We currently lease approximately 15,000 square feet of office space at 360 Central Avenue, Suite 900, St. Petersburg, Florida 33701. We make rent payments of $21.50 per square foot with increases each year through the final year, in which we will pay rent of $26.16 per square foot, plus our percentage of increase in the common area maintenance charge. This lease expires July 2014 with two five-year renewal options. We consider our current office facility suitable for our business as it is presently conducted. We do not own any real estate or other physical properties. Our facility is in good condition.
We currently have independent agents to write policies for us (which we refer to as “direct” policies) and we assume policies from Citizens (which we refer to as “take-out” policies). In 2004, we entered into an agreement with Citizens to assume policies from Citizens and in 2008, we collected and recognized as revenue $6.5 million of bonuses related to the policies that we assumed in 2004 and 2005. During August of 2008, we entered into a new agreement with Citizens to assume additional policies from Citizens and we assumed approximately 7,000 additional policies from Citizens during the fourth quarter of 2008. In February 2009, we assumed 2,200 policies from Citizens and do not anticipate assuming any additional policies from Citizens until October or December 2009. Our current assumption agreement with Citizens does not have a bonus associated with it; therefore, we do not expect to record any additional policy assumption bonuses during 2009.
During 2008, we recorded an estimated loss and LAE for Tropical Storm Fay (“T.S. Fay”) of $3.3 million during 2008 of which $2.2 million was paid at December 31, 2008. During 2008, we also increased our loss and LAE reserves and our reinsurance recoverables by $6.5 million for reinsured claims related to Hurricane Wilma which occurred in 2005. We increased our estimate for loss and LAE related to Hurricane Wilma as we are experiencing unfavorable loss development from Hurricane Wilma due to re-opened claims and new claims being submitted from policyholders as a result of public adjusters encouraging policyholders to file new claims. During 2008, we reduced our incurred but not reported claim (“IBNR”) loss and LAE reserves for non-ceded claims by $2.4 million, due to the favorable loss development related to prior accident years. Claims originating in prior accident years are another year older; therefore, most losses and LAE have been reported and in many cases paid.
We accounted for the Merger as a reverse acquisition and recapitalization since UIH was deemed to be the acquirer for accounting purposes. Accordingly, our historical consolidated financial statements reflect the assets, liabilities and operations of UIH prior to the Merger date, recorded on a historical cost basis. We then recorded UIHC’s (formerly FMG’s) assets and liabilities at their fair value on the date of the Merger.
On our Consolidated Statements of Income, we retroactively restated EPS for periods prior to the Merger. Since the consideration paid in the Merger transaction was cash and common stock, the shares outstanding at the time the Merger was effective were deemed to be the historical shares outstanding prior to the Merger.
Prior to September 30, 2008, some of our subsidiaries had elected to be treated as a partnership for income tax purposes. Accordingly, the income taxes related to these subsidiaries are not reflected in our consolidated financial statements for the periods prior to September 30, 2008. On the Consolidated Statements of Income, the pro forma computation of income tax for the years ended 2008, 2007 and 2006, represents the tax effects that would have been reported had all our subsidiaries been subject to corporate U.S. federal and state income taxes for all periods presented. See Note 12 to our consolidated financial statements for further discussion.
On August 15, 2008, in a transaction related to the Merger, we entered into a note purchase agreement with five noteholders. The issuance of any notes under this agreement was contingent upon our stockholders voting for the Merger which occurred on September 29, 2008. We then issued unsecured notes payable with a total face amount of $18.3 million. In exchange, we received $10 million cash from certain accredited investors and 869,565 shares of our common stock, valued at $6.9 million at the time the notes were issued, from two of our former stockholders. We recorded a discount on these notes of $1.4 million which will be amortized to interest expense over the three-year term. See Note 11 to our consolidated financial statements for a further discussion.
FMG Investors, LLC (“FMGI”) surrendered 179,819 shares of UIHC common stock it owned. No consideration was paid for these surrendered shares and the shares were cancelled. FMGI also surrendered 179,819 of the common stock purchase warrants it owned.
The following is a description of the most significant risks facing us and how we attempt to mitigate those risks:
i) LEGAL/REGULATORY RISK - the risk that changes in the regulatory environment in which we operate could create additional expenses not anticipated by us in pricing our products. That is, regulatory initiatives designed to reduce our profits, restrict underwriting practices and risk classifications, or mandate rate reductions and refunds could create costs for us beyond those recorded in our consolidated financial statements, as could new legal theories or insurance company insolvencies (through guaranty fund assessments). We attempt to mitigate this risk by monitoring proposed regulatory legislation and by assessing the impact of new laws. As we write business only in the State of Florida, we are more exposed to this risk than more geographically-balanced companies. At December 31, 2008, we were in compliance with all regulatory requirements.
The homeowner and dwelling lines of business that constitute the majority of the business written by us are known in the insurance industry as “short-tailed” lines of business. A “short-tailed” line of business is one in which claims are reported and settled quickly following the occurrence of a loss. Consequently, standard actuarial reserve estimating techniques work well to estimate our loss and LAE reserve.
Reserves for reported losses and LAE - When a claim is reported, we establish a case reserve that represents the initial estimate of the losses and LAE that will ultimately be paid on the reported claim. We primarily base the amount of the initial reserve on an evaluation of the type of claim involved, the circumstances surrounding each claim and the policy provisions relating to the loss. Our initial estimate reflects the informed judgment of our claims personnel based on general insurance reserving practices and on the experience and knowledge of our claims personnel. In addition, we set minimum reserves based upon averages of loss and LAE payments made on prior closed claims by claim type. As claims mature, we increase or decrease the initial estimates as deemed necessary by our Claims Department based upon additional information regarding the loss, the results of on-site reviews and any other information we gather while reviewing the claims.
Reserves for IBNR - We determine IBNR reserves by calculating the ultimate losses and LAE as projected using the methods discussed below and then deducting actual loss and LAE payments and case reserves from the projected ultimate losses and LAE. We review and adjust our IBNR reserves on a monthly basis based on information available to us at the balance sheet date.
On an annual basis, our independent actuary provides a Statement of Actuarial Opinion (“SAO”) that indicates the actuaries’ estimate of a reasonable provision for all of our unpaid loss and LAE obligations under the terms of our policies. We review the SAO and compare the projected ultimate losses and LAE per the SAO to our own projection of ultimate losses and LAE to ensure that loss and LAE reserves recorded at each annual balance sheet date are based upon our analysis of all internal and external factors related to known and unknown claims against us and to ensure that our reserves are within NAIC guidelines. We compare our recorded reserves to the indicated range provided in the report accompanying the SAO. If our recorded amount falls within the indicated range determined by the actuaries, we may or may not record an adjustment. Also on a quarterly basis, our independent actuary performs loss reviews to assist us in determining the reasonableness of our quarterly loss reserves.
Our independent actuary uses all of the following actuarial models to calculate our ultimate loss reserves in their SAO. There were no changes in the models used by our independent actuaries during the three-year period ended December 31, 2008.
Incurred Loss Development - Under this version of the Loss Development model, ultimate losses are estimated based on the historical development patterns of incurred losses by accident year. Incurred losses are defined as paid losses plus case reserves.
The Bornhuetter-Ferguson models are generally more stable than the incurred and paid development models, but this relative strength comes at the cost of less responsiveness to real changes in loss experience.
Mathematically, the Bornhuetter-Ferguson model reduces to a weighted average of the Incurred Loss Development model and a method known as the Expected Loss model, with a weight equal to the percentage of expected emerged losses given to the Development model and the Expected Loss model given the percentage of expected un-emerged losses.
We cede a portion of our business to reinsurance companies. This allows us to be reimbursed for the portion of claims we pay that are ceded to reinsurance companies. We record reinsurance recoverable for the estimated paid and unpaid portion of losses and LAE we have ceded. We use the same estimation techniques to estimate the reinsurance recoverable for unpaid ceded claims as we use in establishing our loss and LAE reserves.
Reinsurance recoverable represents our best estimate of the amount of losses and LAE we will ultimately be able to recover from our reinsurers. The process of establishing our unpaid losses and LAE is complex and necessarily imprecise, as it involves using judgment that is affected by many variables in determining our loss and LAE estimates. Due to the uncertain nature of any projection of the future, including the estimation of loss and LAE reserves, the ultimate loss and LAE amounts we recover from our reinsurers may be different from the recorded reinsurance recoverable.
We defer commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of insurance contracts. The policy acquisition costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, anticipated losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Judgments as to ultimate recoverability of our deferred policy acquisition costs are highly dependent upon our estimated future loss and LAE associated with the written premiums. See the Loss and LAE Reserve critical accounting policy discussion above for the estimation techniques used to determine the Loss and LAE reserves.
See Note 3 to our consolidated financial statements for all of the recent accounting pronouncements and the impact the accounting pronouncements may have on our financial statements.
All of our investments are held as available-for-sale. Our investments at December 31, 2008, consist mainly of high-quality money market instruments, securities of the United States government and its agencies and securities of high-quality corporate issuers. The corporate bonds we hold are substantially all in the conglomerate, energy and technology/telecommunications industries, with no material holdings in the financial industry. More than 86% of our fixed-maturity securities are U.S. Treasuries or corporate bonds rated “A” or better; the remaining percentage are corporate bonds rated “BBB”. The equity holdings reflect a similar diversification, with most of our holdings being in the energy, healthcare, industrial and technology sectors. At year end, approximately 0.1% of our equity holdings compared to total investments are in the financial sector. See Note 5 to our consolidated financial statements for the fair value disclosure in accordance with SFAS No. 157 related to these investments. The $0.3 million other long-term investments at December 31, 2008, are invested in a certificate of deposit to secure the payment of our claims as required by the State of Florida. This certificate of deposit automatically renews every twelve months.
Our total investments increased $12.4 million, or 10.9%, to $126.2 million at December 31, 2008, compared to $113.8 million at December 31, 2007. During 2008, we made net purchases totaling $16.2 million of investments available for sale using funds generated from our operations during the year. This $16.2 million increase in our investment portfolio was offset primarily by a decrease of $3.6 million in the fair market value of our investment portfolio during 2008. The $3.6 million was recorded as an unrealized loss and the total unrealized losses we have recorded at December 31, 2008 is $2.4 million. The $3.6 million unrealized losses during 2008 are primarily related to a decrease in the fair market value of our corporate bond portfolio.
Our gross premiums written decreased $3.5 million, or 2.4%, to $141.6 million for 2008, from $145.1 million for 2007. The decrease of $3.5 million is due to a decrease of approximately $44.7 million resulting from wind mitigation credits for new, existing, cancelled and non-renewed polices. The decrease was offset by an increase of approximately $32.4 million primarily due from new business, endorsements and coverage increases. In addition, we had an increase in gross written premiums of $3.1 million from flood and non-homeowner policies and an increase of $5.7 million from the approximately 7,000 policies assumed from Citizens
During the fourth quarter of 2007, we began to implement a new wind mitigation credit enacted by the Florida Legislature. The wind mitigation credits were implemented to encourage homeowners to improve the ability of residential structures to withstand hurricane force winds. New construction must meet stronger building codes, and existing homes are eligible for premium credits through an inspection program that allows homeowners to determine how their homes may be upgraded to mitigate storm damage. According to the State of Florida, these wind mitigation credits result from a home’s reduced vulnerability to hurricane losses. Our underwriting and profitability models take into account these premium credits, which ultimately reduce our average premium per policy when compared to prior years. The full effect of the wind mitigation credits as a decrease to gross premiums written was reflected through all of our in-force-policies by November 30, 2008.
Our average premium per policy decreased from $2,260 at December 31, 2007 to $1,705 at December 31, 2008. The decrease in the average premium per policy of $555 is due mainly to the new wind mitigation credits the OIR required all property and casualty insurance companies to implement. In addition, we had a decrease in policies written in the Tri-County area (Dade, Broward and Palm Beach Counties) and an increase in policies written in other locations in Florida that have a lower average premium per policy.
Net premiums earned decreased $4.2 million, or 4.9%, to $81.1 million for 2008, compared to $85.3 million for 2007. The decrease in net premiums earned is due primarily to the decreases in gross written premium as discussed above.
Net investment income decreased $1.1 million, or 14.4%, to $6.6 million for 2008, compared to $7.7 million for 2007. The lower net investment income is due mainly to a reduction of $0.9 million in interest income on our cash and cash equivalents portfolio. During 2008, on average we had invested $37.7 million in cash and cash equivalents; however, during 2007, on average we had invested $48.4 million in cash and cash equivalents. This lower average cash and cash equivalents invested during 2008 compared to 2007 resulted in lower net investment income. Also, the rates earned on our cash and cash equivalent portfolio were lower during 2008 compared to 2007 contributing to the lower net investment income during 2008 compared to 2007 as well.
Net realized investment gains increased $0.8 million during 2008, compared to 2007. The table below depicts the gains and losses by investment category.
We received a bonus from Citizens for retaining policies we assumed during 2004 and 2005 for three years from the date of the policy assumption and for charging rates similar to Citizens at the date of the assumption. The policy assumption bonus, which includes interest income earned on the bonus amounts, decreased to $6.5 million during 2008 compared to $13.6 million during 2007. The decrease resulted because we collected bonuses on approximately 19,100 policies during 2008, compared to our collection of bonus on approximately 38,600 policies during 2007.
At December 31, 2008, we have earned the entire bonus related to policies we assumed from Citizens in 2004 and 2005. Since the new agreement we entered into with Citizens in August 2008 does not have a bonus provision, we will not receive any bonuses related to assumed policies during 2008 or thereafter.
During 2008, we recorded net loss and LAE of $28 million which is comprised of $3.3 million net incurred for Tropical Storm Fay of which $2.2 million was paid as of year-end, $21.5 million of incurred non-catastrophe losses and $3.2 million of incurred non-catastrophe LAE. We also incurred $1 million of in-house claims administration expenses that are included in several line items on our Consolidated Income Statement.
During 2007, we recorded net loss and LAE of $25.7 million which is comprised of $22.2 million of incurred non-catastrophe losses and $3.5 million of incurred non-catastrophe LAE. We also incurred $0.6 million of in-house claims administration expenses that are included in several line items on our Consolidated Income Statement.
Our reinsurance requirements and costs are based on an amount equal to our estimated 100-year probable maximum loss (“PML”). We analyze our PML on a regular basis through the use of our licensed in-house catastrophe-modeling software program. Our underwriting policies and procedures seek to minimize risk of loss while maximizing premium through the optimization of geographic exposure and the diversification of the portfolio with respect to our PML. The continued focus on disciplined underwriting and procedures to optimize our geographic exposure enables us to maximum our premiums to the risks associated with those premiums.
For homeowner non-catastrophe claims, we maintain a very simple reinsurance structure consisting of only one contract, an excess of loss reinsurance contract. We have never experienced a non-catastrophic loss that required reimbursement through our excess of loss reinsurance contract.
During 2008 there were no hurricanes; however, we increased our losses and LAE reserves related to Hurricane Wilma which occurred in 2005. This increase in reserves did not have an impact on our loss and LAE recorded on our Consolidated Statements of Income, since 100% of these claims are ceded. If we have an increase in our estimated losses and LAE reserves in 2009 relating to the 2004 and 2005 hurricane claims, we do not anticipate that the increase in reserves will have an impact on our loss and LAE recorded on our Consolidated Statements of Income for 2009.
There are inherent difficulties in estimating risks that impact the estimation of our ultimate losses and LAE for catastrophes. These difficulties also affect our ability to estimate reserves for catastrophes. The estimation of reserves related to hurricanes can be affected by the inability to access portions of the impacted areas, the complexity of factors contributing to the losses, the legal and regulatory uncertainties and the nature of the information available to establish the reserves. Complex factors include, but are not limited to, determining whether damage was caused by flooding versus wind; evaluating general liability and pollution exposures; estimating additional living expenses; the impact of demand surge; infrastructure disruption; fraud; the effect of mold damage; business interruption costs; and reinsurance collectibility. The timing of a catastrophe’s occurrence, such as at or near the end of a reporting period, can also affect the information available to us in estimating reserves for that reporting period. The estimates related to catastrophes are adjusted as actual claims emerge and additional information becomes available. Because of the inherent uncertainty in estimating reserves for catastrophes, we cannot be sure our ultimate losses and loss adjustment expenses will not exceed our reserves. If and to the extent our reserves are inadequate, we will be required to increase our reserves for losses and loss adjustment expenses and incur a charge to earnings in the period during which our reserves are increased, which could materially and adversely affect our financial condition and results of operations.
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 received regarding various factors, including: (i) per claim information; (ii) our 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. We revise our estimate based on the results of our 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. We have received an actuary’s opinion as to the adequacy of our reserves. Except for catastrophe claims, we believe the severity and frequency of claims will remain relatively stable for the foreseeable future.
During 2008, we contracted with CSC to become our new third-party administrator and to perform all of the services currently provided by our former third-party administrators (“TPA’s”). We believe that CSC provides us superior resources and is more capable of supporting our future growth objectives. During 2009, we will transition all of our in-force polices, excluding Garage policies, from our former TPA to CSC as each policy comes due. All new policies, excluding Garage and flood policies, written during 2009 will be administered by CSC.
Salaries and wages increased $0.7 million, to $3.5 million during 2008 from $2.8 million during 2007. This increase is due primarily to the additional personnel we added in 2008, specifically in our marketing and finance areas. During 2009, we anticipate adding additional personnel.
We extinguished our note payable to York Enhanced Strategies Fund, LLC (“York”) during the first quarter of 2007, which accelerated the amortization of the participation fee of $1.1 million and original issue discount of $0.7 million related to the York note; $0.3 million of interest was also recognized in the first quarter of 2007 prior to the extinguishment.
Interest expense related to the State Board of Administration of Florida (“SBA”) note increased by $0.5 million because our Minimum Writing Ratio fell below 1.5:1 at December 31, 2007, March 31, 2008 and June 30, 2008; therefore, we were assessed a 450 basis point interest penalty during the first, second and third quarters of 2008. See Note 11 to our consolidated financial statements for more information regarding interest expense related to the SBA note and the amendment to the SBA note which was effective July 1, 2008. For the fourth quarter of 2008, we did not incur any additional interest penalties and we will not incur any additional penalties during the first quarter of 2009.
The decrease in our gross premiums written is attributable to several factors. Specifically, the OIR approved an average 55% rate increase for us that became effective in September 2006. In addition, the Florida legislature passed a bill in early 2007 that froze the rates Citizens, Florida’s state-run insurer and a competitor of ours, was permitted to charge. Also, several new competitors entered the marketplace in 2007 with lower rates than ours. We believe many of these new companies are offering rates which are inadequate to support their operations in the long term. Additionally, we began
Net unearned premiums increased $1.2 million for 2007, as compared to a decrease of $2.7 million for 2006. The change was primarily due to a decrease in gross written homeowner and dwelling fire insurance premiums during 2007.
Net premiums earned increased $11.8 million, or 15.9%, to $85.4 million for 2007, as compared to $73.6 million for 2006. Our reduced reinsurance costs (ceded premium) were the main cause of the increase in net premiums earned.
We received a bonus from Citizens for retaining policies we assumed during 2004 and 2005 for three years. The policy assumption bonus, which includes interest income earned on the bonus amounts, increased to $13.6 million for 2007, as compared to zero for 2006. Since we must meet certain requirements to collect the bonus from policy assumptions made from Citizens, such as offering the assumed policies for renewal for three years, we recognize the policy assumption bonus when the cash is collected. We recognized $12.3 million of the bonus plus $1.3 million of associated interest during 2007, which was the first year we were eligible to collect any of the bonus, resulting in the increase over the prior year.
Other revenue increased $2.8 million, or 710%, to $3.2 million for 2007, as compared to $0.4 million for 2006. All Florida insurers, including UPCIC, are subject to assessments by the Florida Insurance Guaranty Association and Citizens. Florida law allows assessed insurers to recoup the assessments from their policyholders. We recognize these assessments as expenses when they are paid to FIGA or Citizens, and when we collect the assessments from policyholders, we recognize the income. Our collections of assessments increased by $2.8 million in 2007, mainly, because we were assessed approximately $5 million in 2006 and $3.1 million in 2007. Since there is typically a lag between when we pay the assessment and when we recover the assessment, we recovered $3.0 million during 2007 compared to $0.2 million of assessments during 2006.
The amount of assessments imposed by FIGA can vary on a year to year basis, but are capped at two percent of our gross written premium. Moreover, even if assessments and recoupments do offset each other, they may not offset each other in the same fiscal period due to the ultimate timing of the assessments and recoupments.
insured losses and loss adjustment expenses that have occurred at or before the balance sheet date for amounts we estimate will be required to be paid in the future. We revise our loss estimate based upon our analysis of estimated future payments to be made. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events.
The incurred losses and LAE related to prior accident years decreased from a $0.7 million reserve release in 2006 to a $5.8 million reserve release in 2007. The $5.8 million decrease in the incurred losses and LAE related to prior accident years is comprised of a $7.9 million reduction in IBNR reserves which was offset by $2.1 million in additional incurred as it related to case reserves. The $7.9 million reduction in IBNR reserves reflects the favorable loss development of our main line of business. The assumptions and factors used to determine our reserves for prior accident years at December 31, 2007 did not materially change from those used at December 31, 2006. Claims originating in prior accident years are another year older; therefore, most losses and LAE has been incurred and, in many cases, paid on those claims and significantly less additional IBNR is expected on those claims than was expected at December 31, 2006. The $2.1 million of additional incurred as it related to case reserves was due to various water related claims of $1.4 million and additional liability claims for bodily injury of $0.7 million.
Salaries and wages increased $0.5 million, or 19.1%, to $2.8 million for 2007, as compared to $2.3 million for 2006. During 2007, we hired additional personnel, which increased our salary and wage expenses. Our costs for salaries and wages are consistent with our policy of hiring and retaining top-quality personnel and increasing our premium production.
General and administrative expenses increased $0.9 million or 66.9% to $2.1 million for 2007 as compared to $1.2 million for 2006. Increases of $0.3 million of actuarial services, $0.2 million of legal fees and $0.4 million of other general and administrative expenses caused the increase in our general and administrative expenses.
See our Consolidated Statements of Income for a pro forma calculation of the estimated corporate income taxes we would have recorded for 2007 and 2006 if all of our subsidiaries had recorded corporate income taxes at the beginning of 2006.
Our operations provided net operating cash flow of $38.9 million during 2008 compared to $18.2 million during 2007. Our reconciliation of net income to net cash provided by operations is generally influenced by the collection of premiums in advance of paid losses, the quarterly payment of reinsurance premiums and the annual signing of new reinsurance contracts at the beginning of hurricane season, and the timing of our loss payments.
During 2008 and 2007, we received policy assumption bonuses of $6.5 million and $13.6 million, respectively. These bonuses were related to policies we assumed from Citizens during 2004 and 2005 and which we retained for three years. Our current policy assumption agreement with Citizens does not have a provision for bonus payments; therefore, we do not expect to receive any additional cash from Citizens for bonus payments during 2009.
We are not required to pay any principal on our $20 million SBA note until October 1, 2009, at which time the Florida Insurance Commissioner will approve any principal payments and determine if such payment substantially impairs the financial condition of our insurance subsidiary. During 2009, upon OIR approval, the principal payments on our SBA note are expected to be $0.3 million. On November 7, 2008, we amended our SBA note effective July 1, 2008. The Writing Ratio calculation and criteria were amended as discussed in Note 11(a) of our consolidated financial statements. We met the Writing Ratio at December 31, 2008, thus, our first quarter 2009 interest rate on our SBA loan will be the stated rate which is the rate-equivalent to the 10-year Treasury Bond rate and will not include any interest penalties. We pay interest on this loan quarterly.
We believe we maintain sufficient liquidity to pay claims, operating expenses and other obligations as they come due. At December 31, 2008, we had $31.7 million of cash and cash equivalents. We monitor our expected loss and LAE payment needs and maintain a sufficient portion of our assets in cash and cash equivalents to enable us to fund our expected claim payments without having to sell longer-duration investments. As necessary, we adjust our short-term investments and cash and cash equivalents holdings to provide sufficient liquidity to respond to changes in the anticipated pattern of claims payments.
In relation to the Merger Notes issued on September 29, 2008 pursuant to a note repurchase agreement dated as of August 15, 2008, we agreed to certain covenants, the violation of which could cause an event of default. Among others, these covenants include refraining from incurring debt that would cause our aggregate debt balance, including the $18.3 million incurred under this note agreement, to exceed $58.3 million (excluding the SBA note amount), and refraining from making any payments (e.g., dividends or distributions), whether in cash, securities or other property, that would reduce consolidated net worth, as defined in the note agreement, to less than $45 million. We were in compliance with the terms of the covenants at December 31, 2008; however, since our consolidated net worth at December 31, 2008 was less than $45 million, we could not make any dividends or distributions to our stockholders.
The SBA note provides the SBA may, among other things, declare its loan immediately due and payable for all defaults existing under the SBA note. In addition, the CB&T loan agreement provides CB&T may elect to exercise its remedies described above for events of default under any loan agreements affecting us or our subsidiaries. We are not currently in default of these notes; however, if we were in default and either lender elected to pursue these default remedies, it would reduce our surplus and could adversely affect our liquidity.
To enhance the regulation of insurer solvency, the NAIC established risk-based capital requirements for insurance companies that are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. These requirements measure three major areas of risk facing property and casualty insurers: (i) underwriting risks, which encompass the risk of adverse loss developments and inadequate pricing; (ii) declines in asset values arising from credit risk; and (iii) other business risks from investments. Insurers having less statutory surplus than required will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The OIR, which follows these requirements, could require us to cease operations in the event we fail to maintain the statutory capital required by the OIR. UPCIC is in compliance with the risk-based capital requirement at December 31, 2008.
PRIVATE COMPANIES PRACTICE SECTION; TAX DIVISION • FLORIDA INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS • INSTITUTE OF BUSINESS APPRAISERS
On September 30, 2008, United Insurance Holdings Corp. (“UIHC”), formerly known as FMG Acquisition Corp. (“FMG”) acquired United Insurance Holdings, L.C. (“UIH”). We accounted for the transaction as a reverse acquisition and recapitalization since UIH was deemed to be the accounting acquirer. Accordingly, the Consolidated Statements of Cash Flows do not reflect certain transactions that occurred during 2008 prior to the effective date of the Merger. Such transactions include:
We paid cash of $15,740, pursuant to the stock purchase agreement, to repurchase 1,980,671 shares of our common stock on September 29, 2008.
FMG Investors, LLC (“FMGI”) surrendered 179,819 shares of UIHC common stock it owned. No consideration was paid for these surrendered shares and the shares were cancelled. FMGI also surrendered 179,819 of the common stock warrants that it owned. See Note 16 for a further discussion of FMGI being a related party to UIHC.
The underwriter for our IPO surrendered 100,000 of the 450,000 unit purchase options it owned. They also agreed to accelerate the expiration date of their remaining 350,000 unit purchase options to October 4, 2010. Each unit purchase option consists of a share of common stock and a warrant to purchase a share of common stock. The unit purchase options are exercisable beginning October 4, 2008, at an exercise price of $10.00 per unit.
