Management's Discussion and Analysis of Financial Condition and - ------------------------------------------------------------------------ Results of Operations --------------------- Overview -------- General - ------- Unico American Corporation is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary; provides property, casualty, health and life insurance through its agency subsidiaries; and through its other subsidiaries provided claim administration services (through December 31, 2003), insurance premium financing, and membership association services.
The Company's net income was $6,715,004 in 2005, $5,681,500 in 2004, and $1,068,650 in 2003.
A primary challenge of the property and casualty insurance company operation is contending with the fact that the Company sells its products before the ultimate costs are actually known. When pricing its products, the Company projects the ultimate claim and loss adjustment cost that it anticipates will be incurred after the policy is sold. In addition, other factors such as changes in regulations and legal environment, among other things, can all impact the ultimate cost.
AIB sells and services health insurance policies for individual/family and small business groups and receives commissions based on the premiums that it writes. Commissions decreased 25% in the year ended December 31, 2005, compared to 2004. The decrease is primarily due to CIGNA's decision to discontinue its individual/family health insurance program over the period from November 1, 2003, through October 1, 2004. AIB had been assisting former CIGNA policyholders to find health coverage with other insurance carriers that AIB represents.
AAQHC provides various consumer benefits to its members, including participation in group health care and life insurance policies. For these services, AAQHC receives membership and fee income from its members. Membership and fee income decreased 5% in the year ended December 31, 2005, compared to 2004. The decrease is a result of the 9% decrease in the number of members.
Investments and Liquidity - ------------------------- The Company generates revenue from its investment portfolio, which consisted of approximately $140.6 million (at amortized cost) at December 31, 2005, compared to $132.1 million (at amortized cost) at December 31, 2004. Although the investment portfolio increased approximately 8.5 million (at amortized cost) or 6% in 2005 compared to 2004, investment income for the twelve months ended December 31, 2005 and 2004 remained relatively unchanged. Due primarily to the maturity of higher yielding investments and reinvestments in shorter maturities, the annualized yield on the average invested assets decreased from 3.39% in 2004 to 3.17% in 2005. Due to the interest rate environment in the past few years, management believed it was prudent to purchase fixed maturity investments with shorter maturities with minimal credit risk. As of December 31, 2005, the weighted average maturity of the Company's fixed maturity investments was 1.2 years compared to 1.4 years and 1.9 years as of December 31, 2004 and December 31, 2003, respectively.
The most significant liquidity risk faced by the Company would be adverse development of the insurance company claims, both reported and unreported. The Company has taken measures to address the underlying causes of prior adverse development; however, no assurance can be given that the measures taken will be successful or that the Company's estimate of ultimate losses and loss adjustment expenses will be sufficient. Based on the
Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, its reserves for loss payments, and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its investments. Cash and investments (excluding net unrealized gains or losses) at December 31, 2005, were $140,617,062 compared to $132,122,792 at December 31, 2004, a 6% increase. Crusader's cash and investments at December 31, 2005, was $137,990,174 or 98% of the total held by the Company, compared to $129,887,431 or 98% of the total held by the Company at December 31, 2004.
The tax-exempt interest income earned (net of bond premium and discount amortization) during the year ended December 31, 2005, was $14,416 compared to $36,719 in the year ended December 31, 2004. In the year ended December 31, 2003, tax-exempt interest income earned totaled $117,892.
During 2005 the Company began its conversion to a "paperless office" including improvements to its computer network, hardware, switching, and other related computer infrastructure. The "paperless office" conversion of the insurance company underwriting operations was completed in October 2005. The Company estimates that the remaining planned conversion and improvements may take up to one year. As of December 31, 2005, the Company had incurred approximately $650,000 of capital expenditures and anticipates incurring an additional $100,000 to complete the above projects. Upon full implementation of these projects, the Company anticipates its potential payback on these capital expenditures in approximately two to three years due to productivity improvements, improved customer service, and lower operating costs.
The Company has certain obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2005, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
For the year ended December 31, 2004, the Company had income before taxes of $8,672,458 compared to income before taxes of $2,149,371 in the year ended December 31, 2003, an increase in income before taxes of $6,523,087. The increase in pre-tax income was primarily due to an increase of $7,892,277 in the underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader offset by $1,605,512 decrease in gross commissions and fees income.
As of December 31, 2005, Crusader was licensed as an admitted insurance company in the states of Arizona, California, Montana, Nevada, Oregon, and Washington and is approved as a non-admitted surplus lines writer in other states.
For the year ended December 31, 2005, gross written premium decreased by $8,603,237 (12%) over 2004. Gross written premium for the year ended December 31, 2004, increased by $4,824,304 (8%) over 2003. The decrease in written premium in 2005 and the increase in written premium in 2004 are primarily the result of the fluctuations in written premium in the Company's apartment program, a program within the Company's commercial multiple peril line of business. Written premium in the apartment program was $25,265,294 for the twelve months ended December 31, 2005, a decrease of $6,622,191 (21%) from $31,887,485 for the twelve months ended December 31, 2004. Written premium in the apartment program increased $4,582,381 (17%) from $27,305,104 for the twelve months ended December 31, 2003, to $31,887,485 for the twelve months ended December 31, 2004. The decrease in written premium in the Company's apartment program in 2005 was primarily due to increased competition in that market. The Company believes that the "hard market" that existed in California in the past few years has transitioned to a "soft market." The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change. The Company's future writings and growth are dependent on market conditions, competition, and the Company's ability to introduce new and profitable products.
* In accordance with Financial Accounting Standards Board Statement No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," reinsurance recoverable on unpaid losses and loss adjustment expenses are reported for GAAP as assets rather than netted against the corresponding liability for such items on the balance sheet.
As a result of Crusader underwriting losses that began in the year ended December 31, 2000, Crusader's management has been analyzing and acting upon various components of its underwriting activity which it believed was primarily attributable to those losses. The Company believes that implementation of management's actions on these underwriting components has contributed to improved operating results. The development of prior years' losses and loss adjustment expenses in 2005 and 2004 was lower than previously anticipated. Accordingly, the Company reduced the estimate of its ultimate losses and loss adjustment expenses for those prior accident years.
Year ended December 31 ---------------------- 2005 2004 2003 ---- ---- ---- Membership and fee income $318,349 $333,470 $481,366
Membership and fee income for the year ended December 31, 2005, decreased $15,121 (5%), compared to the year ended December 31, 2004. Membership and fee income for the year ended December 31, 2004, decreased $147,896 (31%), compared to the year ended December 31, 2003. Beginning in April 2003, CIGNA discontinued its individual and family health insurance program to new policyholders in the State of California and on November 1, 2003, CIGNA began terminating approximately 2,200 individual and family policyholders on a runoff basis. The termination of policyholders continued through October 1, 2004. The discontinuance of CIGNA's individual and family health insurance program did not affect the CIGNA small group program. Primarily due to the discontinuance of CIGNA's individual and family health insurance program, membership and fee income decreased as these terminated members were no longer members of the association.
Health and Life Insurance Program --------------------------------- Commission income from the health and life insurance sales is as follows:
AIB markets health and life insurance in California through non-affiliated insurance companies for individuals and groups. For these services, AIB receives commission based on the premiums that it writes. Commission income decreased $528,863 (25%) in the year ended December 31, 2005, compared to 2004. Commission income decreased $1,155,791 (35%) in the year ended December 31, 2004, compared to 2003. The decrease in commission in 2005 and 2004 was primarily due to the discontinuance of CIGNA's individual and family health insurance program in the state of California as discussed under the results from the association operation above.
