ITEM 2 – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

Unico American Corporation, referred to herein as the "Company” or “Unico," is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary; provides property, casualty, health and life insurance through its agency subsidiaries; provides insurance premium financing; and provides membership association services.

As reported on Form 8-K filed with the Securities and Exchange Commission on August 5, 2016, Michael Budnitsky was appointed to Treasurer, Chief Financial Officer and Secretary of the Company effective August 1, 2016. Pursuant to a job offer letter signed by the Company when Mr. Budnitsky joined the Company in September 2014, Mr. Budnitsky is entitled to cash compensation, currently set at of $185,000 per year, and a severance payment equal to three years’ salary in the event his employment is terminated due to a change in ownership of the Company. The foregoing is a summary of certain terms of Mr. Budnitsky’s offer letter. A complete copy of the offer letter is attached to this Form 10-Q as Exhibit 10.1.

Total revenues for the three months ended September 30, 2016, were $8,998,342 compared to $8,451,503 for the three months ended September 30, 2015, an increase of $546,839 (6%). Total revenues for the nine months ended September 30, 2016, were $26,250,652 compared to $24,597,393 for the nine months ended September 30, 2015, an increase of $1,653,259 (7%). The Company had net loss of $1,953,497 for the three months ended September 30, 2016, compared to net loss of $649,510 for the three months ended September 30, 2015, an increase in loss before taxes of $1,303,987 (201%). The Company had net loss of $2,001,454 for the nine months ended September 30, 2016, compared to net loss of $933,914 for the nine months ended September 30, 2015, an increase in loss before taxes of $1,067,540 (114%).

This overview discusses some of the relevant factors that management considers in evaluating the Company's performance, prospects and risks. It is not all inclusive and is meant to be read in conjunction with the entirety of the management discussion and analysis, the Company's consolidated financial statements and notes thereto, and all other items contained within the Company’s 2015 Annual Report on Form 10-K as filed with the Securities and Exchange Commission.

Revenue and Income Generation

The Company receives its revenues primarily from earned premium derived from the insurance company operation, commission and fee income generated from the insurance agency operation, fee income from the premium finance operation, and investment income from cash generated primarily from the insurance company operation. The insurance company operation generated approximately 92% of total revenues for the three and nine months ended September 30, 2016, respectively, compared to 92% and 91% of total revenues for the three and nine months ended September 30, 2015, respectively. The Company’s remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually not material to total revenues.

Insurance Company Operation

As of September 30, 2016, Crusader Insurance Company (“Crusader”), a wholly owned subsidiary of the Company, was licensed as an admitted insurance carrier in the states of Arizona, California, Nevada, Oregon, and Washington. From 2004 until June 2014, all of Crusader’s business was written in the state of California. In June 2014, Crusader began writing business in the state of Arizona. During the three and nine months ended September 30, 2016, 99.7% and 99.5% of Crusader’s total direct written premium (before premium ceded to reinsurers) was produced in California, respectively, compared to 99.6% and 99.5% for the three and nine months ended September 30, 2015, respectively. 99% of Crusader’s business was commercial multi-peril policies for the three months and nine ended September 30, 2016 and 2015. On October 28, 2016, A.M. Best Company reaffirmed Crusader’s financial strength rating of A- (Excellent) and a rating outlook of “stable.” In addition, A.M. Best Company assigned Crusader an Issuer Credit Rating of a- (Excellent).

The property and casualty insurance business is cyclical in nature, and the previous years have been characterized as a “soft market.” The conditions of a soft market include premium rates that are stable or falling and insurance is readily available. Contrarily, “hard market” conditions occur during periods in which premium rates rise and coverage may be more difficult to find. The Company believes that the California property and casualty insurance market is intensely competitive but relatively stable.

Written premium is a financial measure that is defined, under statutory accounting principles, as the contractually determined amount charged by the insurance company to the policyholder for the effective period of the contract based on the expectation of risk, policy benefits, and expenses associated with the coverage provided by the terms of the policies. Written premium is a required statutory measure. Written premium is not defined under U.S. generally accepted accounting principles (“GAAP”). Earned premium, the most directly comparable GAAP measure, represents the portion of written premium that is recognized as income in the financial statements for the period presented and earned on a pro-rata basis over the terms of the policies.

The following is a reconciliation of net written premium to net earned premium (after premium ceded to reinsurers):

For the three months ended September 30, 2016, direct written premium, as reported on Crusader’s statutory financial statements was $9,667,046 compared to $9,119,548 for the three months ended September 30, 2015, an increase of $547,498 (6%). For the nine months ended September 30, 2016, direct written premium as reported on Crusader’s statutory financial statements was $29,120,412 compared to $27,699,119 for the nine months ended September 30, 2015, an increase of $1,421,293 (5%).

Insurance company operation underwriting profitability is defined by pre-tax underwriting profit, which is calculated as net earned premium less losses and loss adjustment expenses and policy acquisition costs.

Crusader’s underwriting profit before income taxes is as follows:

 The following table provides an analysis of the losses and loss adjustment expenses:

Losses and loss adjustment expenses were 101% and 77% of net earned premium for the three and nine months ended September 30, 2016, respectively, compared to 57% and 63% of net earned premium for the three and nine months ended September 30, 2015, respectively.

Revenues from Other Insurance Operations

The Company’s revenues from other insurance operations consist of commissions, fees, investment and other income. Excluding investment and other income, these operations accounted for approximately 8% of total revenues in the three and nine months ended September 30, 2016, compared to approximately 8% and 9% of total revenues in the three and nine months ended September 30, 2015, respectively.

Investments and Liquidity

The Company generated revenues from its total invested assets of $90,782,232 (at amortized cost) and $106,417,552 (at amortized cost) as of September 30, 2016 and 2015, respectively, and from two cash deposits by Crusader, in lieu of appeal bonds, placed with the Los Angeles Superior Court. These deposits, totaling $13,373,793, were made on December 28, 2015, for $7,924,178 and on March 21, 2016, for $5,449,615, and their respective balances were included in “Other assets” on the Consolidated Balance Sheet as of September 30, 2016, and December 31, 2015. Investment income included in insurance company operation and other insurance operations revenue increased $105,752 (82%) and $344,950 (110%) to $234,570 and $659,111 for the three and nine months ended September 30, 2016, respectively, compared to $128,818 and $314,161 for the three and nine months ended September 30, 2015, respectively. The increase in investment income was primarily a result of an increase in the Company’s annualized yield on average invested assets to 1.0% and 0.9% for the three and nine months ended September 30, 2016, respectively, from 0.5% and 0.4% for the three and nine months ended September 30, 2015, respectively. The increase in the annualized yield on average invested assets is primarily a result of reinvesting the proceeds of matured short-term and fixed maturity investments into higher yielding fixed maturity investments. Due to the current interest rate and financial market environment, management believes it is prudent to purchase fixed maturity investments with maturities of 5 years or less and with minimal credit risk. As of September 30, 2016, all of the Company’s investments are in U.S. treasury securities, FDIC insured certificates of deposit, money market funds and a savings account. The Company’s investments in U.S treasury securities and money market funds are readily marketable. As of September 30, 2016, the weighted average maturity of the Company’s investments was approximately 1.1 years.

Liquidity and Capital Resources

Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, its reserves for loss and loss adjustment expense payments, and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its investments. Cash and investments (at amortized cost) of the Company at September 30, 2016, were $91,997,503 compared to $98,178,025 at December 31, 2015. Crusader's cash and investments were 99% of the total cash and investments (at amortized cost) held by the Company as of September 30, 2016, and December 31, 2015.

As of September 30, 2016, the Company had invested $82,607,624 (at amortized cost) or 91% of its total invested assets in fixed maturity obligations, which included $19,088,624 (23% of fixed maturity investments) in U.S. treasury notes and $63,519,000 (77% of fixed maturity investments) in long-term certificates of deposit. As of December 31, 2015, the Company had invested $82,202,727 (at amortized cost) or 84% of its total invested assets in fixed maturity obligations, which included $24,075,727 (29% of fixed maturity investments) in U.S. treasury notes and $58,127,000 (71% of fixed maturity investments) in long-term certificates of deposit. The remaining balance of the Company's investments are in short-term investments that include U.S. treasury bills, a U.S. treasury money market fund, certificates of deposit, bank money market accounts and a bank savings account which are all highly rated and redeemable within one year.

The Company is required to classify its investment securities into one of three categories: held-to-maturity, available-for-sale, or trading securities. Although all of the Company's investment in fixed maturity securities are classified as available-for-sale, and, while the Company may sell investment securities, from time to time, in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity.

The Company’s investment guidelines on equity securities limit investments in equity securities to an aggregate maximum of $2,000,000. The Company’s investment guidelines on fixed maturities limit those investments to high-grade obligations with a maximum term of 8 years. The maximum investment authorized in any one issuer is $2,000,000. This dollar limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues. When the Company invests in fixed maturity municipal securities, preference is given to issues that are pre-refunded and secured by U.S. treasury securities. The short-term investments are either U.S. government obligations, FDIC insured, or are in an institution with a Moody's rating of at least P2 and/or a Standard & Poor's rating of A1. All of the Company's fixed maturity investment securities are rated, readily marketable, and could be liquidated without any materially adverse financial impact.

On December 19, 2008, the Board of Directors authorized a stock repurchase program to acquire, from time to time, up to an aggregate of 500,000 shares of the Company’s common stock. This program has no expiration date and may be terminated by the Board of Directors at any time. As of September 30, 2016, and December 31, 2015, the Company had remaining authority under the 2008 program to repurchase up to an aggregate of 188,655 and 197,467 shares of its common stock, respectively. The 2008 program is the only program under which there is authority to repurchase shares of the Company’s common stock. The Company did not repurchase any stock during the three months ended September 30, 2016. The Company repurchased 8,812 shares of stock during the nine months ended September 30, 2016, in unsolicited transactions at a cost of $89,582 of which $4,331 was allocated to capital and $85,251 was allocated to retained earnings. The Company repurchased 9,630 shares of stock during the three months ended September 30, 2015, in unsolicited transactions at a cost of $94,372 of which $4,733 was allocated to capital and $89,639 was allocated to retained earnings. The Company repurchased 11,834 shares of stock during the nine months ended September 30, 2015, in unsolicited transactions at a cost of $117,862 of which $5,816 was allocated to capital and $112,046 was allocated to retained earnings. The Company has or will retire all repurchased stock.

The Company reported $5,567,253 net cash used by operating activities for the nine months ended September 30, 2016, compared to $307,183 net cash used by operating activities for the nine months ended September 30, 2015. The largest contributor to the use of cash for the nine months ended September 30, 2016, was a $5,449,615 cash deposit by Crusader in lieu of an appeal bond placed with the Los Angeles Superior Court on March 21, 2016. No investments were sold prior to their maturity to fund this cash deposit. This cash deposit was in addition to the $ 7,924,178 cash deposit by Crusader in lieu of an appeal bond placed with the Los Angeles Superior Court on December 28, 2015, to appeal two judgments on a Crusader policy liability claim.

Other fluctuations in cash flows from operating activities relate to the timing of the collection and the payment of insurance-related receivables and payables. The variability of the Company’s losses and loss adjustment expenses is due primarily to its small claims population which may result in greater fluctuations in claim frequency and/or severity. Although the Consolidated Statements of Cash Flows reflect net cash used by operating activities, the Company does not anticipate future liquidity problems, and it continues to be well capitalized and adequately reserved. 

Although material capital expenditures may also be funded through borrowings, the Company believes that its cash and short-term investments at September 30, 2016, net of statutory deposits of $700,000, and California insurance company statutory dividend restrictions applicable to Crusader, plus the cash to be generated from operations, should be sufficient to meet its operating requirements during the next 12 months without the necessity of borrowing funds. Since trust receivables were in excess of trust payables, there were no trust restrictions on cash and short-term investments at September 30, 2016.

Results of Operations

All comparisons made in this discussion are comparing the three and nine months ended September 30, 2016, to the three and nine months ended September 30, 2015, unless otherwise indicated.

For the three and nine months ended September 30, 2016, total revenues were $8,998,342 and $26,250,652, respectively, an increase of $546,839 (6%) and $1,653,259 (7%), compared to total revenues of $8,451,503 and $24,597,393 for the three and nine months ended September 30, 2015, respectively. For the three and nine months ended September 30, 2016, the Company had a loss before taxes of $2,966,722 and $3,028,154, respectively, an increase in loss before taxes of $1,999,082 (207%) and $1,652,150 (120%), compared to a loss before taxes of $967,640 and $1,376,004 for the three and nine months ended September 30, 2015, respectively. For the three and nine months ended September 30, 2016, the Company had a net loss of $1,953,497 and $2,001,454, respectively, an increase in net loss of $1,303,987 (201%) and $1,067,540 (114%), compared to net loss of $649,510 and $933,914 for the three and nine months ended September 30, 2015, respectively.

The increase in revenues of $546,839 (6%) for the three months ended September 30, 2016, when compared to September 30, 2015, was primarily due to an increase in net earned premium of $417,336 (6%). The increase in revenues of $1,653,259 (7%) for the nine months ended September 30, 2016, when compared to September 30, 2015, was primarily due to an increase in net earned premium of $1,414,703 (6%).

The increase in loss before tax of $1,999,082 (207%) for the three months ended September 30, 2016, compared to the three months ended September 30, 2015, was due primarily to the increase in losses and loss adjustment expenses of $3,691,583 (85%) partially offset by the increase in net earned premium of $417,336 (6%) and a decrease of $1,287,460 (100%) in capitalized computer software costs impairment. The increase in loss before tax of $1,652,150 (120%) for the nine months ended September 30, 2016, compared to the nine months ended September 30, 2015, was due primarily to the increase in losses and loss adjustment expenses of $4,108,411 (30%) partially offset by the increase in net earned premium of $1,414,703 (6%) and a decrease of $1,287,460 (100%) in capitalized computer software costs impairment. The Company incurred capitalized computer software costs impairment of $0 for the three and nine months ended September 30, 2016, respectively, and $1,287,460 for the three and nine months ended September 30, 2015, respectively.

Written premium is a required statutory measure. Direct written premium reported on Crusader’s statutory financial statements increased $547,498 (6%) and $1,421,293 (5%) to $9,667,046 and $29,120,412 for the three and nine months ended September 30, 2016, respectively, compared to $9,119,548 and $27,699,119 for the three and nine months ended September 30, 2015, respectively.

The property casualty insurance marketplace continues to be intensely competitive. While Crusader attempts to meet such competition with competitive prices, its emphasis is on service, promotion, and distribution. Crusader believes that rate adequacy is more important than premium growth and that underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) is its primary goal. Nonetheless, Crusader believes that it can grow its sales and profitability by continuing to focus upon four areas of its operations: (1) product development, (2) improved service to retail brokers, (3) appointment of captive and independent retail agents, and (4) geographical expansion. While the Company’s policy administration system continues to support the Company’s existing operations, the Company believes it would realize more competitive parity with respect to product and service by switching or upgrading to a more contemporary platform. The Company is currently evaluating potential firms and consultants to assist it with development and execution of its information technology and marketing efforts. Crusader does not intend to substantially increase its number of appointed retail agents until the Company replaces its policy administration system.

Earned premium (before reinsurance) increased $600,266 (7%) to $9,529,911 and $2,004,961 (8%) to $27,797,515 for the three and nine months ended September 30, 2016, respectively, compared to $8,929,645 and $25,792,554 for the three and nine months ended September 30, 2015, respectively. The Company writes annual policies and, therefore, earns written premium ratably over the one-year policy term.

Ceded earned premium increased $182,930 (13%) to $1,548,981 and $590,258 (15%) to $4,526,219 for the three and nine months ended September 30, 2016, respectively, compared to $1,366,051 and $3,935,961 for the three and nine months ended September 30, 2015, respectively. Ceded earned premium as a percentage of direct earned premium (before reinsurance) was 16% for the three and nine months ended September 30, 2016, and 15% for the three and nine months ended September 30, 2015.

In calendar years 2016 and 2015, Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1 ^st layer ($500,000 in excess of $500,000), 0% in its 2 ^nd layer ($2,000,000 in excess of $1,000,000) and 0% in its property and casualty clash treaty. In calendar year 2016, Crusader retained a participation in its catastrophe excess of loss reinsurance treaties of 5% in its 1 ^st layer ($9,000,000 in excess of $1,000,000) and 0% in its 2 ^nd layer ($36,000,000 in excess of $10,000,000). In calendar year 2015, Crusader retained a participation in its catastrophe excess of loss reinsurance treaties of 5% in its 1 ^st layer ($9,000,000 in excess of $1,000,000) and 0% in its 2 ^nd layer ($31,000,000 in excess of $10,000,000). The Company monitors its catastrophe exposure no less than on an annual basis and purchases the level of coverage deemed appropriate.

Crusader’s excess of loss reinsurance treaties provided for a contingent commission for accident years 2006, 2004 and 2003. Crusader’s 2006 1 ^st layer primary excess of loss reinsurance treaty provided for a contingent commission equal to 20% of the net profit, if any, accruing to the reinsurer. Crusader’s 2004 and 2003 1 ^st layer primary excess of loss reinsurance treaties provided for a contingent commission to the Company equal to 45% of the net profit, if any, accruing to the reinsurer. Any contingent commission received is subject to return based on future development of ceded losses and loss adjustment expenses. As of September 30, 2016, and December 31, 2015, the unearned contingent commission balance included in “Accrued expenses and other liabilities” in the Consolidated Balance Sheets was $0. The contingent commission income recognized was $0 for the three months ended September 30, 2016 and 2015, and $0 and $91,686 for the nine months ended September 30, 2016 and 2015, respectively.

The Company evaluates each of its ceded reinsurance contracts at its inception to determine if there is a sufficient risk transfer to allow the contract to be accounted for as reinsurance under GAAP. As of September 30, 2016, all such ceded contracts were accounted for as risk transfer reinsurance.

Crusader’s direct, ceded and net earned premium are as follows:

The Company is currently negotiating its 2017 excess of loss reinsurance treaty. Based on initial indications, the Company expects a rate increase on that treaty; however, the increase cannot yet be quantified.

Investment income, included in insurance company operation and other insurance operations revenues, increased $105,752 (82%) to $234,570 and $344,950 (110%) to $659,111 for the three and nine months ended September 30, 2016, respectively, compared to $128,818 and $314,161 for the three and nine months ended September 30, 2015, respectively.

The increase in investment income was primarily a result of an increase in the Company’s annualized yield on average invested assets to 1.0% and 0.9% for the three and nine months ended September 30, 2016, respectively, from 0.5% and 0.4% for the three and nine months ended September 30, 2015. The increase in the annualized yield on average invested assets is primarily a result of reinvesting the proceeds of matured short-term and fixed maturity investments into higher yielding fixed maturity investments.

Investment income, excluding net realized investment losses, and average annualized yields on the Company’s average invested assets are as follows:

*The average is based on the beginning and ending balance of the amortized cost of the invested assets for each respective period.

The par value, amortized cost, fair value and weighted average yield of fixed maturity investments at September 30, 2016, by contractual maturity are as follows:

Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.

The weighted average maturity of the Company’s fixed maturity investments was 1.1 years as of September 30, 2016, and 1.5 years as of December 31, 2015. Due to the current interest rate environment, management believes it is prudent to purchase fixed maturity investments with maturities of five years or less and with minimal credit risk.

At September 30, 2016, the Company had one fixed maturity investment with gross unrealized losses of $79 for a continuous period of less than 12 months and no fixed maturity investments with gross unrealized losses for a continuous period of more than 12 months. At December 31, 2015, the Company had three fixed maturity investments with gross unrealized losses of $38,509 for a continuous period of less than 12 months and two fixed maturity investments with gross unrealized losses of $6,115 for a continuous period of more than 12 months.

The Company closely monitors its investments. If an unrealized loss is determined to be other-than-temporary, it is written off as a realized loss through the Consolidated Statements of Operations. The Company’s methodology of assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near-term prospects of the issuer, and whether the debtor is current on its contractually obligated interest and principal payments. The unrealized losses on the U.S. treasury securities in unrealized loss positions as of September 30, 2016, and December 31, 2015, were determined to be temporary.

Although the Company does not intend to sell its fixed maturity investments prior to maturity, the Company may sell investment securities from time to time in response to cash flow requirements, economic and/or market conditions. The Company sold three certificates of deposit prior to their maturity during the nine months ended September 30, 2016. These securities had an amortized cost of $746,000. The Company realized an investment loss of $1,278 on the sale. The Company did not sell any fixed maturity investments and there were no realized investment gains or losses during the three months ended September 30, 2016, nor during the three and nine months ended September 30, 2015. The unrealized gains or losses from fixed maturities are reported as “accumulated other comprehensive income (loss),” which is a separate component of stockholders’ equity, net of any deferred tax effect.

Other income, included in insurance company operation and other insurance operations revenues, decreased $1,827 (3%) to $67,147 and $104,900 (34%) to $207,427 for the three and nine months ended September 30, 2016, respectively, compared to $68,974 and $312,327 for the three and nine months ended September 30, 2015, respectively. The decrease from nine months ended September 30, 2015, to nine months ended September 30, 2016, is due primarily to $0 contingent commission recognized on Crusader’s excess of loss reinsurance treaties for accident years 2006, 2004 and 2003 for the nine months ended September 30, 2016, compared to $91,686 for the nine months ended September 30, 2015.

Gross commissions and fees increased $24,877 (4%) to $697,245 and decreased $2,153 (0.1%) to $2,063,429 for the three and nine months ended September 30, 2016, respectively, compared to $672,368 and $2,065,582 for the three and nine months ended September 30, 2015, respectively.

