SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES ACT OF 1934
For the fiscal year ended December 31, 2002
or
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period of _____________to_______________
Commission file number 0-2500111
21ST CENTURY HOLDING COMPANY
(Exact name of registrant as specified in its Charter)
Florida 65-0248866
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No)
4161 N.W. 5TH STREET, PLANTATION, FLORIDA 33317
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(Address of Principal executive offices) (Zip Code)
Registrant's telephone number, including area code (954) 581-9993
----------------
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, par value $0.01 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-X is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in the Exchange Act Rule 12b-2). Yes [ ] No [X]
The aggregate market value of the Issuer's common stock held by
non-affiliates (based on the last sale of the common stock as reported by the
Nasdaq National Market) on June 30, 2002 was: $13,298,055.
As of March 28, 2003, there were 3,012,201 shares of the common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
21st Century Holding Company's definitive proxy statement for its 2003
annual meeting of shareholders will be filed with the SEC not later than 120
days after the end of the fiscal year covered by this report on Form 10-K
pursuant to General Instruction G (3) of the Form 10-K. Information from such
definitive proxy statement will be incorporated by reference into Part III,
Items 10, 11, 12 and 13 hereof.
General information about 21st Century Holding Company (the "Company")
can be found at www.fedusa.com. The Company makes its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to these reports filed or furnished pursuant to Section 13 or 15(d) of the
Securities and Exchange Act of 1934 available free of charge on its web site, as
soon as reasonably practicable after they are electronically filed with the SEC.
FORWARD-LOOKING STATEMENTS
Statements in this report or in documents that are incorporated by
reference that are not historical fact are forward-looking statements that are
subject to certain risks and uncertainties that could cause actual events and
results to differ materially from those discussed herein. Without limiting the
generality of the foregoing, words such as "may", "will", "expect", "believe",
"anticipate", "intend", "could", "would", "estimate", or "continue" or the
negative other variations thereof or comparable terminology are intended to
identify forward-looking statements. The risks and uncertainties include,
without limitation, uncertainties related to estimates, assumptions and
projections generally; inflation and other changes in economic conditions
(including changes in interest rates and financial markets); pricing competition
and other initiatives by competitors; ability to obtain regulatory approval for
requested rate changes and the timing thereof; legislative and regulatory
developments; the outcome of litigation pending against the Company; risks
related to the nature of the Company's business; dependence on investment income
and the composition of the Company's investment portfolio; the adequacy of its
liability for loss and loss adjustment expense ("LAE"); insurance agents; claims
experience; limited experience in the insurance industry; ratings by industry
services; catastrophe losses; reliance on key personnel; weather conditions
(including the severity and frequency of storms, hurricanes, tornadoes and
hail); changes in driving patterns and loss trends; acts of war and terrorist
activities; courts decisions and trends in litigation and health care and auto
repair costs; and other matters described from time to time by the Company in
this report, and other filings with the SEC. You are cautioned not to place
reliance on these forward-looking statements, which are valid only as of the
date they were made. The Company undertakes no obligation to update or revise
any forward-looking statements to reflect new information or the occurrence of
unanticipated events or otherwise. In addition, investors should be aware that
generally accepted accounting principles prescribe when a company may reserve
for particular risks, including litigation exposures. Accordingly results for a
given reporting period could be significantly affected if and when a reserve is
established for a major contingency. Reported results may therefore appear to be
volatile in certain accounting periods.
PART I
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ITEM 1. BUSINESS
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GENERAL
The Company is a vertically integrated insurance holding company,
which, through its subsidiaries, controls substantially all aspects of the
insurance underwriting, distribution and the claims process. The Company
underwrites personal automobile insurance, homeowners insurance and mobile home
property and casualty insurance in the State of Florida through its wholly-owned
subsidiaries, Federated National Insurance Company ("Federated National") and
American Vehicle Insurance Company ("American Vehicle"). The Company internally
processes claims made by its own and third party insureds through a wholly-owned
claims adjusting company, Superior Adjusting, Inc. ("Superior"). The Company
also offers premium financing to its own and third-party insureds through its
wholly-owned subsidiary, Federated Premium Finance, Inc. ("Federated Premium").
The Company markets and distributes its own and third-party insurers'
products and its other services primarily in South Florida, through a network of
23 agencies, owned by Federated Agency Group, Inc. ("Federated Agency Group"), a
wholly-owned subsidiary, 40 franchised agencies and approximately 125
independent agents. The Company, through its wholly-owned subsidiary, FedUSA,
Inc. ("FedUSA"), franchises agencies under the FedUSA name. As of December 31,
2002, franchises were granted for 40 Fed USA agencies, of which 34 were
operating. The Company intends to focus its future expansion efforts for its
agency network on franchised agencies.
The Company offers income tax preparation software and service through
Express Tax Service, Inc. ("Express Tax"), an 80% owned subsidiary, as well as
franchise opportunities for these services through EXPRESSTAX Franchise
Corporation ("EXPRESSTAX"), a wholly-owned subsidiary of Express Tax. As of
December 31, 2002 there were 136 EXPRESSTAX franchises granted.
The Company believes that it can be distinguished from its competitors
because it generates revenue from substantially all aspects of the insurance
underwriting, distribution and claims process. The Company provides quality
service to both its agents and insureds by utilizing an integrated computer
system, which links the Company's insurance and service entities. The Company's
computer and software systems allow for automated premium quotation, policy
issuance, billing, payment and claims processing and enables the Company to
continuously monitor substantially all aspects of its business. Using these
systems, the Company's agents can access a customer's driving record, quote a
premium, offer premium financing and, if requested, generate a policy on-site.
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The Company believes that these systems have facilitated its ability to market
and underwrite insurance products on a cost-efficient basis, allow Company-owned
and franchised agencies to be a "one stop" shop for insurance, tax preparation
and other services, and will enhance the Company's ability to expand in Florida
and to other states.
The Company's primary products are standard and nonstandard personal
automobile insurance. The former is principally provided to insureds who present
an average risk profile in terms of payment history, driving record, vehicle and
other factors. The latter is principally provided to insureds who are unable to
obtain preferred or standard insurance coverage because of their payment
history, driving record, age, vehicle type or other factors, including market
conditions for preferred or standard risks. Underwriting standards for standard
insurance coverage have become more restrictive, thereby requiring more drivers
to seek coverage in the nonstandard automobile insurance market. These factors
have contributed to an increase in the size of the nonstandard personal
automobile insurance market.
The Company currently underwrites and sells insurance only in Florida;
however, the Company intends to expand to other selected states and American
Vehicle has applied to obtain a license to underwrite and sell personal
automobile insurance in South Carolina and Louisiana. The Company will select
additional states for expansion based on a number of criteria, including the
size of the personal automobile insurance market, statewide loss results,
competition and the regulatory climate. The Company's ability to expand into
other states will be subject to the prior regulatory approval of each state.
Certain states impose operating requirements upon licensee applicants, which may
impose burdens on the Company's ability to obtain a license to conduct insurance
business in those other states. There can be no assurance that the Company will
be able to obtain the required licenses, and the failure to do so would limit
the Company's ability to expand geographically.
The Company's executive offices are located at 4161 N.W. 5th Street,
Plantation, Florida and its telephone number is (954) 581-9993.
BUSINESS STRATEGY
The Company's strategy is to seek continued growth of its business by
capitalizing on the efficiencies of its vertical integration and by:
o expanding into additional states. Currently, American Vehicle
has applied to obtain a license to underwrite and sell
automobile insurance in South Carolina and Louisiana;
o expanding the Company's product offerings to include
commercial general liability insurance for businesses, subject
to regulatory approval;
o expanding its agency network primarily through the sale of
FedUSA franchises;
o employing the business practices developed and used in Florida
in its expansion to other selected states;
o maintaining a commitment to provide quality service to agents
and insureds by emphasizing customer service;
o encouraging agents to place a high volume of quality business
with the Company by providing them with attractive commission
structures tied to premium levels and loss ratios; and
o expanding its EXPRESSTAX franchises to all 50 states.
INSURANCE OPERATIONS AND RELATED SERVICES
UNDERWRITING
GENERAL. The Company underwrites its personal automobile insurance,
homeowners and mobile home property insurance and casualty insurance through
Federated National and personal automobile insurance through American Vehicle.
Federated National and American Vehicle are currently licensed to conduct
business only in Florida, although American Vehicle has applied to obtain a
license to underwrite and sell personal automobile insurance in South Carolina
and Louisiana.
The following tables set forth the amount and percentages of the
Company's gross premiums written and premiums ceded to reinsurers and net
premiums written by line of business for the periods indicated.
3
YEARS ENDED DECEMBER 31,
2002 2001 2000
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PREMIUM PERCENT PREMIUM PERCENT PREMIUM PERCENT
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(DOLLARS IN THOUSANDS)
Written:
Automobile.......................... $52,586 83.4% $ 24,743 72.2% $25,361 79.1%
Homeowners.......................... 8,670 13.8% 7,662 22.4% 4,604 14.3%
Mobile Home......................... 1,780 2.8% 1,866 5.4% 2,109 6.6%
------- ----- -------- ----- ------- -----
Total Written...................... $63,036 100.0% $ 34,271 100.0% $32,074 100.0%
Ceded:
Automobile.......................... $25,286 100.0% $(12,789) 100.0% $(7,625) 100.0%
Homeowners.......................... -- -- -- -- -- --
Mobile Home......................... -- -- -- -- -- --
------- ----- -------- ----- ------- -----
Total Ceded......................... $25,286 100.0% $(12,789) 100.0% $(7,625) 100.0%
Net:
Automobile.......................... $27,300 72.3% $11,954 55.6% $17,736 72.5%
Homeowners.......................... 8,670 23.0% 7,662 35.7% 4,604 18.8%
Mobile Home......................... 1,780 4.7% 1,866 8.7% 2,109 8.7%
------- ----- -------- ----- ------- -----
Total Net............................. $37,750 100.0% $ 21,482 100.0% $24,449 100.0%
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The Company markets its personal automobile insurance through its
network of Company-owned agencies, franchised agencies and independent agents.
STANDARD AUTOMOBILE. Standard personal automobile insurance is
principally provided to insureds who present an average risk profile in terms of
payment history, driving record, vehicle type and other factors. Limits on
standard personal automobile insurance are generally significantly higher than
those for nonstandard coverage, but typically provide for deductibles and other
restrictive terms. The Company is underwriting standard personal automobile
insurance policies providing coverage no higher than $100,000 per individual,
$300,000 per accident for bodily injury, $50,000 per accident for property
damage and comprehensive and collision up to $50,000 per accident, with
deductibles ranging from $200 to $1,000.
NONSTANDARD AUTOMOBILE. Nonstandard personal automobile insurance is
principally provided to insureds that are unable to obtain standard insurance
coverage because of their payment history, driving record, age, vehicle type or
other factors, including market conditions. Underwriting standards for preferred
and standard coverage have become more restrictive, thereby requiring more
insureds to seek nonstandard coverage and contributing to the increase in the
size of the nonstandard automobile market. Nonstandard automobile insurance,
however, generally involves the potential for increased loss exposure and higher
claims experience. Loss exposure is limited because premiums usually are at
higher rates than those charged for standard insurance coverage and because
approximately 37% of the policies issued by the company provide the minimum
coverage required of the policyholder by statute and provide no bodily injury
coverage. The Company currently underwrites nonstandard personal automobile
insurance in Florida, where the minimum limits are $10,000 per individual,
$20,000 per accident for bodily injury, $10,000 per accident for property damage
and comprehensive and $50,000 for collision. The average annual premium on
policies currently in force is approximately $717. Both Federated National and
American Vehicle underwrite this coverage on an annual and semi-annual basis.
Due to the purchasing habits of nonstandard automobile insureds (for
example, insureds seeking the least expensive insurance required of the
policyholder by statute which satisfies the requirements of state laws to
register a vehicle), policy renewal rates tend to be low compared to standard
policies. The Company's experience has been that a significant number of
existing nonstandard policyholders allow their policies to lapse and then
reapply for insurance as new policyholders. The Company's average policy renewal
rate is 35% to 40%. The success of the Company's nonstandard automobile
insurance program, therefore, depends in part on its ability to replace
non-renewing insureds with new policyholders through marketing efforts.
HOMEOWNERS. Federated National underwrites homeowners' insurance
principally in Central and Southern Florida. Homeowners' insurance generally
protects an owner of real and personal property against covered causes of loss
to that property. Limit on homeowners' insurance is generally significantly
higher than those for mobile homes, but typically provide for deductibles and
other restrictive terms. Federated National's property lines typically provide
maximum coverage in the amount of $200,000, with the average policy limit being
approximately $150,000. The average annual premium on policies currently in
force is approximately $1,050 and the typical deductible is $1,000. The Company
markets Federated National's homeowners' insurance through its network of
Company-owned agencies and independent agents.
4
FLOOD. In April 2002 the Company was authorized to write flood
insurance through the National Flood Insurance Program ("NFIP"). The Company
writes the policy for the Federal Flood program which assumes 100% of the flood
risk and the Company retains a commission for its service. The average flood
policy premium is $300 with limits not to exceed $250,000.
MOBILE HOME. Federated National underwrites homeowners insurance for
mobile homes, principally in Central and Northern Florida, where the Company
believes that the risk of catastrophe loss from hurricanes is less than in other
areas of the state. Homeowners' insurance generally protects an owner of real or
personal property against covered causes of loss to that property. Homeowners'
insurance for mobile homes generally involves the potential for above-average
loss exposure. In the absence of major catastrophe losses, loss exposure is
limited because premiums usually are at higher rates than those charged for
non-mobile home property and casualty insurance. Additionally, Federated
National's property lines typically provide maximum coverage in the amount of
$75,000, with the average policy limit being approximately $31,000. In addition,
the Company presently limits its mobile home coverage to no more than 10% of its
underwriting exposure. The average annual premium on policies currently in force
is approximately $315 and the typical deductible is $500. The Company markets
Federated National's mobile home property and casualty insurance through
independent agents.
FUTURE PRODUCTS. The Company intends to expand its product offerings by
underwriting additional insurance products and programs such as commercial
general liability insurance for businesses, and marketing them through its
distribution network. Expansion of the Company's product offerings will result
in a slight increase in expenses due to additional costs incurred in additional
actuarial rate justifications, software and personnel. Offering additional
insurance products may require regulatory approval.
ASSURANCE MGA
Assurance MGA acts as Federated National's and American Vehicle's
exclusive managing general agent. Assurance MGA currently provides all
underwriting policy administration, marketing, accounting and financial services
to Federated National, American Vehicle and the Company's agencies and
participates in the negotiation of reinsurance contracts.
Assurance MGA generates revenue through policy fee income and other
administrative fees from the marketing of companies' products through the
Company's distribution network. Although Assurance MGA recently diverted
business from an unaffiliated insurance company to American Vehicle, and ceased
acting as a third party administrator for this company, Assurance MGA plans to
establish relationships with additional carriers and add additional insurance
products in the future.
SUPERIOR ADJUSTING
The Company internally processes claims made by Federated National's
and American Vehicle's insureds through Superior. The Company-owned agencies and
independent agents have no authority to settle claims or otherwise exercise
control over the claims process. Management believes that the employment of
salaried claims personnel, as opposed to independent adjusters, results in
reduced ultimate loss payments, lower loss adjustment expenses and improved
customer service. The Company only retains independent appraisers and adjusters
on an as needed basis. Additionally, Superior currently adjusts claim files for
the Florida Insurance Guarantee Association on a flat fee per file basis as well
as adjusting claims for another unaffiliated local insurance company.
Claims settlement authority levels are established for each adjuster or
manager based on the employee's ability and level of experience. Upon receipt,
each claim is reviewed and assigned to an adjuster based on the type and
severity of the claim. The Company employs an in-house counsel to monitor
claims-related litigation. The claims policy of the Company emphasizes prompt
and fair settlement of meritorious claims and the establishment of appropriate
liability for claims. The Company believes that the internal processing of
claims enables it to provide quality customer service while controlling claims
adjustment expenses.
FEDERATED PREMIUM
Federated Premium provides premium financing to Federated National's,
American Vehicle's and third-party insureds. Premium financing is marketed
through the Company's distribution network of Company-owned and franchised
agencies (but not through independent agents). Lending operations are supported
by Federated Premium's own capital base and are currently leveraged through a
credit facility with FlatIron Funding Company LLC.
Premiums for property and casualty insurance are typically payable at
the time a policy is placed in force or renewed. Federated Premium's services
allow the insured to pay a portion of the premium when the policy is placed in
force and the balance in monthly installments over the life of the policy. As
security, Federated Premium retains a contractual right, if a premium
installment is not paid when due, to cancel the insurance policy and to receive
the unearned premium from the insurer, or in the event of insolvency of an
insurer, from the Florida Guarantee Association, subject to a $100 per policy
5
deductible. In the event of cancellation, Federated Premium applies the unearned
premium towards the payment obligation of the insured. As part of its premium
financing offered to third-party insureds, Federated Premium may advance funds
for financed premiums to independent insurance agencies that represent
third-party insurers. If remittance is not made by the agency to the third-party
insurer, advances made by Federated Premium may only be recoverable to the
extent that the agency's receipt of such advances is received by the third-party
insurer. In the past, the Company closely monitored the independent insurance
agencies it used to reduce this risk. In order to reduce the amount of charge
offs of uncollected accounts, Federated Premium discontinued financing policies
generated by independent agents in the fourth quarter of 2001. Premium financing
which the Company offers to its own insureds involves limited credit risk.
The following table sets forth the amount and percentages of premiums
financed for Federated National, American Vehicle and other insurers for the
periods indicated:
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
PREMIUMS PERCENT PREMIUMS PERCENT PREMIUMS PERCENT
-------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
Federated National........................ $22,331 55.4% $20,174 43.9% $17,006 38.4%
American Vehicle.......................... 12,850 31.9 1,066 2.3 -- --
Other insurers............................ 5,124 12.7 24,728 53.8 27,293 61.6
------- ----- ------- ----- ------- -----
Total.................................. $40,305 100.0% $45,968 100.0% $44,299 100.0%
======= ===== ======= ===== ======= =====
Federated Premium's operations are funded by a revolving loan agreement
("Revolving Agreement") with FlatIron Funding Company LLC ("FlatIron"). The
Revolving Agreement is structured as a sale of contracts receivable under a sale
and assignment agreement with FPF, Inc. (a wholly-owned subsidiary of FlatIron),
which gives FPF Inc. the right to sell or assign these contracts receivable.
Federated Premium, which services these contracts, has recorded transactions
under the Revolving Agreement as secured borrowings. The Revolving Agreement,
which was amended and revised in September 2001, allowed for a maximum credit
commitment of $7.0 million plus an initial additional amount of $700,000 for the
transition from September 30, 2001 when the previous agreement expired. The line
declined by $100,000 each month beginning November 1, 2001. In September 2002
the line was amended and revised allowing for a maximum credit commitment of
$4.0 million. The decline in the required credit commitment is due primarily to
Federated National and American Vehicle's newly developed direct bill program.
Direct billing is where the insurance company accepts from the insured, as a
receivable, a promise to pay the premium, as opposed to requiring the full
amount of the policy, either directly from the insured or from a premium finance
company. The amount of FPF's advance is subject to availability under a
borrowing base calculation, with maximum advances outstanding not to exceed the
maximum credit commitment. The annual interest rate on advances under the
Revolving Agreement is the prime rate plus additional interest varying from
1.25% to 3.25% based on the prior month's ratio of contracts receivable related
to insurance companies with an A. M. Best rating of B or worse to total
contracts receivable. The Revolving Agreement contains various operating and
financial covenants, with which the Company was in compliance at December 31,
2002 and 2001. The Revolving Agreement, as amended, expires September 30, 2004.
