Management's Discussion and Analysis of Financial Condition and Results of Operations -------------------------
Revenue and Income Generation - ----------------------------- The Company receives its revenue primarily from earned premium derived from the insurance company operations, commission and fee income generated from the insurance agency operations, finance charges and
Other Operations - ---------------- The Company's other operations generate commissions, fees, and finance charges from various insurance products. The events that have the most significant economic impact are as follows:
Unifax primarily sells and services insurance policies for Crusader. The commissions paid by Crusader to Unifax are eliminated as intercompany transactions and are not reflected as income in the financial statements. Policy fee income for the twelve months ended December 31, 2006, decreased 12% as compared to the prior year. The decrease in policy fee income is a result of a decrease in the number of policies issued during the twelve months ended December 31, 2006, as compared to 2005, offset in part by an approximate 8% increase in the policy fee for policies effective on or after June 26, 2005.
AAQHC provides various consumer benefits to its members, including participation in group health care and life insurance policies. For these services, AAQHC receives membership and fee income from its members. Membership and fee income decreased 6% in the year ended December 31, 2006, compared to 2005. The decrease is a result of the decrease in the number of members. In May 2006, CIGNA HealthCare began offering new small group medical insurance policies in the state of California. Currently, all new CIGNA small group medical insurance policies are written through AIB and all CIGNA small group medical insurance policyholders are members of AAQHC. The new programs are competitively priced and are being actively marketed.
The daily automobile rental insurance program is produced by Bedford Insurance Services, Inc. Bedford receives a commission from a non-affiliated insurance company based on premium written. Commission in the daily automobile rental insurance program decreased $135,714 (27%) as compared to 2005. The decrease is due to the continued intense competition in the daily automobile rental insurance program. Bedford continues to produce business only at rates that it believes are adequate. Primarily due to declining sales, in April 2006 Bedford hired a new general manager who has substantial experience in the daily automobile rental insurance business. Future sales growth of the Bedford program is also currently dependent upon the non-affiliated insurance company approving and implementing various product enhancements that Bedford recommends. Bedford is currently working with the non-affiliated insurance company to obtain their approval of the recommended program enhancements.
Investments and Liquidity - ------------------------- The Company generates revenue from its investment portfolio, which consisted of approximately $147.3 million (at amortized cost) at December 31, 2006, compared to $140.6 million (at amortized cost) at December 31, 2005. Investment income for the twelve months ended December 31, 2006, increased $1.7 million or 39% in 2006 compared to 2005. The increase was primarily due to both an increase in invested assets of approximately $6.7 million (5%) and an increase in the Company's annualized yield on average invested assets from 3.2% in 2005 to 4.2% in 2006. The increase in the annualized yield on average invested assets is a result of higher yields in the marketplace on both new and reinvested assets. Due to the current interest rate environment, management believes it is prudent to purchase fixed maturity investments with maturities of five years or less and with minimal credit risk.
Liquidity and Capital Resources ------------------------------- Due to the nature of the Company's business (insurance and insurance services) and whereas Company growth does not normally require material reinvestments of profits into property or equipment, the cash flow generated from operations usually results in improved liquidity for the Company. Because the Company is a holding company and operates through its subsidiaries, its cash flow is dependent upon the earnings of its subsidiaries and the distributions of those earnings to the Company.
During 2005 the Company began its conversion to a "paperless office" including improvements to its computer network, hardware, and other related computer infrastructure. These projects were substantially completed in 2006. The Company is now fine-tuning its paperless office systems and back scanning its previous paper files and documents. As of December 31, 2006, the Company had incurred approximately $760,000 of capital expenditures on the paperless office and the related computer infrastructure projects. During 2006, the Company began benefiting from these capital expenditures due to productivity improvements, improved customer service, and lower operating costs. In addition, the Company is in the process of enhancing its technology related to its underwriting procedures and electronic communication systems to better accommodate its customers' needs and to improve operating efficiencies.
The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company (see Note 16 of "Notes to Consolidated Financial Statements"). During the year ended December 31, 2006, the Company did not repurchase any shares of the Company's common stock. As of December 31, 2006, the Company has purchased and retired under the Board of Directors' authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.
General - ------- The Company had net income of $11,794,241 for the year ended December 31, 2006, compared to net income of $6,715,004 for the year ended December 31, 2005, and net income of $5,681,500 for the year ended December 31, 2004. Total revenue for the year ended December 31, 2006, was $54,717,381 compared to $61,182,522 for the year ended December 31, 2005, and $61,903,310 for the year ended December 31, 2004.