The increases/decreases in gross commissions and fees for the three and nine months ended September 30, 2016, as compared to the three and nine months ended September 30, 2015, are as follows:

Unifax Insurance Systems, Inc. (“Unifax”), a wholly owned subsidiary of the Company, sells and services insurance policies for Crusader. The commissions paid by Crusader to Unifax are eliminated as intercompany transactions and are not reflected as income in the consolidated financial statements. Unifax also receives non-refundable policy fee income that is directly related to the Crusader policies it sells. For financial statement reporting purposes, policy fees are earned ratably over the life of the related insurance policy. The unearned portion of the policy fee is recorded as a liability on the Consolidated Balance Sheets under “Accrued expenses and other liabilities.” The earned portion of the policy fee charged to the policyholder by Unifax is recognized as income in the consolidated financial statements. Policy fee income decreased $9,284 (2%) and $3,115 (0.2%) in the three and nine months ended September 30, 2016, respectively, compared to the three and nine months ended September 30, 2015.

American Insurance Brokers, Inc. (“AIB”), a wholly owned subsidiary of the Company, markets health insurance in California through non-affiliated insurance companies for individuals and groups. For these services, AIB receives commission based on the premiums that it writes. Commission income increased $36,821 (17%) and $18,488 (3%) in the three and nine months ended September 30, 2016, respectively, compared to the three and nine months ended September 30, 2015. The increases are due to increases in sales and a one-time adjustment of commissionable base. 

Insurance Club, Inc., dba AAQHC An Administrator (“AAQHC”), a wholly owned subsidiary of the Company, is a third party administrator for contracted insurance companies and is a membership association that provides various consumer benefits to its members, including participation in group health care insurance policies that AAQHC negotiates for the association. For these services, AAQHC receives membership and fee income from its members. Membership and fee income decreased $2,608 (12%) and $8,031 (12%) in the three and nine months ended September 30, 2016, respectively, compared to the three and nine months ended September 30, 2015. These decreases were primarily a result of a decrease in the number of association members enrolled in AAQHC during the three and nine months ended September 30, 2016, compared to the number of association members enrolled during the three and nine months ended September 30, 2015. 

The daily automobile rental insurance program was produced by Bedford Insurance Services, Inc. (“Bedford”), a wholly owned subsidiary of the Company. Bedford received commission income from non-affiliated insurance companies based on written premium and continues to receive contingent commission on previous business written. The Company no longer actively markets this program.

Finance fees earned consist of late fees, returned check fees and payment processing fees. These fees earned by American Acceptance Corporation (“AAC”), a wholly owned subsidiary of the Company, increased $701 (4%) to $18,450 and increased $1,937 (4%) to $50,667 for the three and nine months ended September 30, 2016, compared to $17,749 and $48,730 in fees earned during the three and nine months ended September 30, 2015. During the three and nine months ended September 30, 2016, AAC issued 783 and 2,405 loans, respectively, and had 2,435 loans outstanding as of September 30, 2016. During the three and nine months ended September 30, 2015, AAC issued 822 and 2,605 loans, respectively, and had 2,566 loans outstanding as of September 30, 2015. AAC provides premium financing only for Crusader policies produced by Unifax in California. AAC reduced the interest rate charged on premiums financed to 0% beginning July 20, 2010, and, therefore, did not earn any finance charges during the three and nine months ended September 30, 2016 and 2015. This reduction in the interest rate charged was initiated in an effort to increase the sales of existing renewal and new business written by Unifax for Crusader. Due to the low interest rate environment, the cost of money to provide this incentive is not material. The Company monitors the cost of providing this incentive and, depending on the cost/benefit determination, can continue to offer it or withdraw it at any time.

Losses and loss adjustment expenses were 101% and 77% of net earned premium for the three and nine months ended September 30, 2016, respectively, compared to 57% and 63% of net earned premium for the three and nine months ended September 30, 2015, respectively.

Loss ratio is calculated by dividing losses and loss adjustment expenses by net earned premium. Losses and loss adjustment expenses and loss ratios are as follows:

Some lines of insurance are commonly referred to as "long-tail" lines because of the extended time required before claims are ultimately settled. Lines of insurance in which claims are settled relatively quickly are called "short-tail" lines. It is generally more difficult to estimate loss reserves for long-tail lines because of the long period of time that elapses between the occurrence of a claim and its final disposition and the difficulty of estimating the settlement value of the claim. Crusader’s short-tail lines consist of its property coverages, and its long-tail lines consist of its liability coverages. However, Crusader’s long-tail liability claims tend to be settled relatively quicker than other long-tail lines not underwritten by Crusader, such as workers’ compensation, professional liability, umbrella liability, and medical malpractice. Since trends develop over longer periods of time on long-tail lines of business, the Company generally gives credibility to those trends more slowly than for short-tail or less volatile lines of business.

The 85% loss ratio for the provision for insured events of current year for the three months ended September 30, 2016, compared to the 69% loss ratio for the provision for insured events of current year for the three months ended September 30, 2015, was due primarily to an aberrational increase in the frequency and severity of accident year 2016 short-tail property claims .

The increases in the development of insured events of prior years of $2,095,411 and $3,471,683 for the three and nine months ended September 30, 2016, respectively, compared to the three and nine months ended September 30, 2015, were primarily due to higher than expected long-tail liability claims in accident years 2011, 2013 and 2015.

While it is difficult to estimate adequacy of loss and loss adjustment expense reserves, historically, the Company was able to establish sufficient loss and loss adjustment expense reserves to mitigate adverse prior accident year developments.

The following table breaks out adverse (favorable) development from total losses and loss adjustment expenses quarterly since March 31, 2014:

The variability of the Crusader’s losses and loss adjustment expenses for the periods presented is due primarily to the small and diverse Crusader’s policyholders and claims population, which may result in greater fluctuations in claim frequency and/or severity. In addition, Crusader’s reinsurance retention, which is relatively high in relationship to its net earned premium, can result in increased loss ratio volatility when large losses are incurred in a relatively short period of time. Nevertheless, management believes that its reinsurance retention is reasonable given the amount of Crusader’s surplus and its goal to minimize ceded premium.

The preparation of the Company’s consolidated financial statements requires estimation of certain liabilities, most significantly the liability for unpaid losses and loss adjustment expenses. Management makes its best estimate of the liability for these unpaid claims costs as of the end of each fiscal quarter. Due to the inherent uncertainties in estimating the Company’s unpaid claims costs, actual loss and loss adjustment expense payments are expected to vary, perhaps significantly, from any estimate made prior to the settling of all claims. Variability is inherent in establishing loss and loss adjustment expense reserves, especially for a small insurer like Crusader. For any given line of insurance, accident year, or other group of claims, there is a continuum of possible loss and loss adjustment expense reserve estimates, each having its own unique degree of propriety or reasonableness. Due to the complexity and the nature of the insurance claims process, there are potentially an infinite number of reasonably likely scenarios. Management draws on its collective experience to judgmentally determine its best estimate. In addition to applying a variety of standard actuarial methods to the data, extensive series of diagnostic tests are applied to the resultant loss and loss adjustment expense reserve estimates to determine management’s best estimate of the unpaid claims liability. Among the statistics reviewed for each accident year are: loss and loss adjustment expense development patterns; frequencies; severities; and ratios of loss to premium, loss adjustment expense to premium, and loss adjustment expense to loss.

When there is clear evidence that the actual emerged claims costs are different than expected for any prior accident year, the claims cost estimates for that year are revised accordingly. If the claims costs that emerge are less favorable than initially anticipated, generally, the Company increases its loss and loss adjustment expense reserves immediately. However, if the claims costs that emerge are more favorable than initially anticipated, generally, the Company reduces its loss and loss adjustment expense reserves over time while it continues to assess the validity of the observed trends based on the subsequent emerged claims costs. 

The establishment of loss and loss adjustment expense reserves is a detailed process as there are many factors that can ultimately affect the final settlement of a claim. Estimates are based on a variety of industry data and on the Company’s current and historical accident year claims data, including but not limited to reported claim counts, open claim counts, closed claim counts, closed claim counts with payments, paid losses, paid loss adjustment expenses, case loss reserves, case loss adjustment expense reserves, earned premiums and policy exposures, salvage and subrogation, and unallocated loss adjustment expenses paid. Many other factors, including changes in reinsurance, changes in pricing, changes in policy forms and coverage, changes in underwriting and risk selection, legislative changes, results of litigation and inflation are also taken into account.

At the end of each fiscal quarter, the Company’s loss and loss adjustment expense reserves for each accident year (i.e., for all claims incurred within each year) are re-evaluated independently by the Company’s president, the Company’s chief financial officer and by an independent consulting actuary.  Generally accepted actuarial methods, including the widely used Bornhuetter-Ferguson and loss development methods, are employed to estimate ultimate claims costs. An actuarial central estimate of the ultimate claims costs and IBNR reserves is ultimately determined by management and tested for reasonableness by the independent consulting actuary.

Policy acquisition costs consist of commissions, premium taxes, inspection fees, and certain other underwriting costs that are directly related to and vary with the successful production of Crusader insurance policies. These policy acquisition costs include Crusader expenses and allocated expenses of other Unico subsidiaries. Crusader's reinsurers pay Crusader a ceding commission, which is primarily a reimbursement of the acquisition cost related to the ceded premium. Ceding commission is received on excess of loss ceded premium, and no ceding commission is received on facultative or catastrophe ceded premium. Policy acquisition costs, net of ceding commission, are deferred and amortized as the related premiums are earned. The Company annually re-evaluates its policy acquisition costs to determine that costs related to successful policy acquisition are capitalized and deferred. These policy acquisition costs were approximately 22% of net earned premium for the three and nine months ended September 30, 2016 and 2015. The policy acquisition costs increased in the three and nine months ended September 30, 2016, compared to the three and nine months ended September 30, 2015, due primarily to the increase in the commission expenses associated with the increase in the net earned premium in the three and nine months ended September 30, 2016.

Policy acquisition costs and the ratio to net earned premium are as follows:

Salaries and employee benefits increased $63,655 (5%) to $1,318,622 and $310,975 (8%) to $3,980,055 for the three and nine months ended September 30, 2016, respectively, compared to salary and employee benefits of $1,254,967 and $3,669,080 for the three and nine months ended September 30, 2015, respectively.

Salaries and employee benefits incurred and charged to operating expenses are as follows:

Commissions to agents/brokers on the Company’s health insurance and daily automobile rental insurance programs increased $2,723 (7%) to $40,324 and decreased $5,566 (4%) to $121,379 for the three and nine months ended September 30, 2016, respectively, compared to $37,601 and $126,945 for the three and nine months ended September 30, 2015.

Other operating expenses decreased $1,294,313 (61%) to $826,519 and $1,498,722 (42%) to $2,052,771 for the three and nine months ended September 30, 2016, respectively, compared to $2,120,832 and $3,551,493 for the three and nine months ended September 30, 2015, respectively. The decreases in other operating expenses for the three and nine months ended September 30, 2016, compared to the three and nine months ended September 30, 2015, are primarily related to $1,287,460 capitalized computer software costs impairment that was recognized during the three and nine months ended September 30, 2015. The Company did not have any capitalized computer software costs impairment during the three and nine months ended September 30, 2016. Other operating expenses include costs incurred to review strategic alternatives and potential opportunities. These costs amounted to $139,270 and $346,890 for the three and nine months ended September 30, 2016, respectively, and $87,076 and $89,076 for the three and nine months ended September 30, 2015, respectively .

Income tax benefit increased $695,095 (218%) to an income tax benefit of $1,013,225 (34% of pre-tax income) and $584,610 (132%) to an income tax benefit of $1,026,700 (34% of pre-tax income) for the three and nine months ended September 30, 2016, from an income tax benefit of $318,130 (33% of pre-tax income) and $442,090 (32% of pre-tax income) for the three and nine months ended September 30, 2015. The income tax provision is primarily related to income before taxes. The calculated tax rate for the nine months ended September 30, 2016, consisted of a federal tax benefit rate of 34%. The calculated tax rate for the nine months ended September 30, 2015, consisted of a federal tax benefit rate of 33% and a state income tax expense rate of approximately 1%.

Forward Looking Statements

Certain statements contained herein, including the sections entitled “Business,” “Legal Proceedings” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are not historical facts are forward looking. These statements, which may be identified by forward looking words or phrases such as “anticipate,” “appear,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “should,” and “would” involve risks and uncertainties, many of which are beyond the control of the Company. Such risks and uncertainties could cause actual results to differ materially from these forward looking statements. Factors which could cause actual results to differ materially include: underwriting or marketing actions not being effective; rate increases for coverages not being sufficient; premium rate adequacy relating to competition or regulation; actual versus estimated claim experience; the outcome of rate change filings with regulatory authorities; acceptance by insureds of rate changes; adequacy of rate changes; changes in Crusader’s A.M. Best rating; regulatory changes or developments; the outcome of regulatory proceedings; unforeseen calamities; general market conditions; and the Company’s ability to introduce new profitable products.