Year ended December 31 ---------------------- 2005 2004 2003 ---- ---- ---- Policy fee income $3,001,966 $3,394,783 $3,458,559 Policies issued 17,927 20,885 21,425
Policy fee income for the year ended December 31, 2005, decreased $392,817 (12%) as compared to the year ended December 31, 2004. The 12% decrease in policy fee income is primarily a result of a 2,958 (14%)
decrease in the number of policies issued during 2005 as compared to 2004 offset by the increase in policy fee from $165 per policy to $178 effective on and after August 2005.
The daily automobile rental insurance program commission income (excluding contingent commission) decreased $144,775 (26%) in 2005 compared to 2004. The daily automobile rental insurance program commission income (excluding contingent commission) decreased $18,233 (3%) in 2004 compared to 2003. Premium written in 2005 decreased 24% compared to premium written in 2004, and premium written in 2004 decreased 6% compared to premium written in 2003. The decrease in written premium in 2005 and 2004 is primarily due to the continued intense price competition in the daily automobile rental insurance program, which is causing these reductions in the Company's written premium and related commission income. To avoid underwriting losses for the non-affiliated insurance Company that it represents, Bedford continues to produce business only at rates that it believes to be adequate. The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change.
The Company's subsidiary U.S. Risk Managers, Inc., (U.S. Risk) ceased providing insurance claim administration services to the non-affiliated daily automobile insurer as of December 31, 2003; and it is currently inactive. As of December 31, 2003, the non-affiliated insurer assumed the claim administration responsibility for all outstanding and IBNR claims. During 2003, the Company recognized $200,000 of claim administration fees that were unearned as of December 31, 2002. Although U.S. Risk is inactive, the Company is still responsible for all claim administration cost arising from losses covered by premiums for which it received a claim administration fee. During 2004 and 2005, the Company did not receive any claim administration fees and did not incur any future internal claim administration costs. During 2005, the Company recognized an additional amount of $70,000 of the $100,000 claim administration fees that were unearned as of December 31, 2004. Thus, the unearned claim administration reserve as of December 31, 2005, is $30,000 and it reflects the estimated costs to complete the claim administration by the non-affiliated insurer. As of December 31, 2005, the non-affiliated insurer had not yet billed the Company for these costs.
Year ended December 31 ---------------------- 2005 2004 2003 ---- ---- ---- Earthquake program commission income $48,519 $53,140 $40,015 Miscellaneous commission and fee income 70 111 1,112 ------ ------ ------ Total other commission and fee income $48,589 $53,251 $41,127 ====== ====== ======
purchase fixed maturity investments with shorter maturities, and therefore, the weighted average maturity of the Company's fixed maturity investments has decreased to 1.2 years as of December 31, 2005, from 1.4 years as of December 31, 2004. The Company's average invested assets increased in the year ending December 31, 2005, primarily as a result of increased cash flows from operations. The mix of taxable and tax-exempt securities in the portfolio affects the investment income return percentage. Tax-exempt securities generally carry a lower yield than taxable securities. These securities (at amortized value) decreased to $934,536 (1% of total investments) at December 31, 2005, compared to $970,343 (1% of total investments) at December 31, 2004.
The par value, amortized cost, estimated market value and weighted average yield of fixed maturity investments at December 31, 2005, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
The following table summarizes, for all fixed maturities in an unrealized loss position at December 31, 2005, the aggregate fair value and gross unrealized loss by length of time those fixed maturities have been continuously in an unrealized loss. No securities were sold at a loss during 2005, 2004 or 2003.
At December 31, 2005, the fixed maturity investments with a gross unrealized loss for a continuous periods of 0 to 6 months and 7 to 12 months, both consisted of U.S. treasury securities and investment grade industrial securities. The fixed maturity investments with a gross unrealized loss position for a continuous period over 12 months consisted of U.S. treasury securities, U.S. government sponsored enterprise securities, and pre-refunded municipal bonds. The unrealized loss is primarily due to rising interest rates.
OTHER OPERATING EXPENSES are as follows: Year ended December 31 ---------------------- 2005 2004 2003 ---- ---- ---- Other operating expenses $2,874,025 $2,657,310 $2,897,886
Income Taxes ------------ Income tax expense for the year ended December 31, 2005, was $3,751,426 compared to an income tax expense of $2,990,958 for the year ended December 31, 2004. The effective combined income tax rates for 2005 and 2004 were 36% and 34%, respectively. The pre-tax income increased $1,793,972 for the year ended December 31, 2005, compared to the year ended December 31, 2004, which resulted in an increased income tax expense in 2005. The income tax expense for the year ended December 31, 2004, was $2,990,958 compared to an income tax expense of $1,080,721 for the year ended December 31, 2003. The effective combined income tax rates for 2004 and 2003 were 34% and 50%, respectively.
There were no other accounting standards issued during 2005 that are expected to have a material impact on the Company's consolidated financial statements.
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 may vary 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.
Investments ----------- In accordance with Statement of Financial Accounting Standard No. 115, "Accounting for Certain Investments in Debt and Equity Securities", the Company is required to classify its investments in debt and equity securities into one of three categories: held-to-maturity, available-for-sale or trading securities.
The Company's fixed maturity investments are classified as available-for-sale and are stated at market 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 market value. Investments in equity securities are carried at market value. The unrealized gains or losses from fixed maturities and equity securities 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 value of a fixed maturity or equity security 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.
Page Number ------ Report of Independent Registered Public Accounting Firm 34
Consolidated Balance Sheets as of December 31, 2005, and December 31, 2004 35
Consolidated Statements of Operations for the years ended December 31, 2005, December 31, 2004, and December 31, 2003 36
Consolidated Statements of Comprehensive Income for the years ended December 31, 2005, December 31, 2004, and December 31, 2003 37
Consolidated Statements of Cash Flows for the years ended December 31, 2005, December 31, 2004, and December 31, 2003 39
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Unico American Corporation and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 and 2003
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------- Nature of Business - ----------------- Unico American Corporation is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary; provides property, casualty, health and life insurance through its agency subsidiaries; and provides insurance premium financing and membership association services through its other subsidiaries. Unico American Corporation is referred to herein as the "Company" or "Unico" and such references include both the corporation and its subsidiaries, all of which are wholly owned, unless otherwise indicated. Unico was incorporated under the laws of Nevada in 1969.
Use of Estimates - ---------------- The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of certain assets, liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. While every effort is made to ensure the integrity of such estimates, actual results may differ.
Investments - ----------- All of the Company's fixed maturity investments are classified as available-for-sale and are stated at market 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 market 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 value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses, if any, are included in the consolidated statements of operations based on the specific identification method.
The Company had unrealized investment losses, net of deferred taxes, of $382,224 as of December 31, 2005, and unrealized investment gains, net of deferred taxes, of $376,172 as of December 31, 2004.
c. Insurance Premium Financing Operations ------------------------------------------ Premium finance interest is charged to policyholders who choose to finance insurance premiums. Interest is charged at rates that vary with the amount of premium financed. Premium finance interest is recognized using a method that approximates the interest (actuarial) method.
(2) Included in short-term investments are two deposits assigned and held by Travis County and the Los Angeles Superior courts. These deposits are filed with the superior courts in lieu of a bond in order to stay execution of judgments and to allow the Company to appeal the judgment in these matters.
policies provide a combination of property and liability coverage for businesses. Commercial property coverages insure against loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, hail, water, explosions, severe winter weather and other events such as theft and vandalism, fires and storms and financial loss due to business interruption resulting from covered property damage. Commercial liability coverages insure against third party liability from accidents occurring on the insured's premises or arising out of its operations, such as injuries sustained from products sold or operation of the insured premises. In addition to commercial multiple peril policies, Crusader also writes separate policies to insure commercial property and commercial liability risks on a mono-line basis.
Year ended December 31 ---------------------- 2005 2004 2003 ---- ---- ---- Revenues - -------- Insurance company operation $54,833,512 $54,414,947 $42,005,474 ---------- ---------- ----------
Assets - ------ Insurance company operation $166,911,366 $151,963,707 $138,247,845 Intersegment eliminations (2) (2,180,548) (2,285,589) (2,302,224) ----------- ----------- ----------- Total insurance company operation 164,730,818 149,678,118 135,945,621 Other insurance operations 21,566,361 22,892,158 25,548,074 ---------- ----------- ----------- Total assets $186,297,197 $172,570,276 $161,493,695 =========== =========== ===========
On December 30, 2005, the Company accelerated the vesting of all of its outstanding stock-based compensation awards granted under the Company's 1999 Omnibus Stock Plan. All accelerated options were "in the money." The number shares covered by the options accelerated totaled 67,500 of which 37,500 were originally scheduled to vest on January 1, 2006 and 30,000 were originally scheduled to vest on January 1, 2007. The Company accelerated vesting of the options in order to minimize the compensation costs associated with the adoption of SFAS 123R. All accelerated options were granted to long-term management employees who were not expected to leave the Company prior to the originally scheduled vesting date. The estimated compensation cost that will be excluded from future periods as a result of the acceleration of the vesting of the options is approximately $89,100.
Estimated stock-based employee compensation expense due to the acceleration of future stock options net of related tax effects 89,100 - - --------- --------- --------- Pro forma $6,625,904 $5,637,896 $1,017,011 ========= ========= =========
Income per share - assuming dilution: As reported $1.20 $1.02 $0.19 Pro forma $1.18 $1.01 $0.18
FASB Staff Position (FSP) No. 115-I, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." FSP 115-1 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. If, after consideration of all available evidence to evaluate the realizable value of its investment, impairment is determined to be other-than-temporary, then an impairment loss should be recognized equal to the difference between the investment's cost and its fair value. FSP 115-1 nullifies certain provisions of Emerging Issues Task Force (EITF) Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," while retaining the disclosure requirements of EITF 03-1 which were adopted in 2003. FSP 115-1 is effective for reporting periods beginning after December 15, 2005. The Company does not expect FSP 115-1 will significantly impact its financial statements upon its adoption on January 1, 2006.
The following table illustrates the gross unrealized losses included in the Company's investment portfolio and the fair value of those securities, aggregated by investment category. The table also illustrates the length of time that they have been in a continuous unrealized loss position as of December 31, 2005.
Amortized Gross Cost Fair Value Unrealized Loss ---- ---------- --------------- 0-6 months $46,834,903 $46,585,392 $249,511 7-12 months 14,327,095 14,166,247 160,848 Over 12 months 50,421,376 49,989,695 431,681 ----------- ----------- ------- Total $111,583,374 $110,741,334 $842,040 =========== =========== =======
At December 31, 2005, the fixed maturity investments with a gross unrealized loss for a continuous period of 0 to 6 months consisted of U.S. treasury securities and investment grade industrial securities. The fixed maturity investments with a gross unrealized loss position for a continuous period of 7 to 12 months consisted of U.S. treasury securities and investment grade industrial securities. The fixed maturity investments with a gross unrealized loss position for a continuous period over 12 months consisted of U.S. treasury securities, U.S. government sponsored enterprise securities, and pre-refunded municipal bonds. The unrealized loss is primarily due to rising interest rates. 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, whether the debtor is current on its contractually obligated interest and principal payments, and the Company's intent to hold the investment for a period of time sufficient to allow the Company to recover its costs. The Company has concluded that the gross unrealized losses of $842,040 at December 31, 2005, were temporary in nature. However, facts and circumstances may change which could result in a decline in market value considered to be other than temporary. The Company did not sell any fixed maturity investment in the years ended December 31, 2005 and 2004.
Certificates of deposit $100,000 $400,000 Cash deposited in lieu of bond* 200,000 752,659 Commercial paper 1,830,000 1,005,000 Bank money market accounts 182,673 803,949 U.S. government obligation money market fund 2,150,671 144,925 Bank savings accounts 11,818 11,585 --------- --------- Total short-term investments $4,475,162 $3,118,118 ========= =========
The Company manages its own investment portfolio. A summary of net investment and related income is as follows:
Year ended December 31 ---------------------- 2005 2004 2003 ---- ---- ----
NOTE 4 - PROPERTY AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION) - ---------------------------------------------------------------- Property and equipment consist of the following: Year ended December 31 ---------------------- 2005 2004 ---- ---- Furniture, fixtures, computer, office, and transportation equipment $2,197,041 $1,599,077 Accumulated depreciation 1,372,537 1,320,673 --------- --------- Net property and equipment $824,504 $278,404 ======= =======
Year ended December 31 ---------------------- 2005 2004 ---- ---- Premiums and commission receivable $2,690,402 $2,947,130 Premium finance notes receivable 4,057,137 4,843,060 --------- --------- Total premiums and notes receivable 6,747,539 7,790,190 Less allowance for doubtful accounts 6,746 19,630 --------- --------- Net premiums and notes receivable $6,740,793 $7,770,560 ========= =========
Bad debt expense for the year ended December 31, 2005, and the year ended December 31, 2004, were $8,927 and $29,402, respectively. Premium finance notes receivable represent the balance due to the Company's premium finance subsidiary from policyholders who elect to finance their premiums over the policy term. These notes are net of unearned finance charges.
Year ended December 31 ---------------------- 2005 2004 ---- ---- Note payable - Erwin Cheldin - $500,000 ------- Notes payable - related parties - $500,000 =======
In 2003, Unico made capital contributions totaling $3,000,000 to its Crusader subsidiary. The contributions were made to ensure that Crusader's capital remained above $25,000,000. The funding of Unico's capital contribution to Crusader was derived from available cash from the Company's other operations and the proceeds of two notes. On September 29, 2003, the Company borrowed $1,000,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer, and $500,000 from The Cary and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the Company's executive vice president. As of December 31, 2004, the Company repaid the note from The Cary and Danielle Cheldin Family Trust in full and repaid $500,000 of the Erwin Cheldin note. On April 29, 2005, the note to Erwin Cheldin was paid in full.
* In accordance with Financial Accounting Standards Board Statement No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts", reinsurance recoverable on unpaid losses and loss adjustment expenses are reported for GAAP as assets rather than netted against the corresponding liability for such items on the balance sheet.
The 8% decrease in policy acquisition incurred during the year ended December 31, 2005, is a direct result of the 5% decrease in direct earned premium during the year ended December 31, 2005, compared to the year ended December 31, 2004.
The 30% increase in policy acquisition amortized during the year ended December 31, 2004, is a direct result of the 26% increase in direct earned premium during the year ended December 31, 2004, compared to the year ended December 31, 2003.
Prior to January 1, 1998, National Reinsurance Corporation (acquired by General Reinsurance Corporation in 1996) charged a provisional rate on exposures up to $500,000 that was subject to adjustment and was based on the amount of losses ceded, limited by a maximum percentage that could be charged. That provisionally rated treaty was cancelled on a runoff basis and replaced by a flat rated treaty on January 1, 1998. In 2005, Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($700,000 in excess of $300,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2004 Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2003 Crusader retained a participation in its excess of loss reinsurance treaties of 5% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. Crusader also has catastrophe reinsurance from various highly rated California admitted and Bermuda reinsurance companies. These reinsurance agreements help protect Crusader against liabilities in excess of certain retentions, including major or catastrophic losses that may occur from any one or more of the property and/or casualty risks which Crusader insures. The Company has no reinsurance recoverable balances in dispute.
Crusader's 2004 and 2003 1st layer primary excess of loss treaty provides for a contingent commission to the Company equal to 45% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2003, through December 31, 2005. The Company will calculate and report to the reinsurer its net profit, if any, within 90 days after 36 months following the end of the first accounting period and within 90 days after the end of each 12 month period thereafter until all losses subject the to agreement have been finally settled. Based on losses and loss adjustment expenses ceded (including incurred but not reported losses) as of December 31, 2005, no contingent commission has been accrued. The 2005 1st layer primary excess of loss treaty does not provide for a contingent commission.
Reinsurance ceded premium as a percentage of direct earned premium was 22% in 2005, 26% in 2004 and 31% in 2003. The decrease in the ratio is primarily the result of rate decreases by the Company's reinsurers due to the Company's improving ceded loss experience.
Year ended December 31, 2005 $867,532 Year ended December 31, 2004 $759,482 Year ended December 31, 2003 $674,977
NOTE 14 - STATUTORY CAPITAL AND SURPLUS - --------------------------------------- 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 these differences for statutory accounting are (a) premium income is taken into earnings over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) fixed maturity securities are reported at amortized cost, or the lower of amortized cost or market value, depending on the quality of the security as specified by the NAIC; (c) equity securities are valued by the NAIC as required by Statutory Accounting Principles; d) non-admitted assets are charged directly against surplus; (e) loss reserves and unearned premium reserves are stated net of reinsurance; and (f) 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 10% of statutory surplus; changes in deferred taxes are recorded directly to surplus as regards policyholders. Additionally, the cash flow presentation is not consistent with U.S. generally accepted accounting principles and reconciliation from net income to cash provided by operations is not presented. Comprehensive income is not presented under statutory accounting.
An unusual range of ratio results has been established from studies of the ratios of companies that have become insolvent or have experienced financial difficulties. In the analytical phase, companies that receive four or more financial ratio values outside the usual range are analyzed in order to identify those companies that appear to require immediate regulatory action. Subsequently, a more comprehensive review of the ratio results and an insurer's annual statement is performed to confirm that an insurer's situation calls for increased or closer regulatory attention. In 2005, the Company was not outside the usual values on any of the twelve IRIS ratio tests.
NOTE 15 - STOCK PLANS - --------------------- The Company's 1999 Omnibus Stock Plan that covers 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. On August 26, 1999, the Company granted 135,000 incentive stock options of which 40,000 were terminated and 95,000 were outstanding and exercisable as of December 31, 2005. These options expire 10 years from the date of the grant.
6,500 options had been exercised and 2,500 options had been terminated. These options expire 10 years from the date of the grant.
Options exercisable were 268,000 at December 31, 2005, at a weighted average exercise price of $5.286; 149,500 at December 31, 2004, at a weighted average exercise price of $7.01; 95,000 at December 31, 2003, at a weighted average exercise price of $9.25.
The following table summarizes information regarding the stock options outstanding at December 31, 2005:
Year ended December 31 ---------------------- 2005 2004 ---- ---- Deferred tax assets: Discount on loss reserves $2,270,225 $2,368,238 Unearned premiums 2,116,186 2,418,595 Unrealized loss on investments 196,904 - State income tax deductible in future periods 145,270 152,306 Other 112,072 104,644 --------- --------- Total deferred tax assets $4,840,657 $5,043,783 --------- ---------
NOTE 17 - REPURCHASE OF COMMON STOCK - EFFECT ON STOCKHOLDERS' EQUITY - --------------------------------------------------------------------- The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company. During the year ended December 31, 2005, the Company did not purchase any shares of the Company's common stock. As of December 31, 2005, the Company had purchased and retired under the Board of Directors authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.
NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) - ------------------------------------------------------ Summarized unaudited quarterly financial data for each of the calendar years 2005 and 2004 is set forth below: