You should read the following discussion in conjunction with our consolidated financial statements and related notes and information included elsewhere in this annual report on Form 10-K. You should review the "Risk Factors" section of this annual report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
HAHC is a property and casualty insurance holding company incorporated in Delaware in 2005. In May 2006, we began selling property and casualty insurance products in Texas and beginning April, 2014, we began offering property and casualty insurance products in Arizona through our subsidiary, Homeowners of America Insurance Company. Through the use of highly automated underwriting tools, we currently offer homeowners, dwelling fire and extended coverage, tenant and condominium owner's policies, within market segments which have proven to have long term profitability. Using internet-enabled applications, our products are offered to the public through independent insurance agents.
We have applied for licenses to write business in thirty-two additional states. To date, we have received certificates of authority from twenty-five including Alabama, Arkansas, Colorado, Delaware, Georgia, Indiana, Illinois, Iowa, Kentucky, Louisiana, Michigan, Missouri, Montana, Nebraska, Nevada, North Carolina, North Dakota, Oregon, South Carolina, South Dakota, Tennessee, Utah, Virginia, Washington, and Wyoming to offer homeowners, dwelling fire and extended coverage, tenant and condominium owner's policies. As a condition of granting a Certificate of Authority, a number of states require alien insurance companies to maintain pledged assets for the purpose of meeting obligations to policyholders and creditors.
The Company began selling homeowners coverage in Arizona in 2014 and plans to begin selling homeowners products in South Carolina and Virginia during 2015. The Company is researching additional states for future expansion, which aren't planned for entry until 2016 or later. Dwelling fire and extended coverage, tenant and condominium owners policies will be added to these expansion states, including Arizona, in the latter half of 2015.
The Company is seeing increased competition from companies entering Texas and has formulated marketing strategies to protect its market share.
 Texas seasonally adjusted unemployment rate was 4.6% at December month end, as compared to the national U.S. rate of 5.6%.
 Single family building permits were up 29.3% year over year as of December month end and single family home sales were up 12.2% year over year as of December month end.
Our principal revenues are earned premiums (which are reported net of reinsurance costs), ceding commissions and policy fees. We cede a substantial portion of our earned premium to reinsurers under a quota share program to mitigate high frequency risks as well as protect us from catastrophic events and under an excess of loss contract program to mitigate losses from catastrophic events. Our principal expenses are claims from policyholders, policy acquisition and other underwriting expenses, and general and administrative expenses.
Net income available to common stockholders was $2,164,125 for the year ended December 31, 2014. As of December 31, 2014 we had total assets of $88.1 million and stockholders' equity of $10.7 million.
Year Ended December 31, 2014 compared to Year Ended December 31, 2013
Commencing August 1, 2014 and ending November 30, 2014, the Company increased its catastrophe coverage through fifth layer reinsurance with third party reinsurers. This layer extended the Company's coverage to $140 million, excess of $4 million of ultimate net loss arising out of each loss occurrence. The Company considered this increased coverage limit during the Atlantic hurricane season to be a prudent risk management decision, given the growth in both the number of policy holders, as well as total insured values. When this coverage was in force, the Company's net retention on each loss occurrence remained at $400,000.
Premium production for the year ended December 31, 2014 was $73.6 million, an increase of $15.7 million or 27.03 % over the same period in 2013. The Company attributes this growth to the effects of an increased number of insured properties, increased pricing in selected markets and maintaining persistency on policies subject to renewal in its target markets.
Gross Premiums Earned for the year ended December 31, 2014 and 2013 were $64.9 million and $53.2 million, respectively. The $11.7 million increase or 21.90 %, is primarily the result of increased property insurance premium, which increased $15.8 million or 27.32 %. The increase in property insurance premium is partially offset by a reduction of $0.1 million in private passenger auto insurance written premium year over year. The Company has made the strategic decision to exit the private passenger auto insurance business, the last policy expired October 2013.
Premiums Ceded for the year ended December 31, 2014 and 2013 were approximately $60.5 million and $48.4 million, respectively. Our premiums ceded represent amounts paid to reinsurers to cover losses under both our quota share and excess of loss reinsurance treaties. Premiums ceded were 93.20 % and 90.95 % of gross premiums earned during the year ended December 31, 2014 and 2013, respectively, primarily the result of our 90% quota share reinsurance program. We expect our reinsurance premiums applicable to the current fiscal year, as well as the reinsurance treaty year, to remain in excess of 90% of direct earned premium, trending slightly upward reflecting our increase in in-force premium. The cost of additional catastrophe coverage the Company purchased during the Atlantic hurricane season was $831,550, which along with the Company's 22 % increase in premiums earned, led to our nearly 25 % increase in ceded earned premiums for the period.
Net Premiums Earned for the year ended December 31, 2014 and 2013 were $4.4 million and $4.8 million, respectively, and reflect the gross premiums earned less the appropriate reinsurance costs as described above.
Reinsurance Profit Sharing income for the year ended December 31, 2014 was $1.7 million compared to $1.3 million for the year ended December 31, 2013. Reinsurance profit sharing income, calculated on a treaty year basis (April - March), is recognized when earned, which includes adjustments to earned reinsurance profit share based on changes in incurred losses. The $400,000 increase in income reported in 2014 as compared to 2013 is primarily due to the positive 4th quarter treaty year 2013 results reported in calendar year 2014.
Net Premiums Written during the year ended December 31, 2014 and 2013 was $8.5 million and $6.3 million, respectively. Net premiums written represent the premiums charged on policies issued during a fiscal period less any applicable quota share reinsurance costs.
Investment Income, Net of Investment Expenses increased approximately 4.69 % for the year ended December 31, 2014, reflecting the Company's change in its investment policy, beginning June 1, 2014. This change included the decision to invest a portion of its excess cash in high quality municipal bonds.
Our Losses and Loss Adjustment Expenses amounted to $2.9 million and $2.3 million, respectively, for the years ended December 31, 2014 and 2013. During the year ended December 31, 2014, we sustained gross losses (losses prior to reinsurance recoveries) totaling $27.7 million primarily from increased severe convectional thunderstorm activity occurring in the calendar year. The same period in 2013, we incurred gross losses (losses prior to reinsurance recoveries) of $18.2 million in losses occurring in the calendar year. Our liability for losses and loss adjustment expense ("Reserves") is more fully described below under "Critical Accounting Policies and Estimates". These Reserves include both case reserves on reported claims and our reserves for incurred but not reported ("IBNR") losses. At each period-end date, the balance of our Reserves is based on our best estimate of the ultimate cost of each claim for those known cases and the IBNR loss reserves are estimated based primarily on our historical experience.
General and Administrative Expenses for the years ended December 31, 2014 and 2013 were $5.5 million and $4.2 million, respectively. The $1.3 million increase includes increases of $0.6 million in employee related costs as our head count grew to support our growth in production, an increase of approximately $0.6 million in professional expenses related to being a public company as well as increases in technology, and other administrative costs. As of December 31, 2014, we had 43 employees all but one whom are full time compared to 39 employees as of December 31, 2013.
Another important measurement of operational effectiveness of the Company is the margin between our fee income and acquisition, underwriting, and other operating expenses due to our reliance on quota share reinsurance, under which approximately 90% of our property insurance premium is ceded to reinsurers. The Company receives a ceding commission from reinsurers for the production of the business. This fee income, along with other policy related fees that the Company charges, are used to offset the underwriting and other operating expenses it incurs in the production of premium. For the year ended December 31, 2014 our acquisition and underwriting and other operating expenses were 92.42 %, of policy related fee income, as compared to 97.69 % for the year ended December 31, 2013.
In addition, the Company completed the placement of an excess of loss catastrophe reinsurance program, effective April 1, 2015, with a panel of third party reinsurers. These treaties replace the Company's excess of loss reinsurance program expiring on March 31, 2015 and provides coverage on the Company's retained risk on its property insurance business. Approximately 60% of the program will be for a period of 24 months, while the remaining 40% will have a term of 12 months.
Insurance companies capital and surplus levels are regularly monitored by the insurance department of its state of domicile. The primary tool used to monitor an insurance company's capital adequacy is the National Association of Insurance Commissioner' Risk Based Capital Model or "RBC". Remedial action of varying severity begin once an insurance company's RBC falls below under 200%. HAIC's ratio at year end 2014 was 458% and 396% at the end of 2013. The industry guidelines for net premium writings to surplus is approximately 3:1. HAIC net writings to surplus were .46 in 2014 and .58 in 2013.
Since inception, we have financed our cash flow requirements through net premiums received and investment income. We believe our cash flow from net premiums and investment income will be sufficient to cover our cash outflows for at least the next 12 months. Beyond the next 12 months, our primary cash flow sources will continue to be from premiums and investment income.
In the insurance industry cash collected for premium from policies written is invested, interest and dividends earned thereon. Our primary cash outflows are claim payments and operating expense. In regard to claim payments, while the substantial portion of our claims are paid out within 90 - 180 days, the period of time payments are made varies by the circumstances of the claim, and loss settlement expenses can be paid over periods of more than one year. Additional cash outflow occurs through payments of underwriting costs such as commissions, taxes, payroll, and overhead expenses.
Net cash provided by operating activities for the year ended December 31, 2014 was approximately $3.5 million. Significant factors in this movement consisted primarily of an increase in cash received from net written premiums and policy related fees less cash disbursed for operating expenses and losses and loss adjustment expenses. Net cash used in investing activities of $6.0 million was primarily due to purchases of fixed-maturity securities, held as available-for-sale of $5.0 million, purchases of short-term investments of $4.3 million, purchases of long-term investments of $3.4 million and the purchases of furniture, equipment, and software of approximately $228,000, offset by redemptions of short-term and long-term investments of $4.4 million and $1.9 million, respectively and $0.6 million from early calls of several fixed-maturity securities, held as available-for-sale. Net cash provided by financing activities totaled $7,850 for proceeds from stock options exercised.
In addition to physical security measures employed at the Company's offsite operations center, which is audited annually under SOC 1 (SSAE No.16) standards, the Company's third party operations center uses firewalls, intrusion detection systems, data base field encryption and other "best practices" to protect access to customer data. Access to the databases is not allowed from outside our network, except for specific IP addresses which the Company has specified and has control over. These configurations are reviewed quarterly, to ensure policies and procedures are followed. The Company's third party operations site administration performs annual "ethical hack" tests to identify possible vulnerabilities.
Deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities. Deferred tax liabilities are recognized for temporary differences that will result in taxable amounts in future years. Deferred tax assets are recognized for deductible temporary differences and tax operating loss and tax credit carry forwards and carry backs. The deferred tax assets and liabilities are measured by applying the enacted tax rates and laws in effect for the years in which such differences are expected to reverse.
We have audited the accompanying consolidated balance sheets of Homeowners of America Holding Corporation and Subsidiaries (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows for each of the two years in the period ended December 31, 2014. The Company's management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). Certain reclassifications of prior year amounts have been made to conform to the current year presentation.
Cash and cash equivalents include cash and highly liquid short-term investments, with original maturities of three months or less. The amount is carried at cost, which approximates fair value. At December 31, 2014 and 2013, cash and cash equivalents consist of cash on deposit with financial institutions, as well as money market mutual funds.
As of December 31, 2014, the Company has restricted cash and investments, in the amount of $4.3 million, to the Department of Insurance in certain states as a condition of its Certificate of Authority for the purpose of meeting obligations to policyholders and creditors, which includes approximately $1.0 million of restricted assets. Restricted assets represent investments currently awaiting substitution with various states for matured securities. As of December 31, 2013, the Company had pledged to the Department of Insurance $1.0 million. Restricted and pledged assets are shown separately in the accompanying consolidated balance sheets as "Restricted cash and investments" and include money market accounts and certificates of deposits. "Restricted fixed-maturity securities, classified as available-for-sale" are shown separately in the accompanying consolidated balance sheets and recorded at fair value. With the approval of the Departments of Insurance, the Company may exchange the investments with other funds or investments. In respect to certificates of deposit, management intends to hold the portion of these restricted investments to their maturity. As such, these restricted certificates of deposit are carried at cost, which approximates fair value. Interest earned on these investments inures to the benefit of the Company.
