Federated National owns the Company's current headquarters in Plantation, Florida, a two story building with approximately 13,960 square feet of office space. Federated National also owns and partially occupies a three story building with approximately 39,250 square feet of office space in Lauderdale Lakes, Florida. Approximately 40% of the Lauderdale Lakes building is leased to third parties and the remainder is occupied by Federated National or is vacant.
The Company believes that these facilities are adequate for its current needs.
The Company's business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on the Company's business, results of operations and financial condition. Also, if the Company's estimated liabilities for unpaid losses and LAE are less than actual losses and LAE, the Company will be required to increase reserves with a corresponding reduction in the Ccompany's net income in the period in which the deficiency is identified.
The most significant accounting estimates inherent in the preparation of the Company's financial statements include estimates associated with management's evaluation of the determination of liability for unpaid losses and loss adjustment expense and the recoverability of goodwill. In addition, significant estimates form the bases for the Company's reserves with respect to finance contracts, consumer loans, pay advances receivable, premiums receivable and deferred income taxes. Various assumptions and other factors underlie the determination of these significant estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, and in the case of unpaid losses and loss adjustment expense, an actuarial valuation. Management constantly re-evaluates these significant factors and makes adjustments where facts and circumstances dictate.
ANALYSIS OF FINANCIAL CONDITION AS OF DECEMBER 31, 2001 AS COMPARED TO DECEMBER 31, 2000
FINANCE CONTRACTS, CONSUMER LOANS AND PAY ADVANCES RECEIVABLE. Finance contracts, consumer loans and pay advances receivable decreased $3.0 million from $13.8 million as of December 31, 2000 to $10.8 million as of December 31, 2001 primarily because, beginning in the third quarter, the Company now only finances contracts from Company owned agencies and Company franchised agencies and no longer finances contracts originated by third party agencies.
PREMIUMS RECEIVABLE. Premiums receivable were $1.6 million as of December 31, 2001, an increase of $1.4 million as compared to $247,000 outstanding as of December 31, 2000. This increase is the result of added emphasis placed on direct bill premium financing by Federated National.
DEFERRED ACQUISITION COSTS, NET. Deferred acquisition costs decreased from $1.2 million as of December 31, 2000 to $12,000 as of December 31, 2001. Included in the December 31, 2000 balance were deferred commissions of $2.1 million offset by unearned ceded commissions of $877,000. As of December 31, 2001, deferred commissions were $1.7 million offset by unearned ceded commissions of $1.7 million. The increase in unearned ceded commissions is related to the increase in reinsurance discussed above.
GOODWILL. Goodwill declined from $2.8 million as of December 31, 2000 to $1.8 million as of December 31, 2001, due to amortization of $540,000 and a reduction in goodwill because of the sale of 11 insurance agencies.
UNEARNED PREMIUM. Unearned premium increased $2.0 million form $13.0 million as of December 31, 2000 to $15.0 million as of December 31, 2001. The balance of unearned premium is determined by the amount and timing of when policies are written.
REVOLVING CREDIT OUTSTANDING. Revolving credit outstanding decreased $1.4 million to $6.7 million as of December 31, 2001 from $8.1 million as of December 31, 2000. This decrease is related to the decrease in finance contracts discussed above.
NET REALIZED INVESTMENT GAINS (LOSSES). The Company experienced net losses of $2.9 million for the year ended December 31, 2001 compared to $109,000 for the same period in 2000. Realized gains or losses are primarily a function of the equity markets. In August 2001, the Company divested itself of its investments in common stock and will no longer invest in common stock.
OTHER INCOME. Other income increased $883,000 to $3.1 million for the year ended December 31, 2001 from $2.2 million for 2000. This increase is primarily attributable to an increase in adjusting fees due to the addition in 2000 of two nonaffiliated insurance companies as claims adjusting customers.
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
GROSS PREMIUMS CEDED. Gross premiums ceded increased $1.4 million to $7.6 million for the year ended December 31, 2000 from $6.2 million for the year ended December 31, 1999. The increase in gross premiums ceded is directly related to the increase in gross premiums written.
FINANCE REVENUES. Finance revenues increased 54.5% to $5.7 million for the year ended December 31, 2000 from approximately $3.7 million in 1999. The increase was attributable to an increase in the number of premium contracts financed by Federated Premium, as well as income generated from pay advances, which began operations in the third quarter 1999.
MANAGING GENERAL AGENT FEES. Managing general agent fees increased from $964,000 for the year ended December 31, 1999 to $5.4 million for the year ended December 31, 2000. This increase is because Assurance MGA began writing policies for one unaffiliated insurance company in July 1999 and for an additional company in January 2000. Prior to July 1999, substantially all policies were written for Federated National for which Assurance MGA retained $25 per policy.
OTHER INCOME. Other income increased $1.2 million to $2.2 million for the year ended December 31, 2000 from $1.0 million for the same period in 1999. This increase is primarily attributable to increased tax preparation fees of $860,000 and adjusting fee income of $634,000 for the year ended December 31, 2000 compared to $353,000 and $4,000, respectively, in 1999.
LOSSES AND LAE. The Company's loss ratio, as determined in accordance with GAAP, for 2000 was 73.8% compared with 60.2 % for the same period in 1999. Losses and LAE incurred increased $6.9 million to $15.0 million for the year ended December 31, 2000 from $8.1 million for 1999. Losses and LAE, the Company's most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of its policyholders, including expenses required to settle claims and losses. The Company believes the increase in its loss ratio is a function of a 10% price reduction on policies written from December 1, 1999 to May 31, 2000 coupled with increased claims on policies issued during that period.
SALARIES AND WAGES. Salaries and wages increased 25.4% to $9.4 million for 2000 from $7.5 million for 1999. The increase is related to the increase in the volume of business during the period.
AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS. The amortization of deferred policy acquisition costs increased from a credit of $19,000 for the year ended December 31, 1999 to a debit of $1.7 million for 2000. Policy acquisition costs consists of commission expenses paid to third-party agencies less commissions earned on reinsurance ceded. The increase is primarily due to policy acquisition costs of $1.6 million incurred by Assurance MGA for third party insurers' policies in 2000 compared to zero in 1999.
INCOME TAX EXPENSE. The Company recorded a benefit for income taxes of $462,000 in 2000 as compared to a provision of $680,000 in 1999 primarily due to pre-tax income/loss.
For the year ended December 31, 2001, operations generated a cash flow deficit of $946,000; however, operating cash flow is expected to be positive in the future as the Company currently believes operations will be profitable. The Company's investment portfolio, which is highly liquid as it consists almost entirely of readily marketable securities, is available to offset any cash flow deficits. Cash flow from investing activities was $2.5 million in 2001 and was used to offset deficits in operating and financing cash flows. Cash flow used by financing activities was $2.0 million in 2001, as the Company reduced its revolving credit outstanding and purchased shares of its common stock in the open market. Future financing activities may use cash, if the Company believes its stock is undervalued and decides to continue to purchase its shares in the open market. The Board of Directors has authorized the purchase in the open market of approximately $1.0 million of additional shares. The Company believes that its current capital resources, together with cash flow from its operations and investing activities will be sufficient to meet its anticipated working capital requirements for the foreseeable future. There can be no assurances, however, that such will be the case.
The Company is required to comply with the NAIC's risk-based capital requirements. The NAIC's risk-based capital requirements are a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC's risk-based capital standards are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2001, based on calculations using the appropriate NAIC formula, the Company's total adjusted capital is in excess of ratios that would require any form of regulatory action. GAAP differs in some respects from reporting practices prescribed or permitted by the Florida Department of Insurance. Federated National's statutory capital surplus was approximately $5.7 million as of December 31, 2001 and $6.2 million as of December 31, 2000. Statutory net income was a loss of $2.1 million and $1.4 million for the years ended December 31, 2001 and 2000, respectively, and income of $1.1 million for 1999. American Vehicle had statutory capital surplus of approximately $3.1 million as of December 31, 2001 and had statutory net income of $64,000 in 2001.
Insurance premiums are established before the Company knows the amount of loss and LAE and the extent to which inflation may affect such expenses. Consequently, the Company attempts to anticipate the future impact of inflation when establishing rate levels. While the Company attempts to charge adequate rates, the Company may be limited in raising its premium levels for competitive and regulatory reasons. Inflation also affects the market value of the Company's investment portfolio and the investment rate of return. Any future economic changes which result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred loss and LAE and thereby materially adversely affect future liability requirements.
We have audited the accompanying consolidated balance sheets of 21st Century Holding Company and Subsidiaries ("the Company" and a Florida Corporation) as of December 31, 2001 and 2000, and the related consolidated statements of operations, changes in shareholders' equity and comprehensive income (loss) and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of 21st Century Holding Company and Subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2001 AND 2000
The Company is a vertically integrated insurance holding company, which, through its subsidiaries, controls substantially all aspects of the insurance underwriting, distribution and claims process. The Company underwrites nonstandard and standard personal automobile insurance and homeowners and mobile home property and casualty insurance in the State of Florida through its wholly-owned subsidiaries, Federated National Insurance Company ("Federated National") and American Vehicle Insurance Company ("American Vehicle"). The Company has underwriting authority for third-party insurance companies, which it represents through a wholly-owned managing general agent, Assurance Managing General Agents, Inc. ("Assurance MGA"). The Company internally processes claims made by Federated National, American Vehicle and third-party insurance companies through a wholly-owned claims adjusting company, Superior Adjusting, Inc. ("Superior"). The Company also offers premium financing to its own and third-party insureds through its wholly-owned subsidiary, Federated Premium Finance, Inc. ("Federated Premium"), and pay advances through Fed First Corp ("Fed First").
The Company offers income tax preparation software and service through its 80% owned subsidiary Express Tax Service Company ("Express Tax").
All of the Company's investment securities have been classified as available-for-sale because all of the Company's securities are available to be sold in response to the Company's liquidity needs, changes in market interest rates and asset-liability management strategies, among other reasons. Investments available-for-sale are stated at fair value on the balance sheet. Unrealized gains and losses are excluded from earnings and are reported as a component of other comprehensive income within shareholders' equity, net of related deferred income taxes.
Premiums and discounts are amortized or accreted, respectively, over the life of the related fixed maturity security as an adjustment to yield using a method that approximates the effective interest method. Dividends and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific-identification method for determining the cost of securities sold.
Unpaid losses and loss adjustment expenses are provided for through the establishment of liabilities in amounts estimated to cover incurred losses and loss adjustment expenses. Such liabilities are determined based upon the Company's assessment of claims pending and the development of prior years' loss liability. These amounts include liabilities based upon individual case estimates for reported losses and loss adjustment expenses and estimates of such amounts that are incurred but not reported. Changes in the estimated liability are charged or credited to operations as the estimates are revised. Unpaid losses and loss adjustment expenses are reported net of estimates for salvage and subrogation recoveries, which totaled approximately $544,000, $559,000 and $342,000, net of reinsurance, at December 31, 2001, 2000 and 1999, respectively.
The estimates of unpaid losses and loss adjustment expenses are subject to the effect of trends in claims severity and frequency and are continually reviewed. As part of the process, the Company reviews historical data and considers various factors, including known and anticipated legal developments, changes in social attitudes, inflation and economic conditions. As experience develops and other data becomes available, these estimates are revised, as required, resulting in increases or decreases to the existing unpaid losses and loss adjustment expenses. Adjustments are reflected in results of operations in the period in which they are made and the liabilities may deviate substantially from prior estimates.
Commission income consists of fees earned by the Company-owned agencies placing business with third party insurers and third party premium finance companies. Commission income is earned on a pro rata basis over the life of the policies. Unearned commissions represent the portion of the commissions related to unexpired policy terms.
Provisions for credit losses are charged to operations in amounts sufficient to maintain the allowance for credit losses at a level considered adequate to cover anticipated losses.
The activity in the allowance for credit losses for premiums receivable was as follows for the years ended December 31, 2001, 2000 and 1999:
See Note 4 for the activity in the allowance for credit losses for finance contracts, consumer loans and pay advances receivable.
If substantially all the costs associated with the managing general agent ("MGA") contract are incurred during the underwriting process, then the MGA fees and the related acquisition costs are recognized at the time the policy is underwritten, net of estimated cancellations. If the MGA contract requires significant involvement subsequent to the completion of the underwriting process, then the MGA fees and related acquisition costs are deferred and recognized over the life of the policy.
Policy fees represent a $25 non-refundable application fee for insurance coverage, which is intended to reimburse the Company for the costs incurred to underwrite the policy. The fees and related costs are recognized when the policy is underwritten. These underwriting costs are not included as a component of deferred acquisition costs.
The Company recognizes the income and expense on reinsurance contracts principally on a pro-rata basis over the life of the policies covered under the reinsurance agreements. The Company is reinsured under separate reinsurance agreements for the different lines of business underwritten. Reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company continually monitors its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company only cedes risks to reinsurers whom the Company believes to be financially sound. At December 31, 2001, all reinsurance recoverables are considered collectible.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax-credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company's reinsurance contracts provide ceding commissions for premiums written which are subject to adjustment. The amount of ceding commissions is determined by the loss experience for the reinsurance agreement term. The reinsurer provides commissions on a sliding scale with maximum and minimum achievable levels. The reinsurer provides the Company with the provisional commissions. The Company has recognized the commissions based on the current loss experience for the policy year premiums. This results in establishing a liability for the excess of provisional commissions retained compared to amounts recognized, which is subject to variation until the ultimate loss experience is determinable. No contingent ceding commissions were recognized for the year ended December 31, 2001, approximately $78,000 of contingent ceding commissions were recognized as an expense for the year ended December 31, 2000, and approximately $89,000 of contingent ceding commissions were recognized in income in 1999.
An amount recorded as a component of other assets represents the Company's proportionate share of the net assets of the Association. The Company's proportionate share of premiums, losses, loss expenses, and other related items is recorded and presented in their respective accounts in the accompanying consolidated financial statements.
(II) CREDIT RISK--the risk that issuers of securities owned by the Company will default or that other parties, including reinsurers to whom business is ceded, which owe the Company money, will not pay. The Company attempts to minimize this risk by adhering to a conservative investment strategy, maintaining reinsurance agreements with financially sound reinsurers, and by providing for any amounts deemed uncollectible.
The fair value of the Company's investments are estimated based on prices published by financial services or quotations received from securities dealers and is reflective of the interest rate environment that existed as of the close of business on December 31, 2001 and 2000. Changes in interest rates subsequent to December 31, 2001 may affect the fair value of the Company's investments. Refer to note 3(a) for details.
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2001 and 2000 because of their short-term nature: cash and cash equivalents, premiums receivable, finance contracts, consumer loans and pay advance receivable, due from reinsurers, drafts payable to insurance companies, revolving credit outstanding, bank overdraft, and accounts payable and accrued expenses.
Goodwill, representing the excess of cost over the fair value of assets acquired, is amortized on a straight-line basis over seven years. The carrying value of goodwill is periodically reviewed by the Company based on the expected future undiscounted operating cash flows of the related item. Based upon its most recent analysis, the Company believes that no impairment of goodwill exists at December 31, 2001. See Note 2 ( r ) for additional information.
The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Compensation cost for stock options, if any, is measured as the excess of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock.
SFAS No. 123, "Accounting for Stock-Based Compensation", establishes accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. ( See Note 16.)
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of fixed maturities and equity securities at December 31, 2001 and 2000 is as follows:
Proceeds from sales of fixed maturities and equity securities for the years ending December 31, 2001, 2000 and 1999 were $62,419,076, $49,110,449 and $37,826,024, respectively.
The activity in the allowance for credit losses was as follows for the years ended December 31, 2001, 2000 and 1999:
Property, plant and equipment at December 31, 2001 and 2000 consist of the following:
The Company reinsures (cedes) a portion of its written premiums on a quota-share basis to nonaffiliated insurance companies in order to limit its loss exposure. The Company also maintains coverages to limit losses from large exposures, which the Company believes are adequate for its current volume. To the extent that reinsuring companies are unable to meet their obligations assumed under the reinsurance agreements, the Company remains primarily liable to its policyholders. The impact of reinsurance on the financial statements is as follows:
Direct .......................... $ 11,005,337 $ 9,765,848 Ceded ........................... (4,798,556) (2,789,619) ------------ ------------
As a result of the Company's review of its liability for losses and LAE, which includes a re-evaluation of the adequacy of reserve levels for prior year's claims, the Company increased its liability for loss and LAE for claims occurring in prior years by $2,568,000 for the year ended December 31, 2001, increased its liability for loss and LAE for claims occurring in prior years by $1,445,000 for the year ended December 31, 2000, and reduced its liability for loss and LAE for claims occurring in prior years by $670,000 in 1999. The adjustments in the liability were primarily attributable to loss development with respect to the Company's automobile insurance program. There can be no assurance concerning future adjustments of reserves, positive or negative, for claims through December 31, 2001.
A summary of the provision for income tax expense (benefit) for the years ended December 31, 2001, 2000 and 1999 is as follows:
The actual income tax expense (benefit) differs from the "expected" income tax expense (benefit) for the years ended December 31, 2001, 2000 and 1999 (computed by applying the U.S. federal tax rate of 34 percent to income (loss) before provision for income tax expense (benefit)) as follows:
In assessing the realizability 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, 2001 and 2000, 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 with the exception of the capital loss carryforward, for which a reserve has been provided as of December 31, 2001.
To retain its certificate of authority, the Florida Insurance Code (the "Code") requires that Federated National and American Vehicle maintain capital and surplus equal to the greater of 10 percent of its liabilities or the statutory minimum capital and surplus requirement of $3.0 million as defined in the Code. In 2001, 2000 and 1999, Federated National was required to have capital surplus of $3.0 million, $2.75 million and $5.9 million, respectively. At December 31, 2001, 2000 and 1999, Federated National's capital surplus was $5.7 million, $6.2 million and $7.1 million, respectively. At December 31, 2001, American Vehicle was required to have capital surplus of $3.0 million and had capital surplus of $3.1 million. Further, the Companies were also required to adhere to a prescribed net premium-to-surplus ratio. For the year ended December 31, 2001, both Companies were in compliance with this requirement.
As of December 31, 2001, to meet regulatory requirements, the Company had bonds with a carrying value of approximately $1,538,000 pledged to the Insurance Commissioner of the State of Florida.
Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its shareholders except out of that part of its available and accumulated capital surplus funds which is derived from realized net operating profits on its business and net realized capital gains. A Florida domestic insurer may not make dividend payments or distributions to shareholders without prior approval of the Florida Department of Insurance if the dividend or distribution would exceed the larger of (i) the lesser of (a) 10 percent of capital surplus (b) net income, not including realized capital gains, plus a two-year carryforward, (ii) 10 percent of capital surplus with dividends payable constrained to unassigned funds minus 25 percent of unrealized capital gains of (iii) the lesser of (a) 10 percent of capital surplus or (b) net investment income plus a three-year carryfoward with dividends payable constrained to unassigned funds minus 25 percent of unrealized capital gains. Alternatively, a Florida domestic insurer may pay a dividend or distribution without the prior written approval of the Florida Department of Insurance (i) if the dividend is equal to or less than the greater of (a) 10 percent of the insurer's capital surplus as regards policyholders derived from realized net operating profits on its business and net realized capital gains or (b) the insurer's entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, (ii) the insurer will have policyholder capital surplus equal to or exceeding 115 percent of the minimum required statutory capital surplus after the dividend or distribution, (iii) the insurer files a notice of the dividend or distribution with the department at least ten business days prior to the dividend payment or distribution and (iv) the notice includes a certification by an officer of the insurer attesting that, after the payment of the dividend or distribution, the insurer will have at least 115 percent of required statutory capital surplus as to policyholders. Except as provided above, a Florida domiciled insurer may only pay a dividend or make a distribution (i) subject to prior approval by the Florida Department of Insurance or (ii) 30 days after the Florida Department of Insurance has received notice of such dividend or distribution and has not disapproved it within such time. No dividends were declared or paid in 2001, 2000 or 1999.
The Company is required to comply with NAIC risk-based capital ("RBC") requirements. RBC is a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC's RBC standards are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2001, based on calculations using the appropriate NAIC formula, both Federated National's and American Vehicle's total adjusted capital are in excess of ratios, which would require any form of regulatory action.
The NAIC has developed Insurance Regulatory Information Systems ("IRIS") ratios to assist state insurance departments in identifying companies, which may be developing performance or solvency problems, as signaled by significant changes in the companies' operations. Such changes may not necessarily result from any problems with an insurance company, but may merely indicate changes in certain ratios outside the ranges defined as normal by the NAIC. When an insurance company has four or more ratios falling outside "usual ranges," state regulators may investigate to determine the reasons for the variance and whether corrective action is warranted. As of December 31, 2001, Federated National was outside NAIC's usual ranges with respect to its IRIS tests on 7 out of 12 ratios. Federated National was not in the "usual ranges" primarily because of the losses on the common stock portfolio and because of the short fall in Federated National's loss and LAE reserves in 2000 and 1999. Federated National has sold its common stock portfolio and no longer invests in common stock. In addition, Federated National has carefully reviewed its loss and LAE reserves and management believes that such reserves at December 31, 2001 are adequate. American Vehicle was outside NAIC's usual ranges on three ratios primarily because prior to its acquisition, American Vehicle had not written insurance policies since 1997 and was under capitalized. Management does not currently believe that the Florida Department of Insurance will take any significant action with respect to Federated National or American Vehicle regarding the IRIS ratios, although there can be no assurance that will be the case.
Generally accepted accounting principles differ in some respects from reporting practices prescribed or permitted by the Florida Department of Insurance. Federated National's statutory capital and surplus was $5.7 million and $6.2 million as of December 31, 2001 and 2000, respectively. Federated National's statutory net loss was $2.1 million and $1.4 million for the years ended December 31, 2001 and 2000, respectively. In 1999, Federated National's statutory net income was approximately $1.1 million. Statutory non-admitted assets were approximately $395,000 and $1.2 million as of December 31, 2001 and 2000, respectively. American Vehicle's statutory capital and surplus was $3.1 million as of December 31, 2001, and its statutory net income was $64,000 for the year ended December 31, 2001. Statutory non-admitted assets were approximately $13,000 as of December 31, 2001.
The Company is involved in various 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 the Company's consolidated financial position, results of operations, or liquidity.
In June 2000, a lawsuit was filed against the Company and its directors and executive officers seeking compensatory damages on the basis of allegations that the Company's amended registration statement dated November 4, 1998 was inaccurate and misleading concerning the manner in which the Company recognized ceded insurance commission income, in violation of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The lawsuit was filed in the United States District Court for the Southern District of New York and seeks class action status. The plaintiff class purportedly includes purchasers of the Company's common stock between November 5, 1998 and August 13, 1999. The Company believes that the lawsuit is without merit and is vigorously defending such action. The Company is currently awaiting the Court's ruling on its Motion to Dismiss the plaintiff's First Amended Complaint.
Prior to its acquisition, American Vehicle was involved in litigation with a former officer and director of American Vehicle. The litigation was adjudicated and American Vehicle, among others, was found liable and paid the final judgment. There remains one outstanding issue, which is the assessment of attorney's fees and costs. A petition has been filed seeking costs of $136,000 and appellate attorney's fees in excess of $2 million. If American Vehicle is found liable for such fees and costs, they are indemnified by American Vehicle's previous owners, in accordance with the purchase agreement. Furthermore, the $500,000 purchase price paid to the former owners remains in escrow pending settlement of the fees and costs. Consequently, no liability for these fees and costs has been recorded.
The Company, as a direct premium writer in the State of Florida, is required to participate in certain risk pools. Participation in these pools is based on the Company's written premium by line of business to total premiums written statewide by all insurers. Participation may result in assessments against the Company. For the year ended December 31, 2001, the Company was assessed $203,000, which the Company intends to recover as permitted by the state of Florida through policy surcharges in 2002. For the years ended December 31, 2000 and 1999, no amounts were assessed against the Company.
The Company leases office space under various lease agreements with expiration dates through September 2016. Rental expense associated with operating leases is charged to expense in the period incurred. Rental expenses for 2001, 2000 and 1999 were approximately $797,000, $962,000 and $821,000, respectively, and are included in operating and underwriting expenses in the accompanying consolidated statements of operations.
One of the Company's directors is a partner at Conroy, Simberg, and Ganon, a law firm that handles the Company's claims litigation. Fees paid to this law firm amounted to approximately $530,000, $533,000 and $281,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
Information regarding components of operations for the years ended December 31, 2001, 2000 and 1999 follows:
TOTAL ASSETS 2001 2000 ---- ---- Insurance Segment $42,016,846 $35,849,212 Finance Segment 10,556,012 14,570,175 All Others 3,633,623 7,072,230 --------- --------- Total Operating Segments 56,206,481 57,491,617 Intercompany Eliminations 22,096 (2,078,648) ----------- ----------- Total Assets $56,228,577 $55,412,969 =========== ===========
Supplemental segment information as of and for the year ended December 31, 2001, 2000 and 1999 follows:
In 2001, the Company initiated a franchise stock option plan that provides for the granting of stock options to individuals purchasing Company owned agencies which are then converted to franchised agencies. The purpose of the plan is to advance the interests of the Company by providing an additional incentive to encourage managers of Company owned agencies to purchase the agencies and convert them to franchises. Options outstanding under the plan have been granted at prices, which are above the market value of the stock on the date of grant, vest over a ten-year period, and expire ten years after the grant date. Under this plan, the Company is authorized to grant options to purchase up to 689,000 common shares, and, as of December 31, 2001, the Company had granted options to purchase 83,830 shares.
Activity in the Company's stock option plans for the period from January 1, 1999 to December 31, 2001 is summarized below:
The Company continues to account for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, under which no compensation cost for stock options is recognized for stock option awards granted to employees at or above fair market value. Had compensation expense for the Company's stock compensation plan been determined based upon fair values at the grant dates for awards under the plan in accordance with SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been reduced (increased) to the pro forma amounts indicated below. Additional stock option awards are anticipated in future years.
2001 2000 1999 ---- ---- ---- Dividend yield 2.68%-3.20% 0.00% 0.00% Expected volatility 136%-152% 73%-93% 45% Risk-free interest rate 4.89%-5.29% 5.75% 5.70% Expected life (in years) 10 10 10
Summary information about the Company's stock options outstanding at December 31, 2001:
The Company has established a profit sharing plan under Section 401(k) of the Internal Revenue Code. This plan allows eligible employees to contribute up to 15 percent of their compensation on a pre-tax basis, not to exceed statutory limits. For the year ended December 31, 2001, the Company did not contribute to the plan. For the year ended December 31, 2000, the Company declared a discretionary match of 50 percent of the first 6 percent of the employees' contribution. For the year ended December 31, 1999, the Company declared a discretionary match of 100 percent of the first 3 percent of the employees' contribution. Such matching Company contributions are vested incrementally over five years. The charge to operations for the Company's matching contribution was approximately $143,000 and $59,000 in 2000 and 1999, respectively.
In August 2001, the Company purchased all of the outstanding stock and all of the outstanding surplus notes of American Vehicle for $500,000 in cash. In addition, the Company agreed to pay two executives of American Vehicle a finders' fee of $400,000 over a period of three years. Income and expenses of American Vehicle beginning September 1, 2001 are included in the Company's Consolidated Statements of Operations. The fair value of the net assets (which consisted primarily of marketable securities) of American Vehicle at the date of acquisition was approximately $2.1 million. In accordance with SFAS No. 141, Business Combinations, the excess of the fair value of the net assets purchased over the purchase price has been reported as an extraordinary gain in the accompanying Consolidated Statements of Operations.
The above pro forma information is not necessarily indicative of the results of operations that would have occurred had the acquisition taken place as of the beginning of each period reported, or of results, which may occur in the future.
Reclassification adjustments related to the investment securities included in comprehensive income (loss) for the years ended December 31, 2001, 2000 and 1999 are as follows: