(2) All years have been adjusted to reflect the disposal of our manufactured home community properties and related business, except for NLASCO.
At December 31, 2011, HTH is a holding company that owns all of the outstanding shares of NLASCO, Inc., or NLASCO. NLASCO, in turn, owns National Lloyds Insurance Company, or NLIC, and American Summit Insurance Company, or ASIC, both of which are licensed property and casualty insurers operating in multiple states. In addition, NLASCO also owns the NALICO GA, a general agency that operates in Texas. NLIC commenced business in 1949 and currently operates in 15 states, with its largest market being the state of Texas. NLIC carries a financial strength rating of “A” (Excellent) by A.M. Best. ASIC was formed in 1955 and currently operates in 13 states, its largest market being the state of Arizona. ASIC carries a financial strength rating of “A” (Excellent) by A.M. Best. Both of these companies are regulated by the Texas Department of Insurance.
On July 31, 2007, we sold substantially all of the operating assets used in our manufactured home communities business and our retail sales and financing business to American Residential Communities LLC. We received gross proceeds of approximately $890 million in cash, which represents the aggregate purchase price of $1.794 billion, less the indebtedness assumed by the buyer. After giving effect to expenses, taxes and our continued outstanding preferred stock and senior notes, our net cash balance was approximately $550 million. We used a portion of the proceeds from this transaction for general working capital, liquidation of our operating partnership units and to repay certain outstanding obligations. We intend to make opportunistic acquisitions with certain of the remaining proceeds from this transaction, and, if necessary or appropriate, from additional equity or debt financing sources.
On July, 29, 2011, the Company extended SWS Group, Inc., or SWS, a $50 million term loan, which bears interest at 8% per annum, is prepayable by SWS subject to certain conditions after three years, and has a maturity of five years. SWS issued us a warrant to purchase 8,695,652 shares of SWS common stock, $0.10 par value per share, exercisable at a price of $5.75 per share subject to anti-dillution adjustments.
On October 27, 2011, NLASCO renewed its line of credit with a financial institution. The line allows for borrowings by NLASCO up to $5.0 million and is secured by substantially all of NLASCO’s assets. The line of credit bears interest equal to a base rate, plus 3.75% (5.01% at December 31, 2011), which is due quarterly. This line of credit will expire in October 2012. As of December 31, 2011, there was no outstanding balance on the note.
For the year ended December 31, 2011, net loss attributable to common stockholders was $6.5 million, or $0.12 per share, as compared to a net loss attributable to common stockholders of $13.5 million, or $0.24 per share, for the year ended December 31, 2010, and a net loss attributable to common stockholders of $12.4 million, or $0.22 per share, for the year ended December 31, 2009.
Our recorded reserves reflect our best estimate as of a particular point in time based upon known facts, current law and our judgment. The carried reserve may differ from the actuarial central estimate as the result of our consideration of the factors noted above, as well as other factors impacting claims costs that may not be quantifiable through actuarial analysis. This process results in management’s best estimate, which is then recorded as the reserve for unpaid losses and LAE.
In arriving at our best estimate of the unpaid losses and LAE, and based on management discussion with our actuaries, we would consider reasonably likely changes in the key assumptions, such as the underlying loss development pattern or the expected loss ratio, to have an impact on our best estimate by +/- 10%. As of December 31, 2011, this equates to approximately +/- $1.9 million, which represents approximately 0.3% of equity and 30.2% of calendar year 2011 losses.
The following table presents our gross loss and LAE reserve amounts at December 31, 2011 and 2010 for each of NLIC and ASIC by line of business (dollars in thousands):
We regularly review our investment securities to assess whether the security is impaired and if impairment is other-than-temporary. A decline in the market value of any available-for-sale security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether impairment is other-than-temporary, we consider whether we are more likely than not to hold an investment until a market price recovery and consider whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to period end, and forecasted performance of the investee.
Fair Value Measurements. The Company’s estimates of fair value for financial assets and financial liabilities are based on the framework established in ASC 820, Fair Value Measurements and Disclosures. The framework is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions. The three levels of the hierarchy are as follows:
· Level 1 - Unadjusted quoted market prices for identical assets or liabilities in active markets that the Company has the ability to access.
The Company reviews the estimates of fair value provided by the pricing service and compares the estimates to the Company’s knowledge of the market to determine if the estimates obtained are representative of the prices in the market. In addition, the Company has periodic discussions with the pricing service to discuss any changes in their process and reactions to overall markets. These processes have not highlighted any significant issues with the fair value estimates received from the pricing service.
For public common and preferred stocks, the Company receives prices from a nationally recognized pricing service that are based on observable market transactions and includes these estimates in the amount disclosed in Level 1.
Revenue Recognition. Property and liability premiums are recognized as revenue on a pro rata basis over the policy term. The portion of premiums that will be earned in the future are deferred and reported as unearned premiums. The Company routinely evaluates the premium receivable balance to determine if an allowance for uncollectible accounts is necessary.
Reinsurance. In the normal course of business, NLASCO seeks to reduce losses that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Net premiums earned, losses and LAE and policy acquisition and other underwriting expenses are reported net of the amounts related to reinsurance ceded to other companies. Amounts recoverable from reinsurers related to the portions of the liability for losses and LAE are reported as assets. Amounts recoverable from reinsurers are estimated in a manner consistent with the reinsured policy.
as well as future taxable income and reversals of existing taxable temporary differences. We expect to realize our current deferred tax assets through core earnings, reversal of timing differences, and to the extent necessary, through the implementation of certain tax planning strategies surrounding the Company’s cash holdings. Therefore, the Company concluded there was sufficient positive evidence to outweigh the negative evidence of the prior year cumulative losses. There is no valuation allowance as of December 31, 2011.
Next the Company reviewed the intangible assets both definite and indefinite lived. The definite lived intangibles relate to customer relationships, agency relationships, trade name and software. We believe our customer relationships to be consistent with the value given to them based on the current renewal rate being approximately 90%, slightly higher than when NLASCO was purchased. Our agent relationships remain valuable and we have experienced less than 3% turnover in our agent base since 2007. Our trade names, NLIC and ASIC, are both “A” rated companies with NLIC increased from “A-” in 2007 and ASIC in 2010. Our internally developed software, PACs, is still the main operating system of the company.
Net premiums earned are up $16.9 million for the year ended 2011 as compared to the year ended 2010 due to higher written premiums of $16.1 million and lower reinsurance costs of $4.0 million, offset by increase in unearned premiums of $3.2 million. Net investment income increased $2.9 million for the year ended 2011 as compared to the year ended 2010 due to higher investment income at the parent (HTH) of $2.5 million and $0.4 million at NLASCO.
Underwriting Results. The following table shows the components of NLASCO’s underwriting gain for the year ended December 31, 2011 and 2010. NLASCO’s underwriting gain or loss consists of net premiums earned, less loss and LAE and policy acquisition and other underwriting expenses. The underwriting results are discussed below (in thousands).
Our combined ratio for the twelve months ended December 31, 2011 is 106.2%, as compared to 96.5% for the same period in 2010. The 9.7% increase in combined ratio in 2011 is primarily due to the 11.7% increase in loss and LAE ratio for the twelve months ended December 31, 2011, as compared to 2010. Loss and LAE expenses increased 36.4% in the twelve months ended 2011, as compared to 2010, due to higher incurred losses associated with wind and hail storms in Texas and additional losses associated with a 14.4% increase in earned premiums. Texas typically experiences seasonal tornado and hail storms; however, NLASCO suffered a dramatic increase in losses from five storms in April and May 2011 that created $19.3 million in incurred losses. Additionally, there were fifteen days of widely dispersed, exceptional weather related losses experienced during the three months ended June 30, 2011, which had incurred losses of $8.1 million. NLASCO also experienced an increase in the frequency and severity of fire losses, which resulted in $7.1 million in incurred losses above prior year. Policy acquisition and other underwriting expenses increased 7.4% for the twelve months ended December 31, 2011, as compared to 2010, which is a direct result of an 11.3% increase in direct written premiums.
The Company seeks to consistently generate underwriting profitability. Management evaluates NLASCO’s loss and LAE ratio by bifurcating the losses to derive catastrophic and non-catastrophic loss ratios. The non-catastrophic loss ratio excludes Property Claim Services (PCS) events that exceed $1.0 million of losses to NLASCO. Catastrophic events, including those that do not exceed our reinsurance retention, affect the Company’s loss ratios. For the twelve months ended December 31, 2011, catastrophic events that did not exceed our reinsurance retention accounted for $19.3 million of the total loss and loss adjustment expense, as compared to $12.3 million for the same period in 2010. Excluding catastrophic events, our combined ratios for the twelve months ended December 31, 2011 and 2010 would have been 90.9% and 86.0%, respectively.
Net premiums earned for the year ended December 31, 2011 increased $16.9 million as compared to 2010 due to an increase in net premiums written of $20.0 million, offset by an increase in unearned premiums of $3.2 million.
Loss and Loss Adjustment Expenses. Loss and LAE are recognized based on formula and case basis estimates for losses reported with respect to direct business, estimates of unreported losses based on past experience and deduction of amounts for reinsurance placed with reinsurers. Loss and LAE for the twelve months ended December 31, 2011 was $96.7 million, as compared to $70.9 million for the same period in 2010. The $25.8 million increase is a result of wind and hail storms that occurred in 2011 in Texas, in which five storms incurred losses of $19.3 million, and fifteen days of widely dispersed, exceptional weather related losses had incurred losses of $8.1 million.
The loss and LAE ratio is calculated by taking the ratio of incurred losses and LAE to net premiums earned. The loss and LAE ratio for the year ended December 31, 2011 and 2010 was 72.2% and 60.5%, respectively.
The Company’s net loss and LAE and the gross loss and LAE ratios for the year ended December 31, 2011 and 2010 are shown in the tables below:
General and Administrative Expense. General and administrative expense for 2011 was $8.9 million, as compared to $7.4 million for 2010, an increase of $1.5 million, or 20.3%. This increase is primarily due to increases in professional services of $1.0 million and other administrative expenses of $0.5 million. The increase in professional fees is due to an increase in acquisition activities related to due diligence activities in 2011. Other administrative expenses increased due to the premium of $0.5 million paid on the repurchase of $6.9 million of our senior exchangeable notes.
Interest Expense. Interest expense was $9.0 million for the twelve months ended 2011 and 2010.
Net Loss Attributable to Common Stockholders. As a result of the foregoing, our net loss attributable to common stockholders was $6.5 million for 2011, as compared to $13.5 million for 2010, a decrease of $7.0 million. The majority of this difference is due to the lower underwriting profit of $12.2 million for the twelve months ended December 31, 2011, as compared to 2010.
Comparison of the Year Ended December 31, 2010 to the Year Ended December 31, 2009
Results of insurance operations. NLASCO’s underwriting gain or loss consists of net premiums earned, less loss and LAE and policy acquisition and other underwriting expenses. NLASCO’s underwriting performance is one of the most important factors in evaluating the overall results of operations given the fluctuations that can occur in loss and LAE due to weather related events, as well as the uncertainties involved in the process of estimating reserves for losses and LAE. The underwriting results and fluctuations in other revenue and expense items of NLASCO are discussed in greater detail below. The following table shows the underwriting gain or loss, as well as other revenue and expense items included in the financial results of NLASCO for the year ended December 31, 2010 and 2009 (in thousands).
The loss and LAE ratio is loss and LAE expenses divided by net premiums earned for the same period. The policy acquisition and other underwriting expense ratio is policy acquisition and other underwriting expense divided by net premiums earned for the same period. Combined ratio gives you the sum of both previous ratios.
The Company seeks to consistently generate underwriting profitability. Management evaluates NLASCO’s loss and LAE ratio by bifurcating the losses to derive catastrophic and non-catastrophic loss ratios. The non-catastrophic loss ratio excludes Property Claim Services (PCS) events that exceed $250,000 of losses to NLASCO. Catastrophic events, including those that do not exceed our reinsurance retention, affect the Company’s loss ratios. For the twelve months ended December 31, 2010, catastrophic events that did not exceed our reinsurance retention accounted for $12.3 million of the total loss and loss adjustment expense, as compared to $9.8 million for the same period in 2009. Excluding catastrophic events, our combined ratios for the twelve months ended December 31, 2010 and 2009 would have been 86.0% and 88.2%, respectively.
Net premiums earned for the year ended December 31, 2010 increased as compared to 2009 due to an increase in net premiums written of $6.9 million, offset by an increase in unearned premiums of $4.9 million.
HTH is a holding company whose assets primarily consist of the stock of its subsidiaries and invested assets with a combined value of $925 million at December 31, 2011. HTH’s primary investment objectives, as a holding company, are to preserve capital and have available cash resources to utilize in making opportunistic acquisitions, and, if necessary or appropriate, from additional equity or debt financing sources.
In November 2011, NLASCO purchased $6.9 million of the HTH senior exchangeable notes at a premium of $0.5 million. In accordance with GAAP, this purchase was eliminated in consolidation. Therefore, as of December 31, 2011, we had $131.5 million of debt, consisting of $84.0 million of senior exchangeable notes and $47.5 million of debt owed by NLASCO and its subsidiaries.
Our short-term liquidity needs as of December 31, 2011 include (a) funds to pay our insurance claims of NLASCO and subsidiaries and (b) funds to service our total debt of $131.5 million.
Our insurance operating subsidiary, NLASCO, has primary investment objectives to preserve capital and manage for a total rate of return. NLASCO’s strategy is to purchase securities in sectors that represent the most attractive relative value. Bonds, cash and short-term investments constituted $197.2 million, or 95.7%, of NLASCO’s $206.1 million in investments at
December 31, 2011. NLASCO had $8.9 million, or 4.3% of its investments, in equity investments as of December 31, 2011. We currently do not have any significant concentration in both direct and indirect guarantor exposure. NLASCO has no investments in subprime mortgages. NLASCO has custodial agreements with A.G. Edwards and Wells Fargo Bank and an investment management agreement with DTF Holdings, LLC.
Under Texas State Insurance Law for property and casualty companies, all dividends must be distributed out of earned surplus only. Furthermore, without the prior approval of the Commissioner, dividends cannot be declared or distributed that exceed the greater of ten percent of the company’s surplus, as shown by its last statement on file with the Commissioner, or one hundred percent of net income for such period. The subsidiaries paid no dividends to NLASCO in 2009, $6.0 million in March 2010 and no dividends in 2011. At December 31, 2011, the maximum dividend that may be paid to NLASCO in 2012 without regulatory approval is approximately $11.9 million.
Loss and LAE reserves and reinsurance recoverables decreased $39.1 million and $43.7 million, respectively, primarily due to settlement of claims relating to Hurricane Ike. Unearned premiums increased $3.2 million due to an increase in direct written premiums in 2011 of $15.8 million. Changes in operating assets and liabilities decreased $9.1 million due to a decrease in accounts payable and accrued expenses of $8.1 million. This is due to the changes in the reinsurance payable of $7.4 million.
The increase in deferred acquisition costs is attributable to increases in higher written premiums in the year ended December 2010 as compared to 2009. The decrease in income taxes payable is due to receiving $1.9 million in refunds on income taxes in 2010 as compared to receiving $23.4 million in refunds in 2009. Changes in operating assets and liabilities increased $10.2 million due to increases in loss and LAE reserves of $6.3 million, increases in reinstatement premiums payable of $5.4 million, decreases in investments of $0.5 million and decreases in premium and agents’ balances of $1.0 million.
Inflation in the U.S. has been relatively low in recent years and did not have a material impact on our results of operations for the years ended December 31, 2011, 2010 and 2009. Although the impact of inflation has been relatively insignificant in recent years, it remains a factor in the U.S. economy and may increase the cost of labor and utilities.
The following table sets forth certain information with respect to our indebtedness outstanding as of December 31, 2011 and 2010 excluding indebtedness related to assets held for sale (in thousands):