The Company presently occupies approximately 46,000 square feet of an office building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2012. Erwin Cheldin, the Company's former president and a current director and principal stockholder, is the owner of the building. The Company signed an extension to the lease with a 4% increase in rent effective April 1, 2007. The lease provides for an annual gross rent of $1,066,990 from April 1, 2007, through March 31, 2012. In addition, the lease extension provides for two, five-year options with a rent increase of 5% for each option period. The Company believes that at the inception of the lease agreement and at each subsequent extension, the terms of the lease were at least as favorable to the Company as could have been obtained from non-affiliated third parties. The Company utilizes for its own operations approximately 100% of the space it leases.
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; insurance premium financing; and membership association services.
The Company’s net income was $2,927,375 in 2009, $5,283,016 in 2008, and $6,712,444 in 2007.
The property and casualty insurance industry is highly competitive and includes many insurers, ranging from large companies offering a wide variety of products worldwide to smaller, specialized companies in a single state or region offering only a single product. Many of the Company's existing or potential competitors have considerably greater financial and other resources, have a higher rating assigned by independent rating organizations such as A.M. Best Company, have greater experience in the insurance industry and offer a broader line of insurance products than the Company. As of December 31, 2009, Crusader was licensed as an admitted insurance carrier in the states of Arizona, California, Nevada, Oregon, and Washington. Since 2004, all of Crusader’s business was written in the state of California. During the year ended December 31, 2009, 98% of Crusader’s business was commercial multi peril policies. Effective January 27, 2009, A.M. Best Company upgraded Crusader’s financial strength rating to A- (Excellent) from B++ (Good), and revised Crusader’s rating outlook to “stable” from “positive.” In addition, Crusader’s Issuer Credit Rating was upgraded to a- (Excellent) from bbb+ (Good). These ratings were reaffirmed by A.M. Best as of January 18, 2010.
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. Policy fee income for the twelve months ended December 31, 2009, decreased 6% as compared to the prior year. The decrease in policy fee income is a result of a decrease in the number of policies issued during the twelve months ended December 31, 2009, as compared to 2008.
AIB sells and services health insurance policies for individual/family and small business groups and receives commissions based on the premiums that it writes. Commission income decreased 8% for the year ended December 31, 2009, as compared to 2008. The decrease is primarily due to a decrease in sales of small group medical insurance offered through CIGNA HealthCare. All CIGNA small group medical insurance policyholders are members of AAQHC. In September 2009, CIGNA substantially reduced the medical plans offered to small group employers in the state of California from nineteen plans to four. All new employer groups and existing employer groups on their anniversary date will have the option to choose from the four available plans. AIB will be assisting its CIGNA policyholders in obtaining new coverage in one of the four CIGNA plans or with other contracted carriers. This reduction in CIGNA medical plans offered to Small Group Employers in the state of California resulted in a decrease in AIB commission income and AAQHC fee income. AAQHC will continue to underwrite and administer the remaining four CIGNA medical plans and CIGNA dental plans for individuals and small group employers.
The daily automobile rental insurance program is produced by Bedford Insurance Services, Inc. Bedford receives a commission from a non-affiliated insurance company based on premium written. Commission in the daily automobile rental insurance program decreased 1% as compared to 2008.
As of December 31, 2009, the weighted average maturity of the Company’s fixed maturity investments was 1.7 years compared to 2.1 years and 2.0 years as of December 31, 2008, and December 31, 2007, respectively.
Cash flow used by operations in the year ended December 31, 2009, was $2,663,559, as compared to $1,675,603 in the year ended December 31, 2008 and to $113,640 in the year ended December 31, 2007. In 2009 and 2008 the Company primarily utilized the proceeds from the maturity or sale of its fixed maturity investments to purchase new fixed maturity investments.
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 (at amortized cost) of the Company at December 31, 2009, were $137,717,039 compared to $145,070,097 at December 31, 2008. Crusader's cash and investments at December 31, 2009 and December 31, 2008, were 98% of the total cash and investments held by the Company.
The Company is required to classify its investment securities into one of three categories: held-to-maturity, available-for-sale, or trading securities. Although all of the Company's investment in fixed maturity securities 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.
The investment marketplace in general, and in certain asset classes specifically, has been impacted by volatility as a result of uncertainty in the credit markets that began in 2007 and continued throughout 2009. The Company’s fixed maturity investment portfolio as of December 31, 2009, consisted of 81% U.S. treasury securities, 16% certificates of deposit and 3% highly rated industrial and miscellaneous taxable issues bonds. As of December 31, 2009, the Company’s industrial and miscellaneous taxable bonds were all rated “A” or better by Standard & Poors.
Crusader's statutory capital and surplus as of December 31, 2009, was $62,553,813, a decrease of $2,182,417 (3%) from December 31, 2008. Crusader's statutory capital and surplus as of December 31, 2008, was $64,736,230, an increase of $6,873,896 (12%) from December 31, 2007. In the year ending December 31, 2009, Crusader issued cash dividends of $7,000,000 to Unico, its parent and sole shareholder. These dividends were primarily used to fund the cash dividends paid by Unico to its shareholders, to repurchase and retire shares of Unico common stock and for general corporate purposes. No dividends were declared or paid by Crusader to Unico in 2008 or 2007. Based on Crusader’s statutory net income for the year ended December 31, 2009, the maximum dividend that could be made by Crusader to Unico without prior regulatory approval in 2010 is $6,255,381.
For the year ended December 31, 2009, the Company had income before taxes of $4,163,978 compared to income before taxes of $7,984,466 in the year ended December 31, 2008, a decrease of $3,820,488 (48%) in income before taxes. The decrease in income before taxes was primarily due to a decrease of $1,479,647 in the underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs), and a decrease of $1,564,265 in investment income.
Crusader’s primary line of business is commercial multi peril policies. This line of business represented approximately 98% of Crusader’s total written premium for the years ended December 31, 2009 and 2008, and 96% for the year ended December 31, 2007.
For the year ended December 31, 2009, gross written premium decreased by $1,040,094 (3%) over 2008. For the year ended December 31, 2008, gross written premium decreased by $5,030,129 (11%) over 2007. The decrease in written premium in both 2009 and 2008 reflected heightened competition and management’s continued emphasis on rate adequacy and underwriting discipline. The Company cannot determine how long the existing market condition will continue, nor in which direction it might change.
The insurance marketplace continues to be intensely competitive as more insurers are competing for the same customers. Many of Crusader’s competitors price their insurance at rates that the Company believes are inadequate to support an underwriting profit. While Crusader attempts to meet such competition with competitive prices, its emphasis is on service, promotion, and distribution. Crusader believes that rate adequacy is more important than premium growth and that underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) is its primary goal. Nonetheless, Crusader believes that it can grow its sales and profitability by continuing to focus upon three key areas of its operations: (1) product development, (2) improved service to retail brokers, and (3) appointment of captive and independent retail agents. During 2009, Crusader continued to introduce product changes such as to its rates, eligibility guidelines, rules and coverage forms. Improved service is primarily focused upon transacting business through the internet, as well as providing more options to make the agents’ and brokers’ time more efficiently spent with Crusader (i.e., as opposed to spending time with Crusader’s competitors). As of December 31, 2009, Crusader had appointed sixteen retail agents. Presently, it is expected that each such retail agent should be able to reach an annual sales volume of approximately one to two million dollars of Crusader’s products within three to five years of their appointment by Crusader. However, Crusader does not intend to substantially increase its number of retail agents appointed until such time as the Company implements a new policy administration system. The Company is in the final stages of selecting an outside vendor to provide it with a state of the art policy administration software system. The Company estimates implementation of the new software system to take approximately one to one and one-half years from the date the vendor is selected.
Earned ceded premium for the 12 months ended December 31, 2009, increased $505,338 (6%) to $9,276,407 compared to $8,771,069 for the 12 months ended December 31, 2008. Earned ceded premium for the 12 months ended December 31, 2008, decreased $2,761,239 (24%) to $8,771,069 compared to $11,532,308 for the 12 months ended December 31, 2007. Earned ceded premiums as a percentage of direct earned premiums were 23% in 2009, 21% in 2008, and 24% for 2007.
In 2009 and 2008 Crusader retained a participation in its excess of loss reinsurance treaties of 20% in its 1st layer ($700,000 in excess of $300,000), 15% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 0% in its property and casualty clash treaty. In 2007 Crusader retained a participation in its excess of loss reinsurance treaties of 15% in its 1st layer ($700,000 in excess of $300,000), 15% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 15% in its property clash treaty. In 2006 and 2005 Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($700,000 in excess of $300,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2004 Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2003 Crusader retained a participation in its excess of loss reinsurance treaties of 5% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties.
The 2007 through 2009 excess of loss treaties do not provide for a contingent commission. Crusader’s 2006 1st layer primary excess of loss treaty provides for a contingent commission equal to 20% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2006, through December 31, 2006. The 2005 excess of loss treaties do not provide for a contingent commission. Crusader’s 2004 and 2003 1st layer primary excess of loss treaties provide for a contingent commission to the Company equal to 45% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2003, through December 31, 2004. For each accounting period as described above, the Company will calculate and report to the reinsurers its net profit (excluding incurred but not reported losses), if any, within 90 days after 36 months following the end of the first accounting period, and within 90 days after the end of each 12-month period thereafter until all losses subject to the agreement have been finally settled. Any contingent commission received is subject to return based on future development of ceded losses and loss adjustment expenses. As of December 31, 2009, the Company has received a total net contingent commission of $3,108,324 for the years subject to contingent commission. Of this amount, the Company has recognized $1,686,380 of contingent commission income, of which $766,651 was recognized in the year ended December 31, 2009. The remaining balance of the net payments received of $1,421,944 is currently unearned and included in “Accrued Expenses and Other Liabilities” in the consolidated balance sheets. The unearned contingent commission may be subsequently earned or returned to the reinsurer depending on the future development of the ceded IBNR for the years subject to contingent commission.
The combined ratio is the sum of (1) the net ratio of losses and loss adjustment expenses incurred (including a provision for incurred-but-not-reported losses “IBNR”) to net premiums earned (loss ratio) and (2) the ratio of policy acquisition costs to net premiums earned (expense ratio). The following table shows the loss ratios, expense ratios, and combined ratios of Crusader as derived from data prepared in accordance with GAAP.
As reflected in the above table, the amount of favorable development recognized during the year ended December 31, 2009, increased $398,752 (11%) to $3,955,553 from $3,556,801 in 2008. The amount of favorable development recognized during the year ended December 31, 2008, decreased $561,300 (14%) to $3,556,801 from $4,118,101 in 2007. The favorable development in the above table is not necessarily indicative of the results that may be expected in future periods.
Any reduction in losses and loss adjustment expenses from redundancies in the Company’s December 31, 2009, reserves over actual future payments, and/or any additional losses and loss adjustment expenses from actual future payments that exceed the Company’s reserves, will be recognized in the consolidated statements of operations of future accounting periods. The Company’s current expected loss and loss adjustment expense ratio assumption closely approximates the Company’s historical average loss and loss adjustment expense ratio. The difference between the Company’s current expected loss and loss adjustment expense ratio assumption and the actual loss and loss adjustment expense ratio for a given accident year will ultimately result in a dollar change (either higher or lower) that is a multiple of the earned premium for that year. The actual loss and loss adjustment expense ratio has been within five percentage points of the current expected loss and loss adjustment expense ratio in three of the Company’s twenty-five years. Since the Company’s net earned premium in 2009 was $30,774,471, a difference between the accident year 2009 actual and current expected loss and loss adjustment expense ratios of only five percentage points will ultimately impact losses and loss adjustment expenses by $1,538,724. The actual loss and loss adjustment expense ratio has been within ten percentage points of the current expected loss and loss adjustment expense ratio in eleven of the Company’s twenty-five years. A difference of ten percentage points on accident year 2009 will ultimately impact losses and loss adjustment expenses by $3,077,447. The actual loss and loss adjustment expense ratio has been within twenty percentage points of the current expected loss and loss adjustment expense ratio in eighteen of the Company’s twenty-five years. A twenty percentage point difference between the accident year 2009 actual and the current expected loss and loss adjustment expense ratios will ultimately impact losses and loss adjustment expenses by $6,154,894. In addition, accident years 2008 and prior are also still developing. Future development on those years might either offset or add to any future development that emerges on accident year 2009.
Analysis of the roll forward of reserves for losses and loss adjustment expenses
*In accordance with ASC 944 reinsurance recoverable on unpaid losses and loss adjustment expenses are reported for GAAP as assets rather than netted against the corresponding liability for such items on the consolidated balance sheet.
The Company’s net loss and loss adjustment expense reserve was $55,409,545 as of December 31, 2009. Since underwriting profit is a significant part of income, a small percentage change in reserve estimates may result in a substantial effect on future reported earnings. Such changes might result from a variety of factors, including claims costs emerging in a different pattern than the average historical development patterns. Considering the continuum of possible development patterns, none of which is necessarily more or less likely than the next, one must consider the varying probabilities that the development pattern is off in varying degrees. If future development ultimately ends up being five percent different than the Company’s 2009 net reserve, approximately $2.8 million would be reflected in future periods as an increase or decrease in the provision for events of prior years and would be recognized in the Company’s Consolidated Statements of Operations in future periods. A variance of five percent of net loss and loss adjustment expense reserve is not an unlikely scenario. If future development ultimately ends up being ten percent different than the Company’s 2009 net reserve, approximately $5.5 million would be reflected in future periods as an increase or decrease in the provision for events of prior years and would be recognized in the Company’s Consolidated Statements of Operations in future periods. A variance of ten percent of net loss and loss adjustment expense reserve is not an unlikely scenario. Differences of more than ten percent are also possible, though not quite as likely as differences of ten percent or less.
Membership and fee income from the association program of AAQHC is as follows:
Policy fee income for the year ended December 31, 2009, decreased $129,625 (6%) as compared to the year ended December 31, 2008. The 6% decrease in policy fee income is primarily a result of a 638 (5%) decrease in the number of policies issued during 2009 as compared to 2008.
The daily automobile rental insurance program commission income for the year ended December 31, 2009, decreased $2,114 (1%) compared to the year ended December 31, 2008. For the year ended December 31, 2008, commission income increased $13,284 (3%) compared to the year ended December 31, 2007. The daily automobile rental insurance program commission income excluding contingent commission decreased $9,035 (3%) to $336,315 in 2009 from $345,350 in 2008. The daily automobile rental insurance program commission income excluding contingent commission increased $1,230 (0%) to $345,350 in 2008 from $344,120 in 2007. Premium written in 2009 decreased 2% compared to premium written in 2008. Premium written in 2008 and 2007 were comparable. The daily automobile rental insurance program is still impacted by the intense price competition in the marketplace during the periods covered by this report. The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change. To avoid underwriting losses for the non-affiliated insurance company that it represents, Bedford continues to produce business only at rates that it believes to be adequate.
Premium finance charges and late fees earned from financing policies are as follows:
In the year ended December 31, 2009, the Company’s average invested assets (at amortized value) decreased $4,874,920 (3%) compared to the year ended December 31, 2008. In the year ended December 31, 2009, investment income earned, excluding realized gains, decreased $1,564,265 (27%) compared to the year ended December 31, 2008. The yield on average invested assets decreased to 3.06% in 2009 from 4.03% in 2008. The decrease in the yield on average invested assets is primarily the result of a decrease in the average return on new and reinvested assets in the Company’s investment portfolio. Due to the current interest rate environment, management believes it is prudent to purchase fixed maturity investments with maturities of five years or less and with minimal credit risk. Thus, the weighted average maturity of the Company’s fixed maturity investments as of December 31, 2009, was 1.7 years compared to 2.1 years as of December 31, 2008. The Company’s invested assets (at amortized value) as of December 31, 2009, were $137,598,527 as compared to $145,042,387 as of December 31, 2008.
No securities were sold at a loss during 2009 or 2008.
Commissions to agents/brokers (not including commissions on Crusader policies that are reflected in policy acquisition costs) are generally related to gross commission income from the health insurance program, the daily automobile rental insurance program, and the earthquake program. Commissions to agents and brokers decreased $190,034 (15%) for the year ended December 31, 2009, as compared to the year ended December 31, 2008. The decrease is primarily due to the decrease in written premium in the health insurance program and the decrease in commission income from that program. Commissions to agents and brokers increased $277,050 (28%) for the year ended December 31, 2008, as compared to the year ended December 31, 2007. The increase is primarily due to the increase in written premium in the health insurance program and the increase in commission income from that program.
Other operating expenses increased $79,951 (3%) for the year ended December 31, 2008, compared to the year ended December 31, 2007.
The preparation of the Company’s consolidated financial statements requires judgments and estimates. The most significant is the estimate of loss reserves. Management makes its best estimate of the liability for unpaid claims costs as of the end of each fiscal quarter. Due to the inherent uncertainties in estimating the Company’s unpaid claims costs, actual loss and loss adjustment expense payments may vary, perhaps significantly, from any estimate made prior to the settling of all claims. Variability is inherent in establishing loss and loss adjustment expense reserves, especially for a small insurer like the Company. For any given line of insurance, accident year, or other group of claims, there is a continuum of possible reserve estimates, each having its own unique degree of propriety or reasonableness. Due to the complexity and nature of the insurance claims process, there are potentially an infinite number of reasonably likely scenarios. The Company does not specifically identify reasonably likely scenarios other than utilizing management’s best estimate. In addition to applying the various standard methods to the data, an extensive series of diagnostic tests are applied to the resultant reserve estimates to determine management’s best estimate of the unpaid claims liability. Among the statistics reviewed for each accident year are loss and loss adjustment expense development patterns, frequencies (expected claim counts), severities (average cost per claim), loss and loss adjustment expense ratios to premium, and loss adjustment expense ratios to loss. When there is clear evidence that the actual claims costs emerged are different than expected for any prior accident year, the claims cost estimates for that year are revised accordingly.
At the end of each fiscal quarter, the Company’s reserves are re-evaluated for each accident year (i.e., for all claims incurred within each year) by a committee consisting of the Company’s president and the Company’s chief financial officer. It is also reviewed by an independent consulting actuary. The Company uses the loss ratio method to estimate ultimate claims costs for the current accident year. The current accident year IBNR reserves are initially determined by multiplying earned premiums for the year by the expected loss and loss adjustment expense ratio, then subtracting the current accident year’s cumulative incurred (paid plus case reserves) to date. This method is subject to adjustment based upon actual results incurred during the reporting period. This initial IBNR reserve is adjusted as subsequent development of that accident year takes place.
The Company also applies several additional standard actuarial methods to the historical claims costs data to estimate its unpaid claims liability for each accident year. The additional standard methods include loss development methods and Bornhuetter-Ferguson methods, both of which can be applied to paid losses and loss adjustment expenses (claims costs), reported incurred (paid plus case reserve) claims costs, and/or claim counts. These methodologies do not vary by tail length; however, certain parameters do vary. In particular, loss development factors for short-tail property claims are different than for long-tail liability claims.
Development patterns generally do not tend to change materially over time. Generally, the Company has very little property claim development subsequent to the end of an accident year. Although liability claims may take ten or more years to fully develop, most of the development occurs in the first five to six years subsequent to the end of the accident year. However, liability claims are substantially developed by two years subsequent to the end of the accident year. Other than the change in the expected loss and loss adjustment expense ratio assumption discussed above, the Company’s reserving methodology assumptions have not changed in the years presented. The only significant effect on the Company’s financial statements has resulted from estimated costs being adjusted as actual costs emerge.
The information that management uses to arrive at its best reserve estimate comes from many sources within the Company, including its accounting, legal, claims, and underwriting departments. Informed managerial judgment is applied throughout the reserving process. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount 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 must estimate its ultimate losses and loss adjustment expenses using a very small claim population size. At the beginning of 2008, the Company had 657 open claim files. During 2009, 1,086 new claim files were opened and 1,121 claim files were closed, leaving 622 open claim files at the end of 2009. Due to the small size of the Company and the related small population of claims, the Company’s losses and loss adjustment expenses for any accident year can vary significantly from the initial expectations. Due to the small number of claims, changes in claim frequency and/or severity can materially affect the Company’s reserve estimate. The potential variability from management’s best estimate cannot be measured from any meaningful statistical basis due to the numerous uncertainties in the claims reserving process and the small population of claims.
At each quarterly review, actual claims costs that emerge are compared with the claims costs that were expected to emerge during that development period. Sometimes the previous claims costs estimates prove to have been too high; sometimes they prove to have been too low. In the case of the Company, the estimates proved to be too high in each of the past three years. The favorable development in 2007 through 2009 underscores the inherent uncertainty in insurance claims costs, especially for a very small insurer.
The Company’s recoverable from reinsurers represents an estimate of the amount of future loss and loss adjustment expense payments that will be recoverable from the Company’s reinsurers. These estimates are based upon estimates of the ultimate losses and loss adjustment expenses that the Company expects to incur and the portion of those losses that are expected to be allocable to reinsurers based upon the terms of the reinsurance agreements. Given the uncertainty of the ultimate amounts of losses and loss adjustment expenses, the estimates may vary significantly from the eventual outcome. The Company’s estimate of the amounts recoverable from reinsurers is regularly reviewed and updated by management as new data becomes available. The Company’s assessment of the collectibility of the recorded amounts recoverable from reinsurers is based primarily upon public financial statements and rating agency data. Any adjustments necessary are reflected in the current operations. The Company evaluates each of its ceded reinsurance contracts at their inception to determine if there is sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting literature. At December 31, 2009, all such ceded contracts are accounted for as risk transfer reinsurance.
Consolidated Statements of Comprehensive Income for the years ended December 31, 2009, 2008, and 2007
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2009, 2008, and 2007
We have audited the accompanying consolidated balance sheets of Unico American Corporation and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In June 2009, the FASB issued a new standard related to accounting standards codification and the hierarchy of generally accepted accounting principles. The new standard establishes the FASB Accounting Standards Codification™ as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Company adopted the new standard which became effective for the interim reporting period ended September 30, 2009. The adoption of the new standard did not have a material impact on the Company’s consolidated financial statements.
Investment Securities excluding Long Term Certificates of Deposit - Fair values are obtained from a national quotation service.
ASC 820, “Fair Value Measurements and Disclosures,” was adopted by the Company as of January 1, 2008. The accounting standard establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Financial assets and financial liabilities recorded on the consolidated balance sheets at fair value are categorized based on the reliability of inputs to the valuation techniques as follows:
The Company’s fixed maturity investments are all classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources in active markets for identical assets with reasonable levels of price transparency. Fair value measurements are not adjusted for transaction costs.
ASC 740, which became effective January 1, 2007, prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Since adoption of ASC 740 and as of December 31, 2009, the Company had no unrecognized tax benefits and no additional liabilities or reduction in deferred tax asset. In addition, the Company had not accrued interest and penalties related to unrecognized tax benefits. However, if interest and penalties would need to be accrued related to unrecognized tax benefits, such amounts would be recognized as a component of federal income tax expense.
As required by law, the Company segregates from its operating accounts the premiums collected from insureds which are payable to insurance companies into separate trust accounts. These amounts are included in cash and short-term investments. In 2009, the Company’s receivables from insurance policies exceeded its premiums payable to insurance companies; therefore, there were no trust restrictions on cash and short-term investments.
The insurance company operation is conducted through the Company’s wholly owned subsidiary Crusader Insurance Company (Crusader), which as of December 31, 2009, was licensed as an admitted insurance carrier in the states of Arizona, California, Nevada, Oregon, and Washington. Crusader is a multi-line property and casualty insurance company, which began transacting business on January 1, 1985. For the year ended December 31, 2009, 98% of Crusader’s business was commercial multi peril (CMP) insurance policies. CMP policies provide a combination of property and liability coverage for businesses. Commercial property coverages insure against loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, hail, water, explosions, severe winter weather, and other events such as theft and vandalism, fires and storms and financial loss due to business interruption resulting from covered property damage. However, Crusader does not write earthquake coverage. Commercial liability coverages insure against third party liability from accidents occurring on the insured’s premises or arising out of its operations, such as injuries sustained from products sold or the operation of the insured premises. In addition to commercial multi peril policies, Crusader also writes separate policies to insure commercial property and commercial liability risks on a mono-line basis.
(2) Intersegment asset eliminations reflect the elimination of Crusader receivables and Unifax payables.
In 2009 and 2008, 100% of Crusader’s gross premium written was derived from California. In 2009 approximately 76% of the $2,526,772 commission and fee income from the Company’s health insurance program was from CIGNA HealthCare medical and dental plan programs. In 2008, approximately 82% of the $2,754,293 commission and fee income from the Company’s health insurance program was from CIGNA HealthCare medical and dental plan programs.
At December 31, 2009, the Company’s reinsurance recoverable on paid and unpaid losses and loss adjustment expenses of $16,629,177 was as follows:
In April 2009, the Financial Accounting Standards Board (FASB) issued guidance on “Recognition and Presentation of Other-Than-Temporary Impairments.” This guidance requires entities to separate an other-than-temporary impairment of a debt security into two components when there are credit related losses associated with the impaired debt security and management asserts that it does not have the intent to sell the security and it is more likely than not that it will not be required to sell the security before recovery of its cost basis. The amount of the other-than-temporary impairment related to a credit loss is recognized in earnings and the amount of the other-than-temporary impairment related to other factors is recorded in other comprehensive income (loss). This guidance was effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance did not materially impact the Company’s consolidated financial condition or results of operations.
In June 2009, the FASB issued guidance on “Accounting for Transfers of Financial Assets” that requires enhanced disclosures about transfers of financial assets and a company’s continuing involvement in transferred assets. This guidance is effective for financial statements issued for fiscal years beginning after November 15, 2009. The adoption of this guidance did not materially impact the Company’s consolidated financial condition or results of operations.
The amortized cost and estimated fair value of fixed maturity investments at December 31, 2009, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
At December 31, 2008, the fixed maturity investments with a gross unrealized loss for continuous periods of 0 to 6 months consisted of three investment grade industrial securities.
The Company’s net loss and loss adjustment expense reserve was $55,409,545 as of December 31, 2009. Since underwriting profit is a significant part of income, a small percentage change in reserve estimates may result in a substantial effect on future reported earnings. Such changes might result from a variety of factors, including claims costs emerging in a different pattern than the average historical development patterns. Considering the continuum of possible development patterns, none of which is necessarily more or less likely than the next, one must consider the varying probabilities that the development pattern is off in varying degrees. If future development ultimately ends up being five percent different than the Company’s 2009 net reserve, approximately $2.8 million would be reflected in future periods as an increase or decrease in the provision for events of prior years and would be recognized in the Company’s consolidated statement of operations in future periods. A variance of five percent of net loss and loss adjustment expense reserve is not an unlikely scenario. If future development ultimately ends up being ten percent different than the Company’s 2009 net reserve, approximately $5.5 million would be reflected in future periods as an increase or decrease in the provision for events of prior years and would be recognized in the Company’s consolidated statement of operations in future periods. A variance of ten percent of net loss and loss adjustment expense reserve is not an unlikely scenario. Differences of more than ten percent are also possible, though not quite as likely as differences of ten percent or less.
A reinsurance transaction occurs when an insurance company transfers (cedes) a portion of its exposure on policies written to a reinsurer that assumes that risk for a premium (ceded premium). Reinsurance does not legally discharge the Company from primary liability under its policies. If the reinsurer fails to meet its obligations, the Company must nonetheless pay its policy obligations.
Earned reinsurance ceded premium as a percentage of direct earned premium was 23% in 2009, 21% in 2008 and 24% in 2007.
Crusader is required to file an annual statement with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory). Statutory accounting practices differ in certain respects from GAAP. The more significant of these differences for statutory accounting are (a) premium income is taken into earnings over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) fixed maturity securities are reported at amortized cost, or the lower of amortized cost or fair value, depending on the quality of the security as specified by the NAIC; c) non-admitted assets are charged directly against surplus; (d) loss reserves and unearned premium reserves are stated net of reinsurance; and (e) federal income taxes are recorded when payable and deferred taxes, subject to limitations, are recognized but only to the extent that they do not exceed a specified percentage of statutory surplus; changes in deferred taxes are recorded directly to surplus as regards policyholders. Additionally, the cash flow presentation is not consistent with U.S. generally accepted accounting principles and reconciliation from net income to cash provided by operations is not presented. Comprehensive income is not presented under statutory accounting.
The California Department of Insurance (the insurance department) conducts periodic financial examinations of Crusader. The Insurance Department has completed a financial examination of Crusader’s December 31, 2008, statutory financial statements. A final report on the examination was issued by the Insurance Department on October 22, 2009. No significant issues were reported in the final report.
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 serve as a diagnostic solvency tool for regulators that establishes uniform capital levels and specific authority levels for regulatory intervention when an insurer falls below minimum capital levels. The RBC Model Law specifies four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer if its RBC is equal to or less than 200% of its computed authorized control level RBC. A company's RBC is required to be disclosed in its statutory annual statement. The RBC is not intended to be used as a rating or ranking tool nor is it to be used in premium rate making or approval. Crusader’s adjusted capital at December 31, 2009, was 793% of authorized control level risk-based capital.
An unusual range of ratio results has been established from studies of the ratios of companies that have become insolvent or have experienced financial difficulties. In the analytical phase, companies that receive four or more financial ratio values outside the usual range are analyzed in order to identify those companies that appear to require immediate regulatory action. Subsequently, a more comprehensive review of the ratio results and the insurer’s annual statement is performed to confirm that an insurer’s situation calls for increased or close regulatory attention. In 2009, the Company was not outside the usual values on any of the thirteen IRIS ratio tests.
On December 30, 2005, the Company accelerated the vesting of all of its outstanding stock-based compensation awards granted under the Company’s 1999 Omnibus Stock Plan. All accelerated options were “in the money.” The number of shares covered by the options accelerated totaled 67,500 of which 37,500 were originally scheduled to vest on January 1, 2006, and 30,000 were originally scheduled to vest on January 1, 2007. The Company accelerated vesting of the options in order to minimize the compensation costs associated with the adoption of ASC 718. All accelerated options were granted to long-term management employees who were not expected to leave the Company prior to the originally scheduled vesting date. The estimated compensation cost which would have been excluded from future periods as a result of the acceleration of the vesting of the options was approximately $89,100. There were no options granted during 2009, 2008 and 2007 and there were no unvested options as of January 1, 2006. No compensation expenses were recorded for the years ended December 31, 2009, December 31, 2008 and December 31, 2007.
The Company’s 1999 Omnibus Stock Plan that covered 500,000 shares of the Company’s common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.) was approved by shareholders on June 4, 1999. This plan terminated in accordance with its terms in March 2009. All then outstanding options continued in full force in accordance with the agreements under which those options were issued. On August 26, 1999, the Company granted 135,000 incentive stock options, of which 30,000 options had been exercised, 45,000 had been terminated and the remaining 60,000 options expired on August 26, 2009.
The following table summarizes information regarding the stock options outstanding at December 31, 2009:
The Company and its wholly owned subsidiaries file consolidated federal and state income tax returns. Pursuant to the tax allocation agreement, Crusader Insurance Company and American Acceptance Corporation are allocated taxes or tax credits in the case of losses, at current corporate rates based on their own taxable income or loss. The Company files income tax returns under U.S. federal and various state jurisdictions. The Company is subject to examination by U.S. federal income tax authorities for years 2007 through 2009 and California state income tax authorities for years 2005 through 2009. There are no ongoing examinations of income tax returns by federal or state tax authorities.