Overview: Discussion of our business and overall financial results, and other highlights related to our results of operations for the periods presented.
Combined ratio of 79.4% on a gross basis and 71.4% on a net basis
1. Retroactive reinsurance income of $26.0 million during the year ended December 31, 2013 represents premiums earned, net of losses, for the period from January 1, 2013 through May 31, 2013 from a retroactive reinsurance quota share agreement entered into in connection with our assumption of approximately 39,000 policies from Citizens in June 2013. See Note 2 to our consolidated financial statements included elsewhere in this Annual Report.
2. General and administrative expenses for the years ended December 31, 2014, December 31, 2013 and for the period August 7, 2012 (inception) to December 31, 2012 includes $3.3 million, $5.7 million and $5.5 million of stock-based compensation expense, respectively.
3. Share and per share data for the periods presented gives retroactive effect to the 2,550-for-1 stock split effected on May 7, 2014, but does not give retroactive effect to the “Warrant Exercise” and, together with the Conversion, the “Reorganization Transactions”.
Net loss ratio. Our net loss ratio represents losses and loss adjustment expenses as a percentage of net premiums earned.
Gross premiums earned increased from $140.0 million for the year ended December 31, 2013 to $311.5 million for the year ended December 31, 2014. Our policies in force as of December 31, 2013 and 2014 were approximately 85,100, and 209,400 respectively, and this increase had a favorable impact on our gross premiums earned. Approximately $28.5 million of gross premiums earned during the year ended December 31, 2014 was attributable to the SSIC policies acquired on June 27, 2014, and $17.0 million from our entrance into the commercial residential line of business during the fourth quarter of 2014, via assumptions from Citizens and new voluntary writings.
Ceded premiums increased from $44.8 million for the year ended December 31, 2013 to $87.9 million for the year ended December 31, 2014. The increase in ceded premiums is primarily a result of the significant increase in the policies in force noted above, partially offset by lower reinsurance costs due to favorable reinsurance market conditions and the availability of lower cost reinsurance related to $200 million of catastrophe bonds issued by a third party, and improved geographic spread of risk. Additionally prior to June 1, 2013, our reinsurance costs were significantly lower because we purchased reinsurance limited to non-hurricane losses through May 31, 2013.
Net premiums earned increased from $95.2 million for the year ended December 31, 2013 to $223.6 million for the year ended December 31, 2014. The increase in net premiums earned in the comparable periods is primarily attributable to the increase in the number of policies in force during the year ended December 31, 2014 as compared to the year ended December 31, 2013, partially offset by increased ceded earned premiums.
Due to the impact our reinsurance costs have on net premiums earned from period to period, our management believes the ratios discussed below are more meaningful when viewed on a gross basis.
Our net loss ratio decreased from 40.5% for the year ended December 31, 2013 to 40.1% for the year ended December 31, 2014, primarily as a result in the improvement of the ceded premium ratio to gross earned premiums.
Our gross expense ratio increased modestly from 22.0% for the year ended December 31, 2013 to 22.5% for the year ended December 31, 2014, primarily as a result of the acquisition costs associated with the SSIC book of business that was acquired on June 27, 2014.
Our combined ratio on a gross basis decreased from 81.5% for the year ended December 31, 2013 to 79.4% for the year ended December 31, 2014. Our combined ratio on a net basis decreased from 72.9% for the year ended December 31, 2013 to 71.4% for the year ended December 31, 2014. The changes in our combined ratio, on both a gross and net basis, are primarily as a result of the improvement of the ceded premium ratio to gross earned premiums.
Gross premiums written for the period ended December 31, 2012 were $43.4 million and primarily related to our assumption of approximately 37,000 policies from Citizens in December 2012.
Net investment income was $27,000 for the period ended December 31, 2012.
Interest expense was $0.8 million for the period ended December 31, 2012 and related to the payment of a 20% fee payable upon the exchange of $3.9 million aggregate principal amount of notes for equity.
Provision for income taxes was $0.9 million for the period ended December 31, 2012. Heritage P&C had taxable income for the period ended December 31, 2012, while our limited liability company subsidiaries sustained losses. Such losses were passed through to our equity holders and were not available to offset Heritage P&C’s taxable income.
As of December 31, 2014, we had $160.5 million of cash and cash equivalents, which primarily consisted of cash and money market accounts. We intend to hold substantial cash balances during hurricane season to meet seasonal liquidity needs and the collateral requirements of Osprey Re Ltd, our captive reinsurance company described below. We also had $4.3 million in restricted cash to meet our contractual obligations related to the CAT bonds issued by Citrus Re.
Although we can provide no assurances, we believe that we maintain sufficient liquidity to pay Heritage P&C’s claims and expenses, as well as to satisfy commitments in the event of unforeseen events such, inadequate premium rates, or reserve deficiencies. We maintain a comprehensive reinsurance program at levels management considers adequate to diversify risk and safeguard our financial position.
The net increases (decreases) in cash and cash equivalents are summarized in the following table (in thousands):
Net cash provided by financing activities for the year ended December 31, 2013 was $32.6 million, as compared to $101.3 million for the year ended December 31, 2014. On May 29, 2014 we completed our IPO, which along with the concurrent private placement, raised $78.6 million. In addition, and in connection with the IPO, $22.5 million was raised from the exercise of warrants from existing stockholders.
Premiums receivable represents amounts due from our policyholders for billed premiums and related policy fees. We perform a policy-level evaluation to determine the extent to which the balance of the premium receivable exceeds the balance of the unearned premium. We then age any resulting exposure based on the last date the policy was billed to the policyholder, and we establish an allowance account for credit losses for any amounts outstanding for more than 90 days. When we receive payments on amounts previously charged off, we credit bad debt expense in the period we receive the payment. Balances in premiums receivable and the associated allowance account are removed upon cancellation of the policy due to non-payment. We recorded an allowance of $250,000 and $0 for uncollectible premiums at December 31, 2014 and 2013 respectively.
When we establish our reserves, we analyze various factors such as the evolving historical loss experience of the insurance industry as well as our experience, claims frequency and severity, our business mix, our claims processing procedures, legislative enactments, judicial decisions and legal developments in imposition of damages, and general economic conditions, including inflation. A change in any of these factors from the assumptions implicit in our estimates will cause our ultimate loss experience to be better or worse than indicated by our reserves, and the difference could be material. Due to the interaction of the foregoing factors, there is no precise method for evaluating the impact of any one specific factor in isolation, and an element of judgment is ultimately required. Due to the uncertain nature of any projection of the future, the ultimate amount we will pay for losses will be different from the reserves we record.
Our independent actuary evaluated the adequacy of our reserves as of December 31, 2014 and concluded that total reserves ranging from a low of $45.3 million to a high of $51.9 million would meet the requirements of the insurance laws of Florida, be consistent with reserves computed in accordance with accepted loss reserving standards and principles, and make a reasonable provision for all unpaid loss and loss adjustment expense obligations under the terms of our contracts and agreements. In addition to $21.4 million of recorded case reserves, we recorded $30.1 million of IBNR reserves as of December 31, 2014 to achieve overall reserves of $51.5 million.
Our reinsurance agreements are short-term, prospective contracts. We record an asset, prepaid reinsurance premiums, and a liability, reinsurance payable, for the entire contract amount upon commencement of our new reinsurance agreements. We amortize our prepaid reinsurance premiums over the 12-month contract period.
We estimate uncollectible amounts receivable from reinsurers based on an assessment of factors including the creditworthiness of the reinsurers and the adequacy of collateral obtained, where applicable. We recorded no uncollectible amounts under our reinsurance program or bad debt expense related to reinsurance for the years ended December 31, 2014 and December 31, 2013, respectively.
The carrying amounts for the following financial instruments approximate their fair values at December 31, 2014 and December 31, 2013 because of their short-term nature: cash and cash equivalents, accrued investment income, premiums receivable, reinsurance payable, and accounts payable and accrued expenses.
Stock-Based Compensation. We recognize compensation expense under ASC 718 for its stock-based payments based on the fair value of the awards. The Company grants stock options at exercise prices equal to the fair market value of the Company’s stock on the dates the options are granted. The options have a maximum term of ten years from the date of grant and vest primarily in equal annual installments over a range of one to five year periods following the date of grant for employee options. If a participant’s employment relationship ends, the participant’s vested awards will remain exercisable for the shorter of a period of 30 days or the period ending on the latest date on which such award could have been exercisable. The fair value of each option grant is separately estimated for each grant date. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the award and each vesting date. The Company estimates the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes-Merton multiple-option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense. We recorded $3.3 million, $5.7 million and $5.5 of stock-based compensation in 2014, 2013 and 2012, respectively.
