UIH, with its wholly-owned subsidiaries, is a vertically integrated insurance holding company performing all aspects of insurance underwriting, distribution and claims. Through our wholly-owned subsidiaries, including UPCIC and APPCIC, collectively referred to as the “Insurance Entities”, we are principally engaged in the property and casualty insurance business offered primarily through a network of independent agents. Our primary product is homeowners insurance, which we currently offer in ten states.
Our overall growth strategy includes taking prudent measures to increase our policy count and improve the quality of our business. These initiatives include reducing rates and expanding into selected markets while maintaining rate adequacy. For example, we reduced overall rates for homeowners' insurance in Florida by 2.4% effective in January 2014 for new business and March 2014 for renewals.
The following table provides policy count and total insured value for Florida and other states as of December 31, 2014 and 2013 (dollars in thousands):
Net income and diluted earnings per common share grew by $14.0 million and $0.52, respectively compared to 2013
In April, UPCIC submitted applications to the regulatory entities in Pennsylvania, consistent with the Company’s strategy to increase geographical diversification
In November, Demotech, Inc., affirmed the Financial Stability Rating® of “A” for the Insurance Entities
In December, we sold 1 million shares of common stock in a privately negotiated transaction at $19.00 per share which were issued from treasury
The market price per share of our common stock has increased significantly over the past few years. As disclosed in “Item 8 - Note 9 (Share-Based Compensation)”, stock price affects assumptions utilized in the pricing model for the fair value of stock option awards. In addition, the fair value of the restricted share grants are determined based on the market price of our common stock at the date of grant. As a result, the increase in our common stock price has contributed to the increase of share-based compensation. The increase in our stock price is also a factor in the Company’s effective income tax rate due to an increase in non-deductible expenses including certain share-based compensation.
We use reinsurance to reduce our exposure to catastrophic and non-catastrophic losses through a combination of quota share, catastrophe and other forms of reinsurance. Below is a description of our 2014-2015 reinsurance program. We believe that the overall terms of the 2014-2015 reinsurance program are more favorable than the 2013-2014 reinsurance program. We realized cost reductions in part due to market conditions and our preparation and efforts to manage risk exposure. We also are retaining a greater percentage of gross written premiums with wind risk than we did under our 2013-2014 reinsurance program by reducing our quota share cession rate by 15 percentage points. We expect to increase our overall profitability by retaining more premium; however the reduction in the quota share cession rate affects several line items in our Consolidated Statements of Income. By lowering our cession rate, we increase the amount of premium we retain as well as the related risk. This results in an increase in both earned premium and losses and LAE. The lower cession rate also reduces the amount of ceding commissions we receive that offset costs associated with writing premium. This reduction in ceding commission increases general and administrative expenses.
UPCIC’s reinsurance program, which generally runs from June 1 through May 31 of the following year, consists of quota share, various forms of catastrophe coverage and individual property and liability per risk/per policy coverage. Under the 2014-2015 reinsurance program, UPCIC retains a pre-tax liability of $21 million for the first, second and third catastrophic events under its Florida program with coverage up to $1.794 billion. UPCIC retains a pre-tax liability of $21 million for the first and second catastrophic events under its programs in Delaware, Georgia, Maryland, Massachusetts, North Carolina and South Carolina with coverage up to $125 million and a pre-tax liability of $7 million under its program in Hawaii with coverage up to $30 million. UPCIC reduced its quota share percentage to 30% under its 2014-2015 program compared to 45% under its 2013-2014 program thus retaining more risk and premium per policy. UPCIC has mandatory catastrophe coverage through the FHCF plus voluntary quota share, catastrophe and per risk coverage with private reinsurers. The estimated total net cost after the proportional quota share deductions of UPCIC’s catastrophe, FHCF and per risk related coverage, including reinstatement premium protection coverage is $173.8 million. The largest private participants in UPCIC’s program include Odyssey Re, Everest Re, Renaissance Re, Nephila Capital, ACE Tempest Re and Lloyd’s of London syndicates.
APPCIC’s reinsurance program, which generally runs from June 1 through May 31 of the following year, consists of various forms of catastrophe coverage and individual property and liability per risk/per policy coverage. Under the 2014-2015 reinsurance program, APPCIC retains a pre-tax liability of $2.5 million for the first and second catastrophic events with coverage up to $39.3 million. APPCIC has mandatory catastrophe coverage through the FHCF and voluntary catastrophe and per risk coverage with private reinsurers. The estimated total cost of APPCIC’s catastrophe, FHCF and per risk related coverage, including reinstatement premium protection is $5.0 million. The largest private participants in APPCIC’s reinsurance program include ACE Tempest Re, Hiscox, Odyssey Re, Hannover Ruck, and Lloyd’s of London syndicates.
Separately from the Insurance Entities’ reinsurance programs, UIH protects its own assets against diminution in value due to catastrophe events by purchasing coverage that would provide $80 million in the form of insurance proceeds plus an amount equal to the forgiveness of related debt through a catastrophe risk-linked transaction contract, effective June 1, 2013 through May 31, 2016. This contract provides for recovery by UIH in the event of exhaustion of UPCIC’s catastrophe coverage. The total cost to UIH of this risk-linked transaction contract is $9.0 million per year for each of the three years.
Reserves for losses and LAE are determined in four primary segments. These segments are the estimation of reserves for Florida non-catastrophe losses, hurricane losses, sinkhole losses, and non-Florida non-catastrophe losses. Evaluations are performed for loss and LAE separately, and on a net and direct basis for each segment. The analyses for non-catastrophe losses are further separated into data groupings of like exposure. These groups are property damage on homeowner policy forms HO-3 and HO-8 combined, property damage on homeowner policy forms HO-4 and HO-6 combined, property damage on dwelling fire policies, and all liability exposures combined.
The first method for estimating unpaid amounts for each segment is the reported development method. This method is based upon the assumption that the relative change in a given accident period’s reported loss estimates from one evaluation point to the next is similar to the relative change in prior periods’ reported loss estimates at similar evaluation points. In utilizing this method, actual 6-month historical loss activity is evaluated. Successive periods can be arranged to form a triangle of data. Report-to-report (“RTR”) development factors are calculated to measure the change in cumulative reported losses from one evaluation point to the next. These historical RTR factors form the basis for selecting the RTR factors used in projecting the current valuation of losses to an ultimate basis. In addition, a tail factor is selected to account for loss development beyond the observed experience. The tail factor is based on trends shown in the data and consideration of industry loss development benchmarks. This method’s implicit assumption is that the relative adequacy of case reserves has been consistent over time, and that there have been no material changes in the rate at which claims have been reported or settled. In instances where changes in settlement rates are detected, the RTR factors are adjusted accordingly, utilizing appropriate actuarial techniques.
Bornhuetter-Ferguson (“B-F”) methods are also utilized for estimating unpaid loss and LAE amounts, and relate to the reported, paid and closed development methods discussed above. B-F methods are essentially a blend of two other methods. The first method is an expected loss method, whereby the IBNR estimate equals the difference between predetermined estimates of expected losses and actual reported losses. The second method in each case is the development method (each described above), whereby actual losses are multiplied by an expected development factor. The B-F methods combine these two methods by setting ultimate losses equal to actual reported (or paid) losses plus expected unreported (or unpaid) losses. As an experience year matures and expected unreported (or unpaid) losses become smaller, the initial expected loss assumption becomes gradually less important. This has the advantage of stability, but it does not respond to actual results as they emerge.
An additional method, called the Reported Counts and Averages method, is utilized for the estimate of LAE for each segment, and also for the estimation of loss and LAE reserves for sinkhole losses. In this method, an estimate of unpaid losses or expenses is determined by separately projecting ultimate reported claim counts and ultimate reported claim severities (cost per reported claim) for each accident period. Typically, loss development methods are used to project ultimate claim counts and claim severities based on historical data using the same methodology described in the reported development method above. Estimated ultimate losses are then calculated as the product of the two items. This method is intended to avoid data distortions that may exist with the other methods for the most recent years as a result of changes in case reserve levels, settlement rates and claims handling fees. In addition, it may provide insight into the drivers of loss experience. This method is only utilized for sinkhole losses due to unique settlement patterns that have emerged since the passage of legislation that codified claim settlement practices with respect to sinkhole related claims and subsequent policy form changes implemented by the Company. Claims for sinkholes are expected to be reported and settled at different rates and ultimate values than historically observed, requiring a departure from traditional development methodologies.
Estimation methods described above all produce an estimate of ultimate losses and LAE. Based on the results of these methods, a single estimate (commonly referred to as an actuarial point/central estimate) of the ultimate loss or LAE is selected accordingly for each accident-year claim grouping. Estimated IBNR reserves are determined by subtracting the reported loss from the selected ultimate loss, or the paid LAE from the ultimate LAE. The estimated loss IBNR reserves are added to case reserves to determine the total estimated unpaid losses. No case reserves are carried for LAE, therefore the estimated LAE IBNR reserves equal the total estimated unpaid LAE. For each segment, the reserving methods are carried out on both a net and direct basis in order to estimate liabilities accordingly. When selecting a single actuarial point/central estimate on a net basis, careful consideration is given for the reinsurance arrangements that were in place during each accident year exposure period and segment being reviewed.
adverse changes in loss cost trends, including inflationary pressures in home repair costs;
Loss and LAE reserves also include reserves for catastrophe losses. Catastrophe losses are an inherent risk of the property-casualty insurance industry that have contributed, and will continue to contribute, to potentially material year-to-year fluctuations in results of operations and financial position. A catastrophe is an event that produces significant pre-tax losses before reinsurance and involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time following the event. Catastrophes are caused by various natural events including high winds, tornadoes, wildfires, tropical storms and hurricanes. The nature and level of catastrophes in any period cannot be predicted.
The aggregation of estimates for reported losses and IBNR forms the reserve liability recorded in the Consolidated Balance Sheets.
Due to the uncertainties involved, the scenarios described and quantified above are reasonably likely, but the ultimate cost of losses may vary materially from recorded amounts, which are based on our best estimates. The liability for unpaid losses and LAE at December 31, 2014 is $134.4 million.
We incur costs in connection with the production of new and renewal insurance policies that are referred to as policy acquisition costs. Commissions and state premium taxes are costs of acquiring insurance policies that vary with, and are directly related to, the successful production of new and renewal business. These costs are deferred and amortized over the period during which the premiums are earned on the underlying policies. We collect ceding commissions from certain reinsurers in connection with our quota share reinsurance contracts. We estimate the amount of ceding commissions to be deferred on a basis consistent with the deferral of acquisition costs incurred with the production of the original policies issued and the terms of the applicable reinsurance contracts. The deferred ceding commissions are offset against the deferred policy acquisition costs with the net result presented as “deferred policy acquisition costs, net” on our Consolidated Balance Sheets. As of December 31, 2014, deferred policy acquisition costs were $54.6 million and deferred ceding commissions were $28.9 million. Deferred policy acquisition costs were reduced by deferred ceding commissions and shown net on the Consolidated Balance Sheet in the amount of $25.7 million.
In the normal course of business, we seek to reduce the risk of loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. While ceding premiums to reinsurers reduces our risk of exposure in the event of catastrophic losses, it also reduces our potential for greater profits in the event that such catastrophic events do not occur. We believe that the extent of our reinsurance is typical of a company of our size in the homeowners’ insurance industry. Amounts recoverable from reinsurers are estimated in a manner consistent with the provisions of the reinsurance agreement and consistent with the establishment of our liability. The Insurance Entities’ reinsurance policies do not relieve them from their obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses; consequently, allowances are established for amounts deemed uncollectible. No such allowance was deemed necessary as of December 31, 2014.
year ended December 31, 2014 COMPARED TO YEAR ENDED DECEMBER 31, 2013
Net earned premiums were $326.9 million for the year ended December 31, 2014, compared to $267.7 million for the year ended December 31, 2013. The increase in net earned premiums of $59.2 million, or 22.1%, reflects a decrease in ceded earned premiums of $70.4 million, partially offset by a decrease in direct earned premiums of $11.2 million. Premium earned in the current period reflects premium written over the past 12 months and any changes in rates or policy count during that time. The decrease in ceded earned premiums is attributable to lower reinsurance costs with the 2013-2014 and 2014-2015 reinsurance programs reflected in the results for 2014 compared to the costs of the 2012-2013 and 2013-2014 reinsurance programs reflected in the results for 2013. In our 2014-2015 reinsurance program, we reduced the rate of quota share ceded premium from 45% in our 2012-2013 and 2013-2014 reinsurance programs to 30%. This reduction is reflected in the results beginning in the month of June 2014. The decrease in direct earned premiums is due primarily to a reduction in the number of policies in force in Florida through May 2014, and rate decreases for new business and renewals in Florida which went into effect in January and March 2014, respectively. As discussed above in “Overview”, we have taken what we believe to be prudent measures to increase policy count, while maintaining rate adequacy, resulting in an increase in the number of policies in force in Florida since May 2014.
See “Item 8 - Note 5 (Insurance Operations)” for change in liability for unpaid losses and LAE.
For the year ended December 31, 2014, general and administrative expenses were $118.4 million, compared to $92.0 million for the same period in 2013. The overall increase in general and administrative expenses of $26.4 million, or 28.7%, includes an increase of $11.8 million in the amortization of net deferred policy acquisition costs resulting mostly from changes with the 2014-2015 reinsurance program including a reduction in the rate of ceded premium from 45% to 30% in our quota share contracts. We also had an increase of $5.9 million in the amount of stock-based compensation, an increase in bonuses of $2.6 million, an increase of $2.0 million in advertising and promotional expenses and an increase of $2.8 million in other remaining expenses combined. Also, our recovery of FIGA assessments declined by $4.8 million as compared to prior year. FIGA assessments are initially charged to insurance companies, which then are allowed to recover the assessed amounts from their policyholders. UPCIC recovered the vast majority of its most recent FIGA assessment over a 12-month period ending in early February 2014. We therefore recovered more of the assessment in 2013 than in 2014 due to the timing of the initial assessment and the associated recovery period. These increases were partially offset by a reduction of $2.4 million related to insurance premiums paid for UIH-level coverage, most of which is related to catastrophe-linked insurance and a reduction of $1.1 million in regulatory fees.
Net income increased by $28.7 million, or 94.6%, for the year ended December 31, 2013 reflecting an improvement in underwriting results. The improvement in underwriting results was moderately offset by a greater amount of trading portfolio losses generated as the Company liquidated its trading portfolio during the first quarter of 2013. Diluted earnings per share increased by $0.81 for the year ended December 31, 2013 compared to 2012, $0.17 of which was attributable to a reduction in shares of Common Stock outstanding as a result of UIH’s repurchase of shares from Bradley Meier and Norman Meier. See “Item 8 - Note 8 (Stockholders’ Equity) and Note 13 (Earnings Per Share).”
The following table summarizes changes in each component of our Consolidated Statements of Income and Comprehensive Income for the year ended December 31, 2013 compared to the year ended December 31, 2012 (in thousands):
The net losses and LAE ratios, or net losses and LAE as a percentage of net earned premiums, were 40.6% and 54.6% during years ended December 31, 2013, and 2012, respectively, and were comprised of the following components (in thousands):
Income tax expense was $41.5 million for the year ended December 31, 2013, compared to $22.2 million for the same period in 2012. The increase of $19.3 million was due to an increase in taxable income. Our effective tax rate decreased slightly to 41.3% for the year ended December 31, 2013 compared to 42.3% for the same period during 2012.
