We are authorized to underwrite, and/or place through our wholly owned subsidiaries, homeowners’ multi-peril (“homeowners”), commercial general liability, personal and commercial automobile, personal umbrella, fire, allied lines, workers’ compensation and commercial inland marine insurance in Florida and various other states. We market and distribute our own and third-party insurers’ products and our other services through a network of independent agents. We also utilize a select number of general agents for the same purpose.
In January 2011, we merged Federated National and our other wholly owned insurance subsidiary, American Vehicle Insurance Company (“American Vehicle”), with Federated National continuing the operations of both entities. In connection with this merger, the Company, Federated National and American Vehicle entered into a Consent Order with the Florida Office of Insurance Regulation ("Florida OIR") pursuant to which we agreed to certain restrictions on our a business operations. See “Regulation - Consent Order”.
· We internally process claims made by our insureds through our wholly owned claims adjusting company, Superior Adjusting, Inc. (“Superior”). Until June 2011, we offered premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc. (“Federated Premium”).
· Assurance Managing General Agents, Inc. ("Assurance MGA"), a wholly owned subsidiary of the Company, acts as Federated National’s exclusive managing general agent in Florida and is also licensed as a managing general agent in the States of Alabama, Georgia, Illinois, Louisiana, North Carolina, Mississippi, Missouri, New York, Nevada, South Carolina, Texas and Virginia. Assurance MGA has contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation, personal umbrella and inland marine insurance through Assurance MGA’s existing network of agents.
The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with management’s evaluation of the determination of (i) liability for unpaid losses and LAE, (ii) the amount and recoverability of amortization of Deferred Policy Acquisition Costs ("DPAC"), and (iii) estimates for our reserves with respect to finance contracts, premiums receivable and deferred income taxes. Various assumptions and other factors underlie the determination of these significant estimates, which are described in greater detail in Footnote 2 in this Form 10-K.
Except as described below, we believe that in 2011 there were no significant changes in those critical accounting policies and estimates. Senior management has reviewed the development and selection of our critical accounting policies and estimates and their disclosure in this Form 10-K with the Audit Committee of our Board of Directors.
The process of determining significant estimates is fact-specific and takes into account factors such as historical experience, current and expected economic conditions, and in the case of unpaid losses and LAE, an actuarial valuation. Management regularly reevaluates these significant factors and makes adjustments where facts and circumstances dictate. In selecting the best estimate, we utilize various actuarial methodologies. Each of these methodologies is designed to forecast the number of claims we will be called upon to pay and the amounts we will pay on average to settle those claims. In arriving at our best estimate, our actuaries consider the likely predictive value of the various loss development methodologies employed in light of underwriting practices, premium rate changes and claim settlement practices that may have occurred, and weight the credibility of each methodology. Our actuarial methodologies take into account various factors, including, but not limited to, paid losses, liability estimates for reported losses, paid allocated LAE, salvage and other recoveries received, reported claim counts, open claim counts and counts for claims closed with and without payment for loss.
The methods we use for our short-tail business do not differ from the methods we use for our long-tail business. The Incurred and Paid Development Methods intrinsically recognize the unique development characteristics contained within the historical experience of each material short-tail and long-tail line of business. The Incurred and Paid Cape Cod Methods reflect similar historical development unique to each material short-tail and long-tail line of business.
A key assumption underlying the estimation of the reserve for loss and LAE is that past experience serves as the most reliable estimator of future events. This assumption may materially affect the estimates when the insurance market, the regulatory environment, the legal environment, the economic environment, the book of business, the claims handling department, or other factors (known or unknown) have varied over time during the experience period and / or will vary (expectedly or unexpectedly) in the future. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made. Therefore, the ultimate liability for unpaid losses and LAE will likely differ from the amount recorded at December 31, 2011.
A number of other actuarial assumptions are generally made in the review of reserves for each class of business.
Total investments increased $7.0 million, or 5.7%, to $129.5 million as of December 31, 2011, compared with $122.5 million as of December 31, 2010.
Investments classified as held-to-maturity include debt securities where the Company’s intent and ability are to hold the investment until maturity and are carried at amortized cost without consideration to unrealized gains or losses. Investments classified as trading securities include debt and equity securities bought and held primarily for sale in the near term and are carried at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments and are carried at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, namely “Other Comprehensive Income.”
