We conduct our operations primarily from our company-owned campus located at 1110 West Commercial Boulevard, Suite 100, Fort Lauderdale, Florida 33309, which contains approximately 68,500 square feet of office space. The facilities in our campus are suitable and adequate for our operations.
Over the past several years, we have grown our business both within Florida and elsewhere in the United States through our distribution network of approximately 8,600 licensed independent agents. Our goals are to profitably grow our business, invest in our vertically integrated structure, expand our independent agent network, and return value to shareholders. Some of our key strategies include increasing our policies in force in Florida through continued profitable and organic growth; expanding into other states to diversify our revenue and risk; optimizing our reinsurance program; and continuing to provide high quality service through our vertically integrated business. We believe each of these strategies has contributed towards an increase in earnings and earnings per share as well as an improvement in our overall financial condition. See “-Results of Operations” below for a discussion of our annual results for 2016 compared to the same period in 2015.
Our overall organic growth strategy emphasizes taking prudent measures to increase our policy count and improving the quality of our business rather than merely increasing our policy count. Our focus on long-term capital strength and organic growth causes us to be selective in the risks we accept. Our goal is to write risks that are priced adequately and meet our underwriting standards. We believe that our strategy of organically expanding our premium growth through our independent agent distribution network, streamlining claims management and balancing appropriate pricing with disciplined underwriting standards will maximize our profitable growth. We also intend to continue our expansion outside of Florida in markets that allow us to write profitable business and to diversify our revenue and risk. Upon entering new markets, we leverage our existing independent agent network to generate new local relationships and business and take the time to learn about each new market and any of its unique risks in order to carefully develop our own policy forms, rates and informed underwriting standards. Our expansion efforts differ from our competitors that have grown in recent years primarily through assumption of policies from Citizens, Florida’s statutory residual property insurance market.
As a result of our organic growth strategy and initiatives, we have seen increases in policy count and insured value in all states for over two years. As for states outside of Florida, our total insured value increased from 16% as of December 31, 2015 to 21% as of December 31, 2016. The following table provides direct written premium for Florida and other states for the years ended December 31, 2016 and 2015 (dollars in thousands):
Gross direct premiums overall grew $71.2 by million, or 8.1%, to $954.6 million compared to 2015.
Total revenues increased by $139.1 million, or 25.5%, to $685.7 million compared to 2015.
Diluted EPS decreased by $0.18, or 6.0%, to $2.79 per common share.
APPCIC received authorization from the FLOIR to amend its Certificate of Authority to add Fire, Commercial Multi-Peril, and Other Liability (collectively “Commercial Residential”) lines of business in Florida.
We believe that restructuring our reinsurance program and re-evaluating that structure on an ongoing basis has allowed us to take advantage of attractive reinsurance pricing, while still maintaining reinsurance coverage that we believe is sufficient to protect our policyholders and shareholders. While we believe the changes to the current reinsurance program are beneficial, there can be no assurance that our actual results of operations or financial condition will be positively affected. The Insurance Entities remain responsible for insured losses notwithstanding the failure of any reinsurer to make payments otherwise due to the Insurance Entities. Below is a description of our 2016-2017 reinsurance program for each of the Insurance Entities.
UPCIC structures its reinsurance coverage into layers and utilizes a cascading feature such that the second, third, fourth and fifth reinsurance layers all attach at $90 million. Any layers above the $90 million attachment point are excess of loss over the immediately preceding layer. If the aggregate limit of the preceding layer is exhausted, the next layer cascades down in its place for future events. Further, UPCIC buys four dedicated limits of $55 million in excess of $35 million for the first four catastrophe events. This means that, unless losses exhaust the top layer of our coverage, we are exposed to only $35 million in losses, pre-tax, per catastrophe for each of the first four events.
The estimated total net cost of UPCIC’s FHCF and catastrophe related coverage, including reinstatement premium protection coverage, is $295.6 million. The largest private participants in UPCIC’s program include Allianz Risk Transfer AG, Bermuda Branch (Nephila Capital), Everest Re, Renaissance Re, Chubb Tempest Re, and various Lloyd’s of London syndicates. The table below provides the A.M. Best and Standard and Poor’s (“S&P”) financial strength ratings for each of the largest third party reinsurers in UPCIC’s 2016-2017 reinsurance program.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and 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 periods. Our primary areas of estimates are described below.
