ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Operating Results Overview — Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
The following table sets forth results of operations for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2020
|
|
% Change
|
|
2019
|
|
(Dollars in thousands)
|
Revenues:
|
|
Gross premiums written
|
$
|
726,885
|
|
|
19.0
|
%
|
|
$
|
610,608
|
|
Gross premiums earned
|
720,967
|
|
|
23.8
|
%
|
|
582,334
|
|
Ceded premiums
|
(356,833)
|
|
|
63.2
|
%
|
|
(218,682)
|
|
Net premiums earned
|
364,134
|
|
|
0.1
|
%
|
|
363,652
|
|
Net investment income
|
11,786
|
|
|
(25.9)
|
%
|
|
15,901
|
|
Net realized and unrealized investment gains (losses)
|
18,032
|
|
|
154.5
|
%
|
|
7,084
|
|
Direct written policy fees
|
13,970
|
|
|
37.0
|
%
|
|
10,200
|
|
Other income
|
23,941
|
|
|
32.1
|
%
|
|
18,124
|
|
Total revenues
|
431,863
|
|
|
4.1
|
%
|
|
414,961
|
|
|
|
|
|
|
|
Costs and expenses:
|
|
|
|
|
|
Losses and loss adjustment expenses
|
376,449
|
|
|
37.9
|
%
|
|
273,080
|
|
Commissions and other underwriting expenses
|
124,288
|
|
|
16.0
|
%
|
|
107,189
|
|
General and administrative expenses
|
23,420
|
|
|
0.9
|
%
|
|
23,203
|
|
Interest expense
|
7,661
|
|
|
(28.9)
|
%
|
|
10,776
|
|
Impairment of intangibles
|
11,699
|
|
|
NCM
|
|
—
|
|
Total costs and expenses
|
543,517
|
|
|
31.2
|
%
|
|
414,248
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
(111,654)
|
|
|
NCM
|
|
713
|
|
Income tax expense (benefit)
|
(33,496)
|
|
|
NCM
|
|
(298)
|
|
Net income (loss)
|
$
|
(78,158)
|
|
|
NCM
|
|
$
|
1,011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios to net premiums earned:
|
|
|
|
|
|
Net loss ratio
|
103.4
|
%
|
|
|
|
75.1
|
%
|
Net expense ratio
|
40.5
|
%
|
|
|
|
35.9
|
%
|
Combined ratio
|
143.9
|
%
|
|
|
|
111.0
|
%
|
(1)Net loss ratio is calculated as losses and loss adjustment expenses ("LAE") divided by net premiums earned.
(2)Net expense ratio is calculated as all operating expenses less interest expense divided by net premiums earned.
(3)Combined ratio is calculated as the sum of losses and LAE and all operating expenses less interest expense divided by net premiums earned.
The following table sets forth a reconciliation of GAAP to non-GAAP measures:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
|
(Dollars in thousands)
|
Revenue
|
|
|
|
|
Total revenues
|
|
$
|
431,863
|
|
|
$
|
414,961
|
|
Less:
|
|
|
|
|
Net realized and unrealized investment gains (losses)
|
|
18,032
|
|
|
7,084
|
|
Adjusted operating revenues
|
|
$
|
413,831
|
|
|
$
|
407,877
|
|
|
|
|
|
|
Net Income (Loss)
|
|
|
|
|
Net income (loss)
|
|
$
|
(78,158)
|
|
|
$
|
1,011
|
|
Less:
|
|
|
|
|
Net realized and unrealized investment gains (losses)
|
|
10,801
|
|
|
5,347
|
|
Acquisition and strategic costs
|
|
(171)
|
|
|
(1,267)
|
|
Amortization of identifiable intangibles
|
|
(90)
|
|
|
(10)
|
|
Gain (loss) on early extinguishment of debt
|
|
—
|
|
|
(2,698)
|
|
Impairment of intangibles
|
|
(11,417)
|
|
|
—
|
|
Adjusted operating income (loss)
|
|
$
|
(77,281)
|
|
|
$
|
(361)
|
|
|
|
|
|
|
Income tax rate assumed for reconciling items above, excluding impairment of goodwill
|
|
40.100
|
%
|
|
24.522
|
%
|
Revenue
Total revenue increased $16.9 million, or 4.1%, to $431.9 million for the year ended December 31, 2020, as compared to $415.0 million for the year ended December 31, 2019. The increase was primarily driven by higher net investment gains, policy fees and other income, partially offset by lower net investment income, all of which are discussed below.
Gross Premiums Written
The following table sets forth the gross premiums written for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
|
(In thousands)
|
Gross premiums written:
|
|
|
Homeowners Florida
|
|
$
|
444,576
|
|
|
$
|
451,856
|
|
Homeowners non-Florida
|
|
263,534
|
|
|
142,485
|
|
Federal flood
|
|
19,022
|
|
|
16,413
|
|
Non-core (1)
|
|
(247)
|
|
|
(146)
|
|
Total gross premiums written
|
|
$
|
726,885
|
|
|
$
|
610,608
|
|
(1)Reflects exited lines of business.
Gross premiums written increased $116.3 million, or 19.0%, to $726.9 million for the year ended December 31, 2020, as compared to $610.6 million for the year ended December 31, 2019. The gross premiums written increase was driven by our growth in our non-Florida book of business, including $77.8 million from MIC's non-Florida business, partially offset by a decrease in our Florida business, as we reduce our exposure in the state of Florida, as a result of the challenging litigation environment. Overall, homeowners grew 19.1%.
Gross Premiums Earned
The following table sets forth the gross premiums earned for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
|
(In thousands)
|
Gross premiums earned:
|
|
|
Homeowners Florida
|
|
$
|
459,511
|
|
|
$
|
452,730
|
|
Homeowners non-Florida
|
|
244,192
|
|
|
112,836
|
|
Federal flood
|
|
17,511
|
|
|
15,073
|
|
Non-core (1)
|
|
(247)
|
|
|
1,695
|
|
Total gross premiums earned
|
|
$
|
720,967
|
|
|
$
|
582,334
|
|
(1)Reflects exited lines of business.
Gross premiums earned increased $138.7 million, or 23.8%, to $721.0 million for the year ended December 31, 2020, as compared to $582.3 million for the year ended December 31, 2019. The higher gross premiums earned was primarily driven by continued non-Florida growth, including $73.3 million from MIC's non-Florida business.
Ceded Premiums Earned
Ceded premiums earned increased $138.1 million, or 63.2%, to $356.8 million for the year ended December 31, 2020, as compared to $218.7 million for the year ended December 31, 2019. The increase was driven by approximately $91.5 million higher excess of loss reinsurance spend, as prices and overall property exposures increased, including $32.8 million from the Maison Companies acquisition, this year as compared to last year. Additionally, stemming from the non-cascading portion of our reinsurance tower and number of catastrophe events, we purchased supplemental coverage to backfill layers and gaps in coverage, which increased ceded premium earned by $10.4 million when comparing these periods. Furthermore, there was approximately $34.1 million of additional ceded premium related to the 50% quota-share treaty for FNIC's non-Florida book of business that became effective July 1, 2020 and was subsequently increased to 80% effective December 1, 2020. The increase to ceded premium earned associated with the aforementioned quota-share treaties is partially offset by corresponding reductions in loss and LAE, and commission and other underwriting expenses when comparing the periods. Refer to Note 6 of the notes to our Consolidated Financial Statements for additional information regarding these quota-share treaties.
Net Investment Income
Net investment income decreased $4.1 million, or 25.9%, to $11.8 million for the year ended December 31, 2020, as compared to $15.9 million for the year ended December 31, 2019. The decrease was primarily due to the lower interest rate environment in 2020 and elevated second quarter 2019 income earned on debt proceeds that had not yet been deployed on the Maison Companies acquisition, partially offset by fixed income portfolio growth from the Maison Companies acquisition.
Net Realized and Unrealized Investment Gains (Losses)
Net realized and unrealized investment gains (losses) increased $10.9 million, to $18.0 million for the year ended December 31, 2020, as compared to $7.1 million for the year ended December 31, 2019. We recognized $(4.1) million (more than offset by realized gains on sales) and $4.1 million in unrealized investment gains (losses) for equity securities during these respective periods. Our current and prior year net realized gains are primarily associated with our portfolio managers, under our control, moving out of positions due to both macro and micro conditions, a typical practice each and every quarter. Furthermore, to mitigate the potential COVID-19 related adverse impact on the financial stability of the issuers of securities we hold, certain positions were liquidated during 2020. In addition, to reduce the potential impact of equity market volatility on our capital and liquidity, we sold all of the Company's investments in common stock.
Direct Written Policy Fees
Direct written policy fees increased by $3.8 million, or 37.0%, to $14.0 million for the year ended December 31, 2020, as compared to $10.2 million for the year ended December 31, 2019. The increase is primarily driven by the policy fees generated from MIC's policies in-force and higher fees as a result of FNIC's non-Florida premium growth.
Other Income
Other income increased $5.8 million, or 32.1%, to $23.9 million for the year ended December 31, 2020, as compared to $18.1 million for the year ended December 31, 2019. Other income included the following for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
% Change
|
|
2019
|
|
|
(Dollars in thousands)
|
Other income:
|
|
|
|
|
|
|
Commission income
|
|
$
|
3,357
|
|
|
15.6
|
%
|
|
$
|
2,904
|
|
Brokerage
|
|
18,948
|
|
|
39.6
|
%
|
|
13,577
|
|
Financing and other revenue
|
|
1,636
|
|
|
(0.4)
|
%
|
|
1,643
|
|
Total other income
|
|
$
|
23,941
|
|
|
32.1
|
%
|
|
$
|
18,124
|
|
The increase in other income was primarily driven by higher brokerage revenue. The brokerage revenue increase is the result of higher excess of loss reinsurance spend from the reinsurance programs in place in 2020 as compared to 2019.
Expenses
Losses and LAE
Losses and LAE incurred, net of reinsurance, included the following for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
|
|
|
Net Loss
|
|
|
|
Net Loss
|
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
|
(In thousands)
|
Current accident year, excluding catastrophes:
|
|
|
|
|
|
|
|
|
Homeowners
|
|
$
|
230,602
|
|
|
63.3
|
%
|
|
$
|
207,808
|
|
|
57.1
|
%
|
Non-core (1)
|
|
—
|
|
|
—
|
%
|
|
1,601
|
|
|
0.4
|
%
|
Total current accident year, excluding catastrophes
|
|
230,602
|
|
|
63.3
|
%
|
|
209,409
|
|
|
57.5
|
%
|
Current year catastrophes (2):
|
|
|
|
|
|
|
|
|
Florida
|
|
55,533
|
|
|
15.3
|
%
|
0
|
26,250
|
|
|
7.4
|
%
|
Texas
|
|
26,204
|
|
|
7.2
|
%
|
|
12,400
|
|
|
3.4
|
%
|
Louisiana
|
|
44,174
|
|
|
12.1
|
%
|
|
8,900
|
|
|
2.4
|
%
|
Other states
|
|
2,386
|
|
|
0.7
|
%
|
|
5,150
|
|
|
1.4
|
%
|
Total current year catastrophes
|
|
128,297
|
|
|
35.3
|
%
|
|
52,700
|
|
|
14.6
|
%
|
Prior year loss development (redundancy):
|
|
|
|
|
|
|
|
|
Homeowners
|
|
(655)
|
|
|
(0.2)
|
%
|
|
615
|
|
|
0.2
|
%
|
Non-core (1)
|
|
19,022
|
|
|
5.2
|
%
|
|
12,845
|
|
|
3.5
|
%
|
Ceded losses subject to offsetting experience account adjustments (3)
|
|
(816)
|
|
|
(0.2)
|
%
|
|
(2,489)
|
|
|
(0.7)
|
%
|
Total prior year loss development (redundancy)
|
|
17,551
|
|
|
4.8
|
%
|
|
10,971
|
|
|
3.0
|
%
|
Total net losses and LAE
|
|
$
|
376,449
|
|
|
103.4
|
%
|
|
$
|
273,080
|
|
|
75.1
|
%
|
(1)Reflects exited lines of business.
(2)Includes Property Claims Services ("PCS") weather events and other events impacting multiple insureds for which the Company's insurance carriers established catastrophe event codes, net of the benefit of claims handling services. These
catastrophe events are typically wind, hail and tornado related weather events. Any individual catastrophe event with gross losses greater than $20 million, on a pre-tax basis, are considered significant and specifically addressed in the commentary below.
(3)Reflects homeowners losses ceded under retrospective reinsurance treaties to the extent there is an offsetting experience account adjustment, such that there is no impact on pre-tax net income (loss).
Losses and LAE increased $103.3 million, or 37.9%, to $376.4 million for the year ended December 31, 2020, as compared to $273.1 million for the year ended December 31, 2019. The net loss ratio increased 28.3 percentage points, to 103.4% in 2020, as compared to 75.1% in 2019. The higher loss ratio was primarily the result of higher catastrophe net losses when comparing the periods, as 2020 included $128.3 million, net of reinsurance. Approximately $37 million of catastrophe net losses from FNIC's non-Florida book of business was subject to a 50% profit-sharing agreement prior to the 50% quota share becoming effective on July 1, 2020 and increasing to 80% effective December 1, 2020, as discussed above.
The 2020 catastrophe net losses were $109.8 million, net of reinsurance and profit-share impact described above, which included Hurricanes Laura, Sally, Delta, Zeta and Eta, as well as a number of hail and wind-related severe weather events, which impacted Florida, Louisiana, Texas and other states. By comparison, 2019 catastrophe net losses were $39.5 million, net of reinsurance and profit-share impact, which primarily included $18.7 million attributed to a single hail storm in Brevard County, Florida, and hail and wind related events during the spring months in the southeastern part of the United States. The remaining variance was the result of higher prior year development, as detailed in the table above, and higher current year gross losses from a higher volume of policies, mostly offset by increased ceded losses in FNIC's Florida and non-Florida books of business as a result of additional quota-share agreements in place in the second half of 2020 as compared to the second half of 2019.
Commissions and Other Underwriting Expenses
The following table sets forth the commissions and other underwriting expenses for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
|
(In thousands)
|
Commissions and other underwriting expenses:
|
|
|
|
|
Homeowners Florida
|
|
$
|
54,043
|
|
|
$
|
52,962
|
|
All other
|
|
49,384
|
|
|
25,491
|
|
Ceding commissions
|
|
(27,143)
|
|
|
(12,128)
|
|
Total commissions
|
|
76,284
|
|
|
66,325
|
|
|
|
|
|
|
Fees
|
|
5,079
|
|
|
3,368
|
|
Salaries and wages
|
|
13,791
|
|
|
12,114
|
|
Other underwriting expenses
|
|
29,134
|
|
|
25,382
|
|
Total commissions and other underwriting expenses
|
|
$
|
124,288
|
|
|
$
|
107,189
|
|
Commissions and other underwriting expenses increased $17.1 million, or 16.0%, to $124.3 million for the year ended December 31, 2020, as compared to $107.2 million for the year ended December 31, 2019. The increase was primarily driven by higher non-Florida acquisition related costs, which includes gross commissions, fees and other underwriting expenses as a result of premium growth, including from MIC's non-Florida business. When comparing these periods, this increase was partially offset by a higher ceding commission driven in part by the new quota-share treaties in FNIC's Florida and non-Florida books of business. Refer to Ceded Premium Earned above for additional information.
The net expense ratio increased 4.6 percentage points to 40.5% in 2020, as compared to 35.9% in 2019 due primarily to higher excess of loss ceded reinsurance premiums in 2020.
General and Administrative Expenses
Despite the addition of the Maison Companies and enabled by our rigorous integration efforts, general and administrative expenses increased only $0.2 million, or 0.9%, to $23.4 million for the year ended December 31, 2020, as compared to $23.2 million for the year ended December 31, 2019.
Interest Expense
Interest expense decreased $3.1 million to $7.7 million for the year ended December 31, 2020, as compared to $10.8 million for the year ended December 31, 2019, which included $3.6 million of prepayment fees, including the write-off of remaining debt issuance costs. This decline was partially offset by the fact that our March 2019 debt offering was only outstanding for a portion of the first quarter of 2019.
Impairment of Intangibles
Coinciding with the preparation of the financial statements for the year ended December 31, 2020, the Company’s annual goodwill impairment testing has resulted in the conclusion that the goodwill intangible asset established in conjunction with the acquisition of the Maison Companies in December 2019 is impaired. Therefore, during the fourth quarter of 2020, we recorded a non-cash impairment charge of $11.0 million, against which there is no tax offset, representing the write-off of the full amount of our goodwill asset. The Company’s impairment analysis considered the earnings and share price of the Company and comparable companies, as well as projected cash flows. Continued adverse storm activity, higher excess of loss catastrophe reinsurance costs and the continued unfavorable claims environment in the state of Florida reduced the previously modeled fair value of the Company. These impacts, along with other information relevant to the estimated fair value of the Company, including the trading price of our shares, resulted in the impairment conclusion.
Correspondingly, effective as of October 1, 2020, we believed there was an indication of impairment for our identifiable intangible assets, therefore we performed a discounted cash flow method to measure and record a non-cash impairment of $0.7 million, due primarily to a higher discount rate, which lowered the fair value below carrying value.
Refer to Note 8 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information related to our goodwill and identifiable intangible assets.
Income Taxes
Income tax expense (benefit) decreased $33.2 million to $(33.5) million for the year ended December 31, 2020, as compared to $(0.3) million for the year ended December 31, 2019. The decrease in income tax expense is predominantly the result of the pre-tax loss during the current year as compared to income during 2019. Additionally, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), signed into law on March 27, 2020, enabled us to carry back net operating loss to prior years when the statutory federal income tax rate was at 35%, which increased our effective tax rate during 2020. Refer to Note 11 of the notes to our Consolidated Financial Statements for additional information regarding the CARES Act.
Operating Results Overview — Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
The following table sets forth selected results of operations for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2019
|
|
% Change
|
|
2018
|
|
|
(Dollars in thousands)
|
Revenues:
|
|
|
|
|
|
|
Gross premiums written
|
|
$
|
610,608
|
|
|
7.5
|
%
|
|
$
|
567,764
|
|
Gross premiums earned
|
|
582,334
|
|
|
0.4
|
%
|
|
580,020
|
|
Ceded premiums
|
|
(218,682)
|
|
|
(2.7)
|
%
|
|
(224,763)
|
|
Net premiums earned
|
|
363,652
|
|
|
2.4
|
%
|
|
355,257
|
|
Net investment income
|
|
15,901
|
|
|
27.6
|
%
|
|
12,460
|
|
Net realized and unrealized investment gains (losses)
|
|
7,084
|
|
|
(270.9)
|
%
|
|
(4,144)
|
|
Direct written policy fees
|
|
10,200
|
|
|
(23.7)
|
%
|
|
13,366
|
|
Other income
|
|
18,124
|
|
|
(5.4)
|
%
|
|
19,154
|
|
Total revenues
|
|
414,961
|
|
|
4.8
|
%
|
|
396,093
|
|
|
|
|
|
|
|
|
Costs and expenses:
|
|
|
|
|
|
|
Losses and LAE
|
|
273,080
|
|
|
19.6
|
%
|
|
228,416
|
|
Commissions and other underwriting expenses
|
|
107,189
|
|
|
(11.5)
|
%
|
|
121,109
|
|
General and administrative expenses
|
|
23,203
|
|
|
4.6
|
%
|
|
22,183
|
|
Interest expense
|
|
10,776
|
|
|
158.0
|
%
|
|
4,177
|
|
Total costs and expenses
|
|
414,248
|
|
|
10.2
|
%
|
|
375,885
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
713
|
|
|
(96.5)
|
%
|
|
20,208
|
|
Income tax expense (benefit)
|
|
(298)
|
|
|
(105.4)
|
%
|
|
5,498
|
|
Net income (loss)
|
|
1,011
|
|
|
(93.1)
|
%
|
|
14,710
|
|
Net income (loss) attributable to non-controlling interest
|
|
—
|
|
|
(100.0)
|
%
|
|
(218)
|
|
Net income (loss) attributable to FNHC shareholders
|
|
$
|
1,011
|
|
|
(93.2)
|
%
|
|
$
|
14,928
|
|
|
|
|
|
|
|
|
Ratios to net premiums earned:
|
|
|
|
|
|
|
Net loss ratio
|
|
75.1
|
%
|
|
|
|
64.3
|
%
|
Net expense ratio
|
|
35.9
|
%
|
|
|
|
40.3
|
%
|
Combined ratio
|
|
111.0
|
%
|
|
|
|
104.6
|
%
|
(1)Net loss ratio is calculated as losses and LAE divided by net premiums earned.
(2)Net expense ratio is calculated as all operating expenses less interest expense divided by net premiums earned.
(3)Combined ratio is calculated as the sum of losses and LAE and all operating expenses less interest expense divided by net premiums earned.