Income taxes. On May 22, 2014, the Company converted from a limited liability company to a corporation. As a limited liability company, the Company was treated as a partnership for tax purposes, and accordingly was not subject to
We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences. Should a change in tax rates occur, we recognize the effect on deferred tax assets and liabilities in operations in the period that includes the enactment date. Realization of our deferred income tax assets depends upon our generation of sufficient future taxable income.
We record any income tax penalties and income tax-related interest as income tax expense in the period incurred. We did not incur any material tax penalties or income tax-related interest during the year ended December 31, 2014 or the years ended December 31, 2013 and 2012.
We obtained a $5 million irrevocable letter of credit from a financial institution to secure Osprey’s obligations arising from our reinsurance program. We collateralized this letter of credit facility with otherwise unencumbered real estate. The letter of credit terminates on May 31, 2015.
Consolidated Statements of Operations and Comprehensive Income (Loss) for the Years Ended December 31, 2014 and 2013 and the period from August 7, 2012 (inception) to December 31, 2012
Consolidated Statements of Cash Flows for the Years Ended December 31, 2014 and 2013 and the period from August 7, 2012 (inception) to December 31, 2012
We have audited the accompanying consolidated balance sheets of Heritage Insurance Holdings, Inc. (a Delaware Corporation) and subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive income (loss), changes in stockholders’ equity, and cash flows for the years ended December 31, 2014 and 2013 and the period from August 7, 2012 (inception) to December 31, 2012. 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.
Our insurance subsidiary is Heritage Property & Casualty Insurance Company (“Heritage P&C). Our other subsidiaries include: Heritage MGA, LLC, the managing general agent that manages substantially all aspects of our insurance subsidiary’s business; Contractors’ Alliance Network, LLC, our vendor network manager; Skye Lane Properties, LLC, our property management subsidiary; First Access Insurance Group, LLC, our retail agency; Osprey Re LTD; our reinsurance subsidiary that provides a portion of the reinsurance protection purchased by our insurance subsidiary; and Heritage Insurance Claims, LLC, an inactive subsidiary reserved for future development.
On May 22, 2014, the Company’s registration statement on Form S-1 was declared effective, pursuant to which it sold 6,900,000 shares of common stock to the public at a price of $11.00 per share, including 900,000 shares sold pursuant to the underwriters’ over-allotment option (the “IPO”). Concurrent with the IPO, the Company completed a private placement (the “Private Placement”) with Ananke Ltd., an affiliate of Nephila Capital Ltd., to purchase $10 million of the Company’s common stock at a price per share equal to the IPO price. The Company’s total net proceeds from the IPO and the Private Placement were $78.6 million, after deducting underwriting discounts and other costs.
On June 13, 2014, Heritage P&C, entered into an Insurance Policy Acquisition and Transition Agreement (the “Agreement”) with the Florida Insurance Guaranty Association (“FIGA”) and the Florida Department of Financial Services (“DFS”), the Receiver of Sunshine State Insurance Company (“SSIC”). Pursuant to the Agreement, Heritage P&C had the right to offer a new policy of insurance, effective June 27, 2014 to all (subject to limited exceptions) Florida SSIC policyholders having in-force policies (“Transition Policies”), without the need for SSIC policyholders to file a new application with Heritage P&C or pay premium that has already been paid to SSIC (“Transition Coverage”). As of June 27, 2014, SSIC had approximately 33,000 policies in force, representing approximately $58.9 million of in force premium and unearned premium of approximately $29.3 million. The Transition Coverage will terminate at the end of the original SSIC policy period. Upon termination of each Transition Policy, Heritage P&C will renew such policies at the lesser of SSIC’s and Heritage P&C’s rates on either SSIC’s or Heritage P&C’s forms, respectively. As consideration, Heritage P&C paid $10 million to the DFS, which will be amortized as acquisition costs in relation to the earning of the approximate $29.3 million of unearned premium. Heritage P&C was assigned the entirety of the unearned premium. At December 31, 2014, approximately 29,800 policies were in force representing approximately $53.3 million of annualized premium. The SSIC policies represented approximately 14% of the Company’s total policies in force at December 31, 2014.