See “Item 8 - Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for a discussion of the company’s basis and methodologies used to establish its liability for unpaid losses and loss adjustment expenses along with the following quantitative disclosures:
Five year accident year table on incurred claim and allocated claim adjustment expenses, net of reinsurance including columns of:
Five year accident year table on cumulative paid claims and allocated claim adjustment expenses, net of reinsurance
Reconciliation of tables to the financial statements- Reconciliation of net incurred and paid claims development table to the liability for claims and claim adjustment expenses in the Consolidated Balance Sheet.
Duration- a table of the average historical claims duration for the past 5 years
Key assumptions that materially affect the estimate of the reserve for loss and LAE relate to the effects of emerging claim and coverage issues. As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claim and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. Key assumptions that are premised on future emergence that are inconsistent with historical loss reserve development patterns include but are not limited to:
As loss experience for the current year develops for each type of loss, it is monitored relative to initial assumptions until it is judged to have sufficient statistical credibility. From that point in time and forward, reserves are re-estimated using statistical actuarial processes to reflect the impact loss trends have on development factors incorporated into the actuarial estimation processes.
Loss and LAE reserves also include reserves for catastrophe losses. Catastrophe losses are an inherent risk of the property-casualty insurance industry that have contributed, and will continue to contribute, to potentially material year-to-year fluctuations in results of operations and financial position. A catastrophe is an event that produces significant pre-tax losses before reinsurance and 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 following the event. Catastrophes are caused by various natural events including high winds, tornadoes, wildfires, tropical storms and hurricanes.
At any given point in time, the recorded loss reserve represents our best estimate of the ultimate settlement and administration cost of insured claims incurred and unpaid. Since the process of estimating loss reserves requires significant judgment due to a number of variables, such as fluctuations in inflation, judicial decisions, legislative changes and changes in claims handling procedures, ultimate liability may exceed or be less than these estimates. Reserves for losses and LAE are revised as additional information becomes available, and adjustments, if any, are reflected in earnings in the periods in which they are determined.
We have created a proprietary claims analysis tool Peer-2-Peer (“P2P”) to analyze and calculate reserves to supplement analysis performed by our independent actuaries. P2P is a custom built application that aggregates, analyzes and forecasts reserves based on historical data that spans more than a decade. It identifies historical claims data using same like kind and quality variables that exist in present claims and sets forth appropriate, more accurate reserves on current claims. P2P is utilized by management in reviewing the topography of existing and incoming claims. P2P is analyzed at each quarters end and adjustments to reserves are made at an aggregate level when appropriate.
these new funds along with maturities in higher yield securities while maintaining high credit quality. Total average investments were $592.6 million during the year ended December 31, 2016 compared to $470.4 million in the same period in 2015.
Commission revenue is comprised principally of brokerage commissions we earn from reinsurers on reinsurance placed for the Insurance Entities. For the year ended December 31, 2016 commission revenue was $17.7 million, compared to $14.9 million for the year ended December 31, 2015. The increase in commission revenue of $2.9 million, or 19.3%, was the result of overall changes in the structure of the reinsurance programs in effect during the year ended December 31, 2016, compared to the year ended December 31, 2015, including an increase in our exposures covered by reinsurance.
Policy fees for the year ended December 31, 2016, were $16.9 million compared to $15.4 million for the same period in 2015. The increase of $1.4 million, or 9.3%, was the result of an increase in policies written during the year ended December 31, 2016 compared to the same period in 2015.
Other revenue for the year ended December 31, 2016 was $6.4 million compared to $6.0 million for the same period in 2015. Other revenue represents revenue from policy installment fees, premium financing and other miscellaneous income. The increase of $406 thousand, or 6.7% reflects an increase in the number of policies written during the year ended December 31, 2016 compared to the same period in 2015 and consumer behavior underlying the composition of our insurance portfolio.
Losses and LAE, net of reinsurance were $301.2 million for the year ended December 31, 2016 compared to $187.7 million for the same period in 2015 as follows:
Each year reserve re-estimates, as described in “Item 8 - Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)”, are conducted and the difference between indicated reserves based on new reserve estimates and the previously recorded estimate is recorded and included in “Losses and loss adjustment expenses” in the Consolidated Statements of Income. Reserve re-estimates in 2016 and 2015 resulted in favorable development of $4.7 million and $0.3 million, respectively.
For the year ended December 31, 2016, general and administrative expenses were $221.2 million, compared to $183.8 million for the same period in 2015. The overall net increase in general and administrative expenses of $37.4 million, or 20.3%, includes a $37.5 million increase in acquisitions costs, a $7.0 million increase in other operating costs and a $7.1 million decrease in stock-based compensation. The increase in acquisition and operating costs were incurred to support the increase of policies in force. The increase in acquisition costs also reflects the absence, during 2016, of ceding commission subsequent to the elimination of quota share reinsurance in June 2015. The expense ratio-net or general and administrative expenses as a percentage of net earned premiums, was 35.0% for the year ended December 31, 2016 compared to 36.5% for the same period in 2015. The decrease in the expense ratio resulted from the economies of scale caused by our higher premium volume as compared to the prior period and a reduction in stock-based compensation, partially offset by an increase in net acquisition costs resulting from the absence of ceding commission in 2016.
YEAR ended December 31, 2015 COMPARED TO YEAR ENDED DECEMBER 31, 2014
Net investment income was $5.2 million for the year ended December 31, 2015 compared to $2.4 million for the year ended December 31, 2014. Net investment income is generated primarily from our investment portfolio of securities available for sale, short-term investments, cash and cash equivalents, and investment real estate. The increase in net investment income is the result of increases in our investments funded by cash flows from operations and actions taken to rebalance our portfolio. Invested assets
Management sells investment securities from its portfolio of securities available for sale from time to time when opportunities arise. We sold investment securities available for sale during the year ended December 31, 2015, resulting in a net realized gain of $1.1 million compared to a net realized gain of $5.6 million during the year ended December 31, 2014.
Income taxes increased by $13.9 million, or 25.5% primarily as a result of an increase in income before income taxes. The effective tax rate decreased to 39.2% from 42.8% for the years ended December 31, 2015 and 2014, respectively. See “Item 8 - Note 12 (Income Taxes)” for a reconciliation from the statutory income tax rates to our effective tax rates for these periods.
Premiums receivable represents amounts receivable from policyholders. The increase in premiums receivable of $2.9 million to $53.8 million as of December 31, 2016 relates to the growth of policies in force over the prior year.
Deferred tax assets and liabilities represent temporary differences between GAAP and tax basis of a company's assets and liabilities. During the year ended December 31, 2016 deferred tax assets decreased by $3.2 million primarily due to fluctuations in unrealized gains and losses, deferred policy acquisition costs, and equity based compensation.
See “Item 8 - Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for a roll-forward in the balance of our unpaid losses and LAE. Unpaid losses and loss adjustment expenses decreased $40.3 million to $58.5 million during the year ended December 31, 2016. This reduction was the result of continuing initiatives to expedite claims payments including the ability of our mobile claims teams to rapidly settle certain claims, which we refer to as “Fast Track”.
Advance premium represents premium payments made by policyholders ahead of the effective date of the policies. The decrease of $7.0 million to $17.8 million as of December 31, 2016 reflects the payment pattern of our customers and seasonality of our business as described under “- Overview”.
Reinsurance payable, net increase of $7.3 million to $80.9 million as a result of amounts accrued during 2016 in connection with the Company’s 2016 -2017 reinsurance treaties which we entered into as of June 1, 2016 and unpaid as of year-end.
Long-term debt was reduced by $9.0 million primarily as a result of the cancellation of the Renaissance Re Ventures Ltd. Term Loan. See “- Liquidity and Capital Resources” for further discussion.
See “-Liquidity and Capital Resources” for explanations of changes in common stock, long-term debt and treasury shares.
Accumulated other comprehensive income (loss), net of taxes increased to a $6.4 million loss, an increase of $2.4 million loss from the prior year end. This increase reflects the after tax changes in fair value of our investment portfolio’s unrealized losses since December 31, 2015.
The balance of restricted cash and cash equivalents as of December 31, 2016 and 2015 includes cash equivalents on deposit with regulatory agencies in the various states in which our Insurance Entities do business.
As discussed in “Item 8 - Note 7 (Long-Term Debt),” UVE entered into a revolving loan agreement and related revolving loan “(DB Loan”) with Deutsche Bank Trust Company Americas (“Deutsche Bank”) in March 2013, which was most recently amended in July 2015. The DB Loan makes available to UVE an unsecured line of credit in an aggregate amount not to exceed $15 million. Draws under the DB Loan have a maturity date of July 31, 2017 and carry an interest rate of LIBOR plus a margin of 5.50% or Deutsche Bank’s prime rate plus a margin of 3.50%, at the election of UVE. The DB Loan contains certain covenants and restrictions applicable while amounts are outstanding thereunder, including limitations with respect to our indebtedness, liens, distributions, mergers or dispositions of assets, organizational structure, transactions with affiliates and business activities. As of December 31, 2016, UVE was in compliance with all such covenants, and no amounts have been drawn under this unsecured line of credit.
The maximum amount of dividends that can be paid by Florida insurance companies without prior approval of the Commissioner of the FLOIR is subject to restrictions relating to statutory surplus. The maximum dividend that may be paid by the Insurance Entities to Universal Insurance Holding Company of Florida (“UVECF”) without prior approval is limited to the lesser of statutory net income from operations of the preceding calendar year or statutory unassigned surplus as of the preceding year end. During the years ended December 31, 2016 and 2015, the Insurance Entities did not pay dividends to UVECF.
The Insurance Entities are required annually to comply with the NAIC RBC requirements. RBC requirements prescribe a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC’s RBC requirements are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2016, based on calculations using the appropriate NAIC RBC formula, the Insurance Entities’ reported and respective total adjusted capital was in excess of the requirements. Failure by the Insurance Entities to maintain the required level of statutory capital and surplus could result in the suspension of their authority to write new or renewal business, other regulatory actions, or ultimately, in the revocation of their certificate of authority by the FLOIR.
In 2006, UPCIC entered into a $25.0 million surplus note with the State Board of Administration of Florida (the “SBA”) under Florida’s Insurance Capital Build-Up Incentive Program (the “ICBUI”). The surplus note has a twenty-year term and accrues interest, adjusted quarterly based on the 10-year Constant Maturity Treasury Index. UPCIC is in compliance with each of the loan’s covenants as implemented by rules promulgated by the SBA. An event of default will occur under the surplus note, as amended, if UPCIC: (i) defaults in the payment of the surplus note; (ii) fails to submit quarterly filings to the FLOIR; (iii) fails to maintain at least $50 million of surplus during the term of the surplus note, except for certain situations; (iv) misuses proceeds of the surplus note; (v) makes any misrepresentations in the application for the program; (vi) pays any dividend when principal or interest payments are past due under the surplus note; or (vii) fails to maintain a level of surplus and reinsurance sufficient to cover in excess of UPCIC’s 1-in-100 year probable maximum loss as determined by a hurricane loss model accepted by the Florida Commission on Hurricane Loss Projection Methodology as certified by the FLOIR annually. To avoid a penalty rate, UPCIC must maintain either a ratio of net written premium to surplus of 2:1 or a ratio of gross written premium of 6:1 according to a calculation method set forth in the surplus note. As of December 31, 2016, UPCIC’s net written premium to surplus ratio and gross written premium to surplus ratio were in excess of the required minimums and, therefore, UPCIC is not subject to increases in interest rates. At December 31, 2016, UPCIC was in compliance with the terms of the surplus note. Total adjusted capital surplus was in excess of regulatory requirements for both UPCIC and APPCIC.
On June 13, 2016, the Company announced that its Board of Directors authorized the repurchase of up to $20 million of the Company’s outstanding common stock through December 31, 2017. The Company may repurchase shares from time to time at its discretion, based on ongoing assessments of the capital needs of the Company, the market price of its common stock and general market conditions. The Company will fund the share repurchase program with cash from operations. This new authorization follows completion of the Board authorized share repurchase program announced on November 19, 2015, pursuant to which the Company repurchased 527,107 shares of common stock at an average price of $18.93 per share on the open market. The Company financed the share repurchases under the program using cash on hand.
On April 28, 2016, the Company entered into a Purchase and Exchange Agreement with RenRe, pursuant to which the Company sold an aggregate of 583,771 shares of common stock at a purchase price of $17.13 per share for a total of $10 million, which was comprised of $2,965,000 in cash and $7,035,000 in cancellation of outstanding indebtedness.
During the year ended December 31, 2016, we repurchased an aggregate of 441,036 shares of UVE’s common stock in the open market. Also see“Part II, Item 5 - Unregistered Sales of Equity Securities and Use of Proceeds” for share repurchase activity during the three months ended December 31, 2016.
On January 14, 2016, we declared a cash dividend of $0.14 per share on our outstanding common stock which was paid on March 2, 2016, to the shareholders of record at the close of business on February 18, 2016.
On November 15, 2016, we declared a cash dividend of $0.27 per share on our outstanding common stock which was paid on December 12, 2016 to shareholders of record at the close of business on December 1, 2016.
changes we have made in adjudicating and settling claims are conservatively reflected in the actuarial process. We will continue to validate our actuarial process as the benefits of our accelerated claims settlement process become more apparent. The cumulative redundancy or deficiency in prior year reserve changes is reflected in the chart above.
Insurance premiums are established before we know the amount of loss and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate rates, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation also affects the market value of our investment portfolio and the investment rate of return. Any future economic changes which result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred loss and LAE and thereby materially adversely affect future liability requirements.
In August 2016, the FASB issued guidance intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The new guidance will apply to: 1) debt prepayment or debt extinguishment costs, 2) settlement of zero-coupon debt instruments, 3) contingent consideration payments made after business combination, 4) proceeds from the settlement of insurance claims, 5) proceeds from the settlement of corporate-owned life insurance policies, 6) distributions received from equity method investments, 7) beneficial interests in securitization transactions, and 8) separately identifiable cash flows and application of the predominance principle. The guidance is effective in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently evaluating the impact that this standard will have on our consolidated financial statements.
In June 2016, the FASB issued guidance that introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The new guidance will apply to: 1) loans, accounts receivable, trade receivables, and other financial assets measured at amortized cost, 2) loan commitments and certain other off-balance sheet credit exposures, 3) debt securities and other financial assets measured at fair value through other comprehensive income, and 4) beneficial interests in securitized financial assets. The guidance is effective in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We are currently evaluating the impact that this standard will have on our consolidated financial statements.
In March 2016, the FASB issued guidance that will change certain aspects of accounting for share-based payments to employees. The new guidance will require all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also will allow an employer to repurchase more of an employee's shares than it can today for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur. The guidance is effective for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. Early adoption is permitted in any annual or interim period for which financial statements haven't been issued or made available for issuance, but all of the guidance must be adopted in the same period. The adoption of this guidance is not expected to have a material effect on our results of operations, financial position or liquidity.
In January 2016, the FASB issued guidance on recognition and measurement of financial instruments. The new guidance requires certain equity investments to be measured at fair value with changes in fair value reported in earnings and requires changes in instrument-specific credit risk for financial liabilities recorded at fair value under the fair value option to be reported in other comprehensive income (“OCI”). The new guidance is effective in fiscal years beginning after December 15, 2017, with early adoption permitted for the provisions related to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in OCI.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Because of inherent limitations, internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company generates revenues primarily from the collection of premiums and invests funds in excess of those retained for claims-paying obligations and insurance operations. Other significant sources of revenue include brokerage commissions collected from reinsurers or reinsurance programs placed by the Insurance Entities, policy fees collected from policyholders by our wholly-owned managing general agency subsidiary and payment plan fees charged to policyholders who choose to pay their premiums in installments.
Gains and losses realized on the disposition of investment securities available for sale are determined on the FIFO basis and credited or charged to income. Premium and discount on investment securities are amortized and accreted using the interest method and charged or credited to investment income.
Investment Real Estate. Investment real estate is recorded at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful life of the assets. Real estate taxes, interest and other costs incurred during development and construction of non-income producing properties are capitalized. Income and expenses from income producing real estate are reported under net investment income. Investment real estate is evaluated for impairment when events or circumstances indicate the carrying value may not be recoverable.
Recognition of Policyholder Payment Plan Fee Revenue. The Company offers its policyholders the option of paying their policy premiums in full at inception or in two or four installment payments. The Company charges fees to its policyholders that elect to pay
their premium in installments and records such fees as revenue when the policyholder makes the installment payment election and the Company bills the fees to the policyholder. These fees are included in Other Revenue in the Company’s Consolidated Statements of Income.
Income Taxes. Income tax provisions are based on the asset and liability method. Deferred federal and state income taxes have been provided for temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements, net of valuation allowance if any. The Company reviews its deferred tax assets for recoverability.
Income (Loss) Per Share of Common Stock. Basic earnings per share is computed by dividing the Company’s net income (loss) available to common stockholders, by the weighted-average number of shares of Common Stock outstanding during the period. Diluted earnings per share is computed by dividing the Company’s net income (loss) by the weighted average number of shares of Common Stock outstanding during the period and the impact of all dilutive potential common shares, primarily preferred stock, unvested shares and options. The dilutive impact of stock options and unvested shares is determined by applying the treasury stock method and the dilutive impact of the preferred stock is determined by applying the “if converted” method.