The following table sets forth a reconciliation of GAAP to non-GAAP measures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2019
|
|
2018
|
|
|
(Dollars in thousands)
|
Revenue
|
|
|
Total revenues
|
|
$
|
414,961
|
|
|
$
|
396,093
|
|
Less:
|
|
|
|
|
Net realized and unrealized investment gains (losses)
|
|
7,084
|
|
|
(4,144)
|
|
Adjusted operating revenues
|
|
$
|
407,877
|
|
|
$
|
400,237
|
|
|
|
|
|
|
Net Income (Loss)
|
|
|
|
|
Net income (loss)
|
|
$
|
1,011
|
|
|
$
|
14,928
|
|
Less:
|
|
|
|
|
Net realized and unrealized investment gains (losses)
|
|
5,347
|
|
|
(3,094)
|
|
Acquisition and strategic costs
|
|
(1,267)
|
|
|
(1,968)
|
|
Amortization of identifiable intangibles
|
|
(10)
|
|
|
—
|
|
Gain (loss) on early extinguishment of debt
|
|
(2,698)
|
|
|
—
|
|
Adjusted operating income (loss)
|
|
$
|
(361)
|
|
|
$
|
19,990
|
|
|
|
|
|
|
Income tax rate assumed for reconciling items above
|
|
24.522
|
%
|
|
25.345
|
%
|
Revenue
Total revenue increased $18.9 million, or 4.8%, to $415.0 million for the year ended December 31, 2019, as compared to $396.1 million for the year ended December 31, 2018. The increase was primarily driven by higher net premiums growth from homeowners and higher net investment gains offset by lower net premiums earned in automobile and commercial general liability, all of which are discussed below.
Gross Premiums Written
The following table sets forth the gross premiums written for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Gross premiums written:
|
|
|
|
|
Homeowners Florida
|
|
$
|
451,856
|
|
|
$
|
458,652
|
|
Homeowners non-Florida
|
|
142,485
|
|
|
81,037
|
|
Federal flood
|
|
16,413
|
|
|
14,088
|
|
Non-core (1)
|
|
(146)
|
|
|
13,987
|
|
Total gross premiums written
|
|
$
|
610,608
|
|
|
$
|
567,764
|
|
(1)Reflects exited lines of business.
Gross premiums written increased $42.8 million, or 7.5%, to $610.6 million for the year ended December 31, 2019, as compared to $567.8 million for the year ended December 31, 2018. Gross premiums written increased primarily due to the growth in homeowners non-Florida, including $6.6 million from MIC, partially offset by the decline in the non-core lines we exited, automobile and commercial general liability, as well as a decline in homeowners Florida. Overall, homeowners grew 10.1%.
Gross Premiums Earned
The following table sets forth the gross premiums earned for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Gross premiums earned:
|
|
|
|
|
Homeowners Florida
|
|
$
|
452,730
|
|
|
$
|
473,121
|
|
Homeowners non-Florida
|
|
112,836
|
|
|
66,571
|
|
Federal flood
|
|
15,073
|
|
|
13,132
|
|
Non-core (1)
|
|
1,695
|
|
|
27,196
|
|
Total gross premiums earned
|
|
$
|
582,334
|
|
|
$
|
580,020
|
|
(1)Reflects exited lines of business.
Gross premiums earned increased $2.3 million, or 0.4%, to $582.3 million for the year ended December 31, 2019, as compared to $580.0 million for the year ended December 31, 2018. Gross premiums earned increased primarily due to a 4.8% increase in earned premiums in homeowners, which includes $7.9 million from MIC, partially offset by our decision to exit the automobile and commercial general liability lines.
Ceded Premiums Earned
Ceded premiums earned decreased $6.1 million, or 2.7%, to $218.7 million for the year ended December 31, 2019, as compared to $224.8 million for the year ended December 31, 2018. The decrease was primarily driven by lower ceded premiums in automobile as we have exited that line of business, partially offset by higher excess of loss reinsurance spend in homeowners.
Net Investment Income
Net investment income increased $3.4 million, or 27.6%, to $15.9 million for the year ended December 31, 2019, as compared to $12.5 million for the year ended December 31, 2018. The increase was due to fixed income portfolio growth and the improvement in the yield as a result of rising interest rates during 2018 and from portfolio repositioning.
Net Realized and Unrealized Investment Gains (Losses)
Net realized and unrealized investment gains (losses) increased $11.2 million, to $7.1 million for the year ended December 31, 2019, as compared to $(4.1) million for the year ended December 31, 2018. We recognized $4.1 million and $(1.2) million in unrealized investment gains (losses) for equity securities during these respective periods. Our current year net realized gains and prior year net realized losses are primarily associated with our portfolio managers, under our control, moving out of positions due to both macro and micro conditions, a typical practice each and every quarter. Our prior year net realized losses are resulted from our decision to liquidate certain bond positions, including positions related to tax-free municipal securities during the first quarter of 2018.
Direct Written Policy Fees
Direct written policy fees decreased by $3.2 million, or 23.7%, to $10.2 million for the year ended December 31, 2019, as compared to $13.4 million for the year ended December 31, 2018. The decrease in direct written policy fees is correlated to our decision to exit the automobile line, as discussed earlier.
Other Income
Other income decreased $1.1 million, or 5.4%, to $18.1 million for the year ended December 31, 2019, as compared to $19.2 million for the year ended December 31, 2018. Other income included the following for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2019
|
|
% Change
|
|
2018
|
|
|
(Dollars in thousands)
|
Other income:
|
|
|
|
|
|
|
Commission income
|
|
$
|
2,904
|
|
|
(37.5)
|
%
|
|
$
|
4,649
|
|
Brokerage
|
|
13,577
|
|
|
10.3
|
%
|
|
12,305
|
|
Financing and other revenue
|
|
1,643
|
|
|
(25.3)
|
%
|
|
2,200
|
|
Total other income
|
|
$
|
18,124
|
|
|
(5.4)
|
%
|
|
$
|
19,154
|
|
The decrease in other income was driven by lower commission income and financing revenue, partially offset by higher brokerage revenue. The year over year decrease in commission income were driven by lower automobile fee income from the reduction in premiums earned, as we exited this line of business, and, to a lesser extent, lower fee income from other areas of the business. The brokerage revenue increase is the result of higher excess of loss reinsurance spend from the reinsurance programs in place during 2019 as compared to 2018.
Expenses
Losses and LAE
Losses and LAE incurred, net of reinsurance, included the following for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2019
|
|
2018
|
|
|
|
|
Net Loss
|
|
|
|
Net Loss
|
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
|
(In thousands)
|
Current accident year, excluding catastrophes:
|
|
|
|
|
|
|
|
|
Homeowners
|
|
$
|
207,808
|
|
|
57.1
|
%
|
|
$
|
189,567
|
|
|
53.4
|
%
|
Non-core (1)
|
|
1,601
|
|
|
0.4
|
%
|
|
10,066
|
|
|
2.8
|
%
|
Total current accident year, excluding catastrophes
|
|
209,409
|
|
|
57.5
|
%
|
|
199,633
|
|
|
56.2
|
%
|
Current year catastrophes (2):
|
|
|
|
|
|
|
|
|
Florida
|
|
26,250
|
|
|
7.4
|
%
|
|
27,500
|
|
|
7.8
|
%
|
Texas
|
|
12,400
|
|
|
3.4
|
%
|
|
—
|
|
|
—
|
%
|
Louisiana
|
|
8,900
|
|
|
2.4
|
%
|
|
—
|
|
|
—
|
%
|
Other states
|
|
5,150
|
|
|
1.4
|
%
|
|
4,000
|
|
|
1.1
|
%
|
Total current year catastrophes
|
|
52,700
|
|
|
14.6
|
%
|
|
31,500
|
|
|
8.9
|
%
|
Prior year loss development (redundancy):
|
|
|
|
|
|
|
|
|
Homeowners
|
|
615
|
|
|
0.2
|
%
|
|
(7,576)
|
|
|
(2.1)
|
%
|
Non-core (1)
|
|
12,845
|
|
|
3.5
|
%
|
|
9,742
|
|
|
2.7
|
%
|
Ceded losses subject to offsetting experience account adjustments (3)
|
|
(2,489)
|
|
|
(0.7)
|
%
|
|
(4,883)
|
|
|
(1.4)
|
%
|
Total prior year loss development (redundancy)
|
|
10,971
|
|
|
3.0
|
%
|
|
(2,717)
|
|
|
(0.8)
|
%
|
Total net losses and LAE
|
|
$
|
273,080
|
|
|
75.1
|
%
|
|
$
|
228,416
|
|
|
64.3
|
%
|
(1)Reflects exited lines of business.
(2)Includes PCS weather events and other events impacting multiple insureds for which the Company's insurance carriers established catastrophe event codes, net of the benefit of claims handling services. These catastrophe events are typically wind, hail and tornado related weather events. Any individual catastrophe event with gross losses greater than $20 million, on a pre-tax basis, are considered significant and specifically addressed in the commentary below.
(3)Reflects homeowners losses ceded under retrospective reinsurance treaties to the extent there is an offsetting experience account adjustment, such that there is no impact on pre-tax net income (loss).
Losses and LAE increased $44.7 million, or 19.6%, to $273.1 million for the year ended December 31, 2019, as compared to $228.4 million for the year ended December 31, 2018. The net loss ratio increased 10.8 percentage points, to 75.1% in 2019, as compared to 64.3% in 2018. The higher ratio was primarily the result of higher catastrophe net losses when comparing the periods, as 2019 included $52.7 million, net of reinsurance (of which $26.5 million was from FNIC's non-Florida losses that are subject to a 50% profit-sharing agreement), as compared to $31.5 million, net of reinsurance, from 2018 catastrophe events, which is discussed below.
Also contributing to the higher loss ratio was prior year net development of $11.0 million during 2019, as compared to prior year net redundancy of $2.7 million in 2018. Additionally, we increased the current accident year loss and LAE selection for our homeowners Florida line of business in response to higher severity trends from AOB and the overall litigation environment in Florida. The 2019 prior year net development was driven primarily by our exited non-core lines of business, personal automobile and commercial general liability. The 2018 prior year net redundancy was driven by a combination of favorable net redundancy from lower LAE expenses, primarily associated with Hurricane Irma, and ceded losses related to the retrospective reinsurance treaties, mostly offset by unfavorable net development from our exited non-core personal automobile line of business.
Commissions and Other Underwriting Expenses
The following table sets forth commissions and other underwriting expenses for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Commissions and other underwriting expenses:
|
|
|
|
|
Homeowners Florida
|
|
$
|
52,962
|
|
|
$
|
56,693
|
|
All others
|
|
25,491
|
|
|
19,948
|
|
Ceding commissions
|
|
(12,128)
|
|
|
(12,743)
|
|
Total commissions and other fees
|
|
66,325
|
|
|
63,898
|
|
|
|
|
|
|
Fees
|
|
3,368
|
|
6,469
|
Salaries and wages
|
|
12,114
|
|
|
14,279
|
|
Other underwriting expenses
|
|
25,382
|
|
|
36,463
|
|
Total commissions and other underwriting expenses
|
|
$
|
107,189
|
|
|
$
|
121,109
|
|
Commissions and other underwriting expenses decreased $13.9 million, or 11.5%, to $107.2 million for the year ended December 31, 2019, as compared to $121.1 million for the year ended December 31, 2018. The decrease is the result of lower profit share costs recorded within the other underwriting expenses account. As noted above, we have a 50% profit share agreement with our managing general underwriter on FNIC's non-Florida business, whereby we split 50% of the profits. Accordingly, in 2019, non-Florida incurred higher losses from severe weather events (as previously discussed in the Losses and Loss Adjustment Expenses section), resulting in a $13.3 million reduction.
Additionally, the lower automobile fees and lower homeowners Florida commissions are driven by the corresponding change in premiums earned across periods. The decline in salaries and wages is due in part to our continued focus on operational efficiencies. These items are partially offset by an increase in homeowners non-Florida commissions and fees as a result of higher premiums earned across periods.
The net expense ratio decreased 4.4 percentage points to 35.9% in 2019, as compared to 40.3% in 2018. The decrease in the ratio is attributable to the lower non-Florida profit share expense and other expense reductions. Refer to the discussion above for more information.
General and Administrative Expenses
General and administrative expenses increased $1.0 million, or 4.6%, to $23.2 million for the year ended December 31, 2019, as compared to $22.2 million for the year ended December 31, 2018. The increase was primarily the result of higher professional fees, including deal costs and due diligence costs relating to the acquisition of the Maison Companies, as previously discussed.
Interest Expense
Interest expense increased $6.6 million to $10.8 million for the year ended December 31, 2019, as compared to $4.2 million for the year ended December 31, 2018. The increase in interest expense is the result of $3.6 million of prepayment fees, including the write-off of remaining debt issuance costs, and an increase in the outstanding debt as a result of our first quarter 2019 borrowing. Refer to Notes 3 and 10 of the notes to our Consolidated Financial Statements included herein, for information regarding debt issued and debt retirement that occurred in March 2019.
Income Taxes
Income tax expense (benefit) decreased $5.8 million, or 105.4%, to $(0.3) million for the year ended December 31, 2019, as compared to $5.5 million for the year ended December 31, 2018. The decrease in income tax expense is the result of lower income during 2019, compared to 2018. Additionally, in 2019, we recognized a benefit of $0.4 million relating to an election to carry back capital losses and a benefit of $0.2 million relating to a reduction in the uncertain tax position reserve. Lastly, the State of Florida announced a reduction in its state income tax rate effective January 1, 2019.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our primary sources of funds are gross written premiums, investment income, commission income and fee income. Our primary uses of funds are the payment of claims, catastrophe and other reinsurance premiums and operating expenses. As of December 31, 2020, the Company held $102.4 million in cash and cash equivalents and $491.4 million in investments. As of December 31, 2019, the Company held $133.4 million in cash and cash equivalents and $550.6 million in investments. Total shareholders’ equity decreased $90.5 million, to $158.2 million as of December 31, 2020, as compared to $248.7 million as of December 31, 2019, due primarily to our net loss in 2020 and repurchases of common stock executed early in 2020.
On March 5, 2019, the Company closed on an offering of $100 million of Senior Unsecured Notes due 2029, which bear interest at the annual rate of 7.5%. The net proceeds of the offering were in part used to redeem all $45 million of the Company's Senior Unsecured Fixed Rate Notes due 2022 and the Company's Senior Notes due 2027. Additionally, the remaining cash from the offering was used to purchase the Maison Companies and for other general corporate purposes, including repurchases of shares of our common stock and managing the capital needs of our subsidiaries. Refer to Notes 3 and 8 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information regarding the 2029 Notes as well as the acquisition of the Maison Companies.
Among other things, the 2029 Notes contain customary covenants that limit the Company's ability to enter into certain operational and financial transactions, including, but not limited to incurring additional debt above certain thresholds. The Company's debt to capital ratio exceeds 35%; therefore, the Company is currently precluded from incurring additional debt (absent the consent of existing debt holders), repurchasing shares of our common stock or paying common stock dividends. No acceleration of the related debt is mandated due to the fact that catastrophic weather events drove the ratio over 35% rather than specific actions taken by the Company. The Company's actual debt to capital ratio as of December 31, 2020 was approximately 38.4%.
Historically, we have met our liquidity requirements primarily through cash generated from operations. During 2020, property and casualty businesses, including FNHC’s insurance carriers, have been impacted by catastrophes, hail, and wind-related severe weather events and private reinsurers have tightened coverage provisions and raised the cost of their coverages. As a result, sales of our portfolio of fixed income securities was a significant source of liquidity for the Company during 2020. Quota-share reinsurance treaties are another liquidity management tool, via the ceding commission the Company receives upon inception and the related reduction to statutory surplus requirements. New quota-share treaties entered or increased during 2020 were responsive to these purposes, as well as to reduce the Company's exposure to non-named storm catastrophes.
On March 15, 2021, the Company closed an underwritten public offering of 3,500,000 shares of its common stock at a price of $4.75 per share for gross proceeds of $16.6 million. The offering generates net proceeds to the Company of approximately $15.2 million,
after deducting the underwriter’s discount and estimated offering expenses payable by the Company. The Company will use the net proceeds from this sale of the common stock for general corporate purposes, including to provide additional liquidity in its holding company to be available for future capital contributions to its insurance company subsidiaries, if necessary. This offering is part of our ongoing execution of the strategic review process initiated by the Company’s Board of Directors announced in November 2020.
Management continually monitors and adjusts its liquidity and capital plans for FNHC and its subsidiaries in light of the aforementioned challenges to ensure that we have adequate liquidity and capital. Additional weather-related events and actions by reinsurers could adversely affect the Company’s ability to access sources of liquidity, especially due to our elevated debt to capital ratio and debt covenants discussed above, which currently preclude us from incurring additional debt, absent the approval of existing debt holders.
Statutory Capital and Surplus of our Insurance Subsidiaries
As described more fully in Part I, Item 1. Business, Regulation of this Annual Report, our insurance operations are subject to the laws and regulations of the states in which we operate. The Florida OIR and their regulatory counterparts in other states utilize the National Association of Insurance Commissions ("NAIC") risk-based capital ("RBC") requirements, and the resulting RBC ratio, as a key metric in the exercise of their regulatory oversight. The RBC ratio is a measure of the sufficiency of an insurer’s statutory capital and surplus. In addition, the RBC ratio is used by insurance industry ratings services in the determination of the financial strength ratings (i.e. claims paying ability) they assign to insurance companies. As of December 31, 2020, FNIC’s statutory surplus, which includes MNIC, was $105.9 million. As of December 31, 2020, MIC’s statutory surplus was $39.3 million.
Based upon the 2020, 2019 and 2018 statutory financial statements for FNIC, MIC and MNIC, statutory surplus exceeded the regulatory action levels established by the NAIC’s RBC requirements.
Based on RBC requirements, the extent of regulatory intervention and action increases as the ratio of an insurer’s statutory surplus to its 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% 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% of the ACL amount. The third action level, ACL, 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% of the ACL amount. FNIC’s ratio of statutory surplus to its ACL was 303% and 324% as of December 31, 2020 and 2019, respectively. MNIC’s ratio of statutory surplus to its ACL was 736% and 1,129% as of December 31, 2020 and 2019, respectively. MIC’s ratio of statutory surplus to its ACL was 348% and 306% as of December 31, 2020 and 2019, respectively.
As of December 31, 2020, the Company has $59 million of liquidity in its holding company and non-regulated subsidiaries (collectively referred to “holding company liquidity”) that is available for general corporate purposes, including supporting the capital requirements of its insurance subsidiaries, which the RBC levels are above 300%.
Refer to "Part I, Item 1A., Risk Factors” for more information on how over time, additional weather-related events and actions by reinsurers could adversely affect the Company’s insurance carriers’ ability to maintain adequate capital levels or FNHC's ability to contribute necessary capital.
Cash Flows Discussion
We currently believe that existing cash and investment balances, when combined with anticipated cash flows, will be adequate to meet our expected liquidity needs in both the short-term and the reasonably foreseeable future. We currently believe the combined balances will be sufficient to meet our ongoing operating requirements and anticipated cash needs. Future growth strategies may require additional external financing and we may from time to time seek to obtain external financing. We cannot assure that additional sources of financing will be available to us on favorable terms, or at all, or that the terms of any such financing would not negatively impact our results of operations. Under the terms of our senior note indenture, we are currently precluded from incurring additional debt, repurchasing shares of our common stock or paying common stock dividends.
Operating Activities
Net cash (used in) operating activities decreased to $(91.9) million for the year ended December 31, 2020 compared to net cash provided of $35.3 million for the year ended December 31, 2019. This decrease reflects higher expenses paid, including those related
to commissions and underwriting expenses and losses and LAE, including higher net catastrophe losses, in the year ended December 31, 2020, as compared to prior year.
Net cash provided by operating activities increased to $35.3 million for the year ended December 31, 2019 from $30.3 million for the year ended December 31, 2018. This increase reflects higher premiums collected, partially offset by higher expenses paid, including those related to losses and LAE in the year ended December 31, 2019, as compared to the year ended December 31, 2018.
Investing Activities
Net cash provided by (used in) investing activities was $76.4 million for the year ended December 31, 2020, as compared to $(9.0) million for the year ended December 31, 2019. The change was due to higher proceeds from sales of debt and equity securities of $578.5 million for the year ended December 31, 2020, as compared to $173.4 million for the year ended December 31, 2019 and higher maturities and redemptions of debt securities of $86.8 million for 2020, as compared to $43.9 million for the year ended 2019. This was partially offset by higher purchases of debt and equity securities of $585.6 million for the year ended December 31, 2020, as compared to $234.7 million for the year ended December 31, 2019. The net sales of our fixed income portfolio during 2020 stemmed directly from the higher net catastrophe losses experienced in 2020.
Net cash provided by (used in) investing activities was $(9.0) million for the year ended December 31, 2019, as compared to $(21.2) million for the year ended December 31, 2018. The change was due to lower purchases of debt and equity securities of $234.7 million for the year ended December 31, 2019, as compared to $351.3 million for the year ended December 31, 2018 and net cash acquired from the acquisition of the Maison Companies of $10.4 million in 2019. This was partially offset by lower proceeds from sales of debt and equity securities of $173.4 million for the year ended December 31, 2019, as compared to $239.4 million for the year ended December 31, 2018 and lower maturities and redemptions of debt securities of $43.9 million during 2019, as compared to $92.7 million during 2018.
Financing Activities
Net cash provided by (used in) financing activities was $(15.5) million for the year ended December 31, 2020, as compared to net cash provided by $42.6 million for the year ended December 31, 2019. The change was primarily due to proceeds from issuance of long-term debt of $98.4 million for the year ended December 31, 2019 and repurchases of FedNat common stock of $10.4 million in 2020, as compared to $3.4 million in 2019. These changes were partially offset by payment of long-term debt of $48.0 million for the year ended December 31, 2019.
Net cash provided by (used in) financing activities was $42.6 million for the year ended December 31, 2019, as compared to net cash (used) of $(30.9) million for the year ended December 31, 2018. The change was primarily due to proceeds from issuance of long-term debt of $98.4 million for the year ended December 31, 2019, and the purchase of non-controlling interest of $16.7 million for the year ended December 31, 2018. These changes were partially offset by payment of long-term debt of $48.0 million for the year ended December 31, 2019 as compared to payment of $5.0 million during 2018.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented herein have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the inflationary effect on the cost of paying losses and LAE.