As of December 31, 2014 and December 31, 2013, the Company's investments also include certificates of deposit that mature more than one year after the balance sheet date and are reflected on the consolidated balance sheets as Long-term investments. Based on management's intent to hold to maturity, these investments are carried at cost. Cost approximates fair value based on the rates currently offered for deposits of similar remaining maturities.
The Company's investments in certificates of deposits and money market accounts do not qualify as securities as defined in the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 320, Investment - Debt and Equity Securities. Accordingly, the fair value disclosures required by FASB ASC Topic 820, Fair Value Measurements and Disclosures are not provided. The Company's fixed-maturity securities classified as available-for-sale are "marked to market" as of the end of each calendar quarter. As of that date, unrealized gains and losses are recorded to Accumulated Other Comprehensive Income, except where such securities are deemed to be other-than-temporarily impaired. Where applicable, the Company assesses investments of an issuer currently carrying a net unrealized loss. If in management's judgment, the decline in value is other than temporary, the cost of the investment is written down to fair value with a corresponding charge to earnings. Factors considered in determining whether an impairment exists include financial condition, business prospects and creditworthiness of the issuer, the length of time and magnitude that the asset value has been less than cost, and the ability and intent to hold such investments until the fair value recovers.
Long-lived assets, such as property, equipment and software, are reviewed for impairment whenever business events or circumstances could lead to or indicate that the value of the asset may not be recoverable. The assessment of possible impairment is based on whether the carrying amount of the assets exceeds its fair value. The Company uses estimates of undiscounted future cash flows in determining the recoverability of long-lived assets. As of December 31, 2014 and 2013, no impairment has been recorded.
Deferred policy acquisitions costs ("DAC") as of December 31, 2014 and 2013, consist of commissions, premium taxes and policy underwriting and production expenses which are incurred through and vary directly with, the level of production of new and renewal insurance business and are amortized over the terms of the policies they relate to. The method used in calculating DAC limits the amount of the deferred cost to their estimated realizable value, which gives effect to allocating their expense along with other period costs associated with the insurance business, in relation to the amount of gross premium earned on policies to which they relate and investment income. DAC is reviewed to determine if it is recoverable from future income, including investment income. The amount of DAC considered recoverable could be reduced in the near term if management's estimates of future premium and investment income is reduced which could impair the Company's ability to recover these costs.
The Company recognizes uncertain tax positions in the consolidated financial statements when it is more-likely-than-not the position will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts. The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns, and that its accruals for tax liabilities are adequate for all open tax years based on an assessment of many factors including experience and interpretations of tax laws applied to the facts of each matter. At December 31, 2014, the Company's tax years from 2010 through 2014 remain subject to examination.
The Company's fixed-maturity securities held as available-for-sale are carried at fair value as of December 31, 2014. Fair value for securities are based on the framework for measuring fair value established by FASB ASC Topic 820, Fair Value Measurements and Disclosures.
The Company accounts for stock-based compensation under the fair value recognition provisions of FASB ASC Topic 718 - Compensation - Stock Compensation, which requires the measurement and recognition of compensation for all stock-based awards made to employees and directors including stock options and restricted stock issuances based on estimated fair values. In accordance with FASB ASC Topic 718, the Company recognizes stock-based compensation, if any, in the consolidated statements of operations on a straight line basis over the vesting period of the stock award. For those stock awards vesting 100 % at the issue date, the Company recognizes stock-based compensation immediately.
Diluted earnings (loss) per share of common stock is computed by dividing net income or loss attributable to common stockholders, adjusted for the effect of potentially dilutive securities, by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include convertible notes payable, outstanding convertible preferred stock and common stock options.
Accounting Standards Update No. 2014-12. On June 19, 2014, the FASB issued Accounting Standards Update No. 2014-12 ("ASU 2014-12"), Compensation-Stock Compensation: Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. ASU 2014-12 requires that a performance target that affects the vesting and that can be achieved after the requisite service period be treated as a performance condition. As of December 31, 2014, the Company has not issued stock options with performance targets under the 2005 Management Incentive Plan or the 2013 Equity Compensation Plan. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements. The effective date of ASU 2014-12 is for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted.
Accounting Standards Update No. 2014-15. In August 2014, the FASB issued Accounting Standards Update No. 2014-15 ("ASU 2014-15"), Presentation of Financial Statements - Going Concern (Subtopic 205-40). The purpose of this update is to provide guidance about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 applies to all reporting entities and is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early adoption is permitted. Adoption of this guidance is expected to have no effect on the Company's consolidated financial statements.
In December 2012, HAHC entered into a Convertible Promissory Note with Inter-Atlantic Fund, L.P. and Phoenix Associates, Inc., ( companies controlled by a shareholder and former director, respectively). See Note 9 Convertible Notes Payable for additional disclosure.
For the year ended December 31, 2014, the Company incurred an expense of $450,000 (of which $150,000 is represented by the issuance of 288,462 shares of common stock), for services performed under the Advisory Agreement.
Investment income, net of investment expenses totaled $43,603 and $41,649 for the years ended December 31, 2014 and 2013, respectively.
Securities with gross unrealized loss positions at December 31, 2014 were immaterial. The Company believes there were no fundamental issues such as credit losses or other factors with respect to any of its available-for-sale securities. The unrealized losses on investments in fixed-maturity securities were caused primarily by interest rate changes. It is expected that the securities would not be settled at a price less than par value of the investments. Because the declines in fair value are attributable to changes in interest rates or market conditions and not credit quality, and because the Company has the ability and intent to hold its available-for-sale investments until a market price recovery or maturity, the Company does not consider any of its investments to be other-than-temporarily impaired at December 31, 2014.
 Level 2 - quoted prices for similar assets in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the investment. Such inputs include market interest rates and volatilities, spreads and yield curves.
Property, equipment, and software net consist of the following as of December 31, 2014 and 2013, respectively:
Depreciation and amortization expense for property, equipment and software totaled $128,107 and $88,770 for the years ended December 31, 2014 and 2013, respectively.
Changes in deferred policy acquisition costs for the years ended December 31, 2014 and 2013 are as follows:
The following table provides the reconciliation of the beginning and ending reserve balances for losses and LAE, gross of reinsurance for 2014 and 2013:
As a result of additional information on claims occurring in prior years becoming available to management, changes in estimates of provisions of claims and claim adjustment expenses were made resulting in an increase of $48,000 and $244,000 for the years ended December 31, 2014 and 2013, respectively.
As of December 31, 2013, the Convertible Promissory Note agreements with Inter-Atlantic Fund, L.P. and Phoenix Associates, Inc. (companies controlled by a shareholder and former director, respectively) in the amounts of $950,000 and $50,000, respectively, with an interest rate equal to 10 % per annum (accelerating to 12.5 % per annum in the event of default) were converted into 2,306,152 and 124,988 common shares, respectively.
During the year ended December 31, 2013, interest expense on these notes totaled $68,164.
There were no common stock warrants issued during the years ended December 31, 2014 and 2013.
The following table represents the reconciliation of the Company's basic earnings per common share and diluted earnings per common share computations reported on the Consolidated Statements of Operations for the year ended December 31, 2014 and 2013:
The Company accounts for stock-based compensation under the fair value recognition provision of FASB ASC Topic 718 - Compensation - Stock Compensation.
The Company's 2005 Management Incentive Plan (the "2005 Plan") provides for granting of stock options to enable the Company to obtain and retain the services of selected persons, both employees and directors, considered to be essential to the long-range success of the Company. Under the 2005 Plan, options may be granted to purchase a total not to exceed 789,475 shares in the aggregate (as adjusted for the 2.5:1 forward split), made up of original issue shares, treasury share or a combination of the two. Options have a life of 10 years and vest at a rate of 25% per year, beginning 12 months from their date of issue. At December 31, 2013, options to purchase 783,750 shares have been granted under the 2005 Plan.
On October 24, 2013, the Board of Directors ("the Board) of the Company unanimously approved and adopted the 2013 Equity Compensation Plan (the "2013 Plan") which became effective October 24, 2013. The 2013 Plan provides granting of stock options, incentive stock options, stock awards, and restricted stock units to enable the Company to obtain and retain the services of selected persons, both employees and directors, considered to be essential to the long-range success of the Company. Under the 2013 Plan, options may be granted to purchase a total not to exceed 2,925,000 shares, made up of original issue shares, treasury shares or a combination of the two. The 2013 Plan will terminate on October 23, 2023. At December 31, 2014, options to purchase 1,965,000 shares of common stock and 39,000 shares of common stock in the form of a stock award had been granted under the 2013 Plan.
At December 31, 2014, options to purchase under the 2005 Plan was 773,500 shares and under the 2013 Plan was 1,965,000 shares for a total of 2,738,500 shares.
A summary of the activity of the Company's stock option plan (as adjusted for the 2.5:1 forward split) for the years ended December 31, 2014 and 2013 is as follows:
The fair value of options granted is estimated using a market value approach and the Black-Scholes option pricing model using the following assumptions for the year ended December 31, 2014 and 2013:
The Company records stock-based compensation expense related to granting stock options in general and administrative expenses. The Company recognized compensation expense as follows for the year ended December 31, 2014 and 2013:
For the 12 month period commencing April 1, 2014 and ending March 31, 2015, the Company reinsured its property and casualty risk under quota share reinsurance treaties with third party reinsurers. The treaties cover 80% of its risk under property coverage on any one loss occurrence not to exceed $110 million; 10% of its risk under property coverage on any one loss occurrence not to exceed $4 million and approximately 64% of its risk under casualty coverage.
Commencing August 1, 2014 and ending November 30, 2014, the Company purchased a fifth layer of property catastrophe reinsurance with third party reinsurers to cover its potential maximum loss during the 2014 hurricane season. The layer extended the Company's coverage to $140 million, excess of $4 million of ultimate net loss arising out of each loss occurrence. When this coverage was in force, the Company's net retention on each loss occurrence remained at $400,000.
From April 1, 2013 through March 31, 2014, the Company reinsured with various third party reinsurers under residential quota share reinsurance treaties, 90% of its risk. The reinsurers' liability under the quota share arrangement beginning in respect to any one loss occurrence shall not exceed $80 million. Property catastrophe treaties, which went into effect on the same day and have the term as the quota share treaties, develop over four layers and cover a gross loss of $76 million excess of $4 million per occurrence. The Company's net retention is $400,000 per occurrence.
As of December 31, 2014, HAIC had restricted cash and investments totaling $4.3 million pledged to the Department of Insurance in certain states as a condition of its Certificate of Authority for the purpose of meeting obligations to policyholders and creditors, which includes $1.0 million of restricted assets. Restricted assets represent investments currently awaiting substitution with various states for matured securities. As of December 31, 2013, HAIC had pledged to the Department of Insurance $1.0 million. See Note 1 Organization and Summary of Significant Accounting Policies, Investments for additional disclosure.
The maximum dividend that may be paid without approval of the Insurance Commissioner is limited to the greater of 10% of the statutory surplus at the end of the preceding calendar year or the statutory net income of the preceding calendar year. No dividends were paid by HAIC in 2014 or 2013.
On February 16, 2015, the Company completed placement of its new 2015 quota share reinsurance program with a panel of third party reinsurers, effective April 1, 2015. The quota share ratio remains the same (90%) as the current program. Certain participants on the program will change from the 2014 program.