For the year ended December 31, 2005, the Company had income before taxes of $10,466,430 compared to income before taxes of $8,672,458 in the year ended December 31, 2004, an increase in income before taxes of $1,793,972. The increase in pre-tax income was primarily due to an increase of $3,114,856 in the underwriting
profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader offset by $995,849 decrease in gross commissions and fees income.
As of December 31, 2006, Crusader was licensed as an admitted insurance company in the states of Arizona, California, Montana, Nevada, Oregon, and Washington and is approved as a non-admitted surplus lines writer in other states.
Crusader's 2006 1st layer primary excess of loss treaty provides for a contingent commission equal to 20% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2006, through December 31, 2006. The 2005 1st layer primary excess of loss treaties do not provide for a contingent commission. Crusader's 2004 and 2003 1st layer primary excess of loss treaty provides for a contingent commission to the Company equal to 45% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2003, through December 31, 2004. The Company will calculate and report to the reinsurer its net profit, if any, within 90 days after 36 months following the end of the first accounting period, and within 90 days after the end of each 12 month period thereafter until all losses subject to the agreement have been finally settled. Based on losses and loss adjustment expenses ceded (including incurred but not reported losses) as of December 31, 2006, no contingent commission has been accrued for each of the periods discussed above.
The combined ratio is the sum of (1) the net ratio of losses and loss adjustment expenses incurred (including a provision for incurred-but-not-reported losses "IBNR") to net premiums earned (loss ratio) and (2) the ratio of
The Company's net losses and loss adjustment expenses for the calendar year ended December 31, 2006, were $17,826,979. This amount is comprised of accident year 2006 net losses and loss adjustment expenses of $29,997,662 and favorable development of prior accident years of $12,170,683. The Company's net losses and loss adjustment expenses for the calendar year ended December 31, 2005, were $31,513,732. This amount is comprised of accident year 2005 net losses and loss adjustment expenses of $35,338,196 and favorable development of prior accident years of $3,824,464. The Company's net losses and loss adjustment expenses for the calendar year ended December 31, 2004, were $34,450,738. This amount is comprised of accident year 2004 net losses and loss adjustment expenses of $35,286,172 and favorable development of prior accident years of $835,434.
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Direct reserves Case reserves $21,796,117 $23,114,548 $19,699,000 IBNR reserves 71,800,000 78,800,000 67,770,000 ---------- ----------- ---------- Total direct reserves $93,596,117 $101,914,548 $87,469,000 ========== =========== ==========
Reserves for losses and loss adjustment expenses before reinsurance for each of Crusader's lines of business were as follows:
The Company's net loss and loss adjustment expense reserve was $70,076,430 as of December 31, 2006. Since underwriting profit is a significant part of income, a small percentage change in reserve estimates may result in a substantial effect on future reported earnings. Such changes might result from a variety of factors, including claims costs emerging in a different pattern than the average historical development patterns. Considering the continuum of possible development patterns, none of which is necessarily more or less likely than the next, one must consider the varying probabilities that the development pattern is off in varying degrees. If future development ultimately ends up being five percent different than the Company's 2006 reserve, approximately $3.5 million would be reflected in future periods as an increase or decrease in the provision for events of prior years and would be recognized in the Company's consolidated statement of operations in future periods. A variance of five percent of net loss and loss adjustment expense reserves is not an unlikely scenario. Similarly, a variance of ten percent of the Company's 2006 reserves would be reflected in approximately $7.1 million in future periods as an increase or decrease in the provision for events of prior years and would be recognized in the Company's consolidated statements of operations in future periods. This is also not an unlikely scenario. Differences of more than ten percent are also possible, though not quite as likely as differences of ten percent or less.
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Policy fee income $2,638,985 $3,001,966 $3,394,783 Policies issued 15,186 17,927 20,885
Policy fee income for the year ended December 31, 2006, decreased $362,981 (12%) as compared to the year ended December 31, 2005. The 12% decrease in policy fee income is primarily a result of a 2,741 (15%) decrease in the number of policies issued during 2006 as compared to 2005, offset by the increase in policy fee from $165 per policy to $178 per policy effective on and after August 2005.
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Rental program commission $317,679 $411,189 $555,964 Contingent commission 53,638 29,877 9,488 ------- ------- ------- Total commission 371,317 441,066 565,452 Claim administration fee 4,035 70,000 - ------- ------- ------- Total commission and fee income $375,352 $511,066 $565,452 ======= ======= =======
Unifax began producing commercial earthquake insurance policies in California for non-affiliated insurance companies in 1999. Unifax receives a commission from these insurance companies based on premium written. Commission income on the earthquake program for the year ended December 31, 2006, decreased $10,605 (22%) compared to 2005. Commission income on the earthquake program for the year ended December 31, 2005, decreased $4,621 (9%) compared to 2004.
AAC provides premium financing for Crusader policies produced by Unifax in California. The growth of this program is dependent and directly related to the growth of Crusader's written premium and AAC's ability to market its competitive rates and service. Premium finance charges and fees earned decreased $79,585 (10%) in the year ended December 31, 2006, compared to 2005 due primarily to the fact that there were 604 (14%) fewer loans financed in the current year. Premium finance charges and fees earned decreased $175,204 (19%) in the year ended December 31, 2005, compared to 2004 due primarily to the fact that there were 956 (19%) fewer loans financed in the current year. During 2006, 32% of all Unifax policies were financed and 75% of those policies were financed by AAC. During 2005, 32% of all Unifax policies were financed and 75% of those policies were financed by AAC.
In the year ended December 31, 2006, while the Company's average invested assets (at amortized value) increased $7,602,280 (6%) compared to the year ended December 31, 2005, investment income earned increased $1,689,807 (39%) compared to the year ended December 31, 2005. The yield on average invested assets increased to 4.17% in 2006 from 3.17% in 2005. The increase in the yield on average invested assets is primarily the result of an increase in the average return on new and reinvested assets in the Company's investment portfolio. Due to the current interest rate environment, management believes it prudent to purchase fixed maturity investments with relatively short maturity duration. Thus, the weighted average maturity of the Company's fixed maturity investments as of December 31, 2006 was 1.3 years compared to 1.2 years as of December 31, 2005. The Company's average invested assets increased in the year ending December 31, 2006, primarily as a result of increased cash flows from operations. The mix of taxable and tax-exempt securities in the portfolio affects the investment income return percentage. Tax-exempt securities generally carry a lower yield than taxable securities. These securities (at amortized value) decreased to $15,134 (0% of total investments) at December 31, 2006, compared to $934,536 (1% of total investments) at December 31, 2005.
In the year ended December 31, 2005, while the Company's average invested assets (at amortized value) increased $11,024,341 (9%) compared to the year ended December 31, 2004, investment income earned increased $74,404 (2%) compared to the year ended December 31, 2004. The yield on average invested assets decreased to 3.17% in 2005 from 3.39% in 2004. The decrease in the yield on average invested assets is primarily the result of a decline in the average return on new and reinvested assets in the Company's investment portfolio. Also contributing to the decline in the yield on average invested assets is a shorter weighted average maturity of new and reinvested assets. Due to the 2005 interest rate environment, management believes it prudent to purchase fixed maturity investments with shorter maturities, and therefore, the weighted average maturity of the Company's fixed maturity investments has decreased to 1.2 years as of December 31, 2005, from 1.4 years as of December 31, 2004. The Company's average invested assets increased in the year ending December 31, 2005, primarily as a result of increased cash flows from operations. The mix of taxable and tax-exempt securities in the portfolio affects the investment income return percentage. These securities (at amortized value) decreased to $934,536 (1% of total investments) at December 31, 2005, compared to $970,343 (1% of total investments) at December 31, 2004.
The par value, amortized cost, estimated market value and weighted average yield of fixed maturity investments at December 31, 2006, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
The following table summarizes, for all fixed maturities in an unrealized loss position at December 31, 2006, the aggregate fair value and gross unrealized loss by length of time those fixed maturities have been continuously in an unrealized loss. No securities were sold at a loss during 2006, 2005, or 2004.
