Relative to the Company’s commitments stemming from operational matters, on or about March 1, 2006 we sold our interest in the building which housed our operations in Lauderdale Lakes through December 16, 2011, to an unrelated party. As part of this transaction, we agreed to lease the same facilities for a five-year term. We amended the lease agreement and the note receivable on September 1, 2010. As part of the amendment, we discounted the note receivable and have discontinued the interest on the note. In consideration, we paid a reduced lease payment for the remainder of the lease. Our lease for this office space expired in December 2011.
We are an insurance holding company that controls substantially all steps in the insurance underwriting, distribution and claims processes through our subsidiaries and our contractual relationships with our independent agents and general agents.
Our primary insurance subsidiary is Federated National Insurance Company (“FNIC”). FNIC is licensed as an admitted carrier in Florida. An admitted carrier is an insurance company that has received a license from the state insurance regulator for authority to write specific lines of insurance in that state. Through contractual relationships with a network of approximately 3,000 independent agents, of which approximately 900 actively sell and service our products, FNIC is authorized to underwrite homeowners’, commercial general liability, fire, allied lines and personal and commercial automobile insurance in Florida. FNIC is also licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas, and underwrites commercial general liability insurance in those states and personal automobile insurance in Georgia and Texas.
In January 2011, we merged FNIC and our other wholly owned insurance subsidiary, American Vehicle Insurance Company (“American Vehicle”), with FNIC continuing the operations of both entities. In connection with this merger, the Company, FNIC and American Vehicle entered into a Consent Order with the Florida Office of Insurance Regulation (“Florida OIR”) pursuant to which we agreed to certain restrictions on our business operations. The Consent Order was amended in February 2013 to lessen or eliminate certain of the original requirements, due to FNIC’s statutory underwriting profit during 2012. See “Regulation- Consent Order.”
We internally process claims made by our insureds through our wholly owned claims adjusting company, Federated National Adjusting, Inc. (“FNA”), formerly known as Superior Adjusting, Inc. Until June 2011, we offered premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc. (“Federated Premium”).
Federated National Underwriters, Inc. (“FNU”), formerly known as Assurance Managing General Agents, a wholly owned subsidiary of the Company, acts as FNIC’s exclusive managing general agent in Florida and is also licensed as a managing general agent in the States of Alabama, Georgia, Illinois, Louisiana, North Carolina, Mississippi, Missouri, New York, Nevada, South Carolina, Texas and Virginia. FNU has contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation, personal umbrella, inland marine and other various lines of insurance through FNU’s existing network of agents.
FNU earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. FNU earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliate, FNIC. During the fourth quarter of 2010, FNU, pursuant to the Consent Order as discussed above, reduced its fee, to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date with approval from the Florida OIR. A formal agreement reflecting this fee modification was executed during January 2011.
The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with management’s evaluation of the determination of (i) liability for unpaid losses and LAE, (ii) the amount and recoverability of amortization of Deferred Policy Acquisition Costs (“ DPAC”), and (iii) estimates for our reserves with respect to finance contracts, premiums receivable and deferred income taxes. Various assumptions and other factors underlie the determination of these significant estimates, which are described in greater detail in Footnote 2 in this Form 10-K.
Except as described below, we believe that in 2012 there were no significant changes in those critical accounting policies and estimates. Senior management has reviewed the development and selection of our critical accounting policies and estimates and their disclosure in this Form 10-K with the Audit Committee of our Board of Directors.
Please see Footnote 2 of the Notes to Consolidated Financial Statements for additional discussions regarding critical accounting policies.
Investments classified as held-to-maturity include debt securities wherein the Company’s intent and ability are to hold the investment until maturity and are carried at amortized cost without consideration to unrealized gains or losses. Investments classified as trading securities include debt and equity securities bought and held primarily for sale in the near term and are carried at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments and are carried at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, namely “Other Comprehensive Income.”
The debt and equity securities that are available for sale and carried at fair value represent 94% of total investments as of December 31, 2012, compared with 94% as of December 31, 2011.
The net unrealized gain of $6.5 million is inclusive of $0.7 million of unrealized losses. The $0.7 million of unrealized losses is inclusive of $0.6 million unrealized losses from equity securities and $0.1 million unrealized losses from debt securities.
The $0.6 million of unrealized losses from equity securities is from common stocks and mutual funds held in diverse industries as of December 31, 2012. The Company evaluated the near-term prospects in relation to the severity and duration of the impairment. Based on this evaluation and the Company’s ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2012.
The $0.1 million of unrealized losses from debt securities is related to US government bonds. The Company does not expect to settle at prices less than the amortized cost basis. The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2012 because we neither currently intend to sell these investments nor consider it likely that we will be required to sell these investments before recovery of the amortized cost basis.
Debt securities are carried on the balance sheet at market. At December 31, 2012 and 2011, debt securities had the following quality ratings by S&P and for securities not assigned a rating by S&P, Moody’s or Fitch ratings were used.
The following table summarizes, by maturity, the debt securities as of December 31, 2012 and 2011.
At December 31, 2012, the weighted average maturity of the debt portfolio was approximately 6.2 years.
During 2012 or 2011, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity.
Two reinsurers require FNIC to maintain securities with a fair market value of $4.6 million. As of December 31, 2012, FNIC maintained fully funded trust agreements that totaled $4.8 million in favor of the reinsurers. As of December 31, 2011, FNIC maintained fully funded trust agreement that totaled $4.6 million in favor of the reinsurers.
During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic Underwriters Insurance Company (“Republic”) which was terminated in April 2007. During 2010, the letter of credit in favor of Republic was replaced by a fully funded trust agreement. As of December 31, 2012 and 2011 respectively, the amount held in trust was $1.0 million.
Cash and short-term investments, which include cash, certificates of deposits, and money market accounts, increased $5.9 million, or 39.0%, to $21.1 million as of December 31, 2012, compared with $15.2 million as of December 31, 2011. The increase in cash and short-term investments is for a planned reinsurance payment. We evaluate our asset class allocation on an ongoing basis continually adjust based on economic and business risk.
Premiums receivable, net of allowance for credit losses, increased $2.4 million, or 42.9%, to $8.0 million as of December 31, 2012, compared with $5.6 million as of December 31, 2011.
Our homeowners’ insurance premiums receivable increased $2.3 million, or 60.0%, to $6.0 million as of December 31, 2012, compared with $3.7 million as of December 31, 2011.
Our allowance for credit losses remained unchanged at $0.1 million as of December 31, 2012, compared with $0.1 million as of December 31, 2011.
DPAC increased $0.8 million, or 9.9%, to $8.5 million as of December 31, 2012, compared with $7.7 million as of December 31, 2011. The change is due to the deferral of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned. An analysis of deferred acquisition costs follows.
Deferred income taxes, net, decreased $4.3 million, or 49.6%, to $4.3 million as of December 31, 2012, compared with $8.6 million as of December 31, 2011. Deferred income taxes, net, is comprised of approximately $10.1 million and $12.1 million of deferred tax assets, net of approximately $5.7 million and $3.5 million of deferred tax liabilities as of December 31, 2012 and December 31, 2011. The change in the net deferred tax asset is primarily due to the decrease in the deferred tax assets related to unpaid losses and loss adjustment expenses, allowance for impairments and net operating losses carry forward.
Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Opearations
The Company’s consolidated federal and state income tax returns for 2009-2011 are open for review by the Internal Revenue Service (“IRS”) and various state taxing authorities. The 2012 federal and state income tax returns have been extended and will be filed by the extended due date in Q3 of 2013. The 2005 and 2006 income tax returns and net operating loss carry-back from tax year 2009 have been reviewed by the Joint Committee on Taxation. The Joint Committee on Taxation completed its consideration in September 2011 and took no exception to the conclusions reached by the IRS regarding the net operating loss carry-back from tax year 2009.
Other assets increased $0.6 million, or 26.9%, to $2.7 million as of December 31, 2012, compared with $2.1 million as of December 31, 2011. Major components of other assets are shown in the following table; the accrued interest income receivable is primarily investment related.
Unearned premiums increased $11.1 million, or 23.1%, to $59.0 million as of December 31, 2012, compared with $47.9 million as of December 31, 2011. The change was due to a $10.9 million increase in unearned homeowners’ insurance premiums, a $0.5 million increase in unearned flood insurance premiums, a $0.2 million decrease in unearned commercial general liability premiums, and a $0.1 million decrease in unearned automobile insurance premiums. Generally, as is in this case, an increase in unearned premium directly relates to an increase in written premium on a rolling twelve-month basis.
Bank overdraft decreased $1.9 million, or 24.5%, to $6.0 million as of December 31, 2012, compared with $7.9 million as of December 31, 2011. The bank overdraft relates primarily to losses and LAE disbursements paid but not presented for payment by the policyholder or vendor. The change relates to the timing of presentation of claims checks to the issuing bank.
Accounts payable and accrued expenses decreased $0.5 million, or 15.6%, to $2.6 million as of December 31, 2012, compared with $3.1 million as of December 31, 2011. The change from prior year is primarily due to the timing of payments with our trade vendors.
Effective January 26, 2011, FNIC merged with and into American Vehicle, and the resulting entity changed its name to “Federated National Insurance Company”.
The increase in the sale of homeowners’ policies by $21.4 million, or 26.7%, to $101.8 million in 2012, compared with $80.4 million in 2011, is gross of reinsurance costs and net of Florida’s mandated homeowners’ wind mitigation discounts. We offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. As of December 31, 2012, 72.7% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $61.1 million (a 37.4% reduction of in-force premium), while 63.5% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $31.5 million, (a 28.6 % reduction of in-force premium), as of December 31, 2011.
During 2012 and 2011, the change to the cumulative wind mitigation credits afforded our policyholders totaled $29.6 million and $4.2 million, respectively.
We received approval from the Florida OIR in 2010 for a premium rate increase for our voluntary homeowners’ program within the State of Florida. That premium rate increase averaged approximately 20.2% and was implemented for policies with effective dates as soon as permitted following approval. In addition, in 2010 we received approval from the Florida OIR for a premium rate increase of approximately 15% for homeowners policies assumed from Citizens Property Insurance Corporation (“Citizens”) in Florida beginning July 2010. In February 2012, we received approval from the Florida OIR of a 14.1% rate increase. That rate increase, together with our 2011 rate increase for our voluntary property book of homeowners’ business averaged 20.2% statewide, and our assumed property book of homeowners’ business, averaged 13.9% statewide.
The $13.4 million increase in homeowners’ net premiums earned is due to a $21.4 million increase in gross written premium as discussed, a $3.1 million increase in gross premiums ceded and a $4.9 million increase in the net change to prepaid reinsurance premiums and unearned premium.
See also “Analysis of Financial Condition As of December 31, 2012 Compared with December 31, 2011 - Investments” for a further discussion on our investment portfolio.
Net realized investment gains were $1.1 million for 2012, compared with $2.7 million for 2011. Specifically, net realized losses for equity securities were $0.3 million for 2012 and 2011. For debt securities, net realized gains were $1.4 million for 2012, compared with $3.0 million for 2011. During 2011, the Company, because of the actions taken by the Federal Reserve to maintain a low interest rate environment, realized significant gains in the fixed income portfolio.
The provision for income tax expense was $2.4 million for 2012, compared with a benefit of $0.6 million for 2011. The effective rate for income taxes was 36.1% for 2012, compared with 57.0% for 2011. The 2011 57.0% effective rate reflects the true-up of the 2010 tax return permanent differences.
As a result of the foregoing, the Company’s net income for 2012 was $4.3 million, compared with net loss of $0.4 million for 2011.
The increase in the sale of homeowners’ policies by $3.6 million, or 4.6%, to $80.4 million in 2011, compared with $76.8 million in 2010, is gross of reinsurance costs and net of Florida’s mandated homeowners’ wind mitigation discounts. We offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. As of December 31, 2011, 63.5% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $31.5 million (a 28.6% reduction of in-force premium), while 60.1% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $27.3 million, (a 26.0% reduction of in-force premium), as of December 31, 2010.
We received approval from the Florida OIR in 2009 and 2010 for a premium rate increases for our voluntary homeowners’ program within the State of Florida. These premium rate increases averaged approximately 19% in 2009 and 20.2% in 2010 and were implemented for policies with effective dates as soon as permitted following approval. In addition, in 2010 we received approval from the Florida OIR for a premium rate increase of approximately 15% for homeowners policies assumed from Citizens in Florida beginning July 2010. In February 2012, we received approval from the Florida OIR of a 14.1% rate increase. That rate increase, together with our 2011 rate increases for our voluntary property book of homeowners’ business, averaging 20.2% statewide, and our assumed property book of homeowners’ business, averaging 13.9% statewide, gained momentum and accreted throughout 2012.
Our earnings can also be impacted by our ratings, such as the rating of FNIC by Demotech. FNIC’s rating as of December 31, 2011 was "A" ("Exceptional"). For more information regarding our rating and the impact of a change or withdrawal of our rating, please see “Business-Regulation-Industry Rating Services.”
The increase in unearned premiums was $0.8 million for 2011, compared with a $3.7 million decrease for 2010. The 2011 charge to written premium was due to a $1.5 million increase in unearned homeowners’ insurance premiums, a $0.3 million increase in unearned flood premiums, a $0.4 million decrease in unearned automobile premiums and a $0.6 million decrease in unearned commercial general liability premiums during 2011. These changes are a result of differences in written premium volume during this period as compared with the same period last year. See “Gross Premiums Written” above.
Commission income decreased $0.4 million, or 28.4%, to $1.0 million for 2011, compared with $1.4 million for 2010. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link.
Net investment income increased $0.4 million, or 9.5%, to $4.1 million for 2011, compared with $3.7 million for 2010. Our investment yield, net and gross of investment expenses, excluding equities and including cash, was 2.9% and 3.1%, respectively, for 2011. Our investment yield, net and gross of investment expenses, excluding equities and including cash, was 2.5% and 2.7%, respectively, for 2010.
See also “Analysis of Financial Condition As of December 31, 2011 Compared with December 31, 2010 - Investments” for a further discussion on our investment portfolio.
Net realized investment gains were $2.7 million for 2011, compared with net realized investment gains of $6.8 million for 2010. Specifically, net realized losses for equity securities were $0.3 million for 2011, compared with $1.7 million net realized gains for 2010. For debt securities, net realized gains were nearly $3.0 million for 2011, compared with net realized gains of $4.0 million for 2010. During 2011, the Company, because of the actions taken by the Federal Reserve to maintain a low interest rate environment, realized significant gains in the fixed income portfolio. During 2010, the Company had an overweight position in corporate bonds that performed well and sold these bonds to lock in gains and bolster the surplus of our insurance companies.
Other income increased $0.8 million, or 100.0%, to $1.6 million for 2011, compared with $0.8 million for 2010. The major components of other income for 2011 include $1.1 million from the reconciliation of outstanding checks in connection with our accounting for unclaimed property and $0.5 million in partial recognition of our gain on the sale of our Lauderdale Lakes property. The major components of other income for 2010 included approximately $0.5 million in partial recognition of our gain on the sale of our Lauderdale Lakes property and $0.3 million in recognition of our gain on the sale of a vacant retail property.
Management revises its estimates based on the results of its analysis. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors. Because of our process, reserves were decreased by approximately $6.5 million during 2011. This overall change includes a $3.2 million decrease in reserves for our homeowners’ program, a $4.1 million decrease in reserves for our commercial general liability program and a $0.8 million increase in reserves for our automobile program. The decreases are due to favorable experience based in part on enhanced underwriting and claim processing techniques.
Policy acquisition costs - amortization, decreased $0.7 million, or 5.2%, to $12.3 million for 2011, compared with $13.0 million for 2010.
In 2012, our primary sources of capital included proceeds from the sale of investment securities, increased unearned premiums, decreased deferred income tax expense, amortization of investment premium discount, net, decreased prepaid reinsurance premiums, depreciation and amortization and non-cash compensation. Additional sources of capital included exercised stock options, a tax benefit related to non-cash compensation, purchases of property and equipment and an increased provision for uncollectible premiums receivable. Because we are a holding company, we are largely dependent upon fees and commissions from our subsidiaries for cash flow.
In 2012, net cash provided by operating activities was $1.5 million. In 2011 and 2010, net cash provided and used by operating activities was $4.1 million and $6.6 million, respectively.
FNIC’s statutory capital surplus as of December 31, 2012 was approximately $52.1 million and its statutory net income in 2012 was $6.6 million. FNIC’s statutory capital surplus as of December 31, 2011 was approximately $39.3 million and its statutory net income in 2011 was $0.8 million.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE (LOSS) INCOME
FNHC is an insurance holding company that controls substantially all steps in the insurance underwriting, distribution and claims processes through our subsidiaries and our contractual relationships with our independent agents and general agents.
We are authorized to underwrite, and/or place through our wholly owned subsidiaries, homeowners’, commercial general liability, federal flood, personal auto and various other lines of insurance in Florida and various other states. We are authorized to underwrite in various states on behalf of our wholly owned subsidiary, FNIC and other insurance carriers. FNIC is the resulting entity following the merger of FNIC with and into our other wholly owned subsidiary, American Vehicle in January 2011. In connection with this merger, the Company, FNIC and American Vehicle entered into the Consent Order with the Florida OIR. The Consent Order was amended in February 2013 to lessen or eliminate certain of the original requirements, due to FNIC’s statutory underwriting profit during 2012. See "Footnote 8 - Regulatory Requirements and Restrictions”. We market and distribute our own and third-party insurers’ products and our other services through a network of independent agents. We also utilize a select number of general agents for the same purpose.
We are not certain how hurricanes and other insurable events will affect our future results of operations and liquidity. Loss and loss adjustment expenses (“LAE”) are affected by a number of factors including the following.
We continue to manage the foregoing to the extent within our control. Many of the foregoing are partially, or entirely, outside our control.
FNIC is licensed as an admitted carrier in Florida. Through contractual relationships with a network of approximately 3,000 independent agents, of which approximately 900 actively sell and service our products, FNIC is authorized to underwrite homeowners’, commercial general liability, fire, allied lines and personal and commercial automobile insurance in Florida. Effective January 26, 2011, FNIC merged with and into American Vehicle and American Vehicle changed its name to FNIC.
An admitted carrier is an insurance company that has received a license from the state department of insurance giving the company the authority to write specific lines of insurance in that state. These companies are also bound by rate and form regulations, and are strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Admitted carriers are also required to financially contribute to the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.
FNU, a wholly owned subsidiary of the Company, acts as FNIC’s exclusive managing general agent in Florida and is also licensed as a managing general agent in the States of Alabama, Georgia, Illinois, Louisiana, North Carolina, Mississippi, Missouri, New York, Nevada, South Carolina, Texas and Virginia. FNU has contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation, personal umbrella, inland marine and other various lines of insurance through FNU’s existing network of agents.
We consider all short-term highly liquid investments with original maturities of less than three months to be short term investments.
Financial instruments, which potentially expose us to concentrations of credit risk, consist primarily of investments, premiums receivable, amounts due from reinsurers on paid and unpaid losses and finance contracts. We have not experienced significant losses related to premiums receivable from individual policyholders or groups of policyholders in a particular industry or geographic area. We believe no credit risk beyond the amounts provided for collection losses is inherent in our premiums receivable or finance contracts. In order to reduce credit risk for amounts due from reinsurers, we seek to do business with financially sound reinsurance companies and regularly review the financial strength of all reinsurers used. Additionally, our credit risk in connection with our reinsurers is frequently mitigated by the establishment of irrevocable clean letters of credit in favor of FNIC.
In July 2012, the FASB issued Accounting Standard Update (“ASU”) No. 2012-02: Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. The objective of the amendments in this ASU is to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. The amendments permit an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with Subtopic 350-30. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Upon adoption, these amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012; early adoption is permitted. The adoption of these amendments did not have a material impact on our financial condition, results of operations or cash flows.
In December 2011, the FASB issued ASU No. 2011-12: Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The guidance defers certain provisions contained in ASU No. 2011-05 requiring the requirement to present components of reclassifications of other comprehensive income on the face of the income statement or in the notes to the financial statements. However, this deferral does not impact the other requirements contained in the new standard on comprehensive income as described above. This ASU is effective during interim and annual periods beginning after December 15, 2011. The adoption of this ASU did not have a material impact on our financial condition, results of operations or cash flows.
We are subject to certain risks in our business operations which are described below. Careful consideration of these risks should be made before making an investment decision. The risks and uncertainties described below are not the only ones facing FNHC. Additional risks and uncertainties not presently known or currently deemed immaterial may also impair our business operations.
We may not obtain the necessary regulatory approvals to expand the types of insurance products we offer or the states in which we operate.
The fair value of our investments is estimated based on prices published by financial services or quotations received from securities dealers and is reflective of the interest rate environment that existed as of the close of business on December 31, 2012 and 2011. Changes in interest rates subsequent to December 31, 2012 may affect the fair value of our investments. Refer to Footnote 21 of the Notes to Consolidated Financial Statements for details.
During the year ended December 31, 2012, the Company had three stock-based employee compensation plans, which are described later in Footnote 14, Stock Compensation Plans. Prior to January 1, 2006, we accounted for the plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by the Accounting Principles Board (“APB”) and related Interpretation, as permitted by FASB issued guidance. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.
As of December 31, 2012 and 2011, our investments consisted primarily of corporate bonds held in various industries, municipal bonds and United States government bonds. As of December 31, 2012, 69% of our debt portfolio was in diverse industries and 31% is in United States government bonds. As of December 31, 2012, approximately 87% of our equity holdings were in equities related to diverse industries and 13% were in mutual funds. As of December 31, 2011, 61% of our debt portfolio was in diverse industries and 39% is in United States government bonds. As of December 31, 2011, approximately 83% of our equity holdings were in equities related to diverse industries and 17% were in mutual funds.
During 2012 and 2011, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity.
Below is a summary of debt securities at December 31, 2012 and 2011 by contractual or expected maturity periods. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The table below sets forth investment results for the periods indicated.
Incurred Loss and DCCE Development Method - This reserving method is based on the assumption that the historical incurred loss and DCCE development pattern as reflected by the Company is appropriate for estimating the future loss & DCCE development. Incurred paid plus case amounts separated by accident quarter of occurrence and at quarterly evaluations are used in this analysis. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity. Historical “age-to-age” loss development factors were calculated to measure the relative development of an accident quarter from one maturity point to the next. Loss and DCCE development factors (“LDF”) are selected based on a review of the historical relationships between incurred loss & DCCE at successive valuations and based on industry patterns. The LDFs are multiplied together to derive cumulative LDF’s that, when multiplied by actual incurred loss and DCCE, produce estimates of ultimate loss and DCCE.
The Company has recorded a net deferred tax asset of $4.3 million and $8.6 million as of December 31, 2012 and 2011, respectively. Realization of net deferred tax asset is dependent on generating sufficient taxable income in future periods. Management believes that it is more likely than not that the deferred tax assets will be realized and as such no valuation allowance has been recorded against the net deferred tax asset. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2012 and 2011, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would record valuation allowances as deemed appropriate in the period that the change in circumstances occurs, along with a corresponding increase or charge to net income. The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.
The Merged Company will not write new commercial habitation condominium associations without prior approval from the Florida OIR. The current commercial habitation book of business is less than $0.1 million of policy premium.
The Merged Company agreed to maintain the total number of its homeowners’ policies in Miami-Dade, Broward and Palm Beach counties (the “Tri-County Area”) at 35% of its entire homeowners’ book. As of December 31, 2012, the Company had approximately 20.4% of its homeowners’ policies located within Tri-County Area.
The claims service fees payable by the Merged Company to Federated National Adjusting, Inc. (“FNA”), formerly known as Superior Adjusting, Inc., were reduced from the traditional 4.5% of gross earned premium to 3.6% of gross earned premium. This will have no impact on the Company’s consolidated financial results.
The NAIC has also developed Insurance Regulatory Information Systems (“IRIS”) ratios to assist state insurance departments in identifying companies which may be developing performance or solvency problems, as signaled by significant changes in the companies’ operations. Such changes may not necessarily result from any problems with an insurance company, but may merely indicate changes in certain ratios outside the ranges defined as normal by the NAIC. When an insurance company has four or more ratios falling outside “usual ranges”, state regulators may investigate to determine the reasons for the variance and whether corrective action is warranted.
American Vehicle’s statutory capital and surplus was $21.9 million as of December 31, 2010. American Vehicle’s statutory net income was approximately $1.6 million for 2010. American Vehicle’s statutory non-admitted assets were approximately $5.6 million as of December 31, 2010.
The Company’s consolidated federal and state income tax returns for 2009-2011 are open for review by the IRS and various state taxing authorities. The 2012 federal and state income tax returns have been extended and will be filed by the extended due date in Q3 of 2013. The 2005 and 2006 income tax returns and net operating loss carry-back from tax year 2009 have been reviewed by the Joint Committee on Taxation. The Joint Committee on Taxation completed its consideration in September 2011 and took no exception to the conclusions reached by the IRS regarding the net operating loss carry-back from tax year 2009.
The Company has recorded a net deferred tax asset of $4.3 million and $8.6 million as of December 31, 2012 and December 31, 2011, respectively. Realization of net deferred tax asset is dependent on generating sufficient taxable income in future periods. Management believes that it is more likely than not that the deferred tax assets will be realized and as such no valuation allowance has been recorded against the net deferred tax asset. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2012, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would record valuation allowances as deemed appropriate in the period that the change in circumstances occurs, along with a corresponding increase or charge to net income. The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.
Relative to the Company’s commitments stemming from operational matters, on or about March 1, 2006 we sold our interest in the building that housed our operations in Lauderdale Lakes through December 16, 2011, to an unrelated party. As part of this transaction, we agreed to lease the same facilities for a five-year term. We amended the lease agreement and the note receivable on September 1, 2010. As part of the amendment, we discounted the note receivable and have discontinued the interest on the note. In consideration, we paid a reduced lease payment for the remainder of the lease. Our lease for this office space expired in December 2011.
One of our directors is a partner at a law firm that handles some of the Company’s claims litigation. Fees paid to this law firm amounted to approximately $27,175, $3,349 and $40,000 in 2012, 2011 and 2010, respectively, and is included in LAE.
A summary of the numerator and denominator of the basic and fully diluted 2012, 2011 and 2010 net income (loss) per share is presented below.
We implemented a stock option plan in September 1998, which expired in September 2008, and provided for the granting of stock options to officers, key employees and consultants. The objectives of this plan included attracting and retaining the best personnel, providing for additional performance incentives, and promoting our success by providing employees the opportunity to acquire common stock. Options outstanding under this plan were granted at prices either equal to or above the market value of the stock on the date of grant, typically vest over a four-year or five-year period and expire six or ten years after the grant date. Under this plan, we were authorized to grant options to purchase up to 900,000 common shares, and as of December 31, 2012 and 2011 we had outstanding exercisable options to purchase 78,500 shares and 89,750 shares, respectively.
Prior to January 1, 2006, we accounted for the plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by the APB and related Interpretation, as permitted by FASB issued guidance. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB issued guidance using the modified-prospective-transition method. Under that transition method, compensation costs recognized during 2012 and 2011 include the following.
Summary information about the Company’s stock options outstanding at December 31, 2012 follows.
Effective January 26, 2011, FNIC merged with and into American Vehicle, and the resulting entity changed its name to “Federated National Insurance Company”. See " Footnote 8 - Regulation - Consent Order”.
FNHC (the parent company only) has no long term obligations, guarantees or material contingencies as of December 31, 2012. The following summarizes the major categories of the parent company’s financial statements.
(20) SCHEDULE VI - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS (UNAUDITED)
Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.
Assets measured at fair value on a recurring basis as of December 31, 2012, presented in accordance with this guidance, are as follows.
On March 4, 2013, a total of 100,000 restricted shares from the 2012 Plan were granted pursuant to the vesting requirements and other terms and conditions set forth in Restricted Stock Agreements. Of the total, 25,000 shares were granted to the Company's Chief Executive Officer and President and 15,000 shares were granted to the Company's Chief Financial Officer. An aggregate of 20,000 shares were granted to the Company's directors and the remaining 40,000 shares were granted to other employees of the Company.