On September 26, 2013, Crusader closed escrow on the purchase of land and a building located in Calabasas, California. The real estate consists of a two-story office building located on commercial land, about four miles from the Company’s current location. The office building has approximately 46,884 rentable square feet.
Direct written premium is a non-GAAP financial measure which is defined, under statutory accounting, as the contractually determined amount charged by the Company to the policyholder for the effective period of the contract based on the expectation of risk, policy benefits, and expenses associated with the coverage provided by the terms of the policies. Written premium is a required statutory measure designed to determine written premium production levels. Earned premium, the most directly comparable GAAP measure, represents the portion of written premium that is recognized as income in the Company’s consolidated financial statements for the period presented and earned on a pro-rata basis over the terms of the policies.
The combined ratio is the sum of (1) the net ratio of losses and loss adjustment expenses incurred (including a provision for IBNR to net premium earned (loss ratio) and (2) the ratio of policy acquisition costs to net premium earned (expense ratio). If the combined ratio is below 100%, an insurance company has an underwriting profit; if it is above 100%, the company has an underwriting loss.
Unifax sells and services insurance policies for Crusader. The commissions paid by Crusader to Unifax are eliminated as intercompany transactions and are not reflected as income in the Company’s consolidated financial statements. Policy fee income for the year ended December 31, 2014, decreased $48,042 (3%) as compared to the prior year. The policy fee income is earned ratably over the life of related insurance policies.
The insurance premium financing operation currently finances policies written only through its sister company, Unifax. Since July 2010, AAC has offered 0% financing on policies written by Unifax for Crusader as a promotion to increase the sale of Crusader policies. The Company monitors the cost of providing this incentive, and, depending on the cost/benefit determination, the Company can continue to offer 0% financing or withdraw it at any time. AAC issued 3,278, 3,281 and 3,264 loans in 2014, 2013 and 2012, respectively. Revenue earned in 2014 and 2013 consisted entirely of late fees and other miscellaneous fees charged. The average policy premium financed by AAC was $3,492, $3,276 and $3,039 in 2014, 2013 and 2012, respectively.
The daily automobile rental insurance program is produced by Bedford Insurance Services, Inc. Bedford receives commission income from a non-affiliated insurance company based on written premium. Bedford no longer writes new business for the non-affiliated insurance company it previously represented as a general agent. Bedford entered into a new producer agreement effective June 1, 2013, with a non-affiliated group of insurance companies. Under this agreement, Bedford has the authority to solicit and refer to these companies its daily automobile rental insurance policy submissions. Bedford does not have the authority to bind any risk or commit to any course of action without first requesting prior written permission. For its services, Bedford receives a commission. Commission income in the daily automobile rental insurance program decreased $108,020 (48%) in 2014 as compared to 2013. The decrease in commission income is primarily due to a continued decline in written premium in this program from the non-affiliated insurance companies that it previously represented as a general agent. The Company no longer actively markets this program.
The weighted average maturity of the Company’s fixed maturity investments was 1.8 years, 1.6 years and 0.7 years as of December 31, 2014, 2013 and 2012, respectively.
The Company reported net cash provided by operating activities for year ended December 31, 2014 and net cash used by operating activities for each of the years ended December 31, 2013 and 2012. Cash provided by operating activities in 2014 was $2,468,186 compared to cash used in operating activities in 2013 of $4,108,304, an increase in the amount of cash provided by operating activities of $6,576,490. Cash used by operating activities in 2013 was $4,108,304 compared to cash used in operating activities in 2012 of $1,214,159, an increase in the amount of cash used by operating activities of $2,894,145.
The Company is required to classify its investment securities into one of three categories: held-to-maturity, available-for-sale, or trading securities. Although all of the Company's investments in fixed maturity securities are classified as available-for-sale and while the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity.
The Company’s investment guidelines on equity securities limit investments in equity securities to an aggregate maximum of $2,000,000. The Company’s investment guidelines on fixed maturities limit those investments to high-grade obligations with a maximum term of 8 years. The maximum investment authorized in any one issuer is $2,000,000. This dollar limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues. When the Company invests in fixed maturity municipal securities, preference is given to issues that are pre-refunded and secured by U.S. treasury securities. The short-term investments are either U.S. government obligations, FDIC insured, or are in an institution with a Moody's rating of P2 and/or a Standard & Poor's rating of A1. All of the Company's fixed maturity investment securities are rated, readily marketable and could be liquidated without any materially adverse financial impact.
One of the Company’s agents, which was appointed in 2008 to assist the Company in implementing its Trucking Program, failed to pay the premium and policy fees due Unifax, the exclusive general agent for Crusader. The agent was initially late in paying its February 2009 production that was due to Unifax on April 15, 2009. In May 2009, as a result of the agent’s failure to timely pay its balance due to Unifax, the Company terminated its agency agreement and assumed ownership and control of that agent’s policy expirations written with the Company. The Company subsequently commenced legal proceedings against the agent corporation, its three principals (who personally guaranteed the agent’s obligations) and a fourth individual for the recovery of the balance due and any related recovery costs incurred. All related recovery costs have been expensed as incurred. The agent corporation and two of its principals filed bankruptcy. The corporation was adjudicated bankrupt. The Company obtained judgments, non-dischargeable in bankruptcy, for the full amount due from the two principals who filed bankruptcy. The other principal stipulated to a judgment of $1,200,000 and that person has not filed for bankruptcy. The claim against the fourth individual was resolved. The Company collected $75,000 and $137,750 during the years ended December 31, 2014, and 2013, respectively. As of December 31, 2014 and 2013, the agent’s balance due to Unifax was $1,181,272 and $1,256,272, respectively. As of December 31, 2014 and 2013, the Company’s bad debt reserve associated with this matter was $1,181,272 and $931,272 which represents approximately 100% and 74% of the balance due to Unifax, respectively. Although the receivable is fully reserved for financial reporting purposes at December 31, 2014, the Company continues to pursue collection of the judgments from the three principals. Bad debt expense for the year ended December 31, 2014, was $255,299 and a benefit of $50,792 and $98,798 for the years ended December 31, 2013 and 2012, respectively.
The Company is currently in the process of upgrading the office building it purchased on September 26, 2013, and it is planning and implementing the steps necessary to modify the space it intends to occupy to fit its operational needs with a targeted move in date in mid-2015. The Company is also continuing to incur software development costs on its new policy administration system. These costs will be capitalized as incurred.
Although material capital expenditures may also be funded through borrowings, the Company believes that its cash and short-term investments at year end, net of statutory deposits of $700,000, and California insurance company statutory dividend restrictions applicable to Crusader plus the cash to be generated from operations, should be sufficient to meet its operating requirements during the next 12 months without the necessity of borrowing funds. Trust restrictions on cash and short-term investments were $112,008 and $0 at December 31, 2014 and December 31, 2013, respectively.
The Company has certain obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2014, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
Since 2004, all Crusader business has been written in the state of California until June 2014 when the Crusader also began writing business in the state of Arizona. For the year ended December 31, 2014, 99.8% and 0.2% of direct written premium was produced in California and Arizona, respectively. As of December 31, 2014, Crusader was licensed as an admitted insurance company in the states of Arizona, California, Nevada, Oregon, and Washington and is approved as a non-admitted surplus lines writer in other states.
For the year ended December 31, 2013, direct written premium, as reported on Crusader’s statutory statement, was $31,214,091 compared to $32,572,047 for the year ended December 31, 2012, a decrease of $1,357,956 (4%). The decline in written premium in 2013 of 4% compared to 2012 primarily reflects the soft market place and intense price competition in the Company’s commercial property casualty insurance lines of business, management’s continued emphasis on rate adequacy and underwriting discipline and the termination of relations with certain specialty producers in the Company’s Used Car Dealers and Towing programs.
Ceded earned premium for the year ended December 31, 2014, decreased $30,965 (less than 1%) to $5,090,268 compared to $5,121,233 for the year ended December 31, 2013. Ceded earned premium for the year ended December 31, 2013, decreased $14,696 (less than 1%) to $5,121,233 compared to $5,135,929 for the year ended December 31, 2012.
Ceded earned premium as a percentage of direct earned premium was 16% in 2014, 2013 and 2012. The ceded earned premium as a percentage of direct earned premium is relatively unchanged as there were no major modifications to Crusader’s excess of loss treaties.
In calendar year 2014, Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($500,000 in excess of $500,000), 0% in its 2nd layer ($1,000,000 in excess of $1,000,000) and 0% in its property and casualty clash treaty. In calendar years 2013 and 2012, Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($500,000 in excess of $500,000), 5% in its 2nd layer ($1,000,000 in excess of $1,000,000) and 0% in its property and casualty clash treaty. In calendar year 2014, Crusader retained a participation in its catastrophe excess of loss reinsurance treaties of 5% in its 1st layer ($9,000,000 in excess of $1,000,000) and 0% in its 2nd layer ($31,000,000 in excess of $9,000,000). In calendar years 2013 and 2012, Crusader retained a participation in its catastrophe excess of loss reinsurance treaties of 10% in its 1st layer ($9,000,000 in excess of $1,000,000) and 0% in its 2nd layer ($31,000,000 in excess of $9,000,000).
Crusader’s excess of loss reinsurance treaties provided for a contingent commission for accident years 2006, 2004 and 2003. Crusader’s 2006 1st layer primary excess of loss reinsurance treaty provided for a contingent commission equal to 20% of the net profit, if any, accruing to the reinsurer. Crusader’s 2004 and 2003 1st layer primary excess of loss reinsurance treaties provided for a contingent commission to the Company equal to 45% of the net profit, if any, accruing to the reinsurer. Any contingent commission received is subject to return based on future development of ceded losses and loss adjustment expenses. As of December 31, 2014, Crusader has received a total net contingent commission of $3,647,706 for the years subject to the contingent commission. Of this amount, Crusader has recognized $3,569,867 as contingent commission income. The remaining balance of the net payments received of $77,839 is currently unearned and included in “Accrued Expenses and Other Liabilities” in the consolidated balance sheets. The unearned contingent commission may be subsequently earned or returned to the reinsurer depending on the future development of the ceded losses including IBNR for the years subject to the contingent commission. The contingent commission income recognized was ($17,092), $301,102 and $443,697 in the years ended December 31, 2014, 2013 and 2012, respectively.
The Company evaluates each of its ceded reinsurance contracts at its inception to determine if there is a sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting literature. As of December 31, 2014, all such ceded contracts are accounted for as risk transfer reinsurance.
Crusader’s emerging loss ratios for each accident year are reviewed in detail at the end of each quarter as part of the reserve review process. Net losses and loss adjustment expenses for the calendar years ended December 31, 2014, 2013 and 2012 were $14,617,118, $16,089,175 and $15,233,403, respectively.
As indicated in the above table, the calendar year loss ratio for the year ended December 31, 2014, decreased to 55% from 60% in 2013, and increased to 60% in 2013 from 56% in 2012. The decrease in the 2014 loss ratio when compared to 2013 and 2012 was primarily due to a decrease in the provision for insured events of the current year as a percent of net earned premium. The provision for insured events of the current year as a percent of net earned premium was 68%, 77% and 72% for the years ended December 31, 2014, 2013 and 2012, respectively.
Crusader sets reserves based on its expected loss ratio and its expected loss and loss adjustment expense development patterns. Crusader’s initial expected loss ratio is based on its historical average loss ratio, and its expected loss and loss adjustment expense development patterns are based on its historical loss and loss adjustment expense development patterns. Actuarial methods utilizing expected loss ratios tend to be relied on more heavily earlier in the life of an accident year, while actuarial methods that apply development patterns to emerged losses and loss adjustment expenses tend to be relied on more heavily as an accident year develops. For prior accident years, emerging differences between actual and expected losses and loss adjustment expenses are recognized quarterly in the Consolidated Statements of Operations.
Based on the loss and loss adjustment expense reserve estimates as of December 31, 2014, the estimated ultimate loss ratio is within five percentage points of the initial expected loss ratio in 9 of Crusader’s 30 years. Since Crusader’s net earned premium in 2014 was $26,373,423, a difference between the accident year 2014 actual and initial expected loss ratios of only five percentage points will or may ultimately impact losses and loss adjustment expenses by $1,318,671. The estimated ultimate loss ratio is within ten percentage points of the initial expected loss ratio in 13 of Crusader’s 30 years. A ten percentage point difference between the accident year 2014 actual and the initial expected loss ratios will ultimately impact losses and loss adjustment expenses by $2,637,342. The estimated ultimate loss ratio is within twenty percentage points of the initial expected loss ratio in 23 of Crusader’s 30 years. A twenty percentage point difference between the accident year 2014 actual and the initial expected loss ratios will ultimately impact losses and loss adjustment expenses by $5,274,685.
AIB markets health insurance in California through non-affiliated insurance companies for individuals and groups. For these services, AIB receives commission based on the premium that it writes. Commission income for the year ended December 31, 2014, decreased $150,912 (12%) compared to the year ended December 31, 2013. Commission income for the year ended December 31, 2013, increased $75,624 (7%) compared to the year ended December 31, 2012. The decrease in commission income in 2014 compared to 2013 is a result of decreases in the number of group accounts it underwrites and commission income on individual and group policies due primarily to the Patient Protection and Affordable Care Act. The increase in commission income in 2013 compared to 2012 is primarily the result of an increase in commission income received on group insurance policies. In 2014, approximately 38% of health insurance commission is from Guardian Life Insurance Company of America products compared to 36% in 2013.
Unifax sells and services insurance policies for Crusader. The commissions paid by Crusader to Unifax are eliminated as intercompany transactions and are not reflected as income in the Company’s consolidated financial statements. Unifax also receives non-refundable policy fee income that is directly related to the Crusader policies it sells. For financial statement reporting purposes, policy fees are earned ratably over the life of the related insurance policy and are proportionate to premium earned. The unearned portion of the policy fee is recorded as a liability on the balance sheet under “Accrued Expenses and Other Liabilities.” The earned portion of the policy fee charged to the policyholder by Unifax is recognized as income in the Company’s consolidated financial statements. Unifax’s policy fee income is as follows:
The insurance premium financing operation currently finances policies written only through its sister company, Unifax. Consequently, AAC’s growth is primarily dependent on the growth of Crusader and Unifax business. Effective July 20, 2010, AAC reduced the interest rate charged on premium financed to 0% in an effort to increase the sales of existing renewal and new business written by Unifax for Crusader. Due to the low interest rate environment, the cost of money to provide this incentive is not material. The Company monitors the cost of providing this incentive, and, depending on the cost/benefit determination, can continue to offer it or withdraw it at any time. Income generated by AAC includes late fees, fees for non-sufficient funds and telephone payment processing fees.
*The average is based on the beginning and ending balance of the amortized cost of the invested assets for each respective year.
The Company had one U.S. treasury security in an unrealized loss position for a continuous period of less than twelve months and one U.S. treasury security in an unrealized loss position for a continuous period of more than twelve months as of December 31, 2014. The Company had two U.S. treasury securities in an unrealized loss position for a continuous period of less than twelve months as of December 31, 2013.
The Company monitors its investments closely. If an unrealized loss is determined to be other-than-temporary, it is written off as a realized loss through the Consolidated Statements of Operations. The Company’s methodology of assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near-term prospects of the issuer, and whether the debtor is current on its contractually obligated interest and principal payments. The Company does not have the intent to sell its fixed maturity investments and it is not likely that the Company would be required to sell any of its fixed maturity investments prior to recovery of its amortized costs. There were no realized investment gains or losses in the years ended December 31, 2014, 2013 and 2012. The unrealized gains or losses from fixed maturities are reported as “Accumulated Other Comprehensive Income (Loss),” which is a separate component of stockholders’ equity, net of any deferred tax effect. The Company did not sell any fixed maturity investments in the years ended December 31, 2014, 2013 and 2012.
Other income from insurance company revenues and other insurance operations is primarily comprised of miscellaneous items not relevant to the primary income statement captions:
Policy acquisition costs consist of commissions, premium taxes, inspection fees and certain other underwriting costs that are directly related to and vary with the production of Crusader insurance policies. These costs include both Crusader expenses and the allocated expenses of other Unico subsidiaries. Crusader's reinsurers pay Crusader a ceding commission, which is primarily a reimbursement of the acquisition cost related to the ceded premium. No ceding commission is received on facultative or catastrophe ceded premium. Policy acquisition costs, net of ceding commission, are deferred and amortized as the related premium is earned. Policy acquisition costs decreased $46,019 (less than 1%) in the year ended December 31, 2014, compared to the year ended December 31, 2013, due primarily to lower deferred underwriting expenses. Policy acquisition costs decreased $712,146 (11%) in the year ended December 31, 2013, compared to the year ended December 31, 2012, due primarily to the effect of the implementation of ASU 2010-26 “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (ASC 944) during 2012 and due to the decrease in written premium during the year ended December 31, 2013, and its related effect on acquisition costs. Implementation of ASC 944 in 2012 reduced the amount of salary and salary related costs available to be capitalized and resulted in an increase in amortization of salary and salary related costs in the year ended December 31, 2012, of approximately $317,000 compared to the year ended December 31, 2013. The decrease in written premium reduced direct commission expense and reduced capitalized commissions by approximately $307,000.
Commissions to agents/brokers (not including commissions on Crusader policies that are reflected in policy acquisition costs) are generally related to gross commission income from the health insurance program and the daily automobile rental insurance program. Commissions to agents and brokers decreased $39,417 (17%) for the year ended December 31, 2014, as compared to the year ended December 31, 2013. Commissions to agents and brokers decreased $3,958 (2%) for the year ended December 31, 2013, as compared to the year ended December 31, 2012. The fluctuations in commissions to agents/brokers when compared to prior periods are primarily due to the fluctuations in written premium in the health insurance program and daily automobile rental insurance program and the related commission income from those programs.
Income tax expense for the year ended December 31, 2013, decreased $264,201 to $637,107 compared to income tax expense of $901,308 for the year ended December 31, 2012. The effective income tax rates for 2013 and 2012 were 51% and 32%, respectively. The decrease in income tax expense was primarily due to a decrease in pre-tax income of $1,614,261 (57%) to $1,240,775 in the year ended December 31, 2013, compared to pre-tax income of $2,855,036 in the year ended December 31, 2012. The income tax expense incurred in 2013 included the effect of increasing the valuation allowance on the Company’s state deferred tax assets in the amount of $243,446 or approximately $161,000 net of federal tax benefit. The net increase in the state deferred tax asset valuation allowance was primarily related to the recognition of additional valuation allowances on state tax net operating loss carryforwards generated through the current year that may not be realized prior to their expiration dates.
When there is clear evidence that the actual emerged claims costs are different than the claims costs that were expected for any prior accident year, the claims cost estimates for that year are revised accordingly. If the claims costs that emerge are less favorable than initially anticipated, generally, the Company increases its loss and loss adjustment expense reserves immediately. However, if the claims costs that emerge are more favorable than initially anticipated, generally, the Company reduces its loss and loss adjustment expense reserves over time while it continues to assess the validity of the observed trends based on the subsequent emerged claim costs.
Crusader underwrites four statutory annual statement lines of business: (1) commercial multi-peril, (2) liability other than automobile and products, (3) fire and (4) allied lines. Commercial multi-peril policies comprised 98% of Crusader’s 2014, 2013 and 2012 premium. Commercial multi-peril policies include both property and liability coverages. For all of Crusader’s coverages and lines of business, Crusader’s actuarial loss and loss adjustment expense reserving methods require assumptions that can be grouped into two key categories: (1) expected loss and loss adjustment expense development patterns and (2) expected loss and loss adjustment expense per premium dollar.
The differences between actual and expected claims costs are typically not due to one specific factor but to a combination of many factors such as the period of time between the initial occurrence and the final settlement of the claim, current and perceived social and economic inflation, and many other economic, legal, political, and social factors. The information that management uses to arrive at its booked reserve estimate comes from many sources within the Company, including its accounting, legal, claims and underwriting departments. Informed managerial judgment is applied throughout the reserving process. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount will tend to be. Accordingly, short-tail claims, such as the emergence of property damage claims costs, tend to be subject to less variability than the emergence of long-tail liability claims costs. The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates based on experience and industry data for development of case estimates and for unreported losses and loss adjustment expenses. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims should be expected to vary, perhaps significantly, from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.
The Company must estimate its ultimate losses and loss adjustment expenses using a very small claim population size. At the beginning of 2014, Crusader had 605 open claim files. During 2014, 791 new claim files were opened and 799 claim files were closed, leaving 597 open claim files at the end of 2014. Due to the small size of Crusader and the related small population of claims, Crusader’s losses and loss adjustment expenses for any accident year can vary significantly from the initial expectations. Due to the small number of claims, changes in claim frequency and/or severity can materially affect Crusader’s reserve estimate. The potential variability from management’s best estimate cannot be measured from any meaningful statistical basis due to the numerous uncertainties in the claims reserving process and the small population of claims.
At each quarterly review, actual claims costs that emerge are compared with the claims costs that were expected to emerge during that development period. Sometimes the previous claims costs estimates prove to have been too high; sometimes they prove to have been too low. The favorable development in 2012 through 2014 underscores the inherent uncertainty in insurance claims costs, especially for a very small insurer. While additional redundancies on losses and loss adjustment expenses may emerge, the Company believes that this trend may not be indicative of future results.
The effect of reinsurance on losses and loss adjustment expenses is as follows:
The effect of reinsurance on cash flow is the sum of the effect of reinsurance on the results of operations, reflected above and the following changes in reinsurance recoverable:
For years ended December 31, 2014, 2013, and 2012, Crusader wrote 99.8%, 100.0% and 100.0% of its business in the state of California, respectively. The types of businesses and the coverage limits written by Crusader are not considered difficult lines for obtaining reinsurance. In addition, because the major catastrophe exposure is primarily from riots and from fire following earthquakes, Crusader does not anticipate significant limitations on its ability to cede future losses on a basis consistent with its historical results.
The Company’s fixed maturity investments are classified as available-for-sale and are stated at fair value. Although all of the Company's investments are classified as available-for-sale and the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates fair value. The unrealized gains or losses from fixed maturities are reported as “Accumulated Other Comprehensive Income (Loss),” which is a separate component of stockholders’ equity, net of any deferred tax effect. When a decline in the value of a fixed maturity is considered other-than-temporary, a loss is recognized in the Consolidated Statements of Operations. Realized gains and losses are included in the Consolidated Statements of Operations based on the specific identification method.
The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (GAAP). As described in Note 14, the Company's insurance subsidiary also files financial statements with regulatory agencies prepared on a statutory basis of accounting that differs from GAAP.
The Company has a comprehensive portfolio monitoring process to identify and evaluate each fixed income security whose carrying value may be other-than-temporarily impaired. For each fixed income security in an unrealized loss position, the Company assesses whether it is more likely than not that the Company will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes, or the credit quality of the underlying security. If a security meets this criteria, the security's decline in fair value is considered other than temporary and is recorded as a net realized investment loss in the Consolidated Statements of Operations and in the Consolidated Statements of Comprehensive Income based on the specific identification method. There were no realized investments gains (losses) for any of the periods presented in the accompanying Consolidated Statements of Operations. For each fixed income security that the Company does not intend to sell or for which it is more likely than not that the Company would not be required to sell before an anticipated recovery in value, the Company separates the credit loss component of the impairment, if any, from the amount related to all other factors and reports the credit loss component in net realized investment gains (losses). There was no credit loss component for any of the periods presented in the accompanying Consolidated Statements of Operations. The unrealized gains from fixed maturities are reported as “Accumulated Other Comprehensive Income (Loss),” which is a separate component of stockholders’ equity, net of any deferred tax effect.
1. Investment securities, excluding long-term certificates of deposit - Fair values are obtained from a national quotation service.
All property and equipment is stated at cost less accumulated depreciation and amortization on the Consolidated Balance Sheets.
The Company acquired the office building located at 26050 Mureau Road, Calabasas, California, in September 2013. Leasehold improvements to the structure are amortized over the shorter of the useful life of the leasehold improvements or the remaining years of the lease. Improvements to the structure are amortized over the useful life of the improvements.
Premium finance interest may be charged to policyholders who choose to finance insurance premium. Interest may be charged at rates that vary with the amount of premium financed. Premium finance interest, if any, is recognized using a method that approximates the interest (actuarial) method. Other charges and fees earned include late fees, NSF fees and telephone payment processing fees that are earned when recorded.
ASC Topic 944, “Financial Services - Insurance,” establishes uniformity in the practice of determining costs related to the acquisition of new or renewal insurance contracts that qualify for deferral. Policy acquisition costs consist of commissions, premium taxes, inspection fees and certain other underwriting costs, which are related to the successful production of Crusader insurance policies. Policy acquisition costs that are eligible for deferral are deferred and amortized as the related premium is earned and are limited to their estimated realizable value based on the related unearned premium plus investment income less anticipated losses and loss adjustment expenses. Ceding commission applicable to the unexpired terms of policies in force is recorded as unearned ceding commission, which is included in deferred policy acquisition costs.
In July 2013, the Financial Accounting Standards Board (“FASB”) issued ASU 2013-11 “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (ASC 740). The objective of ASC 740 is to improve the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASC 740 seeks to reduce the diversity in practice by providing guidance on the presentation of unrecognized tax benefits to better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. ASC 740 became effective for annual and interim reporting periods beginning after December 15, 2013. The Company adopted ASC 740 on January 1, 2014, and the adoption of ASC 740 did not have a material impact on the Company’s consolidated financial statements.
The Company monitors its investments closely. If an unrealized loss is determined to be other-than-temporary, it is written off as a realized loss through the Consolidated Statements of Operations. The Company’s methodology of assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near-term prospects of the issuer, and whether the debtor is current on its contractually obligated interest and principal payments. The unrealized losses on the two U.S. treasury securities in an unrealized loss position as of December 31, 2014, and December 31, 2013, were determined to be temporary.
The Company’s investment in Certificates of Deposit (CDs) included $14,489,000 and $6,249,000 of brokered CDs as of December 31, 2014, and December 31, 2013, respectively. Brokered CDs provide the safety and security of a CD combined with the convenience gained by one-stop shopping for rates at various institutions. This allows the Company to spread its investments across multiple institutions so that all of its CD investments are insured by the Federal Deposit Insurance Corporation (FDIC). Brokered CDs are purchased through UnionBanc Investment Services, LLC, a registered broker-dealer, investment advisor, member of FINRA/SIPC, and a subsidiary of Union Bank, N.A. Brokered CDs are a direct obligation of the issuing depository institution, are bank products of the issuing depository institution, are held in the name of Union Bank as Custodian for the benefit of the Company, and are FDIC insured within permissible limits. All the Company’s brokered CDs are within the FDIC insured permissible limits. As of December 31, 2014 and 2013, the Company’s remaining CDs totaling $600,000 were from four different banks and represent statutory deposits that are assigned to and held by the California State Treasurer and the Insurance Commissioner of the State of Nevada. These deposits are required for writing certain lines of business in California and for admission in the state of Nevada. All the Company’s brokered and non-brokered CDs are within the FDIC insured permissible limits. Due to nature of the Company’s business, certain bank accounts may exceed FDIC insured permissible limits.
In determining the fair value of its financial instruments, the Company employs a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Financial assets and financial liabilities recorded on the consolidated balance sheets at fair value are categorized based on the reliability of inputs to the valuation techniques as follows:
The following table presents information about the Company’s financial instruments and their estimated fair values, which are measured on a recurring basis, allocated among the three levels within the fair value hierarchy as of December 31, 2014 and 2013:
Fair value measurements are not adjusted for transaction costs. The Company recognizes transfers between levels at either the actual date of the event or a change in circumstances that caused the transfer. The Company did not have any transfers between Levels 1, 2 and 3 of the fair value hierarchy during the years ended December 31, 2014 and 2013.
Depreciation on property and equipment located in Woodland Hills, California, is computed using straight line methods over 3 to 7 years. Amortization of leasehold improvements on property located in Woodland Hills, California, is computed using the shorter of the useful life of the leasehold improvements or the remaining years of the lease. Depreciation and amortization expense on all property and equipment for the years ended December 31, 2014, 2013 and 2012, were $539,608, $307,237 and $139,293, respectively.
Premium and notes receivables are substantially secured by unearned premium and funds held as security for performance. Premium finance notes receivable represents the balance due to AAC, the Company's premium finance subsidiary, from policyholders who elected to finance their premium over a nine-month term. These notes are net of unearned finance charges and credit loss reserves.
At each review period, actual claims costs that emerge are compared with the claims costs that were expected to emerge during that development period. Sometimes the previous claims costs estimates prove to have been too high; sometimes they prove to have been too low. In the case of Crusader, the estimates proved to be too high in each of the years reflected in the table. The favorable development in 2012 through 2014 underscores the inherent uncertainty in insurance claims costs, especially for a very small insurer. Management reviews claims costs that appear to be different from the historical claims costs to determine whether those differences are a normal part of the process or an indication that a change in reserve assumptions is appropriate. Management concluded that the differences noted above are differences between actual and expected claims costs that emerge from time to time, particularly in an insurer the size of Crusader.
The Company presently occupies approximately 23,000 square feet of an office building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease that expired on March 31, 2013. Erwin Cheldin, the Company's former president and a current director and principal stockholder, is the owner of the building. The lease provided for an annual gross rent of $486,000 and was effective from April 1, 2012, through March 31, 2013. The lease provided for extension options at the same terms and conditions. The Company exercised its right to extend the lease through June 30, 2014, and the lease continues thereafter on a month-to-month basis. The Company believes that at the inception of the lease agreement, and at each subsequent extension, the terms of the lease were at least as favorable to the Company as could have been obtained from non-affiliated third parties. The Company utilizes for its own operations 100% of the space it leases. The Company also leases storage space from Erwin Cheldin. Depending on usage, storage space rental is estimated to be approximately $15,000 annually. The total rent was $501,258, $500,770 and $712,248 for the years ended December 31, 2014, 2013 and 2012, respectively.
In calendar year 2014, Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($500,000 in excess of $500,000), 0% in its 2nd layer ($1,000,000 in excess of $1,000,000) and 0% in its property and casualty clash treaty. In calendar years 2013 and 2012, Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($500,000 in excess of $500,000), 5% in its 2nd layer ($1,000,000 in excess of $1,000,000) and 0% in its property and casualty clash treaty.
Crusader’s excess of loss reinsurance treaties provided for a contingent commission for accident years 2006, 2004 and 2003. Crusader’s 2006 1st layer primary excess of loss reinsurance treaty provided for a contingent commission equal to 20% of the net profit, if any, accruing to the reinsurer. Crusader’s 2004 and 2003 1st layer primary excess of loss reinsurance treaties provided for a contingent commission to the Company equal to 45% of the net profit, if any, accruing to the reinsurer. Any contingent commission received is subject to return based on future development of ceded losses and loss adjustment expenses. As of December 31, 2014, Crusader has received a total net contingent commission of $3,647,706 for the years subject to the contingent commission. Of this amount, Crusader has recognized $3,569,867 as contingent commission income. The remaining balance of the net payments received of $77,839 is currently unearned and included in “Accrued Expenses and Other Liabilities” in the consolidated balance sheets. The unearned contingent commission may be subsequently earned or returned to the reinsurer depending on the future development of the ceded losses including IBNR for the years subject to the contingent commission. The contingent commission income (loss) recognized was $(17,092), $301,102 and $443,697 in the years ended December 31, 2014, 2013 and 2012, respectively.
The effect of reinsurance on written premium, earned premium and incurred losses loss adjustment expenses is as follows:
The Company’s Profit Sharing Plan and Money Purchase Plan contributions are as follows:
Crusader is required to file an annual statement with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory). Statutory accounting practices differ in certain respects from GAAP. The more significant of the differences for statutory accounting practices are (a) policy acquisition and commission costs are expensed when incurred rather than over the periods covered by the policies; (b) fixed maturity securities are reported at amortized cost, or the lower of amortized cost or fair value, depending on the quality of the security as specified by the National Association of Insurance Commissioners (NAIC); (c) non-admitted assets are charged directly against surplus; (d) loss and loss adjustment expense reserves and unearned premium reserves are stated net of reinsurance; and (e) federal income taxes are recorded when payable and deferred taxes, subject to limitations, are recognized but only to the extent that they do not exceed a specified percentage of statutory surplus; changes in deferred taxes are recorded directly to surplus as regards policyholders. Additionally, the cash flow presentation is not consistent with GAAP and reconciliation from net income to cash provided by operations is not presented. Comprehensive income is not presented under statutory accounting practices.
The California Department of Insurance (CA DOI) conducts periodic financial examinations of Crusader. During 2012, the CA DOI began conducting a financial examination of Crusader’s December 31, 2009, through December 31, 2011, statutory financial statements. On June 6, 2013, Crusader was notified that the report of examination was officially filed and became part of the records of the CA DOI. No comments or recommendations were identified in the current report of examination or the previous report of examination.
Crusader is restricted in the amount of dividends it may pay to its parent in any 12-month period without prior approval of the CA DOI. Presently, without prior regulatory approval, Crusader may pay a dividend in any 12-month period to Unico equal to the greater of (a) 10% of its statutory policyholders' surplus or (b) its statutory net income for the preceding calendar year. Based on Crusader’s statutory surplus for the year ended December 31, 2014, the maximum dividend that could be made by Crusader to Unico without prior regulatory approval in 2015 is $6,349,237. In the years ended December 31, 2014, 2013 and 2012, Crusader paid to Unico cash dividends in the amount of $0, $0 and $11,750,000, respectively.
The Company’s 1999 Omnibus Stock Plan that covered 500,000 shares of the Company’s common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.) was approved by shareholders on June 4, 1999. This plan terminated in accordance with its terms in March 2009. As of December 31, 2014, there were no existing options to purchase shares of common stock outstanding or exercisable under the 1999 Plan as all existing options were exercised during the year ended December 31, 2012.
No options were granted during the years ended December 31, 2014 and 2013. The Company granted no options to non-employees during the years ended December 31, 2014, 2013 and 2012.
The Company recognized stock-based compensation expense in the amount of $23,104, $23,104 and $23,104 for all awards issued under the Company’s 2011 Stock Option plan in the salaries and employee benefits line item in the consolidated statements of operations in the year ended December 31, 2014, 2013 and 2012, respectively. As of December 31, 2014, there was $159,122 of total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested stock-based payments which are expected to be recognized over a weighted average remaining period of 6.72 years.
The valuation allowance is related to expected utilization of state tax net operating loss carryforwards to be realized prior to their expiration dates. The allowance increased $204,042 during the year ended December 31, 2014, compared to an increase of $425,869 during the year ended December 31, 2013.