Our principal executive offices are located at 1154 Broadway, Hewlett, New York. Our insurance underwriting business is located at 15 Joys Lane, Kingston, New York.
The current yearly aggregate base rental for our executive offices is approximately $20,000. We own the building from which our insurance underwriting business operates, free of mortgage.
Our expenses include the insurance underwriting expenses of KICO and other operating expenses. Insurance companies incur a significant amount of their total expenses from policyholder losses, which are commonly referred to as claims. In settling policyholder losses, various loss adjustment expenses (“LAE”) are incurred such as insurance adjusters’ fees and litigation expenses. In addition, insurance companies incur policy acquisition expenses. Policy acquisition costs include commissions paid to producers, premium taxes, and other expenses related to the underwriting process, including employees’ compensation and benefits.
Other operating expenses include the corporate expenses of our holding company, Kingstone Companies, Inc. These expenses include legal, auditing and consulting fees, occupancy costs related to our corporate office, executive employment costs, and other costs directly associated with being a public company.
Net loss ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company’s business. Expressed as a percentage, this is the ratio of net losses and loss adjustment expenses (“LAE”) incurred to net premiums earned.
We believe that the most critical accounting policies relate to the reporting of reserves for loss and LAE, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third party reinsurers, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities, intangible assets and the valuation of stock-based compensation. See Note 2 (Accounting Policies and Basis of Presentation) of the Notes to Consolidated Financial Statements following Item 15 of this Annual Report.
(1) For the year ended December 31, 2011, includes direct catastrophe losses and loss adjustment expenses of $1,796,000, and net catastrophe losses and loss adjustment expenses of $449,000, incurred from August 27, 2011 to August 29, 2011 from Tropical Storm Irene. Catastrophe losses incurred from Tropical Storm Irene increased our ceded loss ratio which reduced our contingent ceding commission revenue by $200,000. We define a “catastrophe” as an event that involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time constituting the event. Catastrophes are caused by various natural events including high winds, excessive rain, winter storms, tornadoes, hailstorms, wildfires, tropical storms, and hurricanes.
Direct written premiums during the year ended December 31, 2011 (“2011”) were $40,735,000 compared to $33,249,000 during the year ended December 31, 2010 (“2010”). The increase of $7,485,000, or 22.5%, was primarily due to an increase in policies in-force during 2011 as compared to 2010. We wrote more policies as a result of an increase in demand for the products in the markets that we serve. Policies in-force increased by 20.1% as of December 31, 2011 compared to December 31, 2010. In addition to the increase of policies in-force, we are also writing more policies which have higher premiums.
Net premiums earned increased $3,733,000, or 33.5%, to $14,869,000 in 2011 from $11,136,000 in 2010. As premiums written earn ratably over a twelve month period, the increase was a result of higher net written premiums for the twelve months ended December 31, 2011 compared to the twelve months ended December 31, 2010.
Net loss and loss adjustment expenses were $8,571,000 in 2011 compared to $6,426,000 in 2010. The net loss ratio was 57.6% in 2011 compared to 57.7% in 2010. Net losses in 2011 included the effects of Tropical Storm Irene in August 2011, which we define as a catastrophe. As a result of Tropical Storm Irene, we incurred $449,000 of losses and loss adjustment expenses (net of reinsurance recoverable of $1,347,000), and added 3.0 percentage points to our net loss ratio.
Other operating expenses, related to the corporate expenses of our holding company, were $1,203,000 in 2011 compared to $1,610,000 in 2010. The $407,000 decrease in 2011 was primarily due to decreases in professional fees, executive employment costs, and amortization of stock options. The reduction of professional fees in 2011 was due to the elimination of the additional costs incurred in 2010 stemming from the acquisition of KICO on July 1, 2009. The reduction of executive employment costs is due to share-based bonus compensation to our Chief Executive Officer in 2010, which was incurred pursuant to his amended employment agreement dated March 24, 2010. No such share-based bonus compensation was incurred in 2011. The reduction in amortization of stock options decreased as a result of more stock options being fully vested prior to 2011.
Interest expense was $121,000 in 2011 compared to $185,000 in 2010. The $64,000 decrease in interest expense was due to the partial redemption of $703,000 to our 2009/2010 Notes during the quarter ended June 30, 2011, and effective July 11, 2011, a reduction in the interest rate to 9.5% per annum from the previous 12.625% per annum.
Interest expense on mandatorily redeemable preferred stock was $-0- in 2011 compared to $75,000 in 2010. The reduction was due to the exchange of all of the outstanding preferred stock into common stock on June 30, 2010, which resulted in the elimination of additional related interest expense as of that date.
Income tax expense in 2011 was $1,089,000, which resulted in an effective tax rate of 30.3%. Income tax expense in 2010 was $767,000, which resulted in an effective tax rate of 41.5%. The decrease in our effective tax rate resulted primarily from a net change in tax exempt permanent differences in 2011 and the true-up of our 2010 income tax liability in 2011, which resulted in a tax benefit compared to the true-up of 2009 income tax liability in 2010, which resulted in a tax expense.
Loss from discontinued operations was $-0- in 2011 compared to a loss of $99,000 in 2010. All discontinued operations ceased in 2010.
Net income was $2,502,000 in 2011 compared to $983,000 in 2010. The increase in net income of $1,519,000 was due to the circumstances that caused the increases in our net premiums earned and ceding commission revenue, increase in net realized gains and a decrease in other operating expenses, offset by increases in our other underwriting expenses, as described above.
Our insurance underwriting business reported on a standalone basis for the years ended December 31, 2011 and 2010 follows:
The key measures for our insurance underwriting business for the years ended December 31, 2011 and 2010 are as follows:
(1) The effect of catastrophes reduced contingent ceding commission revenue by $200,516 for the year ended December 31, 2011. A provision in our quota share reinsurance treaty, which expired June 30, 2011, limited the maximum contingent ceding commission that could be paid to us, with the unused benefit carried forward to the current treaty year which began July 1, 2011. The carry forward of the unused benefit resulted in additional contingent ceding commission revenue of approximately $264,000 for the year ended December 31, 2011.
The following table presents a breakdown of the amortized cost, aggregate fair value and unrealized gains and losses by investment type as of December 31, 2011 and 2010:
The table below summarizes the credit quality of our fixed-maturity securities as of December 31, 2011 and 2010 as rated by Standard and Poor’s:
The table below summarizes the average duration by type of fixed-maturity security as well as detailing the average yield as of December 31, 2011 and 2010:
As more fully described in Note 3 to our Consolidated Financial Statements, “Investments-Impairment Review,” we completed a detailed review of all our securities in a continuous loss position as of December 31, 2011 and December 31, 2010, and concluded that the unrealized losses in these asset classes are the result of a decrease in value due to technical spread widening and broader market sentiment, rather than fundamental collateral deterioration, and are temporary in nature.
The table below summarizes the gross unrealized losses of our fixed-maturity securities available for sale and equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2011 and December 31, 2010:
On July 1, 2009, we completed the acquisition of 100% of the issued and outstanding common stock of KICO (formerly known as Commercial Mutual Insurance Company (“CMIC”)) pursuant to the conversion of CMIC from an advance premium cooperative to a stock property and casualty insurance company. Pursuant to the plan of conversion, we acquired a 100% equity interest in KICO. In connection with the plan of conversion of CMIC, we agreed with the Department of Financial Services (formerly known as the Insurance Department) (the “Department”) that, for a period of two years following the effective date of conversion of July 1, 2009, no dividend could be paid by KICO to us without the approval of the Department (“Dividend Restriction Period”). No such request was made by us to the Department. For the year ended December 31, 2011, KICO paid dividends of $350,000 to us after the expiration of the Dividend Restriction Period. On February 23, 2012, KICO’s board of directors approved a cash dividend of $175,000 to us which was paid on February 24, 2012. We also agreed with the Department that certain intercompany transactions between KICO and us must be filed with the Department 30 days prior to implementation and not disapproved by the Department.
The primary sources of cash flow for our holding company operations are in connection with the fee income we receive from the premium finance loans and collection of principal and interest income from the notes received by us upon the sale of businesses that were included in our discontinued operations. Effective July 1, 2011, as discussed above, we may also receive cash dividends from KICO, subject to statutory restrictions. As of December 31, 2011, the maximum distribution that KICO could pay without prior regulatory approval was approximately $617,000.
In December 2011, we entered into an agreement with a bank for a $500,000 line of credit to be used for general corporate needs. The principal balance is payable on demand, and must be reduced to zero for a minimum of 30 consecutive days during each year of the term of the credit line. The outstanding balance was $300,000 as of December 31, 2011. If the aforementioned is insufficient to cover our holding company cash requirements, we will seek to obtain additional financing. See “Business - Government Regulation” in Item 1 of this Annual Report.
The following table summarizes each reinsurer that accounted for more than 10% of our reinsurance recoverables on paid and unpaid losses and loss adjustment expenses as of December 31, 2011:
Our reinsurance treaties covering our Personal Lines business, which primarily consists of homeowners policies, and Commercial Lines business, other than commercial auto, were renewed as of July 1, 2011. The treaties, which are renewed annually, provide for the following terms:
Personal Lines business, which includes homeowners, dwelling fire and canine legal liability insurance, is reinsured under a 75% quota share treaty which provides coverage up to $700,000 per occurrence. An excess of loss contract provides $1,500,000 of coverage in excess of the $700,000 included under the 75% quota share treaty for a total coverage up to $2,200,000 per occurrence. Personal umbrella policies are reinsured under a 90% quota share treaty limiting KICO to a maximum of $100,000 per occurrence for the first $1,000,000 of coverage. The second $1,000,000 of coverage is 100% reinsured.
A total of $54,000,000 of catastrophe reinsurance coverage has been obtained, whereby KICO retains $500,000 per occurrence.
Our reinsurance program is structured to reflect our obligations and goals. Reinsurance via quota share allows for a carrier to write business without increasing its leverage above a management determined ratio. The additional business written allows a reinsurer to assume the risks involved, but gives the reinsurer the profit (or loss) associated with such. Since KICO’s conversion to a stock company in 2009, we have determined it to be in the best interests of our shareholders to prudently reduce our reliance on quota share reinsurance. This will result in higher earned premiums and a reduction in ceding commission revenue in future years. Our participation in reinsurance arrangements do not relieve us of our obligations to policyholders.
Based upon the following factors, as well as other factors affecting our operating results and financial condition, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. In addition, such factors, among others, may affect the accuracy of certain forward-looking statements contained in this Annual Report.
We are a holding company and a legal entity separate and distinct from our operating subsidiaries, KICO and Payments, Inc. As a holding company with limited operations of our own, the principal sources of our funds are dividends and other payments from KICO and Payments, Inc. Consequently, we must rely on KICO and Payments, Inc. for our ability to repay debts, pay expenses and pay cash dividends to our shareholders
Our ability to receive dividends from KICO is restricted by the state laws and insurance regulations of New York. These restrictions are related to surplus and net investment income. Dividends are restricted to the lesser of 10% of surplus or 100% of investment income (on a statutory accounting basis) for the trailing four quarters. As of December 31, 2011, the maximum distribution that KICO could pay without prior regulatory approval was approximately $792,000, which is based on investment income for the last four quarters.
Financial strength ratings are important factors in establishing the competitive position of insurance companies and generally have an effect on an insurance company's business. Many insurance buyers, agents, brokers and secured lenders use the ratings assigned by A.M. Best and other agencies to assist them in assessing the financial strength and overall quality of the companies from which they are considering purchasing insurance or in determining the financial strength of the company that provides insurance with respect to the collateral they hold. In 2009, KICO applied for its initial A.M. Best rating, and was assigned a letter rating of “B” (Fair) by A.M. Best in 2010. Our rating was upgraded to B+ (Good) in 2011. KICO is in the process of undergoing its annual review by A.M. Best, which may result in a change to its rating. A. M. Best ratings are derived from an in-depth evaluation of an insurance company’s balance sheet strengths, operating performances and business profiles. A.M. Best evaluates, among other factors, the company’s capitalization, underwriting leverage, financial leverage, asset leverage, capital structure, quality and appropriateness of reinsurance, adequacy of reserves, quality and diversification of assets, liquidity, profitability, spread of risk, revenue composition, market position, management, market risk and event risk. On an ongoing basis, rating agencies such as A.M. Best review the financial performance and condition of insurers and can downgrade or change the outlook on an insurer's ratings due to, for example, a change in an insurer's statutory capital, a reduced confidence in management or a host of other considerations that may or may not be under the insurer's control. We currently have a Demotech rating of A (Excellent), which generally permits lenders to accept our policies. All ratings are subject to continuous review; therefore, the retention of these ratings cannot be assured. A downgrade in any of these ratings could have a material adverse effect on our competitiveness, the marketability of our product offerings and our ability to grow in the marketplace.
Because our operations are currently derived from sources located in New York, our business may be adversely affected by conditions in such state.
Our future results may be adversely affected by claims made against an underwriting pool in which KICO was a participant but over which it has no control.
KICO was a member of the New York Mutual Underwriters Pool (the “NYMU”) and is responsible for its proportionate share of losses with respect to accident dates through October 31, 1997. During 2006 and 2007, the NYMU received a disproportionately large number of lead paint claims (approximately 50) for accident dates prior to October 31, 1997. KICO’s liability for each claim is $50,000 (assuming full reinsurance recovery). Since 2007, far fewer lead paint claims have been filed against the NYMU. We believe that, as of December 31, 2011, KICO is fully reserved for all reported claims and that its provision for IBNR for future claims is adequate (in each case giving effect to the collectability of reinsurance); however, we do not have any control over the claims made against the NYMU. Accordingly, future results may be adversely affected from losses over which we have no control.
Our future success will depend, in part, upon the efforts of Barry Goldstein, our President and Chief Executive Officer, and John Reiersen, Executive Vice President of KICO and, until January 1, 2012, President and Chief Executive Officer of KICO. The loss of Messrs. Goldstein and/or Reiersen or other key personnel could prevent us from fully implementing our business strategies and could materially and adversely affect our business, financial condition and results of operations. As we continue to grow, we will need to recruit and retain additional qualified management personnel, but we may not be able to do so. Our ability to recruit and retain such personnel will depend upon a number of factors, such as our results of operations and prospects and the level of competition then prevailing in the market for qualified personnel. Effective January 1, 2012, Mr. Reiersen became Executive Vice President of KICO and provides, in a part-time capacity, advice and assistance to the President and Chief Executive Officer of KICO, and other management personnel, with regard to the management and operation of KICO. Mr. Goldstein assumed the duties and responsibilities of President and Chief Executive Officer of KICO effective January 1, 2012. Although Mr. Goldstein has served as our President and Chief Executive Officer since 2001, as KICO’s Chairman of the Board and Chairman of the Executive Committee since 2006 and as KICO’s Chief Investment Officer since 2008, prior to January 1, 2012, he had never served as President and Chief Executive Officer of an insurance company.
Some economists continue to project significant negative macroeconomic trends, including relatively high and sustained unemployment, reduced consumer spending, lower home prices, and substantial increases in delinquencies on consumer debt, including defaults on home mortgages. Moreover, recent disruptions in the financial markets, particularly the reduced availability of credit and tightened lending requirements, have impacted the ability of borrowers to refinance loans at more affordable rates. As with most businesses, we believe difficult conditions in the economy could have an adverse effect on our business and operating results. General economic conditions also could adversely affect us in the form of consumer behavior, which may include decreased demand for our products. As consumers become more cost conscious, they may choose lower levels of insurance.