Federated National is licensed as an admitted carrier in Florida. Through contractual relationships with a network of approximately 4,200 independent agents, of which approximately 400 actively sell and service our products, Federated National is authorized to underwrite homeowners’, fire, allied lines and personal automobile insurance in Florida. Effective January 26, 2011, Federated National merged into American Vehicle.
American Vehicle is licensed as an admitted carrier in Florida, and underwrites commercial general liability, and personal and commercial automobile insurance. American Vehicle is also licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas, and underwrites commercial general liability insurance in those states. American Vehicle operates as a non-admitted carrier in Arkansas, California, Kentucky, Maryland, Missouri, Nevada, Oklahoma, South Carolina, Tennessee and Virginia, and can underwrite commercial general liability insurance in all of these states.
The Merged Company shall retain the following licenses: (010) Fire, (020) Allied Lines, (040) Homeowners Multi Peril, (050) Commercial Multi Peril, (090) Inland Marine, (170) Other Liability, (192) Private Passenger Auto Liability, (194) Commercial Auto Liability, (211) Private Passenger Auto Physical Damage and (212) Commercial Auto Physical Damage.
The Merged Company shall not write commercial multi peril policy premium without prior approval from the Florida OIR. The Merged Company currently has no commercial multi peril policy premium in force.
The Merged Company shall not write new commercial habitation condominium associations without prior approval from the Florida OIR. The current commercial habitation book of business is approximately $2.6 million of policy premium, which will be renewed pursuant to normal underwriting guidelines.
The Merged Company has 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% will be 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, 2010, the Company had approximately 46.5% of its homeowners’ policies located within Tri-County Area.
The managing general agency fees payable by the Merged Company to Assurance Managing General Agents, Inc. (“Assurance MGA”), the Company’s wholly owned subsidiary, which are currently 6% of gross written premium, will be reduced and will not exceed 4% without prior approval from the Florida OIR. The Merged Company has lowered the fee to 2% of gross written premium for the first quarter of 2011, 3% of gross written premium for the second quarter of 2011, and 4% of gross written premium thereafter. This will have no impact on the Company’s consolidated financial results.
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. During 2009, 81.2%, 14.6%, 3.4% and 0.8% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and personal automobile insurance, respectively.
The Company’s sale of homeowners’ policies decreased $7.9 million, or 9.3%, to $76.8 million in 2010, compared with $84.7 million in 2009, primarily due to the effects of Florida’s mandated homeowners’ wind mitigation discounts and the 2009 inclusion of $17.9 million from policies we assumed from Citizens Property Insurance Corporation (“Citizens”). The primary factor for the decrease in commercial general liability production is a slowdown in the economy which has a dramatic impact on the artisan contractor portfolio written by American Vehicle.
The preparation of financial statements in conformity with Generally Accepted Accounting Principles (“GAAP”) requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
Except as described below, we believe that in 2010 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 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, 2010. 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:
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, 2010 premised on future emergence inconsistent with historical loss reserve development patterns.
In December 2010, the FASB issued Accounting Standard Update (“ASU”) No. 2010-29: Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations a consensus of the FASB Emerging Issues Task Force. The objective of this update is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. Paragraph 805-10-50-2(h) requires a public entity to disclose pro forma information for business combinations that occurred in the current reporting period. The disclosures include pro forma revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma revenue and earnings of the combined entity for the comparable prior reporting period should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. In practice, some preparers have presented the pro forma information in their comparative financial statements as if the business combination that occurred in the current reporting period had occurred as of the beginning of each of the current and prior annual reporting periods. Other preparers have disclosed the pro forma information as if the business combination occurred at the beginning of the prior annual reporting period only, and carried forward the related adjustments, if applicable, through the current reporting period. The amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The adoption of this update did not have a material impact on the Company’s 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 will reflect the new guidance.
In January 2010, the FASB issued ASU No. 2010-06: Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. The amendments in ASU 2010-06 require additional disclosures about fair value measurements, including transfers in and out of Levels 1 and 2 and activity in Level 3 on a gross basis, and clarifies certain other existing disclosure requirements including level of disaggregation and disclosures around inputs and valuation techniques. The provisions of the new standards are effective for interim or annual reporting periods beginning after December 15, 2009, except for the additional Level 3 disclosures, which will become effective for fiscal years beginnings after December 15, 2010. These standards are disclosure only in nature and do not change accounting requirements. Accordingly, adoption of the new standard had no impact on the Company’s consolidated financial position, results of operations or cash flows.
In May 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 165, “Subsequent Events” (“SFAS No. 165”), which is now part of ASU Topic 855, Subsequent Events. In SFAS No. 165, the FASB establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued. Our adoption of SFAS No. 165 on April 1, 2009 did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4“). FSP FAS 157-4 is related to determining fair value when the volume and level of activity for an asset or liability have significantly decreased and identifying transactions that are not orderly. The guidance indicates that if an entity determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. The guidance is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted and must be applied prospectively. The adoption of FSP FAS 157-4 did not have a material impact on the Company’s financial statements or condition.
In April 2009, the FASB issued FASB Staff Position (“FSP”) FAS 115-2 and FSP FAS 124-2, “Recognition and Presentation of Other-Than Temporary Impairments” (“FSP FAS 115-2 and FSP FAS 124-2”) related to the recognition and presentation of other-than temporary impairments. In April 2009, the SEC also adopted similar guidance with Staff Accounting Bulletin (“SAB”) No. 111 (“SAB 111”) on Other-Than-Temporary Impairment. FSP FAS 115-2 and FSP FAS 124-2 establishes a new method of recognizing and reporting other-than-temporary impairments of debt securities and contains additional disclosure requirements related to debt and equity securities. This new accounting guidance establishes a new method of recognizing and reporting other-than-temporary impairments of debt securities and contains additional disclosure requirements related to debt and equity securities. For debt securities, the “ability and intent to hold” provision is eliminated, and impairment is considered to be other-than-temporary if an entity (i) intends to sell the security, (ii) more likely than not will be required to sell the security before recovering its cost, or (iii) does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). This new framework does not apply to equity securities (i.e., impaired equity securities will continue to be evaluated under previously existing guidance). The “probability” standard relating to the collectability of cash flows is eliminated, and impairment is now considered to be other-than-temporary if the present value of cash flows expected to be collected from the debt security is less than the amortized cost basis of the security. The accounting guidance provides that for debt securities which (i) an entity does not intend to sell and (ii) it is not more likely than not that the entity will be required to sell before the anticipated recovery of its remaining amortized cost basis, the impairment is separated into the amount related to estimated credit losses and the amount related to all other factors. The amount of the total impairment related to all other factors is recorded in other comprehensive loss and the amount related to estimated credit loss is recognized as a charge against current period earnings. The new guidance expands disclosure requirements for both debt and equity securities and requires a more detailed, risk-oriented breakdown of security types and related information, and requires that the annual disclosures be made in interim periods. The accounting guidance is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. At the time of adoption, the Company did not have any Other-Than-Temporary Impairments for debt securities, and, the adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
Total Investments increased $8.3 million, or 7.2%, to $122.5 million as of December 31, 2010, compared with $114.2 million as of December 31, 2009.
The net unrealized gain of $0.8 million is inclusive of $1.7 million of unrealized losses. The $1.7 million of unrealized losses is inclusive of $0.7 million unrealized losses from marketable equity securities and $1.0 million unrealized losses from debt securities.
The $0.7 million of unrealized losses from marketable equity securities is from common stocks held in diverse industries as of December 31, 2010. The Company evaluated the near-term prospects in relation to the severity and duration of the impairment. Based on this evaluation and the Company’s ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2010.
The $1.0 million of unrealized losses from debt securities is made up of $0.1 million, $0.3 million and $0.6 million from US government, federal agency mortgage-backed securities and corporate bonds respectively. The unrealized losses on the Company’s investment in federal agency mortgage-backed securities were caused by interest rate changes. The contractual cash flows of those investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s investments. Also, the Company does not intend to sell these investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis and does not consider these investments to be other-than-temporarily impaired at December 31, 2010.
The unrealized losses on the Company’s investment in corporate bonds relates to $29.0 million invested in bonds across diverse sectors; 83% of these bonds had at least an A rating and the unrealized losses were caused by interest rate changes. The Company does not expect to settle at prices less than the amortized cost basis. Because the Company does not intend to sell these investments and it is not more likely than not that the Company will be required to sell these investments before recovery of the amortized cost basis, it does not consider these investments to be other-than-temporarily impaired at December 31, 2010.
Pursuant to this guidance, the Company records the unrealized losses, net of estimated income taxes that are associated with that part of our portfolio classified as available for sale, through the shareholders' equity account titled “Other Comprehensive Income”. 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, but are not limited to, 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.
As of December 31, 2009, 36.9% of the investment portfolio is in corporate bonds, 34.4% was in obligations of states and political subdivisions, and 11.2% was in United States government bonds. Approximately 17.5% of the holdings were in equities related to diverse industries.
As of December 31, 2010 and 2009, we have classified $6.2 million and $2.7 million, respectively, of our bond portfolio as held-to-maturity. We only classify bonds as held-to-maturity to support securitization of credit requirements. Fully funded trust agreements or outstanding irrevocable letters of credit, used for such purposes, total $3.6 million and $2.8 million for the period ended December 31, 2010 and 2009, respectively.
Cash and short-term investments, which include cash, certificates of deposits, and money market accounts, decreased $12.0 million, or 42.5%, to $16.2 million as of December 31, 2010, compared with $28.2 million as of December 31, 2009. The decrease in cash and short-term investments resulted from portfolio reallocation based on improving risk profiles; wherein we decided to increase our exposure to corporate bonds. We evaluate our asset class allocation on an ongoing basis continually adjust based on economic and business risk.
Prepaid reinsurance premiums increased $0.1 million, or 0.9%, to $10.4 million as of December 31, 2010, compared with $10.3 million as of December 31, 2009. The change is due to our payments and amortization of prepaid reinsurance premiums associated with our homeowners’ insurance book of business. We believe concentrations of credit risk associated with our prepaid reinsurance premiums are not significant.
Our commercial general liability insurance premiums receivable increased $0.5 million, or 60.6%, to $1.4 million as of December 31, 2010, compared with $0.9 million as of December 31, 2009.
Reinsurance recoverable, net, decreased $7.3 million, or 47.5%, to $8.0 million as of December 31, 2010, compared with $15.3 million as of December 31, 2009. The change is due to the payment patterns by our reinsurers, as influenced by the diminishing catastrophe related claims. All amounts are current and deemed collectable. We believe concentrations of credit risk associated with our reinsurance recoverables, net, are not significant.
DPAC decreased $0.4 million, or 4.7%, to $7.9 million as of December 31, 2010, compared with $8.3 million as of December 31, 2009. The change is due to decreased homeowners’ and commercial general liability written and unearned premium.
Deferred income taxes, net, increased $3.2 million, or 69.3%, to $7.9 million as of December 31, 2010, compared with $4.7 million as of December 31, 2009. Deferred income taxes, net, is comprised of approximately $11.2 million and $9.1 million of deferred tax assets, net of approximately $3.3 million and $4.4 million of deferred tax liabilities as of December 31, 2010 and December 31, 2009, respectively.
Income taxes receivable decreased $4.7 million, or 66.1%, to $2.4 million as of December 31, 2010, compared with $7.1 million as of December 31, 2009. 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, 2010 Compared with Year Ended December 31, 2009”.
Other assets decreased $1.4 million, or 37.1%, to $2.3 million as of December 31, 2010, compared with $3.7 million as of December 31, 2009. Major components of other assets are shown in the following table; the accrued interest income receivable is primarily investment related.
Unearned premiums decreased $3.8 million, or 7.3%, to $47.1 million as of December 31, 2010, compared with $50.9 million as of December 31, 2009. The change was due to a $3.2 million decrease in unearned homeowners’ insurance premiums, a $1.6 million decrease in unearned commercial general liability premiums, a $0.2 million increase in unearned flood insurance premiums, and a $0.8 million increase in unearned automobile premiums. Generally, as is in this case, a decrease in unearned premium directly relates to a decrease in written premium on a rolling twelve-month basis. Competition could negatively affect our unearned premium.
Bank overdraft decreased $0.9 million, or 9.9%, to $7.4 million as of December 31, 2010, compared with $8.3 million as of December 31, 2009. The bank overdraft relates primarily to losses and LAE disbursements paid but not presented for payment by the policyholder or vendor. The change relates to our payment patterns in relationship to the rate at which those cash disbursements are presented to the bank for payment.
Accounts payable and accrued expenses decreased $0.4 million, or 17.0%, to $2.2 million as of December 31, 2010, compared with $2.6 million as of December 31, 2009.
Gross premiums written decreased $8.0 million, or 7.6%, to $96.4 million for the year ended December 31, 2010 (“2010”), compared with $104.4 million for the year ended December 31, 2009 (“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.
As of December 31, 2010, Federated National and American Vehicle were rated by Demotech, Inc. (“Demotech”) as "A" ("Exceptional"), which is the third of seven ratings, and defined as “Regardless of the severity of a general economic downturn or deterioration in the insurance cycle, insurers earning a Financial Stability Rating (“FSR”) of “A” possess “Exceptional” financial stability related to maintaining surplus as regards to policyholders”. Demotech’s ratings are based upon factors of concern to agents, reinsurers and policyholders and are not primarily directed toward the protection of investors. Our Demotech rating could be jeopardized by factors including adverse development and various surplus related ratio exceptions. On December 15, 2010, Demotech reaffirmed Federated National’s FSR of “A” (“Exceptional).
Net premiums earned decreased $2.9 million, or 6.1%, to $45.1 million for in 2010, compared with $48.0 million in 2009.
The change in automobile net premiums earned is a result of a $2.9 million increase in gross written premium as discussed, a $1.9 million increase in gross premiums ceded and a $0.3 million decrease in the change to unearned premium.
Commission income remained unchanged at $1.4 million in 2010, compared with $1.4 million in 2009. 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 $0.3 million, or 9.7%, to $3.7 million in 2010, compared with $3.4 million in 2009. Our investment yield, net and gross of investment expenses, excluding equities and including cash, were 2.5% and 2.7%, respectively, in 2010. Our investment yield, net and gross of investment expenses, excluding equities and including cash, were 2.2% and 2.3%, respectively, in 2009.
See also “Analysis of Financial Condition As of December 31, 2010 Compared with December 31, 2009 - Investments” for a further discussion on our investment portfolio.
The table below depicts the net realized investment gains by investment category in 2010 and 2009.
In accordance with GAAP and for the reasons discussed above, our loss ratio is computed as losses and LAE divided by net premiums earned. A lower loss ratio generally results in higher operating income. Our loss ratio in 2010 was 89.0% compared with 91.1% for the same period in 2009.
Policy acquisition costs - amortization, decreased $0.7 million, or 5.2%, to $13.0 million in 2010, compared with $13.7 million in 2009.
As a result of the foregoing, the Company’s net loss in 2010 was $8.0 million compared with $10.3 million in 2009.
The Florida Legislature required a rate decrease that resulted in an average 15.2% decrease statewide on homeowners' policies that was integrated into our rates on June 1, 2007. The effect of this rate decrease on existing policies and the corresponding premium decrease in direct written premium was fully recognized in policies by May 31, 2008. In addition, a rate decrease of 11.3% statewide for homeowners' policies was approved by the Florida OIR and implemented with an effective date of May 1, 2008 for new business and June 1, 2008 for renewal business for the homeowners' program. The effect of this rate decrease is flowing through the Company’s homeowners’ book of business such that a full impact of the premium decreases on direct written premium was realized by April 2009 for the homeowners' program. These rate decreases have had an adverse effect on gross and earned premium.
We are required to report write-your-own flood premiums on a direct and 100% ceded basis for the twelve months ended December 31, 2008 and subsequent periods. Prior to 2008, we reported only the commissions income associated with this program. Commissions in connection with this program totaled $0.1 million, $0.2 million and $0.3 million in 2009, 2008 and 2007.
Gross premiums ceded increased to $56.2 million in 2009, compared with $34.6 million in 2008. Gross premiums ceded under our catastrophe reinsurance program totaled $52.5 million and gross premiums ceded to the write-your-own flood program totaled $3.6 million in 2009.
Net premiums earned decreased $17.1 million, or 26.3%, to $48.0 million in 2009, compared with $65.1 million in 2008. The following table denotes net premiums earned by product line.
The change in commercial general liability net premiums earned is a result of decreased premium volume. The primary factor for the decrease in premium volume is a slowdown in the economy which has a dramatic impact on the artisan contractor portfolio written by American Vehicle. An additional factor is our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas.
Finance revenue decreased $0.1 million, or 16.1%, to $0.3 million in 2009, compared with $0.4 million in 2008. This is primarily due to the Company’s decreased emphasis on automobile insurance and the finance revenue derived from these policies.
Net investment income decreased $3.1 million to $3.4 million for 2009, compared with $6.5 million for 2008. Our investment yields net and gross of investment expenses were 2.1% and 2.3% respectively for 2009, compared with 4.1% net of investment expenses for 2008. Our investment yields net and gross of investment expenses measured against debt securities, excluding cash were 3.5% and 3.7% respectively for 2009. Our net investment income and yields were adversely affected by having an average cash balance of $55.0 million in the prime money market account that provided less than a 1% yield during 2009.
Net investment income on corporate bonds, which generally provide a higher yield than United States government bonds, decreased $1.5 million to $1.6 million for 2009, compared with $3.1 million for 2008. The decrease in corporate bond income was due to our selection of higher quality bonds that reduce overall portfolio risk though offer a lower yield. Municipal bond income increased $0.7 million to $1.4 million for 2009 compared to $0.7 million in 2008. The increase in Municipal bond income was due to the increase in the municipal bond portfolio to $40.0 million in 2009, from approximately $5.0 million in 2008.
See additional discussion within the above “Analysis of Financial Condition As of December 31, 2009 Compared with December 31, 2008- Investments”.
Major components of other income in 2009 and 2008 included approximately $0.5 million in partial recognition of our gain on the sale of our Lauderdale Lakes property.
In 2010, our primary sources of capital included proceeds from the sale of investment securities, decreased reinsurance recoverable, net, decreased premiums receivable, decreased income taxes recoverable, amortization of investment premium discount, net, decreased other assets, non-cash compensation and decreased policy acquisition costs, net of amortization. Also contributing to our liquidity was increased premium deposits and customer credit balances, depreciation and amortization, a tax benefit related to non-cash compensation and a provision for credit losses, net. Because we are a holding company, we are largely dependent upon fees and commissions from our subsidiaries for cash flow.
In 2010, operations used $26.3 million of gross cash flow primarily due to $6.8 million of net realized investment gains, a $4.1 million decrease in unpaid losses and LAE, a $3.7 million decrease in unearned premiums, a $2.3 million decrease in deferred income tax expense, a $0.8 million decrease in bank overdraft, a $0.4 million decrease in accounts payable and accrued expenses, $0.1 million increase in prepaid reinsurance premiums, a less than $0.1 million decrease in the provision for uncollectible premiums receivable and all in conjunction with a net loss of $8.0 million.
In 2010, net financing activities used $0.4 million, as compared with $2.0 million and $4.3 million in 2009 and 2008, respectively. In 2010, the sources of cash in connection with financing activities included a less than $0.1 million tax benefit related to non-cash compensation. The uses of cash in connection with financing activities included $0.5 million in dividends paid.
As of December 31, 2010, 2009, and 2008, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “structured finance” or “special purpose” entities, which were established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. As such, management believes that we currently are not exposed to any financing, liquidity, market or credit risks that could arise if we had engaged in transactions of that type requiring disclosure herein.
The consolidated financial statements and related data presented herein have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the inflationary effect on the cost of paying losses and LAE.
We have audited the accompanying consolidated balance sheets of 21st Century Holding Company as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2010. 21st Century Holding Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
The insurable events during 2010, 2009 and 2008 did not include any weather related catastrophic events such as the well publicized series of hurricanes that occurred in Florida during 2005 and 2004. During 2010, 2009 and 2008 we processed property and liability claims stemming from our homeowners’, commercial general liability and private passenger automobile lines of business. Our reinsurance strategy serves to smooth the liquidity requirements imposed by most severe insurable events and for all other insurable events we manage, at a micro and macro perspective, in the normal course of business.
Our business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on our business, results of operations and financial condition. When our estimated liabilities for unpaid losses and LAE are less than the actuarially determined amounts, we increase the expense in the current period. Conversely, when our estimated liabilities for unpaid losses and LAE are greater than the actuarially determined amounts, we decrease the expense in the current period. We internally process claims made by our insureds through our wholly owned claims adjusting company, Superior.
We are focusing our marketing efforts on continuing to expand our distribution network and market our products and services throughout Florida and in other states by establishing relationships with additional independent agents and general agents. As this occurs, we will seek to replicate our distribution network in those states. For example, American Vehicle became an admitted insurer in the state of Georgia during the quarter ended September 30, 2010. There can be no assurance, however, that we will be able to obtain the required regulatory approvals to offer additional insurance products or expand into other states.
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 mitigated by the establishment of irrevocable clean letters of credit in favor of Federated National.
the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements,
Our revenues and operating performance may fluctuate due to statutorily approved assessments that support property and casualty insurance pools and associations.
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 2010, 2009 and 2008 include:
Certain 2009 and 2008 financial statement amounts have been reclassified to conform to the 2010 presentations.
The debt and equity securities that are available for sale and carried at fair value represent 95% of total investments as of December 31, 2010, compared with 98% as of December 31, 2009.
The investments held as of December 31, 2010 were comprised mainly of corporate bonds held in various industries, municipal bonds and United States government bonds. As of December 31, 2010, 72% of the debt portfolio is in diverse industries and 28% is in United States government bonds. As of December 31, 2010, approximately 77% of the equity holdings are in equities related to diverse industries and 23% are in mutual funds.
The investments held as of December 31, 2009, were comprised mainly of corporate bonds held in various industries, municipal bonds and United States government bonds. As of December 31, 2009, 89% of the debt portfolio was in diverse industries and 11% was in United States government bonds. As of December 31, 2009, approximately 89% of the equity holdings were in equities related to diverse industries and 11% are in mutual funds.
As of December 31, 2010, 55% of the investment portfolio was in corporate bonds, 7% is in obligations of states and political subdivisions, and 24% is in United States government bonds. Approximately 10% of the common stock holdings are related to foreign entities.
The following table shows the realized gains (losses) for debt and equity securities for the years ended December 31, 2010 and 2009.
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of debt and equity securities at December 31, 2010 and 2009 is as follows.
A summary of net realized investment gains (losses) and increases in net unrealized gains (losses) follows.
Below is a summary of the components of the finance contracts receivable balance.
The Company holds collateral under related reinsurance agreements in the form of fully funded trust agreements totaling $3.6 million that can be drawn on for amounts that remain unpaid for more than 120 days.
As a result of our review of liability for losses and LAE, which includes a re-evaluation of the adequacy of reserve levels for prior year’s claims, we increased the liability for losses and LAE for claims occurring in prior years by $2.8 million, $1.7 million and $4.5 million for the years ended December 31, 2010, 2009 and 2008, respectively.
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, 2010.
The actual income tax expense differs from the "expected" income tax expense (computed by applying the combined applicable effective federal and state tax rates to income before provision for income tax expense) as follows.
To retain our certificate of authority, the Florida Insurance Code (the "Code") requires Federated National and American Vehicle to maintain capital and surplus equal to the greater of 10% of their liabilities or a statutory minimum capital and surplus as defined in the Code. Federated National and American Vehicle are required to have a minimum capital surplus of $4.0 million. At December 31, 2010, 2009 and 2008, Federated National’s statutory capital surplus was $18.7 million, $21.0 million and $31.5 million, respectively. At December 31, 2010, 2009 and 2008, American Vehicle had statutory capital surplus of $21.9 million, $25.8 million and $25.1 million, respectively.
We had bonds with a carrying value of approximately $2.0 million pledged to the Florida OIR, as of December 31, 2010 and 2009, in accordance with regulatory requirements.
No dividends were paid by Federated National or American Vehicle in 2010, 2009 or 2008, and none are anticipated in 2011. 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 in excess of the amount available, to be paid by Federated National and American Vehicle 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.
In order to enhance the regulation of insurer solvency, the National Association of Insurance Commissioners (“NAIC”) established risk-based capital requirements for insurance companies that are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policy holders. These requirements measure three major areas of risk facing property and casualty insurers: (i) underwriting risks, which encompass the risk of adverse loss developments and inadequate pricing; (ii) declines in asset values arising from credit risk; and (iii) other business risks from investments. Insurers having less statutory surplus than required will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The Florida OIR, which follows these requirements, could require Federated National or American Vehicle to cease operations in the event they fail to maintain the required statutory capital.
Based upon the 2010 and 2009 statutory financial statements for Federated National and American Vehicle, statutory surplus exceeded the regulatory action levels established by the NAIC’s risk-based capital requirements.
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 222.8%, 245.1 % and 739.4% at December 31, 2010, 2009 and 2008, respectively. American Vehicle’s ratio of statutory surplus to its ACL was 373.4%, 426.9% and 402.5% at December 31, 2010, 2009 and 2008, respectively.
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 recently approved additional rate increase for our voluntary property book of homeowners’ business, averaging 20.2% statewide, which is expected to gain momentum and accrete throughout 2011. As of December 31, 2009, Federated National was outside NAIC’s usual range for four of thirteen IRIS ratios. Three exceptions related to underwriting operations and one related to lower than expected investment yields. The operations ratios relate to the timing of premium rate corrections and elevated reinsurance costs. The Florida OIR granted Federated National an average statewide increase of 19.0% for policies that went into effect November 1, 2009 and December 1, 2009 for new and renewed homeowner insurance policies, respectively. As of December 31, 2008, Federated National was outside NAIC’s usual ranges with respect to its tests on two out of thirteen IRIS ratios. There was one exception in connection with change in net written premium and one in connection with two year reserve development to policyholders’ surplus.
As of December 31, 2010, American Vehicle 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. As of December 31, 2009, American Vehicle was outside NAIC’s usual range for three of thirteen IRIS ratios. These ratios reflect the decline in premium volume and operating results. The third ratio related to lower than expected investment yields. As of December 31, 2008, American Vehicle was outside NAIC’s usual range for two of thirteen IRIS ratios. There was one exception in connection with the two year overall operating ratio and one in connection with two year reserve development to policyholders’ surplus.
There was no action taken by the Florida OIR in connection with the December 31, 2009 IRIS ratio results. We do not currently believe that the Florida OIR will take any significant action with respect to Federated National or American Vehicle regarding the 2010 IRIS ratios, although there can be no assurance that will be the case.
American Vehicle’s statutory capital and surplus was $21.9 million and $25.8 million as of December 31, 2010 and 2009, respectively. American Vehicle’s statutory net income (loss) was approximately $1.6 million, ($1.1) million and ($2.4) million for the years ended December 31, 2010, 2009 and 2008, respectively. American Vehicle’s statutory non-admitted assets were approximately $5.6 million and $0.9 million as of December 31, 2010 and 2009, respectively.
The Florida OIR issued Information Memorandum OIR-06-008M, titled Notice of Anticipated Florida Hurricane Catastrophe Fund Assessment, and dated May 4, 2006, to all property and casualty insurers, surplus lines insurers, and surplus lines agents in the state of Florida placing them on notice of an anticipated FHCF assessment. Sighting the unprecedented hurricane seasons of 2004 and 2005, the FHCF exhausted nearly all of the $6 billion in reserves it had accumulated since its inception in 1993. The Florida SBA issued its directive to levy an emergency assessment upon all property and casualty business in the state of Florida. There is no statutory requirement that policyholders be notified of the FHCF assessment. The FHCF and Florida OIR are, however, recommending that insurers include the FHCF assessment in a line item on the declaration page for two reasons: (1) this is a multi-year assessment and (2) there may be concurrent assessments and the insureds should know what amount is for which assessment. The assessment became effective on all policies effective after January 1, 2007 and will be remitted to the administrator of the assessment as collected.
The Company has recorded a net deferred tax asset of $7.9 million and $4.7 million as of December 31, 2010 and 2009, respectively. The realization of a net deferred tax asset is dependent on generating sufficient taxable income in future periods. Management believes that it is more likely than not that the deferred tax assets will be realized and as such no valuation allowance has been recorded against the net deferred tax asset. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2010 and 2009, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would record valuation allowances as deemed appropriate in the period that the change in circumstances occurs, along with a corresponding increase or charge to net income. The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.
On September 4, 2009, a stipulation of settlement ("Stipulation of Settlement") was submitted to the Court by lead plaintiffs, the derivative plaintiff and the defendants, setting forth the terms of a settlement of the Class Litigation and Derivative Litigation ("Settlement Agreement") which proposed that a payment of $2.4 million be made to the lead plaintiffs and the derivative plaintiff. The Stipulation of Settlement contains no admission of liability or wrongdoing by the Company or its officers and directors. The Company's insurance carriers agreed to fund the $2.4 million settlement payment. The Stipulation of Settlement was preliminarily approved by the Court on October 19, 2009.
Net loss per share is computed by dividing net loss by the weighted average number of shares of common stock and common stock equivalents outstanding during the periods presented.
A summary of the numerator and denominator of the basic and fully diluted 2010, 2009 and 2008 net loss per share is presented below.
If any one of the following exists, a segment must be reported on.
Identifiable assets are 10% or more of total assets of all operating segments.
In 2001, we implemented a franchisee stock option plan that was terminated during September 2008, and provided for the granting of stock options to individuals purchasing Company owned agencies that were then converted to franchised agencies. The purpose of the plan was to advance our interests by providing an additional incentive to encourage managers of Company owned agencies to purchase the agencies and convert them to franchises. Options outstanding under the plan were granted at prices, which were above the market value of the stock on the date of grant, vested over a ten-year period, and expired ten years after the grant date. Under this plan, we were authorized to grant options to purchase up to 988,500 common shares, and, as of December 31, 2010 and December 31, 2009, we had no outstanding exercisable options to purchase shares.
Activity in our stock option plans for the period from January 1, 2008 to December 31, 2010 is summarized below.
Options outstanding as of December 31, 2010 are exercisable as follows.
Compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair-value estimated in accordance with the provisions of FASB issued guidance. Results for prior periods have not been restated, as not required to be by the pronouncement.
Basic and diluted loss per share for 2010 would have been $0.98, if the Company had not adopted FASB issued guidance, compared with reported basic and diluted loss per share of $1.01.
Summary information about the Company’s stock options outstanding at December 31, 2010 follows.
For the years ended December 31, 2010, 2009 and 2008, comprehensive loss consisted of the following.
Our Amended and Restated Articles of Incorporation authorize the issuance of one million shares of preferred stock with designations, rights and preferences determined from time to time by our board of directors. Accordingly, our Board of Directors is empowered, without shareholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. We have not issued preferred shares as of December 31, 2010.
Assets measured at fair value on a recurring basis are presented in accordance with this guidance are as follows.