Comprehensive income includes net income and other comprehensive income (loss). The other comprehensive loss of $376 thousand for the year ended December 31, 2013, reflects after-tax changes in fair value of securities held in our investment portfolio of securities available for sale net of reclassifications out of cumulative other comprehensive income (loss) for securities sold during the year. See “Item 8 - Note 14 (Other Comprehensive Income (Loss)).” There was no other comprehensive income (loss) for the year ended December 31, 2012.
Reinsurance recoverable represents ceded losses and LAE. The decrease of $52.6 million to $55.2 million as of December 31, 2014 was primarily due to the reduction in the losses and LAE we cede to quota share reinsurers and also due to the timing of settlements and amounts available for right of offset with our reinsurers.
Reinsurance payable, net, represents our liability to reinsurers for ceded written premiums, net of ceding commissions receivable. The decrease of $20.2 million to $66.1 million as of December 31, 2014 was primarily due to the reduction in the premium we cede to quota share reinsurers.
See “Item 8 - Note 12 (Income Taxes)” for a schedule of deferred income taxes as of December 31, 2014 and 2013, which shows the components of deferred tax assets and liabilities as of both balance sheet dates.
The balance of cash and cash equivalents as of December 31, 2014 was $115.4 million compared to $117.3 million at December 31, 2013. See “Item 8 - Consolidated Statements of Cash Flows” for a reconciliation of the balance of cash and cash equivalents between December 31, 2014 and 2013. The decrease in cash and cash equivalents was driven by cash flows used for investing and financing activities in excess of those generated from operations. Most of the balance of cash and cash equivalents maintained is available to pay claims in the event of a catastrophic event in addition to any amounts recovered under our reinsurance agreements.
Liquidity for UIH and its non-insurance subsidiaries is required to cover the payment of general operating expenses, dividends to shareholders (if and when authorized and declared by our Board of Directors), payment for the possible repurchase of our common stock (if and when authorized by our Board of Directors), payment of income taxes, and interest and principal payments on debt obligations. The declaration and payment of future dividends by UIH to its shareholders, and any future repurchases of UIH common stock, will be at the discretion of our Board of Directors and will depend upon many factors, including our operating results, financial condition, debt covenants and any regulatory constraints. Principal sources of liquidity for UIH and its non-insurance subsidiaries include revenues generated from fees paid by the Insurance Entities to the managing general agency and for policy administration, inspections and claims adjusting services. Additional sources of liquidity include brokerage commissions earned on reinsurance contracts and any unused credit lines. UIH also maintains investments in equity securities which would generate funds upon sale.
Liquidity for the Insurance Entities is primarily required to cover payments for reinsurance premiums, claims payments including potential payments of catastrophe losses offset by recovery of any reimbursement amounts under our reinsurance agreements, fees paid to affiliates for managing general agency services, inspections and claims adjusting services, agent commissions, premium and income taxes, regulatory assessments, general operating expenses, and interest and principal payments on debt obligations. The principal source of liquidity for the Insurance Entities consists of the revenue generated from the collection of net premiums, after deductions for expenses and the collection of reinsurance recoverable.
The Insurance Entities are responsible for losses related to catastrophic events with incurred losses in excess of coverage provided by the Insurance Entities’ reinsurance programs and for losses that otherwise are not covered by the reinsurance programs, which could have a material adverse effect on either the Insurance Entities’ or our business, financial condition, results of operations and liquidity. See “Item 7. Management’s Discussion of Financial Condition and Results of Operations - 2014-2015 Reinsurance Program” for a discussion of our reinsurance programs.
On November 9, 2006, UPCIC entered into a $25.0 million surplus note with the State Board of Administration of Florida (“SBA”) under Florida’s Insurance Capital Build-Up Incentive Program (“ICBUI”). The surplus note has a twenty-year term and accrues interest, adjusted quarterly based on the 10-year Constant Maturity Treasury Index. For the first three years of the term of the surplus note, UPCIC was required to pay interest only.
Based upon consultations with our independent actuarial consultants and their statement of opinion on losses and LAE, we believe that the liability for unpaid losses and LAE is currently adequate to cover all claims and related expenses that may arise from incidents reported and IBNR. The company has adjusted prior year reserves to reflect both positive and negative development trends. The company continues to see an increase in claim settlement rates as a result of ongoing claims department initiatives which were introduced in 2013. This has resulted in favorable development for the majority of claim segments, particularly for the most recent accident years, but is partially offset by unfavorable development in bringing closure to claims previously in a litigious environment.
The following table provides total unpaid loss and LAE, net of related reinsurance recoverable for the dates presented (in thousands):
The table below illustrates the change over time of the direct reserves established for unpaid losses and LAE for the Insurance Entities (Liability for Unpaid Losses and LAE “re-estimates”) at the end of the last ten calendar years through December 31, 2013 (in thousands):
There are generally no notional or stated amounts related to unpaid losses and LAE. Both the amounts and timing of future loss and LAE payments are estimates and subject to the inherent variability of legal and market conditions affecting the obligations and make the timing of cash outflows uncertain. The ultimate amount and timing of unpaid losses and LAE could differ materially from the amounts in the table above. Further, the unpaid losses and LAE do not represent all of the obligations that will arise under the contracts, but rather only the estimated liability incurred through December 31, 2014.
These amounts represent minimum salaries, which may be subject to annual percentage increases, non-equity incentive compensation based on pre-tax or net income levels, and fringe benefits based on the remaining term of employment agreements we have with our executives. These amounts do not reflect equity awards of approximately 500 thousand shares of restricted common stock to be granted to executives in 2015 under their employment agreements.
In May 2014, the FASB issued updated guidance to clarify the principles for revenue recognition. The guidance in this update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g. insurance contracts). Although insurance contracts are not within the scope of this updated guidance, the Company’s commission revenue, policy fees, and payment plan fees may be subject to this updated guidance. This guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and earlier adoption is not permitted. The adoption of this guidance is not expected to have a material effect on our results of operations, financial position or liquidity.
Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012
We have audited the accompanying consolidated balance sheets of Universal Insurance Holdings, Inc. and Subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2014. We also have audited the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
The Company generates revenues primarily from the collection of premiums and invests funds in excess of those retained for claims-paying obligations and insurance operations. Other significant sources of revenue include commissions collected from reinsurers, policy fees collected from policyholders through our wholly-owned managing general agency subsidiary and payment plan fees charged to insureds who pay premium in installments.
The consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America (“U.S. GAAP”). The consolidated financial statements include the accounts of UIH and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. The Company’s primary areas of estimate are the recognition of premium revenues, liabilities for unpaid losses and loss adjustment expenses, provision for premium deficiency and reinsurance. Actual results could differ from those estimates.
Cash and Cash Equivalents. The Company includes in cash equivalents all short-term, highly liquid investments that are readily convertible to known amounts of cash and have an original maturity of three months or less. These amounts are carried at cost, which approximates fair value. The Company excludes any net negative cash balances from cash and cash equivalents that the Company has with any single financial institution. These amounts represent outstanding checks not yet presented to the financial institution and are reclassified to liabilities and presented as book overdraft in the Company’s Consolidated Balance Sheets. The Company maintains its cash and cash equivalents at various financial institutions and accounts are insured up to $250 thousand per depositor under FDIC insurance coverage. Throughout the year, the Company’s cash balances were in excess of FDIC insurance coverage. The Company has not experienced any losses in such accounts and does not believe it is exposed to any significant credit risk on cash and cash equivalents.
Restricted Cash and Cash Equivalents. The Company classifies amounts of cash and cash equivalents that are restricted in terms of their use and withdrawal separately on the face the Consolidated Balance Sheets. See “NOTE 5 - INSURANCE OPERATIONS,” for a discussion of the nature of the restrictions.
Gains and losses realized on the disposition of investment securities held in trading were determined on the first-in-first-out (“FIFO”) basis and credited or charged to income. Premium and discount on investment securities held in trading were amortized and accreted using the interest method and charged or credited to investment income.
Fair Value Measurements. The Company’s policy is to record transfers of assets and liabilities, if any, between Level 1 and Level 2 at their fair values as of the end of each reporting period, consistent with the date of the determination of fair value.
In July 2013, the Financial Accounting Standards Board (“FASB”) issued accounting guidance on the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. Under this guidance, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should generally be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward. This guidance is effective for fiscal years and interim periods beginning after December 15, 2013, but earlier adoption is permitted. The Company adopted this guidance effective January 1, 2014. The adoption did not have an impact on the presentation of the Company’s financial statements and notes herein.
The following table provides the credit quality of investments with contractual maturities as of the dates presented (in thousands):
The following table summarizes the fair value and gross unrealized losses on securities available for sale, aggregated by major investment category and length of time that individual securities have been in a continuous unrealized loss position as of the dates presented (in thousands):
(1)Includes interest earned on cash and cash equivalents and restricted cash and cash equivalents.
(2)Includes investment expenses related to cash and cash equivalents and restricted cash and cash equivalents.
The Company liquidated its trading portfolio in March 2013; therefore, for periods subsequent to March 31, 2013 there was no effect of trading activities on the Company’s results of operations.
The Company seeks to reduce its risk of loss by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers, generally as of the beginning of the hurricane season on June 1 of each year. The Company’s reinsurance program consists of excess of loss, quota share and catastrophe reinsurance, subject to the terms and conditions of the applicable agreements. The Company is responsible for insured losses related to catastrophes and other events in excess of coverage provided by its reinsurance program. The Company remains responsible for the settlement of insured losses irrespective of the failure of any of its reinsurers to make payments otherwise due to the Company.
The Company reduced the percentage of premiums ceded by UPCIC to its quota share reinsurers to 30% beginning with the reinsurance program effective June 1, 2014, from 45% under the prior year quota share contracts that were effective June 1, 2013 through May 31, 2014. By ceding 15 percentage points less premium to its quota share reinsurers, the Company expects to increase its profitability by retaining more premium. The reduction in cession rate also decreases the amount of losses and LAE that may be ceded by UPCIC and effectively increases the amount of risk retained by UPCIC and the Company. The reduction of cession rate also reduces the amount of ceding commissions earned from the Company’s quota share reinsurer during the contract term and decreases the amount of deferred ceding commission, as of December 31, 2014, that is a component of net deferred policy acquisition costs.
In order to reduce credit risk for amounts due from reinsurers, the Insurance Entities seek to do business with financially sound reinsurance companies and regularly evaluate the financial strength of all reinsurers used.
Amounts represent prepaid reinsurance premiums, reinsurance receivables, and net recoverables for paid and unpaid losses, including incurred but not reported reserves, loss adjustment expenses, and offsetting reinsurance payables.
The beginning balances for the twelve months ended December 31, 2012 have been adjusted in connection with the adoption of the FASB's updated guidance related to deferred policy acquisition costs as discussed below.
As discussed in “NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES,” the Company prospectively adopted new accounting guidance effective January 1, 2012 related to accounting for costs associated with acquiring or renewing insurance contracts. This guidance resulted in a 13% reduction of our net deferred policy acquisition costs as of December 31, 2011, and a corresponding pre-tax charge of $1.6 million against earnings during the first quarter of 2012. This charge represents a charge-off of capitalized costs existing at December 31, 2011, which would have been amortized to earnings within a twelve-month period under the old guidance. In the period of adoption (three months ended March 31, 2012), approximately $9 million of net costs would have been deferred under the old guidance compared to the $5.6 million under the new guidance. Future expenses will be accelerated with the adoption of this guidance, as the amounts being deferred have decreased, partially offset by less amortization. The effect of this change in periods subsequent to March 31, 2012, on income and per share amounts is not determinable as the historical methodology will have been discontinued after adoption.
The Insurance Entities are subject to regulations and standards of the Florida Office of Insurance Regulation. These standards require the Insurance Entities to maintain specified levels of statutory capital and restrict the timing and amount of dividends and other distributions that may be paid to the parent company. Except in the case of extraordinary dividends, these standards generally permit dividends to be paid from statutory unassigned surplus of the regulated subsidiary and are limited based on the regulated subsidiary’s level of statutory net income and statutory capital and surplus. The maximum dividend that may be paid by UPCIC and APPCIC to their immediate parent company, Universal Insurance Holding Company of Florida (“UIHCF”), without prior regulatory approval is limited to the lesser of statutory net income from operations of the preceding calendar year or 10.0% of statutory unassigned surplus as of the preceding year end. These dividends are referred to as “ordinary dividends.” However, if the dividend, together with other dividends paid within the preceding twelve months, exceeds this statutory limit or is paid from sources other than earned surplus, the entire dividend is generally considered an “extraordinary dividend” and must receive prior regulatory approval.
As of the dates in the table above, both UPCIC and APPCIC met the Florida capitalization requirement. UPCIC and APPCIC are also required to adhere to prescribed premium-to-capital surplus ratios and have met those requirements at such dates.
UPCIC and APPCIC are required annually to comply with the NAIC Risk-Based Capital (“RBC”) requirements. RBC requirements prescribe a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC RBC requirements are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2014, based on calculations using the appropriate NAIC RBC formula, UPCIC’s and APPCIC’s reported total adjusted capital was in excess of the requirements.
UPCIC received an order from the OIR dated May 30, 2013 related to the OIR’s Target Market Conduct Final Examination Report of UPCIC for the period January 2009 through May 2013 (“OIR Order”). The OIR Order alleged certain violations and findings and sought to impose certain requirements and an administrative fine of $1.3 million upon UPCIC. On October 4, 2013, UPCIC and the OIR signed a Consent Order settling the OIR Order. The Consent Order clarified language contained in the OIR Order, imposed certain requirements on UPCIC and required UPCIC to pay the administrative fine of $1.3 million, which it paid on October 18, 2013.
Depreciation and amortization was $1.2 million, $1.0 million and $840 thousand for the years ended December 31, 2014, 2013 and 2012, respectively.
Long-term debt consists of a surplus note entered into by UPCIC with carrying amounts of $17.3 million and $18.8 million as of December 31, 2014 and 2013, respectively; a term loan with a carrying amounts of $13.3 million and $18.5 million as of December 31, 2014 and 2013, respectively; and any amounts drawn upon an unsecured line of credit.
On November 9, 2006, UPCIC entered into a $25.0 million surplus note with the State Board of Administration of Florida (“SBA”) under Florida’s Insurance Capital Build-Up Incentive Program (“ICBUI”). Under the ICBUI, which was implemented by the Florida Legislature to encourage insurance companies to write additional residential insurance coverage in Florida, the SBA matched UPCIC’s funds of $25.0 million that were earmarked for participation in the program. The carrying amount of the surplus note is included in the statutory capital and surplus of UPCIC of approximately $200.2 million as of December 31, 2014.
On March 29, 2013, UIH entered into a revolving loan agreement and related revolving note with Deutsche Bank Trust Company Americas (“Deutsche Bank”), amended as of May 23, 2013 (“DB Loan”). The DB Loan makes available to UIH an unsecured line of credit in an aggregate amount not to exceed $10.0 million. Draws under the DB Loan have a maturity date of March 27, 2015 and carry an interest rate of LIBOR plus a margin of 5.50% or Deutsche Bank’s prime rate plus a margin of 3.50%. The interest rate is at the election of UIH. The DB Loan contains financial covenants. As of December 31, 2014, UIH was in compliance with all such covenants. UIH had not drawn any amounts under the unsecured line of credit as of December 31, 2014.
Interest expense was $1.5 million, $1.2 million, and $414 thousand for the years ended December 31, 2014, 2013 and 2012, respectively.
During the year ended December 31, 2014, 9,975 shares of Series A Preferred Stock were converted into an aggregate of 24,938 shares of UIH’s common stock. There were no conversions of Series A Preferred Stock during the year ended December 31, 2013.
The Series M Preferred Stock pays a cumulative dividend of $0.20 per share per year. The Company declared and paid aggregate dividends to holders of record of the Company’s Series M Preferred Stock of $0.4 thousand and $9 thousand for the years ended December 31, 2014 and 2013, respectively.
All shares acquired represent shares tendered to cover the strike price for options and tax withholdings on the intrinsic value of options exercised or Restricted Stock (as defined in “NOTE 9 - SHARE-BASED COMPENSATION “) vested. These shares have been cancelled by the Company.
During the year ended December 31, 2013, UIH entered into various repurchase agreements with Bradley I. Meier, the Company’s former Chairman, President and Chief Executive Officer, to repurchase shares of UIH’s common stock owned by Mr. Meier. UIH repurchased an aggregate of 7,016,000 shares from Mr. Meier at a total cost of $30.5 million.
During the year ended December 31, 2013, UIH entered into a repurchase agreement with Norman M. Meier, a former director and the former UIH Secretary, to repurchase shares of UIH’s common stock owned by Mr. Meier. UIH repurchased an aggregate of 241,933 shares from Mr. Meier at a total cost of $1.8 million.
On December 2, 2014, UIH sold 1,000,000 registered shares of its common stock at a price of $19.00 per share, in a privately negotiated transaction, to Ananke Catastrophe Investments Ltd. (“Ananke”), an affiliate of Nephila Capital Ltd., which is subject to certain holding period restrictions. Ananke is required to hold the shares of common stock for a minimum of six months and then may: 1) sell up to one-third during the next three-month period, 2) sell another one-third during the next three-month period and 3) sell the remaining purchased thereafter.
UIH purchases insurance coverage through a covered loss index swap transaction which protects its own assets against diminution in value due to certain catastrophe events impacting UPCIC. In the event any covered loss index swap in place is triggered for payment, UIH shall, at the option of Ananke, repurchase all or any part of the common stock then owned by Ananke at a price of $19.00 per share. The proceeds from the covered loss index swap would be used to fund the repurchase. Circumstances under which the covered loss index swap would be triggered are considered by the Company to be remote. The Company must exhaust a specific layer within UPCIC’s Florida catastrophe reinsurance coverage before triggering payment on the covered loss index swap. The specific layer that triggers payment has a remote probability of occurrence according to the leading insurance industry catastrophe models licensed by the Company that simulate expected loss outcomes on UPCIC’s portfolio of risks. Subsequent adjustments to the carrying amount will not be made since the contingently redeemable common stock is not currently redeemable and it is not probable it will become redeemable in the future. The capital resulting from this transaction is not restricted.
On February 19, 2015, the company entered into an amended agreement with Ananke to delete, in its entirety effective December 2, 2014, the provision giving rise to the redemption feature described above. This modification results in classification of the common shares in permanent equity on the date of the amendment. No consideration was exchanged with the amendment since both parties agreed that, given the remote possibility of the redemption to occur, the value of the redemption feature was de-minimis. The following table has been provided to show the pro-forma effects to equity on the consolidated balance sheet as of December 31, 2014.
An aggregate of 1.8 million shares of Common Stock was initially reserved for issuance and available for awards under the Incentive Plan. Awards under the Incentive Plan may include incentive stock options, non-qualified stock option awards (“Stock Option”), stock appreciation rights, non-vested shares of Common Stock (“Restricted Stock”), restricted stock units, performance share or unit awards, other share-based awards and cash-based incentive awards. Awards under the Incentive Plan may be granted to employees, directors, consultants or other persons providing services to the Company or its affiliates. The Incentive Plan also provides for awards that are intended to qualify as “performance-based compensation” in order to preserve the deductibility of such compensation by the Company under Section 162(m) of the Internal Revenue Code.
At the 2012 Annual Meeting of Shareholders held on June 8, 2012, shareholders voted to approve the recommendation of the Company’s Board of Directors to amend the Incentive Plan. Significant aspects of this amendment include: an increase of 3 million in the shares reserved for grant, an extension of the term, an expansion of the list of performance goals, a provision for recovery compensation in connection with financial restatements, and certain modifications in order to provide internal consistency.
At the 2013 Annual Meeting of Shareholders held on June 6, 2013, shareholders voted to approve the recommendation of the Company’s Board of Directors to amend the Incentive Plan to add 3 million shares to the shares reserved for grant.
The following table provides certain information related to Stock Options and Restricted Stock during the year ended December 31, 2014 (in thousands, except per share data):
All shares outstanding as of December 31, 2014 are expected to vest.
The following table provides certain information in connection with the Company’s share-based compensation arrangements for the periods presented (in thousands):
Stock Options granted by the Company generally expire between 5 to 7 years from the grant date and generally vest over a 1 to 3 year service period commencing on the grant date.
The following table provides the assumptions utilized in the Black-Scholes model for Stock Options granted during the periods presented:
On September 4, 2012, the Company granted Stock Options for an aggregate 500 thousand shares of Common Stock to the Company’s Chief Operating Officer (“COO”) in consideration for services rendered pursuant to terms of an employment agreement and to provide the COO with a continued incentive to share in the success of the Company. The options have an exercise price of $3.51, expire on September 4, 2019 and vest over two years as follows: options for 250 thousand shares on the one year anniversary of the grant date and options for 250 thousand shares on the two year anniversary of the grant date.
On March 12, 2013, the Company granted the COO a Stock Option to purchase 100 thousand shares of common stock. The option has an exercise price of $4.51 per share, expires on March 12, 2018 and vests over three years as follows: one third on the one (1) year anniversary of the date of grant, one third on the two (2) year anniversary of the date of grant and one third on the three (3) year anniversary of the date of grant.
On November 12, 2013, the Company granted the Chief Administrative Officer (“CAO”) a Stock Option to purchase 200 thousand shares of common stock. The Company also granted the Chief Executive Officer (“CEO”) a Stock Option to purchase 300 thousand shares of common stock. Both option grants have an exercise price of $8.01 per share, expire on November 12, 2020 and vest over three years as follows: one third on the one (1) year anniversary of the date of grant, one third on the two (2) year anniversary of the date of grant and one third on the three (3) year anniversary of the date of grant.
Effective August 23, 2012, the Company issued 650 thousand shares of Restricted Stock at a price of $3.37 per share to its COO. The stock vested cumulatively over a two-year period as follows: 38.5 percent, 77 percent and 100 percent, respectively, on January 1, 2013, January 1, 2014 and December 31, 2014.
Effective August 8, 2013, the Company issued 150 thousand shares of Restricted Stock at a price of $8.55 per share to its Chief Financial Officer. The stock vests cumulatively over a two-year period as follows: 50 percent and 50 percent, respectively, on October 1, 2014 and October 1, 2015.
Effective April 1, 2014, the Company issued 500 thousand shares of Restricted Stock at a price of $12.88 per share to its CEO. The stock vests on April 7, 2015.
Effective April 1, 2014, the Company issued 250 thousand shares of Restricted Stock at a price of $12.88 per share to its COO. The stock vested on December 31, 2014.
Effective April 1, 2014, the Company issued 200 thousand shares of Restricted Stock at a price of $12.88 per share to its CAO. The stock vests cumulatively over a two-year period as follows: 50 percent and 50 percent, respectively, on December 31, 2014 and December 31, 2015.
There were no amounts due to SPC Global RE Advisors LLC as of December 31, 2014 and 2013, respectively. Payments due to Downes and Associates and SPC Global RE Advisors LLC were or are generally made in the month the services are provided.
The following table reconciles the statutory federal income tax rate to the Company’s effective tax rate for the periods presented:
Tax years that remain open for purposes of examination of the Company’s income tax liability due to taxing authorities, include the years ended December 31, 2013, 2012 and 2011. However, there is currently an IRS examination underway related to the loss carryback of realized losses from securities sold during 2012 applied to the 2009 tax year.
The following table reconciles the numerator (i.e., income) and denominator (i.e., shares) of the basic and diluted earnings per share computations for the periods presented (in thousands, except per share data):
There were no amounts of other comprehensive income for the year ended December 31, 2012.
In July 2013, UPCIC entered into a lease agreement (“Lease Agreement”) for an office building adjacent to its principal office in Fort Lauderdale, Florida (“Property”) and expects to use the Property for additional office and storage space. The Company took possession of the Property and began monthly rental payments in October 2013. The lease agreement was classified as an operating lease. As discussed in “NOTE 6 - PROPERTY AND EQUIPMENT,” UPCIC purchased the Property in December 2014.
The following table provides future minimum rental payments required under the non-cancelable operating leases as of the date presented (in thousands):
On December 2, 2014, UIH entered into a letter agreement with Ananke that calls for a minimum annual spend of $5 million towards covered loss index swaps during the period from June 1, 2016 through May 31, 2025.
Excludes $12.5 million of certificates of deposit not subject to remeasurement.
The Company utilizes third-party independent pricing services that provide a price quote for each fixed maturity and equity security and short-term investment. Management reviews the methodology used by the pricing services. If management believes that the price used by the pricing service does not reflect an orderly transaction between participants, management will use an alternative valuation methodology. There were no adjustments made by the Company to the prices obtained from the independent pricing source for any fixed maturities, equity securities or short-term investments included in the tables above.
The improvement in the fourth quarter results for 2014 compared to 2013 includes an increase in revenues of $26.9 million offset by an increase in operating expenses of $16.0 million. The primary driver behind these increases was the reduction of the quota-share cession rate from 45% to 30% in June of 2014. The Company has also benefited from an overall decrease in the cost of certain reinsurance and operational initiatives to expedite the settlement of claims. These initiatives have reduced both the severity of claims as well as the time to settle them, thereby reducing losses and loss adjustment expenses as a percent of earned premium.
The Company performed an evaluation of subsequent events through the date the financial statements were issued and determined there were no recognized or unrecognized subsequent events that would require an adjustment or additional disclosure in the consolidated financial statements as of December 31, 2014.
On January 13, 2015, the Company declared a dividend of $0.12 per share on its outstanding common stock payable on March 2, 2015, to shareholders of record on February 18, 2015.
On February 19, 2015, the company entered into an amended agreement with Ananke to delete, in its entirety effective December 2, 2014, the provision giving rise to the redemption feature described in Note 8. See Note 8 for the pro-forma effects of the amendment under the heading PRO-FORMA INFORMATION CONCERNING STOCKHOLDERS’ EQUITY.