Insurance premiums are established before we know the amount of losses and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate premiums, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation may also affect the market value of our investment portfolio and the investment rate of return. Any future economic changes that result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred losses and LAE and thereby materially adversely affect future liability requirements.
CONTRACTUAL OBLIGATIONS
The table sets forth a summary of long-term contractual obligations as of December 31, 2020, and includes amounts that represent estimates of gross undiscounted amounts payable over time, as follows:
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Payments Due By Period
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Less
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More
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than
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1 - 3
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3 - 5
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than
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Total
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|
1 Year
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|
Years
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|
Years
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|
5 Years
|
|
|
(In thousands)
|
Loss and loss adjustment expense reserves (1)
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|
$
|
540,367
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|
|
$
|
318,817
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|
|
$
|
162,110
|
|
|
$
|
32,422
|
|
|
$
|
27,018
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|
Long-term debt (2)
|
|
100,000
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|
|
—
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|
|
—
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|
|
—
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|
|
100,000
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|
Operating leases
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|
8,892
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|
|
1,066
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|
|
2,229
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|
|
2,279
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|
|
3,318
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|
Total long-term contractual obligations
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|
$
|
649,259
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|
|
$
|
319,883
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|
|
$
|
164,339
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|
|
$
|
34,701
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|
|
$
|
130,336
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|
(1)Loss and loss adjustment expense reserves do not have contractual maturity dates; however, based on historical payment patterns, the amount presented is our estimate of the expected timing of these payments. The timing of payments is subject to significant uncertainty. We maintain a portfolio of marketable investments with varying maturities and a substantial amount of cash and cash equivalents intended to provide adequate cash flows for such payments.
(2)Represents the principal amounts of debt only. See Note 10 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States ("GAAP"), which requires us 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 may materially differ from those estimates.
We believe our most critical accounting estimates inherent in the preparation of our financial statements are: (i) fair value measurements of our investments; (ii) accounting for investments; (iii) premium and unearned premium calculation; (iv) reinsurance contracts; (v) the amount and recoverability of deferred acquisition costs and value of business acquired; (vi) goodwill and other intangible assets; (vii) reserve for loss and losses adjustment expenses; and (viii) income taxes. The accounting estimates require the use of assumptions about certain matters that are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, our financial condition, results of operations, and cash flows would be affected.
Fair Value
Fair value is the price that would be received to sell an asset or paid to transfer a liability between market participants in the principal market or in the most advantageous market when no principal market exists. Adjustments to transaction prices or quoted market prices may be required in illiquid or disorderly markets in order to estimate fair value. Alternative valuation techniques may be appropriate under the circumstances to determine the value that would be received to sell an asset or pay to transfer a liability in an orderly transaction. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. Our nonperformance or credit risk is considered in determining the fair value of liabilities. Considerable judgment may be required in interpreting market data used to develop the estimates of fair value. Accordingly, estimates of fair value presented herein are not necessarily indicative of the amounts that could be realized in a current or future market exchange. Refer to Note 4 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information.
Investments
Investments consist of debt and equity securities. Debt securities consist of securities with an initial fixed maturity of more than three months, including corporate bonds, municipal bonds and United States government bonds. Equity securities generally consist of securities that represent ownership interests in an enterprise. The Company determines the appropriate classification of investments in debt and equity securities at the acquisition date and re-evaluates the classification at each balance sheet date.
Held-to-maturity debt securities are recorded at the amortized cost, reflecting the ability and intent to hold the securities to maturity. All other debt securities are classified as available-for-sale and recorded at fair value. Unrealized gains and losses during the year, net of the related tax effect applicable to available-for-sale are excluded from income and reflected in other comprehensive income (loss) as a separate component of shareholders’ equity until realized. Prior to January 1, 2020, if a decline in fair value was deemed to be other-than-temporary, the investment was written down to its fair value and the amount of the write-down is recorded as an other-than-temporary impairment ("OTTI") loss on the statement of operations. As the result of the adoption of Accounting Standards Update (“ASU”) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument ("ASU 2016-13") beginning on January 1, 2020, we instead record an allowance for credit loss. Refer to Note 7 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information regarding allowances for credit loss. Any portion of the market decline related to debt securities that is believed to arise from factors other than credit is recorded as a component of other comprehensive income (loss) rather than against income. Equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) are measured at fair value with changes in fair value recognized in net income (loss).
When we invest in certain companies, such as limited partnerships and limited liability companies, and if we determine we are not the primary beneficiary, we account for them using the equity method to determine the carry value, which is included in other assets on our Consolidated Balance Sheets. Our maximum exposure to loss is limited to the capital we invest.
Net realized gains and losses on investments are determined in accordance with the specific identification method.
Net investment income consists primarily of interest income from debt securities, cash and cash equivalents, including any premium amortization or discount accretion and dividend income from equity securities; less expenses related to investments.
Refer to Note 5 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information regarding investments.
Premiums and Unearned Premiums
We recognize premiums as revenue on a pro-rata basis over the term of an insurance policy. Assumed reinsurance premiums written and earned are based on reports received from ceding companies for pro-rata treaty contracts and are generally recorded as written based on contract terms for excess-of-loss and quota-share contracts. Premiums are earned ratably over the terms of the related coverage.
Unearned premiums and ceded unearned premiums represent the portion of gross premiums written and ceded premiums written, respectively, relating to the unexpired terms of such coverage.
Premium receivable balances are reported net of an allowance for estimated uncollectible premium amounts. Such allowance is based upon an ongoing review of amounts outstanding, length of collection periods, the creditworthiness of the insured and other relevant factors. Amounts deemed to be uncollectible are written off against the allowance. Refer to Note 7 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information allowances for credit loss.
Reinsurance
Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. Reinsuring loss exposures does not relieve a ceding entity from its obligations to policyholders and cedants. Reinsurance recoverables (including amounts related to claims incurred but not reported) and ceded unearned premiums are reported as assets. To minimize exposure to losses from a reinsurer’s inability to pay, the financial condition of such reinsurer is evaluated initially upon placement of the reinsurance and periodically thereafter. In addition to considering the financial condition of the reinsurer, the collectability of the reinsurance recoverables is evaluated (and where appropriate, whether an allowance for estimated uncollectible reinsurance recoverables is to be established) based upon a number of other factors. Such factors include the amounts outstanding, length of collection periods, disputes, any collateral or letters of credit held and other relevant factors. Refer to Note 7 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information regarding allowances for credit loss.
Ceded premiums written are recorded in accordance with applicable terms of the various reinsurance contracts and ceded premiums earned are charged against revenue over the period of the various reinsurance contracts. This also generally applies to reinstatement premiums paid to a reinsurer, which arise when contractually-specified ceded loss triggers have been breached. Ceded commissions
reduce commissions, brokerage and other underwriting expenses and ceded losses incurred reduce net losses and LAE incurred over the applicable periods of the various reinsurance contracts with third party reinsurers. If premiums or commissions are subject to adjustment (for example, retrospectively-rated or experience-rated), the estimated ultimate premium or commission is recognized over the period of the contract.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business and consistent with the terms of the underlying reinsurance contract.
Deferred Acquisition Costs and Value of Business Acquired
Deferred acquisition costs represent those costs that are incremental and directly related to the successful acquisition of new or renewal of existing insurance contracts. We defer incremental costs that result directly from, and are essential to, the acquisition or renewal of an insurance contract. Such deferred acquisition costs generally include agent or broker commissions, referral fees, premium taxes, medical and inspection fees that would not have been incurred if the insurance contract had not been acquired or renewed. Each cost is analyzed to assess whether it is fully deferrable.
We also defer a portion of the employee total compensation and payroll-related fringe benefits directly related to time spent performing specific acquisition or renewal activities, including costs associated with the time spent on underwriting, policy issuance and processing, and sales force contract selling.
The acquisition costs are deferred and amortized over the period in which the related premiums written are earned, generally twelve months. Deferred acquisition cost balances are grouped consistent with the manner in which the insurance contracts are acquired, serviced and measured for profitability and is reviewed for recoverability based on the profitability of the underlying insurance contracts. Investment income is anticipated in assessing the recoverability of deferred acquisition costs. We assess the recoverability of deferred acquisition costs on an annual basis or more frequently if circumstances indicate impairment may have occurred.
Value of business acquired ("VOBA”) is an asset that reflects the estimated fair value of in-force contracts in an acquisition and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the business in-force at the acquisition date. VOBA is amortized over the period in which the related premiums written are earned, generally twelve months or less for property insurance business. VOBA amortization is reported within commissions and other underwriting expenses on our consolidated statements of operations. VOBA is reviewed to ensure that the unamortized portion does not exceed the expected recoverable amount as of October 1, each year, and more frequently if circumstances indicate impairment may have occurred.
Goodwill and Other Intangible Assets
Goodwill and identifiable intangible assets with indefinite lives are not amortized but are reviewed for impairment annually as of October 1 and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value below its associated carrying value. Identifiable intangibles that do not have indefinite lives are amortized on a straight-line basis over their estimated useful lives.
When we perform a quantitative goodwill impairment test, the fair value of the reporting unit, which we define as consolidated FNHC, is determined and compared to its carrying value. If the carrying value of the reporting unit is greater than the reporting unit’s fair value, goodwill is impaired and written down to the reporting unit’s fair value; and a charge is reported in impairment of intangibles on our consolidated statements of operations. The fair value of our reporting unit is comprised of the value of in-force (i.e., existing) business and the value of new business. To determine the value of in-force and new business, we use a discounted cash flows technique that applies a discount rate reflecting the market expected, weighted-average rate of return adjusted for the risk factors associated with operations to the projected future cash flow for our reporting unit.
For identifiable intangible assets, if there is an indication of impairment, then the discounted cash flow method would be used to measure the impairment, and the carrying value would be adjusted as necessary.
We apply significant judgment when determining the estimated fair values discussed above. Factors that can influence these values include any items that can directly or indirectly affect future production levels, profitability and cash flows. Examples of unfavorable changes to assumptions or factors that could result in future impairment include, but are not limited to, the following:
•Lower expectations for future production levels or future profitability;
•Higher discount rates;
•Customer acceptance, capital market, legislative, regulatory or tax changes that affect the cost of, or demand for, our products, the required amount of reserves and/or surplus, or otherwise affect our ability to conduct business, including changes to statutory reserve requirements or changes to RBC requirements; and
•Valuations of significant mergers or acquisitions of companies or blocks of business that would provide relevant market-based inputs for our impairment assessment that could support less favorable conclusions regarding the estimated fair value of our reporting unit.
Estimates of fair value are inherently uncertain and represent only management’s reasonable expectation regarding future developments.
Coinciding with the preparation of the financial statements for the year ended December 31, 2020, the Company’s annual goodwill impairment testing has resulted in the conclusion that the goodwill intangible asset established in conjunction with the acquisition of the Maison Companies in December 2019 is impaired. Therefore, during the fourth quarter of 2020, we recorded a non-cash impairment charge of $11.0 million, against which there is no tax offset, representing the write-off of the full amount of our goodwill asset. The Company’s impairment analysis considered the earnings and share price of the Company and comparable companies, as well as projected cash flows. Continued adverse storm activity, higher excess of loss catastrophe reinsurance costs and the continued unfavorable claims environment in the state of Florida reduced the previously modeled fair value of the Company. These impacts, along with other information relevant to the estimated fair value of the Company, including the trading price of our shares, resulted in the impairment conclusion.
Correspondingly, effective as of October 1, 2020, we believed there was an indication of impairment for our identifiable intangible assets, therefore we performed a discounted cash flow method to measure and record a non-cash impairment of $0.7 million, due primarily to a higher discount rate, which lowered the fair value below carrying value.
Refer to Note 8 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information related to our goodwill and identifiable intangible assets.
Losses and Loss Adjustment Expenses
Overview
The estimation of the liability for unpaid losses and LAE is inherently difficult and subjective, especially in view of changing legal and economic environments that impact the development of loss reserves, and therefore, quantitative techniques frequently have to be supplemented by subjective considerations and managerial judgment. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect liability development to the same degree in the future.
Each of our insurance companies establishes reserves on its balance sheet for unpaid losses and LAE related to its property and casualty insurance and related reinsurance contracts. As of any balance sheet date, there are claims that have not yet been reported, and some claims may not be reported for many years after the date a loss occurs. As a result of this historical pattern, the liability for unpaid losses and LAE includes significant estimates for IBNR claims. Additionally, reported claims are in various stages of the settlement process. Each claim is settled individually based upon its merits, and certain claims may take years to settle, especially if legal action is involved. As a result, the liabilities for unpaid losses and LAE include significant judgments, assumptions and estimates made by management relating to the actual ultimate losses that will arise from the claims. Due to the inherent uncertainties in the process of establishing these liabilities, the actual ultimate loss from a claim is likely to differ, perhaps materially, from the liability initially recorded.
The time period between the occurrence of a loss and the time it is settled is referred to as the “claim tail.” In general, actuarial judgments for shorter-tailed lines of business generally have much less of an effect on the determination of the loss reserve amount than when those same judgments are made regarding longer-tailed lines of business. Reported losses for the shorter-tailed classes, such as property and certain marine, aviation and energy classes, generally reach the ultimate level of incurred losses in a relatively short period of time. Rather than having to rely on actuarial assumptions for many accident years, these assumptions are generally only relevant for the more recent accident years.
The process of recording quarterly and annual liabilities for unpaid losses and LAE for short-tail lines is primarily focused on maintaining an appropriate reserve level for reported claims and IBNR. Specifically, we assess the reserve adequacy of IBNR in light of such factors as the current levels of reserves for reported claims and expectations with respect to reporting lags, catastrophe events, historical data, legal developments, and economic conditions, including the effects of inflation.
Standard actuarial methodologies employed to estimate ultimate losses incorporate the inherent lag from the time claims occur to when they are reported to an insurer and if applicable, to when an insurer reports the claims to a reinsurer. Certain actuarial methodologies may be more appropriate than others in instances where this lag may not be consistent from period to period. Consequently, additional actuarial judgment is employed in the selection of methodologies to best incorporate the potential impact of this situation.
Our insurance companies provide coverage on both a claims-made and occurrence basis. Claims-made policies generally require that claims occur and be reported during the coverage period of the policy. Occurrence policies allow claims which occur during a policy’s coverage period to be reported after the coverage period, and as a result, these claims can have a very long claim tail, occasionally extending for decades. Casualty claims can have a very long claim tail, in certain situations extending for many years. In addition, casualty claims are more susceptible to litigation and the legal environment and can be significantly affected by changing contract interpretations, all of which contribute to extending the claim tail. For long-tail casualty lines of business, estimating the ultimate liabilities for unpaid losses and LAE is a more complex process and depends on a number of factors, including the line and volume of the business involved. For these reasons, our insurance companies will generally use actuarial projections in setting reserves for all casualty lines of business.
In conformity with GAAP, our insurance companies are not permitted to establish reserves for catastrophe losses that have not occurred. Therefore, losses related to a significant catastrophe, or accumulation of catastrophes, in any reporting period could have a material adverse effect on our results of operations and financial condition during that period.
We believe that the reserves for unpaid losses and LAE established by our insurance companies are adequate as of December 31, 2020; however, additional reserves, which could have a material impact upon our financial condition, results of operations and cash flows, may be necessary in the future.
Methodologies and Assumptions
Our insurance companies use a variety of techniques that employ significant judgments and assumptions to establish the liabilities for unpaid losses and LAE recorded at the balance sheet date. These techniques include detailed statistical analyses of past claims reporting, settlement activity, claims frequency, internal loss experience, changes in pricing or coverages and severity data when sufficient information exists to lend statistical credibility to the analyses. More subjective techniques are used when statistical data is insufficient or unavailable. These liabilities also reflect implicit or explicit assumptions regarding the potential effects of future inflation, judicial decisions, changes in laws and recent trends in such factors, as well as a number of actuarial assumptions that vary across our reinsurance and insurance subsidiaries and across lines of business. This data is analyzed by line of business, coverage, accident year or underwriting year and reinsurance contract type, as appropriate.
Our loss reserve review processes use actuarial methods that vary by operating subsidiary and line of business and produce point estimates for each class of business. The actuarial methods used include the following methods:
•Reported Loss Development Method: A reported loss development pattern is calculated based on historical loss development data, and this pattern is then used to project the latest evaluation of cumulative reported losses for each accident year or underwriting year, as appropriate, to ultimate levels;
•Paid Development Method: A paid loss development pattern is calculated based on historical paid loss development data, and this pattern is then used to project the latest evaluation of cumulative paid losses for each accident year or underwriting year, as appropriate, to ultimate levels;
•Expected Loss Ratio Method: Expected loss ratios are applied to premiums earned, based on historical company experience, or historical insurance industry results when company experience is deemed not to be sufficient; and
•Bornhuetter-Ferguson Method: The results from the Expected Loss Ratio Method are essentially blended with either the Reported Loss Development Method or the Paid Development Method.
The primary actuarial assumptions used by insurance companies include the following:
•Expected loss ratios represent management’s expectation of losses, in relation to earned premium, at the time business is written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. For certain longer-tailed reinsurance business that are typically lower frequency, high severity classes, expected loss ratios are often used for the last several accident years or underwriting years, as appropriate.
•Rate of loss cost inflation (or deflation) represents management’s expectation of the inflation associated with the costs we may incur in the future to settle claims. Expected loss cost inflation is particularly important for longer-tailed classes.
•Reported and paid loss emergence patterns represent management’s expectation of how losses will be reported and ultimately paid in the future based on the historical emergence patterns of reported and paid losses and are derived from past experience of our subsidiaries, modified for current trends. These emergence patterns are used to project current reported or paid loss amounts to their ultimate settlement value.
In the absence of sufficiently credible internally-derived historical information, each of the above actuarial assumptions may also incorporate data from the insurance industries as a whole, or peer companies writing substantially similar coverages. Data from external sources may be used to set expectations, as well as assumptions regarding loss frequency or severity relative to an exposure unit or claim, among other actuarial parameters. Assumptions regarding the application or composition of peer group or industry reserving parameters require substantial judgment.
Loss Frequency and Severity
Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described above. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic conditions or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations. Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to our insurance companies. The length of the loss reporting lag affects their ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags), as well as the amount of reserves needed for IBNR. If the actual level of loss frequency and severity is higher or lower than expected, the ultimate losses will be different than management’s estimates.
Prior Year Development
Our insurance companies continually evaluate the potential for changes, both favorable and unfavorable, in their estimates of their loss and LAE liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid losses and LAE established in prior years, these liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect favorable or unfavorable development in loss experience and new information, including, for certain catastrophe events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid losses and LAE, both favorable and unfavorable, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior accident year reserve development. We adjusted our prior year loss and LAE reserve estimates based on current information that differed from previous assumptions made at the time such loss and LAE reserves were previously estimated.
Refer to Note 1 and Note 9 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information regarding our losses and LAE.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss, capital loss and tax-credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income or expense in the period that includes the enactment date. Refer to Note 11 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information regarding our income taxes.
Recent Accounting Pronouncements
Refer to Note 2 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for a discussion of recent accounting pronouncements and their effect, if any, on our company.
Off-Balance Sheet Transactions
For the years ended December 31, 2020 and 2019, we did not have any off balance sheet transactions.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of
FedNat Holding Company
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of FedNat Holding Company and subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and the financial statement schedules listed in the index at Item 15 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 29, 2021 expressed an adverse opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
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Valuation of incurred but not reported reserves
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Description of the Matter
|
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At December 31, 2020, the Company’s reserve for losses and loss adjustment expense ("LAE") balance was $540.4 million of which a significant portion is incurred but not reported reserves (“IBNR”). The carrying amount represents management’s best estimate of the ultimate liability, which in turn is composed of the Company’s assessment of claims pending and the development of prior years’ loss liability, including liabilities based upon individual case estimates for reported losses and LAE and estimates of IBNR. As described in Note 9 of the consolidated financial statements, the establishment of loss reserves is an inherently uncertain process and there is significant uncertainty in determining management’s best estimate of the ultimate liability which is used to determine the IBNR reserves. In particular, the estimate is subject to a number of variables including loss frequency and severity, payment patterns, expected loss ratios and the weighting of the four actuarial methods used for each accident year and line of business.
Auditing management’s best estimate of IBNR was complex due to the judgmental nature of the significant assumptions used in the valuation of the estimate. The significant judgment was primarily due to the sensitivity of management’s estimate to the actuarial methods applied and the assumptions used in the determination of the loss factors and ultimate costs.
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How We Addressed the Matter in Our Audit
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We obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over the process to estimate the IBNR reserves. This included, among others, controls over the review and approval processes that management has in place for the methods and assumptions used in estimating the IBNR reserves.
To test the IBNR reserves, our procedures included among others, the involvement of our actuarial specialists to assess the selection and the weighting of actuarial methods used by management with those methods and weightings used in prior periods and those used in the industry. Additionally, to evaluate the significant assumptions used in the actuarial methods, we compared the significant assumptions, including severity, frequency, payment patterns and expected loss ratios to factors historically used. We performed a review of historical results of the development of the loss and loss adjustment expense reserves related to prior years. We also independently calculated a range of reasonable reserve estimates and compared the range of reasonable reserve estimates to management’s recorded best estimate and performed a review of the historical results of the development of the estimate
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Reinsurance
|
Description of the Matter
|
|
At December 31, 2020, the Company’s reinsurance recoverable, net of allowance, was $413.0 million. As discussed in Note 6 to the consolidated financial statements, during 2020 the Company expanded its reinsurance program that provides quota share and excess of loss coverage for the risks inherent in the business written and the concentration of the Company’s exposure in certain geographies. Certain of these reinsurance arrangements are complex as they contain risk limiting provisions. To qualify as reinsurance for accounting purposes, a contract must embody substantive risk transfer, which is defined as the reasonable possibility that the reinsurer could experience a significant loss on the treaty.
Auditing the reinsurance arrangements was complex due to contractual provisions in certain of the reinsurance arrangements that limit the extent or timing of the net loss that the reinsurers can experience and the judgmental nature of the significant assumptions included in the assessment to determine risk transfer.
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How We Addressed the Matter in Our Audit
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We obtained an understanding, evaluated the design, and tested the operating effectiveness of the controls over the reinsurance process including, among others and controls related to assessing risk transfer.
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Our audit procedures included, among others, gaining an understanding of the terms of the reinsurance agreements with the counterparties and evaluating management’s risk transfer assessment.
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/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2015.
Charlotte, North Carolina
March 29, 2021
FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
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|
|
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|
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December 31,
|
|
|
2020
|
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2019
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ASSETS
|
|
|
|
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Investments:
|
|
|
|
|
Debt securities, available-for-sale, at fair value (amortized cost of $473,126 and $512,645, respectively)
|
|
$
|
488,210
|
|
|
$
|
526,265
|
|
Debt securities, held-to-maturity, at amortized cost
|
|
—
|
|
|
4,337
|
|
Equity securities, at fair value
|
|
3,157
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|
|
20,039
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|
Total investments
|
|
491,367
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|
|
550,641
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|
Cash and cash equivalents
|
|
102,367
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|
|
133,361
|
|
Prepaid reinsurance premiums
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|
278,272
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|
|
145,659
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|
Premiums receivable, net of allowance of $233 and $159, respectively
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50,803
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|
41,422
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|
Reinsurance recoverable, net of allowance of $65 and $0, respectively
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|
413,026
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|
|
209,615
|
|
Deferred acquisition costs and value of business acquired, net
|
|
25,405
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|
|
56,136
|
|
Current and deferred income taxes, net
|
|
35,035
|
|
|
2,552
|
|
Goodwill
|
|
—
|
|
|
10,997
|
|
Other assets
|
|
32,262
|
|
|
28,633
|
|
Total assets
|
|
$
|
1,428,537
|
|
|
$
|
1,179,016
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|
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LIABILITIES AND SHAREHOLDERS’ EQUITY
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|
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Liabilities
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|
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Loss and loss adjustment expense reserves
|
|
$
|
540,367
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|
|
$
|
324,362
|
|
Unearned premiums
|
|
366,789
|
|
|
360,870
|
|
Reinsurance payable and funds withheld liabilities
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|
202,827
|
|
|
102,467
|
|
Long-term debt, net of deferred financing costs of $1,317 and $1,478, respectively
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|
98,683
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|
|
98,522
|
|
Deferred revenue
|
|
7,187
|
|
|
6,856
|
|
Other liabilities
|
|
54,524
|
|
|
37,246
|
|
Total liabilities
|
|
1,270,377
|
|
|
930,323
|
|
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|
|
|
|
Commitments and contingencies (see Note 12)
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|
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Shareholders' Equity
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|
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Preferred stock, $0.01 par value: 1,000,000 shares authorized
|
|
—
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|
|
—
|
|
Common stock, $0.01 par value: 25,000,000 shares authorized; 13,717,908 and 14,414,821 shares issued and outstanding, respectively
|
|
137
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|
|
144
|
|
Additional paid-in capital
|
|
169,298
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|
|
167,677
|
|
Accumulated other comprehensive income (loss)
|
|
11,386
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|
|
10,281
|
|
Retained earnings (deficit)
|
|
(22,661)
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|
|
70,591
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|
|
|
|
|
|
|
|
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|
Total shareholders’ equity
|
|
158,160
|
|
|
248,693
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|
Total liabilities and shareholders' equity
|
|
$
|
1,428,537
|
|
|
$
|
1,179,016
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The accompanying notes are an integral part of the consolidated financial statements.
FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
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Year Ended December 31,
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2020
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2019
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2018
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Revenues:
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Net premiums earned
|
|
$
|
364,134
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|
|
$
|
363,652
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|
|
$
|
355,257
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Net investment income
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|
11,786
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|
|
15,901
|
|
|
12,460
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|
Net realized and unrealized investment gains (losses)
|
|
18,032
|
|
|
7,084
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|
|
(4,144)
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Direct written policy fees
|
|
13,970
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|
|
10,200
|
|
|
13,366
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Other income
|
|
23,941
|
|
|
18,124
|
|
|
19,154
|
|
Total revenues
|
|
431,863
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|
|
414,961
|
|
|
396,093
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|
|
|
|
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|
|
Costs and expenses:
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|
|
|
|
|
|
Losses and loss adjustment expenses
|
|
376,449
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|
|
273,080
|
|
|
228,416
|
|
Commissions and other underwriting expenses
|
|
124,288
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|
|
107,189
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|
|
121,109
|
|
General and administrative expenses
|
|
23,420
|
|
|
23,203
|
|
|
22,183
|
|
Interest expense
|
|
7,661
|
|
|
10,776
|
|
|
4,177
|
|
Impairment of intangibles
|
|
11,699
|
|
|
—
|
|
|
—
|
|
Total costs and expenses
|
|
543,517
|
|
|
414,248
|
|
|
375,885
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
(111,654)
|
|
|
713
|
|
|
20,208
|
|
Income tax expense (benefit)
|
|
(33,496)
|
|
|
(298)
|
|
|
5,498
|
|
Net income (loss)
|
|
(78,158)
|
|
|
1,011
|
|
|
14,710
|
|
Net income (loss) attributable to non-controlling interest
|
|
—
|
|
|
—
|
|
|
(218)
|
|
Net income (loss) attributable to FedNat Holding Company shareholders
|
|
$
|
(78,158)
|
|
|
$
|
1,011
|
|
|
$
|
14,928
|
|
|
|
|
|
|
|
|
Net Income (Loss) Per Common Share
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|
|
|
|
|
|
Basic
|
|
$
|
(5.64)
|
|
|
$
|
0.08
|
|
|
$
|
1.17
|
|
Diluted
|
|
(5.64)
|
|
|
0.08
|
|
|
1.16
|
|
|
|
|
|
|
|
|
Weighted Average Number of Shares of Common Stock Outstanding
|
|
|
|
|
|
|
Basic
|
|
13,846
|
|
|
12,977
|
|
|
12,775
|
|
Diluted
|
|
13,846
|
|
|
13,023
|
|
|
12,867
|
|
|
|
|
|
|
|
|
Dividends Declared Per Common Share
|
|
$
|
0.36
|
|
|
$
|
0.33
|
|
|
$
|
0.24
|
|
The accompanying notes are an integral part of the consolidated financial statements.
FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(78,158)
|
|
|
$
|
1,011
|
|
|
$
|
14,710
|
|
|
|
|
|
|
|
|
Change in net unrealized gains (losses) on investments, available-for-sale, net of tax
|
|
1,105
|
|
|
14,031
|
|
|
(5,444)
|
|
Comprehensive income (loss)
|
|
(77,053)
|
|
|
15,042
|
|
|
9,266
|
|
|
|
|
|
|
|
|
Less: comprehensive income (loss) attributable to non-controlling interest, net of tax
|
|
—
|
|
|
—
|
|
|
(447)
|
|
Comprehensive income (loss) attributable to FedNat Holding Company shareholders
|
|
$
|
(77,053)
|
|
|
$
|
15,042
|
|
|
$
|
9,713
|
|
The accompanying notes are an integral part of the consolidated financial statements.
FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(In thousands, except per share data)
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders'
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
Attributable to
|
|
|
|
|
|
|
|
|
Common Stock
|
|
Additional
|
|
Other
|
|
Retained
|
|
FedNat Holding
|
|
Non-
|
|
Total
|
|
|
Preferred
|
|
Issued
|
|
|
|
Paid-in
|
|
Comprehensive
|
|
Earnings
|
|
Company
|
|
Controlling
|
|
Shareholders'
|
|
|
Stock
|
|
Shares
|
|
Amount
|
|
Capital
|
|
Income (Loss)
|
|
(Deficit)
|
|
Shareholders
|
|
Interest
|
|
Equity
|
Balance as of January 1, 2018
|
|
$
|
—
|
|
|
12,988,247
|
|
|
$
|
130
|
|
|
$
|
139,728
|
|
|
$
|
1,770
|
|
|
$
|
70,009
|
|
|
$
|
211,637
|
|
|
15,822
|
|
|
$
|
227,459
|
|
Cumulative effect of new accounting standards
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(994)
|
|
|
994
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Net income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
14,928
|
|
|
14,928
|
|
|
(218)
|
|
|
14,710
|
|
Other comprehensive income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(4,221)
|
|
|
—
|
|
|
(4,221)
|
|
|
(229)
|
|
|
(4,450)
|
|
Dividends declared
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(3,120)
|
|
|
(3,120)
|
|
|
—
|
|
|
(3,120)
|
|
Acquisition of non-controlling interest
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,005)
|
|
|
(305)
|
|
|
—
|
|
|
(1,310)
|
|
|
(15,375)
|
|
|
(16,685)
|
|
Shares issued under share-based compensation plans
|
|
—
|
|
|
122,905
|
|
|
1
|
|
|
38
|
|
|
—
|
|
|
—
|
|
|
39
|
|
|
—
|
|
|
39
|
|
Repurchases of common stock
|
|
—
|
|
|
(326,708)
|
|
|
(3)
|
|
|
—
|
|
|
—
|
|
|
(5,058)
|
|
|
(5,061)
|
|
|
—
|
|
|
(5,061)
|
|
Share-based compensation
|
|
—
|
|
|
—
|
|
|
—
|
|
|
2,367
|
|
|
—
|
|
|
—
|
|
|
2,367
|
|
|
—
|
|
|
2,367
|
|
Balance as of December 31, 2018
|
|
—
|
|
|
12,784,444
|
|
|
128
|
|
|
141,128
|
|
|
(3,750)
|
|
|
77,753
|
|
|
215,259
|
|
|
—
|
|
|
215,259
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,011
|
|
|
1,011
|
|
|
—
|
|
|
1,011
|
|
Other comprehensive income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
14,031
|
|
|
—
|
|
|
14,031
|
|
|
—
|
|
|
14,031
|
|
Dividends declared
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(4,309)
|
|
|
(4,309)
|
|
|
—
|
|
|
(4,309)
|
|
Shares issued for acquisition
|
|
—
|
|
|
1,773,102
|
|
|
18
|
|
|
24,373
|
|
|
—
|
|
|
—
|
|
|
24,391
|
|
|
—
|
|
|
24,391
|
|
Shares issued under share-based compensation plans
|
|
—
|
|
|
94,922
|
|
|
1
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1
|
|
|
—
|
|
|
1
|
|
Repurchases of common stock
|
|
—
|
|
|
(237,647)
|
|
|
(3)
|
|
|
—
|
|
|
—
|
|
|
(3,864)
|
|
|
(3,867)
|
|
|
—
|
|
|
(3,867)
|
|
Share-based compensation
|
|
—
|
|
|
—
|
|
|
—
|
|
|
2,176
|
|
|
—
|
|
|
—
|
|
|
2,176
|
|
|
—
|
|
|
2,176
|
|
Balance as of December 31, 2019
|
|
—
|
|
|
14,414,821
|
|
|
144
|
|
|
167,677
|
|
|
10,281
|
|
|
70,591
|
|
|
248,693
|
|
|
—
|
|
|
248,693
|
|
Net income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(78,158)
|
|
|
(78,158)
|
|
|
—
|
|
|
(78,158)
|
|
Other comprehensive income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,105
|
|
|
—
|
|
|
1,105
|
|
|
—
|
|
|
1,105
|
|
Dividends declared
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(5,077)
|
|
|
(5,077)
|
|
|
—
|
|
|
(5,077)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative effect of new accounting standards
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(25)
|
|
|
(25)
|
|
|
—
|
|
|
(25)
|
|
Shares issued under share-based compensation plans
|
|
—
|
|
|
103,322
|
|
|
1
|
|
|
41
|
|
|
—
|
|
|
—
|
|
|
42
|
|
|
—
|
|
|
42
|
|
Repurchases of common stock
|
|
—
|
|
|
(800,235)
|
|
|
(8)
|
|
|
—
|
|
|
—
|
|
|
(9,992)
|
|
|
(10,000)
|
|
|
—
|
|
|
(10,000)
|
|
Share-based compensation
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,580
|
|
|
—
|
|
|
—
|
|
|
1,580
|
|
|
—
|
|
|
1,580
|
|
Balance as of December 31, 2020
|
|
—
|
|
|
13,717,908
|
|
|
$
|
137
|
|
|
$
|
169,298
|
|
|
$
|
11,386
|
|
|
$
|
(22,661)
|
|
|
$
|
158,160
|
|
|
$
|
—
|
|
|
$
|
158,160
|
|
The accompanying notes are an integral part of the consolidated financial statements.
FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
Cash flow from operating activities:
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(78,158)
|
|
|
$
|
1,011
|
|
|
$
|
14,710
|
|
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
Net realized and unrealized investment (gains) losses
|
|
(18,032)
|
|
|
(7,084)
|
|
|
4,144
|
|
Impairment of intangibles
|
|
11,699
|
|
|
—
|
|
|
—
|
|
Loss (gain) on early extinguishment of debt
|
|
—
|
|
|
3,575
|
|
|
—
|
|
Amortization of investment premium or discount, net
|
|
3,740
|
|
|
916
|
|
|
1,546
|
|
Depreciation and amortization
|
|
1,904
|
|
|
1,477
|
|
|
1,385
|
|
Share-based compensation
|
|
1,580
|
|
|
2,176
|
|
|
2,367
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
Prepaid reinsurance premiums
|
|
(132,613)
|
|
|
(11,803)
|
|
|
26,915
|
|
Premiums receivable, net
|
|
(9,381)
|
|
|
(8,654)
|
|
|
16,602
|
|
Reinsurance recoverable, net
|
|
(203,443)
|
|
|
9,412
|
|
|
(86,823)
|
|
Deferred acquisition costs and value of business acquired, net
|
|
30,731
|
|
|
(7,979)
|
|
|
1,457
|
|
Current and deferred income taxes, net
|
|
(32,835)
|
|
|
(3,723)
|
|
|
6,109
|
|
Deferred revenue
|
|
331
|
|
|
756
|
|
|
(1,637)
|
|
Loss and loss adjustment expense reserves
|
|
216,005
|
|
|
11,472
|
|
|
65,715
|
|
Unearned premiums
|
|
5,919
|
|
|
28,365
|
|
|
(12,431)
|
|
Reinsurance payable and funds withheld liabilities
|
|
100,360
|
|
|
14,797
|
|
|
(8,345)
|
|
Other
|
|
10,285
|
|
|
602
|
|
|
(1,444)
|
|
Net cash provided by (used in) operating activities
|
|
(91,908)
|
|
|
35,316
|
|
|
30,270
|
|
Cash flow from investing activities:
|
|
|
|
|
|
|
Proceeds from sales of equity securities
|
|
22,050
|
|
|
9,203
|
|
|
10,639
|
|
Proceeds from sales of debt securities
|
|
556,463
|
|
|
164,196
|
|
|
228,777
|
|
Purchases of equity securities
|
|
(4,727)
|
|
|
(6,565)
|
|
|
(13,542)
|
|
Purchases of debt securities
|
|
(580,876)
|
|
|
(228,132)
|
|
|
(337,776)
|
|
Maturities and redemptions of debt securities
|
|
86,814
|
|
|
43,925
|
|
|
92,744
|
|
Payment for acquisition, net of cash acquired
|
|
—
|
|
|
10,402
|
|
|
—
|
|
Purchases of property and equipment
|
|
(3,357)
|
|
|
(2,040)
|
|
|
(2,026)
|
|
Net cash provided by (used in) investing activities
|
|
76,367
|
|
|
(9,011)
|
|
|
(21,184)
|
|
Cash flow from financing activities:
|
|
|
|
|
|
|
Proceeds from issuance of long-term debt, net of issuance costs
|
|
—
|
|
|
98,390
|
|
|
—
|
|
Payment of long-term debt and prepayment penalties
|
|
—
|
|
|
(48,000)
|
|
|
(5,000)
|
|
Purchase of non-controlling interest
|
|
—
|
|
|
—
|
|
|
(16,685)
|
|
Purchases of FedNat Holding Company common stock
|
|
(10,418)
|
|
|
(3,449)
|
|
|
(5,061)
|
|
Issuance of common stock for share-based awards
|
|
42
|
|
|
1
|
|
|
39
|
|
Dividends paid
|
|
(5,077)
|
|
|
(4,309)
|
|
|
(4,184)
|
|
Net cash provided by (used in) financing activities
|
|
(15,453)
|
|
|
42,633
|
|
|
(30,891)
|
|
Net increase (decrease) in cash and cash equivalents
|
|
(30,994)
|
|
|
68,938
|
|
|
(21,805)
|
|
Cash and cash equivalents at beginning-of-period
|
|
133,361
|
|
|
64,423
|
|
|
86,228
|
|
Cash and cash equivalents at end-of-period
|
|
$
|
102,367
|
|
|
$
|
133,361
|
|
|
$
|
64,423
|
|
The accompanying notes are an integral part of the consolidated financial statements.
FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
Cash paid (received) during the period for interest
|
|
$
|
7,500
|
|
|
$
|
4,860
|
|
|
$
|
4,266
|
|
Cash paid (received) during the period for income taxes
|
|
(635)
|
|
|
3,504
|
|
|
(1,104)
|
|
|
|
|
|
|
|
|
Significant non-cash investing and financing transactions:
|
|
|
|
|
|
|
Right-of-use asset
|
|
(7,430)
|
|
|
(8,096)
|
|
|
—
|
|
Lease liability
|
|
7,430
|
|
|
8,096
|
|
|
—
|
|
The accompanying notes are an integral part of the consolidated financial statements.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020
1. ORGANIZATION, CONSOLIDATION AND BASIS OF PRESENTATION
Organization
FedNat Holding Company (“FNHC,” the “Company,” “we,” “us,” or “our”) is a regional insurance holding company that controls substantially all aspects of the insurance underwriting, distribution and claims processes through our subsidiaries and contractual relationships with independent agents and general agents. We, through our wholly owned subsidiaries, are authorized to underwrite and/or place homeowners multi-peril (“homeowners”), federal flood and other lines of insurance in Florida and other states. We market, distribute and service our own and third-party insurers’ products and other services through a network of independent and general agents.
FedNat Insurance Company (“FNIC”), our largest wholly owned insurance subsidiary, is licensed as an admitted carrier to write homeowners property and casualty insurance by the state’s insurance departments in Florida, Louisiana, Texas, Georgia, South Carolina, Alabama and Mississippi.
Maison Insurance Company ("MIC"), an insurance subsidiary, is licensed as an admitted carrier to write homeowners property and casualty insurance as well as wind/hail-only exposures by the state's insurance departments in Louisiana, Texas and Florida.
Monarch National Insurance Company (“MNIC”), an insurance subsidiary, is licensed as an admitted carrier to write homeowners property and casualty insurance in Florida.
Material Distribution Relationships
Ivantage Select Agency, Inc.
The Company is a party to an insurance agency master agreement with Ivantage Select Agency, Inc. (“ISA”), an affiliate of Allstate Insurance Company (“Allstate”), pursuant to which the Company has been authorized by ISA to appoint Allstate agents to offer our FNIC homeowners insurance products to consumers in Florida. As a percentage of the total homeowners premiums we underwrote, 20.7%, 23.2% and 23.8%, were from Allstate’s network of Florida agents, for the years ended December 31, 2020, 2019 and 2018, respectively.
SageSure Insurance Managers, LLC
The Company is a party to a managing general underwriting agreement with SageSure Insurance Managers, LLC (“SageSure”) to facilitate growth in our FNIC homeowners business outside of Florida. As a percentage of the total homeowners premiums, 25.5%, 23.1% and 15.0% of the Company’s premiums were underwritten by SageSure, for the years ended December 31, 2020, 2019, and 2018, respectively. As part of our partnership with SageSure, previously we entered into a profit share agreement, whereby we shared 50% of net profits of this line of business through June 30, 2020, as calculated per the terms of the agreement, subject to certain limitations, which included limits on the net losses that SageSure could realize. The limit was based on the amount of inception to date profits within the profit share agreement. In addition, refer to Note 6 for information regarding a fully collateralized quota-share treaty on this book of business that became effective July 1, 2020.
Basis of Presentation and Principles of Consolidation
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”). The consolidated financial statements include the accounts of FNHC and its wholly-owned subsidiaries and all entities in which the Company has a controlling financial interest and any variable interest entity (“VIE”) of which the Company is the primary beneficiary. The Company’s management believes the consolidated financial statements reflect all material adjustments, including normal recurring adjustments, necessary to fairly state the financial position, results of operations and cash flows of the Company for the periods presented. All significant intercompany accounts and transactions have been eliminated in consolidation.
The Company identifies a VIE as an entity that does not have sufficient equity to finance its own activities without additional financial support or where the equity investors lack certain characteristics of a controlling financial interest. The Company assesses its contractual, ownership or other interests in a VIE to determine if the Company’s interest participates in the variability the VIE was designed to absorb and pass onto variable interest holders. The Company performs an ongoing qualitative assessment of its variable interests in a VIE to determine whether the Company has a controlling financial interest and would therefore be considered the
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
primary beneficiary of the VIE. If the Company determines it is the primary beneficiary of a VIE, the Company consolidates the assets and liabilities of the VIE in its consolidated financial statements.
We completed our acquisition of MNIC in February 2018 by acquiring the membership interests in MNIC’s indirect parent, Monarch Delaware Holdings LLC (“Monarch Delaware”), held by our joint venture partners. As such, the Company consolidated Monarch Delaware in its consolidated financial statements. In accordance with the accounting standard on consolidation, a primary beneficiary that acquires additional ownership of the previously controlled and consolidated subsidiaries is accounted for as an equity transaction and re-measurement of assets and liabilities of previously controlled and consolidated subsidiaries is not permitted. As a result, we accounted for this transaction by eliminating the carrying value of the non-controlling interest to reflect our 100% ownership interest in MNIC as of February 21, 2018. The difference between the consideration paid and the amount by which the non-controlling interest was eliminated has been recognized in additional paid-in capital. Following the closing, Monarch Delaware and Monarch Holdings were merged into MNIC.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
Accounting Estimates and Assumptions
The Company prepares the accompanying consolidated financial statements in accordance with GAAP, which 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 may materially differ from those estimates.
Similar to other property and casualty insurers, the Company’s liability for loss and loss adjustment expenses ("LAE") reserves, although supported by actuarial projections and other data, is ultimately based on management’s reasoned expectations of future events. Although considerable variability is inherent in these estimates, the Company believes that the liability and LAE reserve is adequate. The Company reviews and evaluates its estimates and assumptions regularly and makes adjustments, reflected in current operations, as necessary, on an ongoing basis.
Business Combinations
We use the acquisition method of accounting for all business combination transactions, and accordingly, recognize the fair values of assets acquired, liabilities assumed and any non-controlling interests in our consolidated financial statements. The allocation of fair values may be subject to adjustment after the initial allocation for up to a one-year period as more information becomes available relative to the fair values as of the acquisition date. The consolidated financial statements include the results of operations of any acquired company since the acquisition date.
Fair Value
Fair value is the price that would be received to sell an asset or paid to transfer a liability between market participants in the principal market or in the most advantageous market when no principal market exists. Adjustments to transaction prices or quoted market prices may be required in illiquid or disorderly markets in order to estimate fair value. Alternative valuation techniques may be appropriate under the circumstances to determine the value that would be received to sell an asset or pay to transfer a liability in an orderly transaction. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. Our nonperformance or credit risk is considered in determining the fair value of liabilities. Considerable judgment may be required in interpreting market data used to develop the estimates of fair value. Accordingly, estimates of fair value presented herein are not necessarily indicative of the amounts that could be realized in a current or future market exchange. Refer to Note 4 below for additional information regarding fair value.
Investments
Investments consist of debt and equity securities. Debt securities consist of securities with an initial fixed maturity of more than three months, including corporate bonds, municipal bonds and United States government bonds. Equity securities generally consist of securities that represent ownership interests in an enterprise. The Company determines the appropriate classification of investments in debt and equity securities at the acquisition date and re-evaluates the classification at each balance sheet date.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Held-to-maturity debt securities are recorded at the amortized cost, reflecting the ability and intent to hold the securities to maturity. All other debt securities are classified as available-for-sale and recorded at fair value. Unrealized gains and losses during the year, net of the related tax effect applicable to available-for-sale, are excluded from income and reflected in other comprehensive income (loss) as a separate component of shareholders' equity. Prior to January 1, 2020, if a decline in fair value was deemed to be other-than-temporary, the investment was written down to its fair value and the amount of the write-down is recorded as an other-than-temporary impairment ("OTTI") loss on the statement of operations. As the result of the adoption of Accounting Standards Update (“ASU”) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument ("ASU 2016-13") beginning on January 1, 2020, we instead record an allowance for credit loss. Refer to Note 7 below for additional information regarding allowances for credit loss. Any portion of the market decline related to debt securities that is believed to arise from factors other than credit is recorded as a component of other comprehensive income (loss) rather than against income. Equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) are measured at fair value with changes in fair value recognized in net income (loss).
When we invest in certain companies, such as limited partnerships and limited liability companies, and if we determine we are not the primary beneficiary, we account for them using the equity method to determine the carry value, which is included in other assets on our Consolidated Balance Sheets. Our maximum exposure to loss is limited to the capital we invest.
Net realized gains and losses on investments are determined in accordance with the specific identification method.
Net investment income consists primarily of interest income from debt securities, cash and cash equivalents, including any premium amortization or discount accretion and dividend income from equity securities; less expenses related to investments.
Refer to Note 5 below for additional information regarding investments.
Cash and Cash Equivalents
Cash and cash equivalents consist of all deposit or deposit in transit balances with a bank that are available for withdrawal. The Company considers all highly liquid investments with an original maturity of three months or less at the date of the purchase to be cash equivalents.
Premiums and Unearned Premiums
The Company recognizes premiums as revenue on a pro-rata basis over the term of the insurance policy.
Unearned premiums represent the portion of gross premiums written, related to the unexpired terms of such coverage.
Premium receivable balances, which include any outstanding receivable from the SageSure profit sharing agreement, are reported net of an allowance for estimated uncollectible premium amounts. Such allowance is based upon an ongoing review of amounts outstanding, length of collection periods, the creditworthiness of the insured and other relevant factors. Amounts deemed to be uncollectible are written off against the allowance. Refer to Note 7 below for additional information regarding allowances for credit loss.
Reinsurance
Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. Reinsuring loss exposures does not relieve a ceding entity from its obligations to policyholders and cedants. Reinsurance recoverables (including amounts related to claims incurred but not reported) and ceded unearned premiums are reported as assets. To minimize exposure to losses from a reinsurer’s inability to pay, the financial condition of such reinsurer is evaluated initially upon placement of the reinsurance and periodically thereafter. In addition to considering the financial condition of the reinsurer, the collectability of the reinsurance recoverables is evaluated (and where appropriate, whether an allowance for estimated uncollectible reinsurance recoverables is to be established) based upon a number of other factors. Such factors include the amounts outstanding, length of collection periods, disputes, any collateral or letters of credit held and other relevant factors. To the extent that an allowance for uncollectible reinsurance recoverable is established, amounts deemed to be uncollectible are written off against the allowance for estimated uncollectible reinsurance recoverables. Refer to Note 7 below for additional information regarding allowances for credit loss.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Ceded premiums written are recorded in accordance with applicable terms of the various reinsurance contracts and ceded premiums earned are charged against revenue over the period of the various reinsurance contracts. This also generally applies to reinstatement premiums paid to a reinsurer, which arise when contractually-specified ceded loss triggers have been breached.
Ceded commissions reduce commissions and other underwriting expenses and ceded losses incurred reduce net losses and LAE incurred over the applicable periods of the various reinsurance contracts with third party reinsurers. If premiums or commissions are subject to adjustment (for example, retrospectively-rated or experience-rated), the Company records adjustments to the premiums or ceding commission in the period that changes in the estimated losses are determined.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business and consistent with the terms of the underlying reinsurance contract. Reinsurance payable and funds withheld liabilities represents the unpaid reinsurance premiums or reinstatement premiums due to reinsurers, or in the case of certain reinsurance agreements amounts withheld as collateral by us.
Refer to Note 6 below for additional information regarding reinsurance.
Deferred Acquisition Costs and Value of Business Acquired
Deferred acquisition costs represent those costs that are incremental and directly related to the successful acquisition of new or renewal of existing insurance contracts. The Company defers incremental costs that result directly from, and are essential to, the acquisition or renewal of an insurance contract. Such deferred acquisition costs generally include agent or broker commissions, referral fees, premium taxes, medical and inspection fees that would not have been incurred if the insurance contract had not been acquired or renewed. Each cost is analyzed to assess whether it is fully deferrable.
The Company also defers a portion of the employee total compensation and payroll-related fringe benefits directly related to time spent performing specific acquisition or renewal activities, including costs associated with the time spent on underwriting, policy issuance and processing, and sales force contract selling.
The acquisition costs are deferred and amortized over the period in which the related premiums written are earned, generally twelve months for homeowners policies. Deferred acquisition cost balances are grouped consistent with the manner in which the insurance contracts are acquired, serviced and measured for profitability and is reviewed for recoverability based on the profitability of the underlying insurance contracts. Investment income is anticipated in assessing the recoverability of deferred acquisition costs. The Company assesses the recoverability of deferred acquisition costs on an annual basis or more frequently if circumstances indicate impairment may have occurred.
Value of business acquired ("VOBA") is an asset that reflects the estimated fair value of in-force contracts in an acquisition and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the business in-force at the acquisition date. VOBA is amortized over the period in which the related premiums written are earned, generally twelve months or less for property insurance business. VOBA amortization is reported within commissions and other underwriting expenses on our consolidated statements of operations. VOBA is reviewed to ensure that the unamortized portion does not exceed the expected recoverable amount as of October 1 and more frequently if circumstances indicate impairment may have occurred.
Goodwill
We recognize the excess of the purchase price, plus the fair value of any non-controlling interest in the acquiree, over the fair value of identifiable net assets acquired at the acquisition date as goodwill. Goodwill is not amortized but is reviewed for impairment annually as of October 1 and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. We perform a quantitative goodwill impairment test where the fair value of the reporting unit is determined and compared to the carrying value of the reporting unit. If the fair value of the reporting unit is greater than the reporting unit’s carrying value, then the carrying value of the reporting unit is deemed to be recoverable. If the carrying value of the reporting unit is greater than the reporting unit’s fair value, goodwill is impaired and written down to the reporting unit’s fair value; and a charge is reported in impairment of intangibles on our consolidated statements of operations. Refer to Note 8 below for additional information regarding goodwill.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Other Assets
Other assets consist primarily of identifiable intangible assets, property and equipment owned, right-of-use assets for our long-term leases, receivables resulting from sales of securities that had not yet settled as of the balance sheet date and prepaid expenses.
Property and equipment is stated at cost, net of accumulated depreciation and amortization. Depreciation is calculated using a straight-line method over the estimated useful lives, ranging from 3 to 15 years. Repairs and maintenance are charged to expense as incurred.
The Company accounts for internal-use software development costs in accordance with accounting guidelines which state that software costs, including internal payroll costs, incurred in connection with the development or acquisition of software for internal use is charged to expense as incurred until the project enters the application development phase. Costs incurred in the application development phase are capitalized and are depreciated using the straight-line method over an estimated useful life of 3 years, beginning when the software is ready for use.
We recognize the estimated fair value of identifiable intangibles such as trade names and non-compete agreements acquired through a business combination at the acquisition date. Identifiable intangible assets are amortized on a straight-line basis over their identified useful life, if applicable. The carrying values of identifiable intangible assets are reviewed at least annually for indicators of impairment in value that are other-than-temporary, including unexpected or adverse changes in the following: the economic or competitive environments in which the company operates; profitability analysis; cash flow analysis; and the fair value of the relevant business operation. If there is an indication of impairment, then the discounted cash flow method would be used to measure the impairment, and the carrying value would be adjusted as necessary and reported in impairment of intangibles on our consolidated statements of operations. Refer to Note 8 below for additional information regarding identifiable intangible assets.
Direct Written Policy Fees
Policy fees represent a non-refundable application fee for insurance coverage. These policy fees are deferred over the related policy term in a manner consistent with how the related premiums are earned.
Other Income
Other income represents brokerage, commission related income from the Company’s agency operations, fees generated from the exited personal automobile line of business as well as recognition of equity method investment results. Brokerage income is recognized over the term of the reinsurance period, typically one year. Commission income from agency operations are recognized up-front upon policy inception. In applying the equity method, the Company records its initial investment at cost, and subsequently increases or decreases the carrying amount of the investment by its proportionate share of the net earnings or losses with any dividends or distributions received are recorded as a decrease in the carrying value of the investment.
Losses and Loss Adjustment Expenses
The reserves for losses and LAE represent management’s best estimate of the ultimate cost of all reported and unreported losses incurred through the balance sheet date. Such liabilities are determined based upon the Company’s assessment of claims pending and the development of prior years’ loss liability, including liabilities based upon individual case estimates for reported losses and LAE and estimates of such amounts that are incurred but not yet reported ("IBNR”). Changes in the estimated liability are charged or credited to operations as the losses and LAE are settled.
The estimates of the liability for loss and LAE reserves are subject to the effect of trends in claims severity and frequency and are continually reviewed. As part of this process, the Company review historical data and consider various factors, including known and anticipated legal developments, 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 loss and LAE reserves. Adjustments are reflected in the results of operations in the period in which they are made and the liabilities may deviate substantially from prior estimates.
Refer to Note 9 below for additional information regarding reserves for losses and LAE.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Long-Term Debt, Net of Deferred Financing Costs
The Company records long-term debt, net in the consolidated balance sheets at carrying value.
The Company incurs specific incremental costs, other than those paid to lenders, in connection with the issuance of the Company’s debt instruments. These deferred financing costs include loan origination costs, issue costs and other direct costs payable to third parties and are recorded as a direct deduction from the carrying value of the associated debt liability in the consolidated balance sheets, when the debt liability is recorded. The Company amortizes the deferred financing costs as interest expense over the term of the related debt using the effective interest method in the consolidated statements of operations.
Refer to Note 10 below for additional information regarding long-term debt.
Income Taxes
The Company applies the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss, capital loss and tax-credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income or expense in the period that includes the enactment date. The Company will establish a valuation allowance if management determines, based on available information, that it is more likely than not that deferred income tax assets will not be realized. Significant judgment is required in determining whether valuation allowances should be established and the amount of such allowances.
The Company’s management makes assumptions, estimates and judgments, which are subject to change, in accounting for income taxes. The Company’s management also considers events and transactions on an on-going basis and the laws enacted as of the Company’s reporting date.
Refer to Note 11 below for further information regarding income taxes.
Share-Based Compensation
We expense the fair value of stock awards included in our stock incentive compensation plans. The Company grants awards and amortizes them on a straight-line over the vesting term using the straight-line basis for service awards and over successive one-year requisite service periods for performance based awards. For all restricted stock awards (“RSAs”), excluding grants based on relative total shareholder return ("TSR"), the fair value is determined based on the closing market price on the date of grant. For grants based on TSR, grant date fair value is determined using a Monte Carlo simulation and, unlike the performance condition awards, the expense is not reversed if the performance condition is not met. Non-employee directors are treated as employees for accounting purposes. The non-cash share-based compensation expense is reflected in commissions and other underwriting and general and administrative expense on our Consolidated Statements of Operations and is recognized as an increase to additional paid-in capital on our Consolidated Balance Sheets.
Basic and Diluted Net Income (Loss) per Share
Basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of common shares, while diluted net income per share is computed by dividing net income available to common shareholders by the weighted average number of such common shares and dilutive share equivalents result from the assumed exercise of employee stock options and vesting of restricted common stock and are calculated using the treasury stock method.
Recently Issued Accounting Pronouncements, Adopted
In January 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-01, which addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. Most notably, the combined new guidance required equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
value recognized in net income. The Company adopted the guidance effective January 1, 2018, by reflecting a cumulative adjustment, which increased retained earnings (deficit) and decreased accumulated other comprehensive income (loss) by $1.0 million. This adjustment represented the level of net unrealized gains and losses associated with our equity investments with readily determinable market values as of January 1, 2018. The adoption also resulted in the recognition of $(1.2) million in our consolidated statements of operations and statements of comprehensive income (loss), which represented the change in net unrealized gains and losses on our equity securities for 2018. This new guidance increases our earnings volatility compared to the prior accounting rules.
In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The update allowed a reclassification from accumulated other comprehensive income (loss) to retained earnings (deficit) for stranded tax effects resulting from the Tax Cuts and Job Act of 2017 ("Tax Act"). Guidance had previously required the effect of a change in tax laws or rates on deferred tax balances to be reported in income from continuing operations in the accounting period that includes the period of enactment, even if the related income tax effects were originally charged or credited directly to accumulated other comprehensive income. The Company adopted the guidance effective January 1, 2018, by reflecting a cumulative effect adjustment to retained earnings (deficit) with an off-setting adjustment to accumulated other comprehensive income (loss) for less than $0.1 million.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The update superseded the prior lease guidance in Topic 840, Leases and lessees were required to recognize for all leases, with the exception of short-term leases, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis. Additionally, lessees are required to recognize a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. The Company adopted the guidance effective January 1, 2019, by reflecting a $6.1 million right-of-use asset, after-tax, and $6.1 million lease liability, after-tax, on our consolidated balance sheets for our leases in existence as of that date. All of the Company's leases were classified as operating leases and we elected the practical expedient, therefore no adjustment to comparative prior periods presented have been made. The provisions of this ASU did not have an impact on our pattern of lease expense recognition on our consolidated statements of operations. Refer to Note 12 below for additional information regarding leases.
In June 2016, the FASB issued ASU 2016-13, which significantly changes the measurement of credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The update requires entities to record allowances for available-for-sale debt securities rather than reduce the carrying amount, as currently performed under the other-than-temporary impairment ("OTTI") model. The update also requires enhanced disclosures for financial assets measured at amortized cost and available-for-sale debt securities to help the financial statement users better understand significant judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. The Company adopted the guidance effective January 1, 2020, by reflecting a cumulative effect adjustment of less than $0.1 million, after-tax, which decreased retained earnings (deficit), held-to-maturity debt securities and reinsurance recoverable. Refer to Note 7 for additional information regarding allowances for credit loss.
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. ASU 2017-04 eliminated the requirement to perform Step 2 of the goodwill impairment test in favor of only applying a quantitative test (referred to in previous guidance as Step 1). As part of the quantitative test, the fair value of the reporting unit is compared with its carrying value, and an impairment charge is recognized when the carrying value exceeds the reporting unit’s fair value. An entity still has the option to first perform a qualitative assessment of an individual reporting unit to determine if the quantitative assessment is necessary. The Company adopted the guidance effective January 1, 2020. Refer to Note 8 for information regarding our goodwill impairment assessment.
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ASU 2018-15 requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in Accounting Standards Codification 350-40 to determine which implementation costs to defer and recognize as an asset. The Company adopted the guidance effective January 1, 2020, which did not have any impact on the Company’s consolidated financial condition or results of operations.
Recently Issued Accounting Pronouncements, Not Yet Adopted
In January 2020, the FASB issued ASU 2020-1, Accounting for Equity Securities and Equity Investments, which clarifies the interaction between accounting standards related to equity securities (Topic 321), equity method investments (Topic 323), and certain derivatives (Topic 815). The update clarifies that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The update is effective for interim and annual reporting periods beginning
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
after December 15, 2021, with early adoption permitted. The Company is in the early stage of evaluating the impact that the update will have on the Company’s consolidated financial position or results of operations.
3. ACQUISITION
On December 2, 2019, the Company completed its acquisition of the insurance operations of 1347 Property Insurance Holdings, Inc. ("PIH"). Specifically, the Company purchased from PIH all of the outstanding equity of MIC, Maison Managers, Inc., and ClaimCor LLC (collectively, the "Maison Companies"). The Maison Companies provide multi-peril and wind/hail only coverage to personal residential dwellings and manufactured/mobile homes in Louisiana, Texas and Florida. The acquisition enables us to increase geographic diversification of our book of business outside Florida and generate additional business with operating synergies and general and administrative expense savings.
The purchase price was $51.0 million, which includes $25.5 million in cash and shares of the Company’s common stock equal to $25.5 million, which amounted to 1,773,102 shares of the Company's common stock. The number of shares was determined by the closing price of 20 trading days immediately preceding the closing date, December 2, 2019. The resale of these shares was registered and are subject to a standstill agreement. We recognized the fair value of the shares as of the acquisition date, net of issuance costs, by increasing shareholders' equity by $24.4 million
In addition to the purchase price, PIH received five-year right of first refusal to provide reinsurance of up to 7.5% of any layer in FNHC’s catastrophe reinsurance program. PIH also agreed to a non-compete for five years following the closing with respect to residential property insurance in Alabama, Florida, Georgia, Louisiana, South Carolina and Texas.
Subsequent to the effective acquisition date, the revenues and net income of the business acquired were $4.4 million and $1.4 million, respectively, for the year ended December 31, 2019. We recognized $1.3 million of acquisition-related costs, pre-tax, for the twelve months ended December 31, 2019. These costs are included in the general and administrative expenses line item of the consolidated statement of operations. We also capitalized $0.5 million in application development costs to property and equipment included in the other asset line item on the consolidated balance sheet.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The acquisition date fair values of certain assets and liabilities, including VOBA and intangible assets, were not adjusted during the one year following the December 2, 2019 acquisition date. The following presents (in thousands) the acquisition date fair values of the net assets acquired related to the Maison Companies as of December 2, 2019:
|
|
|
|
|
|
|
|
|
|
|
Fair
|
|
|
Value
|
Assets:
|
|
|
Debt securities, available-for-sale
|
|
$
|
56,929
|
|
Cash and cash equivalents
|
|
35,968
|
|
Prepaid reinsurance premium
|
|
25,279
|
|
Premiums receivable
|
|
2,977
|
|
Reinsurance recoverable
|
|
7,603
|
|
Deferred acquisition costs and value of business acquired, net
|
|
8,721
|
|
Other assets
|
|
3,507
|
|
Total assets acquired
|
|
140,984
|
|
|
|
|
Liabilities:
|
|
|
Loss and adjustment expense reserves
|
|
16,660
|
|
Unearned premiums
|
|
50,513
|
|
Reinsurance payable
|
|
24,071
|
|
Income taxes, net
|
|
1,778
|
|
Deferred revenue
|
|
1,515
|
|
Other liabilities
|
|
7,487
|
|
Total liabilities assumed
|
|
102,024
|
|
|
|
|
Net specifically identifiable assets acquired
|
|
38,960
|
|
Goodwill
|
|
10,997
|
|
Net assets acquired
|
|
$
|
49,957
|
|
All the gross contractual amounts of acquired receivables have been fully collected.
The entire $8.7 million acquired VOBA balance was fully amortized as of December 31, 2020.
The goodwill recorded as part of the acquisition included the expected synergies and other benefits that resulted from the acquisition including reinsurance savings and reduction in operating and general and administrative expenses. Refer to Note 8 below for additional information regarding goodwill and identifiable intangible assets.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Pro Forma Financial Information
The following unaudited pro forma condensed consolidated statements of operations of the Company assume that the acquisition of the Maison Companies was completed on January 1, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Revenue
|
|
$
|
471,438
|
|
|
$
|
454,469
|
|
Net income (loss)
|
|
(9,025)
|
|
|
17,432
|
|
Pro forma adjustments include the revenue and net income (loss) of the Maison Companies for each period as well as estimates for amortization of identifiable intangible assets acquired and fair value adjustments associated with investments, VOBA (different than deferred acquisition costs) and reinsurance recoverable. Other pro forma adjustments include the incremental increase to interest expense attributable to financing the acquisition and the impact of reflecting acquisition and integration costs in 2018, instead of 2019.
4. FAIR VALUE
Fair Value Disclosures of Financial Instruments
The Company accounts for financial instruments at fair value or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are generally based upon observable and unobservable inputs. Observable inputs are based on market data from independent sources, while unobservable inputs reflect the Company’s view of market assumptions in the absence of observable market information. All assets and liabilities that are recorded at fair value are classified and disclosed in one of the following three categories:
•Level 1 — Quoted market prices (unadjusted) for identical assets or liabilities in active markets is defined as a market where transactions for the financial statement occur with sufficient frequency and volume to provide pricing information on an ongoing basis, or observable inputs;
•Level 2 — Quoted market prices for similar assets or liabilities and valuations, using models or other valuation techniques using observable market data. Significant other observable that can be corroborated by observable market data; and
•Level 3 — Instruments that use non-binding broker quotes or model driven valuations that do not have observable market data or those that are estimated based on an ownership interest to which a proportionate share of net assets is attributed.
If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The Company’s financial instruments measured at fair value on a recurring basis and the level of the fair value hierarchy of inputs used consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2020
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
(In thousands)
|
Debt securities - available-for-sale, at fair value:
|
|
|
|
|
|
|
|
|
United States government obligations and authorities
|
|
$
|
38,511
|
|
|
$
|
133,264
|
|
|
$
|
—
|
|
|
$
|
171,775
|
|
Obligations of states and political subdivisions
|
|
—
|
|
|
22,264
|
|
|
—
|
|
|
22,264
|
|
Corporate securities
|
|
—
|
|
|
266,528
|
|
|
—
|
|
|
266,528
|
|
International securities
|
|
—
|
|
|
27,643
|
|
|
—
|
|
|
27,643
|
|
Debt securities, at fair value
|
|
38,511
|
|
|
449,699
|
|
|
—
|
|
|
488,210
|
|
|
|
|
|
|
|
|
|
|
Equity securities, at fair value
|
|
1,881
|
|
|
1,276
|
|
|
—
|
|
|
3,157
|
|
|
|
|
|
|
|
|
|
|
Total investments, at fair value
|
|
$
|
40,392
|
|
|
$
|
450,975
|
|
|
$
|
—
|
|
|
$
|
491,367
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
(In thousands)
|
Debt securities - available-for-sale, at fair value:
|
|
|
|
|
|
|
|
|
United States government obligations and authorities
|
|
$
|
83,764
|
|
|
$
|
110,429
|
|
|
$
|
—
|
|
|
$
|
194,193
|
|
Obligations of states and political subdivisions
|
|
—
|
|
|
24,020
|
|
|
—
|
|
|
24,020
|
|
Corporate securities
|
|
—
|
|
|
278,302
|
|
|
—
|
|
|
278,302
|
|
International securities
|
|
—
|
|
|
29,750
|
|
|
—
|
|
|
29,750
|
|
Debt securities, at fair value
|
|
83,764
|
|
|
442,501
|
|
|
—
|
|
|
526,265
|
|
|
|
|
|
|
|
|
|
|
Equity securities, at fair value
|
|
17,361
|
|
|
2,678
|
|
|
—
|
|
|
20,039
|
|
|
|
|
|
|
|
|
|
|
Total investments, at fair value
|
|
$
|
101,125
|
|
|
$
|
445,179
|
|
|
$
|
—
|
|
|
$
|
546,304
|
|
Held-to-maturity debt securities reported on the consolidated balance sheets at amortized cost and disclosed at fair value below (and in Note 5) and the level of fair value hierarchy of inputs used consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
(In thousands)
|
December 31, 2020
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
December 31, 2019
|
|
3,453
|
|
|
878
|
|
|
—
|
|
|
4,331
|
|
We measure the fair value of our securities based on assumptions used by market participants in pricing the security. The most appropriate valuation methodology is selected based on the specific characteristics of the security, and we consistently apply the valuation methodology to measure the security’s fair value. Our fair value measurement is based on a market approach that utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. We review the third party pricing methodologies on a quarterly basis and validate the fair value prices to a separate independent data service and ensure there are no material differences. Additionally, market indicators, industry and economic events are monitored.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
A summary of the significant valuation techniques and market inputs for each financial instrument carried at fair value includes the following:
•United States Government Obligations and Authorities: In determining the fair value for United States government securities in Level 1, the Company uses quoted prices (unadjusted) in active markets for identical or similar assets. In determining the fair value for United States government securities in Level 2, the Company uses the market approach utilizing primary valuation inputs including reported trades, dealer quotes for identical or similar assets in markets that are not active, benchmark yields, credit spreads, reference data and industry and economic events.
•Obligations of States and Political Subdivisions: In determining the fair value for state and municipal securities, the Company uses the market approach utilizing primary valuation inputs including reported trades, dealer quotes for identical or similar assets in markets that are not active, benchmark yields, credit spreads, reference data and industry and economic events.
•Corporate and International Securities: In determining the fair value for corporate securities the Company uses the market approach utilizing primary valuation inputs including reported trades, dealer quotes for identical or similar assets in markets that are not active, benchmark yields, credit spreads (for investment grade securities), observations of equity and credit default swap curves (for high-yield corporates), reference data and industry and economic events.
•Equity Securities: In determining the fair value for equity securities in Level 1, the Company uses quoted prices (unadjusted) in active markets for identical or similar assets. In determining the fair value for equity securities in Level 2, the Company uses the market approach utilizing primary valuation inputs including reported trades, dealer quotes for identical or similar assets in markets that are not active, benchmark yields, credit spreads, reference data and industry and economic events.
We did not have securities trading in less liquid or illiquid markets with limited or no pricing information, therefore we did not use unobservable inputs to measure fair value as of December 31, 2020 and 2019. Additionally, we did not have any assets or liabilities measured at fair value on a nonrecurring basis as of December 31, 2020 and 2019, and we noted no significant changes in our valuation methodologies between those periods.
There were no changes to the Company's valuation methodology and the Company is not aware of any events or circumstances that would have a significant adverse effect on the carrying value of its assets and liabilities measured at fair value as of December 31, 2020 and 2019. There were no transfers between the fair value hierarchy levels during the years ended December 31, 2020, 2019 and 2018.
5. INVESTMENTS
Unrealized Gains and Losses
The difference between amortized cost or cost and estimated fair value and gross unrealized gains and losses, by major investment category, consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized
|
|
Gross
|
|
Gross
|
|
|
|
|
Cost
|
|
Unrealized
|
|
Unrealized
|
|
|
|
|
or Cost
|
|
Gains
|
|
Losses
|
|
Fair Value
|
|
|
(In thousands)
|
December 31, 2020
|
|
|
|
|
|
|
|
|
Debt securities - available-for-sale:
|
|
|
|
|
|
|
|
|
United States government obligations and authorities
|
|
$
|
169,947
|
|
|
$
|
1,866
|
|
|
$
|
38
|
|
|
$
|
171,775
|
|
Obligations of states and political subdivisions
|
|
21,560
|
|
|
704
|
|
|
—
|
|
|
22,264
|
|
Corporate
|
|
254,618
|
|
|
11,989
|
|
|
79
|
|
|
266,528
|
|
International
|
|
27,001
|
|
|
659
|
|
|
17
|
|
|
27,643
|
|
|
|
$
|
473,126
|
|
|
$
|
15,218
|
|
|
$
|
134
|
|
|
$
|
488,210
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized
|
|
Gross
|
|
Gross
|
|
|
|
|
Cost
|
|
Unrealized
|
|
Unrealized
|
|
|
|
|
or Cost
|
|
Gains
|
|
Losses
|
|
Fair Value
|
|
|
(In thousands)
|
December 31, 2019
|
|
|
|
|
|
|
|
|
Debt securities - available-for-sale:
|
|
|
|
|
|
|
|
|
United States government obligations and authorities
|
|
$
|
191,546
|
|
|
$
|
3,073
|
|
|
$
|
426
|
|
|
$
|
194,193
|
|
Obligations of states and political subdivisions
|
|
23,748
|
|
|
294
|
|
|
22
|
|
|
24,020
|
|
Corporate
|
|
268,182
|
|
|
10,252
|
|
|
132
|
|
|
278,302
|
|
International
|
|
29,169
|
|
|
593
|
|
|
12
|
|
|
29,750
|
|
|
|
512,645
|
|
|
14,212
|
|
|
592
|
|
|
526,265
|
|
|
|
|
|
|
|
|
|
|
Debt securities - held-to-maturity:
|
|
|
|
|
|
|
|
|
United States government obligations and authorities
|
|
3,585
|
|
|
12
|
|
|
39
|
|
|
3,558
|
|
Corporate
|
|
697
|
|
|
20
|
|
|
—
|
|
|
717
|
|
International
|
|
55
|
|
|
1
|
|
|
—
|
|
|
56
|
|
|
|
4,337
|
|
|
33
|
|
|
39
|
|
|
4,331
|
|
Total investments, excluding equity securities
|
|
$
|
516,982
|
|
|
$
|
14,245
|
|
|
$
|
631
|
|
|
$
|
530,596
|
|
Net Realized and Unrealized Gains and Losses
The Company calculates the gain or loss realized on the sale of investments by comparing the sales price (fair value) to the cost or amortized cost of the security sold. Net realized gains and losses on investments are determined in accordance with the specific identification method.
Net realized and unrealized gains (losses) recognized in earnings, by major investment category, consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Gross realized and unrealized gains:
|
|
|
|
|
|
|
Debt securities
|
|
$
|
20,470
|
|
|
$
|
2,829
|
|
|
$
|
423
|
|
Equity securities
|
|
8,587
|
|
|
5,928
|
|
|
2,374
|
|
Total gross realized and unrealized gains
|
|
29,057
|
|
|
8,757
|
|
|
2,797
|
|
|
|
|
|
|
|
|
Gross realized and unrealized losses:
|
|
|
|
|
|
|
Debt securities
|
|
(2,879)
|
|
|
(664)
|
|
|
(3,990)
|
|
Equity securities
|
|
(8,146)
|
|
|
(1,009)
|
|
|
(2,951)
|
|
Total gross realized and unrealized losses
|
|
(11,025)
|
|
|
(1,673)
|
|
|
(6,941)
|
|
Net realized and unrealized gains (losses) on investments
|
|
$
|
18,032
|
|
|
$
|
7,084
|
|
|
$
|
(4,144)
|
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The above line item, net realized and unrealized gains (losses) on investments, includes the following equity securities gains (losses) recognized in earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
|
|
(In thousands)
|
Net gains (losses) on equity securities:
|
|
|
|
|
|
|
|
|
Realized
|
|
$
|
4,555
|
|
|
$
|
803
|
|
|
$
|
591
|
|
|
|
Unrealized
|
|
(4,114)
|
|
|
4,116
|
|
|
(1,168)
|
|
|
|
|
|
441
|
|
|
4,919
|
|
|
(577)
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
Net realized and unrealized gains (losses) on securities sold
|
|
309
|
|
|
672
|
|
|
732
|
|
|
|
Net unrealized gains (losses) still held as of the end-of-period
|
|
$
|
132
|
|
|
$
|
4,247
|
|
|
$
|
(1,309)
|
|
|
|
Contractual Maturity
Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.
Amortized cost and estimated fair value of debt securities, by contractual maturity, consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2020
|
|
|
Amortized
|
|
|
|
|
Cost
|
|
Fair Value
|
|
|
(In thousands)
|
Securities with Maturity Dates
|
|
|
|
|
Debt securities, available-for-sale:
|
|
|
|
|
One year or less
|
|
$
|
21,454
|
|
|
$
|
21,573
|
|
Over one through five years
|
|
137,378
|
|
|
142,457
|
|
Over five through ten years
|
|
144,296
|
|
|
149,674
|
|
Over ten years
|
|
169,998
|
|
|
174,506
|
|
Total
|
|
$
|
473,126
|
|
|
$
|
488,210
|
|
Net Investment Income
Net investment income consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Interest income
|
|
$
|
11,563
|
|
|
$
|
15,605
|
|
|
$
|
12,253
|
|
Dividends income
|
|
223
|
|
|
296
|
|
|
207
|
|
Net investment income
|
|
$
|
11,786
|
|
|
$
|
15,901
|
|
|
$
|
12,460
|
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Aging of Gross Unrealized Losses
Gross unrealized losses and related fair values for debt securities, grouped by duration of time in a continuous unrealized loss position, consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 months
|
|
12 months or longer
|
|
Total
|
|
|
|
|
Gross
|
|
|
|
Gross
|
|
|
|
Gross
|
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
December 31, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt securities - available-for-sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
United States government obligations and authorities
|
|
$
|
25,521
|
|
|
$
|
38
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
25,521
|
|
|
$
|
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
7,989
|
|
|
79
|
|
|
—
|
|
|
—
|
|
|
7,989
|
|
|
79
|
|
International
|
|
2,175
|
|
|
16
|
|
|
132
|
|
|
1
|
|
|
2,307
|
|
|
17
|
|
|
|
$
|
35,685
|
|
|
$
|
133
|
|
|
$
|
132
|
|
|
$
|
1
|
|
|
$
|
35,817
|
|
|
$
|
134
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 months
|
|
12 months or longer
|
|
Total
|
|
|
|
|
Gross
|
|
|
|
Gross
|
|
|
|
Gross
|
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
December 31, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt securities - available-for-sale:
|
|
|
|
|
|
|
|
|
|
|
United States government obligations and authorities
|
|
$
|
49,833
|
|
|
$
|
409
|
|
|
$
|
2,218
|
|
|
$
|
17
|
|
|
$
|
52,051
|
|
|
$
|
426
|
|
Obligations of states and political subdivisions
|
|
6,810
|
|
|
22
|
|
|
—
|
|
|
—
|
|
|
6,810
|
|
|
22
|
|
Corporate
|
|
15,872
|
|
|
94
|
|
|
7,694
|
|
|
38
|
|
|
23,566
|
|
|
132
|
|
International
|
|
3,856
|
|
|
10
|
|
|
179
|
|
|
2
|
|
|
4,035
|
|
|
12
|
|
|
|
76,371
|
|
|
535
|
|
|
10,091
|
|
|
57
|
|
|
86,462
|
|
|
592
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt securities, held-to-maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
United States government obligations and authorities
|
|
—
|
|
|
—
|
|
|
2,287
|
|
|
39
|
|
|
2,287
|
|
|
39
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
—
|
|
|
2,287
|
|
|
39
|
|
|
2,287
|
|
|
39
|
|
Total investments, excluding equity securities
|
|
$
|
76,371
|
|
|
$
|
535
|
|
|
$
|
12,378
|
|
|
$
|
96
|
|
|
$
|
88,749
|
|
|
$
|
631
|
|
As of December 31, 2020, the Company held a total of 47 debt securities that were in an unrealized loss position, of which 2 securities were in an unrealized loss position continuously for 12 months or more. As of December 31, 2019, the Company held a total of 203 debt securities that were in an unrealized loss position, of which 24 securities were in an unrealized loss position continuously for 12 months or more. The unrealized losses associated with these securities consisted primarily of losses related to corporate securities. The Company did not have any OTTI losses on its available-for-sale securities for the years ended December 31, 2020, 2019 and 2018, respectively. Refer to Note 7 below for information regarding allowances for credit loss.
Collateral Deposits
Cash and cash equivalents and investments, the majority of which were debt securities, with fair values of $11.5 million and $11.2 million were deposited with governmental authorities and into custodial bank accounts as required by law or contractual obligations, as of December 31, 2020 and 2019, respectively.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Reclassification of Held-to-Maturity Securities to Available-for-Sale
The Company sold held-to-maturity securities with a carrying value of $70 thousand and realized a loss of less than $1 thousand during the second quarter of 2020 due to credit concerns for certain securities. The Company, as of the date of the aforementioned sales, reclassified its remaining held-to-maturity securities to available-for-sale. The held-to-maturity securities transferred had an amortized cost of $4.2 million and fair value of $4.3 million and resulted in $58 thousand of unrealized gains, pre-tax, recognized in other comprehensive income (loss) in the year ended December 31, 2020.
6. REINSURANCE
Overview
Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. The Company reinsures (cedes) a portion of written premiums on an excess of loss or a quota-share basis in order to limit the Company’s loss exposure. To the extent that reinsuring companies are unable to meet their obligations assumed under these reinsurance agreements, the Company remains primarily liable to its policyholders.
The Company is selective in choosing reinsurers and considers numerous factors, the most important of which is the financial stability of the reinsurer or capital specifically pledged to uphold the contract, its history of responding to claims and its overall reputation. In an effort to minimize the Company’s exposure to the insolvency of a reinsurer, the Company evaluates the acceptability and review the financial condition of the reinsurer at least annually with the assistance of the Company’s reinsurance broker.
Significant Reinsurance Contracts
2019-2020 Catastrophe Excess of Loss Reinsurance Program
Given the December 2, 2019 acquisition of the Maison Companies, the Company and PIH agreed to combine FNIC, MIC and MNIC under a single reinsurance program allowing the carriers to capitalize on efficiencies, spread of risk and scale.
The combined reinsurance treaties provide approximately $1.3 billion of single-event reinsurance coverage in excess of a $27 million retention for catastrophic losses on the first event (and $15 million on the second and third events), including hurricanes, and aggregate coverage of $1.9 billion, at an approximate total cost of $224.3 million.
The combined FNIC, MIC and MNIC private market excess of loss treaties, covering both Florida and non-Florida exposures, became effective July 1, 2019 and all private layers have prepaid automatic reinstatement protection, which affords the carriers additional coverage for subsequent events. This private market excess of loss treaty structure breaks coverage into layers, with a cascading feature such that substantially all layers attach after $20 million in losses for FNIC, $2 million in losses for MNIC and $5 million in losses for MIC. For FNIC and MNIC, the second and third event attaches at $10 million per event, on a combined basis. If the aggregate limit of the preceding layer is exhausted, the next layer drops down (cascades) in its place. Additionally, any unused layer protection drops down for subsequent events until exhausted. The overall reinsurance program is with reinsurers that currently have an A.M. Best Company or Standard & Poor’s rating of “A-” or better, or have fully collateralized their maximum potential obligations in dedicated trusts.
As indicated above, FNIC, MIC and MNIC’s combined 2019-2020 reinsurance program is estimated to cost $224.3 million. This amount includes approximately $178.5 million for private reinsurance for the carriers’ exposure described above, including prepaid automatic premium reinstatement protection, along with approximately $45.8 million payable to the FHCF. The combination of private and FHCF reinsurance treaties affords FNIC, MIC and MNIC approximately $1.9 billion of aggregate coverage with a maximum single event coverage totaling approximately $1.3 billion, exclusive of retentions. Each carrier will pay directly its allocated portion of the aggregate reinsurance ceded premium cost. The allocation methodology by which FNIC, MIC and MNIC determines their share of the premium and distribution of reinsurance recoveries under the combined reinsurance tower is based on catastrophe loss modeling of the separate books of business. Each carrier shares the combined program cost in proportion to its contribution to the total expected loss in each reinsurance layer. Each carrier's reinsurance recoveries will be based on that carrier's contributing share of a given event's total loss. Both FNIC and MNIC maintained their FHCF participation at 75% for the 2019 hurricane season, and MIC increased its FHCF participation to 90%.
FNIC’s non-Florida excess of loss reinsurance treaty affords us an additional $18 million of coverage for a second event, which applies to hurricane losses only. The result is a non-Florida retention of $20 million for FNIC for the first event and $2 million for the second
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
event, although these retentions are reduced to $10 million and $1 million after taking into account the profit-sharing agreement that FNIC has with the non-affiliated managing general underwriter that writes FNIC’s non-Florida property business. FNIC’s non-Florida reinsurance program cost for the above specific coverage approximates $1.8 million for this private reinsurance.
The insurance carriers’ cost and amounts of reinsurance are based on current analysis of exposure to catastrophic risk. The data is subjected to exposure level analysis at various dates through December 31, 2019. This analysis of the carriers’ exposure level in relation to the total exposures to the FHCF and excess of loss treaties may produce changes in retentions, limits and reinsurance premiums in total, and by carrier, as a result of increases or decreases in the carriers’ exposure levels.
2020-2021 Catastrophe Excess of Loss Reinsurance Program
The Company’s excess of loss catastrophe reinsurance program for 2020-2021 (the “Program”), which covers the Company and its wholly-owned insurance subsidiaries, FNIC, MIC and MNIC was renewed effective July 1, 2020. FNIC, MIC and MNIC are collectively referred to herein as the “carriers”. The Program provides up to approximately $1.3 billion of single-event reinsurance coverage in excess of up to a $31 million retention for catastrophic losses, including hurricanes, and aggregate coverage up to $1.9 billion, at an approximate total cost of $286.0 million, subject to adjustments based on actual exposure or premium of policies at different points in time in the coming months. The Company will retain 100% of the first $25 million retention on each event plus up to an additional $6 million in retention on the first event by retaining an approximate 9.1% co-participation of the next $70 million of limit after the first $25 million. More specifically, the Program includes up to approximately $1.3 billion in aggregate private reinsurance for coverage in all states in which the Company operates, of which up to approximately $650 million is limited to any one event, plus an additional $650 million of reinsurance provided by the Florida Hurricane Catastrophe Fund (“FHCF”), that responds on both a per occurrence and in the aggregate basis, and which coverage is exclusive to the state of Florida.
The private layers of the Program, covering both Florida and non-Florida exposures have prepaid automatic reinstatement protection, which affords the carriers additional coverage for subsequent events. The private reinsurance market continued to harden this year due to a number of factors, including issues unique to the U.S. coastal catastrophe reinsurance marketplace generally and the Florida market specifically. These factors resulted in more restrictive terms by some of our individual reinsurers. The change in terms from the prior year’s program includes some portion of the program having a single aggregate retention for our carriers taken as a whole, versus each carrier’s own individual retention, plus some portions of the program not “cascading”, which provides less broad coverage for multiple event scenarios generating gaps in coverage that need to be filled with additional post renewal reinsurance protection or be retained net by the Company. As of December 31, 2020, the overall reinsurance Program was placed with reinsurers with an A.M. Best Company or Standard & Poor’s rating of “A-” or better, or that have fully collateralized their maximum potential obligations in dedicated trusts. For the purpose of debt covenant compliance, if any reinsurer on the program is not collateralized or has a rating lower than “A-” by A.M. Best Company or Standard & Poor’s then the Company treats that reinsurer’s participation as if it was part of the Company’s net retention. Refer to "Part II, Item 1A., Risk Factors” for more information.
The total Program cost includes approximately $238.2 million for private reinsurance for the carriers’ exposure described above, including prepaid automatic reinstatement premium protection, along with approximately $47.8 million payable to the FHCF. The combination of private and FHCF reinsurance treaties will afford the carriers up to approximately $1.9 billion of aggregate coverage within Florida and $1.3 billion in states outside Florida with a maximum single event coverage totaling up to approximately $1.3 billion within Florida and approximately $650 million outside Florida, exclusive of retentions.
Each carrier will share the combined program cost in proportion to its contribution to the total expected loss in each reinsurance layer. Each carrier’s reinsurance recoveries will be based on that carrier’s contributing share of a given event’s total loss and each carrier will be responsible for its portion of the Program’s $25 million per event retention ($31 million for the first event only) based on a specific allocation formula. Both FNIC and MNIC increased their FHCF participation to 90% for the 2020 hurricane season, and MIC maintained its FHCF participation at 90%.
In addition, the Company purchased subsequent event reinsurance coverage that has a lower retention than the first event. Under the Program, FNIC’s non-Florida book of business as written by SageSure has excess of loss reinsurance treaties which afford this specific book of business additional protection through an additional $16 million of coverage for a second event, which applies to hurricane losses only. This additional reinsurance coverage is specific to FNIC's non-Florida business and does not afford coverage to MIC's non-Florida business. The result is a retention of approximately $18 million for FNIC's book with SageSure for the first event and approximately $2 million for the second event, although these retentions are reduced to approximately $9 million and approximately $1 million after taking into account the quota-share reinsurance agreement that FNIC has with Anchor Re, Inc. ("Anchor Re"). Furthermore, for Florida only losses, the carriers purchased second and third event coverage of 71.5% of $15 million excess of $10 million that reduces the second and third event retention for the carriers, from $25 million to $14.3 million per event, on a
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
combined basis, which could be reduced further by an additional 28.5% placed on a parametric basis with an Excess and Surplus lines carrier that will provide coverage for the second and third Florida hurricane loss, if the first event loss criteria has been satisfied to the carriers after the inception of treaty. The amount of recovery with the parametric product is based on the magnitude of the hurricane and the proximity of the individual insured risk to the hurricane path. This coverage terminates on May 31, 2021.
Furthermore, on September 3, 2020, the Company secured $39.2 million of reinsurance limit at an approximate cost of $11.2 million. This limit is available for Hurricane Delta and any subsequent events that occur during the remainder of the current treaty year. In addition, on October 13, 2020, the Company secured 50% of $10 million excess of $8 million of reinsurance limit at an approximate cost of $875 thousand to lower its retention and further protect FNIC’s non-Florida book of business written by SageSure. This limit was available for any named storm event during the remainder of 2020. On November 4, 2020, the Company secured an additional $13.5 million of reinsurance limit at an approximate cost of $2.0 million. This limit was available for any subsequent events that occurred for the remainder of 2020, except for Hurricane Eta.
Effective January 1, 2021, the Company entered into a new aggregate excess of loss agreement on its MIC book of business. This new agreement provides reinsurance coverage on non-named storms, of 65% of $15 million excess of $10 million with a $0.9 million occurrence deductible and a $4.2 million occurrence limit at an approximate cost of $2.3 million.
The carriers’ cost and amounts of reinsurance are based on current analysis of exposure to catastrophic risk. The data is subjected to exposure level analysis at various dates through December 31, 2020. This analysis of the carriers’ exposure levels in relation to the total exposures to the FHCF and excess of loss treaties may produce changes in retentions, limits and reinsurance premiums in total, and by carrier, as a result of increases or decreases in the carriers’ exposure levels.
Quota-Share Reinsurance Programs
FNIC's reinsurance programs also include quota-share treaties. One such treaty for 30% became effective July 1, 2014, and another for 10% became effective on July 1, 2015 with each running for two years. The combined treaties provided up to a 40% quota-share reinsurance on covered losses for the homeowners’ property and liability insurance program in Florida. The treaties are accounted for as retrospectively rated contracts whereby the estimated ultimate premium or commission is recognized over the period of the contracts.
On July 1, 2016, the 30% quota-share treaty expired on a cut-off basis, which means as of that date the Company retained an incremental 30% of its unearned premiums and losses. On July 1, 2017, the 10% quota-share treaty expired on a cut-off basis, which means as of that date we retained an incremental 10% of the underlying unearned premiums and losses. The reinsurers remain liable for the paid losses occurring during the terms of the treaties, until each treaty is commuted.
On July 1, 2017, FNIC bound a 10% quota-share on its Florida homeowners book of business, which excluded named storms, subject to certain limitations. This treaty is not subject to accounting as a retrospectively rated contract. This treaty expired on July 1, 2018 on a cut-off basis, meaning that the reinsurer will not be liable (under this agreement) for losses as a result of occurrences taking place after the date of termination, and the unearned premium previously ceded was returned to FNIC.
On July 1, 2018, FNIC renewed the quota-share treaty on its Florida homeowners book of business, on an in-force, new and renewal basis, excluding named storms, which was initially set at a 2% cession, and is subject to certain limitations. In addition, this quota-share allowed FNIC to prospectively increase or decrease the cession percentage up to three times during the term of the agreement. Effective October 1, 2018, FNIC elected to increase the cession percentage from 2% to 10% on an in-force, new and renewal basis. The treaty expired on July 1, 2019 on a cut-off basis, meaning that the reinsurer will not be liable (under this agreement) for losses as a result of occurrences taking place after the date of termination, and the unearned premium previously ceded was returned to FNIC.
On July 1, 2019, FNIC renewed the quota-share treaty on its Florida homeowners book of business, on an in-force, new and renewal basis, excluding named storms, which was set at a 10% cession and is subject to certain limitations. In addition, this quota-share allows FNIC the flexibility to prospectively increase or decrease the cession percentage up to three times during the term of the agreement. The treaty expired on July 1, 2020 on a cut-off basis, meaning that the reinsurer will not be liable (under this agreement) for losses as a result of occurrences taking place after the date of termination, and the unearned premium previously ceded was returned to FNIC.
On July 1, 2020, FNIC renewed the quota-share treaty on its Florida homeowners book of business, on an in-force, new and renewal basis, excluding named storms, which was set at a 10% cession and is subject to certain limitations. In addition, this quota-share allows FNIC the flexibility to prospectively increase or decrease the cession percentage up to three times during the term of the agreement.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
On July 1, 2020, FNIC entered into a quota-share treaty on its non-Florida homeowners book of business with Anchor Re, an Arizona captive reinsurance entity that is an affiliate of SageSure. The treaty provides 50% quota-share reinsurance protection on claims incurred subsequent to July 1, 2020 on in-force, new and renewal business through June 30, 2021, subject to certain limitations, which include limits on the net losses that Anchor Re can realize during the treaty year. The treaty arrangement is fully collateralized through Anchor Re. The financial economics of this treaty substantially mirror the 50% profit-sharing arrangement that was previously in place. Thus, this treaty is not expected to have any impact on the pre-tax operating results of the Company, though the components of the combined ratio will be affected by the ceding of premiums, claims and commissions. On November 3, 2020, FNIC, with the agreement of Anchor Re, increased its cession percentage in this treaty from 50% to 80%, effective December 1, 2020, on claims incurred subsequent to December 1, 2020 on in-force, new and renewal basis.
Effective October 1, 2020, FNIC, with the agreement of Swiss Re, increased its cession percentage on this treaty from 10% to 20% on an in-force, new and renewal basis. This treaty excludes named storms and includes a cap on non-named storm catastrophe losses (as discussed above).
Effective November 15, 2020, FNIC entered into a new 10% quota-share reinsurance treaty through November 15, 2021 on its Florida homeowners book of business on an in-force, new and renewal basis. This treaty excludes all catastrophe losses and provides coverage only on attritional losses and is subject to certain limitations.
Effective December 31, 2020, FNIC entered into an additional new 10% quota-share reinsurance treaty through December 31, 2021 on its Florida homeowners book of business on an in-force, new and renewal basis. This treaty excludes named storms, but otherwise contains no caps with respect to non-named storm catastrophe losses.
As a result of these three actions, the Company now has 40% quota-share coverage in place through June 30, 2021, at which point 20% of this coverage will be up for renewal. It is the Company’s current intent to seek such renewal.
Associated Trust Agreements
Certain reinsurance agreements require FNIC to secure the credit, regulatory and business risk. Fully funded trust agreements securing these risks totaled less than $0.1 million as of December 31, 2020 and 2019.
Reinsurance Recoverable, Net
Amounts recoverable from reinsurers are recognized in a manner consistent with the claims liabilities associated with the reinsurance placement and presented on the consolidated balance sheet as reinsurance recoverable. Reinsurance recoverable, net consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
2020
|
|
2019
|
|
|
(In thousands)
|
Reinsurance recoverable on paid losses
|
|
$
|
54,898
|
|
|
$
|
45,186
|
|
Reinsurance recoverable on unpaid losses
|
|
358,193
|
|
|
164,429
|
|
Allowance for credit loss
|
|
(65)
|
|
|
—
|
|
Reinsurance recoverable, net
|
|
$
|
413,026
|
|
|
$
|
209,615
|
|
As of December 31, 2020 and 2019, the Company had reinsurance recoverable of $304.3 million (as a result of Hurricanes Irma, Laura, Sally, Michael and Delta) and $163.7 million (as a result of Hurricanes Irma and Michael). Hurricane Delta made landfall in Louisiana on October 9, 2020 as a Category 2 hurricane impacting both Texas and Louisiana. Hurricane Sally made landfall in Alabama on September 16, 2020 as a Category 2 hurricane impacting both Alabama and the Florida panhandle. Hurricane Laura made landfall in Louisiana on August 27, 2020 as a Category 4 hurricane impacting both Louisiana and eastern Texas.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Net Premiums Written and Net Premiums Earned
Net premiums written and net premiums earned consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Net Premiums Written
|
|
|
|
|
|
|
Direct
|
|
$
|
726,885
|
|
|
$
|
610,608
|
|
|
$
|
567,764
|
|
Ceded
|
|
(490,262)
|
|
|
(232,729)
|
|
|
(202,732)
|
|
|
|
$
|
236,623
|
|
|
$
|
377,879
|
|
|
$
|
365,032
|
|
|
|
|
|
|
|
|
Net Premiums Earned
|
|
|
|
|
|
|
Direct
|
|
$
|
720,967
|
|
|
$
|
582,334
|
|
|
$
|
580,020
|
|
Ceded
|
|
(356,833)
|
|
|
(218,682)
|
|
|
(224,763)
|
|
|
|
$
|
364,134
|
|
|
$
|
363,652
|
|
|
$
|
355,257
|
|
7. ALLOWANCES FOR CREDIT LOSS
Overview
There is significant risk and judgment involved in determining estimates of our allowances for credit loss, which reduce the amortized cost of an asset to produce an estimate of the net amount that will be collected over the asset's contractual life. Longer time horizons generally present more uncertainty in expected cash flow. We evaluate the expected credit loss of assets on an individual basis, except in cases where assets collectively share similar risk characteristics where we pool them together. We evaluate and estimate our allowances for credit loss by considering reasonable, relevant and supportable available information.
Activity in the allowances for credit loss, by asset line item on the consolidated balance sheet, is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt
|
|
|
|
|
|
|
|
|
Securities
|
|
|
|
Reinsurance
|
|
|
|
|
Held-to-
|
|
Premiums
|
|
Recoverable,
|
|
|
|
|
Maturity
|
|
Receivable
|
|
Net
|
|
Total
|
|
|
(In thousands)
|
Balance as of December 31, 2019
|
|
$
|
—
|
|
|
$
|
159
|
|
|
$
|
—
|
|
|
$
|
159
|
|
Cumulative effect of new accounting standard (1)
|
|
1
|
|
|
—
|
|
|
32
|
|
|
33
|
|
Credit loss expense (recovery) (2)
|
|
(1)
|
|
|
74
|
|
|
33
|
|
|
106
|
|
Balance as of December 31, 2020
|
|
$
|
—
|
|
|
$
|
233
|
|
|
$
|
65
|
|
|
$
|
298
|
|
(1)Refer to Note 2 above about our adoption of ASU 2016-13 on January 1, 2020.
(2)Reflected in commissions and other underwriting expenses on the consolidated statements of comprehensive income (loss).
Accrued investment income is included in other assets on the consolidated balance sheet. We immediately write-off accrued investment income if it becomes uncollectible, therefore we do not measure or record an allowance for credit losses.
Investments
Our investment policy is established by the Board of Directors’ Investment Committee and is reviewed on a regular basis. This policy currently limits investment in non-investment-grade debt securities (including high-yield bonds), and limits total investments in preferred stock, common stock and mortgage notes receivable. We also comply with applicable laws and regulations that further restrict the type, quality and concentration of our investments. We do not use any swaps, options, futures or forward contracts to hedge or enhance our investment portfolio.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Our investment portfolio has inherent risks because it contains volatility associated with market pricing and interest rate sensitive instruments, such as bonds, which may be adversely affected by changes in interest rates or credit worthiness. The effects of market volatility, declining economic conditions, such as a U.S. or global economic slowdown, whether due to COVID-19, or other factors, could adversely impact the credit quality of securities in our portfolio and may have unforeseen consequences on the liquidity and financial stability of the issuers of securities we hold.
Our debt securities portfolio includes securities that:
•Are explicitly guaranteed by a sovereign entity that can print its own currency;
•The currency is routinely held by central banks, used in international commerce and commonly viewed as a reserve currency; and
•Have experienced a consistent high credit rating by rating agencies and a long history with no credit losses.
We believe if these governments were to technically default it is reasonable to assume an expectation of immaterial losses, even in the current strained market conditions. Refer to Note 5 above for the balances of these sovereign debt securities, which are reported in the following investment categories:
•United States government obligations and authorities;
•Obligations of states and political subdivisions; and
•International.
For our debt securities, available-for-sale, the fact that a security’s fair value is below its amortized cost is not a decisive indicator of credit loss. In many cases, a security’s fair value may decline due to factors that are unrelated to the issuer’s ability to pay. For this reason, we consider the extent to which fair value is below amortized cost in determining whether a credit-related loss exists. The Company also considers the credit quality rating of the security, with a special emphasis on securities downgraded below investment grade. A comparison is made between the present value of expected future cash flows for a security and its amortized cost. If the present value of future expected cash flows is less than amortized cost, a credit loss is presumed to exist and an allowance for credit loss is established. Management may conclude that a qualitative analysis is sufficient to support its conclusion that the present value of the expected cash flows equals or exceeds a security’s amortized cost. As a result of this review, management concluded that there were no credit-related impairments of our available-for-sale securities as of January 1, 2020, and December 31, 2020. Management does not intend to sell available-for-sale securities in an unrealized loss position, and it is not “more likely than not” that the Company will be required to sell these securities before a recovery in their value to their amortized cost basis occurs.
Our equity investments are measured at fair value through net income (loss), therefore they do not require an allowance for credit loss.
Premiums Receivable
We do have collectability risk, but our homeowners policy terms are one year or less and our policyholders are dispersed throughout the southeast United States, although the majority of our policyholders are located in Florida.
We write-off premiums receivable if the individual policy becomes uncollectible. Because collectively our premiums receivable share similar risk characteristics, we pool them to measure our valuation allowance for credit losses using an aging method approach. This method applies historical loss rates to levels of delinquency for our policy terms that are one year or less. Based upon historical collectability, adjusted for current and future economic conditions, we have measured and recorded our valuation allowances for premiums receivable.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The aging of our premiums receivable and associated allowance for credit loss as of December 31, 2020 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Days Past Due
|
|
|
|
|
Current
|
|
1-29
|
|
30-59
|
|
60-89
|
|
90 plus
|
|
Total
|
|
|
(In thousands)
|
Amortized cost
|
|
$
|
46,376
|
|
|
$
|
4,253
|
|
|
$
|
159
|
|
|
$
|
94
|
|
|
$
|
154
|
|
|
$
|
51,036
|
|
Allowance for credit loss
|
|
—
|
|
|
(43)
|
|
|
(8)
|
|
|
(28)
|
|
|
(154)
|
|
|
(233)
|
|
Net
|
|
$
|
46,376
|
|
|
$
|
4,210
|
|
|
$
|
151
|
|
|
$
|
66
|
|
|
$
|
—
|
|
|
$
|
50,803
|
|
Reinsurance Recoverable
Refer to Note 6 above for details of our efforts to minimize our exposure to losses from a reinsurer’s inability to pay.
We measure and record our valuation allowances for credit losses on our reinsurance recoverables asset by multiplying the probability the asset would default within a given timeframe (“PD”) by the percentage of the asset not expected to be collected upon default, or loss given default (“LGD”) and multiplying the result by the amortized cost of the asset. We use market observable data for our PD and LGD assumptions, and in cases where we are unable to observe LGD, we assume it is 100%.
8. GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS
The changes in carrying amount of goodwill were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
Accumulated
|
|
|
|
|
|
|
|
|
Goodwill
|
|
Impairment
|
|
|
|
|
|
Net
|
|
|
as of
|
|
as of
|
|
Acquisition
|
|
|
|
Goodwill
|
|
|
Beginning-
|
|
Beginning-
|
|
Accounting
|
|
|
|
as of End-
|
|
|
of-Year
|
|
of-Year
|
|
Adjustments
|
|
Impairment
|
|
of-Year
|
|
|
(In thousands)
|
For the year ended December 31,:
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
10,997
|
|
|
$
|
—
|
|
|
$
|
10,997
|
|
2020
|
|
10,997
|
|
|
—
|
|
|
—
|
|
|
(10,997)
|
|
|
—
|
|
Related to our annual quantitative goodwill impairment assessment performed on October 1, our reporting unit is defined as consolidated FNHC. The fair value of the reporting unit, which we consider a Level 3 fair value estimate, is comprised of the value of in-force (i.e., existing) business and the value of new business. Specifically, new business is representative of cash flows and profitability associated with policies or contracts we expect to issue in the future, reflecting our forecasts of volume and product mix over a 10-year period. To determine the value of in-force and new business, we use a discounted cash flows technique that applies a discount rate reflecting the market expected, weighted-average rate of return adjusted for the risk factors associated with our operations to the projected future cash flow for our reporting unit.
Coinciding with the preparation of the financial statements for the year ended December 31, 2020, the Company’s annual goodwill impairment testing has resulted in the conclusion that the goodwill intangible asset established in conjunction with the acquisition of the Maison Companies in December 2019 is impaired. Therefore, during the fourth quarter of 2020, we recorded a non-cash impairment charge of $11.0 million, against which there is no tax offset, representing the write-off of the full amount of our goodwill asset. The Company’s impairment analysis considered the earnings and share price of the Company and comparable companies, as well as projected cash flows. Continued adverse storm activity, higher excess of loss catastrophe reinsurance costs and the continued unfavorable claims environment in the state of Florida reduced the previously modeled fair value of the Company. These impacts, along with other information relevant to the estimated fair value of the Company, including the trading price of our shares, resulted in the impairment conclusion.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The gross carrying amounts and accumulated amortization for each major specifically identifiable intangible asset class were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2020
|
|
December 31, 2019
|
|
Weighted-
|
|
|
Gross
|
|
|
|
Gross
|
|
|
|
Average-
|
|
|
Carrying
|
|
Accumulated
|
|
Carrying
|
|
Accumulated
|
|
Amortization
|
|
|
Amount
|
|
Amortization
|
|
Amount
|
|
Amortization
|
|
Period
|
|
|
(In thousands)
|
Trade name (1)
|
|
$
|
1,100
|
|
|
$
|
—
|
|
|
$
|
1,800
|
|
|
$
|
—
|
|
|
0
|
Non-compete agreements (2)
|
|
300
|
|
|
162
|
|
|
300
|
|
|
13
|
|
|
2
|
Insurance licenses (3)
|
|
180
|
|
|
—
|
|
|
182
|
|
|
—
|
|
|
0
|
Total
|
|
$
|
1,580
|
|
|
$
|
162
|
|
|
$
|
2,282
|
|
|
$
|
13
|
|
|
|
(1)This intangible has an indefinite useful life. We recorded impairment of $0.7 million in the year ended December 31, 2020, due primarily to a higher discount rate, which lowered the fair value.