The net unrealized gain of $1.4 million is inclusive of $2.4 million of unrealized losses. The $2.4 million of unrealized losses is inclusive of $2.0 million unrealized losses from equity securities and $0.4 million unrealized losses from debt securities.
FASB has also issued guidance regarding when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. Factors used in such consideration include the extent and length of time over which the market value has been less than cost, the financial condition and near-term prospects of the issuer and our ability and intent to keep the investment for a period sufficient to allow for an anticipated recovery in market value. In reaching a conclusion that a security is either other-than-temporarily or permanently impaired, we also consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor’s and Moody’s Investors Service, Inc. (“Moody’s”), as well as information released via the general media channels. During 2011, in connection with the process, we have charged to operations $0.8 million of investment losses. During 2010, in connection with this process, we have not charged any net realized investment loss to operations.
The following table summarizes, by type, our investments as of December 31, 2011 and 2010.
During 2011, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity.
During 2010, we re-classified $3.1 million of amortized cost to held-to-maturity from available-for-sale to fund trust agreements.
Premiums receivable, net of allowance for credit losses, remained unchanged at $5.6 million as of December 31, 2011, compared with $5.6 million as of December 31, 2010.
Our commercial general liability insurance premiums receivable decreased $0.2 million, or 15.2%, to $1.2 million as of December 31, 2011, compared with $1.4 million as of December 31, 2010.
Deferred income taxes, net, increased $0.7 million, or 8.8%, to $8.6 million as of December 31, 2011, compared with $7.9 million as of December 31, 2010. Deferred income taxes, net, is comprised of approximately $12.1 million and $11.2 million of deferred tax assets, net of approximately $3.5 million and $3.3 million of deferred tax liabilities as of December 31, 2011 as of December 31, 2010. The change in the net deferred tax asset is primarily due to the increase in the deferred tax assets related to discounted unearned premiums, discount on advanced premiums and net operating losses carry forward.
Income taxes receivable decreased $2.4 million, or 100.0%, to nothing as of December 31, 2011, compared with $2.4 million as of December 31, 2010. The change is due to the receipt of our prior year refund, net of our loss as discussed within “Results of Operations- Year Ended December 31, 2011 Compared with Year Ended December 31, 2010”.
Other assets decreased $0.2 million, or 9.4%, to $2.1 million as of December 31, 2011, compared with $2.3 million as of December 31, 2010. Major components of other assets are shown in the following table; the accrued interest income receivable is primarily investment related.
During 2011 and 2010, the change to the cumulative wind mitigation credits afforded our policyholders totaled $4.2 million and ($0.3) million, respectively.
Our in-force homeowners’ policies increased by approximately 700, or approximately 2.0%, to approximately 43,800 as of December 31, 2011, as compared with approximately 43,100 as of December 31, 2010.
Our earnings can also be impacted by our ratings, such as the rating of Federated National by Demotech, Inc. (“Demotech”). Federated National’s rating as of December 31, 2011 was "A" ("Exceptional"). For more information regarding our rating and the impact of a change or withdrawal of our rating, please see “Business-Regulation-Industry Rating Services.”
The decrease to gross premiums ceded relating to our homeowners’ program is primarily due to the reduced cost of reinsurance purchased from the Florida Hurricane Catastrophe Fund ("FHCF"). The ceded relating to our automobile program is associated with our arrangement to write nonstandard private passenger automobile insurance through a reputable managing general agent familiar with the Georgia market. A quota share treaty cedes 100% of the risk and fully collateralizes for unearned premium and unpaid loss and LAE.
Commission income decreased $0.4 million, or 28.4%, to $1.0 million for 2011, compared with $1.4 million for 2010. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link, Inc. (“Insure-Link”).
Net investment income increased $0.4 million, or 9.5%, to $4.1 million for 2011, compared with $3.7 million for 2010. Our investment yield, net and gross of investment expenses, excluding equities and including cash, were 2.9% and 3.1%, respectively, for 2011. Our investment yield, net and gross of investment expenses, excluding equities and including cash, were 2.5% and 2.7%, respectively, for 2010.
Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, were 3.1% and 3.4%, respectively, for 2011. The primary reason for our lower investment yield in 2011 was the Company harvested gains that were a result of the Federal Reserve's activity in the bond market, which pushed up bond prices and lowered yields. Hence the proceeds from recognizing the gains were reinvested at yields that were lower than what was sold. Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, were 3.4% and 3.7%, respectively, for 2010.
Net realized investment gains were $2.7 million for 2011, compared with net realized investment gains of $6.8 million for 2010. Specifically, net realized losses for equity securities were $0.3 million for 2011, compared with $1.7 million net realized gains for 2010. For debt securities, net realized gains were nearly $3.0 million for 2011, compared with net realized gains of $4.0 million for 2010. During 2011, the Company, because of the actions taken by the Federal Reserve to maintain a low interest rate environment, realized significant gains in the fixed income portfolio. During 2010, the Company had an overweight in corporate bonds that performed well and sold these bonds to lock in gains and bolster the surplus of our insurance companies.
The table below depicts the net realized investment gains by investment category during 2011 and 2010.
Operating and underwriting expenses decreased $0.9 million, or 8.5%, to $9.9 million for 2011, compared with $10.8 million for 2010. The decreases include $0.4 million in surveys and underwriting reports, $0.3 million in actuarial fees and $0.2 million in insurance expense.
Policy acquisition costs - amortization, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned.
Gross premiums written decreased $8.0 million, or 7.6%, to $96.4 million for 2010, compared with $104.4 million for 2009. The following table denotes gross premiums written by major product line. This decrease reflected primarily a decrease in the sale of homeowners’ and commercial general liability policies.
The decrease in the sale of homeowners’ policies by $7.9 million, or 9.3%, to $76.8 million in 2010, compared with $84.7 million in 2009, is gross of reinsurance costs and net of Florida’s mandated homeowners’ wind mitigation discounts. We offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. As of December 31, 2010, 60.1% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $27.3 million (a 26.0% reduction of in-force premium), while 56.8% of our in-force homeowners’ policyholders were receiving wind mitigation credits totaling approximately $27.6 million, (a 24.2 % reduction of in-force premium), as of December 31, 2009.
As a result of our expanded underwriting criteria, our in-force homeowners’ policies decreased by approximately 9,500, or approximately 18.0%, to approximately 43,100 as of December 31, 2010, as compared with approximately 52,600 as of December 31, 2009.
The change in homeowners’ net premiums earned is due to an $8.0 million decrease in gross written premium as discussed, a $5.6 million decrease in gross premiums ceded and a $3.8 million increase in the net change to prepaid reinsurance premiums and unearned premium.
The change in commercial general liability net premiums earned is a result of a $3.4 million decrease in gross written premium, reflecting the impact of the economic slowdown on the artisan contractor portfolio written by American Vehicle and our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas. The change is also a result of a $0.1 million increase in gross premiums ceded and a $2.3 million decrease in the net change to unearned premium.
Other income remained unchanged at $0.8 million in 2010, compared with $0.8 million in 2009. The major component of other income in 2010 and 2009 included approximately $0.5 million in partial recognition of our gain on the sale of our Lauderdale Lakes property.
Operating and underwriting expenses increased $1.1 million, or 11.9%, to $10.8 million in 2010, compared with $9.7 million in 2009. The change is primarily due to a $0.4 million increase in actuarial fees, a $0.2 million increase in consulting fees, a $0.2 million increase in licenses and fees, a less than $0.2 million increase in surveys and underwriting reports, and immaterial increases in other expenses.
In 2011, our primary sources of capital included proceeds from the sale of investment securities, decreased reinsurance recoverable, net, decreased income taxes recoverable, decreased prepaid reinsurance premiums, amortization of investment premium discount, net, increased accounts payable and accrued expenses, increased unearned premiums and increased bank overdraft. Also contributing to our liquidity was increased premium deposits and customer credit balances, non-cash compensation, depreciation and amortization, decreased policy acquisition costs, net of amortization and increased income taxes payable. Because we are a holding company, we are largely dependent upon fees and commissions from our subsidiaries for cash flow.
In 2011, net cash provided by operating activities was $4.2 million. In 2010 and 2009, net cash used by operating activities was $6.5 million and $11.6 million, respectively.
In 2011, 2010 and 2009, net cash used by investing activities was $5.2 million, $5.1 million and $82.7 million. Our available for sale investment portfolio is highly liquid as it consists entirely of readily marketable securities. In 2011, investing activities generated $108.3 million and used $113.5 million.
In 2011, net cash provided by financing activities was less than $0.1 million. In 2010 and 2009, net cash used by financing activities was $0.4 million and $2.0 million, respectively. In 2011, the source of cash in connection with financing activities was a tax benefit related to non-cash compensation.
Federated National’s statutory capital surplus as of December 31, 2011 was approximately $39.3 million and its statutory net income in 2011 was $0.8 million.
Federated National’s and American Vehicle’s statutory capital surplus as of December 31, 2010 were approximately $18.7 million and $22.0 million, respectively, and their statutory net losses in 2010 were $12.0 million and $1.6 million, respectively.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of 21st Century Holding Company as of December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.
21st Century is an insurance holding company that controls substantially all steps in the insurance underwriting, distribution and claims processes through our subsidiaries and our contractual relationships with our independent agents and general agents.
We are authorized to underwrite, and/or place through our wholly owned subsidiaries, homeowners, commercial general liability, personal and commercial automobile, personal umbrella, fire, allied lines, workers’ compensation and commercial inland marine insurance in Florida and various other states. We are authorized to underwrite in various states on behalf of our wholly owned subsidiary, Federated National and other insurance carriers. Federated National is the resulting entity following the merger of Federated National with and into our other wholly owned subsidiary, American Vehicle in January 2011.In connection with this merger, the Company, Federated National and American Vehicle entered into the Consent Order with the Florida OIR. See "Footnote 8 - Regulatory Requirements and Restrictions”. We market and distribute our own and third-party insurers’ products and our other services through a network of independent agents. We also utilize a select number of general agents for the same purpose.
Federated National is licensed as an admitted carrier in Florida. Through contractual relationships with a network of approximately 3,000 independent agents, of which approximately 600 actively sell and service our products, Federated National is authorized to underwrite homeowners’, fire, allied lines and personal and commercial automobile insurance in Florida. Effective January 26, 2011, Federated National merged with and into American Vehicle and American Vehicle changed its name to Federated National.
A non-admitted carrier is allowed to do business in that state and is strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Sometimes, non-admitted carriers are referred to as “excess and surplus” lines carriers. Non-admitted carriers are subject to considerably less regulation with respect to policy rates and forms. Non-admitted carriers are not required to financially contribute to and benefit from the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.
During 2007 American Vehicle applied for and was granted, by the Florida OIR in 2008, a license to underwrite commercial multi-peril and inland marine lines of business as an admitted carrier. Operations under American Vehicle’s newly granted lines of authority began in 2009.
During 2011, 81.8%, 10.3%, 4.6% and 3.3% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and personal automobile insurance, respectively. During 2010, 79.7%, 12.3%, 4.1% and 3.9% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and personal automobile insurance, respectively.
Premium revenue on all lines is earned on a pro-rata basis over the life of the policies. Unearned premiums represent the portion of the premium related to the unexpired policy term.
We recognize the income and expense on reinsurance contracts principally on a pro-rata basis over the term of the reinsurance contracts or until the reinsurers maximum liability is exhausted, whichever comes first. We are reinsured under separate reinsurance agreements for the different lines of business underwritten. Reinsurance contracts do not relieve us from our obligations to policyholders. We continually monitor our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. We only cede risks to reinsurers whom we believe to be financially sound. At December 31, 2011, all reinsurance recoverables are considered current and deemed collectable.
Financial instruments, which potentially expose us to concentrations of credit risk, consist primarily of investments, premiums receivable, amounts due from reinsurers on paid and unpaid losses and finance contracts. We have not experienced significant losses related to premiums receivable from individual policyholders or groups of policyholders in a particular industry or geographic area. We believe no credit risk beyond the amounts provided for collection losses is inherent in our premiums receivable or finance contracts. In order to reduce credit risk for amounts due from reinsurers, we seek to do business with financially sound reinsurance companies and regularly review the financial strength of all reinsurers used. Additionally, our credit risk in connection with our reinsurers is frequently mitigated by the establishment of irrevocable clean letters of credit in favor of Federated National.
In June 2011, the FASB issued ASU No. 2011-05: Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The guidance in this ASU is intended to increase the prominence of items reported in other comprehensive income in the financial statements by presenting the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The guidance in this ASU does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. Upon adoption, this update is to be applied retrospectively and is effective during interim and annual periods beginning after December 15, 2011. Early adoption is permitted. The adoption of this ASU will not have a material impact on our financial condition, results of operations or cash flows.
In September 2011, the FASB issued ASU No. 2011-08: Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which amends ASC Topic 350, Intangibles-Goodwill and Other. The guidance in this ASU permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC Topic 350. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The adoption of this ASU will not have a material impact on our financial condition, results of operations or cash flows.
In October 2010, the FASB issued ASU No. 2010-26: Financial Services - Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, a consensus of FASB Emerging Issues Task Force. The amendments in this update modify the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. The amendments in this update specify that the costs must be based on successful efforts (that is, acquiring a new or renewal contract). The amendments also specify that advertising costs should be included as deferred acquisition costs under certain circumstances. The amendments in this update are effective for fiscal years, and interim period within those fiscal years, beginning after December 15, 2011. The amendments in this update should be applied prospectively upon adoption. Retrospective application to all prior periods presented upon the date of adoption also is permitted, but not required. Early adoption is permitted, but only at the beginning of an entity’s annual reporting period. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.
In February 2010, the FASB issued ASU No. 2010-09: Amendments to Certain Recognition and Disclosure Requirements, an amendment to Topic 855 Subsequent Events, to address potentially conflicting interactions of the requirements in this Topic with the SEC’s reporting requirements. This update amends Topic 855 as follows: i) an entity that either is a SEC filer or a conduit bond obligor is required to evaluate subsequent events through the date that the financial statements are issued, if the entity does not meet either of these criteria then it should evaluate subsequent events through the date the financial statements are available to be issued; and ii) an SEC filer is not required to disclose the date through which subsequent events have been evaluated. All amendments in this ASU are effective upon issuance of this ASU, except for the use of the issued date for conduit debt obligors which effective date is for interim and annual periods ending after June 15, 2010. The Company’s subsequent events disclosure reflects the new guidance.
The fair value of our investments is estimated based on prices published by financial services or quotations received from securities dealers and is reflective of the interest rate environment that existed as of the close of business on December 31, 2011 and 2010. Changes in interest rates subsequent to December 31, 2011 may affect the fair value of our investments. Refer to Footnote 21 of the Notes to Consolidated Financial Statements for details.
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2011 and 2010 because of their short-term nature: cash and short term investments, premiums receivable, finance contracts, due from reinsurers, revolving credit outstanding, bank overdraft, accounts payable and accrued expenses.
Property, plant and equipment is stated at cost less accumulated depreciation. Depreciation on property, plant and equipment is calculated on a straight-line basis over the following estimated useful lives: building and improvements - 30 years and furniture and fixtures - 7 years. We capitalize betterments and any other expenditure in excess of $1,000 if the asset is expected to have a useful life greater than one year. The carrying value of property, plant and equipment is periodically reviewed based on the expected future undiscounted operating cash flows of the related item. Based upon our most recent analysis, we believe that no impairment of property, plant and equipment exists at December 31, 2011.
Total Investments increased $7.0 million, or 5.7%, to $129.5 million as of December 31, 2011, compared with $122.5 million as of December 31, 2010.
The debt and equity securities that are available for sale and carried at fair value represent 94% of total investments as of December 31, 2011, compared with 95% as of December 31, 2010.
The FASB issued guidance also addresses the determination as to when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. The Company’s policy for the valuation of temporarily impaired securities is to determine impairment based on the analysis of the following factors.
As of December 31, 2011 and December 31, 2010, we have classified $7.1 million and $6.2 million, respectively, of our bond portfolio as held-to-maturity. We only classify bonds as held-to-maturity to support securitization of credit requirements.
United States Treasury notes with a book value of $2,004,527 and $64,438, maturing in 2012 and 2016, respectively, were on deposit with the Florida OIR as of December 31, 2011, as required by law for Federated National, and are included with other investments held until maturity.
Depreciation of property, plant, and equipment was $167,753, $221,494 and $188,424 during 2011, 2010 and 2009, respectively.
The Company holds collateral under related reinsurance agreements in the form of fully funded trust agreements totaling $4.6 million that can be drawn on for amounts that remain unpaid for more than 120 days.
The liability for unpaid losses and LAE is determined on an individual-case basis for all incidents reported. The liability also includes amounts for unallocated expenses, anticipated future claim development and IBNR.
The estimated Ultimate Loss and Defense & Cost Containment Expense (“DCCE”) is based on an analysis by line of business, coverage and by accident quarter performed using data as of December 31, 2011. The analysis relies primarily on four actuarial methods: Incurred Loss & DCCE Development Method, Paid Loss & DCCE Development Method, Bornhuetter-Ferguson Incurred Method, and Bornhuetter-Ferguson Paid Method. Each method relies on company experience, and, where relevant, the analysis includes comparisons to industry experience. The following is a description of each of these methods:
We select an estimate of ultimate loss & DCCE for each accident quarter after considering the results of each projection method for the quarter and the relative maturity of the quarter (the time elapsed between the start of the quarter and December 31, 2011). Reserves for unpaid losses & DCCE for each quarter are the differences between these ultimate estimates and the amount already paid. The reserves for each quarter and each coverage are summed, and the result is the overall estimate of unpaid losses & DCCE liability for the company.
We also produce an estimate of unpaid Adjusting and Other Expense (“A&O”), as a reserve is required under SAP even if this expense has been pre-paid or with an unconsolidated affiliate. Although we do not prepay for A&O, the majority of the A&O incurred is with an affiliated company and eliminated under the accounting principles for consolidation. The unpaid A&O is added to unpaid losses & DCCE, resulting in total unpaid losses and LAE.
In practice there are factors that change over time; however, many (such as inflation) are intrinsically reflected in the historical development patterns, and others typically do not materially affect the estimate of the reserve for unpaid losses and LAE. Therefore, no specific adjustments have been incorporated for such contingencies projecting future development of losses and LAE. There are no key assumptions as of December 31, 2011 premised on future emergence inconsistent with historical loss reserve development patterns.
Effective January 26, 2011, Federated National merged with and into American Vehicle, and the resulting entity changed its name to “Federated National Insurance Company”.
As part of its approval of the January 2011 merger between Federated National and American Vehicle, the Florida OIR, the Company, Federated National and American Vehicle entered into a consent order with the Florida OIR dated January 25, 2011 (the “Consent Order”) pursuant to which the Company and the resulting company in the merger (the “Merged Company”) agreed to the following:
The Merged Company will not write commercial multi peril policy premium without prior approval from the Florida OIR. The Merged Company has no commercial multi peril policy premium in force.
The Merged Company will not write new commercial habitation condominium associations without prior approval from the Florida OIR. The current commercial habitation book of business is approximately $1.6 million of policy premium, which will renew pursuant to normal underwriting guidelines.
The Merged Company agreed to reduce the total number of its homeowners’ policies in Miami-Dade, Broward and Palm Beach counties (the “Tri-County Area”) to 40% of its entire homeowners’ book by December 31, 2011 and limit its new homeowners’ policies in the Tri-County Area to $500,000 of new policy premium per month. The 40% was achieved through the increased writing of property located outside of the Tri-County Area, the non-renewal of certain policies located within the Tri-County Area, and limiting the writing of new property located within the Tri-County Area. As of December 31, 2011, the Company had approximately 33.2% of its homeowners’ policies located within Tri-County Area.
The claims service fees payable by the Merged Company to Superior were reduced from the traditional 4.5% of gross earned premium to 3.6% of gross earned premium. This will have no impact on the Company’s consolidated financial results.
We had bonds with a carrying value of approximately $2.1 million and $2.0 million pledged to the Florida OIR, as of December 31, 2011 and 2010, respectively, in accordance with regulatory requirements.
No dividends were paid by Federated National or American Vehicle in 2011, 2010 and 2009, and none are anticipated in 2012 as a result of our Consent Order with the Florida OIR. Although we believe that amounts required to meet our financial and operating obligations will be available from sources other than dividends from our insurance subsidiaries, there can be no assurance in this regard. Further, there can be no assurance that, if requested, the Florida OIR will allow any dividends to be paid by Federated National to us, the parent company, in the future. The maximum dividends permitted by state law are not necessarily indicative of an insurer’s actual ability to pay dividends or other distributions to a parent company, which also may be constrained by business and regulatory considerations, such as the impact of dividends on capital surplus, which could affect an insurer’s competitive position, the amount of premiums that can be written and the ability to pay future dividends. Further, state insurance laws and regulations require that the statutory capital surplus of an insurance company following any dividend or distribution by it be reasonable in relation to its outstanding liabilities and adequate for its financial needs.
Based on risk-based capital requirements, the extent of regulatory intervention and action increases as the ratio of an insurer’s statutory surplus to its Authorized Control Level (“ACL”), as calculated under the NAIC’s requirements, decreases. The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200.0% of the ACL amount. The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150.0% of the ACL amount. The third action level, ACL, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70.0% of the ACL amount. Federated National’s ratio of statutory surplus to its ACL was 409.7%, 222.8 % and 245.1% at December 31, 2011, 2010 and 2009, respectively. American Vehicle’s ratio of statutory surplus to its ACL was 373.4% and 426.9% at December 31, 2010 and 2009, respectively.
Most recently the Florida OIR subjected Federated National to a balance sheet audit as of December 31, 2009. There were no material findings by the independent auditors in connection with this examination. Federated National also experienced a regularly scheduled statutory examination by the Florida OIR which occurred during 2010 for the five years ended December 31, 2009. There were no material findings in connection with this examination. The previous regulatory examination conducted by the Florida OIR on Federated National covered the three-year period ended on December 31, 2004.
American Vehicle also experienced a regularly scheduled statutory examination by the Florida OIR which occurred during 2011 for the five years ended December 31, 2010. There were no material findings in connection with this examination. The previous regulatory examination conducted by the Florida OIR on American Vehicle covered the three-year period ended on December 31, 2005.
As of December 31, 2011, Federated National was outside NAIC’s usual range for two of thirteen IRIS ratios. These exceptions related to two-years overall operating ratio and investment yield.
As of December 31, 2010, Federated National was outside NAIC’s usual range for four of thirteen IRIS ratios. These exceptions related to two-years overall operating ratio, investment yield, gross change in policyholders’ surplus and change in adjusted policyholders’ surplus. The Florida OIR approved an additional rate increase for our voluntary property book of homeowners’ business which averaged 20.2% statewide and went into effect November 1, 2009 and December 1, 2009 for new and renewed homeowner insurance policies, respectively.
The table below reflects the range and test results for both Federated National and American Vehicle for the years ended December 31, 2011 and 2010, respectively.
Federated National's statutory net income was $1.0 million for 2011, and Federated National's statutory net loss was $12.0 million and $12.2 million for 2010 and 2009, respectively. Federated National’s statutory non-admitted assets were approximately $5.7 million and $3.1 million as of December 31, 2011 and 2010, respectively.
The Company also faces, in the ordinary course of business, lawsuits that seek damages beyond policy limits, commonly known as bad faith claims. During 2010, one such suit was brought against one of the Company’s affiliates. This suit was dismissed and the dismissal is currently under appeal. In the opinion of management, the ultimate disposition of this matter will not have a material adverse effect on our financial condition or results of operations. The Company continually evaluates potential liabilities and reserves for litigation of these types using the criteria established by FASB issued guidance. Under this guidance, reserves for a loss are recorded if the likelihood of occurrence is probable and the amount can be reasonably estimated. If a loss, while not probable, is judged to be reasonably possible, management will make an estimate of a possible range of loss or state that an estimate cannot be made. Management considers each legal action using this guidance and records reserves for losses as warranted.
Federated National and American Vehicle are also required to participate in an insurance apportionment plan under Florida Statutes Section 627.351, which is referred to as a JUA Plan. The JUA Plan provides for the equitable apportionment of any profits realized, or losses and expenses incurred, among participating automobile insurers. In the event of an underwriting deficit incurred by the JUA Plan which is not recovered through the policyholders in the JUA Plan, such deficit shall be recovered from the companies participating in the JUA Plan in the proportion that the net direct written premiums of each such member during the preceding calendar year bear to the aggregate net direct premiums written in this state by all members of the JUA Plan. Neither Federated National nor American Vehicle was assessed by the JUA Plan during 2011, 2010 or 2009. Future assessments by this association are undeterminable at this time.
The Company’s consolidated federal and state income tax returns for 2005-2010 are open for review by the IRS and various state taxing authorities. The federal income tax returns for 2003 and 2002 have been examined by the IRS. The IRS concluded its examination for 2003 and 2002 and there were no material changes in the tax liability for those years. The 2005 and 2006 income tax returns and net operating loss carry-back from tax year 2009 have been reviewed by the Joint Committee on Taxation. The Joint Committee on Taxation completed its consideration in September 2011 and took no exception to the conclusions reached by the IRS regarding the net operating loss carry-back from tax year 2009.
A summary of the numerator and denominator of the basic and fully diluted 2011, 2010 and 2009 net loss per share is presented below.
We implemented a stock option plan in September 1998, which expired in September 2008, and provided for the granting of stock options to officers, key employees and consultants. The objectives of this plan included attracting and retaining the best personnel, providing for additional performance incentives, and promoting our success by providing employees the opportunity to acquire common stock. Options outstanding under this plan were granted at prices either equal to or above the market value of the stock on the date of grant, typically vest over a four-year or five-year period and expire six or ten years after the grant date. Under this plan, we were authorized to grant options to purchase up to 900,000 common shares, and, as of December 31, 2011 and December 31, 2010, we had outstanding exercisable options to purchase 89,750 shares.
In 2002, we implemented the 2002 Stock Option Plan. The purpose of this plan is to advance our interests by providing an additional incentive to attract, retain and motivate highly qualified and competent persons who are key to the Company, including employees, consultants, independent contractors, officers and directors. Our success is largely dependent upon their efforts and judgment; therefore, by authorizing the grant of options to purchase common stock, we encourage stock ownership. Options outstanding under the plan were granted at prices either equal to or above the market value of the stock on the date of grant, expire six or ten years after the grant date and have vesting periods determined by the Compensation Committee of our Board of Directors. Under this plan, we are authorized to grant options to purchase up to 1,800,000 common shares, and, as of December 31, 2011 and December 31, 2010, we had outstanding exercisable options to purchase 624,700 and 574,800 shares, respectively.
Options outstanding as of December 31, 2011 are exercisable as follows.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB issued guidance using the modified-prospective-transition method. Under that transition method, compensation costs recognized during 2011 and 2010 include the following.
As a result of adopting FASB issued guidance on January 1, 2006, the Company’s loss from continuing operations before provision for income tax benefit and net loss for 2011 are higher by approximately $240,000 and $150,000, respectively, than if it had continued to account for share-based compensation under APB guidance.
We have established a profit sharing plan under Section 401(k) of the Internal Revenue Code. This plan allows eligible employees to contribute up to 100 percent of their compensation, not to exceed statutory limits. The Company match totaled $0.1 million during each of the years 2011, 2010 and 2009. Through December 31, 2010, the Company matched 50% of the first 6% of a participant’s elective contributions. Effective January 1, 2011, the Board of Directors approved an amendment to our 401(k) plan to be a qualified automatic contribution arrangement with an employer match of 100% of the first 1% of elective contributions and an employer match of 50% of the next 2% to 6% of elective contributions, which is vested 100% after 2 years of service.
Effective January 26, 2011, Federated National merged with and into American Vehicle, and the resulting entity changed its name to “Federated National Insurance Company”. See " Footnote 8 - Regulation - Consent Order”.
In October 2008, the FASB issued accounting guidance to clarify the application of GAAP in determining fair value of financial instruments in a market that is not active. The guidance was effective upon issuance, including prior periods for which financial statements had not been issued. Our adoption of this guidance does not have a material effect on our financial position, results of operations, cash flows or disclosures.
Assets measured at fair value on a recurring basis as of December 31, 2011, presented in accordance with this guidance, are as follows.
On February 28, 2012, Federated National entered into a Reimbursement Contract and Addendum No. 1 thereto (together, the “Reimbursement Contract”) with the SBA for the 2012-2013 hurricane season. This Reimbursement Contract is part of the Company’s reinsurance program and will reimburse Federated National for covered property losses under its homeowners’ insurance policies resulting from hurricanes that cause damage in the State of Florida through May 31, 2013.
Under this Reimbursement Contract, the FHCF will provide approximately $135.0 million of aggregate seasonal coverage for covered losses in excess of approximately $53.0 million, subject to a 10.0% Company participation. Federated National’s premium for the FHCF reinsurance coverage will be approximately $8.2 million payable in three installments between August 2012 and December 2012. The actual attachment point, total coverage and cost will not be finalized until December 31, 2012.