United Insurance Holdings Corp. (“UIHC”, “we”, “our”, the “Company”), formerly known as FMG Acquisition Corp. (“FMG”), was formed under the laws of the State of Delaware in 2007 as a blank-check company. We were formed specifically as a vehicle to effect a merger, acquisition or similar business combination with one operating business, with efforts focused on seeking a business combination within the insurance industry. We consummated our initial public offering (“IPO”) on October 11, 2007. On September 30, 2008, we completed a merger pursuant to the Amended and Restated Agreement and Plan of Merger, dated August 15, 2008, as amended on September 23, 2008, by and among UIHC, United Subsidiary Corp. (“Merger Sub”), a Florida corporation, and our wholly-owned subsidiary, and United Insurance Holdings, L.C. (“UIH”), a Florida limited liability company, whereby Merger Sub was merged into UIH, with UIH remaining as the surviving entity (the “Merger”). In connection with the Merger, we changed our name from FMG Acquisition Corp. to United Insurance Holdings Corp. Our certificate of incorporation in Delaware has been amended to reflect our new status as a holding company.
UPCIC was formed in 1999 under the laws of the State of Florida and is authorized by the Florida Office of Insurance Regulation (“OIR”) to underwrite homeowner and dwelling property and casualty lines. We write our own policies throughout the State of Florida utilizing our vast, independent agency network. We occasionally supplement those writings by assuming policies from Citizens Property Insurance Corporation (“Citizens”). The OIR has also authorized UPCIC to write flood coverage and a smaller commercial auto (“Garage”) line of business.
Our consolidated financial statements include our accounts and the accounts of our subsidiaries. All significant intercompany balances and transactions have been eliminated.
We accounted for the Merger as a reverse acquisition and recapitalization since UIH was deemed to be the acquirer for accounting purposes. Accordingly, our historical consolidated financial statements reflect the assets, liabilities and operations of UIH prior to the Merger date, recorded on a historical cost basis. We then recorded and consolidated UIHC’s (formerly FMG’s) assets and liabilities at their fair value on the date of the Merger.
We estimate the fair value of our investments using the closing prices on the last business day of the reporting period, obtained from active markets such as the NYSE, NASDAQ, AMEX, etc. For securities for which quoted prices in active markets are unavailable, we use observable inputs such as quoted prices in inactive markets, quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs. We do not have any investments in our portfolio which require us to use unobservable inputs. Our estimates of fair value are reflective of the interest rate environment that existed as of the close of business on December 31, 2008 and 2007. Changes in interest rates subsequent to December 31, 2008, may affect the fair value of our investments. See Note 2(l) for discussion of our policy regarding fair value measurements.
We incur policy acquisition costs that vary with, and are directly related to, the production of new business. Policy acquisition costs consist primarily of the following three items: i) commissions paid to outside agents at the time of policy issuance and commissions paid to Citizens for policies assumed, net of commissions refunded for cancelled policies; ii) policy administration fees paid to a third-party administrator (“TPA”) at the time of policy issuance; and iii) premium tax. We capitalize policy acquisition costs, net of related ceding commissions and unearned policy fees, to the extent recoverable, in accordance with SFAS No. 60, Accounting and Reporting by Insurance Enterprises. We amortize the policy acquisition costs over the period during which we earn the related premiums. The accounting for policy fees and ceding commissions is described in Notes 2(i) and 2(j), respectively.
We record our property and equipment at cost less accumulated depreciation and amortization. We use the straight-line method of calculating depreciation over the estimated useful lives of the assets, which are three to five years. We also use the straight-line method to calculate amortization of leasehold improvements over the estimated useful lives of the assets or the term of the lease, whichever is shorter. We periodically review estimated useful lives and, where appropriate, we make changes prospectively. We charge maintenance and repair costs to expense as incurred.
We capitalize certain direct development costs associated with internal-use software. We amortize the capitalized software costs over the contract term of six years, which is the minimum period of time we expect the software to be useful to us.
On our Consolidated Balance Sheets, we report our reserves for unpaid losses and LAE gross of the amounts recoverable from reinsurers related to unpaid losses and LAE. On our Consolidated Statements of Income, we report losses and LAE net of amounts ceded to reinsurers. We do not discount our loss and LAE reserves for financial statement purposes.
We estimate amounts recoverable from reinsurers in a manner consistent with our estimation of reserves for unpaid losses and LAE associated with the reinsured policies. We estimate uncollectible amounts receivable from reinsurers based on an assessment of factors including the creditworthiness of the reinsurers and the adequacy of collateral obtained, where applicable. We recorded no allowance for uncollectible reinsurance at December 31, 2008, 2007 or 2006.
Certain of our reinsurers pay us ceding commissions on our quota share contracts related to the portion of our Garage line that we cede to them. We record our ceding commissions as income on a pro rata basis over 12 months, and we report the amount in Commissions and fees on our Consolidated Statements of Income. Additionally, we pay commissions to Citizens for any policies that we assume. We amortize our assumed commissions on a pro rata basis over 12 months, recording the amount as an expense in Policy acquisition costs on our Consolidated Statements of Income.
We record guaranty fund and other insurance-related assessments in accordance with Statement of Position (“SOP”) 97-3, Accounting by Insurance and Other Enterprises for Insurance-Related Assessments. We record assessments imposed upon us as an expense in the period the regulatory agency imposes the assessment. To recover the assessment, the OIR provides us with an immediate rate increase in the amount of the assessment. We then record the recoveries as revenue in the period that we record the policies containing the approved rate increase.
Prior to September 30, 2008, UIH had elected to be treated as a partnership for income tax purposes (UPCIC was taxed as a C-corporation from its inception). The taxable income and all tax credits of UIH and its two limited liability company subsidiaries, UIM and Skyway, were reportable by the entities’ members on their individual tax returns.
In accordance with SFAS No. 128, Earnings per Share, we compute basic earnings per share (“EPS”) by dividing net income by the weighted-average number of common stock shares outstanding during the period. We compute diluted EPS by dividing net income by the weighted-average number of common stock shares and common stock equivalents outstanding during the period. We compute common stock equivalents using the treasury stock method, which assumes shares of common stock are issued upon the exercise of warrants that are “in the money” and that the proceeds thereof are used to purchase shares of common stock at the average market price during the period.
Since we currently operate only in Florida, we are subject to a geographic concentration of credit risk. We are also subject to a group concentration of credit risk with regard to our reinsurance recoverable, since all of our reinsurers are engaged in similar activities and have similar economic characteristics that could cause their ability to repay us to be similarly affected by changes in economic or other conditions. We mitigate both risks by reinsuring a portion of our business only with financially-stable reinsurers, and by securing irrevocable letters of credit from reinsurers when necessary.
At December 31, 2008 and 2007, we did not have a stock-based employee compensation plan. Prior to the Merger, however, UIH’s Board granted UIH membership units to key personnel in 2007 and 2006. All grants were valued at fair market value in accordance with the SFAS No. 123(R), Share-Based Payment (see Note 17 for additional information).
Since we acquired the operations of UIH in the Merger, we are no longer a developmental-stage company.
To prepare our financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”), we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Accordingly, actual results could differ from those estimates.
In October 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (“FSP 157-3”). In FSP 157-3, the FASB clarifies the application of SFAS No. 157 when the market for that financial asset is not active. FSP 157-3 was effective upon issuance and applies to financial assets within the scope of accounting pronouncements that require or permit fair value measurements in accordance with SFAS No. 157. The adoption of FSP 157-3 had no material effect on our consolidated financial statements.
On January 1, 2008, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities- Including an Amendment of SFAS No. 115 (“SFAS No. 159”). SFAS No. 159 provides a choice to measure many financial instruments and certain other items at fair value on specified election dates and requires disclosures about the election of the fair value option. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. We have chosen not to elect the fair value option for any financial or non-financial instruments as of the adoption date, thus our adoption of SFAS No. 159 did not have an impact on our consolidated financial statements.
Since the transaction costs did not exceed the $25,000 cash received in the transaction, we recorded the $2,891 of transaction costs associated with the Merger as a reduction of Additional paid-in-capital on our Consolidated Balance Sheets.
In the first quarter of 2008, we sold one of our investments in common stock back to the issuing company, a related party known as Prime Holdings Insurance Services, Inc. (“Prime”), in exchange for a note receivable in the amount of $1,133. The deferred gain at the time of the sale was $133. The note is payable to us in three annual installments, the first of which we received on May 1, 2008. We recognized $45 of gain when we received the first installment, and we recorded the remaining $88 as deferred revenue at December 31, 2008. See Note 16 for a discussion of all related party transactions.
The following table details the change in the difference between cost or amortized cost and estimated fair value, by major investment category, at December 31, 2008 and 2007:
The investments held at the end of the year were comprised mainly of high-quality money market instruments, securities of the United States government and its agencies, and securities of high-quality corporate issuers.
The SFAS No. 157 fair value hierarchy prioritizes fair value measurements into one of three levels based on the nature of the inputs, as follows:
The State of Florida, by statute, requires us to maintain a deposit to secure the payment of claims. We have assigned a twelve-month, automatically renewing certificate of deposit in the amount of $300 to the OIR to satisfy this requirement. This amount is included in Other long-term investments in the accompanying Consolidated Balance Sheets at December 31, 2008 and 2007.
We have a unit purchase option outstanding for 350,000 units; each unit consists of a share of common stock and a warrant to purchase a share of common stock. For the years ended 2008, 2007 and 2006, the unit purchase option was anti-dilutive; therefore, the shares associated with the unit purchase option are not included in the diluted weighted average shares outstanding in the table above.
On our Consolidated Statement of Income, we retroactively restated EPS for periods prior to the Merger. We accounted for the Merger as a reverse acquisition and recapitalization [see Note 2(b)] and since the consideration paid was cash and common stock, the shares outstanding at the time the Merger was effective were deemed to be the historical shares outstanding prior to the Merger. Since our IPO occurred during October 2007, for certain periods during the years ended 2007 and 2006, there was no quoted market price; therefore, we used the average quoted market price of our common stock for the first 15 days subsequent to the IPO as the average market price in our treasury stock method calculation to compute our dilutive common stock equivalents related to the periods for which no quoted market price was available.
We anticipate that our deferred policy acquisition costs will be fully recoverable in the near term. The table below depicts the activity with regard to deferred policy acquisition costs:
Our catastrophe reinsurance contracts provide us coverage against severe weather events. For our catastrophe reinsurance program, we have entered into excess-of-loss contracts with a group of private reinsurers and with the Florida Hurricane Catastrophe Fund (“FHCF”). The private contract provides coverage against severe weather events such as hurricanes, tropical storms and tornadoes. The contract with the FHCF provides coverage only against storms that are designated as hurricanes by the National Hurricane Center.
FHCF divides our coverage into three layers: the Limited-Apportionment Company (“LAC”) layer, the Mandatory layer and the Temporary-Increase-in-Coverage-Limit (“TICL”) layer. Should a hurricane occur, we have chosen to pay, or “retain”, the first $15,500 of catastrophe losses before our reinsurance agreements provide coverage. Our retained loss would be the first $25,500 of catastrophe loss should a single, non-hurricane catastrophic event occur. In the unlikely event that catastrophe losses exceed our reinsurance coverage, we would also retain any such catastrophe loss in excess of the coverage provided by our reinsurance contracts. The following table summarizes our catastrophe coverage for a single severe weather event:
Should multiple severe weather events occur, the coverage provided by the FHCF LAC layer and each of the private layers will be reinstated. The first layer of our private contract requires us to pay 100% additional premium to reinstate the coverage under that schedule. To protect us in the event a reinstatement of coverage under the first layer of our private contract becomes necessary, we purchased a Reinsurance Premium Protection policy from a private reinsurer that reimburses us the amount of any reinstatement premium that we would have to pay to reinstate coverage. The FHCF LAC layer and the remaining layers of our private contract provide for reinstatement of coverage at no additional premium. The FHCF Mandatory and TICL layers do not provide for reinstatement of coverage. The private contract provides aggregate coverage, including reinstatements, of $169,400 for all occurrences, while any single occurrence is limited to $84,700. The FHCF LAC layer provides aggregate coverage, including reinstatements, of $20,000 for all occurrences, while any single occurrence is limited to $10,000.
Our non-catastrophe reinsurance contract provides excess-of-loss coverage for losses arising out of property business up to $1,700 in excess of $1,000 per risk. Should a loss recovery, or series of loss recoveries, exhaust the coverage provided under the contract for losses arising out of property business, one reinstatement of the $1,700 of coverage limit is included at 50% additional premium. The contract, including reinstatements, provides aggregate coverage of $3,400 for losses arising out of property business, while any single occurrence is limited to $1,700. The contract also provides coverage for losses arising out of a combination of property and casualty business up to $1,700 for property and $500 for casualty in excess of $1,000 per occurrence, subject to a maximum recovery on any one loss occurrence, regardless of the number of risks involved for property or the number or type of insureds for casualty, of $2,200.
We write flood insurance under contract with the National Flood Insurance Program (“NFIP”). Per the contract, we cede 100% of the premiums written and 100% of risk of loss. We earn commissions for the issuance of flood policies based upon a fixed percentage of net written premiums and the processing of flood claims based upon a fixed percentage of incurred losses.
The following table depicts written premiums, earned premiums, and losses, showing the effects that our reinsurance transactions have on these components of our Consolidated Statements of Income:
Ceded losses and LAE incurred decreased from $115,677 in 2006 to $11,875 in 2007 primarily due to the lack of catastrophic storms in 2006 and 2007. Ceded losses and LAE incurred increased from $11,875 in 2007 to $22,778 due to an increase in the number of claims filed and the number of claims reopened primarily in Dade, Broward and Palm Beach counties, resulting from the involvement of public adjusters in catastrophe claims. The losses and LAE we incurred in 2008, 2007 or 2006 related to storms that occurred in those same years did not exceed our retained loss.
The following table highlights the effects that our reinsurance transactions have on unpaid losses and unearned premiums in our Consolidated Balance Sheets:
Reinsurance recoverable at December 31, 2008 and 2007, consists of the following:
As part of an assumption agreement with Citizens that ended in 2006, we received bonuses for policies assumed from Citizens during multiple assumptions in 2004 and 2005. The bonuses were calculated at 17.5% of the written premium originally assumed, net of adjustments related to policies that we did not renew or retain. The bonus money due to us was on deposit with an escrow agent, as specified by the terms of the agreement. To receive the bonuses, we were required to offer to renew the assumed policies for a period of three years at our approved rates and on substantially similar terms. Approximately three years after each assumption date, the escrow agent distributed the bonus funds to us, and in November 2008, distributed to us the interest income earned on the
In August 2008, we entered into a new assumption agreement (“2008 Agreement”) with Citizens. In conjunction with the assumption agreement, we agreed to a Consent Order from the OIR that allows us to assume as many as 75,000 policies from Citizens over an 18-month period beginning August 27, 2008. In addition, we agreed that any rates we charge to policyholders within one year from the date we assume the policies shall remain at or below the approved rates for Citizens. The agreement does not contain a bonus provision; therefore, no bonus income will be recognized on any of the assumptions made under this new agreement. Florida law allows Citizens’ policyholders to “opt out” of the assumption at any time until we issue them our renewal policy.
As of December 31, 2008, we have already assumed approximately seven thousand policies under the 2008 Agreement, totaling $5,669 of written premium assumed and $907 of assumed commissions incurred.
Based upon our internal analysis and our review of the Statement of Actuarial Opinion provided by our independent actuarial consultants, we believe that the liability for unpaid losses and LAE is reasonable to cover all claims and related expenses which may arise from incidents reported and incurred but not reported at December 31, 2008.
As of December 31, 2008, the annual maturities of our long-term debt are as follows:
Interest expense for the years ended December 31, 2008, 2007 and 2006, was $2,811, $6,078, and $4,081, respectively.
a Writing Ratio based on Gross Written Premium to Surplus of 3:1 for July 1, 2008 through the end of the first calendar year on December 31, 2008, a 4.5:1 ratio for the second calendar year from January 1, 2009 through December 31, 2009, and a 6:1 ratio for the third calendar year beginning on January 1, 2010 and thereafter for the remaining term of the note agreement.
For purposes of calculating the Writing Ratio on a quarterly basis, the amended note defines surplus as the sum of the $20,000 new capital contributed to UPCIC at the time the note was executed and the outstanding principal balance of the note. If we choose to meet the Writing Ratio based on Net Written Premium to Surplus and our actual Writing Ratio is 1:1 or less during 2009 or 1.5:1 or less thereafter, we will be assessed an interest rate penalty of 450 basis points above the stated rate of the note. If we choose to meet the Writing Ratio based on Gross Written Premium to Surplus and our actual Writing Ratio is 3:1 or less during 2009 or 4.5:1 or less thereafter, we will be assessed an interest rate penalty of 450 basis points above the stated rate of the note. Any other Writing Ratio deficiencies result in an interest rate penalty of 25 basis points above the stated rate of the note. The stated rate for the SBA note is a rate equivalent to the 10-year Treasury Bond rate.
On August 11, 2008, we entered into a Second Amendment to the note agreement with CB&T. The Second Amendment calls for principal payments to cease after the July 2008 installment and recommence with the April 2009 installment. During the period from August 1, 2008 through March 31, 2009, interest only payments will be made to CB&T. We entered into this Second Amendment because we applied the $13,090 held by CB&T in an escrow account per the note agreement against the outstanding principle of the note. See Note 16 for a discussion of all related party transactions.
On August 15, 2008, we entered into a note purchase agreement with five noteholders. The issuance of any notes under this agreement was contingent upon our stockholders voting for the Merger transaction. Upon approval of the Merger on September 29, 2008, we issued unsecured notes payable with a total face amount of $18,280. In exchange, we received $10,000 cash from certain accredited investors and 869,565 shares of our common stock from two former UIHC stockholders, the shares being valued at $6,878 at the time the notes were issued. We recorded a discount on these notes of $1,402 which will be amortized to interest expense over the three-year term of the notes. The notes bear interest at 11% per annum, and require semi-annual interest-only payments each April 1 and October 1. The entire principal balance is due and payable on September 29, 2011; however, we have the option to prepay in full any principal amount then outstanding within 30 days after each of the first and second anniversary dates of the notes. Any such prepayment will be made at 105% of the principal amount prepaid. Management currently does not intend to prepay these notes. See Note 16 for additional information regarding one of the noteholders that is a related party.
We agreed to certain covenants, the violation of which could cause an event of default. Among others, these covenants include refraining from incurring debt that would cause our aggregate debt balance, including the $18,280 incurred under these note agreements, to exceed $58,280 (excluding the SBA note amount), and refraining from making any payments (e.g., dividends or distributions), whether in cash, securities or other property, that would reduce consolidated net worth, as defined in the note agreement, to less than $45,000. We were in compliance with the terms of the covenants at December 31, 2008; however, since our consolidated net worth at December 31, 2008 was below $45,000, we could not make any dividends or distributions to our stockholders.
On September 10, 2006, UIH and York Enhanced Strategies Fund, LLC (“York”) entered into a $20,000 loan agreement (“York Note”). In connection with the transaction, York received a 4.75% equity interest in UIH (“Ownership Interest”) and entered into a redeemable Put Agreement (the “Put”) with UIH. The Put provided the holder of the Ownership Interest with an option to sell its entire interest back to UIH at a purchase price of two times the consolidated book value of UIH at the end of the fiscal quarter immediately preceding the Put date. The Put date would have been the date within the periods of September 15, 2009 through September 15, 2010, or September 15, 2011 through September 15, 2012 upon which the holder of the Put would have had to provide written notice of its intent to exercise the option. When the Merger between FMG and UIH became effective, York exchanged its Ownership Interest, including the ability to exercise the Put, for the Merger consideration. To account for the fact that the Put no longer represents a liability to us as of the close of the Merger on September 30, 2008, we reversed the liability of $2,564 we had recorded prior to the Merger and recorded it in Other Income on our Consolidated Statements of Income.
On our Consolidated Statements of Income, the pro forma computation of income taxes for the years ended 2008, 2007 and 2006, represents the tax effects that would have been reported had all of our subsidiaries recorded U.S. federal and state income taxes as part of filing a consolidated tax return for all periods presented. Pro forma taxes are based upon the statutory income tax rates and adjustments to income for estimated permanent differences occurring during each period. Actual rates and expenses could have differed had all our subsidiaries actually been subject to U.S. federal and state income taxes for all periods presented. Therefore, the pro forma amounts are for informational purposes only and are not intended to be indicative of the results of operations had we been required to file a consolidated tax return that included all of our subsidiaries for all periods presented.
Florida law requires that UPCIC maintain capital and surplus equal to the greater of 10% of its total liabilities or $4,000. Our statutory capital surplus was $54,675 at December 31, 2008, and exceeded the minimum capital and surplus requirements. State law also requires UPCIC to adhere to prescribed premium-to-capital surplus ratios, with which we were in compliance at December 31, 2008.
The National Association of Insurance Commissioners (“NAIC”) established risk-based capital requirements for insurance companies that are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. Insurers having less statutory surplus than required will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The OIR, which follows these requirements, could require an insurer to cease operations in the event it fails to maintain the required statutory capital.
Florida law permits an insurer to pay dividends or make distributions out of that part of statutory surplus derived from net operating profit and net realized capital gains. The law further provides calculations to determine the amount of dividends or distributions that can be made without the prior approval of the OIR and the amount of dividends or distributions that would require prior approval of the OIR. The NAIC risk-based capital (“RBC”) requirements may further restrict UPCIC’s ability to pay dividends or make distributions if the amount of the intended dividend or distribution would cause statutory surplus to fall below minimum RBC requirements.
Florida law limits an insurer’s investment in equity instruments and also restricts investments in medium to low quality debt instruments. We were in compliance with all investment restrictions at December 31, 2008 and 2007.
Under current regulations, insurers may recover the amount of their assessments from policyholders, or, in some cases, collect the amount of the assessments from policyholders as surcharges for the benefit of the assessing agency. To recover an assessment, we file for a rate increase which the OIR immediately approves. The rate increase is valid for a twelve-month period following the approval of the rate increase. Any assessment not recovered during the first twelve-month period can be included in subsequent rate filings until we fully recover the assessment.
The table below summarizes the activity related to assessments imposed upon us:
Because we issued a surplus note as defined by statutory accounting principles (“SAP”), as discussed in Note 11(a), we are subject to the authority of the Insurance Commissioner of the State of Florida with regard to our ability to repay principal and interest on the surplus note. Any payment of principal or interest requires permission from the OIR.
SAP require us to expense policy acquisition costs when incurred, while GAAP allows us to defer and amortize policy acquisition costs over the estimated life of the policies.
We are involved in claims-related legal actions arising in the ordinary course of business. Amounts resulting from claims-related legal actions are accrued in Unpaid Losses and Loss Adjustment Expenses during the period an unfavorable outcome becomes probable and the amounts can be estimated. Revisions to our estimates are based on our analysis of subsequent information that we receive regarding various factors, including: (i) per claim
In November 2008, the Florida Legislature noted that the FHCF is facing a potential shortfall of nearly $19 billion in 2009. The FHCF has the authority to raise additional cash to pay claims through the issuance of bonds, the retirement of which would be funded by imposing additional assessments on future insurance premiums written in the state. Because of our participation in assigned risk plans, we may be exposed to losses that surpass the capitalization of these facilities and/or to additional assessments from these facilities. In addition, while we can recover these assessments from policyholders through premium rate increases, our payment of the assessments and our recoveries may not offset each other in the same fiscal period in our financial statements.
We are also subject to changing social, economic, and regulatory conditions. Regulatory authorities as well as legislative bodies in the State of Florida seek to influence and restrict premium rates, require premium refunds to policyholders, restrict the ability of insurers to cancel or non-renew policies, require insurers to continue to write new policies or limit their ability to write new policies. They can also limit insurers’ ability to change coverage terms or impose underwriting standards or impose additional regulations regarding agent and broker compensation. All of these items result in an expansion of the overall regulation of insurance products and the insurance industry.
director until the close of the Merger. The reinsurers pay commissions to the broker determined in accordance with industry rates. As of September 30, 2008, the aforementioned person no longer serves as a director, but remains a common stockholder.
We have entered into an investment-management agreement with Synovus Trust Company, N.A. (“Synovus Trust”), which provides discretionary investment management services for the investment accounts of our subsidiaries. The agreement was effective October 8, 2003, and remains in effect until terminated by either party. Synovus Trust is owned by Synovus Financial Corporation (“Synovus”). Synovus owned 14.6% of our outstanding common shares at December 31, 2008, and owned 17.2% of UIH at December 31, 2007. During 2008, 2007, and 2006, our subsidiaries incurred combined fees under the agreement of $104, $99 and $78, respectively.
As of December 31, 2007, we had notes receivable from certain officers in the amount of $100. The notes, plus accrued interest of $15, were forgiven in March 2008.
Our Chairman of the Board of Directors also sits on the Board of Directors of Prime. Prime is the company that issued us a note receivable in exchange for the Prime common stock that we owned, as discussed in Note 5.
In a private placement immediately prior to the offering that took place on October 11, 2007 (the “Offering”), certain of our directors purchased, through FMGI, common stock warrants which they can exercise to purchase 1,250,000 shares of our common stock. The common stock warrants were purchased at a price of $1.00 per warrant from us and not as part of the Offering. As a result of the Merger, FMGI surrendered back to us warrants to purchase 179,819 shares of our common stock.
In addition to surrendering the warrants mentioned above, FMGI also agreed, as part of the Merger transaction, to reduce the number of shares of our common stock they owned by 179,819. No consideration was paid for these surrendered shares and these shares were cancelled.
At December 31, 2008 and 2007, we did not have a stock-based employee compensation plan. Prior to the Merger, however, UIH’s Board granted UIH membership units to key personnel in 2007 and 2006. For the years ended December 31, 2007 and 2006, the fair market value of the membership units awarded was $206 and $190, respectively.
Comprehensive income (loss) includes unrealized gains and losses, net of the related income tax effect, on debt and equity securities classified as available-for-sale, and is included as a component of stockholders’ equity.
As further detailed in Note 4, we completed the acquisition of, and merger with, UIH effective September 30, 2008. The following transactions relating to our capital stock occurred in connection with the Merger:
We paid cash of $15,740 pursuant to the stock purchase agreements to repurchase 1,980,671 shares of our common stock on September 29, 2008.
We repurchased 869,565 shares from two former stockholders by exchanging notes payable for the shares. The notes have a face value of $7,527 and bear interest at 11% per annum (see Note 11).
We paid cash of $10,039 to holders of 1,267,863 shares of our common stock who did not vote in favor of the Merger and elected to have their shares of common stock converted to cash. Subsequent to the Merger, none of our common stock is redeemable.
FMGI surrendered 179,819 shares of UIHC common stock it owned. No consideration was paid for these surrendered shares and the shares were cancelled. FMGI also surrendered 179,819 of the common stock warrants that it owned. See Note 16 for a further discussion of FMGI being a related party to UIHC.
See Note 11(c) for a discussion regarding restrictions on dividends or distributions imposed by the notes payable related to the Merger.