Outstanding borrowings under the Revolving Agreement as of December 31, 2002 and
2001 were approximately $4.3 million and $6.7 million, respectively. Outstanding
borrowings in excess of the $4.0 million commitment totaled $312,420 and are
permissible by reason of a compensating cash balance of $352,433 held for the
benefit of FPF, Inc. Interest expense on this revolving credit line for the
years ended December 31, 2002, 2001 and 2000 totaled approximately $342,000,
$592,000 and $643,000, respectively.
TAX PREPARATION SERVICES AND ANCILLARY SERVICES
The Company also offers other services at its Company-owned and
franchised agencies including tax return preparation and electronic filing and
the issuance and renewal of license tags. In August 1999, the Company acquired
an 80% interest in Express Tax. Express Tax licenses tax return preparation
software to business locations throughout the United States and also earns fees
on all electronically filed returns. Express Tax previously licensed its
software to the Company's agencies and will continue to do so in the future.
FRANCHISE OPERATIONS
FedUSA franchises insurance and financial service. FedUSA commenced the
offering of franchises in December 2000 and as of December 31, 2002 had 34
operating franchises.
The franchise agreement for each FedUSA franchise grants the franchisee
a license for the operation of a FedUSA insurance agency within an exclusive
territory to open and operate a center for a ten-year period, with two
additional ten-year options. FedUSA collects a non-refundable initial franchise
fee of $14,950, royalty fees, advertising fees, and other fees.
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In 2002, EXPRESSTAX began franchising an agency for tax return
preparation, electronic filing and related financial products. The EXPRESSTAX
franchise agreement grants the franchisee a non-exclusive license to open and
operate a center for a ten-year period, with two additional ten-year options.
EXPRESSTAX may collect a non-refundable initial franchise in addition to royalty
fees, advertising fees, and other fees. As of December 31, 2002, 136 EXPRESSTAX
franchises have been granted.
MARKETING AND DISTRIBUTION
The Company markets and distributes its own and third-party insurers'
products and its other services primarily in Central and South Florida through a
network of 23 Company-owned agencies, 34 franchised agencies and approximately
125 independent agents. Company-owned agencies are located in Miami-Dade,
Broward, Palm Beach, Martin, Orange, Osceola, Volusia and Seminole Counties,
Florida. Franchised agencies are located in Miami-Dade, Broward, Palm Beach,
Martin, St. Lucie and Orange Counties, Florida. Independent agents are located
primarily in South Florida. The Company supports its agency network by
advertising in various media in conjunction with its franchised agencies.
Whether Company-employed, franchise-employed or independent, agents
have the authority to sell and bind insurance coverages in accordance with
procedures established by Assurance MGA. Assurance MGA reviews all coverages
bound by the agents promptly and generally accepts all coverages that fall
within stated underwriting criteria. Assurance MGA also has the right, within a
period of 60 days from a policy's inception, to cancel any policy upon 45 days'
notice, even if the risk falls within its underwriting criteria.
The Company believes that its integrated computer system, which allows
for rapid automated premium quotation and policy issuance by its agents, is a
key element in providing quality service to both its agents and insureds. For
example, upon entering a customer's basic personal information, the customer's
driving record is accessed and a premium rate is quoted. If the customer chooses
to purchase the insurance, the system generates the policy on-site. Each agency,
whether company-owned or franchised, is designed to be a "one stop" shop for
insurance, tax preparation and ancillary services.
The Company believes that its distribution system will ultimately
enable it to lower its expense ratio and operate with more favorable loss
experience. A lower expense ratio will, in turn, allow the Company to more
effectively compete with larger providers of automobile insurance as well as
other forms of insurance.
The following table sets forth the amount and percentages of insurance
premiums written through Company-owned agencies, franchised agencies and
independent agents for the periods indicated:
YEARS ENDED DECEMBER 31,
2002 2001 2000
---------------------- ---------------------- ----------------------
PREMIUMS PERCENT PREMIUMS PERCENT PREMIUMS PERCENT
-------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
Through Company-owned agencies.......... 20,403 32.4% $ 9,932 29.0% $12,990 40.5%
Through franchised agencies............. 11,761 18.6% 2,659 7.7% -- --
Through independent agents.............. 30,872 49.0% 21,680 63.3% 19,084 59.5%
------ ----- ------- ---- ------- -----
Total................................ $63,036 100.0% $34,271 100.0% $32,074 100.0%
======= ===== ======= ===== ======= =====
The Company plans to continue to expand its distribution network and
market its products and services in other regions of Florida and other states by
franchising additional insurance agencies and establishing relationships with
additional independent agents. As the Company expands its insurance operations
to other states, the Company will seek to replicate its distribution network in
those states. There can be no assurance, however, that the Company will be able
to obtain the required regulatory approvals to offer additional insurance
products or expand into states other than Florida.
REINSURANCE
The Company follows industry practice of reinsuring a portion of its
risks and paying for that protection based upon premiums received on all
policies subject to such reinsurance. Reinsurance involves an insurance company
transferring or "ceding" all or a portion of its exposure on insurance
underwritten by it to another insurer, known as a "reinsurer." The reinsurer
assumes a portion of the exposure in return for a portion, or quota share, of
the premium, and pays the ceding company a commission based upon the amount of
insurance ceded. The ceding of insurance does not legally discharge the insurer
from its primary liability for the full amount of the policies. If the reinsurer
fails to meet its obligations under the reinsurance agreement, the ceding
company is still required to pay the loss.
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Reinsurance is ceded under separate contracts or "treaties" for the
separate lines of business underwritten. The Company collectively ceded $25.3
million in premiums written for the year ended December 31, 2002. The Company's
reinsurance for automobile insurance is primarily ceded with Transatlantic, an
A++ rated reinsurance company. Federated National ceded 40%, 50% and 30% of
automobile premiums written and losses incurred in 2002, 2001 and 2000,
respectively, to Transatlantic.
American Vehicle ceded 80% of its premiums written and losses incurred
during 2001. From January 2002 until November 2002 the Company reduced its
percentage of ceded premiums written and losses incurred to 70% and then to 40%
effective November 1, 2002.
During 2002 Federated National entered into a 10% quota-share agreement
with its affiliate American Vehicle. The agreement ceded 10% of its premium and
losses on all policies with an effective date of 2002. For presentation purposes
and in accordance with the principles of consolidation the agreement between the
two affiliated insurance companies has been eliminated.
The reinsurance programs renew annually, although the Company
continually reviews the programs and may elect to change it more frequently.
Reinsurance is placed directly by the Company on the automobile line of
business.
The Company is selective in choosing a reinsurer and considers numerous
factors, the most important of which is the financial stability of the
reinsurer, its history of responding to claims and its overall reputation. In an
effort to minimize its exposure to the insolvency of a reinsurer, the Company
evaluates the acceptability and reviews the financial condition of the reinsurer
at least annually. The Company's current policy is to use only reinsurers that
have an A.M. Best rating of "A" (Excellent) or better.
In order to minimize the effect of a natural disaster, the Company
purchases catastrophic reinsurance from both the state run Florida Hurricane
Catastrophe Fund and private re-insurers. The Company insures to the one-in-100
year event. As of December 31, 2002, Federated National would pay approximately
$3 million in claims before catastrophic reinsurance would take effect.
Afterward, the Company would pay all claims in excess of approximately $33
million.
LIABILITY FOR UNPAID LOSSES AND LAE
The Company is directly liable for loss and loss adjustment expense
("LAE") payments under the terms of the insurance policies that it writes. In
many cases there may be a time lag between the occurrence and reporting of an
insured loss to the Company and the Company's payment of that loss. As required
by insurance regulations and accounting rules, the Company reflects its
liability for the ultimate payment of all incurred losses and LAE by
establishing a liability for those unpaid losses and LAE for both reported and
unreported claims, which represent estimates of future amounts needed to pay
claims and related expenses.
When a claim involving a probable loss is reported, the Company
establishes a liability for the estimated amount of the Company's ultimate loss
and LAE payments. The estimate of the amount of the ultimate loss is based upon
such factors as the type of loss, jurisdiction of the occurrence, knowledge of
the circumstances surrounding the claim, severity of injury or damage, potential
for ultimate exposure, estimate of liability on the part of the insured, past
experience with similar claims and the applicable policy provisions.
All newly reported claims received with respect to personal automobile
policies are set up with an initial average liability. The average liability for
these claims are determined every quarter by dividing the number of closed
claims into the total amount paid during the three-month period. If a claim is
open more than 45 days, that open case liability is evaluated and the liability
is adjusted upward or downward according to the facts and damages of that
particular claim.
In addition, management provides for a liability on an aggregate basis
to provide for losses incurred but not reported ("IBNR"). The Company utilizes
independent actuaries to help establish its liability for unpaid losses and LAE.
The Company does not discount the liability for unpaid losses and LAE for
financial statement purposes.
The estimates of the liability for unpaid losses and LAE are subject to
the effect of trends in claims severity and frequency and are continually
reviewed. As part of this process, the Company reviews historical data and
considers various factors, including known and anticipated legal developments,
changes in social attitudes, inflation and economic conditions. As experience
develops and other data become available, these estimates are revised, as
required, resulting in increases or decreases to the existing liability for
unpaid losses and LAE. Adjustments are reflected in results of operations in the
period in which they are made and the liabilities may deviate substantially from
prior estimates.
8
Among the classes of insurance underwritten by the Company, the
automobile and homeowners liability claims historically tend to have longer time
lapses between the occurrence of the event, the reporting of the claim to the
Company and the final settlement than do automobile physical damage and
homeowners property claims. Liability claims often involve parties filing suit
and therefore may result in litigation. By comparison, property damage claims
tend to be reported in a relatively shorter period of time and settle in a
shorter time frame with less occurrence of litigation.
There can be no assurance that the Company's liability for unpaid
losses and LAE will be adequate to cover actual losses. If the Company's
liability for unpaid losses and LAE proves to be inadequate, the Company will be
required to increase the liability with a corresponding reduction in the
Company's net income in the period in which the deficiency is identified. Future
loss experience substantially in excess of established liability for unpaid
losses and LAE could have a material adverse effect on the Company's business,
results of operations and financial condition.
The following table sets forth a reconciliation of beginning and ending
liability for unpaid losses and LAE as shown in the Company's consolidated
financial statements for the periods indicated.
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(DOLLARS IN THOUSANDS)
Balance at January ........................................... $11,005 $ 9,766 $ 6,314
Less reinsurance recoverables............................... (4,798) (2,790) (1,886)
------- ------- -------
Net balance at January 1................................... $ 6,207 $ 6,976 $ 4,428
======= ======= =======
Incurred related to:
Current year................................................ $15,896 $13,586 $13,545
Prior years................................................. 91 2,569 1,445
------- ------- -------
Total incurred............................................. $15,987 $16,155 $14,990
======= ======= =======
Paid related to:
Current year................................................ $ 8,149 $ 8,769 $ 8,013
Prior years................................................. 4,908 8,258 4,429
------- ------- -------
Total paid................................................. $13,057 $17,027 $12,442
======= ======= =======
Balance, American Vehicle, at acquisition date................ $ -- $ 103 $ --
======= ======= =======
Net balance at end of period.................................. $ 9,136 $ 6,207 $ 6,976
Plus reinsurance recoverables............................... 7,848 4,798 2,790
------- ------- -------
Balance at end of period................................... $16,984 $11,005 $ 9,766
======= ======= =======
As shown above, as a result of the Company's review of its liability
for losses and LAE, which includes a re-evaluation of the adequacy of reserve
levels for prior year's claims, the Company increased its liability for loss and
LAE for claims occurring in prior years by $91,000, $2,569,000 and $1,445,000
for the years ended December 31, 2002, 2001 and 2000, respectively. There can be
no assurance concerning future adjustments of reserves, positive or negative,
for claims through December 31, 2002.
Based upon consultations with the Company's independent actuarial
consultants and their statement of opinion on losses and LAE, the Company
believes that the liability for unpaid losses and LAE is currently adequate to
cover all claims and related expenses which may arise from incidents reported
and IBNR.
The following table presents total unpaid loss and LAE, net, and total
reinsurance recoverables shown in the Company's consolidated financial
statements for the periods indicated.
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(DOLLARS IN THOUSANDS)
Loss and LAE, net............................................. $5,585 $2,736 $4,662
IBNR, net..................................................... 3,551 3,471 2,314
------ ------ ------
Total unpaid loss and LAE, net............................. $9,136 $6,207 $6,976
====== ====== ======
Reinsurance recoverable....................................... $4,382 $1,910 $1,861
IBNR recoverable.............................................. 3,466 2,888 929
------ ------ ------
Total reinsurance recoverable.............................. $7,848 $4,798 $2,790
====== ====== ======
9
The following table presents the liability for unpaid losses and LAE
for the Company for the years ended December 31, 1993 through 2002. The top line
of the table shows the estimated net liabilities for unpaid losses and LAE at
the balance sheet date for each of the periods indicated. These figures
represent the estimated amount of unpaid losses and LAE for claims arising in
all prior years that were unpaid at the balance sheet date, including losses
that had been incurred but not yet reported. The portion of the table labeled
"Cumulative paid as of" shows the net cumulative payments for losses and LAE
made in succeeding years for losses incurred prior to the balance sheet date.
The lower portion of the table shows the re-estimated amount of the previously
recorded liability based on experience as of the end of each succeeding year.
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000 1999 1998 1997 1996 1995 1994 1993
------ ------ ------- ------- ------ ------ ------ ------- ------- ------
(DOLLARS IN THOUSANDS)
Balance Sheet Liability $9,136 $6,207 $ 6,976 $ 4,428 $5,366 $4,635 $4,532 $ 3,688 $ 3,355 $2,507
Cumulative paid as of:
One year later.................... 5,275 8,228 4,289 3,460 2,694 2,850 3,250 2,412 1,916
Two years later................... 9,568 5,799 4,499 3,533 3,539 3,898 3,675 2,377
Three years later................. 6,328 5,111 3,972 3,882 4,164 3,901 2,817
Four years later.................. 5,387 4,241 4,107 4,300 3,997 2,897
Five years later.................. 4,325 4,223 4,404 4,054 2,928
Six years later................... 4,262 4,493 4,119 3,027
Seven years later................. 4,423 4,187 3,027
Eight years later................. 4,083 3,091
Nine years later.................. 2,936
Re-estimated net liability as of:
End of year....................... $9,136 $6,207 $ 6,976 $ 4,428 $5,366 $4,635 $4,532 $ 3,688 $ 3,355 $2,507
One year later.................... 6,954 9,445 5,875 4,676 4,360 4,332 4,728 3,654 2,375
Two years later................... 10,197 6,284 5,160 4,063 4,255 4,867 4,540 2,577
Three years later................. 6,605 5,352 4,317 4,102 4,872 4,613 2,981
Four years later.................. 5,515 4,386 4,304 4,748 4,598 3,003
Five years later.................. 4,395 4,321 4,899 4,516 3,023
Six years later................... 4,321 4,905 4,626 3,085
Seven years later................. 4,792 4,644 3,085
Eight years later................. 4,523 3,127
Nine years later.................. 3,081
Cumulative redundancy (deficiency).. $ -- $ (747) $(3,221) $(2,177) $ (149) $ 240 $ 211 $(1,104) $(1,168) $ (574)
The cumulative redundancy or deficiency represents the aggregate change
in the estimates over all prior years. A deficiency indicates that the latest
estimate of the liability for losses and LAE is higher than the liability that
was originally estimated and a redundancy indicates that such estimate is lower.
It should be emphasized that the table presents a run-off of balance sheet
liability for the periods indicated rather than accident or policy loss
development for those periods. Therefore, each amount in the table includes the
cumulative effects of changes in liability for all prior periods. Conditions and
trends that have affected liabilities in the past may not necessarily occur in
the future.
The table below sets forth the differences between Loss and LAE
reserves as disclosed for GAAP basis compared to SAP basis presentation for the
years ending 2002 and 2001.
YEARS ENDED DECEMBER 31,
2002 2001
---- ----
(DOLLARS IN THOUSANDS)
GAAP basis Loss and LAE reserves $16,984 $11,005
Less unpaid Losses and LAE ceded (7,847) (4,798)
Insurance apportionment plan 285 --
------- -------
SAP basis Loss and LAE reserves $ 9,422 $ 6,207
======= =======
The table below sets forth the differences between Loss and LAE
incurred as disclosed for GAAP basis compared to SAP basis presentation for the
years ending 2002, 2001 and 2000.
10
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(DOLLARS IN THOUSANDS)
GAAP basis Loss and LAE incurred $15,987 $16,155 $14,990
Intercompany adjusting and other expenses 2,484 1,440 1,224
Insurance apportionment plan 700 -- --
Other -- 10 --
------- ------- -------
SAP Basis Loss and LAE incurred $19,171 $17,605 $16,214
======= ======= =======
Underwriting results of insurance companies are frequently measured by
their Combined Ratios. However, investment income, Federal income taxes and
other non-underwriting income or expense are not reflected in the Combined
Ratio. The profitability of property and casualty insurance companies depends on
income from underwriting, investment and service operations. Underwriting
results are considered profitable when the Combined Ratio is under 100% and
unprofitable when the Combined Ratio is over 100%.
The following table sets forth Loss Ratios, Expense Ratios and Combined
Ratios for the periods indicated for the insurance business of Federated
National and American Vehicle for 2002. The amounts for 2001 and 2000 are for
Federated National only. The ratios, inclusive of unallocated loss adjustment
expenses ("ULAE"), are shown in the table below, and are computed based upon
SAP. The expense ratios include management fees paid to the Company in the
amount of $0, $0 and $300,000 in 2002, 2001 and 2000, respectively.
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Loss Ratio........................... 60% 82% 80%
Expense Ratio........................ 25% 25% 31%
-- --- ---
Combined Ratio....................... 85% 107% 111%
== === ===
In order to reduce losses and thereby reduce the Loss Ratio and the
Combined Ratio, both Federated National and American Vehicle raised premium
rates once in 2002, and plan to request further rate increases in 2003. The
improved loss ratio for 2002 as compared to 2001 is attributed the $2.6 million
adverse reserve development experienced in 2001 where only $.09 million was
incurred in 2002. Highlights for the improved ratios include, but are not
limited to the termination of unprofitable agency relations, increased scrutiny
over fraudulently asserted claims, streamlined paperless claims processing
system, new claims management supervision and in house legal counsel, as well as
limiting loss exposures in historically high loss areas.
American Vehicle's first full year of operations produced a Loss Ratio
of 72%, an Expense Ratio of 14% and a Combined Ratio of 86% based on SAP.
Comparing Federated National to American Vehicle's Loss, Expense and Combined
Ratios, it should be noted that 2002 was American Vehicle's first full year of
operations under ownership by the Company. As such, the earnings cycle of
American Vehicle is less mature than Federated National's earning cycle.
Generally, for a company writing policies with a term of 12 months the earnings
cycle would not be considered complete until there have been 24 months of
consecutive level written premiums.
COMPETITION
The Company operates in a highly competitive market and faces
competition from both national and regional insurance companies, many of whom
are larger and have greater financial and other resources than the Company, have
favorable A.M. Best ratings and offer more diversified insurance coverage. The
Company's competitors include other companies which market their products
through agents, as well as companies, which sell insurance directly to their
customers. Large national writers may have certain competitive advantages over
agency writers, including increased name recognition, increased loyalty of their
customer base and reduced policy acquisition costs. The Company may also face
competition from new or temporary entrants in its niche markets. In some cases,
such entrants may, because of inexperience, desire for new business or other
reasons, price their insurance below the pricing structure of the Company.
Although the Company's pricing is inevitably influenced to some degree by that
of its competitors, management of the Company believes that it is generally not
in the Company's best interest to compete solely on price, choosing instead to
compete on the basis of underwriting criteria, its distribution network and
superior service to its agents and insureds. The Company competes with respect
to automobile insurance in Florida with more than 100 companies, which
underwrite personal automobile insurance. Companies of comparable or smaller
size, which compete with the Company in the personal automobile insurance
industry, include U.S. Security Insurance Company, United Automobile Insurance
Company, Direct General Insurance Company and Security National Insurance
Company, as well as major insurers such as Progressive Casualty Insurance
Company. Competition could have a material adverse effect on the Company's
business, results of operations and financial condition.
11
REGULATION
GENERAL
The Company is subject to the laws and regulations in Florida and will
be subject to the laws and regulations of any other states in which it seeks to
conduct business in the future. The regulations cover all aspects of its
business and are generally designed to protect the interests of insurance
policyholders, as opposed to the interests of shareholders. Such regulations
relate to authorized lines of business, capital and surplus requirements,
allowable rates and forms (particularly for the nonstandard auto segment),
investment parameters, underwriting limitations, transactions with affiliates,
dividend limitations, changes in control, market conduct, maximum amount
allowable for premium financing service charges and a variety of other financial
and non-financial components of the Company's business. The failure of the
Company to comply with certain provisions of applicable insurance laws and
regulations could have a material adverse effect on the Company's business,
results of operations or financial condition. In addition, any changes in such
laws and regulations including the adoption of consumer initiatives regarding
rates charged for automobile or other insurance coverage, could materially
adversely affect the operations of the Company's, ability to expand its
operations. The Company, however, is unaware of any consumer initiatives, which
could have a material adverse effect on the Company's business, results of
operations or financial condition.
Many states have also enacted laws which restrict an insurer's
underwriting discretion, such as the ability to terminate policies, terminate
agents or reject insurance coverage applications, and many state regulators have
the power to reduce, or to disallow increases in, premium rates. These laws may
adversely affect the ability of an insurer to earn a profit on its underwriting
operations.
Most states have insurance laws requiring that rate schedules and other
information be filed with the state's insurance regulatory authority, either
directly or through a rating organization with which the insurer is affiliated.
The regulatory authority may disapprove a rate filing if it finds that the rates
are inadequate, excessive or unfairly discriminatory. Rates, which are not
necessarily uniform for all insurers, vary by class of business, hazard covered,
and size of risk. Florida and several other states have recently adopted laws or
are considering proposed legislation which, among other things, limit the
ability of insurance companies to effect rate increases or to cancel, reduce or
non-renew insurance coverage with respect to existing policies, particularly
personal automobile insurance.
Most states require licensure or regulatory approval prior to the
marketing of new insurance products. Typically, licensure review is
comprehensive and includes a review of a company's business plan, solvency,
reinsurance, character of its officers and directors, rates, forms and other
financial and non-financial aspects of a company. The regulatory authorities may
not allow entry into a new market by not granting a license or by withholding
approval.
All insurance companies must file quarterly and annual statements with
certain regulatory agencies and are subject to regular and special examinations
by those agencies. The last regulatory examination of Federated National covered
the three-year period ended on December 31, 1998. No material deficiencies were
found during this regulatory examination. In some instances, various states
routinely require deposits of assets for the protection of policy holders either
in those states or for all policyholders. As of December 31, 2002, Federated
National and American Vehicle hold investment securities with a fair value of
approximately $1,027,000 and $1,066,000, respectively, as deposits with the
State of Florida.
Under Florida law, a domestic insurer may not pay any dividend or
distribute cash or other property to its shareholders except out of that part of
its available and accumulated capital surplus funds which is derived from
realized net operating profits on its business and net realized capital gains. A
Florida domestic insurer may not make dividend payments or distributions to
shareholders without prior approval of the Florida Department of Financial
Services if the dividend or distribution would exceed the larger of (i) the
lesser of (a) 10.0% of its capital surplus or (b) net income, not including
realized capital gains, plus a two-year carryforward, (ii) 10.0% of capital
surplus with dividends payable constrained to unassigned funds minus 25% of
unrealized capital gains or (iii) the lesser of (a) 10.0% of capital surplus or
(b) net investment income plus a three-year carryforward with dividends payable
constrained to unassigned funds minus 25.0% of unrealized capital gains.
Alternatively, a Florida domestic insurer may pay a dividend or distribution
without the prior written approval of the Florida Department of Financial
Services (i) if the dividend is equal to or less than the greater of (a) 10.0%
of the insurer's capital surplus as regards policyholders derived from realized
net operating profits on its business and net realized capital gains or (b) the
insurer's entire net operating profits and realized net capital gains derived
during the immediately preceding calendar year, (ii) the insurer will have
policy holder capital surplus equal to or exceeding 115.0% of the minimum
required statutory capital surplus after the dividend or distribution, (iii) the
insurer files a notice of the dividend or distribution with the Florida
Department of Financial Services at least ten business days prior to the
dividend payment or distribution and (iv) the notice includes a certification by
an officer of the insurer attesting that, after the payment of the dividend or
distribution, the insurer will have at least 115% of required statutory capital
surplus as to policyholders. Except as provided above, a Florida domiciled
insurer may only pay a dividend or make a distribution (i) subject to prior
approval by the Florida Department of Financial Services or (ii) 30 days after
the Florida Department of Financial Services has received notice of such
dividend or distribution and has not disapproved it within such time.
12
Under these laws, Federated National would be permitted to pay
dividends of approximately $142,000 to the Company in 2003, and American Vehicle
would be permitted to pay $9,000 in dividends in 2003. Although the Company
believes that amounts required for it to meet its financial and operating
obligations will be available from sources other than dividends from insurance
subsidiaries, there can be no assurance in this regard. Further, there can be no
assurance that, if requested, the Florida Department of Financial Services will
allow any dividends in excess of the amount available, to be paid by Federated
National to the Company in the future. No dividends were paid by Federated
National or American Vehicle in 2002, 2001 or 2000, and none are anticipated in
2003.The maximum dividends permitted by state law are not necessarily indicative
of an insurer's actual ability to pay dividends or other distributions to a
parent company, which also may be constrained by business and regulatory
considerations, such as the impact of dividends on capital surplus, which could
affect an insurer's competitive position, the amount of premiums that can be
written and the ability to pay future dividends. Further, state insurance laws
and regulations require that the statutory capital surplus of an insurance
company following any dividend or distribution by it be reasonable in relation
to its outstanding liabilities and adequate for its financial needs.
While the non-insurance company subsidiaries are not subject directly
to the dividend and other distribution limitations, insurance holding company
regulations govern the amount that any affiliate within the holding company
system may charge any of the insurance companies for service (e.g., management
fees and commissions).
In order 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 policy holders. 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 requirements establish various levels of
regulatory action. Based upon the 2002 statutory financial statements for
Federated National and American Vehicle, each company's statutory surplus
exceeds all regulatory action levels established by the NAIC. The Florida
Department of Financial Services, which follows these requirements, could
require Federated National or American Vehicle to cease operations in the event
they fail to maintain the required statutory capital.
The extent of regulatory intervention and action increases as the ratio
of an insurer's statutory surplus to its Authorized Control Level ("ACL"), as
calculated under the NAIC's requirements, decreases. The first action level, the
Company Action Level, requires an insurer to submit a plan of corrective actions
to the insurance regulators if statutory surplus falls below 200.0% of the ACL
amount. The second action level, the Regulatory Action Level, requires an
insurer to submit a plan containing corrective actions and permits the insurance
regulators to perform an examination or other analysis and issue a corrective
order if statutory surplus falls below 150.0% of the ACL amount. The Authorized
Control Level, the third action level, allows the regulators to rehabilitate or
liquidate an insurer in addition to the aforementioned actions if statutory
surplus falls below the ACL amount. The fourth action level is the Mandatory
Control Level, which requires the regulators to rehabilitate or liquidate the
insurer if statutory surplus falls below 70.0% of the ACL amount. Federated
National's ratio of statutory surplus to its ACL was 274.2%, 300.8% and 273.2%
at December 31, 2002, 2001 and 2000, respectively. American Vehicle's ratio of
statutory surplus to its ACL was 412.4% and 3,234.6% at December 31, 2002 and
2001, respectively. Regulatory action is triggered if surplus falls below 200.0%
of the ACL amount.
The NAIC has also developed Insurance Regulatory Information Systems
("IRIS") ratios to assist state insurance Department of Financial Services in
identifying companies, which may be developing performance or solvency problems,
as signaled by significant changes in the companies' operations. Such changes
may not necessarily result from any problems with an insurance company, but may
merely indicate changes in certain ratios outside the ranges defined as normal
by the NAIC. When an insurance company has four or more ratios falling outside
"usual ranges," state regulators may investigate to determine the reasons for
the variance and whether corrective action is warranted. As of December 31,
2002, Federated National was outside NAIC's usual ranges with respect to its
IRIS tests on 7 out of 12 ratios. Federated National was not in the "usual
ranges" primarily because of the loss stemming from its other than temporary
write down of the WorldCom bonds and because of the short fall in Federated
National's loss and LAE reserves in 2000 and 1999. IRIS ratios in excess of
"usual ranges" relative to surplus growth stemmed from the Company's infusion of
$2.1 million into Federated National. Federated National has carefully reviewed
its loss and LAE reserves and management believes that such reserves at December
31, 2002 are adequate. American Vehicle was outside NAIC's usual ranges on six
ratios primarily because American Vehicle was in operation for the entire year
2002 as compared to 2001 when it resumed business in November. Prior to 2001
American Vehicle had not written insurance policies since 1997 and was under
capitalized. Management does not currently believe that the Florida Department
of Financial Services will take any significant action with respect to Federated
National or American Vehicle regarding the IRIS ratios, although there can be no
assurance that will be the case.
13
Effective January 1, 2001, the Company's insurance subsidiaries adopted
the Codification of Statutory Accounting Principles guidance issued by the NAIC,
which provides guidance for areas where statutory accounting has been silent and
changes current accounting in some areas. The adoption of this codification did
not have a material effect on the Company's consolidated financial statements.
INSURANCE HOLDING COMPANY REGULATION
The Company is subject to laws governing insurance holding companies in
Florida where Federated National and American Vehicle are domiciled. These laws,
among other things, (i) require the Company to file periodic information with
the Florida Department of Financial Services, including information concerning
its capital structure, ownership, financial condition and general business
operations, (ii) regulate certain transactions between the Company and its
affiliates, including the amount of dividends and other distributions and the
terms of surplus notes and (iii) restrict the ability of any one person to
acquire certain levels of the Company's voting securities without prior
regulatory approval. Any purchaser of 5% or more of the outstanding shares of
Common Stock of the Company will be presumed to have acquired control of
Federated National and American Vehicle unless the Florida Insurance
Commissioner, upon application, determines otherwise.
FINANCE COMPANY REGULATION
The Company's premium financing program is also subject to certain laws
governing the operation of premium finance companies. These laws pertain to such
matters as books and records that must be kept, forms, licensing, fees and
charges. For example, in Florida, the maximum late payment fee Federated Premium
may charge is the greater of $10 per month or 5% of the amount of the overdue
payment.
FRANCHISE COMPANY REGULATION
FedUSA and EXPRESSTAX are subject to Federal Trade Commission ("FTC")
regulation, and state and international laws, which regulate the offer and sale
of franchises. FedUSA and EXPRESSTAX are also subject to a number of state laws,
which regulate substantive aspects of the franchisor-franchisee relationship.
The FTC's Trade Regulation Rule on Franchising (the "FTC Rule") require FedUSA
and EXPRESSTAX to furnish to prospective franchisees a franchise offering
circular containing information prescribed by the FTC Rule.
State laws that regulate the offer and sale of franchises and the
franchisor-franchisee relationship presently exist in a substantial number of
states. Such laws often require registration of the franchise offering with
state authorities and regulate the franchise relationship by, for example,
requiring the franchisor to deal with its franchisees in good faith, prohibiting
interference with the right of free association among franchisees, limiting the
imposition of standards of performance on a franchisee and regulating
discrimination among franchisees in charges, royalties or fees.
UNDERWRITING AND MARKETING RESTRICTIONS
During the past several years, various regulatory and legislative
bodies have adopted or proposed new laws or regulations to address the cyclical
nature of the insurance industry, catastrophic events and insurance capacity and
pricing. These regulations include (i) the creation of "market assistance plans"
under which insurers are induced to provide certain coverages, (ii) restrictions
on the ability of insurers to rescind or otherwise cancel certain policies in
mid-term, (iii) advance notice requirements or limitations imposed for certain
policy non-renewals and (iv) limitations upon or decreases in rates permitted to
be charged.
LEGISLATION
From time to time, new regulations and legislation are proposed to
limit damage awards, to control plaintiffs' counsel fees, to bring the industry
under regulation by the Federal government, to control premiums, policy
terminations and other policy terms and to impose new taxes and assessments. It
is not possible to predict whether, in what form or in what jurisdictions, any
of these proposals might be adopted, or the effect, if any, on the Company.
INDUSTRY RATINGS SERVICES
Federated National received a B rating and American Vehicle received a
B+ rating from A.M. Best during 2002. A.M. Best's ratings are based upon factors
of concern to agents, reinsurers and policyholders and are not primarily
directed toward the protection of investors. Federated National and American
Vehicle are both rated "A" (Exceptional) by Demotech, Inc.
14
EMPLOYEES
As of December 31, 2002, the Company and its subsidiaries had 233
employees, including four executive officers. The Company is not a party to any
collective bargaining agreement and has not experienced work stoppages or
strikes as a result of labor disputes. The Company considers relations with its
employees to be satisfactory.
EXECUTIVE OFFICERS
Set forth below is certain information concerning an executive officer
of the Company who is not also a director of the Company:
James Gordon Jennings, III was appointed Chief Financial Officer of the
Company in August 2002. Mr. Jennings became the Company's Controller in May 2000
and for approximately ten years prior thereto was employed by American Vehicle,
where he was formally involved with all aspects of property and casualty
insurance since then. Mr. Jennings', formerly a certified public accountant,
also holds a Certificate in General Insurance and an Associate in Insurance
Services as designated by the Insurance Institute of America.
James A. Epstein was appointed Secretary in January 2002. Mr. Epstein
joined the Company as General Counsel in September 2002.
GLOSSARY OF SELECTED TERMS
CEDE To transfer to an insurer or reinsurer all
or part of the insurance written by an
insurance entity.
CEDING COMMISSION A payment by a reinsurer to the ceding
company, generally on a proportional basis,
to compensate the ceding company for its
policy acquisition costs.
COMBINED RATIO The total of the Loss Ratio plus the Expense
Ratio on either SAP or GAAP basis.
EXPENSE RATIO Under SAP, the ratio of underwriting
expenses to net written premiums. Using GAAP
basis, the ratio of underwriting expenses to
net premiums earned.
GENERALLY ACCEPTED ACCOUNTING Accounting practices and principles, as
PRINCIPLES ("GAAP") defined principally by the American
Institute of Certified Public Accountants,
the Financial Accounting Standards Board.
GAAP is the method of accounting typically
used by the Company for reporting to persons
or entities other than insurance regulatory
authorities.
GROSS PREMIUMS WRITTEN The total of premiums received or to be
received for insurance written by an insurer
during a specific period of time without any
reduction for reinsurance ceded.
HARD MARKET The portion of the market cycle of the
property and casualty insurance industry
characterized by constricted industry
capital and underwriting capacity,
increasing premium rates and, typically,
enhanced underwriting performance.
INCURRED BUT NOT REPORTED LOSSES The estimated liability of an insurer, at a
("IBNR") given point in time, with respect to losses
that have been incurred but not yet reported
to the insurer, and for potential future
developments on reported claims.
INSURANCE REGULATORY INFORMATION A system of ratio analysis developed by the
SYSTEM ("IRIS") NAIC primarily intended to assist state
insurance Department of Financial Services
in executing their statutory mandates to
oversee the financial condition of insurance
companies.
LOSS ADJUSTMENT EXPENSE ("LAE") The expense of investigating and settling
claims, including legal fees, outside
adjustment expenses and other general
expenses of administering the claims
adjustment process.
LOSS RATIO Under both SAP and GAAP, net losses and LAE
incurred, divided by net premiums earned,
expressed as a percentage.
15
LOSS RESERVES The estimated liability of an insurer, at a
given point in time, with respect to unpaid
incurred losses, including losses, which are
IBNR and related LAE.
LOSSES INCURRED The total of all policy losses sustained by
an insurance company during a period,
whether paid or unpaid. Incurred losses
include a provision for claims that have
occurred but have not yet been reported to
the insurer.
NATIONAL ASSOCIATION OF INSURANCE A voluntary organization of state insurance
COMMISSIONERS ("NAIC") officials that promulgates model laws
regulating the insurance industry, values
securities owned by insurers, develops and
modifies insurer financial reporting,
statements and insurer performance criteria
and performs other services with respect to
the insurance industry.
NET PREMIUMS EARNED The amount of net premiums written allocable
to the expired period of an insurance policy
or policies.
NET PREMIUMS WRITTEN The gross premiums written during a specific
period of time, less the portion of such
premiums ceded to (reinsured by) other
insurers.
NONSTANDARD Risks that generally have been found
unacceptable by standard lines insurers for
various underwriting reasons.
REINSURANCE A procedure whereby a primary insurer
transfers (or "cedes") a portion of its risk
to a reinsurer in consideration of a payment
of premiums by the primary insurer to the
reinsurer for their assumption of such
portion of the risk. Reinsurance can be
affected by a treaty or individual risk
basis. Reinsurance does not legally
discharge the primary insurer from its
liabilities with respect to its obligations
to the insured.
REINSURERS Insurers (known as the reinsurer or assuming
company) who agree to indemnify another
insurer (known as the reinsured or ceding
company) against all or part of a loss that
the latter may incur under a policy or
policies it has issued.
RISK-BASED CAPITAL REQUIREMENTS Capital requirements for property and
("RBC") casualty insurance companies adopted by the
NAIC to assess minimum capital requirements
and to raise the level of protection that
statutory surplus provides for policy holder
obligations.
SOFT MARKET The portion of the market cycle of the
property and casualty insurance industry
characterized by heightened premium rate
competition among insurers, increased
underwriting capacity and, typically,
depressed underwriting performance.
STANDARD AUTOMOBILE INSURANCE Personal automobile insurance written for
those individuals presenting an average risk
profile in terms of loss history, driving
record, type of vehicle driven and other
factors.
STATUTORY ACCOUNTING PRACTICES Those accounting principles and practices
("SAP") which provide the framework for the
preparation of financial statements, and the
recording of transactions, in accordance
with the rules and procedures adopted by
regulatory authorities, generally
emphasizing solvency consideration rather
than a going concern concept of accounting.
The principal differences between SAP and
GAAP are as follows: (a) SAP, certain assets
(non-admitted assets) are eliminated from
the balance sheet; (b) under SAP, policy
acquisition costs are expensed upon policy
inception, while under GAAP they are
deferred and amortized over the term of the
policies; and (c) under SAP, certain
reserves are recognized which are not
recognized under GAAP.
16
UNDERWRITING The process whereby an underwriter reviews
applications submitted for insurance
coverage and determines whether it will
provide all or part of the coverage being
requested, and the price of such premiums.
Underwriting also includes an ongoing review
of existing policies and their pricing.
UNDERWRITING EXPENSE The aggregate of policy acquisition costs,
including that portion of general and
administrative expenses attributable to
underwriting operations.
UNEARNED PREMIUMS The portion of premiums written representing
unexpired policy terms as of a certain date.
ITEM 2. PROPERTIES
- ------- ----------
Federated National owns the Company's current headquarters in
Plantation, Florida, a two-story building with approximately 13,960 square feet
of office space. Federated National also owns and partially occupies a
three-story building with approximately 39,250 square feet of office space in
Lauderdale Lakes, Florida. Approximately 75.5% of the Lauderdale Lakes building
is leased to third parties and the remainder is occupied by Federated National
or is vacant.
The Company's agencies are primarily located in leased locations
pursuant to leases expiring at various times through February 2016. The
aggregate annual rental for the facilities is approximately $371,000. Two
locations are owned by the Company.
The Company believes that these facilities are adequate for its current
needs.
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations, or liquidity.
In June 2000, a lawsuit was filed against the Company and its directors
and executive officers seeking compensatory damages on the basis of allegations
that the Company's amended registration statement dated November 4, 1998 was
inaccurate and misleading concerning the manner in which the Company recognized
ceded insurance commission income, in violation of Sections 11 and 15 of the
Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934. The lawsuit was filed in the United States District Court for the
Southern District of New York and seeks class action status. The plaintiff class
purportedly includes purchasers of the Company's common stock between November
5, 1998 and August 13, 1999. The Company believes that the lawsuit is without
merit and is vigorously defending such action. The Court recently denied the
Company's Motion to Dismiss the plaintiff's First Amended Complaint and the
Company filed an Answer and Affirmative Defenses.
Prior to its acquisition by the Company in 2001, American Vehicle was
involved in litigation with a former officer and director. The litigation was
adjudicated and American Vehicle, among others, was found liable and paid the
final judgment. A petition was filed seeking costs of $136,000 and appellate
attorneys fees in excess of $2.0 million for fees American Vehicle's previous
owners have agreed to indemnify the Company against any such fees and costs and,
the $500,000 purchase price for American Vehicle is held in escrow pending
settlement of the fees and costs issued. On February 26, 2003, the 11th Judicial
Circuit in Miami, Florida entered an amended final judgment awarding the
plaintiffs $1,140,387 in attorney fees and costs. Both parties are appealing
this judgment. Management anticipates that there will be no costs associated
with the settlement of this case, consequently, no liability for fees and costs
have been accrued.
The Company, as a direct premium writer in the State of Florida, is
required to participate in certain insurer solvency pools under Florida Statutes
631.57(3)(a). Participation in these pools is based on the Company's written
premium by line of business to total premiums written statewide by all insurers.
Participation may result in assessments against the Company. The Company was
assessed $258,000 and $203,000, for the years ended December 31, 2002 and 2001,
respectively. During 2002 the Company recovered $180,000 of the 2001 assessment
and is entitled to recover all of these assessments as permitted by the state of
Florida through policy surcharges in 2003. For the years ended December 31, 2000
and 1999, no amounts were assessed against the Company.
Federated National and American Vehicle are also required to
participate in an insurance apportionment plan under Florida Statutes 627.351
referred to as a Joint Underwriting Association Plan ("JUA Plan"). The "JUA
Plan" shall provide for the equitable apportionment of any profits realized, or
losses and expenses incurred, among participating insurers. In the event of an
underwriting deficit incurred by the "JUA Plan" and the deficit is not recovered
17
through the policyholders in the "JUA Plan", such deficit shall be recovered
from the companies participating in the "Plan" in the proportion that the net
direct premiums of each such member written during the preceding calendar year
bear to the aggregate net direct premiums written in this state by all members
of the joint underwriting "JUA Plan".
No assessments by have been incurred by either insurance company
through the date of issuance of this report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
None
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
- ------- -------------------------------------------------
STOCKHOLDER MATTERS
-------------------
(a) MARKET INFORMATION
The Company's common stock has been listed for trading on the Nasdaq
National Market under the symbol "TCHC" since November 5, 1998. For the calendar
quarters indicated, the table below sets forth the high and low closing prices
per share of the common stock based on published financial resources.
QUARTER ENDED HIGH LOW
------------- ---- ---
March 31, 2002 $ 4.89 $3.04
June 30, 2002 $12.20 $4.55
September 30, 2002 $ 7.45 $4.29
December 31, 2002 $13.61 $6.68
March 31, 2001 $ 3.38 $1.91
June 30, 2001 $ 3.10 $2.03
September 30, 2001 $ 2.65 $0.98
December 31, 2001 $ 3.15 $1.50
(b) HOLDERS
As of March 28, 2003, there were approximately 37 holders of record of
the Company's common stock. The Company believes that the number of beneficial
owners of its Common Stock is in excess of 850.
(c) DIVIDENDS
The Company paid a quarterly dividend of $0.02 per share on its common
stock from the fourth quarter of 2000, until the third quarter of 2002. The
Company declared a $0.05 per share dividend in the third quarter of 2002 and a
$0.06 per share dividend in the fourth quarter of 2002. The Company expects to
continue to pay a quarterly dividend in the future. However, payment of
dividends in the future will depend on the Company's earnings and financial
position and such other factors, as the Company's Board of Directors deems
relevant. Moreover, the ability of the Company to continue to pay dividends may
be restricted by regulatory limits on the amount of dividends that Federated
National and American Vehicle are permitted to pay to the Company.
(d) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The section under the heading "Executive Compensation" entitled "Equity
Compensation Plan Information for Fiscal 2003" in the Company's proxy statement
for the 2003 annual meeting of shareholders is incorporated herein by reference.
For additional information concerning the Company's capitalization
please see Note 16, "Stock Compensation Plans" of the Notes to the Consolidated
Financial Statements included in Item 8.
18
ITEM 6. SELECTED FINANCIAL DATA
- ------- -----------------------
As of or for the year ended December 31,
---------------------------------------
OPERATIONS DATA: 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Revenue:
Gross premiums written ........................ $ 63,036,468 $ 34,271,338 $ 32,073,768 $ 19,273,561 $ 21,195,144
Gross premiums ceded .......................... (25,286,828) (12,789,404) (7,625,095) (6,221,853) (6,628,270)
------------ ------------ ------------ ------------ ------------
Net premiums written ...................... 37,749,640 21,481,934 24,448,673 13,051,708 14,566,874
Decrease (increase) in unearned premiums,
net of prepaid reinsurance premiums ......... (8,356,636) (1,226,373) (4,127,334) 404,640 (604,143)
------------ ------------ ------------ ------------ ------------
Net premiums earned ....................... 29,393,004 20,255,561 20,321,339 13,456,348 13,962,731
Commission income ............................. 1,905,936 2,828,779 2,780,869 4,410,856 2,036,637
Finance revenue ............................... 4,452,626 5,267,523 5,709,848 3,696,843 1,825,268
Managing general agent fees ................... 1,970,226 5,871,388 5,410,500 963,797 971,794
Net investment income ......................... 1,253,765 1,066,641 1,225,413 853,659 983,592
Net realized investment gains (losses) ........ (1,369,961) (2,911,658) (109,256) 952,153 441,810
Other income .................................. 2,973,950 3,098,332 2,214,894 1,043,798 446,635
------------ ------------ ------------ ------------ ------------
Total revenue ............................. 40,579,545 35,476,566 37,553,607 25,377,454 20,668,467
------------ ------------ ------------ ------------ ------------
Expenses:
Losses and loss adjustment expenses ........... 15,987,125 16,154,902 14,990,118 8,094,677 9,133,332
Operating and underwriting expenses ........... 10,778,990 11,644,183 11,892,577 7,032,428 4,291,613
Salaries and wages ............................ 8,004,694 8,478,771 9,375,775 7,474,572 4,042,226
Amortization of deferred acquisition costs, net (2,064,314) 1,467,238 1,673,754 (18,563) 179,057
Amortization of goodwill ...................... -- 540,010 606,653 547,548 239,619
------------ ------------ ------------ ------------ ------------
Total expenses ............................ 32,706,495 38,285,104 38,538,877 23,130,662 17,885,847
------------ ------------ ------------ ------------ ------------
Income (loss) before provision for income
tax expense and extraordinary gain ............ 7,873,050 (2,808,538) (985,270) 2,246,792 2,782,620
(Provision) benefit for income tax expense ....... (3,302,849) 630,553 462,396 (680,061) (965,000)
------------ ------------ ------------ ------------ ------------
Net income (loss) and extraordinary gain .. 4,570,201 (2,177,985) (522,874) 1,566,731 1,817,620
Extraordinary gain ............................... -- 1,185,895 -- -- --
------------ ------------ ------------ ------------ ------------
Net income (loss) ......................... $ 4,570,201 $ (992,090) $ (522,874) $ 1,566,731 $ 1,817,620
============ ============ ============ ============ ============
Basic net income (loss) per share
before extraordinary gain ..................... $ 1.52 $ (0.69) $ (0.15) $ 0.46 $ 0.79
============ ============ ============ ============ ============
Extraordinary gain ............................... -- 0.38 -- -- --
============ ============ ============ ============ ============
Basic net income (loss) per share ................ $ 1.52 $ (0.31) $ (0.15) $ 0.46 $ 0.79
============ ============ ============ ============ ============
Cash dividends declared per share ................ $ 0.15 $ 0.08 $ 0.02 -- --
============ ============ ============ ============ ============
BALANCE SHEET DATA:
Total assets ..................................... $ 75,318,011 $ 56,228,577 $ 55,412,969 $ 38,686,404 $ 38,176,403
Investments ................................... 25,377,796 17,507,422 18,965,798 13,916,571 17,705,266
Finance contracts, consumer loans and
pay advances receivable, net ................ 7,217,873 10,813,881 13,792,791 9,642,163 7,093,593
Total liabilities ................................ 57,220,348 42,019,446 40,456,972 22,932,516 23,208,580
Unpaid losses and loss adjustment expenses .... 16,983,756 11,005,337 9,765,848 6,314,307 7,603,460
Unearned premiums ............................. 28,934,486 14,951,228 13,038,417 8,037,083 8,534,320
Revolving credit outstanding .................. 4,312,420 6,676,817 8,091,034 4,650,026 2,062,948
Total shareholders' equity ....................... $ 18,097,664 $ 14,209,131 $ 14,955,997 $ 15,753,888 $ 14,967,823
Book value per share ............................. $ 6.02 $ 4.69 $ 4.49 $ 4.67 $ 4.47
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
- ------- -----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
OVERVIEW
The Company is a vertically integrated insurance holding company,
which, through its subsidiaries, controls substantially all aspects of the
insurance underwriting, distribution and claims process. The Company underwrites
personal automobile insurance and homeowners and mobile home property and
casualty insurance in the State of Florida through its subsidiaries, Federated
National and American Vehicle. The Company internally processes claims made by
its own and third party insureds through a wholly-owned claims adjusting
company, Superior. The Company also offers premium financing to its own and
third-party insureds through its wholly-owned subsidiary, Federated Premium.
The Company markets and distributes its own and third-party insurers'
products and its other services primarily in South Florida, through a network of
23 agencies owned by Federated Agency Group, a wholly-owned subsidiary, 34
franchised agencies and approximately 125 independent agents. The Company,
through its wholly-owned subsidiary, FedUSA, franchises agencies under the
FedUSA name. The Company intends to focus its future expansion efforts for its
agency network on franchised agencies.
The Company offers income tax preparation software and service through
Express Tax, its 80% owned subsidiary, as well as franchise opportunities for
these services through EXPRESSTAX, a wholly-owned subsidiary of Express Tax. As
of December 31, 2002, there were 136 EXPRESSTAX franchises granted.
The Company's business, results of operations and financial condition
are subject to fluctuations due to a variety of factors. Abnormally high
severity or frequency of claims in any period could have a material adverse
effect on the Company's business, results of operations and financial condition.
Also, if the Company's estimated liabilities for unpaid losses and LAE are less
than actual losses and LAE, the Company will be required to increase reserves
with a corresponding reduction in the Company's net income in the period in
which the deficiency is identified.
The Company operates in a highly competitive market and faces
competition from both national and regional insurance companies, many of whom
are larger and have greater financial and other resources than the Company, have
favorable A.M. Best ratings and offer more diversified insurance coverage. The
Company's competitors include other companies that market their products through
agents, as well as companies that sell insurance directly to their customers.
Large national writers may have certain competitive advantages over agency
writers, including increased name recognition, increased loyalty of their
customer base and reduced policy acquisition costs. The Company may also face
competition from new or temporary entrants in its niche markets. In some cases,
such entrants may, because of inexperience, desire for new business or other
reasons, price their insurance below the pricing structure of the Company.
Although the Company's pricing is inevitably influenced to some degree by that
of its competitors, management of the Company believes that it is generally not
in the Company's best interest to compete solely on price, choosing instead to
compete on the basis of underwriting criteria, its distribution network and
superior service to its agents and insureds. The Company competes with respect
to automobile insurance in Florida with more than 100 companies, which
underwrite personal automobile insurance. Companies of comparable or smaller
size, which compete with the Company in the personal automobile insurance
industry, include U.S. Security Insurance Company, United Automobile Insurance
Company, Direct General Insurance Company and Security National, as well as
major insurers such as Progressive Casualty Insurance Company. Competition could
have a material adverse effect on the Company's business, results of operations
and financial condition.
CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are more fully described in Note 2 of
Notes to Consolidated Financial Statements. As disclosed therein, the
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions about future events that affect the amounts
reported in the financial statements and accompanying notes. Future events and
their effects cannot be determined with absolute certainty. Therefore, the
determination of estimates requires the exercise of judgment. Actual results
inevitably will differ from those estimates, and such differences may be
material to the financial statements.
The most significant accounting estimates inherent in the preparation
of the Company's financial statements include estimates associated with
management's evaluation of the determination of liability for unpaid losses and
loss adjustment expense and the recoverability of goodwill. In addition,
significant estimates form the bases for the Company's reserves with respect to
finance contracts, premiums receivable and deferred income taxes. Various
assumptions and other factors underlie the determination of these significant
estimates. The process of determining significant estimates is fact specific and
takes into account factors such as historical experience, current and expected
economic conditions, and in the case of unpaid losses and loss adjustment
expense, an actuarial valuation. Management constantly reevaluates these
significant factors and makes adjustments where facts and circumstances dictate.
See Note 2 of Notes to Consolidated Financial Statements.
20
ACCOUNTING CHANGES. In June 2000, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standard No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities -- an amendment of
Financial Accounting Standards Board Statement No. 133," which because of the
Company's early adoption of Statement of Financial Accounting Standard No. 133,
was effective for all fiscal quarters beginning after June 15, 2000. This
statement amends the accounting and reporting standards of Statement of
Financial Accounting Standard No. 133 for certain derivative instruments and
certain hedging activities. Because the Company has limited involvement with
derivative financial instruments and does not engage in the derivative market
for hedging purposes, the adoption of Statement of Financial Accounting Standard
No. 138 did not have a material effect on the Company's financial statements.
Effective January 1, 2000, the Company adopted Statement of Position
98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts
That Do Not Transfer Insurance Risk." The Statement of Position provides
guidance on accounting for insurance and reinsurance contracts that do not
transfer insurance risk. All of the Company's reinsurance agreements are
risk-transferring arrangements, accounted for according to Statement of
Financial Accounting Standard No. 113, "Accounting and Reporting for Reinsurance
of Short-Duration and Long-Duration Contracts." The adoption of Statement of
Position 98-7 had no effect on the Company's financial statements.
Effective July 1, 2000, the Company adopted Financial Accounting
Standards Board Interpretation No. 44, "Accounting for Certain Transactions
Including Stock Compensation (an Interpretation of Accounting Principles Board
Opinion No. 25)." Financial Accounting Standards Board Interpretation No. 44
clarifies the application of Accounting Principles Board Opinion No. 25 for only
certain issues, such as: (a) the definition of employee for purposes of applying
Accounting Principles Board Opinion No. 25; (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan; (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award; and (d) the accounting for an exchange of stock compensation
awards in a business combination. The adoption of Financial Accounting Standards
Board Interpretation No. 44 did not have a material effect on the Company's
financial statements.
Effective December 31, 2000, the Company adopted Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements." The Staff
Accounting Bulletin summarizes the SEC staff's views on applying accounting
principles generally accepted in the United States to the recognition of revenue
in financial statements. The adoption of Staff Accounting Bulletin No. 101 had
no effect on the Company's financial statements.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 141, "Business Combinations," which became
effective January 1, 2002. Statement of Financial Accounting Standard No. 141
requires all business combinations initiated after September 30, 2001 to be
accounted for using the purchase method. Additionally, Statement of Financial
Accounting Standard No. 141 requires an acquired intangible asset, whenever
acquired, to be recognized separately from goodwill if the benefit of the
intangible asset is obtained through contractual or other legal rights or if the
intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets,"
which became effective January 1, 2002. Statement of Financial Accounting
Standard No. 142 eliminates the amortization of goodwill over its estimated
useful life, but requires goodwill to be subject to at least an annual
assessment for impairment by applying a fair-value-based test. Upon adoption of
Financial Accounting Standards No.142 January 1, 2002, the Company ceased
amortization of goodwill. See footnote (t) GOODWILL for additional information.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 143, "Accounting for Asset Retirement
Obligations," which became effective for fiscal years beginning after June 15,
2002. Statement of Financial Accounting Standard No. 143 addresses financial
accounting and reporting for obligations associated with the retirement of
tangible, long-lived assets and the associated asset retirement costs. Adoption
of this statement has had no material effect on the Company's financial
statements.
In October 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which became effective for fiscal
years beginning after December 15, 2001, and interim periods within those fiscal
years. Statement of Financial Accounting Standard No. 144 revises and clarifies
the existing professional guidance addressing: (a) recognition and measurement
of the impairment of long-lived assets to be held and used; (b) the measurement
of long-lived assets to be disposed of by sale; and (c) the reporting of
discontinued operations and components of an entity that either has been
disposed of (by sale, by abandonment, or in a distribution to owners) or is
classified as held for sale. The adoption of Statement of Financial Accounting
Standard No. 144 had no effect on the Company's financial statements.
21
In April 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 145, "Rescission of Financial
Accounting Standards Board Statements No. 4, 44 and 64, Amendment of Financial
Accounting Standards Board Statement No. 13, and Technical Corrections," which
became effective for fiscal years beginning after May 15, 2002. The rescission
of Statement of Financial Accounting Standard No. 4, "Reporting Gains and Losses
from Extinguishment of Debt," and Statement of Financial Accounting Standard No.
64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements," which
had amended Statement of Financial Accounting Standard No. 4, will affect income
statement classification of gains and losses from extinguishment of debt.
Statement of Financial Accounting Standard No. 4 required material gains and
losses from extinguishment of debt to be classified as extraordinary items.
Under Statement of Financial Accounting Standard No. 145, extinguishment of debt
is now considered a risk management strategy by the reporting enterprise, and
the Financial Accounting Standar