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.
This overview discusses some of the relevant factors that management considers in evaluating the Company's performance, prospects and risks. It is not all-inclusive and is meant to be read in conjunction with the entirety of the management discussion and analysis, the Company's financial statements and notes thereto, and all other items contained within the report on this Annual Report on Form 10-K.
Revenue and Income Generation - ----------------------------- The Company receives its revenue primarily from earned premium derived from the insurance company operations, commission and fee income generated from the insurance agency operations, finance charges and fee income from the premium finance operations, and investment income from cash generated primarily from the insurance company operation. The insurance company operation generates approximately 88% of the Company's total revenue. The Company's remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually not material to consolidated revenues.
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, factors such as changes in, among other things, regulations, changes in the legal environment, and inflation can all impact the ultimate cost.
The 2004 development of prior year losses was favorable in the amount of $835,434 as compared to $2,751,585 of adverse development of prior year losses in 2003 and $7,790,817 in 2002. The 2003 adverse development of prior year losses was substantially lower than 2002, and the 2003 adverse development was primarily attributable to one claim.
Other Operations - ---------------- The Company's other operations generate commissions, fees, and finance charges from various insurance products. The events that have the most significant economic impact on other operations are as follows:
Unifax primarily 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 financial statements. As a result of a slight decrease in the number of policies sold by Unifax during 2004 as compared to 2003, policy fee income for the 12 months ended December 31, 2004, decreased 2% as compared to the prior year period.
AIB sells and services health insurance policies for individual/family and small business groups primarily for CIGNA HealthCare (CIGNA) and receives commission and fee income based on the premiums that it writes. Commission and fee income in this program decreased 35% in the year ended December 31, 2004, compared to 2003. The decrease is a result of 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. As such, AIB's commission from all insurance carriers other than CIGNA increased approximately 78% in 2004 as compared to 2003.
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 Company's current loss and loss expense reserves and expected current and future payments, the Company believes that there are no current liquidity issues.
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, 2004, were $132,122,792 compared to $118,592,895 at December 31, 2003, an 11% increase. Crusader's cash and investments at December 31, 2004, was $129,887,431 or 98% of the total held by the Company, compared to $116,736,763 or 98% of the total held by the Company at December 31, 2003.
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 trust restriction of $773,404, statutory deposits of $700,000, cash deposited (with superior courts) in lieu of bond of $752,659 and dividend restriction between Crusader and Unico (see Item 1 - Business - Insurance Company Operation - - Holding Company Act) plus the cash to be generated from operations, should be sufficient to meet its operating requirements during the next twelve months without the necessity of borrowing funds. The Company anticipates incurring approximately $600,000 of capital expenditures in 2005 for computer hardware and software related to its conversion to a "paperless office." This project is expected to be completed by mid-2005. The Company's analysis of its potential return on this capital expenditure is estimated to be approximately two years due to anticipated productivity improvements and lower operating costs.
For the year ended December 31, 2003, the Company had income before taxes of $2,149,371 compared to a loss before taxes of $4,814,059 in the year ended December 31, 2002, an increase in income before taxes of $6,963,430. The increase in pre-tax income was primarily due to a decrease of $6,086,381 in the underwriting loss (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader. The Company had a net income for the year ended December 31, 2003, of $1,068,650 compared to a net loss of $3,224,689 for the year ended December 31, 2002, an increase in net earnings of $4,293,339.
The effect of inflation on the net income of the Company during the years ended December 31, 2004, 2003, and 2002 was not significant.
As indicated in the above table, the number of policies issued during the 12 months ended December 31, 2004, decreased by 540 (3%) as compared to the prior year. However, the average premium per policy in 2004 increased by $309 (10%) as compared to the 12 months ended December 31, 2003. As previously discussed, the increase in average gross written premium per policy is a result of several factors including a subsidence in price based competition in the property casualty insurance market (making the Company's products more competitive) and an increase in rates for some of the Company's products.
The Company writes annual policies and, therefore, earns written premium daily over the one-year policy term. Premium earned before reinsurance increased $14,136,689 (26%) in the year ended December 31, 2004, compared to the year ended December 31, 2003, and increased $13,185,274 (33%) in the year ended December 31, 2003, compared to the year ended December 31, 2002. The increase in earned premium before reinsurance in 2004 and 2003 is a direct result of the increase in written premium for these years.
Ceding commissions on the Company's excess of loss treaties increased from 25% in 2002 to 35% beginning January 1, 2003. Ceding commission is a component of policy acquisition costs. The annual aggregate deductible on Crusader's primary excess of loss treaty was $675,000 in 2002, and $500,000 in 2003 and 2004. In 2004 Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st and 2nd layers (i.e., 10% of $750,000 in excess of $250,000 and 10% of $1,000,000 in excess of $1,000,000, respectively), and 15% in its property clash treaty. In 2003 Crusader retained a participation in its excess of loss reinsurance treaties of 5% in its 1st layer (i.e., 5% of $750,000 in excess of $250,000), 10% in its 2nd layer (i.e., 10% of $1,000,000 in excess of $1,000,000), and 30% in its property clash treaty. Premium ceded under the provisionally rated contract, which was canceled on a runoff basis effective December 31, 1997, is subject to adjustment based on the amount of losses ceded, limited by a maximum percentage that can be charged by the reinsurer.
Crusader's 2004 and 2003 1st layer primary excess of loss treaty provides for a contingent commission equal to 45% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission is December 31, 2005. Based on losses and loss adjustment expenses ceded (including incurred but not reported losses) as of December 31, 2004, no contingent commission has been accrued.
Beginning January 1, 2005, Crusader increased its retention from $250,000 to $300,000 per risk. There has been no change in the 2005 annual aggregate deductible amount or participation rates compared to 2004. The contingent commission does not apply to 2005 premium. Due to favorable loss experience in 2003 and 2004, reinsurance premium on the Company's 1st layer primary excess of loss treaty ($700,000 in excess of $300,000) decreased by 24% compared to 2004.
Reserves for losses and loss adjustment expenses before reinsurance was $87,469,000 at December 31, 2004, compared to $78,139,090 and $74,905,284 at December 31, 2003 and 2002 respectively. The increase in loss and loss adjustment expense reserves in 2004 and 2003 is primarily a result of increased IBNR reserves as a result of the 26% and 32% increase in direct earned premium in the years ended December 31, 2004 and 2003 respectively, as discussed above.
Managements analysis and actions regarding underwriting activity - ---------------------------------------------------------------- Crusader incurred underwriting losses in 2000, 2001, and 2002. As a result of these underwriting losses, Crusader's management analyzed and acted upon the following components of its underwriting activity:
A. In September 2000, the Company identified a subcategory of apartment building risk, referred to as the "Big and Old" group. The Company believes that members of this group pose a greater-than-average probability of habitability loss.
C. On September 7, 2002, the Company changed its coverage forms to limit the "costs taxed against the insured" clause of the "Supplementary Provisions" coverage grant, from unlimited to $100,000.
3. Construction Defect Exposure: The Company continuously modifies its underwriting practice with respect to subcontractors in an effort to improve loss experience. For example, subcontractors performing "waterproofing, weather-coating, or decking" were deemed ineligible by the Company in 1995; and, to minimize the adverse effects of the Montrose decision of 1995, the Company changed its coverage forms in 1996; and, the Company adopted numerous, program-specific questions to its applications, inspections, and survey forms. Although the Company believes that the ultimate results of its post-1996 underwriting of this class of business will prove to be profitable, the results will not be known until the 10 year statute runs. Therefore, on April 18, 2002, the Company sought regulatory approval for a change in or discontinuation of its experience rating plan. When the regulator disapproved that filing, on June 18, 2002, the Company imposed a moratorium on all new offers of artisan contractors' insurance. In January 2003 Crusader received regulatory approval of its plan to discontinue experience rating, which translates into a 21% rate increase for all coverages offered to artisan contractors. However, because the Company is cautious about underwriting this type of business, it has not lifted the underwriting moratorium that started on June 18, 2002. Since that date, attrition was significant, reducing the number of policies in force. Until such time that the Company can change this program to make underwriting more predictable, the moratorium will not be lifted.
4. The Special Risks Division: The Company's Special Risk class of business represents risks written within current underwriting programs that have a higher degree of exposure and require special pricing and underwriting. In November 2000 after a change of program management, the Company reviewed those policies underwritten by its Special Risks division. That review resulted in the cancellation of a significant number of policies, those thought to be generating most of the losses.
Special Risk Special Risk Special Risk Direct Written Direct Earned Policies Year Premium Premium In Force ---- ------- ------- -------- 1998 $2,734,635 $3,380,747 259 as of 12/31/98 1999 $2,595,032 $2,636,451 235 as of 12/31/99 2000 $2,851,194 $2,731,012 250 as of 12/31/00 2001 $2,922,257 $2,925,365 201 as of 12/31/01 2002 $2,329,771 $2,582,673 131 as of 12/31/02 2003 $1,804,249 $2,222,707 115 as of 12/31/03 2004 $25,772 $775,167 10 as of 12/31/04
8. Terrorism Exposure: All policies are endorsed with a "Terrorism Endorsement" that conforms with the Federal Terrorism Risk Insurance Act of November 26, 2002. All policyholders that reject the federal coverage will get a policy containing a Terrorism Exclusion endorsement.
Commission and fee income decreased $1,156,924 (35%) in the year ended December 31, 2004, compared to 2003. The decrease is primarily due to the discontinuance of CIGNA's individual and family health insurance program in the state of California. AIB was able to secure other insurance for approximately half of the 2,200 CIGNA members that were terminated by CIGNA. AIB could not obtain insurance for the remaining CIGNA individuals and family members primarily due to their pre-existing health conditions or that they were able to secure insurance through their employer or their spouse's employer. The discontinuance of CIGNA's individual and family health insurance program did not affect the CIGNA small group program. Due to intense competition in both rates and benefits offered, CIGNA small group program membership decreased in 2004. As of December 31, 2004, CIGNA small group program membership is comprised of 1,488 subscribers and 878 dependents compared to 1,935 subscribers and 1,149 dependents as of December 31, 2003.
Commissions/overrides from other carriers are generally higher than the commission structure paid by CIGNA. As such, AIB's commission income from all insurance carriers except CIGNA increased approximately 78% in 2004 as compared to 2003.
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Policy fee income $3,394,783 $3,458,559 $2,241,883 Policies written 20,885 21,425 18,603
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Rental program commission $555,964 $574,197 $642,005 Claim administration fee - 241,428 80,531 Contingent commission 9,488 - 66,947 ------- ------- ------- Total commission and fee income $565,452 $815,625 $789,483 ======= ======= =======
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Membership and fee income $333,470 $481,366 $424,784
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. 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.
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Earthquake program commission income $53,140 $40,015 $51,576 Miscellaneous commission and fee income 111 1,112 11,626 ------ ------ ------ Total other commission and fee income $53,251 $41,127 $63,202 ====== ====== ======
Unifax began producing commercial earthquake insurance policies in California for non-affiliated insurance companies in 1999. Unifax receives a commission from these insurance companies based on premium written. Commission income on the earthquake program for the year ended December 31, 2004, increased $13,125 (33%) compared to the prior year. The commission income on the earthquake program is based on premium written.
AAC provides premium financing to Crusader policies produced by Unifax in California. The growth of this program is dependent and directly related to the growth of Crusader's written premium and AAC's ability to market its competitive rates and service to finance those policies. Premium finance charges and fees earned decreased $19,014 (2%) in the year ended December 31, 2004, compared to the prior year due to the fact that there were 1,060 (17%) fewer loans financed in the current year. However, the decrease in the number of new loans issued during 2004 was offset by the 13% increase in the average premium financed as compared to 2003. During 2004, 33% of all Unifax policies were financed and 74% of those policies were financed by AAC. During 2003, 36% of all Unifax policies were financed and 81% of those policies were financed by AAC.
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Interest income Insurance company operations $4,204,573 $4,801,133 $5,401,870 Other operations 38,250 47,010 56,176 --------- --------- --------- Total interest income 4,242,823 4,848,143 5,458,046 Net realized investment gains - - 3,690 --------- --------- --------- Total investment income and realized gains $4,242,823 $4,848,143 $5,461,736 ========= ========= =========
In the year ended December 31, 2004, while the Company's average invested assets (at amortized value) increased $14,716,855 (13%) compared to the year ended December 31, 2003, investment income earned (excluding net realized gains) decreased $605,320 (12%) compared to the year ended December 31, 2003. The decrease in investment income is primarily the result of a decline in the average return on new and reinvested assets in the Company's investment portfolio. Also contributing to the decline in average return is a shorter weighted average maturity of new and reinvested assets. Due to the current interest rate environment, management believes it prudent to purchase fixed maturity investments with shorter maturities and therefore, the weighted average maturity of the Company's fixed maturity investments has decreased from 1.9 years as of December 31, 2003, to 1.4 years as of December 31, 2004. In the year ended December 31, 2004, the Company's average yield on invested assets (at amortized value) was 3.39% compared to 4.38% at the year ended December 31, 2003. The Company's average invested assets increased in the year ending December 31, 2004, 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 $970,343 (1% of total investments) at December 31, 2004, compared to $2,029,891 (2% of total investments) at December 31, 2003.
In the year ended December 31, 2003, while the Company's average invested assets (at amortized value) increased $11,939,605 (12%) compared to the year ended December 31, 2002, investment income earned (excluding net realized gains) decreased $609,903 (11%) compared to the year ended December 31, 2002. The decrease in investment income was primarily the result of a decline in the average return on new and reinvested invested assets in the Company's investment portfolio due to both a general decline in short and long-term yield in the marketplace and a shorter weighted average maturity of the portfolio. The weighted average maturity of the Company's fixed maturity investments has decreased from 2.4 years as of December 31, 2002, to 1.9 years as of December 31, 2003. In the year ended December 31, 2003, the Company's average yield on invested assets (at amortized value) was 4.38% compared to 5.53% at the year ended December 31, 2002. The Company's average invested assets increased in the year ending December 31, 2003, 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 $2,029,891 (2% of total investments) at December 31, 2003, compared to $2,731,060 (3% of total investments) at December 31, 2002.
The Company continually evaluates the recoverability of its investment holdings. All securities held by the Company are rated. When a decline in value of fixed maturities or equity securities is considered other than temporary, a loss is recognized in the consolidated statements of operations. In 2004, there were no other than temporary declines in the value of fixed maturity or equity securities recognized in the consolidated statements of operations. No securities were sold at a loss during 2004, 2003 or 2002.
The following table summarizes, for all fixed maturities in an unrealized loss position as of December 31, 2004, the aggregate fair value and gross unrealized loss by length of time those fixed maturities have been continuously in an unrealized loss position:
Operating Expenses - ------------------ 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 allocated expenses of other Unico subsidiaries. On certain reinsurance treaties, Crusader receives a ceding commission from its reinsurer that represents a reimbursement of the acquisition costs related to the premium ceded. No ceding commission is received on facultative, catastrophe, or provisionally rated ceded premium. Policy acquisition costs, net of ceding commission, are deferred and amortized as the related premiums are earned. The ratio of policy acquisition cost to net earned premium in 2004 and 2003 were lower than the ratio in 2002 primarily due to the increase in the Company's ceding commission from its reinsurer as of January 1, 2003 from 25% in 2002 to 35% in both 2003 and 2004. Policy acquisition costs, net of ceding commission, are as follows:
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Policy acquisition costs $10,319,186 $7,941,199 $9,274,263 Ratio to net earned premium (GAAP ratio) 21% 21% 28%
SALRIES AND EMPLOYEE BENEFITS incurred for the year ended December 31, 2004, increased $349,347 (4%) compared to the year ended December 31, 2003.
OTHER OPERATING EXPENSES generally do not change significantly with changes in production. This is true for both increases and decreases in production. Operating expenses decreased $240,576 (8%) for the year ended December 31, 2004, compared to the year ended December 31, 2003. The decrease in other operating expenses was in part due to $111,122 decrease in interest expense. As described below, due a change in law in September 2004, the Company recognized as income 80% of the interest expense accrued at December 31, 2003, on a Notice of Proposed Assessment (NPA) by the California Franchise Tax Board for tax years 1999 and 2000.
Recently Issued Accounting Standards - ------------------------------------ In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 123R, "Share-Based Payment" ("SFAS No. 123R") that will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards will be re-measured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123R replaces Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," the principles that the Company currently employs to account and report its employee stock option awards. SFAS No. I 23R is effective for the first interim reporting period that begins after June 15, 2005.
Significant Accounting Policies - ------------------------------- The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of certain 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 period. While every effort is made to ensure the integrity of such estimates, actual results could differ.
Losses and Loss Adjustment Expenses ----------------------------------- The preparation of the Company's financial statements requires judgments and estimates. The most significant is the estimate of loss reserves as required by Statement of Financial Accounting Standards No 60 (SFAS No. 60), Accounting and Reporting by Insurance Enterprises and Statement of Financial Accounting Standards No. 5 (SFAS No. 5), Accounting for Contingencies. Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. 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 can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. 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 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.
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.
Consolidated Balance Sheets as of December 31, 2004, and December 31, 2003 36
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2004, December 39 31, 2003, and December 31, 2002 39
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 and 2002
The Company had net unrealized investment gains, net of deferred taxes, of $376,172 as of December 31, 2004, and $2,110,979 as of December 31, 2003.
Year ended December 31 ---------------------- 2004 2003 ---- ---- Premium trust funds (1) $773,404 $939,491 Cash deposited in lieu of bond (2) 752,659 752,659 Assigned to state agencies (3) 700,000 2,825,000 --------- --------- Total restricted funds $2,226,063 $4,517,150 ========= =========
Deferred Policy Acquisition Costs - --------------------------------- Policy acquisition costs consist of costs associated with the production of insurance policies such as commissions, premium taxes, and certain other underwriting expenses that vary with and are primarily related to the production of the insurance policy. Policy acquisition costs are deferred and amortized as the related premiums are earned and are limited to their estimated realizable value based on the related unearned premiums 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.
The insurance company operation is conducted through the Company's wholly owned subsidiary Crusader Insurance Company (Crusader), which as of December 31, 2004, was licensed as an admitted insurance carrier in the states of Arizona, California, Idaho, Montana, Nevada, Ohio, Oregon, and Washington. Crusader is a multiple-line property and casualty insurance company, which began transacting business on January 1, 1985. As of December 31, 2004, 98% of Crusader's business was commercial multiple peril business package insurance
At December 31, 2004, the Company's reinsurance recoverable on paid and unpaid losses and loss adjustment expenses of $20,137,523 were as follows:
A.M. Best Amount Name of Reinsurer Rating Recoverable - ----------------- ------ ----------- Platinum Reinsurance A $7,508,919 Partners Reinsurance of the U.S. A+ 5,430,618 Hannover Ruckversicherungs AG A 4,070,346 General Reinsurance Corporation A++ 2,180,640 QBE Reinsurance Corporation A 947,000 ---------- Total $20,137,523 ==========
Recently Issued Accounting Standards - ------------------------------------ In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 123R, Share-Based Payment (SFAS No. 123R) that will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards will be re-measured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123R replaces Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, the principles that the Company currently employs to account and report its employee stock option awards. SFAS No. I23R is effective for the first interim reporting period that begins after June 15, 2005.
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Fixed maturities $4,200,190 $4,742,204 $5,354,707 Short-term investments 42,633 105,939 103,339 --------- --------- --------- Total investment income $4,242,823 $4,848,143 $5,458,046 ========= ========= =========
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ----
Year ended December 31 ---------------------- 2004 2003 ---- ---- Certificates of deposit $400,000 $425,000 Cash deposited in lieu of bond * 752,659 752,659 Commercial paper 1,005,000 2,000,000 U.S. treasury bills - 2,998,850 Commercial bank money market accounts 803,949 902,517 U.S. government obligation money market fund 144,925 147,666 Savings account 11,585 2,623 --------- --------- Total short-term investments $3,118,118 $7,229,315 ========= =========
NOTE 4 - PROPERTY AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION) - ---------------------------------------------------------------- Property and equipment consist of the following:
Bad debt expense for the fiscal year ended December 31, 2004, and the fiscal year ended December 31, 2003, was $29,402 and $23,895, 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.
NOTE 9 - LEASE COMMITMENT TO RELATED PARTY - ------------------------------------------ The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The total rent expense under this lease agreement was $1,025,952 for the year ended December 31, 2004; $1,025,952 for the year ended December 31, 2003; and $1,025,952 for the year ended December 31, 2002.
Year ended December 31 ---------------------- 2004 2003 ---- ---- Premium payable $3,394,181 $4,241,811 Unearned claim administration income 100,000 100,000 Profit sharing contributions 636,186 477,000 Accrued salaries 331,054 250,803 Commission payable 333,525 299,153 Assessments due California Insurance Guarantee Association - 650,448 Other 429,837 956,073 --------- --------- Total accrued expenses and other liabilities $5,224,783 $6,975,288 ========= =========
On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays a commission to Crusader, which includes a reimbursement of the cost of acquiring the portion of the premium, which is ceded. Ceding commission was $6,031,987 in 2004, $5,429,330 in 2003, and $1,356,061 in 2002. Crusader does not currently assume any reinsurance. The Company intends to continue obtaining reinsurance although the availability and cost may vary from time to time. The unpaid losses ceded to the reinsurer are recorded as an asset on the balance sheet.
The effect of reinsurance on premiums written, premiums earned, and incurred losses is as follows:
Incurred losses and loss adjustment expenses: Direct $40,436,295 $39,036,895 $54,352,403 Assumed - - - Ceded (5,985,557) (7,316,362) (21,625,380) --------- ---------- ---------- Net incurred losses and loss adjustment expenses $34,450,738 $31,720,533 $32,727,023 ========== ========== ==========
NOTE 13 - PROFIT SHARING PLAN - ----------------------------- During the fiscal year ended March 31, 1986, the Company adopted the Unico American Corporation Profit Sharing Plan. Employees who are at least 21 years of age and have been employed by the Company for at least two years are participants in the Plan. Pursuant to the terms of the Plan, the Company annually contributes to the account of each participant an amount equal to a percentage of the participant's eligible compensation as determined by the Board of Directors. Participants are entitled to receive benefits under the plan upon the later of
the following: the date 60 days after the end of the plan year in which the participant's retirement occurs or one year and 60 days after the end of the plan year following the participant's termination with the Company. However, the participant's interest must be distributed in its entirety no later than April 1 of the calendar year following the calendar year in which the participant attains age 70 1/2 or otherwise in accordance with the Treasury Regulations promulgated under the Internal Revenue Code of 1954 as amended.
Year ended December 31, 2004 $759,482 Year ended December 31, 2003 $674,977 Year ended December 31, 2002 $434,789
In December 1993, the National Association of Insurance Commissioners (NAIC) adopted a Risk-Based Capital (RBC) Model Law for property and casualty companies. The RBC Model Law is intended to provide standards for calculating a variable regulatory capital requirement related to a company's current operations and its risk exposures (asset risk, underwriting risk, credit risk and off-balance sheet risk). These standards are intended to
Insurance Regulatory Information System (IRIS) was developed by a committee of state insurance regulators primarily to assist state insurance departments in executing their statutory mandate to oversee the financial condition of insurance companies. IRIS helps those companies that merit highest priority in the allocation of the regulators' resources on the basis of 12 financial ratios that are calculated annually. The analytical phase is a review of annual statements and the financial ratios. The ratios and trends are valuable in pointing to companies likely to experience financial difficulties, but are not themselves indicative of adverse financial condition. The ratio and benchmark comparisons are mechanically produced and are not intended to replace the state insurance department's own in-depth financial analysis or on-site examinations.
In 2004, the Company was outside the usual values on two of the twelve IRIS ratio tests. These ratios were the Estimated Current Reserve Deficiency to Surplus Ratio and the Investment Yield Ratio. The Estimated Current Reserve Deficiency to Surplus ratio was outside the usual values due to adverse development of the Company's losses and loss adjustment expense reserves in 2002 and 2003. The Investment Yield Ratio compares the Company's investment yield of 3.4% to an established minimum and maximum range of greater than 4.5% and less than 10%. The decrease in the Company's investment yield is primarily the result of a decline over the last 5 years in short and long-term yields in the marketplace and a shorter weighted average maturity of the portfolio. Due to the interest rate environment, management believed it was prudent to purchase fixed maturity investments with shorter maturities with minimal credit risk.
On December 18, 2002, the Company granted an additional 182,000 incentive stock options under the Company's 1999 Omnibus Stock Plan of which 2,500 options were exercised, 2,500 options were terminated and 177,000 were outstanding as of December 31, 2004. These options expire 10 years from the date of the grant. These options become exercisable as follows:
Weighted Average Options Exercise Price ------- -------------- Outstanding at December 31, 2001 116,415 $8.686 Options granted 182,000 3.110 Options exercised (8,245) 3.500 Options terminated (3,170) 3.500 ------- Outstanding at December 31, 2002 287,000 5.356 Options granted - - Options exercised - - Options terminated (10,000) 9.250 ------- Outstanding at December 31, 2003 277,000 5.216 Options granted - - Options exercised (2,500) 3.110 Options terminated (2,500) 3.110 ------- Outstanding at December 31, 2004 272,000 $5.254 =======
The following table summarizes information regarding the stock options outstanding at December 31, 2004:
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Current provision: Federal $2,947,668 $703,663 (1,599,760) State 64,400 572,822 160,626 --------- ---------- --------- Total federal and state 3,012,068 1,276,485 (1,439,134) Deferred (21,110) (195,764) (150,236) --------- --------- --------- Provision for taxes $2,990,958 $1,080,721 $(1,589,370) ========= ========= =========
2002 federal income tax loss carryback to 1998 (1,548,427) Adjustment to 2001 tax provision (51,333) --------- 2002 federal income tax provision $(1,599,760) =========
Deferred tax liabilities: Deferred acquisition costs $2,789,102 $2,738,484 Unrealized gain on investments 193,785 1,087,474 State tax on undistributed insurance company earnings 157,249 - Tax depreciation in excess of book depreciation 66,913 32,483 Other 166,529 178,519 --------- --------- Total deferred tax liabilities $3,376,588 $4,036,960 --------- ---------
In the year ended December 31, 2003, the Company recognized an income tax expense of $287,000 resulting from an assessment for the years 1999 and 2000 from the California Franchise Tax Board. The assessment resulted from a court ruling in Ceridian vs. Franchise Tax Board that held that the California statute permitting the tax deductibility of dividends received from a wholly owned insurance subsidiary was unconstitutional because it discriminated against out-of-state holding companies and thus was in violation of the interstate commerce clause of the United States Constitution. The ruling concluded that the discriminatory sections of the statute are not severable and the entire statute was invalid and unenforceable. California law provides that the proper remedy in such circumstances is to disallow the deduction to those taxpayers who benefited from the deduction. As a result of the court ruling, in February 2003, the Franchise Tax Board (FTB) notified the Company that it would issue a Notice of Proposed Assessment (NPA) for tax years 1999 and 2000 of approximately $287,000 representing California state franchise taxes plus related interest of approximately $80,000. In September 2004, California enacted legislation (AB 263) that
addresses many aspects of the tax treatment of insurance company owners, including holding companies such as Unico. The legislation provides for an election, applicable if made to all tax years ending after December 1, 1997, and before January 1, 2005, under which a dividend-received deduction of up to 80% of dividends paid by an insurer to a non-insurer parent is allowed. The Company made the election authorized by AB 263 and, therefore, has reversed 80% of the $287,000 income tax expense. The Company has also reversed 80% of the interest accrued at December 31, 2003, on the $287,000 assessment. In addition, as a result of AB 263, the Company recognized a state deferred tax liability of $157,249 in accordance with FASB 109. This deferred tax liability represents the Company's future state tax liability for all undistributed earnings of Crusader since January 1, 1993. The federal tax benefit resulting from AB 263 as of December 31, 2004, is $53,465. Thus, the net deferred tax liability as of December 31, 2004, is $103,784.
NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) - ------------------------------------------------------ Summarized unaudited quarterly financial data for each of the calendar years 2004 and 2003 is set forth below: