Our executive offices are located at 3661 West Oakland Park Boulevard, Lauderdale Lakes, Florida in a 39,250 square feet office facility. All of our operations are consolidated in this facility, including our underwriting, claims, accounting and premium finance.
Effective March 1, 2005, Federated National sold its interest in the Lauderdale Lakes property to 21st Century at the property’s net book value of approximately $2.9 million. Effective on or about March 1, 2006, 21st Century sold the property to an unrelated party for approximately $5.0 million cash and a $0.9 million six year 5% note. As part of the transaction, 21st Century has agreed to lease the same facilities for a six year term. Our lease for this office space expires in February 2011.
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report on Form 10-K
Accounting for loss contingencies pursuant to Statements of Financial Accounting Standards (“SFAS”), No.5 involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur. Additionally, accounting for a loss contingency requires management to assess each event as probable, reasonably possible or remote. Probable is defined as the future event or events are likely to occur. Reasonably possible is defined as the chance of the future event or events occurring is more than remote but less than probable, while remote is defined as the chance of the future event or events occurring is slight. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: First, the amount can be reasonably estimated; and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements. It is implicit in this condition that it is probable that one or more future events will occur confirming the fact of the loss or incurrence of a liability.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS, No. 123, Share-Based Payments (revised 2004) (“SFAS No. 123R”). This statement eliminates the option to apply the intrinsic value measurement provisions of APB No. 25 to stock compensation awards issued to employees. Rather, SFAS No. 123R requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award - the requisite service period (usually the vesting period). SFAS No. 123R will also require companies to measure the cost of employee services received in exchange for employee stock purchase plan awards. SFAS No. 123R will be effective for 21st Century’s fiscal quarter beginning July 1, 2005. We have not yet determined the effect on us of the adoption of SFAS No. 123R.
In April 2005, the Securities and Exchange Commission’s Office of the Chief Accountant and its Division of Corporation Finance has released Staff Accounting Bulletin (SAB) No.107 to provide guidance regarding the application of FASB Statement No. 123 (revised 2004), Share-Based Payment. Statement No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SAB 107 provides interpretative guidance related to the interaction between Statement No. 123R and certain SEC rules and regulations, as well as the staff’s views regarding the valuation of share-based payment arrangements for public companies.
APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. This Statement shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We do not believe that the adoption of SFAS 154 will have a significant effect on our financial statements.
In September 2004, the FASB staff issued clarifying guidance for comment in FASB Staff Position (“FSP”) EITF Issue No. 03-1-a, “Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1” (“FSP Issue No. 03-1-a”) and subsequently voted to delay the implementation of the impairment measurement and recognition guidance contained in paragraphs 10-20 of EITF Issue No. 03-1 in order to deliberate again certain aspects of the consensus as well as the implementation guidance included in FSP Issue No. 03-1-a. The disclosure requirements including quantitative and qualitative information regarding investments in an unrealized loss position remain effective and are included in Note 2.
Total Investments increased $15.7 million, or 18.6%, to $100.1 million as of December 31, 2005, as compared to $84.4 million as of December 31, 2004. The increase is primarily a result of our investment of the proceeds from an increase in written insurance premiums.
We did not hold any non-traded investment securities during 2005 or 2004.
During December 2005, we classified $19.7 million of our bond portfolio as held-to-maturity. The decision to classify this layer of our bond portfolio as held-to-maturity was predicated by our intention to establish an irrevocable letter of credit in order to facilitate business opportunities in connection with our commercial general liability program.
An analysis of our portfolio indicates that as of December 31, 2005 19.5%, or $0.4 million of unrealized losses relate to the remaining bonds classified as available for sale and have continuously been in an unrealized loss position for more than twelve months. Additionally, as of December 31, 2005, $0.2 million of unrealized losses relate to bonds classified as held to maturity that have been in an unrealized loss position for more than twelve months.
Cash and cash equivalents, which include cash, certificates of deposits, and money market accounts, remained unchanged at approximately $6.1 million as of December 31, 2005, as compared to December 31, 2004. These balances are held primarily in money market accounts.
Premiums receivable, net of allowance for credit losses, increased $1.5 million, or 24.6%, to $7.5 million as of December 31, 2005, as compared to $6.0 million as of December 31, 2004.
Deferred policy acquisition costs increased $2.2 million, or 32.0%, to $9.2 million as of December 31, 2005, as compared to $7.0 million as of December 31, 2004. Contributing to the increased acquisition costs is the 2004 sale of our captive agencies, wherein our cost of acquiring policies from those agencies will no longer be eliminated under the principles of consolidation.
Property, plant and equipment, net, decreased $0.4 million, or 8.7%, to $3.9 million as of December 31, 2005, as compared to $4.3 million as of December 31, 2004. The net decrease is due to the natural aging of our fixed assets for which accumulated depreciation increased $0.4 million, or 20.0%, to $2.4 million as of December 31, 2005, as compared to $2.0 million as of December 31, 2004.
Goodwill, net, decreased to nothing, as of December 31, 2005, as compared to $0.2 million as of December 31, 2004. The decline is due to the sale of our interest in Express Tax on January 1, 2005.
Premium deposits increased $0.3 million, or 14.6%, to $2.1 million, as of December 31, 2005, as compared to $1.9 million, as of December 31, 2004. Premium deposits represent payments received by the Company for insurance policies with an effective date of coverage that is beyond the balance sheet dates. The increase was due to a $0.4 million increase in homeowner’s insurance premium deposits, offset by a combined $0.1 million decrease in mobile home insurance, automobile, and commercial liability premium deposits.
Revolving credit outstanding decreased $2.0 million, or 90.8%, to $0.2 million, as of December 31, 2005, as compared to $2.1 million, as of December 31, 2004. The decrease is due to our cash management efforts, requested credit reduction from the lender, and sale in December 2004 of our assets related to our non-standard automobile insurance agency business in Florida and the derived finance contracts receivable.
Bank overdraft decreased $2.6 million, or 17.5%, to $12.2 million as of December 31, 2005 as compared to $14.8 million as of December 31, 2004. Bank overdraft relates to hurricane-related loss and LAE disbursements paid but not yet presented for payment by the policyholder or vendor. The decrease relates to our payment patterns in relationship to the rate at which those cash disbursements are presented to the bank for payment.
As noted above, the Company’s efforts to expand commercial liability lines of insurance products are coming to fruition, as reflected by increased premiums written of $22.6 million for the year ended December 31, 2005, as compared to $12.5 million for the same period in the prior year. Furthermore, these policies reflect an increased percentage of the Company’s total gross premiums written, increasing to 18.9% of total premiums written in the year ended December 31, 2005, as compared to 12.42% in the same period of fiscal 2004.
The Company’s sale of auto insurance policies is relatively steady with premiums relatively constant at $20.7 million for the year ended December 31, 2005, as compared to $24.2 million in the same period of fiscal 2004, despite the sale of the Company’s captive agents who handled most of the auto insurance policies.
The increase in unearned premiums was $11.7 million for the year ended December 31, 2005, as compared to $16.0 million for the year ended December 31, 2004. The increase in unearned premiums of $11.7 million for the year ended December 31, 2005 was due to an $11.5 million increase in unearned homeowners’ insurance premiums, a $4.4 million increase in unearned commercial liability premiums, a $3.7 million decrease in unearned automobile premiums, and a $0.5 million decrease in unearned mobile home insurance premiums. These changes reflect our continued growth along our homeowners’ and commercial liability lines of business. For further discussion, see “Unearned Premiums” above.
Finance revenue decreased $0.1 million, or 2.8%, to $3.6 million for the year ended December 31, 2005, as compared to $3.7 million for the year ended December 31, 2004. The modest decrease is primarily due to the sale in December 2004 of our assets related to our non-standard automobile insurance agency business in Florida and the finance revenue derived there from.
Loss and LAE, our most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of our policyholders, including expenses required to settle claims and losses. Management revises its estimates based on the results of its analysis of estimated future payments to be made. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events.
Operating and underwriting expenses increased $0.1 million, or 1.0%, to $8.2 million for the year ended December 31, 2005, as compared to $8.1 million for the year ended December 31, 2004. The modest increase is primarily due to premium taxes, which increased $0.6 million, or 43.1%, to $1.9 million for the year ended December 31, 2005, as compared to $1.3 million for the year ended December 31, 2004. Premium tax expense is directly correlated to written premium, which experienced an increase over 2004.
The increase in policy acquisition costs, net of amortization, is primarily attributable to the sale of our captive agencies in December of 2004, wherein our cost of acquiring policies from those agencies will no longer be eliminated under the principles of consolidation.
Year Ended December 31, 2004 as Compared to December 31, 2003
This table reflects the success of our continued efforts to expand our line of insurance products to include products other than automobile insurance.
Prepaid reinsurance premiums decreased $0.5 million, or 15.3%, to ($2.9) million as of December 31, 2004, from ($3.4) million for the year ended December 31, 2003. The decrease is due primarily to our decreased reliance on quota-share reinsurance for its automobile insurance products.
Managing General Agent Fees decreased modestly by $0.2 million, or 11.0%, to $2.1 million as compared to $2.3 million as of December 31, 2003. The decrease reflects an overall decrease in the production of insurance policies mitigated by policies with higher rates and volume of one-year term policies.
Net investment income increased by $1.6 million, or 95.3%, to $3.2 million for the year ended December 31, 2004, as compared to $1.6 million for the year ended December 31, 2003. The increase in investment income is a result of the additional amounts of invested assets. Our overall investment yield increased by .35%, from 4.47% for the year ended December 31, 2003 to 4.82% for the year ended December 31, 2004.
For each catastrophic occurrence, the excess of loss treaty will insure us for $24 million with the Company retaining the first $10 million of loss and LAE. The treaty has a provision which, for an additional prorated premium will insure us for another $24 million of loss and LAE for subsequent occurrences with the Company retaining the first $10 million in loss and LAE. As a result of the loss and LAE incurred in connection with the Hurricanes Charles and Frances the Company has exhausted its recoveries of $48 million under the terms of this treaty.
The excess of loss treaty also insures us for an additional $34 million in excess of the Company’s $10 million retention plus the next $24 million as described above. Accordingly, loss and LAE incurred for Hurricanes Ivan, Jeanne and any subsequent catastrophic events through June 30, 2005, up to $34 million each, are the responsibility of the Company.
Salaries and wages increased $0.7 million, or 13.0%, to $6.1 million for the year ended December 31, 2004, as compared to $5.4 million for the year ended December 31, 2003. Management believes that the increase in salaries and wages is consistent with retaining quality management and increased premium production.
Policy acquisition costs, net of amortization, increased by $9.3 million, charging earnings by $8.4 million for the year ended December 31, 2004, as compared to a credit of $0.9 million as of December 31, 2003. Policy acquisition costs, net of amortization, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned.
For the year ended December 31, 2005, our primary sources of capital were revenues generated from operations, including increased unpaid losses and LAE, increased unearned premiums and realized income tax recoveries. Additionally, operational sources of capital came from increased income taxes payable, and an increase in funds held under reinsurance treaties. Also contributing to our liquidity were proceeds from the sale of investment securities available for sale, exercised employee stock options, exercised warrants and the sale of our interests in Express Tax and EXPRESSTAX. Because we are a holding company, we are largely dependent upon fees and commissions from our subsidiaries for cash flow.
For the year ended December 31, 2005, operations provided net operating cash flow of $19.4 million, as compared to $24.0 million and $12.3 million for the years ended December 31, 2004 and 2003, respectively.
For the year ended December 31, 2005, operations generated $147.9 million of gross cash flow, due to a $107.5 million increase in unpaid losses and LAE, an $11.7 million increase in unearned premiums, a $7.9 million decrease in income taxes recoverable in conjunction with a $3.0 million increase in income taxes payable stemming from current year profitable results of operations. Operations also generated sources of cash through a $1.5 million increase in funds held under reinsurance treaties, a $1.0 million decrease in deferred income tax expense and a $0.6 million decrease in the provision for credit losses. To a much less significant extent, operations generated additional sources of cash via a $0.5 million in net realized investment gains, a $0.5 million increase in accounts payable and accrued expenses, $0.4 million in depreciation and amortization, a $0.3 million decrease in finance contracts receivable, $0.3 million of common stock issued for interest on debt, as well as a $0.3 million increase in premium deposits, and $0.2 million in goodwill; all in conjunction with net income of $12.1 million.
For the year ended December 31, 2005, operations used $128.5 million of gross cash flow primarily due to a $111.2 million increase in due from reinsurers, net, a $6.6 million increase in prepaid reinsurance premiums, a $2.6 million decrease in bank overdrafts, a $2.3 million increase in other assets, $2.2 million increase in policy acquisition costs, net of amortization and $1.6 million in connection with our sale of discontinued operations. Other uses of cash include a $1.2 million increase in premiums receivable, a $0.3 million decrease to the provision for uncollectible premiums receivable, a $0.3 million decrease in the equity of the subsidiary sold, and $0.2 million in amortization of investment premiums, net.
Federated Premium’s operations are partially funded by the Revolving loan agreement with FlatIron. The effective interest rate on this line of credit, based on our average outstanding borrowings under the Revolving Agreement, was 6.39%, 5.71%, and 5.59% for the years ended December 31, 2005, 2004, and 2003, respectively. Interest expense on this revolving credit line for the years ended December 31, 2005, 2004, and 2003 totaled approximately $75,000, $178,000, and $57,000, respectively.
Outstanding borrowings under the Revolving Agreement as of December 31, 2005 were approximately $0.2 million. The $0.1 million outstanding borrowings in excess of the $2.0 million credit limit as of December 31, 2004 was permissible by reason of a compensating cash balance of $0.2 million that was held for the benefit of WPAC and was included in other assets as of December 31, 2004.
The Warrants issued in this placement to the purchasers of the July 2003 Notes and to the placement agent in the offering, J. Giordano Securities Group (“J. Giordano”), each entitle the holder to purchase ¾ of one share of our Common Stock at an exercise price of $12.744 per whole share (as adjusted for the Company’s three-for-two stock split) until July 31, 2006. The total number of shares issuable upon exercise of 2003 Warrants issued to the purchasers of the July 2003 Notes and to J. Giordano totaled 612,075. GAAP requires that detachable warrants be valued separately from debt and included in paid-in capital. Based on the terms of the purchase agreement with the investors in the private placement, management believes that the July 2003 Warrants had zero value at the date of issuance. During the third quarter of 2005, the Company purchased and ultimately retired 300,000 of the 2003 Warrants (or the equivalent of 225,000 shares of common stock) issued in connection with the July 2003 Notes for a total of $240,000 plus broker fees.
We have audited the accompanying consolidated balance sheets of 21st Century Holding Company and Subsidiaries (the “Company”), a Florida corporation, as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders' equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of 21st Century Holding Company and Subsidiaries at December 31, 2005 and 2004 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005 in conformity with U.S. generally accepted accounting principles.
During the year ended December 31, 2005, 63.4%, 17.3 %, 18.9 % and 0.4 % of the premiums we underwrote were for homeowners’ property and casualty insurance, personal automobile insurance, commercial general liability insurance, and mobile home property and casualty insurance, respectively. During the year ended December 31, 2004, 62.0%, 24.1%, 12.4 % and 1.5% of the premiums we underwrote were for homeowners’ property and casualty insurance, personal automobile insurance, commercial general liability insurance, and mobile home property and casualty insurance, respectively. We internally process claims made by our own and third-party insureds through our wholly owned claims adjusting company, Superior. We also offer premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium.
Our investment securities have been classified as either available-for-sale or held to maturity in response to our liquidity needs, changes in market interest rates and asset-liability management strategies, among other reasons. Investments available-for-sale are stated at fair value on the balance sheet. Investments held to maturity are stated at amortized costs on the balance sheet Unrealized gains and losses are excluded from earnings and are reported as a component of other comprehensive income within shareholders' equity, net of related deferred income taxes.
There can be no assurance that our unpaid losses and LAE will be adequate to cover actual losses. If our unpaid losses and LAE prove to be inadequate, we will be required to increase the liability with a corresponding reduction in our net income in the period in which the deficiency is identified. Future loss experience substantially in excess of the established unpaid losses and LAE could have a material adverse effect on our business, results of operations and financial condition.
Provisions for credit losses are provided in amounts sufficient to maintain the allowance for credit losses at a level considered adequate to cover anticipated losses. Generally, accounts that are over 90 days old are written off to the allowance for credit losses. We have been increasing our reliance on direct billing our policyholders for their insurance premiums. Direct billing is when the insurance company accepts from the insured, as a receivable, a promise to pay the premium, as opposed to requiring payment of the full amount of the policy, either directly from the insured or from a premium finance company. We manage the credit risk associated with our direct billing program through our integrated computer system which allows us to monitor the equity in the unearned premium to the underlying policy. Underwriting criteria are designed with down payment requirements and monthly payments that create policyholder equity, also called unearned premium, in the insurance policy. The equity in the policy is collateral for the extension of credit to the insured. The decrease during the year ended December 31, 2005 in the allowance for credit losses can be primarily attributed to the decline in homeowner and mobile homeowner policyholder receivables greater than ninety days old as compared to December 31, 2004. The increase during the year ended December 31, 2004 in the allowance for credit losses can be primarily attributed to homeowner and mobile homeowner policyholder receivables greater than ninety days old due in part to a cancellation moratorium in effect for non-payment of insurance premiums.
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, 2005, all reinsurance recoverables are considered collectible.
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, finance contracts, consumer loans and pay advances receivable. 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.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123, Share-Based Payments (revised 2004) (“SFAS No. 123R”). This statement eliminates the option to apply the intrinsic value measurement provisions of APB No. 25 to stock compensation awards issued to employees. Rather, SFAS No. 123R requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award - the requisite service period (usually the vesting period). SFAS No. 123R will also require companies to measure the cost of employee services received in exchange for employee stock purchase plan awards. SFAS No. 123R is effective for 21st Century’s fiscal quarter beginning July 1, 2005. Although disclosures in connection with the adoption of FASB 123R will be modified we do not expect that adoption of 123R will have a material effect on future operations.
CATASTOPHIC EVENT RISK-the risk associated with writing insurance policies covering automobile owners, homeowners, and business owners for losses that result from catastrophes, including hurricanes, tropical storms, tornadoes or other weather related events. We mitigate our risk of catastrophic events through the use of reinsurance, forecast modeling techniques and the monitoring of concentrations of risk, all designed to protect the statutory surplus of the insurance companies.
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2005 and 2004 because of their short-term nature: cash and cash equivalents, premiums receivable, finance contracts, due from reinsurers, drafts payable to insurance companies, revolving credit outstanding, bank overdraft, accounts payable, accrued expenses and subordinated debt.
The FASB Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (FAS 123) establishes financial accounting and reporting standards for stock-based compensation plans. As permitted by FAS 123, we use the accounting method prescribed by Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (APB 25) to account for our stock-based compensation plans. Companies using APB 25 are required to make pro forma footnote disclosures of net income and earnings per share as if the fair value method of accounting, as defined in FAS 123, had been applied. See Note (p) “Accounting Changes” and Note 16 “Stock Compensation Plans” for more information.
As of December 31, 2002 we adopted the FASB Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (FAS 148). FAS 148 amends FAS 123 to provide alternative methods of transition to FAS 123’s fair value method of accounting for stock-based compensation. FAS 148 also amends the disclosure provisions of FAS 123 to require disclosure in the Summary of Significant Accounting Policies footnote the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share.
Certain 2004 financial statement amounts have been reclassified to conform with the presentations.
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of fixed maturities and equity securities at December 31, 2005 and 2004 is as follows:
During December 2005 we reclassified $19.7 million of our bond portfolio as held-to-maturity. The decision to classify this layer of our bond portfolio as held-to-maturity was predicated by our intention to establish an irrevocable letter of credit in order to facilitate business opportunities in connection with our commercial general liability program.
Pursuant to FASB 115, 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 is either other than temporary 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.
Proceeds from sales of fixed maturities and equity securities for the years ended December 31, 2005, 2004 and 2003 were approximately $122.5 million, $81.2 million and $168.0 million, respectively.
A summary of realized investment gains (losses) and (increases) in net unrealized losses follows:
Depreciation of property, plant, and equipment was $444,744, $490,697 and $437,356 during 2005, 2004 and 2003, respectively.
The impact of reinsurance on the financial statements is as follows:
Based upon consultations with our independent actuarial consultants and their statement of opinion on losses and LAE, we believe that the liability for unpaid loses and LAE is adequate to cover all claims and related expenses which may arise from incidents reported.
Federated Premium’s operations are funded by the Revolving Agreement with FlatIron. The Revolving Agreement is structured as a sale of contracts receivable under a sale and assignment agreement with WPAC, a wholly-owned subsidiary of FlatIron, which gives WPAC the right to sell or assign these contracts receivable. Federated Premium, which services these contracts, has recorded transactions under the Revolving Agreement as secured borrowings.
During September 2004, we negotiated a new revolving loan agreement in which the maximum credit commitment available to us was reduced at our request to $2.0 million with built-in options to incrementally increase the maximum credit commitment up to $4.0 million over the next three years. We believe that this available credit is sufficient based on our current operations. Our lender, however, could decide to reduce our available credit based on a number of factors, including the A.M. Best ratings of Federated National and American Vehicle. If the A.M. Best rating of Federated National falls below a “C,” or if the financial condition of American Vehicle, as determined by our lender in its sole discretion suffers a material adverse change, then under the terms of the Revolving Agreement, policies written by that subsidiary will no longer be eligible collateral, causing our available credit to be reduced. If that occurs and we are not able to obtain working capital from other sources, then we would have to restrict our growth and, possibly, our operations. As of December 31, 2004, under the terms of our agreement with FlatIron, only American Vehicle policies are eligible for collateral and beginning in March 2005, our lender agreed to permit policies written by Federated National to be eligible collateral up to $165,000.
The WPAC’s advances are subject to availability under a borrowing base calculation, with maximum advances outstanding not to exceed the maximum credit commitment. The annual interest rate on advances under the Revolving Agreement is the prime rate plus additional interest varying from 1.25% to 3.25% based on the prior month’s ratio of contracts receivable related to insurance companies with an A. M. Best rating of B or lower, to total contracts receivable. As of December 31, 2005, our interest rate was 9.5% as compared to our interest rate as of December 31, 2004 of 7.00%
The Revolving Agreement contains various operating and financial covenants, with which we were in compliance at December 31, 2005 and December 31, 2004. Outstanding borrowings under the Revolving Agreement as of December 31, 2005 and December 31, 2004 were $0.2 million and $2.1 million, respectively. Outstanding borrowings in excess of the $2.0 million commitment totaled $148,542 as of December 31, 2004. The excess amount, permissible by reason of a compensating cash balance of $156,070 for December 31, 2004, was held for the benefit of FPF and is included in other assets. Interest expense on this revolving credit line for the years ended December 31, 2005, 2004 and 2003 totaled approximately $75,000, $178,000 and $203,000, respectively.
The annual interest rate on advances under the Revolving Agreement is the prime rate plus additional interest varying from 1.25% to 3.25% based on the prior month’s ratio of contracts receivable related to insurance companies with an A. M. Best rating of B or worse to total contracts receivable. The effective interest rate on this line of credit, based on our average outstanding borrowings under the Revolving Agreement, was 6.39%, 5.71% and 4.83% for the years ended December 31, 2005, 2004 and 2003, respectively.
The actual income tax expense (benefit) differs from the "expected" income tax expense (benefit) (computed by applying the combined applicable effective federal and state tax rates to income (loss) before provision for income tax expense (benefit)) as follows:
Due to the significant hurricanes that occurred in 2004 we provided a valuation allowance for Federal and State net operating loss carry forwards of approximately $0.8 million and $1.0 million, respectively
The 2004, 2003 and 2002 consolidated Federal Income Tax Returns filed by the Company are currently under examination by the Internal Revenue Service during 2006 and 2005. The examination for 2002 is near completion and the Company has not recorded any adjustments nor do we expect any significant comments or corrections as a result of their examination efforts. The 2004 and 2003 examinations are in progress and we do not expect any significant comments or corrections.
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 percent of their liabilities or a statutory minimum capital and surplus as defined in the Code. In 2005, 2004 and 2003, Federated National and American Vehicle were required to have capital surplus of $4.0 million, $4.0 million and $3.6 million, each, respectively. At December 31, 2005, 2004 and 2003, Federated National’s statutory capital surplus was $11.2 million, $7.6 million and $16.7 million, respectively. At December 31, 2005, 2004 and 2003, American Vehicle had statutory capital surplus of $18.0 million, $17.1 million and $10.7 million, respectively.
The insurance companies are also required to adhere to prescribed premium-to-capital surplus ratios. As of December 31, 2005, both Federated National and American Vehicle were in compliance with the prescribed premium-to-surplus ratio.
As of December 31, 2004, Federated National was not in compliance with its requirement to maintain minimum capital surplus primarily based on the incurred losses associated with the four hurricanes that occurred in August and September 2004. Under the provisions afforded Federated National according to Statement of Statutory Accounting Principles No 72 titled “Surplus and Quasi-reorganizations”, compliance with this provision was restored. American Vehicle remains in compliance with statutory minimum capital and surplus requirement. As of December 31, 2004, Federated National did not comply with the prescribed premium-to-capital surplus ratio, primarily based on the incurred losses associated with the four hurricanes that occurred in August and September 2004. Under the provisions afforded Federated National according to Statement of Statutory Accounting Principles No 72, compliance with this provision was also restored. American Vehicle remained in compliance with statutory premium-to-capital surplus ratios.
Based upon the 2005 statutory financial statements for American Vehicle, statutory surplus exceeded all regulatory action levels established by the NAIC’s risk-based capital requirements. As or the year ended December 31, 2005, statutory financial statements for Federated National did not exceed company action levels as established by the NAIC. Federated National’s results require us to submit a plan containing corrective actions. Federated National has not submitted its plan for corrective action yet, however we will submit a plan in the near future.
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 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 Authorized Control Level, the third action level, 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 154.0 %, 125.5% and 434.2% at December 31, 2005, 2004 and 2003, respectively. American Vehicle’s ratio of statutory surplus to its ACL was 329.7%, 545.1% and 585.2% at December 31, 2005, 2004 and 2003, respectively.
Federated National and American Vehicle are scheduled to have their statutorily required triennial examinations concurrently performed during 2006. American Vehicle’s examination will be for the three years ended December 31, 2005 and Federated National’s will be for the one year ended December 31, 2005. Subsequent to the 2005 examination, both American Vehicle and Federated National will be scheduled for concurrent examinations. Both of these examinations are to be performed by the Florida OIR.
Federated National’s 2004 regularly scheduled statutory triennial examination during 2005 for the three years ended December 31, 2004 as performed by the Florida OIR resulted in no corrective orders being issued. We may be the subject of additional targeted examinations or analysis. These examinations or analysis may result in one or more corrective orders being issued by the Florida OIR.
As of December 31, 2005, American Vehicle was outside NAIC’s usual ranges for two out of thirteen ratios. The first ratio relates to a larger than anticipated change in net writings, the second ratio relates to a modestly higher ratio of Gross Agents’ Balances due to the Company over the Policyholder Surplus. These Gross Agent Balances are all less than ninety days old.
Effective on or about March 1, 2006, the Company sold its interest in the property located at 3661 West Oakland Park Boulevard, Lauderdale Lakes, Florida to an unrelated party for approximately $5.0 million cash and a $0.9 million six year 5% note. As part of the transaction, the Company has agreed to lease the same facilities for a six year term In accordance with FASB 13, the lease will be treated as an operating lease. The expected future five year payout schedule is as follows:
At December 31, 2005, there were no minimum aggregate rental commitments.
We operate principally in two business segments consisting of insurance and financing. The insurance segment consists of underwriting through Federated National and American Vehicle, managing general agent operations through Assurance MGA, claims processing through Superior and marketing and distribution through independent agents and general agents. The insurance segment sells primarily homeowners’ and, mobile home property and casualty insurance, general liability insurance and standard and nonstandard personal automobile insurance. This segment includes substantially all aspects of the insurance, distribution and claims process. The financing segment consists of premium financing through Federated Premium. The financing segment provides premium financing to our insureds and third party carrier insureds, and is marketed through our distribution network.
Information regarding components of operations for the years ended December 31, 2005, 2004 and 2003 follows:
Information regarding total assets as of December 31, 2005 and 2004 follows:
We implemented a stock option plan in November 1998 that provides for the granting of stock options to officers, key employees and consultants. The objectives of this plan includes 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 have been granted at prices, which are either equal to or above the market value of the stock on the date of grant, vest over a four-year period, and expire ten years after the grant date. Under this plan, we are authorized to grant options to purchase up to 900,000 common shares, and, as of December 31, 2005, we had outstanding exercisable options to purchase 97,650 shares.
In 2001, we implemented a franchisee stock option plan that provides for the granting of stock options to individuals purchasing Company owned agencies which are then converted to franchised agencies. The purpose of the plan is 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 have been granted at prices, which are above the market value of the stock on the date of grant, vest over a ten-year period, and expire ten years after the grant date. Under this plan, we are authorized to grant options to purchase up to 988,500 common shares, and, as of December 31, 2005, we had outstanding exercisable options to purchase 15,000 shares.
In 2002, we implemented the 2002 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 key employees, consultants, independent contractors, Officers and Directors, upon whose efforts and judgment our success is largely dependent, by authorizing the grant of options to purchase Common Stock to persons who are eligible to participate hereunder, thereby encouraging stock ownership by such persons, all upon and subject to the terms and conditions of the Plan. Options outstanding under the plan have been granted at prices which are above the market value of the stock on the date of grant, vest over a five-year period, and expire six years after the grant date. Under this plan, we are authorized to grant options to purchase up to 1,800,000 common shares, and, as of December 31, 2005, we had outstanding exercisable options to purchase 818,608 shares.
Activity in our stock option plans for the period from January 1, 2003 to December 31, 2005 is summarized below:
Options outstanding as of December 31, 2005 are exercisable as follows:
The weighted average fair value of options granted during 2005, 2004 and 2003 estimated on the date of grant using the Black-Scholes option-pricing model was $2.81 to $10.75; $6.13 to $18.26 and $4.21 to $8.31 respectively. The fair value of options granted is estimated on the date of grant using the following assumptions:
Summary information about the Company’s stock options outstanding at December 31,
During December 2005 we reclassified $19.7 million of our bond portfolio as held-to-maturity. The decision to classify this layer of our bond portfolio as held-to-maturity was predicated by our intention to establish an irrevocable letter of credit in order to facilitate business opportunities in connection with our commercial general liability program. Unrealized loss in connection with the reclass totaled $0.26 million, net of a $0.16 income tax effect.
The following summarizes the major categories of 21st Century Holding Company’s (parent company only) financial statements:
The Warrants issued to the purchasers of the September 2004 Notes and to the placement agent in the offering, J. Giordano, each entitle the holder to purchase one share of our Common Stock at an exercise price of $12.75 per share and will be exercisable until September 30, 2007. The number of shares issuable upon exercise of the 2004 Warrants issued to purchasers equaled $12.5 million divided by the exercise price of the warrants, and totaled 980,392. The number of shares issuable upon exercise of the 2004 Warrants issued to J. Giordano equaled $500,000 divided by the exercise price of the warrants, and totaled 39,216. GAAP requires that detachable warrants be valued separately from debt and included in paid-in capital. Based on the terms of the purchase agreement with the investors in the private placement, management believes that the September 2004 Warrants also had zero value at the date of issuance.
The terms of the 2004 Warrants provide for adjustment of the exercise price and the number of shares issuable thereunder upon the occurrence of certain events typical for private offerings of this type.
For the September 2004 Notes, the scheduled loan payments for the next two years are as follows:
In accordance with the provisions contained in both Notes, we have announced our intention to make the April 30, 2006 payment in common stock rather than cash.
On January 31, 2006, Mr. Kent M. Linder, the Chief Operating Officer of the Company and the Company entered into a Separation and Release Agreement (the "Agreement") under which Mr. Linder resigned from his position as Chief Operating Officer effective as of January 31, 2006, and from all other officer and director positions with the Company and its subsidiaries. Mr. Linder resigned for personal reasons and does not have any disagreements with the Company. The Company has not appointed a replacement Chief Operating Officer at this time.
In accordance with the provisions contained in both Notes, we have announced to the note holders our intention to make the April 30, 2006 payment in common stock rather than cash.
The Company announced on March 28th that it received approval from the Florida OIR to enter into a business relationship with certain member companies of The Republic Group of Dallas, Texas. Specifically, American Vehicle has reached an agreement in principal with member companies of The Republic Group, subject to the parties entering into a definitive written agreement and American Vehicle providing the required security that will enable American Vehicle to underwrite general liability business and other commercial lines in various states through member companies of The Republic Group. The Republic companies have an A.M. Best Company, Inc. rating of "A-" Excellent.