The insurable events during 2008, 2007 and 2006 did not include any weather related catastrophic events such as the well publicized series of hurricanes that occurred in Florida during 2005 and 2004. During 2008, 2007 and 2006 we processed property and liability claims stemming from our homeowners’, commercial general liability and private passenger automobile lines of business. Our automobile claims generally will exceed commercial general liability and homeowners’ claims with respect to frequency of claimant activity; however the per-claim severity in connection with our commercial general liability and homeowner lines would be expected to exceed the automobile line. Our reinsurance strategy serves to smooth the liquidity requirements imposed by the most severe insurable events and for all other insurable events we manage, at a micro and macro perspective, in the normal course of business.
legal and political factors such as legislative initiatives and public opinion.
Assurance MGA, a wholly owned subsidiary, acts as Federated National’s and American Vehicle’s exclusive managing general agent in the state of Florida. As American Vehicle continues its expansion into other states we shall contract with general agents to market our commercial general liability insurance product beyond the state of Florida. Assurance MGA currently provides underwriting policy administration, marketing, accounting and financial services to Federated National and American Vehicle, and participates in the negotiation of reinsurance contracts.
Assurance MGA generates revenue through a 6% commission fee from the insurance companies’ gross written premium, policy fee income of $25 per policy and other administrative fees from the marketing of company products through the Company’s distribution network. The 6% commission fee from Federated National and American Vehicle was made effective January 1, 2005. Assurance MGA plans to establish relationships with additional carriers and servicing additional insurance products in the future.
Except as described below, we believe that in 2008 there were no significant changes in those critical accounting policies and estimates. Senior management has reviewed the development and selection of our critical accounting policies and estimates and their disclosure in this Form 10-K with the Audit Committee of our Board of Directors.
Incurred Loss & DCCE Development Method - This reserving method is based on the assumption that the historical incurred loss & DCCE development pattern as reflected by the Company is appropriate for estimating the future loss & DCCE development. Incurred paid plus case amounts separated by accident quarter of occurrence and at quarterly evaluations are used in this analysis. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity. Historical “age-to-age” loss development factors were calculated to measure the relative development of an accident quarter from one maturity point to the next. Loss & DCCE development factors (“LDF”) are selected based on a review of the historical relationships between incurred loss & DCCE at successive valuations and based on industry patterns. The LDFs are multiplied together to derive cumulative LDF’s that, when multiplied by actual incurred loss & DCCE, produce estimates of ultimate loss & DCCE.
We also produce an estimate of unpaid Adjusting and Other Expense (“A&O”), as a reserve is required under statutory accounting principles even if this expense has been pre-paid or with an unconsolidated affiliate. Although we do not prepay for A&O, the majority of the A&O incurred is with an affiliated company and eliminated under the accounting principles for consolidation. The unpaid A&O is added to unpaid loss & DCCE, resulting in total unpaid loss and LAE.
A key assumption underlying the estimation of the reserve for loss and LAE is that past experience serves as the most reliable estimator of future events. This assumption may materially affect the estimates when the insurance market, the regulatory environment, the legal environment, the economic environment, the book of business, the claims handling department, or other factors (known or unknown) have varied over time during the experience period and / or will vary (expectedly or unexpectedly) in the future. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made. Therefore, the ultimate liability for unpaid loss and LAE will likely differ from the amount recorded at December 31, 2008.
We are required to review the contractual terms of all our reinsurance purchases to ensure compliance with SFAS No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts (“SFAS No. 113”). The statement establishes the conditions required for a contract with a reinsurer to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. Contracts that do not result in the reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed generally do not meet the conditions for reinsurance accounting and must be accounted for as deposits. SFAS No. 113 also requires us to disclose the nature, purpose and effect of reinsurance transactions, including the premium amounts associated with reinsurance assumed and ceded. It also requires disclosure of concentrations of credit risk associated with reinsurance receivables and prepaid reinsurance premiums.
The fixed maturities and the equity securities that are available for sale and carried at fair value represent 48% of total investments as of December 31, 2008, compared with 85% as of December 31, 2007.
All of our securities, except as noted above, are in good standing and are not impaired as defined by FASB SFAS No. 115.
