We lease office space in Nashville, Tennessee for our corporate offices, claims, customer service and data center (approximately 53,000 square feet). We also lease office space for our regional claims office in Tampa, Florida and for our regional claims office and customer service center in Chicago, Illinois. Our retail locations are all leased and typically are located in storefronts in retail shopping centers, and each location typically contains approximately 1,000 square feet of space. See Note 8 to our consolidated financial statements for further information about our leases.
The following tables provide selected historical consolidated financial and operating data of the Company at the dates and for the periods indicated. In conjunction with the data provided in the following tables and in order to more fully understand our historical consolidated financial and operating data, you should also read our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the accompanying notes included in this report. On November 15, 2011, our Board of Directors approved a change in fiscal year end from June 30 to December 31, effective December 31, 2011. As a result of this change, a Form 10-K was previously filed including financial information for the six-month transition period from July 1, 2011 to December 31, 2011. The comparative financial information provided for the year ended December 31, 2011 presented below is unaudited and includes all normal recurring adjustments necessary for a fair statement of the results for the respective period. We derived our selected historical consolidated financial data at December 31, 2015, 2014, and 2013 and for the years then ended from our consolidated financial statements included in this report. We derived our selected historical consolidated financial data at December 31, 2012 and 2011 from our consolidated financial statements which are not included in this report. The results for past periods are not necessarily indicative of the results to be expected for any future period.
the anticipated effects on our results of operations or financial condition from recent and expected developments or events, including the recently completed acquisition of the Titan Agencies;
We are principally a retailer, servicer and underwriter of non-standard personal automobile insurance. We also own two tracts of land in San Antonio, Texas that are held for sale, one of which is currently under contract for a sale expected to close in May 2016. Non-standard personal automobile insurance is made available to individuals because of their inability or unwillingness to obtain standard insurance coverage due to various factors, including payment history, payment preference, and failure in the past to maintain continuous insurance coverage, driving record and/or vehicle type.
Effective July 1, 2015, we acquired certain assets of Titan Insurance Services, Inc. and Titan Auto Insurance of New Mexico, Inc. (the “Titan Agencies”). These agencies, which are now rebranded under our Acceptance Insurance name, sell private passenger non-standard automobile insurance through 83 retail locations, principally in California (48), but also in Texas (12), Arizona (10), Florida (4), Nevada (4) and New Mexico (5). Approximately 240 employees accepted offers of employment with us as a part of this acquisition. The Titan Agencies were previously owned and operated by Nationwide.
These new Acceptance stores have continued to write policies for both Nationwide and other unrelated insurance companies for which our revenues are in the form of commission and fee income. Going forward, we plan to develop our own products for California, Arizona, Nevada and New Mexico, and introduce our current Texas and Florida products into stores in those states. FAIC has applied for an insurance company license in California and is already licensed in the three other states where it does not currently write business. These new products are not expected to be available until sometime in 2016, and California is subject to the approval of our insurance company license application by the California Department of Insurance.
The following table presents gross premiums earned by state (in thousands). Driven by an increase in the number of policies sold, higher average premiums, and an increase in the average life of a policy, net premiums earned for the year ended December 31, 2015 increased 22.3% compared with the same period in the prior year.
Combined Ratio - Combined ratio is the sum of the loss ratio and the expense ratio. If the combined ratio is at or above 100%, an insurance company cannot be profitable without sufficient investment income.
Since the beginning of 2012, we renewed our focus on improving the customer experience and value through several initiatives. Through February 2016, our progress has included:
development of electronic signature capabilities, thereby enabling customers to receive quotes and bind policies over the phone and through our website and mobile platform;
development of an internet-specific sales strategy to drive quote traffic to our website, including the release of a mobile platform that puts the full range of our services into the broad spectrum of handheld devices; including mobile phones and tablets;
continued expansion of our call center staff and capabilities to meet increasing customer demand;
launch and expansion of complementary insurance products including, renters, term life, and third party homeowners and commercial automobile;
expansion to new markets including California, Arizona, Nevada, and New Mexico from the Titan acquisition, and Virginia, our first new state since 2005.
The value of our consolidated available-for-sale investment portfolio was $131.6 million at December 31, 2015 and consisted of fixed maturity securities, preferred stock and investments in mutual funds, all carried at fair value with unrealized gains and losses reported as a separate component of stockholders’ equity. At December 31, 2015, we had gross unrealized gains of $4.7 million and gross unrealized losses of $1.4 million in our consolidated investments available-for-sale portfolio. We also held $11.3 million of other investments at December 31, 2015.
At December 31, 2015, 94% of the fair value of our fixed maturities portfolio was rated “investment grade” (a credit rating of AAA to BBB-) by nationally recognized statistical rating organizations. Investment grade securities generally bear lower yields and have lower degrees of risk than those that are unrated or non-investment grade. We believe that a high quality investment portfolio is more likely to generate a stable and predictable investment return.
The following table summarizes our investments available-for-sale at December 31, 2015 (in thousands).
Premiums earned increased by $48.7 million, or 22%, to $267.0 million for the year ended December 31, 2015, from $218.3 million for the year ended December 31, 2014. This improvement was primarily due to higher average premiums and an increase in the number of policies in force.
Investment income decreased slightly to $5.0 million during the year ended December 31, 2015 from $5.1 million during the year ended December 31, 2014. This decrease in investment income was primarily a result of the lower returns on reinvested fixed maturities. At December 31, 2015 and 2014, the book yields for our fixed maturities and cash equivalents portfolio were 2.3% and 2.8%, respectively, with effective durations of 3.04 and 3.10 years, respectively.
Net realized gains (losses) on investments, available-for-sale during the year ended December 31, 2015 included $11 thousand of net realized losses on redemptions, compared with $23 thousand of net realized gains on redemptions during the year ended December 31, 2014.
Excluding the development related to prior fiscal years, the loss ratios for the years ended December 31, 2015 and 2014 were 81.7% and 76.1%, respectively. The year-over-year increase in the loss ratio was primarily due to higher than expected claim frequency and severity across multiple coverages principally in property damage liability and collision claims. We believe that an increase in the number of miles driven by insured drivers as a result of lower gas prices and a favorable economy has been a contributing factor to an industry-wide increase in frequency. In response, the Company has continued to implement aggressive rate and underwriting actions as warranted at a state and coverage level.
Revenues from insurance operations were $263.1 million for the year ended December 31, 2014, compared with $240.5 million for the year ended December 31, 2013. Income before income taxes from insurance operations for the year ended December 31, 2014 was $12.5 million, compared with income before income taxes from insurance operations of $12.7 million for the year ended December 31, 2013.
Premiums earned increased by $18.6 million, or 9%, to $218.3 million for the year ended December 31, 2014, from $199.7 million for the year ended December 31, 2013. This improvement was primarily due to an increase in the number of policies in force, in addition to a higher percentage of full coverage policies sold and our recent pricing actions which have increased our average premium per policy.
Commission and fee income increased 13% to $39.7 million for the year ended December 31, 2014, from $35.1 million for the year ended December 31, 2013. This increase in commission and fee income was a result of higher fee income related to commissionable ancillary products sold and the increase in the number of policies in force.
Our holding company requires cash for general corporate overhead expenses and for debt service related to our debenture and term loan payable. The holding company’s primary source of unrestricted cash to meet its obligations is the sale of ancillary products and policies on behalf of third-party carriers. The agency operations related to the Titan acquisition currently produce additional unrestricted cash. If necessary and available subject to state law limitations, the holding company may receive dividends from our insurance company subsidiaries. To a lesser extent, the holding company also receives cash from operating activities as a result of investment income. Through an intercompany tax allocation arrangement, taxable losses of the holding company provide cash to the holding company to the extent that taxable income is generated by the insurance company subsidiaries. At December 31, 2015, our holding company had $7.2 million available in unrestricted cash and investments. These funds and the additional unrestricted cash from the sources noted above will be used to pay our future cash requirements outside of the insurance company subsidiaries.
The National Association of Insurance Commissioners Model Act for risk-based capital provides formulas to determine each December 31 on an annual basis the amount of statutory capital and surplus that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. There are also statutory guidelines that suggest that on an annual calendar year basis an insurance company should not exceed a ratio of net premiums written to statutory capital and surplus of 3-to-1. On a combined basis, the ratios for our insurance company subsidiaries of net premiums written for the last twelve months to statutory capital and surplus were 2.88-to-1 at December 31, 2015. Based on our current forecast on a combined basis, including anticipated underwriting operations from the newly acquired Titan locations, we anticipate that our risk-based capital levels will be adequate and that our ratio of net premiums written to statutory capital and surplus will not exceed the 3-to-1 statutory guideline for the reasonably foreseeable future. We therefore believe that our insurance company subsidiaries have sufficient statutory capital and surplus available to support their net premium writings in this time frame.
The following table summarizes our contractual obligations by period at December 31, 2015 (in thousands).
Payments due by period assume a contractual variable interest rate of LIBOR plus 375 basis points, or 4.366% at January 31, 2016.
Payments due by period assume a flat contractual interest rate of 8%.
In establishing a valuation allowance at December 31, 2015, we estimated our future taxable income from the 2016 budget and the long-term forecasts we use to manage our business. We have demonstrated that our past budgets and forecasts have been a reasonable means of forecasting taxable income. A key consideration in our current analysis was also the fact that no deferred tax assets have had expiration dates that we believed would be a factor in the timing of their ultimate realization.
These quantitative impairment tests all require us to make significant estimates and judgements in determining what assumptions to use in the calculating the estimated fair value of the goodwill and identifiable intangible assets. These evaluations include multiple assumptions that may change over time. If unfavorable events or trends occur, goodwill and identifiable intangible assets impairment charges may become necessary that could have a materially adverse impact on our results of operations in the period in which the write-off occurs.
Securities with declines attributable to issuer-specific fundamentals are reviewed to identify all available evidence to estimate the potential for impairment. Resources used include historical financial data included in SEC filings for corporate bonds and performance data regarding the underlying loans for CMOs. Securities with declines attributable solely to market or sector declines where we do not intend to sell the security and it is more likely than not that we will not be required to sell the security before the full recovery of its amortized cost basis are not deemed to be other-than-temporarily impaired.
In reviewing our investment portfolio for impairment at December 31, 2015, we were able to rely upon the objective factor that the unrealized losses as of this date were related to the increase in market interest rates.
We have audited the accompanying consolidated balance sheets of First Acceptance Corporation and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. Our audits also included the financial statement schedule listed in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Acceptance Corporation and subsidiaries at December 31, 2015 and 2014, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), First Acceptance Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) and our report dated March 15, 2016 expressed an unqualified opinion thereon.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. It also requires disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported revenues and expenses during the period. Actual results could differ from those estimates.
During the quarter ended December 31, 2015, the Company voluntarily changed the timing of its annual goodwill and identifiable intangible assets impairment testing from June 30th to October 1st of each year. The change in the goodwill and identifiable intangible assets impairment testing date is preferable under the circumstances in order to combine evaluation efforts to provide for a more consistent, efficient, and effective entity-wide impairment testing process as it better aligns the impairment testing procedures with the timing of the Company’s annual budgetary process, which is a significant input to the testing, and it allows the Company more time to accurately complete its impairment testing process in order to incorporate the results in the annual consolidated financial statements.
The Company has determined that it is unable to objectively determine, without the use of hindsight, the projected cash flows and related valuation estimates for earlier periods. Therefore, the Company has prospectively applied the change in the annual goodwill and identifiable intangible assets impairment testing date beginning October 1, 2015 as retrospective application to prior periods is deemed impracticable. This change in testing date did not delay, accelerate, or avoid a goodwill or identifiable intangible assets impairment charge. No impairment was recorded in 2015.
Certain reclassifications have been made to the prior year’s consolidated financial statements to conform with the current presentation.
If management can assert that it does not intend to sell an impaired fixed maturity security and it is more likely than not that it will not have to sell the security before recovery of its amortized cost basis, then an entity must separate other-than-temporary impairments (“OTTI”) into the following two components: (i) the amount related to credit losses, which are charged against income, and (ii) the amount related to all other factors, which are recorded in other comprehensive income (loss). The credit-related portion of an OTTI is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge is required to reduce the amortized cost of that security to fair value.
The Company accounts for income tax uncertainties under the provisions of FASB ASC 740, Income Taxes. The Company has recognized no additional liability or reduction in deferred tax assets for unrecognized tax benefits at December 31, 2015 and 2014. Any interest and penalties incurred in connection with income taxes are recorded as a component of the provision for income taxes. The Company is generally not subject to U.S. federal, state or local income tax examinations by tax authorities for taxable years prior to 2011.
In May 2014, the FASB issued ASU No. 2015-09, “Financial Services-Insurance (Topic 944): Disclosures about Short-Duration Contracts” which requires insurance companies to make additional disclosures about short-term duration contracts. This guidance has an effective date for public companies for annual reporting periods beginning after December 15, 2015 and interim reporting periods beginning after December 15, 2016, with early adoption permitted. The Company believes that it will be reasonably able to comply with these requirements.
In April 2015, the FASB issued ASU No. 2015-03, “Interest-Imputation of Interest” as final guidance to simplify the presentation of debt issuance costs by requiring such costs to be presented as a deduction from the corresponding liability, consistent with the presentation of debt discounts or premiums. Although this guidance has an effective date for public companies for annual and interim periods beginning after December 15, 2015, the Company elected early adoption as permitted at March 31, 2015 and has retrospectively restated all prior periods presented in the consolidated financial statements. As a result, $124 thousand and $130 thousand, respectively, were reclassified and deducted from debentures payable at December 31, 2015 and 2014, respectively.
In September 2015, the FASB issued ASU No. 2015-16, “Business Combination (Topic 805): Simplifying the Accounting for Measurement-period Adjustments” to eliminate the requirement that an acquirer in a business combination account for measurement-period adjustments retrospectively. Under this new guidance, measurement-period adjustments will be recognized during the period in which the amount of the adjustment is determined. The guidance is effective for public business entities for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years, with early adoption permitted. The Company has elected early adoption as permitted and has made measurement-period adjustments as a result of its recent business combination described in Note 17.
Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares, while diluted net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of such common shares and dilutive share equivalents. Dilutive share equivalents result from the assumed exercise of employee stock options restricted stock units and are calculated using the treasury stock method.
Fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are generally based upon observable and unobservable inputs. Observable inputs are based on market data from independent sources, while unobservable inputs reflect the Company’s view of market assumptions in the absence of observable market information. All assets and liabilities that are carried at fair value are classified and disclosed in one of the following categories:
The fair values of the Company’s investments are determined by management after taking into consideration available sources of data. All of the portfolio valuations classified as Level 1 or Level 2 in the above tables are priced exclusively by utilizing the services of independent pricing sources using observable market data. The Level 2 classified security valuations are obtained from a single independent pricing service. The Level 3 classified security in the table above consists of an investment in the common stock of a real estate investment trust for which fair value has been determined using a model driven valuation that does not have observable market data. There were no transfers between Level 1 and Level 2 for years ended December 31, 2015 and 2014. The Company’s policy is to recognize transfers between levels at the end of the reporting period based on specific identification. The Company has not made any adjustments to the prices obtained from the independent pricing sources.
The Company has reviewed the pricing techniques and methodologies of the independent pricing service for Level 2 investments and believes that its policies adequately consider market activity, either based on specific transactions for the security valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. The Company monitored security-specific valuation trends and has made inquiries with the pricing service about material changes or the absence of expected changes to understand the underlying factors and inputs and to validate the reasonableness of the pricing. Likewise, the Company reviews the Level 3 valuation model to understand the underlying factors and inputs and to validate the reasonableness of the pricing.
Other investments consist of the common stock of a real estate investment trust and limited partnership interests in three funds that invest in (i) commercial real estate and secured commercial real estate loans acquired from financial intuitions, (ii) small balance distressed secured loans and debt securities and (iii) undervalued international publicly-traded equities. These investments have redemption and transfer restrictions. In 2015, the Company started the withdrawal process for one of the limited partnership investments which is taking place over a twelve-month period in 25% increments, one of which was received prior to December 31, 2015. The Company does not intend to sell the remaining investments, and it is more likely than not that the Company will not be required to sell them before the expiration of such restrictions. At December 31, 2015, the Company had unfunded commitments of $1.1 million with two of these investments.
At December 31, 2015, fixed maturities and cash equivalents with a fair value and amortized cost of $6.5 million were on deposit with various insurance departments as a requirement of doing business in those states. Cash equivalents with a fair value and amortized cost of $9.4 million were on deposit with another insurance company as collateral for an assumed reinsurance contract.
Realized gains and losses on sales and redemptions are computed based on specific identification. The non-credit related portion of OTTI is included in other comprehensive income (loss). The amounts of non-credit OTTI for securities still owned was $0.9 million for non-agency backed residential CMOs and $0.2 million for non-agency backed commercial at December 31, 2015 and 2014.
The following is a progression of the credit-related portion of OTTI on investments owned at December 31, 2015, 2014, and 2013 (in thousands).
At December 31, 2015, the Insurance Companies had unsecured aggregate reinsurance receivables of $0.5 million.
Ceded premiums earned and reinsurance recoveries on losses and loss adjustment expenses were as follows (in thousands):
The Company has issued stock options (“Stock Option Awards”) and restricted common stock and restricted stock units (“Restricted Stock Awards”) to employees and directors under its Amended and Restated First Acceptance Corporation 2002 Long Term Incentive Plan (the “Plan”) and accounts for such issuances in accordance with FASB ASC 718, Compensation - Stock Compensation. At December 31, 2015, there were 6,141,970 shares remaining available for issuance under the Plan. Stock Option Awards are generally granted with an exercise price equal to or greater than the market price of the Company’s stock at the date of grant. Stock Option Awards expire over five or ten years from the date of grant and vest in designated installments over four or five years through January 2016, while the outstanding Restricted Stock Awards vest in full in March 2018. Certain awards provide for accelerated vesting if there is a change in control (as defined in the Plan).
On January 31, 2012, the Compensation Committee of the Board of Directors of the Company awarded two executive officers Stock Option Awards to purchase 750,000 and 75,000 shares of the Company’s common stock at an exercise price of $1.45 per share and vest 40% and 20%, respectively, upon grant with the remainder vesting in equal installments over three and four years, respectively. Additionally, these Stock Option Awards expire on January 31, 2017. Compensation expense related to these Stock Option Awards was $522 thousand, of which $521 thousand was amortized through December 2015 and the remaining $1 thousand will be amortized in January 2016. The fair value of these Stock Option Awards was estimated at the grant date using the Black-Scholes option pricing model with an expected volatility of 73%, a risk-free interest rate of 0.71%, a dividend yield rate of zero, and a five-year expected term. Based on the calculation using the Black-Scholes option pricing model, the grant date fair value of options granted was $0.63 per share. Expected volatility is based on the historical volatility in the price of the Company’s common stock since April 2004. The risk-free interest rate is the five-year Treasury rate, based on the term of the options. The dividend yield assumption is based on our history and expectation of dividend payments on common stock. The expected term represents the period of time that these Stock Option Awards are expected to remain outstanding.
On March 10, 2015, the Compensation Committee of the Board of Directors of the Company awarded 141 thousand restricted stock units to executive officers. Such restricted stock units will vest, and an equal number of shares of common stock will be deliverable upon the third anniversary of the date of grant. Compensation expense related to the units was calculated based upon the closing market price of the common stock on the date of grant ($2.44) and is recorded on a straight-line basis over the vesting period.
The Company is committed under various operating lease agreements for office space. Certain lease agreements contain renewal options and rent escalation clauses. Rental expense for the years ended December 31, 2015, 2014 and 2013 was $11.2 million, $8.9 million and $9.2 million, respectively, and is included within insurance operating expenses in the accompanying consolidated statements of operations and comprehensive income (loss). Future minimum lease payments under these agreements follow (in thousands).
In June 2007, First Acceptance Statutory Trust I (“FAST I”), a wholly-owned unconsolidated subsidiary trust of the Company, issued 40,000 shares of preferred securities at $1,000 per share to outside investors and 1,240 shares of common securities to the Company, also at $1,000 per share. FAST I used the proceeds from the sale of the preferred securities to purchase $41.2 million of junior subordinated debentures from the Company. The sole assets of FAST I are $41.2 million of junior subordinated debentures issued by the Company. The debentures will mature on July 30, 2037 and are currently redeemable by the Company in whole or in part and the preferred securities are callable. The debentures paid a fixed rate of 9.277% until July 30, 2012, after which the rate became variable (Three-Month LIBOR plus 375 basis points, resetting quarterly). The interest rate related to the debentures ranged from 3.983% to 4.072% during 2015. In January 2016, the interest rate reset to 4.366% through April 2016.
The provision (benefit) for income taxes differs from the amounts computed by applying the statutory federal corporate tax rate of 35% to income (loss) before income taxes as a result of the following (in thousands).
The Company had a valuation allowance of approximately $1.8 million at both December 31, 2015 and 2014, relating to certain amounts that are more likely than not to be realized. The change in the valuation allowance for the year ended December 31, 2015 was not material.
Prior to December 31, 2014, the Company had a full valuation allowance against its deferred tax asset based upon past negative evidence in the form of historical taxable losses. Based upon positive evidence from recent taxable income and the Company’s outlook for future profitability, the deferred tax valuation allowance for the year ended December 31, 2014 was decreased by $22.4 million to include only the amounts referred to above. For the year ended December 31, 2014, the change in the valuation allowance included a decrease of $1.2 million related to the unrealized change on investments included in other comprehensive income (loss) and was net of the utilization of $9.8 million in NOL carryforwards.
In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the net deferred tax asset will not be realized. The Company is required to assess whether a valuation allowance should be established against the Company’s net deferred tax asset based on the consideration of all available evidence using a more likely than not standard. In making such judgments, significant weight is given to evidence that can be objectively verified. In assessing the Company’s ability to support the realizability of its net deferred tax asset, management considers both positive and negative evidence. In establishing a full deferred tax valuation allowance from June 30, 2009 through September 30, 2014, the Company placed greater weight on historical results than on the Company’s outlook for future profitability. Negative evidence, including a twelve quarter cumulative taxable loss, resulted in the establishment of a full valuation allowance. As of December 31, 2014, the Company’s historical results reflected a twelve quarter cumulative taxable income which management considered to be a trend of positive evidence in assessing the realizability of its net deferred tax asset. Based on this fact and the Company’s outlook for future profitability, the deferred tax asset valuation allowance was adjusted as of December 31, 2014 and resulted in the aforementioned change in the valuation allowance.
The total financial impact of this litigation on the Company, including the aggregate settlement payment, related payroll taxes and the Company’s legal costs in connection with the defense of the litigation, has been presented separately in the consolidated statements of operations and comprehensive income (loss) under the litigation settlement expense line item for all periods presented.
The statutory-basis financial statements of the Insurance Companies are prepared in accordance with accounting practices prescribed or permitted by the Department of Insurance in each respective state of domicile. Each state of domicile requires that insurance companies domiciled in the state prepare their statutory-basis financial statements in accordance with the National Association of Insurance Commissioners Accounting Practices and Procedures Manual subject to any deviations prescribed or permitted by the insurance commissioner in each state of domicile. The Insurance Companies are required to report their risk-based capital (“RBC”) each December 31. Failure to maintain an adequate RBC could subject the Insurance Companies to regulatory action and could restrict the payment of dividends. At December 31, 2015, the RBC levels of the Insurance Companies did not subject them to any regulatory action.
The following table summarizes the estimated fair value of the assets acquired at the date of acquisition:
Liabilities assumed included a $2.0 million estimate of the expected liability for returned commissions as of the closing date. This liability is subject to change based on the actual amount of returned commissions. This, or any other change in the fair value determinations, would result in an adjustment to goodwill. At December 31, 2015, the Company’s new estimation of this liability resulted in a $0.8 million reduction in goodwill. A final determination will be made as of the June 30, 2016 measurement date.
The pro forma combined financial statements do not necessarily reflect what the combined results of operations would have been had the acquisition occurred on the date indicated. They also may not be useful in predicting the future combined results of operations. The actual combined results of operations may differ significantly from the combined pro forma amounts reflected herein due to a variety of factors.
Calculated income tax effect of pro forma adjustments at the estimated combined federal and state statutory rate of 40%