Accordingly, the admitted assets, liabilities and capital and surplus of UPCIC and APPCIC as of December 31, 2016 and 2015 and the results of operations and cash flows, for the years ended December 31, 2016, 2015 and 2014, have been determined in accordance with statutory accounting principles, but adjusted to GAAP for purposes of these financial statements. The statutory accounting principles are designed primarily to demonstrate the ability to meet obligations to policyholders and claimants and, consequently, differ in some respects from GAAP.
As of December 31, 2016, the Company held fixed maturity, equity securities and short-term investments that were in an unrealized loss position as presented in the table above. For fixed maturity securities with significant declines in value, the Company performs quarterly fundamental credit analysis on a security-by-security basis, which includes consideration of credit quality and credit ratings, review of relevant industry analyst reports and other available market data. For fixed maturity, equity securities and short-term investments, the Company considers whether it has the intent and ability to hold the securities for a period of time sufficient to recover its cost basis. Where the Company lacks the intent and ability to hold to recovery, or believes the recovery period is extended, the security’s decline in fair value is considered other than temporary and is recorded in earnings. Based on our analysis, our fixed income portfolio is of high quality and we believe we will recover the amortized cost basis of our fixed income securities. We continually monitor the credit quality of our fixed income investments to assess if it is probable that we will receive our contractual or estimated cash flows in the form of principal and interest. Additionally, the Company considers management’s intent and ability to hold the securities until recovery and its credit analysis of the individual issuers of the securities. Based on this process and analysis, management has no reason to believe the unrealized losses for securities available for sale as of December 31, 2016 are other than temporary.
The following prepaid reinsurance premiums and reinsurance recoverable and receivable are reflected in the Consolidated Balance Sheets as of the dates presented (in thousands):
The Insurance Entities are subject to regulations and standards of the FLOIR. UPCIC also is subject to regulations and standards of regulatory authorities in other states where it is licensed, although as a Florida-domiciled insurer its principal regulatory authority is the FLOIR. These standards require the Insurance Entities to maintain specified levels of statutory capital and restrict the timing and amount of dividends and other distributions that may be paid by the Insurance Entities to the parent company. Except in the case of extraordinary dividends, these standards generally permit dividends to be paid from statutory unassigned surplus of the regulated subsidiary and are limited based on the regulated subsidiary’s level of statutory net income and statutory capital and surplus. The
maximum dividend that may be paid by UPCIC and APPCIC to their immediate parent company, Universal Insurance Holding Company of Florida (“UVECF”), without prior regulatory approval is limited by the provisions of Florida Statutes. These dividends are referred to as “ordinary dividends.” However, if the dividend, together with other dividends paid within the preceding twelve months, exceeds this statutory limit or is paid from sources other than earned surplus, the entire dividend is generally considered an “extraordinary dividend” and must receive prior regulatory approval.
In accordance with Florida Statutes, and based on the calculations performed by the Company as of December 31, 2016, UPCIC has the capacity to pay ordinary dividends of $57.7 million during 2017. APPCIC does not have the capacity to pay ordinary dividends during 2017. For the year ended December 31, 2016, no dividends were paid from UPCIC or APPCIC to UVECF. Dividends paid to the shareholders of UVE in 2016 have been paid from the earnings of UVE and its non-insurance subsidiaries.
UPCIC and APPCIC are required annually to comply with the NAIC risk-based capital (“RBC”) requirements. RBC requirements prescribe a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC RBC requirements are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2016, based on calculations using the appropriate NAIC RBC formula, UPCIC’s and APPCIC’s reported total adjusted capital was in excess of the requirements.
The effective interest rate paid on the surplus note was 1.88%, 2.21% and 2.73% for years ended December 31, 2016, 2015 and 2014, respectively. Any payment of principal or interest by UPCIC on the surplus note must be approved by the Commissioner of the OIR. Quarterly principal payments of $368 thousand are due through 2026. Aggregate principal payments of $1.5 million were made during each of the years ended December 31, 2016, 2015 and 2014.
Through the interest rate payment of 0.50% per annum and the amortization of the discount, the effective interest rate on the Term Loan was 5.99%.
Amortization of the original issue discount is included in interest expense, a component of general and administrative expenses, in the Consolidated Statements of Income and was $149 thousand $521 thousand and $840 thousand for the years ended December 31, 2016, 2015 and 2014, respectively.
On March 29, 2013, UVE entered into a revolving loan agreement and related revolving note (the “DB Loan”) with Deutsche Bank Trust Company Americas (“Deutsche Bank”), which was amended in July 2015. The DB Loan makes available to UVE an unsecured line of credit in an aggregate amount not to exceed $15.0 million. Draws under the DB Loan have a maturity date of July 31, 2017 and carry an interest rate of LIBOR plus a margin of 5.50% or Deutsche Bank’s prime rate plus a margin of 3.50%, at the election of UVE. The DB Loan contains certain covenants and restrictions applicable while amounts are outstanding thereunder, including limitations with respect to our indebtedness, liens, distributions, mergers or dispositions of assets, organizational structure, transactions with affiliates and business activities. As of December 31, 2016, UVE was in compliance with all such covenants. UVE had not drawn any amounts under the unsecured line of credit as of December 31, 2016.
Interest expense was $0.4 million, $1.0 million, and $1.5 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Awards under the Incentive Plan may include incentive stock options, non-qualified stock option awards (“Stock Option”), stock appreciation rights, non-vested shares of Common Stock (“Restricted Stock”), restricted stock units, performance share units (“PSUs”), other share-based awards and cash-based incentive awards. Awards under the Incentive Plan may be granted to employees, directors, consultants or other persons providing services to the Company or its affiliates. The Incentive Plan also provides for awards that are intended to qualify as “performance-based compensation” in order to preserve the deductibility of such compensation by the Company under Section 162(m) of the Internal Revenue Code.
The following table provides certain information related to Stock Options, Restricted Stock, and PSUs during the year ended December 31, 2016 (in thousands, except per share data):
Unless otherwise specified, such as in the case of the exercise of Stock Options, the per share prices were determined using the closing price of the Company’s Common Stock as quoted on the exchanges on which the Company was listed. Shares issued upon exercise of options represent original issuances in private transactions pursuant to Section 4(2) of the Securities Act of 1933, as amended or issuances under the Company's Incentive Plan.
The plan titled the “Universal Property & Casualty 401(K) Profit Sharing Plan and Trust” (the “401(k) Plan”) is a defined contribution plan that allows employees to defer compensation through contributions to the 401(k) Plan. The contributions are invested on the employees’ behalf, and the benefits paid to employees are based on contributions and any earnings or loss. The 401(k) Plan includes a Company contribution of 100 percent of each eligible participant’s contribution that does not exceed five percent of their compensation during the 401(k) Plan year. The Company may make additional profit-sharing contributions. However, no additional profit-sharing contribution was made during the years ended December 31, 2016, 2015 and 2014.
The Company accrued for aggregate contributions of approximately $1.2 million, $1.0 million and $0.8 million to the 401(k) Plan during the years ended December 31, 2016, 2015 and 2014, respectively.
Management believes that it is more likely than not that a portion of the benefit from certain state capital loss carryforwards will not be realized. In recognition of this risk, the company has provided a valuation allowance of $133 thousand on the deferred tax asset relating to the state capital loss carryforward. If management’s assumptions change and we determine the Company will be able to realize these capital loss carryforwards, the tax benefits related to any reversal of the valuation allowance on deferred tax assets as of December 31, 2016, will be accounted for as a future reduction in income tax expense and a corresponding increase in equity.
During 2015, the Company amended its 2010 federal tax return which resulted in a decrease to the 2013 Capital Loss carryforward and offsetting refund of approximately $5.6 million. As of December 31, 2016 the Company has recovered this refund.
Basic earnings per share (“EPS”) is based on the weighted average number of common shares outstanding for the period, excluding any dilutive common share equivalents. Diluted EPS reflects the potential dilution resulting from exercises of stock options, vesting of restricted stock, vesting of performance share units, and conversion of preferred stock.
Represents the dilutive effect of unvested Restricted Stock, unvested Performance Share Units, and unexercised Stock Options.
In 2014, UVE entered into a letter agreement with Ananke Catastrophe Investment Ltd., an affiliate of Nephila Capital Ltd., that calls for a minimum annual spend of $5 million towards covered loss index swaps during the period from June 1, 2016 through May 31, 2025, of which UVE incurred $900 thousand towards that minimum annual spend through December 31, 2016. UVE has an annual spend remaining of $4.1 million towards covered loss index swaps by May 31, 2017.
GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. GAAP describes three approaches to measuring the fair value of assets and liabilities: the market approach, the income approach and the cost approach. Each approach includes multiple valuation techniques. GAAP does not prescribe which valuation technique should be used when measuring fair value, but does establish a fair value hierarchy that prioritizes the inputs used in applying the various techniques. Inputs broadly refer to the assumptions that market participants use to make pricing decisions, including assumptions about risk. Level 1 inputs are given the highest priority in the hierarchy while Level 3 inputs are given the lowest priority. Assets and liabilities carried at fair value are classified in one of the following three categories based on the nature of the inputs to the valuation technique used:
Long-term debt: The fair value of the surplus note was determined by management from the expected cash flows discounted using the interest rate quoted by the holder. The SBA is the holder of the surplus note and the quoted interest rate is below prevailing rates
quoted by private lending institutions. However, as the Company’s use of funds from the surplus note is limited by the terms of the agreement, the Company has determined the interest rate quoted by the SBA to be appropriate for purposes of establishing the fair value of the note.
The information about unpaid losses and loss adjustment expenses for the years ended December 31, 2012 to 2015, is presented as supplementary information and is unaudited.
Set forth is the supplementary information about average historical claims duration as of December 31, 2016:
Incurred but not reported (“IBNR”), which are anticipated losses expected to be reported to the company and development of reported claims
LAE, which are the estimated expenses associated with the settlement of case reserves and IBNR
Underwriting results are significantly influenced by the company’s practices in establishing its estimated liability for unpaid losses and LAE. The liability is an estimate of amounts necessary to ultimately settle all current and future claims and LAE on claims occurring during the policy coverage period each year as of the financial statement date.
The liability for unpaid losses and LAE, also known as reserves, are established based on estimates of the ultimate future amounts needed to settle claims, either known or unknown, less losses that have been paid to date. Claims are typically reported promptly with relatively little reporting lag between the date of occurrence and the date the loss is reported. The company’s claim settlement data suggests that homeowners’ property losses have an average settlement time of less than one year, while homeowners’ liability losses generally take longer.
Reserves for losses and LAE are determined in three primary sectors. These sectors are (1) the estimation of reserves for Florida non-catastrophe losses, (2) hurricane losses, and (4) non-Florida non-catastrophe losses and any other losses. Evaluations are performed for gross loss, LAE and subrogation separately, and on a net and direct basis for each sector. The analyses for non-catastrophe losses are further separated into data groupings of like exposure or type of loss. These groups are property damage on homeowner policy forms HO-3 and HO-8 combined, property damage on homeowner policy forms HO-4 and HO-6 combined, property damage on dwelling fire policies, sinkhole claims, water damage claims and all liability exposures combined. Although our analysis is looked at in these three sectors, these sectors are aggregated into the single tables noted above due to the analogous nature of the product and similar claim settlement traits.
As claims are reported, the claims department establishes an estimate of the liability for each individual claim called case reserves. For certain liability claims of sufficient size and complexity, the field adjusting staff establishes case reserve estimates of ultimate cost, based on their assessment of facts and circumstances related to each individual claim. For other claims which occur in large volumes and settle in a relatively short time frame, it is not practical or efficient to set case reserves for each claim, and an initial case reserve of $2,500 is set for these claims. In the normal course of business, we may also supplement our claims processes by utilizing third party adjusters, appraisers, engineers, inspectors, other professionals and information sources to assess and settle catastrophe and non-catastrophe related claims.
A second method is the reported development method. This method is similar to the paid development method; however, case reserves are considered in the analysis. Successive periods of reported loss estimates (including paid loss, subrogation recoveries, paid LAE and held case reserves) are organized similar to the paid development method in order to evaluate and select Report-to-Report (“RTR”) development factors. This method has the advantage of recognizing the information provided by current case reserves. Its implicit
assumption is that the relative adequacy of case reserves is consistent over time, and that there have been no material changes in the rate at which claims have been reported or settled. In cases where significant reserve strengthening or other changes have occurred, RTR factors are adjusted accordingly, utilizing appropriate actuarial techniques.
Total revenues for each quarter in 2016 exceeded 2015 whereby net income improved only during the first two quarters of 2016 versus 2015. In the fourth quarter of 2016 the company recorded losses and LAE for weather events including Hurricane Matthew
The Company performed an evaluation of subsequent events through the date the financial statements were issued and determined there were no recognized or unrecognized subsequent events that would require an adjustment or additional disclosure in the consolidated financial statements as of December 31, 2016.
On January 23, 2017, the Company declared a dividend of $ 0.14 per share on its outstanding common stock payable on March 2, 2017, to shareholders of record on February 17, 2017.