The Company classifies all of its investments in fixed maturity securities and equity securities as available-for-sale, and reports them at fair value. The Company’s mortgage loan is classified as held to maturity and reported at amortized cost. Subsequent to its acquisition of available-for-sale securities, the Company records changes in value through the date of disposition as unrealized holding gains and losses, net of tax effects, and includes them as a component of other comprehensive income (loss). The Company includes realized gains and losses, which it calculates using the specific-identification method for determining the cost of securities sold, in net income. The Company amortizes any premium or discount on fixed maturities over the remaining maturity period of the related securities using the effective interest method, and the Company reports the amortization in net investment income. The Company recognizes dividends and interest income when earned.
Quarterly, the Company performs an assessment of its investments to determine if any are “other-than-temporarily” impaired. An investment is impaired when the fair value of the investment declines to an amount less than the cost or amortized cost of that investment. As part of the assessment process, the Company determines whether the impairment is temporary or “other-than-temporary”. The Company bases its assessment on both quantitative criteria and qualitative information, considering a number of factors including, but not limited to: how long the security has been impaired; the amount of the impairment; whether, in the case of equity securities, the Company intends to hold, and have the ability to hold, the security for a period sufficient for us to recover our cost basis, or whether, in the case of debt securities and participations in mortgage loans, the Company intends to sell the investment or it is more likely than not that the Company will have to sell the investment before it recovers the amortized cost or cost; the financial condition and near-term prospects of the issuer; whether the issuer is current on contractually-obligated interest and principal payments; key corporate events pertaining to the issuer and whether the market decline was affected by macroeconomic conditions.
The Company estimates the fair value of its investments using the closing prices on the last business day of the reporting period, obtained from active markets such as the NYSE, NASDAQ and NYSE MKT. For securities for which quoted prices in active markets are unavailable, the Company uses observable inputs such as quoted prices in inactive markets, quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs. The Company does not have any investments in its portfolio which require the use of unobservable inputs. The Company’s estimate of fair value reflect the interest rate environment that existed as of the close of business on December 31, 2014. Changes in interest rates subsequent to December 31, 2014 may affect the fair value of the Company’s investments.
The carrying amounts for the following financial instruments approximate their fair values at December 31, 2014 because of their short-term nature: cash and cash equivalents, accrued investment income, premiums receivable, reinsurance payable, and accounts payable and accrued expenses.
The Company records assumed premiums written (premiums from policies that the Company assumed from SSIC and from Citizens Property Insurance Corporation (“Citizens”), net of opt-outs) and direct premiums written (premiums from subsequent renewals of Citizens’ and SSIC policies and voluntary policies written during the period) as revenue, net of ceded amounts, on a daily pro rata basis over the contract period of the related policies that are in force. For any portion of premiums not earned at the end of the reporting period, the Company records an unearned premium liability.
we establish an allowance for credit losses for any amounts outstanding for more than 90 days. When we receive payments on amounts previously charged off, we reduce bad debt expense in the period we receive the payment. Balances in premiums receivable and the associated allowance account are removed upon cancellation of the policy due to non-payment. We recorded an allowance of $250,000 and $0 for uncollectible premiums at December 31, 2014 and 2013, respectively. Bad debt expense related to uncollectible premiums was $250,000, $0 and $0 for the years ended December 31, 2014 and 2013 and the period from August 7, 2012 (inception) to December 31, 2012, respectively. The Company has no direct write offs to date.
During June 2013, we received authorization from FLOIR to enter into a quota share reinsurance agreement with Citizens that was retroactive to January 1, 2013. All of the terms and conditions of the policies assumed pursuant to that agreement, including coverage and rates, remained unchanged for the remainder of the policy term. The assumed Citizens policies that do not opt-out or cancel will remain in effect until their respective expiration date and will be renewed by us on our own policy forms thereafter. Effective June 28, 2013, we assumed the premiums and losses associated with approximately 39,000 policies pursuant to a retroactive reinsurance agreement for the period January 1, 2013 through June 27, 2013. The transaction involved a period in the past, where known loss activity had already been determined (January 1, 2013 to May 31, 2013) as well as a period after which our policy selection had been made and the loss activity undetermined. The transaction exhibited both retroactive and prospective characteristics; the pending transaction’s terms were substantially set by May 31, 2013 and the reinsurance consequences of the pending transaction would begin on June 1, 2013, at the placement of our 2013-2014 catastrophe excess of loss reinsurance program. Based on these factors, we concluded that consideration received relating to the period from January 1 through May 31, 2013 was retroactive reinsurance and the effects of this portion of the transaction were excluded from our underwriting results. In 2013, we incurred no reinsurance cost associated with the retroactive component of this transaction and we recognized retroactive reinsurance income of $26.0 million, net of associated losses and loss adjustment expenses of $1.1 million, for the period January 1, 2013 through May 31, 2013. We do not currently expect to enter into similar transactions in future periods.
The Company assesses the recoverability of long-lived assets when events or circumstances indicate that the assets might have become impaired. The Company determines whether the assets can be recovered from undiscounted future cash flows and, if not recoverable, the Company recognizes impairment to reduce the carrying value to fair value. Recoverability of long lived assets is dependent upon, among other things, the Company’s ability to maintain profitability, so as to be able to meet its obligations when they become due. In the opinion of management, based upon current information and projections, long-lived assets will be recovered over the period of benefit.
The Company reports its reserves for unpaid losses and loss adjustment expenses gross of the amounts related to unpaid losses recoverable from reinsurers and reports losses net of amounts ceded to reinsurers. The Company does not discount its loss reserves for financial statement purposes.
The Company’s reinsurance agreements are short-term, prospective contracts. The Company records an asset, prepaid reinsurance premiums, and a liability, reinsurance payable, for the entire contract amount upon commencement of new reinsurance agreements. The Company amortizes its prepaid reinsurance premiums over the 12-month contract period.
On May 22, 2014, the Company converted from a limited liability company to a corporation. As a limited liability company, the Company was treated as a partnership for tax purposes, and accordingly was not subject to entity-level federal or state income taxation. The Company’s income tax provision generally consisted of income taxes payable by its separate subsidiaries that are taxed as corporations. As such, the Company’s effective tax rate as a limited liability company was historically driven primarily by the taxable income recognized by its taxable subsidiaries. As a corporation, the Company is subject to typical corporate U.S. federal and state income tax rates on a consolidated basis which it expects to result in a combined federal and state statutory tax rate of approximately 38.575% under current tax law.
The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company measures deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which it expects to recover or settle those temporary differences. Should a change in tax rates occur, the Company recognizes the effect on deferred tax assets and liabilities in operations in the period that includes the enactment date. Realization of the Company’s deferred income tax assets depends upon our generation of sufficient future taxable income.
The Company records any income tax penalties and income-tax-related interest as income tax expense in the period incurred. The Company did not incur any material tax penalties or income-tax-related interest for the years ended December 31, 2014, 2013, and the period from August 7, 2012 (inception) to December 31, 2012, respectively.
The Company expenses all advertising costs when it incurs those costs. For the years and period ended December 31, 2014, 2013 and 2012, the Company incurred advertising costs of $14,200, $393,000, and $77,000, respectively.
The Company estimates the fair value of options on the date of grant using the Black-Scholes-Merton option-pricing model. Key assumptions used in estimating the grant-date fair value of these options are as follows: the fair value of the ordinary shares, expected term, expected volatility, risk-free interest rate, and expected dividend yield.
The risk-free interest rate is based on the yield for a U.S. Treasury security having a maturity similar to the expected term of the related option grant.
Credit risk-The Company chooses to deposit all its cash at four financial institutions
With regard to cash, the Company had $154.4 million and $65.9 million in excess of Federal Deposit Insurance Corporation (FDIC) insurance limits at December 31, 2014 and December 31, 2013, respectively. Deposits held in non- interest-bearing transaction accounts are combined with interest-bearing accounts and are insured up to $250,000.
performance target is achieved. The updated guidance clarifies that such a term should be treated as a performance condition that affects vesting. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which the requisite service has already been rendered. The guidance will be effective for the Company beginning with year 2016, and may be applied either prospectively or retrospectively. The Company does not anticipate that this guidance will materially impact its consolidated financial statements and related disclosures.
The following table details the difference between cost or adjusted/amortized cost and estimated fair value, by major investment category, at December 31, 2014 and December 31, 2013:
The Company calculates the gain or loss realized on the sale of investments by comparing the sales price (fair value) to the cost or adjusted/amortized cost of the security sold. The Company determines the cost or adjusted/ amortized cost of the security sold using the specific-identification method. The following tables detail the Company’s realized gains (losses) by major investment category as of December 31, 2014 and 2013, respectively:
The following table presents an aging of the Company’s unrealized investment losses by investment class as of December 31, 2014 and December 31, 2013:
Expected annual rental income due under non-cancellable operating leases for our real estate properties is as follows (in thousands):
The Company anticipates that its DPAC costs will be fully recoverable in the near term. The table below depicts the activity with regard to DPAC for the years ended December 31, 2014 and 2013:
The DPAC at December 31, 2014 includes the unamortized portion of $10 million of deferred costs paid during June 2014 in connection with the Company’s assumption of policies from SSIC. Likewise, $7.6 million amortization has been recorded related to the SSIC policy acquisition costs for the year ended December 31, 2014. Therefore, the DPAC cost is $2.5 million related to SSIC at December 31, 2014.
During the second quarter of 2013, the Company placed its reinsurance program for the period from June 1, 2013 through May 31, 2014. The Company’s reinsurance program, which was segmented into layers of coverage, protected it for excess property catastrophe losses and loss adjustment expenses. The Company’s previous year’s reinsurance program incorporated the mandatory coverage required by law to be placed with the Florida Hurricane Catastrophe Fund, a state-mandated catastrophe reinsurance fund (“FHCF”). The Company also purchased private reinsurance below, alongside and above the FHCF layer, as well as aggregate reinsurance coverage. The following describes the various layers of the Company’s June 1, 2013 to May 31, 2014 reinsurance program.
The Company’s Retention. For the first catastrophic event, the Company had a primary retention of the first $9 million of losses and loss adjustment expenses, of which the Company’s reinsurance subsidiary, Osprey Re Ltd (“Osprey”), was responsible for $3 million. For a second and third catastrophic event, Heritage P&C’s primary retention decreased to $3 million per event. To the extent that there was reinsurance coverage remaining, Heritage P&C had no primary retention for events beyond the third catastrophic event. Osprey had no primary retention beyond the first catastrophic event.
Layers Below FHCF. Immediately above the Company’s retention, the Company purchased $94 million of reinsurance from third party reinsurers and Osprey. Through Osprey, the Company retained an aggregate participation in this coverage of $3.5 million, comprised of a 3% participation of $31 million of losses and loss adjustment expenses in excess of $9 million, or $0.9 million, and a 4% participation of $63 million of losses and loss adjustment expenses in excess of $40 million, or $2.5 million. Through the payment of a reinstatement premium, the Company was able to reinstate the full amount of this reinsurance one time. To the extent that $94.0 million or a portion thereof was exhausted in a first catastrophic event, the Company purchased reinstatement premium protection insurance to pay the required premium necessary for the reinstatement of this coverage.
FHCF Layer. The Company’s FHCF coverage included an estimated maximum provisional limit of 90% of $270 million, or $243 million, in excess of the Company’s retention and private reinsurance of $103 million. The limit and retention of the FHCF coverage was subject to upward or downward adjustment based on, among other things, submitted exposures to FHCF by all participants. The Company purchased coverage alongside and above the FHCF layer from third party reinsurers. The layer alongside was in the amount of $27 million and the layer immediately above was in the amount of $28.5 million. To the extent the FHCF coverage was adjusted, this private reinsurance would adjust to fill in any gaps in coverage up to the reinsurers’ aggregate limits for this layer. Through the payment of a reinstatement premium, the Company was able to reinstate the full amount of this private reinsurance one time. To the extent that all or a portion of either of these private layers was exhausted in a first catastrophic event, the Company purchased reinstatement premium protection insurance to pay the required premium necessary for the reinstatement of this coverage. The FHCF coverage could not be reinstated once exhausted, but it did provide coverage for multiple events.
Layers Below FHCF. Immediately above the Company’s retention, the Company has purchased $185 million of reinsurance from third party reinsurers. Through the payment of a reinstatement premium, the Company is able to reinstate the full amount of this reinsurance one time. To the extent that $185 million or a portion thereof is exhausted in a first catastrophic event, the Company has purchased reinstatement premium protection insurance to pay the required premium necessary for the reinstatement of this coverage. A portion of this coverage wraps around the FHCF and provides coverage alongside the FHCF.
Aggregate Coverage. In addition to the layers described above, the Company has also purchased $105 million of aggregate reinsurance coverage for losses and loss adjustment expenses in excess of $825.0 million for a first catastrophic event. To the extent that this coverage is not fully exhausted in the first catastrophic event, it provides coverage commencing at its reduced retention levels for second and subsequent events and where underlying coverage has been previously exhausted. There is no reinstatement of the aggregate reinsurance coverage once exhausted, but it does provide coverage for multiple events. Osprey Re Ltd. provides $20 million of protection in the layer above $940 million.
For a first catastrophic event, the Company’s reinsurance program provides coverage for $990 million of losses and loss adjustment expenses, including its retention, and the Company is responsible for all losses and loss adjustment expenses in excess of such amount. For subsequent catastrophic events, the Company’s total available coverage depends on the magnitude of the first event, as the Company may have coverage remaining from layers that were not previously fully exhausted. The Company has also purchased reinstatement premium protection insurance to provide an additional $185 million of coverage. The Company aggregate reinsurance layer also provides coverage for second and subsequent events to the extent not exhausted in prior events.
Prepaid reinsurance premiums related to twenty-one and sixteen reinsurers at December 31, 2014 and December 31, 2013, respectively. There were no amounts receivable with respect to reinsurers at December 31, 2014, 2013 or 2012. Thus, there were no concentrations of credit risk associated with reinsurance receivables as of December 31, 2014, 2013 and 2012. The percentages of assumed premiums earned to net premiums earned for the periods ended December 31, 2014, 2013 and 2012 were 46.8%, 98.6% and 102%, respectively.
The Company writes insurance in the state of Florida, which could be exposed to hurricanes or other natural catastrophes. Although the occurrence of a major catastrophe could have a significant effect on its monthly or quarterly results, such an event is unlikely to be so material as to disrupt its overall normal operations. However, the Company is unable to predict the frequency or severity of any such events that may occur in the near term or thereafter. The Company believes that the reserve for unpaid losses reasonably represents the amount necessary to pay all claims and related expenses which may arise from incidents that have occurred as of the balance sheet date.
The Company’s losses incurred in 2014 and 2013 reflect prior year redundancies of $223,000 and $467,000, respectively, due to changes in the Company’s estimate of ultimate losses on claims incurred in prior years not attributable to any specific trend or claims handling dynamic.
The following table sets forth the components of income (loss) before income taxes for the years ended December 31, 2014 and 2013 and the period from August 7, 2012 (inception) to December 31, 2012 (in thousands):
The statue of limitations related to our federal and state income tax returns remains open from our first filings for 2012 through 2014. No taxing authorities are currently examining any of our federal or state income tax returns.
State laws and regulations, as well as national regulatory agency requirements, govern the operations of all insurers such as our insurance subsidiary. The various laws and regulations require that insurers maintain minimum amounts of statutory surplus and risk-based capital, restrict insurers’ ability to pay dividends, specify allowable investment types and investment mixes, and subject insurers to assessments.
Office of Insurance Regulation to examine affiliated entities within an insurance holding company system in order to ascertain the financial condition of the insurer. The law also provides for certain disclosures with regard to enterprise risk, which are satisfied by the provision of related information filed with the SEC. This legislation was designed to bolster regulation for insurer solvency and governance and became effective January 1, 2015.
1. No Action Level-If RBC is greater than 200%, no further action is required.
2. Company Action Level-If RBC is between 150%-200%, the insurer must prepare a report to the regulator outlining a comprehensive financial plan that identifies conditions that contributed to the insurer’s financial condition and proposes corrective actions.
Governmental agencies or certain quasi-governmental entities can levy assessments upon the Company in the states in which the Company writes policies. See Note 2 for a description of how the Company recovers assessments imposed upon it.
Governmental agencies or certain quasi-governmental entities can also levy assessments upon policyholders, and the Company collects the amount of the assessments from policyholders as surcharges for the benefit of the assessing agency. We currently collect assessments levied upon policyholders on behalf of Citizens in the amount of 1.0%, and on behalf of FHCF in the amount of 1.3%. The Company multiplies the premium written on each policy by these assessment percentages to determine the additional amount that it will collect from the policyholder and remit to the assessing agencies.
Statutory accounting requires that the Company excluded certain assets, called non-admitted assets, from the balance sheet.
Statutory accounting dictates how much of a deferred income tax asset the Company can admit on a statutory balance sheet.
The Company’s insurance subsidiary must file with the insurance regulatory authorities an “Annual Statement” which reports, among other items, net income (loss) and surplus as regards policyholders, which is called stockholder’s equity under GAAP.
The table below reconciles our consolidated GAAP stockholders’ equity to the surplus as regards policyholders of our insurance subsidiary (in thousands):
The Company has been party to various related party transactions involving certain of its officers, directors and significant stockholders as set forth below. The Company has entered into these arrangements without obligation to continue its effect in the future and the associated expense was immaterial to its results of operations or financial position as of December 31, 2014 and December 31, 2013.
The Company entered into an agreement for the construction of a parking facility for its Clearwater property with a relative of one of its directors. As of December 31, 2014, the Company has made payments of approximately $2.6 million for engineering and architectural services. The project was completed during September 2014.
The Company provides a 401(k) plan for substantially all of its employees. The Company contributes 3% of employees’ salary, up to the maximum allowable contribution, regardless of the employees’ level of participation in the plan. For the years ended December 31, 2014 and 2013, the Company’s contributions to the plan on behalf of the participating employees were $285,000, and $155,000, respectively.
The total amount of our authorized capital stock consists of 50,000,000 shares of common stock, $0.0001 par value, and 5,000,000 shares of preferred stock, $0.0001 par value. As of December 31, 2014, the Company had 29,794,960 shares of common stock outstanding and no shares of preferred stock outstanding.
As of December 31, 2014, the Company had outstanding warrants to purchase an aggregate of 30,600 shares of common stock. The warrants have an exercise price of $5.88 per share and expire on March 31, 2018. The warrants are non-redeemable by the Company and are subject to certain restrictions on transfer.
Prior to the IPO, certain of the Company’s stockholders held warrants to purchase an aggregate of 7,716,300 shares of the Company at an exercise price of $5.88 per share. On May 22, 2014, warrants to purchase an aggregate of 7,685,700 shares were exercised (the “Warrant Exercise”), including warrants to purchase an aggregate of 3,858,150 shares exercised on a cashless basis. Pursuant to the cashless exercise provisions of the warrants, each warrant holder paid the exercise price by surrendering to the Company an amount of shares having a value equal to the aggregate exercise price of the warrants being exercised. The terms of the warrants provided that the value ascribed to each share surrendered to the Company as payment for the exercise price was equal to our initial public offering price per share of common stock. As a result, an aggregate of 5,622,519 shares were issued in connection with the Warrant Exercise. The Company received $22.5 million in proceeds from the cash exercise of 3,827,550 warrants.
Ananke, an affiliate of Nephila Capital Ltd, purchased $10 million of the Company’s common stock (909,090 shares) in the Private Placement at a price per share equal to the public offering price. Poseidon Re Ltd., another affiliate of Nephila Capital Ltd, is currently a participating reinsurer in the Company’s reinsurance program. The sale of such shares was not registered under the Securities Act and was conducted in accordance with Section 4(a)(2) of the Securities Act.
On December 2, 2014, the Company granted 1,326,923 options to certain employees and directors. The employee options were awarded with the strike price set at the fair market value at the grant date, and vest at 50 percent upon grant and 50 percent on April 30, 2015 with an expiration date of December 2, 2017. The directors’ options were awarded with the strike price set at the fair market value at the grant date, and vest quarterly commencing on January 1, 2015 with an expiration date of December 2, 2017. The fair value of each option grant, which ranged from $3.07 to $3.54 per option granted in 2014, is estimated on the date of grant using the Black-Scholes option-pricing model.
A summary of information related to stock options outstanding at December 31, 2014 is as follows:
The Company had approximately $1.9 million of unrecognized stock compensation expense on December 31, 2014 related to non-vested compensation, which the Company expects to recognize ratably over the period of 0.5 years. The Company recognized $3.3 million of compensation expense for the year ended December 31, 2014. The intrinsic value of the Company’s outstanding stock options totaled approximately $5.2 million at December 31, 2014.
On January 1, 2013 (the modification date), the Company executed employment agreements with three of its key executives each containing a provision requiring the Company to repurchase the executive’s stock if the executive is terminated for any reason. Because the redemption of the shares is subject to redemption at the option of the holder in an event that is outside of our control, these shares are required to be classified outside of permanent equity on the consolidated balance sheets and recorded at fair value as of the modification date with adjustments to fair value through the settlement date. Accordingly, this temporary equity is recorded as “redeemable shares” on our consolidated balance sheets at December 31, 2013. Upon amendment to the employment agreements in February 2014, the redemption provision was removed and the shares were reclassified to equity.
The following table provides a summary of quarterly results for the periods presented (in thousands, except per share data):
Fourth quarter net income of $19.7 million in 2014 compared to $0.8 million in 2013 can be primarily attributed to growth in our in force premium, which was significantly impacted by the introduction into the commercial residential line of business coupled with successful transition of SSIC policies to our Company, and the lower cost of catastrophe reinsurance.