As of December 31, 2008 we have classified $13.5 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 on our intention and ability to hold these securities until maturity. Additionally, we have and may continue to use this position to secure irrevocable letters of credit to facilitate business opportunities in connection with our commercial general liability program. During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic which was terminated in April 2007. As of December 31, 2007 the letter of credit in favor of Republic totaled $10.0 million. . As of December 31, 2008 the letter of credit in favor of Republic totaled $3.0 million.
Our daily closing cash balance of approximately $1.0 million is swept into an overnight Repurchase Agreement (“Repo”) account backed by U.S. Government securities.
Our fixed income portfolio contained callable features exercised in 2008. The proceeds from these called securities are currently in cash and short-term investments, of which approximately $121.4 million are invested in the MTB Prime Money Market-Inst Fund Number 142. We are currently evaluating long and short- term investment securities for best yields that match our liquidity needs.
Prepaid reinsurance premiums decreased $2.9 million, or 34.6%, to $5.5 million as of December 31, 2008, compared with $8.5 million as of December 31, 2007. The decrease is due to our payments and amortization of prepaid reinsurance premiums, which are reduced as compared with the prior year, associated with our homeowners’ book of business.
Our homeowners’ insurance premiums receivable increased $0.5 million, or 43.2%, to $1.7 million as of December 30, 2008, compared with $1.2 million as of December 31, 2007. The increase can be attributed to the seasonality of the purchasing patterns of our policyholders.
Reinsurance recoverable, net of allowance for credit losses, decreased $6.1 million, or 26.4%, to $16.9 million as of December 31, 2008, compared with $22.9 million as of December 31, 2007. The decrease is due to payment patterns by our reinsurers. All amounts are current and deemed collectable, except for a particular reinsurer in connection with the 2005 - 2006 reinsurance treaties, for whom we have recorded a $0.2 million pretax valuation allowance.
Deferred policy acquisition costs decreased $2.4 million, or 26.8%, to $6.6 million as of December 31, 2008, compared with $9.0 million as of December 31, 2007. The recent decreased production volume for both the homeowners’ and commercial general liability product lines is the reason for the decrease in this asset.
Deferred income taxes, net, increased $2.9 million, or 51.2%, to $8.5 million as of December 31, 2008, compared with $5.6 million as of December 31, 2007. Significant components of our net deferred tax asset are as follows:
Income taxes receivable increased to $2.3 million, as of December 31, 2008, compared with nothing as of December 31, 2007. The increase is due to tax payment patterns in connection with our tax liabilities.
The Company’s consolidated federal income tax returns for 2003 and 2002 have been examined by the IRS and there have been no material changes in the tax liability for those years. See income taxes payable, below.
Property, plant and equipment, net, decreased $0.2 million, or 18.3%, to $0.9 million as of December 31, 2008, compared with $1.0 million as of December 31, 2007. The decrease is primarily due to depreciation and amortization of our existing property, plant and equipment.
Unpaid losses and LAE increased $5.1 million, or 8.5%, to $64.8 million as of December 31, 2008, compared with $59.7 million as of December 31, 2007. The increase in unpaid losses and LAE relates primarily to our loss reserve strengthening relative to the commercial general liability and property lines of business. The composition of unpaid loss and LAE by product line is as follows:
The process of determining significant unpaid losses and LAE estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, and an actuarial valuation. Management regularly reevaluates these significant factors and makes adjustments where facts and circumstances dictate. In selecting the best estimate, we utilize various actuarial methodologies. Each of these methodologies is designed to forecast the number of claims we will be called upon to pay and the amounts we will pay on average to settle those claims. In arriving at our best estimate, our actuaries consider the likely predictive value of the various loss development methodologies employed in light of underwriting practices, premium rate changes and claim settlement practices that may have occurred, and weight the credibility of each methodology. Our actuarial methodologies take into account various factors, including, but not limited to, paid losses, liability estimates for reported losses, paid allocated LAE, salvage and other recoveries received, reported claim counts, open claim counts and counts for claims closed with and without payment of loss.
Bank overdraft remained unchanged at $8.7 million as of December 31, 2008, compared with December 31, 2007. The bank overdraft relates primarily to loss and LAE disbursements paid but not yet presented for payment by the policyholder or vendor. The balance relates to our payment patterns in relationship to the rate at which those cash disbursements are presented to the bank for payment.
Income taxes payable decreased to nothing as of December 31, 2008, compared with $4.2 million as of December 31, 2007. The change is due to tax payment patterns in connection with our tax liabilities. See income taxes receivable, above.
Deferred gain from sale of property decreased $0.5 million, or 25.2%, to $1.5 million as of December 31, 2008, compared with $2.0 million as of December 31, 2007. In accordance with the provisions of SFAS No. 13, we are amortizing the deferred gain over the term of the leaseback, which is scheduled to end in December 2011.
Gross premiums written decreased $45.3 million, or 33.9%, to $88.2 million for the year ended December 31, 2008 (“2008”), compared with $133.6 million for year ended December 31, 2007 (“2007”). The following table denotes gross premiums written by major product line.
The Company’s sale of homeowners’ policies decreased $38.8 million, or 39.0% to $60.7 million in 2008, compared with $99.5 million in 2007. The significant erosion is primarily due to the soft market conditions prevailing in the state of Florida. The soft market conditions are lead by Citizens, the state run insurance company. We believe that these marketplace conditions have forced some carriers to pursue market share based on “best case” pricing models that may ultimately prove unprofitable from an underwriting perspective. We do not intend to compete with others solely based on pricing. We will continue to market our property insurance product in territories in Florida where our rates are competitive.
The (decrease) increase in prepaid reinsurance premiums was ($4.5) million in 2008, compared with ($11.3) million in 2007. The change in this account is primarily associated with the timing of our reinsurance payments measured against the term of the underling reinsurance policies.
Commission income decreased $5.6 million, to $1.6 million in 2008, compared with $7.2 million in 2007. The 2008 commission income is primarily in connection with our reinsurance treaties.
Finance revenue decreased $0.2 million, or 35.7%, to $0.4 million in 2008, compared with $0.5 million in 2007. The change is primarily due to the Company’s decreased emphasis on automobile insurance and the finance revenue derived there-from.
Managing general agent fees decreased $0.3 million, or 14.2%, to $1.7 million in 2008, compared with $2.0 million in 2007.
Net investment income decreased $1.6 million, or 20.2%, to $6.4 million in 2008, compared with $8.0 million in 2007. Net investment income on corporate bonds, which generally provide a higher yield than U.S. government bonds, increased $2.4 million, to $3.1 million in 2008, compared with $0.7 million in 2007. Net investment income on U.S. government bonds decreased $3.6 million, to $0.9 million in 2008, compared with $4.5 million in 2007.
Other income increased less than $0.1 million, or 2.1%, to $0.7 million in 2008, compared with $0.6 million in 2007. Major components of other income in 2008 included approximately $0.5 million in partial recognition of our gain on the sale of our Lauderdale Lakes property and $0.2 million of rental income, interest income and miscellaneous income.
Losses and LAE decreased by $5.8 million, or 12.1%, to $41.9 million in 2008, compared with $47.6 million in 2007. The overall change includes a $1.0 million decrease in our homeowners’ program, a $2.2 million increase in our commercial general liability program and a $7.0 million decrease in connection with our automobile program.
The composition of unpaid losses and LAE by product line is as follows:
For further discussion, see Footnote 7 to the Consolidated Financial Statements included under Part II, Item 8, of this Report.
Operating and underwriting expenses decreased $5.6 million, or 44.0%, to $7.1 million in 2008, compared with $12.7 million in 2007. The change is primarily due to a $2.9 million decrease in fees paid to boards, bureaus and associations, a $1.8 million decrease in premium taxes and a $1.2 million decrease in bad debts.
Salaries and wages increased $0.7 million, or 10.3%, to $7.4 million in 2008, compared with $6.7 million in 2007. In 2008, we had a $0.3 million severance payment. The charge to operations for stock based compensation, in accordance with the provisions of SFAS No. 123R Share Based Payment (“SFAS No. 123R”), was approximately $0.5 million in 2008 compared with approximately $0.6 million in 2007.
Interest expense decreased $0.2 million to nothing in 2008, compared with $0.2 million in 2007. The decrease results from the repayment of our subordinated debt on September 30, 2007.
Year Ended December 31, 2007 Compared with Year Ended December 31, 2006
Gross premiums written decreased $19.1 million, or 12.5%, to $133.6 million for the year ended December 31, 2007 (“2007”), compared with $152.7 million for the year ended December 31, 2006 (“2006”). The following table denotes gross premiums written by major product line.
The Company’s sale of homeowners’ policies decreased $14.9 million, or 13.0% to $99.5 million in 2007, compared with $114.4 million in 2006. The decrease is primarily due to the soft market conditions prevailing in the state of Florida. The soft market conditions are lead by Citizens, the state run insurance company. We believe that the competition in this market is based primarily on pricing insurance products at rates that do not reflect current economic conditions. We do not intend to compete with others solely on the basis of pricing mechanisms. Where our rates are competitive (and there are territories in Florida that so exist) we will continue to market our property insurance product.
The Company’s sale of auto insurance policies decreased by $4.2 million, or 69.2%, to $1.9 million in 2007, compared with $6.1 million in 2006.
The decrease (increase) in unearned premiums was $21.4 million in 2007, compared with ($16.0) million in 2006. The change was due to a $19.4 million decrease in unearned homeowners’ insurance premiums, a $0.5 million decrease in unearned commercial general liability premiums, and a $1.5 million decrease in unearned automobile premiums. These changes are a result of our decreased premium volume during this period. See Gross Premiums Written.
Net premiums earned increased $9.9 million, or 11.1%, to $99.2 million in 2007, compared with $89.3 million in 2006. The following table denotes net premiums earned by major product line.
Commission income increased $5.5 million, to $7.2 million in 2007, compared with $1.7 million in 2006. Recurring components of our commission income totaled $1.4 million. Non-reoccurring components of our commission income totaled $5.8 million stemming from two separate events. First and pursuant to provisions contained in the three-year reinsurance treaties, we were afforded the right to cancel the remaining two years and be entitled to receive a no loss experience commission. In connection with this treaty, we reported approximately $2.8 million in 2007. The second non-reoccurring operating event was in connection with commission income totaling approximately $3.0 million in connection with our participation in a Citizens take out program in 2004, wherein the commission was earned by us upon the successful retention of the policyholder for thirty-six months.
Finance revenue decreased $1.1 million, or 67.7%, to $0.5 million in 2007, compared with $1.7 million in 2006. The change is primarily due to the Company’s decreased emphasis on automobile insurance and the finance revenue derived there-from.
Net realized investment (losses) gains were ($0.1) million in 2007, compared with $1.1 in 2006. The table below depicts (losses) gains by investment category.
We continue to revise our estimates of the ultimate financial impact of past storms. The revisions to our estimates are based on our analysis of subsequent information that we receive regarding various factors, including: (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages, and (iv) trends in general economic conditions, including the effects of inflation. Management revises its estimates based on the results of its analysis. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors.
The table below reflects no impact to operations in 2007 from the four hurricanes that occurred in July, August, September and October of 2005.
Interest expense decreased $0.5 million, or 73.6%, to $0.2 million in 2007, compared with $0.7 million in 2006. The decrease results from our subordinated debt retirement on September 30, 2007.
In 2008, our primary sources of capital were revenues generated from operations, including decreased reinsurance recoverable, net, increased unpaid losses and LAE, decreased prepaid reinsurance premiums, decreased policy acquisition costs, net of amortization, non-cash compensation, depreciation and amortization, decreased premiums receivable, decreased premium finance contracts receivable, provision for uncollectible premiums receivable and decreased other assets. Also contributing to our liquidity were proceeds from the sale of investment securities and exercised employee stock options. Because we are a holding company, we are largely dependent upon fees and commissions from our subsidiaries for cash flow.
In 2008, operations generated $18.0 million of gross cash flow, due to a $6.1 million decrease in reinsurance recoverable, net, a $5.1 million increase in unpaid losses and LAE, a $2.9 million decrease in prepaid reinsurance premiums, a $2.4 million decrease in policy acquisition costs, net of amortization, $0.4 million of non-cash compensation, $0.3 million of depreciation and amortization, a $0.3 million decrease in premiums receivable, a $0.2 million decrease in premium finance contracts receivable, $0.2 million in the provision for uncollectible premiums receivable and a $0.1 million decrease in other assets.
In 2008, net investing activities provided $128.7 million, as compared with used $19.0 million and $19.7 million in 2007 and 2006, respectively. Our available for sale investment portfolio is highly liquid as it consists entirely of readily marketable securities. In 2008, investing activities generated $156.7 million and used $28.0 million from the maturity several times over of our very short municipal portfolio.
In 2008, net financing activities used $4.3 million, as compared with used $9.2 million and provided $4.1 million in 2007 and 2006, respectively. In 2008, the sources of cash in connection with financing activities included $1.3 million of exercised stock options and a $0.2 million tax benefit related to non-cash compensation. The uses of cash in connection with financing activities included $5.7 million in dividends paid and $0.1 million for the purchase of treasury stock.
We believe that our current capital resources will be sufficient to meet currently anticipated working capital requirements. There can be no assurances, however, that such will be the case.
Federated National’s and American Vehicle’s statutory capital surplus levels as of December 31, 2008 were approximately $31.5 million and $25.1 million, respectively, and their statutory net losses in 2008 were $2.2 million and $2.4 million, respectively.
For the years ended December 31, 2008 and 2007, there were no off balance sheet transactions.
In 2008, 68.8%, 27.0%, 3.7% and 0.6% of the premiums we underwrote were for homeowners’ property and casualty insurance, commercial general liability insurance, federal flood, and personal automobile insurance, respectively. In 2007, 74.5%, 24.1% and 1.4% of the premiums we underwrote were for homeowners’ property and casualty insurance, commercial general liability insurance and personal automobile insurance, respectively.
We are focusing our marketing efforts on continuing to expand our distribution network and market our products and services in other regions of Florida and other states by establishing relationships with additional independent agents and general agents. As this occurs, we will seek to replicate our distribution network in those states. There can be no assurance, however, that we will be able to obtain the required regulatory approvals to offer additional insurance products or expand into other states.
Accounting for loss contingencies pursuant to 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 April 2008, the FASB issued FSP No. 142-3, “Determination of the Useful Life of Intangible Assets”. FSP 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB Statement No. 142, “Goodwill and Other Intangible Assets”. This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. FSP 142-3 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early adoption is prohibited. The Company does not expect the impact of SFAS No. 142-3 Goodwill and Other Intangible Assets (“SFAS No. 142-3”) on its financial position, results of operations or cash flows to be material.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”). SFAS No. 161 requires companies with derivative instruments to disclose information that should enable financial-statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“SFAS No. 133”) and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company does not utilize Derivative Instruments, and, accordingly the adoption of SFAS No. 161 for the year ended December 31, 2008 did not have an impact on our consolidated financial statements.
In February 2008, FASB issued FSP FASB 157-2, Effective Date of FASB No. 157 (“FSP FASB 157-2”). FSP FASB 157-2, which was effective upon issuance and delayed the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except for items recognized or disclosed at fair value at least once a year, to fiscal years beginning after November 15, 2008. FSP FASB No. 157-2 also covers interim periods within the fiscal years for items within the scope of this FSP. We adopted SFAS No. 157 effective with the first interim period beginning after January 1, 2008.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51 (“SFAS No. 160”). SFAS No. 160 requires noncontrolling interests to be treated as a separate component of equity, not as a liability or other item outside of equity. Disclosure requirements include net income and comprehensive income to be displayed for both the controlling and noncontrolling interests and a separate schedule that shows the effects of any transactions with the noncontrolling interests on the equity attributable to the controlling interest. The provisions of this statement are effective for fiscal years beginning after December 15, 2008. This statement should be applied prospectively except for the presentation and disclosure requirements which shall be applied retrospectively for all periods presented. The Company does not expect the impact of SFAS No. 160 on its financial position, results of operations or cash flows to be material.
In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108 to address diversity in practice in quantifying financial statement misstatements. SAB No. 108 requires that registrants quantify the impact on the current year’s financial statements of correcting all misstatements, including the carryover and reversing effects of prior years’ misstatements, as well as the effects of errors arising in the current year. SAB No. 108 is effective as of the first fiscal year ending after November 15, 2006, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006, for errors that were not previously deemed material, but are material under the guidance in SAB No. 108. There was no impact on our consolidated financial statements with respect to the adoption of SAB No. 108.
We are named as a defendant in a securities class action lawsuit and a derivative lawsuit and it may have an adverse impact on our business.
We may not continue making dividend payments on our common stock.
Effective January 1, 2006, the Company adopted the fair value recognitions provisions of SFAS No. 123R using the modified-prospective-transition method. Under that transition method, compensation cost recognized in 2008 and 2007 includes:
Compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and
Certain 2007 and 2006 financial statement amounts have been reclassified to conform to the 2008 presentations.
During 2008, the Company purchased three intangible assets totaling $0.6 million. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No.142”), the accounting for these recognized intangible assets is based on their useful life to the Company. The useful life of these intangible assets is the period over which they are expected to contribute directly or indirectly to the future cash flows of the Company. These intangible assets have definite finite lives ranging from six to twelve months, and are amortized accordingly.
SFAS No. 115 addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. SFAS No. 115 requires that these securities be classified into one of three categories, (a) held-to-maturity, (b) trading securities or (c) available-for-sale. Investments classified as held-to-maturity include debt securities wherein the Company’s intent and ability are to hold the investment until maturity. The accounting treatment for held-to-maturity investments is to carry them at amortized cost without consideration to unrealized gains or losses. Investments classified as trading securities include debt and equity securities bought and held primarily for the sale in the near term. The accounting treatment for trading securities is to carry them at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments. The accounting treatment for available-for-sale securities is to carry them at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, namely “Other Comprehensive Income”. We did not hold any non-trading equity investment securities during 2008 or 2007.
Additional provisions contained in SFAS No. 115 address the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. The Company’s policy for the valuation of temporarily impaired securities is to determine impairment based on the analysis of the following factors:
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of fixed maturities and equity securities at December 31, 2008 and 2007 is as follows:
Below is a summary of the components of the finance contracts receivable balance:
Depreciation of property, plant, and equipment was $290,417, $316,525 and $342,108 during 2008, 2007 and 2006, respectively.
In assessing the net realizable value of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2008 and 2007, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences.
To retain our certificate of authority, the Florida Insurance Code (the "Code") requires Federated National and American Vehicle to maintain capital and surplus equal to the greater of 10% of their liabilities or a statutory minimum capital and surplus as defined in the Code. Federated National and American Vehicle are required to have a minimum capital surplus of $4.0 million. At December 31, 2008, 2007 and 2006, Federated National’s statutory capital surplus was $31.5 million, $32.3 million and $19.5 million, respectively. At December 31, 2008, 2007 and 2006, American Vehicle had statutory capital surplus of $25.1 million, $27.6 million and $26.7 million, respectively.
No dividends were paid by Federated National or American Vehicle in 2008, 2007 or 2006, and none are anticipated in 2009. Although we believe that amounts required to meet our financial and operating obligations will be available from sources other than dividends from our insurance subsidiaries, there can be no assurance in this regard. Further, there can be no assurance that, if requested, the Florida OIR will allow any dividends in excess of the amount available, to be paid by Federated National and American Vehicle to us in the future. The maximum dividends permitted by state law are not necessarily indicative of an insurer’s actual ability to pay dividends or other distributions to a parent company, which also may be constrained by business and regulatory considerations, such as the impact of dividends on capital surplus, which could affect an insurer’s competitive position, the amount of premiums that can be written and the ability to pay future dividends. Further, state insurance laws and regulations require that the statutory capital surplus of an insurance company following any dividend or distribution by it be reasonable in relation to its outstanding liabilities and adequate for its financial needs.
Based upon the 2008 statutory financial statements for Federated National and American Vehicle, statutory surplus exceeded all regulatory action levels established by the NAIC’s risk based capital requirements. Based upon the 2007 statutory financial statements for Federated National and American Vehicle, statutory surplus exceeded all regulatory action levels established by the NAIC’s risk-based capital requirements.
Based on risk-based capital requirements, the extent of regulatory intervention and action increases as the ratio of an insurer’s statutory surplus to its Authorized Control Level (“ACL”), as calculated under the NAIC’s requirements, decreases. The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200.0% of the ACL amount. The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150.0% of the ACL amount. The third action level, ACL, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70.0% of the ACL amount. Federated National’s ratio of statutory surplus to its ACL was 739.4%, 653.0% and 165.4 % at December 31, 2008, 2007 and 2006, respectively. American Vehicle’s ratio of statutory surplus to its ACL was 402.5%, 448.5% and 444.2% at December 31, 2008, 2007 and 2006, respectively.
Federated National anticipates a regularly scheduled statutory examination by the Florida OIR to occur during 2010 for the five years ended December 31, 2009. American Vehicle anticipates a regularly scheduled statutory examination by the Florida OIR to occur during 2011 for the five years ended December 31, 2010. We have not received any notice of such examinations.
As of December 31, 2008, Federated National was outside NAIC’s usual ranges with respect to its IRIS tests on two out of thirteen ratios. There was one exception in connection with change in net written premium and one in connection with two year reserve development to policyholders’ surplus. As of December 31, 2007, Federated National was outside NAIC’s usual ranges with respect to its IRIS tests on three out of thirteen ratios. There were two exceptions in connection with surplus growth and one exception in connection with adverse homeowner claims in connection with the hurricanes of 2004 and 2005.
As of December 31, 2008, American Vehicle was outside NAIC’s usual range for two of thirteen ratios. There was one exception in connection with the two year overall operating ratio and one in connection with two year reserve development to policyholders’ surplus. As of December 31, 2007, American Vehicle was outside NAIC’s usual range for two of thirteen ratios. The exceptions were in connection with reserve development in connection with our commercial general liability program.
There was no action taken by the Florida OIR in connection with the December 31, 2007 IRIS ratio results. We do not currently believe that the Florida OIR will take any significant action with respect to Federated National or American Vehicle regarding the 2008 IRIS ratios, although there can be no assurance that will be the case.
GAAP differs in some respects from reporting practices prescribed or permitted by the Florida OIR. Federated National's statutory capital and surplus was $31.5 million and $32.3 million as of December 31, 2008 and 2007, respectively. Federated National's statutory net income (loss) was $(2.2) million, $15.3 million and 1.7 million for the years ended December 31, 2008, 2007 and 2006, respectively. Federated National’s statutory non-admitted assets were approximately $2.4 million and $1.2 million as of December 31, 2008 and 2007, respectively.
American Vehicle’s statutory capital and surplus was $25.1 million and $27.6 million as of December 31, 2008 and 2007, respectively. American Vehicle’s statutory net income (loss) was approximately ($2.4) million, $1.3 million and $6.2 million for the years ended December 31, 2008, 2007 and 2006 respectively. American Vehicle’s statutory non-admitted assets were approximately $1.5 million and $0.9 million as of December 31, 2008 and 2007, respectively.
We are involved in other claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, results of operations, or liquidity. For additional discussion of our involvement in other claims and legal actions arising in the ordinary course of business please see ITEM 3 - LEGAL PROCEEDINGS.
As a direct premium writer in the state of Florida, we are required to participate in certain insurer solvency associations under Florida Statutes 631.57(3) (a), administered by FIGA. Participation in these pools is based on our written premium by line of business to total premiums written statewide by all insurers. Participation may result in assessments against us as it did in 2006 and 2007. Through 2007 we have been assessed $6.7 million in connection with the association. For statutory accounting purposes these assessments are not charged to operations in contrast GAAP treatment is to charge current operations for the assessments. Through policyholder surcharges, as approved by the Florida OIR, we recouped $2.3 million and $1.8 million in connection with these assessments during 2008 and 2007, respectively. There were no assessments made for the years ended December 31, 2008.
During its regularly scheduled meeting on August 17, 2005, the Board of Governors of Citizens determined a 2004 plan year deficit existed in the High Risk Account. Citizens decided that a $515 million Regular Assessment was in the best interest of Citizens and consistent with Florida Statutes. On this basis, Citizens certified for a Regular Assessment. Federated National’s participation in this assessment totaled $2.0 million.
In 2008, neither Federated National nor American Vehicle was assessed by the JUA Plan. In 2007 Federated National was assessed $7,470 and American Vehicle recovered $842 by and from the JUA Plan based on its December 2007 Cash Activity Report. These charges are contained in operating and underwriting expenses in the Statement of Operations. Future assessments by this association are undeterminable at this time.
As of December 31, 2008 bonds totaling $3.4 million secure a $3.0 million irrevocable letter of credit in favor of Republic in order to facilitate business opportunities in connection with our commercial general liability program.
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 agreed to lease the same facilities for a six year term; in accordance with SFAS No. 13 Accounting for Leases (“SFAS No. 13”), the lease will be treated as an operating lease. The expected future payout schedule is as follows:
Rent expense in 2008, 2007 and 2006 were $0.6 million, $0.6 million and $0.5, respectively.
We implemented a stock option plan in September 1998, which expired in September 2008, and provided for the granting of stock options to officers, key employees and consultants. The objectives of this plan included 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 were granted at prices either equal to or above the market value of the stock on the date of grant, typically vest over a four-year or five-year period and expire six or ten years after the grant date. Under this plan, we were authorized to grant options to purchase up to 900,000 common shares, and, as of December 31, 2008 and December 31, 2007, we had outstanding exercisable options to purchase 130,099 and 152,599 shares, respectively.
Activity in our stock option plans for the period from January 1, 2006 to December 31, 2008 is summarized below:
Reclassification adjustments related to the investment securities sold and previously included in comprehensive income (loss) for the years ended December 31, 2008, 2007 and 2006 are as follows:
21st Century (the parent company only) has no long term obligations, guarantees or material contingencies as of December 31, 2008. The following summarizes the major categories of the parent company’s financial statements:
The July 2003 Notes paid interest at the annual rate of 6%, were subordinated to senior debt of the Company, and matured on July 31, 2006. Quarterly payments of principal and interest due on the July 2003 Notes were made in cash or, at our option, in shares of our Common Stock. When paid in shares of Common Stock, the number of shares issued was determined by dividing the payment due by 95% of the weighted-average volume price for the Common Stock on NASDAQ as reported by Bloomberg for the 20 consecutive trading days preceding the payment date.
On September 30, 2004, we completed a private placement of 6% Senior Subordinated Notes due September 30, 2007 (the “September 2004 Notes”). These notes were offered and sold to accredited investors as units consisting of one September 2004 Note with a principal amount of $1,000 and warrants to purchase shares of our Common Stock (the “2004 Warrants”), the terms of which are similar to our July 2003 Notes and 2003 Warrants, except as described below. We sold an aggregate of $12.5 million of units in this placement, which resulted in proceeds (net of placement agent fees of $700,000 and offering expenses of $32,500) to us of $11,767,500.
The 2004 Warrants issued to the purchasers of the September 2004 Notes and to the placement agent in the offering, J. Giordano, each entitled the holder to purchase one share of our Common Stock at an exercise price of $12.75 per share and was exercisable until September 30, 2007. The number of shares issued upon exercise of the 2004 Warrants to purchasers equaled $12.5 million divided by the exercise price of the warrants, and totaled 980,392. The number of shares issued upon exercise of the 2004 Warrants to J. Giordano equaled $500,000 divided by the exercise price of the warrants, and totaled 39,216. GAAP required 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 determined that the September 2004 Warrants had zero value at the date of issuance.
On September 30, 2007, we made the final principal payment of $1,041,667 on the September 2004 Notes and the September 2004 warrants expired. Of the 1,019,608 shares that could have been issued in connection with the September 2004 warrants, 911,270 were exercised and 108,338 were unexercised. The unexercised warrants were cancelled as of September 30, 2007.
As indicated below, we paid, pursuant to the terms of the July 2003 Notes and in accordance with the contractual computations, selected quarterly payments of principal and interest due in shares of our Common Stock.