Amortized Gross Cost Fair Value Unrealized Loss ---- ---------- --------------- 0-6 months $17,464,974 $17,406,777 $58,197 7-12 months 27,040,360 26,931,181 109,179 Over 12 months 57,120,330 56,813,213 307,117 ----------- ---------- ------- Total $101,625,664 $101,151,171 $474,493 =========== =========== =======
At December 31, 2006, the fixed maturity investments with a gross unrealized loss for continuous periods of 0 to 6 months consisted of U.S. treasury securities. The fixed maturity investments with a gross unrealized loss position for continuous periods of 7 to 12 months consisted both U.S. treasury securities and investment grade industrial securities. The fixed maturity investments with a gross unrealized loss position for a continuous period over 12 months consisted of U.S. treasury securities, investment grade industrial securities and pre-refunded municipal bonds. The unrealized loss is primarily due to rising interest rates.
Operating Expenses ------------------ POLICY ACQUISITION COSTS are as follows: Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Policy acquisition costs $9,250,989 $10,512,688 $10,319,186 Ratio to net earned premium (GAAP ratio) 22% 21% 21%
Total salaries and employee benefits incurred for the year ended December 31, 2006, increased $511,983 (5%) compared to the year ended December 31, 2005. Factors that affected the 5% increase were primarily general salary increases and increases in employee benefits costs. Total salaries and employee benefits incurred for the year ended December 31, 2005, increased $274,828 (3%) compared to the year ended December 31, 2004. Factors that affected the 3% increase were general salary increases and increases in employee benefits costs, offset by reduction in the number of employees.
COMMISSIONS TO AGENTS/BROKERS are as follows: Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Commission to agents/brokers $611,200 $674,674 $934,452
Commissions to agents/brokers (not including commissions on Crusader policies that are reflected in policy acquisition costs) are generally related to gross commission income from the health and life insurance program, the daily automobile rental insurance program, and the earthquake program. Commissions to agents and brokers decreased $63,474 (9%) for the year ended December 31, 2006, as compared to the year ended December 31, 2005. Commissions to agents and brokers decreased $259,778 (28%) for the year ended December 31, 2005, as compared to the year ended December 31, 2004. The decreases in both years are primarily the result of a decrease in premiums written and the related decrease in the commission expense in the health and life insurance program and the daily automobile rental insurance program.
Other operating expenses generally do not change significantly with changes in production. This is true for both increases and decreases in production. Other operating expenses increased $138,653 (5%) for the year ended December 31, 2006, compared to the year ended December 31, 2005. Operating expenses increased $216,715 (8%) for the year ended December 31, 2005, compared to the year ended December 31, 2004.
Income Taxes ------------ Income tax expense for the year ended December 31, 2006, was $6,359,745 compared to an income tax expense of $3,751,426 for the year ended December 31, 2005. The effective combined income tax rates for 2006 and 2005 were 35% and 36%, respectively. The pre-tax income increased $7,687,556 for the year ended December 31, 2006, compared to the year ended December 31, 2005, which resulted in an increased income tax expense in 2006. The income tax expense for the year ended December 31, 2005, was $3,751,426 compared to an income tax expense of $2,990,958 for the year ended December 31, 2004. The effective combined income tax rates for 2005 and 2004 were 36% and 34%, respectively.
In September 2006, the FASB issued Statement No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an Amendment of FASB Statement No. 87, 88, 106 and 132(R)" ("SFAS 158"). SFAS 158 requires a business entity that sponsors an employer defined benefit plan to measure plan assets and obligations as of the date of the employer's fiscal year-end statement of financial position and recognize funded status as a component of other comprehensive income. SFAS 158 is effective for fiscal years ending after December 15, 2006. There is no impact on the Company's consolidated financial statements from adoption of this standard since the Company does not provide a defined benefit plan to its employees.
Management believes the Company's current critical accounting policies comprise the following:
The Company underwrites four statutory annual statement lines of business: (1) commercial multiple peril, (2) liability other than automobile and products, (3) fire, and (4) allied lines. Commercial multiple peril policies comprised 97% of the Company's 2006 and 2005 premium volume. Commercial multiple peril policies include both property and liability coverages. For all of the Company's coverages and lines of business, the Company's actuarial loss and loss adjustment expense reserving methods require assumptions that can be grouped into two key categories: (1) expected loss and loss adjustment expense, required by the expected loss ratio and Bornhuetter-Ferguson methods, and (2) expected development patterns, required by the loss development and Bornhuetter-Ferguson methods.
The Company also segregates most of its business into smaller homogeneous categories primarily for management's internal detailed business review and analysis. These homogeneous categories used by the Company include various combinations and special groupings of its lines of business, programs types, states, and coverages. Some categories exclude certain items and/or others include certain items. Not all categories are defined in the same way. This analysis includes the tracking of historical claims costs and development patterns separately for each of these uniquely designed categories. Generally, neither the liability development patterns nor the property development patterns vary significantly by category.
Development patterns generally do not tend to change materially over time. Generally, the Company has very little property claim development subsequent to the end of an accident year. Although liability claims may take 10 or more years to fully develop, most of the development occurs in the first five to six years subsequent to the end of the accident year. However, liability claims are substantially developed by two years subsequent to the end of the accident year. Other than the change in the expected loss and loss adjustment expense ratio assumption discussed above, the Company's reserving methodology assumptions have not changed in the years presented and the only significant effect on the Company's financial statements has resulted from estimated costs being adjusted as actual costs emerge.
The Company must estimate its ultimate losses and loss adjustment expenses using a very small claim population size. At the beginning of 2006, the Company had 771 open claim files. During 2006, 1,230 new claim files were opened and 1,284 claim files were closed, leaving 717 open claim files at the end of 2006. Due to the small size of the Company and the related small population of claims, the Company's losses and loss adjustment expenses for any accident year can vary significantly from the initial expectations. Due to the small number of claims, changes in claim frequency and/or severity can materially affect the Company's reserve estimate. The potential variability from management's best estimate cannot be measured from any meaningful statistical basis due to the numerous uncertainties in the claims reserving process and the small population of claims.
The effect of ceded reinsurance on results of operations is as follows:
Investments ----------- In accordance with Statement of Financial Accounting Standard No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company is required to classify its investments in debt and equity securities into one of three categories: held-to-maturity, available-for-sale or trading securities.
Forward Looking Statements - -------------------------- Certain statements contained herein, including the sections entitled "Business," "Legal Proceedings" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," that are not historical facts are forward looking. These statements, which may be identified by forward looking words or phrases such as "anticipate," "appears," "believe," "estimates," "expect," "intend," "may," "should," and "would," involve risks and uncertainties, many of which are beyond the control of the Company. Such risks and uncertainties could cause actual results to differ materially from these forward looking statements. Factors which could cause actual results to differ materially include those described under Item 1 - "Business - Competition" and Item 1A - "Risk Factors"; premium rate adequacy relating to competition or regulation; actual versus estimated claim experience; the outcome of rate change filings with regulatory authorities; acceptance by insureds of rate changes; adequacy of rate changes; changes in Crusader's A.M. Best rating; regulatory changes or developments; the outcome of regulatory proceedings; unforeseen calamities; general market conditions; and the Company's ability to introduce new profitable products.
Consolidated Statements of Operations for the years ended December 31, 2006, 2005, and 2004 41
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------ Nature of Business - ------------------ Unico American Corporation is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary; provides property, casualty, health and life insurance through its agency subsidiaries; and provides insurance premium financing and membership association services through its other subsidiaries. Unico American Corporation is referred to herein as the "Company" or "Unico" and such references include both the corporation and its subsidiaries, all of which are wholly owned, unless otherwise indicated. Unico was incorporated under the laws of Nevada in 1969.
Investments - ----------- All of the Company's fixed maturity investments are classified as available-for-sale and are stated at fair value. Although all of the Company's investments are classified as available-for-sale and the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates fair value. The unrealized gains or losses from fixed maturities are reported as "accumulated other comprehensive income (loss)," which is a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses, if any, are included in the Consolidated Statements of Operations based on the specific identification method.
The Company had unrealized investment losses, net of deferred taxes, of $216,074 as of December 31, 2006, and unrealized investment losses, net of deferred taxes, of $382,224 as of December 31, 2005.
Revenue Recognition - -------------------- a. General Agency Operations ----------------------------- Commissions and policy fees due the Company are recognized as income on the effective date of the insurance policies.
Restricted Funds - ---------------- Restricted funds are as follows: Year ended December 31 ---------------------- 2006 2005 ---- ----
The insurance company operation is conducted through the Company's wholly owned subsidiary Crusader Insurance Company (Crusader), which as of December 31, 2006, was licensed as an admitted insurance carrier in the states of Arizona, California, Montana, Nevada, Oregon, and Washington. Crusader is a multiple-line property and casualty insurance company, which began transacting business on January 1, 1985. As of December 31, 2006, 97% of Crusader's business was commercial multiple peril insurance policies. Commercial multiple peril policies provide a combination of property and liability coverage for businesses. Commercial property coverages insure against loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, hail, water, explosions, severe winter weather and other events such as theft and vandalism, fires and storms and financial loss due to business interruption resulting from covered property damage. Commercial liability coverages insure against third party liability from accidents occurring on the insured's premises or arising out of its operations, such as injuries sustained from products sold or operation of the insured premises. In addition to commercial multiple peril policies, Crusader also writes separate policies to insure commercial property and commercial liability risks on a mono-line basis. Revenues, income before income taxes and assets by segment are as follows:
Prior to January 1, 2006, the Company applied the intrinsic-value based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations including FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation," an interpretation of APB Opinion No. 25, to account for its fixed-plan stock options. Under this method, compensation expense was recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. FASB Statement No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," and FASB Statement No. 148, "Accounting for Stock Based Compensation - Transition and Disclosure," an amendment of SFAS 123, established accounting and disclosure requirements using a fair-value based method of accounting for stock-based employee compensation plans. As permitted by existing accounting standards, the Company elected to continue to apply the intrinsic-value based method of accounting described above and has adopted only the disclosure requirements of SFAS 123, as amended for applicable periods prior to 2006. In December 2004, FASB Statement No. 123R (SFAS 123R) which revised SFAS 123 was issued and was adopted by the Company in 2006 (see Note 14).
On December 30, 2005, the Company accelerated the vesting of all of its outstanding stock-based compensation awards granted under the Company's 1999 Omnibus Stock Plan. All accelerated options were "in the money." The number of shares covered by the options accelerated totaled 67,500 of which 37,500 were originally scheduled to vest on January 1, 2006 and 30,000 were originally scheduled to vest on January 1, 2007. The Company accelerated vesting of the options in order to minimize the compensation costs associated with the adoption of SFAS 123R. All accelerated options were granted to long-term management employees who were not expected to leave the Company prior to the originally scheduled vesting date. The estimated compensation cost which will be excluded from future periods as a result of the acceleration of the vesting of the options is approximately $89,100. There were no options granted during 2006 and there were no unvested options as of January 1, 2006 on adoption of SFAS 123R, as a result, there is no compensation expenses recorded for the year ended December 31, 2006.
Had compensation cost for the Company's stock-based compensation plan been reflected in the accompanying consolidated financial statements based on the fair value at the grant dates for option awards consistent with the method of SFAS 123, the Company's net income for the years ended December 31, 2005, and December 31, 2004, would have been reduced to the pro forma amounts indicated in the following table:
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 ("SAB 108"). SAB 108 requires registrants to quantify misstatements by using both the balance-sheet and income-statement approaches and to determine whether financial statement restatement is necessary. SAB 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006. The Company's adoption of SAB 108 did not have an effect on its results of operations or financial position.
There were no other accounting standards issued during 2006 that are expected to have a material impact on the Company's consolidated financial statements.
Some of the Company's health and life programs require payments of premium prior to the effective date of coverage; and, accordingly, invoices are sent out as early as two months prior to the coverage effective date. Insurance premiums received for coverage months effective after the balance sheet date are recorded as advance premiums. The Company received deposits to guarantee the payment of premiums for past coverage months on its daily automobile rental program. These deposits are required when information such as gross receipts or number of rental cars is required to compute the actual premium due but is not available until after the coverage month.
The amortized cost and estimated fair value of fixed maturity investments at December 31, 2006, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
The following table illustrates the gross unrealized losses included in the Company's investment portfolio and the fair value of those securities, aggregated by investment category. The table also illustrates the length of time that they have been in a continuous unrealized loss position as of December 31, 2006 and December 31, 2005.
Year Ended Amortized Gross December 31 Cost Fair Value Unrealized Loss - ----------- ---- ---------- ---------------
- ---- 0-6 months $17,464,974 $17,406,777 $58,197 7-12 months 27,040,360 26,931,181 109,179 Over 12 months 57,120,330 56,813,213 307,117 ----------- ----------- ------- Total $101,625,664 $101,151,171 $474,493 =========== =========== ======= - ---- 0-6 months $46,834,903 $46,585,392 $249,511 7-12 months 14,327,095 14,166,247 160,848 Over 12 months 50,421,376 49,989,695 431,681 ---------- ----------- ------- Total $111,583,374 $110,741,334 $842,040 =========== =========== =======
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Fixed maturities $5,824,510 $4,218,302 $4,200,190 Realized gains on fixed maturities 2,617 - - Short-term investments 179,907 98,925 42,633 --------- --------- --------- Total investment income $6,007,034 $4,317,227 $4,242,823 ========= ========= =========
Bad debt expense for the year ended December 31, 2006, and the year ended December 31, 2005, were $10,023 and $8,927, respectively. Premium finance notes receivable represent the balance due to the Company's premium finance subsidiary from policyholders who elect to finance their premiums over the policy term. These notes are net of unearned finance charges.
The Company's loss and loss adjustment expense reserves are as follows:
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Direct reserves Case reserves $21,796,117 $23,114,548 $19,699,000 IBNR reserves 71,800,000 78,800,000 67,770,000 ---------- ---------- ---------- Total direct reserves $93,596,117 $101,914,548 $87,469,000 ========== =========== ==========
The following table provides an analysis of the roll-forward of Crusader's losses and loss adjustment expenses, including a reconciliation of the ending balance sheet liability for the periods indicated:
2004 net losses and loss adjustment expenses of $35,286,172 and favorable development of prior accident years of $835,434.
NOTE 8 - LEASE COMMITMENT TO RELATED PARTY --------------------------------- The lease commitment provides for the following minimum annual rental commitments:
The Company presently occupies a 46,000 square foot office building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2012. Erwin Cheldin, the Company's president, chairman, and principal stockholder, is the owner of the building. The Company signed an extension to the lease with a 4% increase in rent effective April 1, 2007. The lease provides for an annual gross rent of $1,025,952 through March 31, 2007 and $1,066,990 from April 1, 2007 through March 31, 2012. In addition, the lease extension provides for two, five-year options with a rent increase of 5% for each option period. The Company believes that at the inception of the lease agreement and at each subsequent extension, the terms of the lease were at least as favorable to the Company as could have been obtained from non-affiliated third parties. The Company utilizes for its own operations approximately 100% of the space it leases. The total rent expense under this lease agreement was $1,025,952 for the year ended December 31, 2006; $1,025,952 for the year ended December 31, 2005; and $1,025,952 for the year ended December 31, 2004.
Premium payable $2,221,559 $2,494,285 Unearned claim administration income - 30,000 Profit sharing contributions 650,000 645,000 Accrued salaries 345,560 333,354 Commission payable 214,766 210,451 Other 60,997 195,331 --------- --------- Total accrued expenses and other liabilities $3,492,882 $3,908,421 ========= =========
Likewise, the Company is sometimes named as a cross-defendant in litigation, which is principally directed against an insurer who was issued a policy of insurance directly or indirectly through the Company. Incidental actions are sometimes brought by customers or others, which relate to disputes concerning the issuance or non-issuance of individual policies. These items are also handled on a routine basis by the Company's general counsel, and they do not materially affect the operations of the Company. Management is confident that the ultimate outcome of pending litigation should not have an adverse effect on the Company's consolidated operation or financial position.
The aggregate amount of earned premium ceded to the reinsurers was $13,758,424 for the year ended December 31, 2006, $14,234,844 for the year ended December 31, 2005, and $17,784,240 for the year ended December 31, 2004.
NOTE 12 - RETIREMENT PLANS ---------------- Profit Sharing Plan - ------------------- During the fiscal year ended March 31, 1986, the Company adopted the Unico American Corporation Profit Sharing Plan. Company employees who are at least 21 years of age and have been employed by the Company for at least two years are participants in such Plan. Pursuant to the terms of such Plan, the Company annually contributes for the account of each participant an amount equal to a percentage of the participant's eligible compensation as determined by the Board of Directors. Participants must be employed by the Company on the last day of the plan year to be eligible for contribution. Participants are entitled to receive distribution of benefits under the Plan upon retirement, termination of employment, death or disability.
Year ended December 31, 2006 $896,063 Year ended December 31, 2005 $867,532 Year ended December 31, 2004 $759,482
The insurance department also conducts periodic financial examinations of Crusader. The insurance department has completed its financial examination of Crusader's December 31, 2004, statutory financial statements. A final
In December 1993, the National Association of Insurance Commissioners (NAIC) adopted a Risk-Based Capital (RBC) Model Law for property and casualty companies. The RBC Model Law is intended to provide standards for calculating a variable regulatory capital requirement related to a company's current operations and its risk exposures (asset risk, underwriting risk, credit risk, and off-balance sheet risk). These standards are intended to serve as a diagnostic solvency tool for regulators that establishes uniform capital levels and specific authority levels for regulatory intervention when an insurer falls below minimum capital levels. The RBC Model Law specifies four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer if its RBC is equal to or less than 200% of its computed authorized control level RBC. A company's RBC is required to be disclosed in its statutory annual statement. The RBC is not intended to be used as a rating or ranking tool nor is it to be used in premium rate making or approval. Crusader's adjusted capital at December 31, 2006, was 624% of authorized control level risk-based capital.
Insurance Regulatory Information System (IRIS) was developed by a committee of state insurance regulators primarily to assist state insurance departments in executing their statutory mandate to oversee the financial
condition of insurance companies. IRIS helps those companies that merit highest priority in the allocation of the regulators' resources on the basis of 13 financial ratios that are calculated annually. The analytical phase is a review of annual statements and the financial ratios. The ratios and trends are valuable in pointing to companies likely to experience financial difficulties but are not themselves indicative of adverse financial condition. The ratio and benchmark comparisons are mechanically produced and are not intended to replace the state insurance department's own in-depth financial analysis or on-site examinations.
An unusual range of ratio results has been established from studies of the ratios of companies that have become insolvent or have experienced financial difficulties. In the analytical phase, companies that receive four or more financial ratio values outside the usual range are analyzed in order to identify those companies that appear to require immediate regulatory action. Subsequently, a more comprehensive review of the ratio results and an insurer's annual statement is performed to confirm that an insurer's situation calls for increased or close regulatory attention. In 2006, the Company was outside the usual values on one of the thirteen IRIS ratio tests. The ratio was the Net Change in Adjusted Policyholders' Surplus. This ratio compares the Company's ratio to an established minimum and maximum range of greater than 10% decrease in adjusted policyholders' surplus and less than 25% increase in adjusted policyholders' surplus. The Company's net change in adjusted policyholders' surplus ratio was an increase of 37%.
NOTE 14 - STOCK PLANS ----------- The Company's 1999 Omnibus Stock Plan that covers 500,000 shares of the Company's common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.) was approved by shareholders on June 4, 1999. On August 26, 1999, the Company granted 135,000 incentive stock options. As of December 31, 2006, 92,500 of those options were outstanding and exercisable, 2,500 options had been exercised, and 40,000 options had been terminated. These options expire 10 years from the date of the grant.
On December 18, 2002, the Company granted 182,000 incentive stock options under the Company's 1999 Omnibus Stock Plan. On December 30, 2005, the Company accelerated the vesting of 37,500 options that were originally schedule to vest on January 1, 2006, and 30,000 options that were originally schedule to vest on January 1, 2007 (see Note 1). As of December 31, 2006, 79,750 of those options were outstanding and exercisable, 99,750 options had been exercised and 2,500 options had been terminated. These options expire 10 years from the date of the grant.
Options exercisable were 172,250 at December 31, 2006, at a weighted average exercise price of $6.407; 268,000 at December 31, 2005, at a weighted average exercise price of $5.286; 149,500 at December 31, 2004, at a weighted average exercise price of $7.01. Aggregate intrinsic value of outstanding and currently exercisable options at December 31, 2006 was $1,149,383.
NOTE 15 - TAXES ON INCOME --------------- The provision for taxes on income consists of the following:
Year ended December 31 ---------------------- 2006 2005 2004 ---- ---- ---- Current provision: Federal $6,137,538 $3,319,904 $2,947,668 State 11,537 142,923 64,400 --------- --------- --------- Total federal and state 6,149,075 3,462,827 3,012,068 Deferred 210,670 288,599 (21,110) --------- --------- --------- Provision for taxes $6,359,745 $3,751,426 $2,990,958 ========= ========= =========
The income tax provision reflected in the consolidated statements of operations is different than the expected federal income tax on income as shown in the table below:
NOTE 16 - REPURCHASE OF COMMON STOCK - EFFECT ON STOCKHOLDERS' EQUITY ----------------------------------------------------------- The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company. During the year ended December 31, 2006, the Company did not purchase any shares of the Company's common stock. As of December 31, 2006, the Company had purchased and retired under the Board of Directors' authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.
NOTE 18 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) -------------------------------------------- Summarized unaudited quarterly financial data for each of the calendar years 2006 and 2005 is set forth below: