiary; First Access Insurance Group, LLC, our retail agency; Osprey Re Ltd,; our reinsurance subsidiary that provides a portion of the reinsurance protection purchased by our insurance subsidiary; and Heritage Insurance Claims, LLC, an inactive subsidiary reserved for future development.
The Company qualifies as an “emerging growth company” as defined in Section 2(a)(19) of the Securities Act, as modified by the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). As a result, the Company is eligible for certain exemptions from various reporting requirements applicable to other public companies that are not emerging growth companies. The Company intends to continue to take advantage of some, but not all, of the exemptions available to emerging growth companies until such time that it is no longer an emerging growth company. The Company has, however, irrevocably elected not to take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards. As a result, the Company will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies.
As of December 31, 2015 and 2014, restricted cash was $13.1 million and $4.3 million, respectively. Heritage P&C holds approximately $13.1 million relating to a reinsurance agreement with an entity that issued catastrophe (“CAT”) bonds, as Heritage P&C is contractually required to deposit two installments of reinsurance premiums into a trust account.
If the Company were to determine that an equity security has incurred an “other-than-temporary” impairment, the Company would permanently reduce the cost of the security to fair value and recognize an impairment charge in its consolidated statements of operations and comprehensive income. If a debt security or participation in a commercial mortgage loan was impaired and the Company either intends to sell the investment or it is more likely than not that the Company will have to sell the investment before it is able to recover the amortized cost or cost, then the Company would record the full amount of the impairment in its consolidated statement of operations and other comprehensive income.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price). When reporting the fair values of the Company’s financial instruments, the Company prioritizes those fair value measurements into one of three levels based on the nature of the inputs, as follows:
The carrying amounts for the following financial instruments approximate their fair values at December 31, 2015 because of their short-term nature: cash and cash equivalents, restricted cash, accrued investment income, premiums receivable, net, reinsurance payable, and accrued compensation.
The Company’s non-financial assets, such as goodwill (reported in other assets), and property, plant and equipment are carried at cost until there are indicators of impairment, and are recorded at fair value only when an impairment charge is recognized.
The Company records assumed premiums written (premiums from policies that the Company assumed from Sunshine State Insurance Company (“SSIC”) and from Citizens Property Insurance Corporation (“Citizens”), net of opt-outs) and direct premiums written (premiums from subsequent renewals of Citizens’ and SSIC policies and voluntary policies written during the period) as revenue, net of ceded amounts, on a daily pro rata basis over the contract period of the related policies that are in force. For any portion of premiums not earned at the end of the reporting period, the Company records an unearned premium liability. As a one-time only transaction on June 27, 2014, the Company assumed approximately $58.9 million of annualized premiums from SSIC. The Company acquired 32,000 policies and as of December 31, 2015 have renewed approximately 24,100. At December 31, 2015, the Company assumed approximately $53.3 million of annualized premium. The SSIC policies account for approximately 7% of the Company’s total policies in force as of December 31, 2015.
Premiums receivable represents amounts due from our policyholders for billed premiums and related policy fees. We perform a policy-level evaluation to determine the extent to which the balance of premiums receivable exceeds the balance of unearned premiums. We then age any resulting exposure based on the last date the policy was billed to the policyholder, and we establish an allowance for credit losses for any amounts outstanding for more than 90 days. When we receive payments on amounts previously charged off, we reduce bad debt expense in the period we receive the payment. Balances in premiums receivable and the associated allowance account are removed upon cancellation of the policy due to non-payment. We recorded an allowance of $0 and $250,000 for uncollectible premiums at December 31, 2015 and 2014, respectively. Bad debt expense recovery related to uncollectible premiums was $(250,000), $250,000 and $0 for the years ended December 31, 2015, 2014 and 2013, respectively.
The application of the purchase method of accounting for business combinations requires the use of significant estimates and assumptions in determining the fair value of assets acquired and liabilities assumed in order to properly allocate the purchase price. The estimates of the fair value of the assets acquired and liabilities assumed are based upon assumptions believed to be reasonable using established valuation techniques that consider a number of factors and when appropriate, valuations performed by independent third party appraisers. Asset acquired and liabilities assumed in connection with business combinations are recorded based on their respective fair values at the date of acquisition. The identifiable intangible assets that we have acquired are non-compete agreements, customer relationships and trade names and associated trademarks. Goodwill is calculated as the excess of the cost of the acquired entity over the net fair value of the assets acquired and the liabilities assumed. Non-compete agreements, customer relationships and trade names and associated trademarks are valued based on an excess earnings or income approach based on projected cash flows.
The Company estimates uncollectible amounts receivable from reinsurers based on an assessment of factors including the creditworthiness of the reinsurers and the adequacy of collateral obtained, where applicable. The Company recorded no uncollectible amounts under its reinsurance program or bad debt expense related to reinsurance for the years ended December 31, 2015, 2014 and 2013.
Guaranty fund and other insurance-related assessments imposed upon the Company are recorded as policy acquisition costs in the period the regulatory agency imposes the assessment. To recover Florida Insurance Guaranty Association (“FIGA”) assessments, the Company in turn calculates and begins collecting a policy surcharge that will allow it to collect the entire assessment over a 12-month period, based on an estimate of the number of policies the Company expects to write. The Company then submits an information only filing, pursuant to Florida Statute 631.57(3)(h), to the insurance regulatory authority requesting formal approval of the policy FIGA surcharge. The process may be repeated in successive 12-month periods until the Company collects the entire assessment. The Company records the recoveries as revenue in the period that it collects the cash. While current regulations allow the Company to recover from policyholders the amount of assessments imposed upon the Company, the Company’s payment of the assessments and recoveries may not offset each other in the same year. There were no such assessments during the periods presented.
The Company expenses all advertising costs when it incurs those costs. For the years ended December 31, 2015, 2014 and 2013, the Company incurred advertising costs of $27,000, $14,200, and $393,000, respectively.
The Company measures stock-based compensation at the grant date based on the fair value of the award and recognizes stock-based compensation expense over the requisite vesting period. Determining the fair value of stock option awards requires judgment, including estimating stock price volatility, forfeiture rates and expected option life. Restricted stock awards are valued based on the fair value of the stock on the grant date and the related compensation expense is recognized over the vesting period.
Group concentration of credit risk-all of the Company’s reinsurers engage in similar activities and have similar economic characteristics that could cause their ability to repay us to be similarly affected by changes in economic or other conditions
With regard to cash, the Company had $243.7 million and $154.4 million in excess of Federal Deposit Insurance Corporation (“FDIC”) insurance limits at December 31, 2015 and December 31, 2014, respectively. Deposits held in non- interest-bearing transaction accounts are combined with interest-bearing accounts and are insured up to $250,000.
In June 2014, the FASB issued ASU Topic 2014-12, Compensation - Stock Compensation, which clarifies accounting for share-based payments for which the terms of an award provide that a performance target 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 could be achieved and still be eligible to vest in the award if and when the performance target is achieved. The updated guidance clarifies that such a term should be treated as a performance condition that affects vesting. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which the requisite service has already been rendered. The guidance will be effective for the Company beginning with year 2016, and may be applied either prospectively or retrospectively. The Company does not anticipate that this guidance will materially impact its consolidated financial statements and related disclosures.
The following table details the difference between cost or adjusted/amortized cost and estimated fair value, by major investment category, at December 31, 2015 and December 31, 2014:
During the Company’s quarterly evaluations of its securities for impairment, the Company determined that none of its investments in debt and equity securities that reflected an unrealized loss position were other-than-temporarily impaired. The issuers of the debt securities in which the Company invests continue to make interest payments on a timely basis and have not suffered any credit rating reductions. The Company does not intend to sell, nor is it likely that it would be required to sell, the debt securities before the Company recovers its amortized cost basis. All the issuers of the equity securities it owns had near-term prospects that indicated the Company could recover its cost basis, and the Company also has the ability and the intent to hold these securities until the value equals or exceeds its cost.
The following table presents an aging of the Company’s unrealized investment losses by investment class as of December 31, 2015 and December 31, 2014:
The following table presents information about the Company’s assets measured at fair value on a recurring basis. The Company assesses the levels for the investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that caused the transfer in accordance with the Company’s accounting policy regarding the recognitions of transfers between levels of the fair value hierarchy. For the years ended December 31, 2015 and 2014, there were no transfers in or out of Level 1, 2, and 3.
Property and equipment, net consists of the following at December 31, 2015 and 2014 (in thousands):
As of December 31, 2015, the Company recorded goodwill and intangibles in other assets.
The Company’s Retention. For the first catastrophic event, the Company had a primary retention of the first $15 million of losses and loss adjustment expenses, of which Osprey was responsible for $6 million. For a second event, Heritage P&C’s primary retention decreases to $2 million and Osprey was responsible for $4 million. To the extent that there was reinsurance coverage remaining, Heritage P&C has a $2 million primary retention for events beyond the third catastrophic event. Osprey has no primary retention beyond the second catastrophic event.
FHCF Layer. The Company’s FHCF coverage includes an estimated maximum provisional limit of 90% of $484 million, or $436 million, in excess of its retention and private reinsurance of $181 million. The limit and retention of the FHCF coverage was subject to upward or downward adjustment based on, among other things, submitted exposures to FHCF by all participants. The Company purchased coverage alongside from third party reinsurers. The layer alongside was in the amount of $48 million. To the extent the FHCF coverage was adjusted, this private reinsurance will adjust to fill in any gaps in coverage up to the reinsurers’ aggregate limits for this layer. The FHCF coverage cannot be reinstated once exhausted, but it does provide coverage for multiple events.
FHCF Layer. The Company’s FHCF coverage includes an estimated maximum provisional limit of 75% of $920 million, or $690 million, in excess of its retention and private reinsurance of $336 million. The limit and retention of the FHCF coverage is subject to upward or downward adjustment based on, among other things, submitted exposures to FHCF by all participants. The Company has purchased coverage alongside from third party reinsurers and through reinsurance agreements with Citrus Re Ltd To the extent the FHCF coverage is adjusted, this private reinsurance with third party reinsurers and Citrus Re Ltd will adjust to fill in any gaps in coverage up to the reinsurers’ aggregate limits for this layer. The FHCF coverage cannot be reinstated once exhausted, but it does provide coverage for multiple events.
Aggregate Coverage. In addition to the layers described above, the Company has also purchased $125 million of aggregate reinsurance coverage for losses and loss adjustment expenses in excess of $1.648 billion for a first catastrophic event. To the extent that this coverage is not fully exhausted in the first catastrophic event, it provides coverage commencing at its reduced retention for second and subsequent events and where underlying coverage has been previously exhausted. There is no reinstatement of the aggregate reinsurance coverage once exhausted, but it does provide coverage for multiple events.
The Company’s losses incurred during the year ended December 31, 2015 reflect a prior year redundancy of $5.3 million associated with management’s best estimate of the actuarial loss and LAE reserves with consideration given to a longer history of Company specific experience. Additionally, during the year ended December 31, 2015, the Company experienced favorable development of losses and LAE reserves for its personal and commercial lines. The Company’s losses incurred related to prior years reflect redundancies of $223,000 and $467,000 for the years ended December 31, 2014 and 2013, respectively.
The following table sets forth the components of income before income taxes for the years ended December 31, 2015, 2014 and 2013 (in thousands):
The effective income tax rate differs from the statutory income tax rate in 2015, 2014 and 2013 primarily due to state income taxes and the fact that a portion of the Company’s consolidated pre-tax income through May 22, 2014 was earned at our limited liability companies that had elected to be taxed under the Partnership provisions of the Internal Revenue Code. Accordingly, all income or losses and applicable tax credits generated by these entities through that date are reported on the common shareholders’ individual tax returns, and no federal income taxes were recorded by the Company.
In assessing the net carrying amount of deferred tax assets, we consider whether it is more likely than not that we will not realize some portion or all of the deferred tax assets. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.
In 2014, the Florida legislature passed Senate Bill 1308, which was signed into law by the Governor. Among other things, this bill incorporates the National Association of Insurance Commissioners (“NAIC”) recommendations with regard to expansion of the regulation of insurers to include non-insurance entity affiliates. Specifically, the new law permits the Office of Insurance Regulation to examine affiliated entities within an insurance holding company system in order to ascertain the financial condition of the insurer. The law also provides for certain disclosures with regard to enterprise risk, which are satisfied by the provision of related information filed with the SEC. This legislation was designed to bolster regulation for insurer solvency and governance and became effective January 1, 2015.
Florida law permits an insurer to pay dividends or make distributions out of that part of statutory surplus derived from net operating profit and net realized capital gains. The law further provides calculations to determine the amount of dividends or distributions that can be made without the prior approval of the insurance regulatory authority and the amount of dividends or distributions that would require prior approval of the insurance regulatory authority. Statutory risk-based capital requirements may further restrict our insurance subsidiary’s ability to pay dividends or make distributions if the amount of the intended dividend or distribution would cause statutory surplus to fall below minimum risk-based capital requirements. However, the consent order
Florida law limits an insurer’s investment in equity instruments and also restricts investments in medium to low quality debt instruments. The Company was in compliance with all investment restrictions at December 31, 2015 and 2014.
Statutory accounting requires an additional admissibility test outlined in Statements on Statutory Accounting Principles, No. 101 and the change in deferred income tax is reported directly in capital and surplus, rather than being reported as a component of income tax expense under GAAP.
The table below reconciles the Company’s consolidated GAAP stockholders’ equity to surplus with regards to policyholders of the Company’s insurance subsidiary (in thousands):
For the year ended December 31, 2015, the Company recognized employee bonus compensation expense of approximately $14.1 million based on 8.5% of earnings before interest, taxes, depreciation and amortization, which the Company paid out in cash of approximately $12.1 million as of December 31, 2015. For the year ended December 31, 2014, the Company accrued bonuses of $7.7 million based on 8.5% of earnings before interest, taxes, depreciation and amortization, which was paid out in cash as of December 31, 2014. For the year ended December 31, 2013, the Company awarded its directors, executive officers and select employees’ bonus compensation of $11.5 million in the aggregate for 2013, comprised of $6.4 million in cash and $5.1 million in ownership equity. The equity component was issued in the form of 389 ownership shares at a value of $13,125 per share. The per share value was determined based on an independent valuation, and the Company evaluated the assumptions, methodologies and conclusions associated with that valuation.
The Company provides a 401(k) plan for substantially all of its employees. The Company contributes 3% of employees’ salary, up to the maximum allowable contribution, regardless of the employees’ level of participation in the plan. For the years ended December 31, 2015 and 2014, the Company’s contributions to the plan on behalf of the participating employees were $276,300 and $209,400, respectively.
The total amount of our authorized capital stock consists of 50,000,000 shares of common stock, $0.0001 par value, and 5,000,000 shares of preferred stock, $0.0001 par value. As of December 31, 2015, the Company had 30,441,410 shares of common stock outstanding and no shares of preferred stock outstanding.
As of December 31, 2014, there were 29,794,960 shares of common stock outstanding and 30,600 warrants and 1,685,923 stock options outstanding representing $188.3 million of additional paid-in capital. The following discloses the changes in the Company’s stockholders’ equity during 2015.
In March 2015, the Company issued 12,500 shares of common stock upon the exercise of 12,500 stock options granted at an exercise price of $16.89 per share and received proceeds of $211,125.
In May and June 2015, the Company issued an aggregate of 157,500 shares of common stock upon the exercise of 137,500 and 20,000 stock options which were granted at an exercise price of $16.89 and $14.02 per share and received proceeds of $2,322,375 and $280,400, respectively.
At December 31, 2015 and 2014, there were 170,814 and 1,295,814 shares available for grant under the Plan, respectively.
In connection with the IPO in May 2014, the Company’s Board of Directors approved a 2,550 for 1 stock split of the Company’s Shares. The stock split became effective on May 7, 2014. All share and per share amounts in the consolidated financial statements and notes thereto have been retroactively adjusted for all periods presented to give effect to this stock split and for changes allocated with conversion from a limited liability company to a corporation.
During February 2016, the Company entered into two catastrophe reinsurance agreements with Citrus Re Ltd. The agreements provide for three years of coverage from catastrophe losses caused by certain named storms, including hurricanes, beginning on June 1, 2016. The Company pays a periodic premium to Citrus Re Ltd during this three-year risk period. Citrus Re Ltd issued $250 million of principal-at-risk variable notes due February 2019 to fund the reinsurance trust account and its obligations to the Company under the reinsurance agreements. The Class D-50 notes provide up to $150 million of coverage and the Class E-50 notes provide $100 million of coverage. Proceeds from the Class D-50 and Class E-50 notes provide reinsurance coverage for a portion of the sliver of the catastrophe coverage that had previously been provided by the Florida Hurricane Catastrophe Fund. The limit of coverage is fully collateralized by a reinsurance trust account for the benefit of the Company. The maturity date of the notes may be extended up to two additional years to satisfy claims for catastrophic events occurring during the three-year term of the reinsurance agreements. The reinsurance agreements related to the 2016 notes provide coverage from catastrophe losses incurred by the Company in Florida and other states and also provides coverage to future affiliates once named. Zephyr Insurance Company (“ZIC”) is specifically covered with the expectation that the Company acquires Zephyr Acquisition Company (“ZAC”); if ZAC is not ultimately acquired, ZIC will be not covered under these reinsurance agreements.