(2)Will become fully amortized during the year ended December 31, 2021.
(3)This intangible has an indefinite useful life. We recorded impairment of $2 thousand for the year ended December 31, 2020, due primarily to a higher discount rate, which lowered the fair value.
9. LOSS AND LOSS ADJUSTMENT RESERVES
The liability for loss and LAE reserves is determined on an individual-case basis for all claims reported. The liability also includes amounts for unallocated expenses, anticipated future claim development and IBNR.
Activity in the liability for loss and LAE reserves is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Gross reserves, beginning-of-period
|
|
$
|
324,362
|
|
|
$
|
296,230
|
|
|
$
|
230,515
|
|
Less: reinsurance recoverable (1)
|
|
(164,429)
|
|
|
(166,396)
|
|
|
(98,345)
|
|
Net reserves, beginning-of-period
|
|
159,933
|
|
|
129,834
|
|
|
132,170
|
|
|
|
|
|
|
|
|
Net reserves from the Maison Companies acquisition
|
|
—
|
|
|
11,825
|
|
|
—
|
|
|
|
|
|
|
|
|
Incurred loss, net of reinsurance, related to:
|
|
|
|
|
|
|
Current year
|
|
358,952
|
|
|
262,118
|
|
|
231,133
|
|
Prior year loss development (redundancy) (2)
|
|
18,367
|
|
|
13,460
|
|
|
2,166
|
|
Ceded losses subject to offsetting experience account adjustments (3)
|
|
(816)
|
|
|
(2,489)
|
|
|
(4,883)
|
|
Prior years
|
|
17,551
|
|
|
10,971
|
|
|
(2,717)
|
|
Amortization of acquisition fair value adjustment
|
|
(54)
|
|
|
(9)
|
|
|
—
|
|
Total incurred loss and LAE, net of reinsurance
|
|
376,449
|
|
|
273,080
|
|
|
228,416
|
|
|
|
|
|
|
|
|
Paid loss, net of reinsurance, related to:
|
|
|
|
|
|
|
Current year
|
|
253,344
|
|
|
173,313
|
|
|
155,462
|
|
Prior years
|
|
100,799
|
|
|
81,493
|
|
|
75,290
|
|
Total paid loss and LAE, net of reinsurance
|
|
354,143
|
|
|
254,806
|
|
|
230,752
|
|
|
|
|
|
|
|
|
Net reserves, end-of-period
|
|
182,239
|
|
|
159,933
|
|
|
129,834
|
|
Plus: reinsurance recoverable (1)
|
|
358,128
|
|
|
164,429
|
|
|
166,396
|
|
Gross reserves, end-of-period
|
|
$
|
540,367
|
|
|
$
|
324,362
|
|
|
$
|
296,230
|
|
(1)Reinsurance recoverable in this table includes only ceded loss and LAE reserves.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
(2)Reflects loss development from prior accident years impacting pre-tax net income. Excludes losses ceded under retrospective reinsurance treaties to the extent there is an offsetting experience account adjustment.
(3)Reflects losses ceded under retrospective reinsurance treaties to the extent there is an offsetting experience account adjustment, such that there is no impact on pre-tax net income (loss).
The establishment of loss reserves is an inherently uncertain process and changes in loss reserve estimates are expected as such estimates are subject to the outcome of future events. The factors influencing changes in claim costs are often difficult to isolate or quantify and developments in paid and incurred losses from historical trends are frequently subject to multiple interpretations. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made.
During the year ended December 31, 2020, the Company experienced $18.4 million of net unfavorable loss and LAE reserve development on prior accident years, primarily in its commercial general liability line of business as a result of higher than expected late reported claims across a number of accident years during 2020.
During the year ended December 31, 2019, the Company experienced $13.5 million of net unfavorable loss and LAE reserve development on prior accident years, primarily in its personal automobile and commercial general liability lines of business. The development in commercial general liability was driven by late reported claims as well as large losses that drove up the overall severity metrics. Additionally, the unfavorable automobile development primarily related to 2017 accident year from our auto programs in the states of Georgia and Texas, and was driven by claims reopening and higher severity.
During the year ended December 31, 2018, the Company experienced $2.2 million of net unfavorable loss and LAE reserve development on prior accident years, primarily driven by net development in our personal automobile line of business, partially offset by net redundancy in our homeowners line of business. The unfavorable development on automobile primarily related to the 2016 accident year in the state of Georgia. The favorable net redundancy on homeowners was primarily driven by lower LAE expenses associated with Hurricane Irma, partially offset by continued adverse impact from assignment of benefits (“AOB”) and related litigation costs in the state of Florida.
As previously disclosed, the Company entered into 30% and 10% retrospectively-rated Florida-only property quota-share treaties, which ended on July 1, 2016 and 2017, respectively. These agreements included a profit share (experience account) provision, under which the Company will receive ceded premium adjustments at the end of the treaty to the extent there is a positive balance in the experience account. This experience account is based on paid losses rather than incurred losses. Due to the retrospectively-rated nature of this treaty, when the experience account is positive we cede losses under these treaties as the claims are paid with an equal and offsetting adjustment to ceded premiums (in recognition of the related change to the experience account receivable), with no impact on net income. Conversely, when the experience account is negative, the Company cedes losses on an incurred basis with no offsetting adjustment to ceded premiums, which impacts net income. Loss development can be either favorable or unfavorable regardless of whether the experience account is in a positive or negative position.
AOB is a legal construct that allows a third party to step into the shoes of the insured and is then paid directly by an insurance company for services rendered on behalf of the insured for a covered loss. Absent an AOB, the insured would pay the third party and those costs would be reimbursed by the insurance company to the insured. AOB is commonly used when a homeowner experiences a water loss, for example a leaky pipe, an overflow from a sink, or a damaged appliance, and contacts a contractor or water remediation company.
Misuse of this legal construct has led to contractors over inflating costs of claims and/or submitting improper claims, causing insurance companies to have to either pay the overinflated claim, fight the claim in court, or both. In all cases, AOB claims cost the insurance company, on average, more than five times the cost to settle non-AOB claims, which has been a primary driver the increase to our overall loss and loss adjustment in comparison to historical severity averages.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The following tables provide incurred losses and allocated LAE ("ALAE") and cumulative paid losses and ALAE, net of reinsurance, for the prior 10 accident years, and the total of IBNR reserves plus expected development on reported claims and the cumulative number of reported claims (in thousands, except number of reported claims), as of the most recent reporting period, by the Company’s significant lines of business, which are homeowners, commercial general liability and automobile.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
IBNR & Expected
|
|
Cumulative
|
|
|
Homeowners Incurred Losses and ALAE, Net of Reinsurance
|
|
Development on
|
|
Number of
|
|
|
For the Years Ended December 31,
|
|
Reported Claims
|
|
Reported Claims (1)
|
|
|
(Unaudited)
|
|
|
|
|
|
|
Accident Year
|
|
2011
|
|
2012
|
|
2013
|
|
2014
|
|
2015
|
|
2016
|
|
2017
|
|
2018
|
|
2019
|
|
2020
|
|
2020
|
|
2020
|
2011
|
|
$
|
20,492
|
|
|
$
|
21,344
|
|
|
$
|
23,007
|
|
|
$
|
23,932
|
|
|
$
|
24,582
|
|
|
$
|
25,957
|
|
|
$
|
26,143
|
|
|
$
|
26,394
|
|
|
$
|
26,394
|
|
|
$
|
26,375
|
|
|
$
|
12
|
|
|
2,428
|
|
2012
|
|
|
|
23,032
|
|
|
23,301
|
|
|
24,186
|
|
|
24,468
|
|
|
25,889
|
|
|
26,356
|
|
|
26,836
|
|
|
26,951
|
|
|
26,984
|
|
|
85
|
|
|
2,694
|
|
2013
|
|
|
|
|
|
43,807
|
|
|
42,021
|
|
|
35,834
|
|
|
35,859
|
|
|
37,185
|
|
|
37,880
|
|
|
37,978
|
|
|
38,088
|
|
|
15
|
|
|
3,431
|
|
2014
|
|
|
|
|
|
|
|
64,312
|
|
|
63,300
|
|
|
61,770
|
|
|
62,206
|
|
|
61,817
|
|
|
62,043
|
|
|
62,535
|
|
|
378
|
|
|
7,606
|
|
2015
|
|
|
|
|
|
|
|
|
|
99,497
|
|
|
92,411
|
|
|
95,129
|
|
|
94,760
|
|
|
94,703
|
|
|
96,144
|
|
|
1,522
|
|
|
13,038
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
171,264
|
|
|
162,043
|
|
|
158,764
|
|
|
157,880
|
|
|
156,316
|
|
|
1,394
|
|
|
22,614
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
202,844
|
|
|
192,769
|
|
|
188,548
|
|
|
179,327
|
|
|
47,728
|
|
|
67,165
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
210,158
|
|
|
213,128
|
|
|
216,570
|
|
|
20,849
|
|
|
35,817
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
257,644
|
|
|
261,541
|
|
|
23,909
|
|
|
19,661
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
342,119
|
|
|
236,080
|
|
|
35,117
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,405,999
|
|
|
|
|
|
(1)The cumulative number of reported claims is measured by individual claimant at a coverage level.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Homeowners Cumulative Paid Losses and ALAE, Net of Reinsurance
|
|
|
For the Years Ended December 31,
|
|
|
(Unaudited)
|
|
|
Accident Year
|
|
2011
|
|
2012
|
|
2013
|
|
2014
|
|
2015
|
|
2016
|
|
2017
|
|
2018
|
|
2019
|
|
2020
|
2011
|
|
$
|
11,119
|
|
|
$
|
19,250
|
|
|
$
|
21,323
|
|
|
$
|
22,723
|
|
|
$
|
24,047
|
|
|
$
|
25,580
|
|
|
$
|
25,982
|
|
|
$
|
26,287
|
|
|
$
|
26,340
|
|
|
$
|
26,342
|
|
2012
|
|
|
|
13,693
|
|
|
20,728
|
|
|
23,120
|
|
|
23,923
|
|
|
25,186
|
|
|
26,113
|
|
|
26,777
|
|
|
26,861
|
|
|
26,901
|
|
2013
|
|
|
|
|
|
19,986
|
|
|
31,606
|
|
|
33,867
|
|
|
35,123
|
|
|
35,803
|
|
|
37,473
|
|
|
37,688
|
|
|
37,915
|
|
2014
|
|
|
|
|
|
|
|
37,033
|
|
|
53,831
|
|
|
57,891
|
|
|
59,722
|
|
|
60,555
|
|
|
61,441
|
|
|
61,692
|
|
2015
|
|
|
|
|
|
|
|
|
|
52,214
|
|
|
79,359
|
|
|
86,647
|
|
|
90,415
|
|
|
92,327
|
|
|
93,405
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
102,556
|
|
|
142,716
|
|
|
148,274
|
|
|
152,258
|
|
|
153,997
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
135,589
|
|
|
176,580
|
|
|
179,327
|
|
|
178,013
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
141,173
|
|
|
194,160
|
|
|
206,133
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
157,768
|
|
|
236,090
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
236,197
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,256,685
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All outstanding liabilities for unpaid claims and ALAE prior to 2011, net of reinsurance
|
|
—
|
|
Total outstanding liabilities for unpaid claims and ALAE, net of reinsurance
|
|
$
|
149,314
|
The following table provides supplementary information about the average annual percentage payout of incurred losses and ALAE, net of reinsurance, for homeowners policies, as of December 31, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Annual Payout of Losses and ALAE, Net of Reinsurance
|
|
|
(Unaudited)
|
|
|
Year 1
|
|
Year 2
|
|
Year 3
|
|
Year 4
|
|
Year 5
|
|
Year 6
|
|
Year 7
|
|
Year 8
|
|
Year 9
|
|
Year 10
|
Homeowners
|
|
62.0
|
%
|
|
25.6
|
%
|
|
4.6
|
%
|
|
1.9
|
%
|
|
1.8
|
%
|
|
2.3
|
%
|
|
1.0
|
%
|
|
0.6
|
%
|
|
0.2
|
%
|
|
—
|
%
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
IBNR & Expected
|
|
Cumulative
|
|
|
Commercial General Liability Incurred Losses and ALAE, Net of Reinsurance
|
|
Development on
|
|
Number of
|
|
|
For the Years Ended December 31,
|
|
Reported Claims
|
|
Reported Claims
|
|
|
(Unaudited)
|
|
|
|
|
|
|
Accident Year
|
|
2011
|
|
2012
|
|
2013
|
|
2014
|
|
2015
|
|
2016
|
|
2017
|
|
2018
|
|
2019
|
|
2020
|
|
2020
|
|
2020
|
2011
|
|
$
|
6,436
|
|
|
$
|
5,854
|
|
|
$
|
4,749
|
|
|
$
|
4,603
|
|
|
$
|
4,760
|
|
|
$
|
5,409
|
|
|
$
|
6,254
|
|
|
$
|
6,828
|
|
|
$
|
7,817
|
|
|
$
|
9,394
|
|
|
$
|
1,572
|
|
|
1,367
|
|
2012
|
|
|
|
5,279
|
|
|
4,952
|
|
|
4,801
|
|
|
4,700
|
|
|
4,658
|
|
|
4,346
|
|
|
4,509
|
|
|
5,109
|
|
|
6,431
|
|
|
1,209
|
|
|
817
|
|
2013
|
|
|
|
|
|
7,095
|
|
|
5,069
|
|
|
5,221
|
|
|
5,502
|
|
|
5,704
|
|
|
5,580
|
|
|
5,984
|
|
|
7,588
|
|
|
1,245
|
|
|
759
|
|
2014
|
|
|
|
|
|
|
|
7,475
|
|
|
7,709
|
|
|
6,384
|
|
|
6,620
|
|
|
6,348
|
|
|
6,697
|
|
|
9,028
|
|
|
1,549
|
|
|
1,016
|
|
2015
|
|
|
|
|
|
|
|
|
|
8,082
|
|
|
7,008
|
|
|
6,020
|
|
|
5,377
|
|
|
7,947
|
|
|
9,141
|
|
|
2,043
|
|
|
877
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
10,727
|
|
|
5,809
|
|
|
6,561
|
|
|
8,502
|
|
|
12,267
|
|
|
3,086
|
|
|
845
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,289
|
|
|
7,853
|
|
|
6,558
|
|
|
8,519
|
|
|
3,369
|
|
|
639
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,553
|
|
|
6,233
|
|
|
7,280
|
|
|
4,281
|
|
|
420
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,604
|
|
|
2,535
|
|
|
1,826
|
|
|
114
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
37
|
|
|
—
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
72,220
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial General Liability Cumulative Paid Losses and ALAE, Net of Reinsurance
|
|
|
For the Years Ended December 31,
|
|
|
(Unaudited)
|
|
|
Accident Year
|
|
2011
|
|
2012
|
|
2013
|
|
2014
|
|
2015
|
|
2016
|
|
2017
|
|
2018
|
|
2019
|
|
2020
|
2011
|
|
$
|
764
|
|
|
$
|
2,763
|
|
|
$
|
3,366
|
|
|
$
|
3,673
|
|
|
$
|
4,246
|
|
|
$
|
4,866
|
|
|
$
|
5,831
|
|
|
$
|
6,349
|
|
|
$
|
7,365
|
|
|
$
|
7,693
|
|
2012
|
|
|
|
871
|
|
|
1,714
|
|
|
2,632
|
|
|
3,342
|
|
|
3,686
|
|
|
3,841
|
|
|
4,098
|
|
|
4,521
|
|
|
4,790
|
|
2013
|
|
|
|
|
|
882
|
|
|
2,233
|
|
|
3,366
|
|
|
3,867
|
|
|
4,606
|
|
|
5,033
|
|
|
5,467
|
|
|
5,847
|
|
2014
|
|
|
|
|
|
|
|
717
|
|
|
2,593
|
|
|
3,855
|
|
|
4,375
|
|
|
5,130
|
|
|
6,270
|
|
|
6,901
|
|
2015
|
|
|
|
|
|
|
|
|
|
798
|
|
|
2,296
|
|
|
3,249
|
|
|
3,827
|
|
|
5,866
|
|
|
6,566
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
1,515
|
|
|
3,657
|
|
|
5,088
|
|
|
6,606
|
|
|
8,382
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,592
|
|
|
2,478
|
|
|
3,293
|
|
|
4,225
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
963
|
|
|
1,554
|
|
|
2,604
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
147
|
|
|
424
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
47,437
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All outstanding liabilities for unpaid claims and ALAE prior to 2011, net of reinsurance
|
|
3,545
|
|
Total outstanding liabilities for unpaid claims and ALAE, net of reinsurance
|
|
$
|
28,328
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The following table provides supplementary information about the average annual percentage payout of incurred losses and ALAE, net of reinsurance, for commercial general liability policies, as of December 31, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Annual Payout of Losses and ALAE, Net of Reinsurance
|
|
|
(Unaudited)
|
|
|
Year 1
|
|
Year 2
|
|
Year 3
|
|
Year 4
|
|
Year 5
|
|
Year 6
|
|
Year 7
|
|
Year 8
|
|
Year 9
|
|
Year 10
|
Commercial general liability
|
|
10.2
|
%
|
|
14.1
|
%
|
|
10.4
|
%
|
|
7.2
|
%
|
|
10.3
|
%
|
|
6.5
|
%
|
|
6.3
|
%
|
|
5.0
|
%
|
|
7.2
|
%
|
|
4.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
IBNR & Expected
|
|
Cumulative
|
|
|
Automobile Incurred Losses and ALAE, Net of Reinsurance
|
|
Development on
|
|
Number of
|
|
|
For the Years Ended December 31,
|
|
Reported Claims
|
|
Reported Claims
|
|
|
(Unaudited)
|
|
|
|
|
|
|
Accident Year
|
|
2011
|
|
2012
|
|
2013
|
|
2014
|
|
2015
|
|
2016
|
|
2017
|
|
2018
|
|
2019
|
|
2020
|
|
2020
|
|
2020
|
2011
|
|
$
|
3,580
|
|
|
$
|
3,350
|
|
|
$
|
2,954
|
|
|
$
|
2,912
|
|
|
$
|
2,762
|
|
|
$
|
2,848
|
|
|
$
|
2,796
|
|
|
$
|
2,756
|
|
|
$
|
2,762
|
|
|
$
|
2,760
|
|
|
$
|
—
|
|
|
789
|
|
2012
|
|
|
|
1,735
|
|
|
1,741
|
|
|
1,717
|
|
|
1,424
|
|
|
1,455
|
|
|
1,491
|
|
|
1,448
|
|
|
1,444
|
|
|
1,448
|
|
|
4
|
|
|
824
|
|
2013
|
|
|
|
|
|
1,517
|
|
|
1,863
|
|
|
1,826
|
|
|
1,829
|
|
|
2,161
|
|
|
2,123
|
|
|
2,127
|
|
|
2,127
|
|
|
6
|
|
|
3,471
|
|
2014
|
|
|
|
|
|
|
|
2,038
|
|
|
3,213
|
|
|
3,551
|
|
|
4,315
|
|
|
4,379
|
|
|
4,417
|
|
|
4,413
|
|
|
4
|
|
|
6,019
|
|
2015
|
|
|
|
|
|
|
|
|
|
3,045
|
|
|
2,882
|
|
|
2,781
|
|
|
2,878
|
|
|
2,915
|
|
|
2,944
|
|
|
14
|
|
|
6,553
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
13,414
|
|
|
20,205
|
|
|
24,346
|
|
|
25,918
|
|
|
25,923
|
|
|
251
|
|
|
67,655
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,411
|
|
|
22,472
|
|
|
24,579
|
|
|
24,669
|
|
|
740
|
|
|
52,885
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,513
|
|
|
4,623
|
|
|
4,439
|
|
|
887
|
|
|
9,604
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3)
|
|
|
—
|
|
|
2
|
|
|
101
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
—
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
68,723
|
|
|
|
|
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile Cumulative Paid Losses and ALAE, Net of Reinsurance
|
|
|
For the Years Ended December 31,
|
|
|
(Unaudited)
|
|
|
Accident Year
|
|
2011
|
|
2012
|
|
2013
|
|
2014
|
|
2015
|
|
2016
|
|
2017
|
|
2018
|
|
2019
|
|
2020
|
2011
|
|
$
|
1,417
|
|
|
$
|
2,381
|
|
|
$
|
2,562
|
|
|
$
|
2,644
|
|
|
$
|
2,726
|
|
|
$
|
2,755
|
|
|
$
|
2,755
|
|
|
$
|
2,755
|
|
|
$
|
2,755
|
|
|
$
|
2,755
|
|
2012
|
|
|
|
867
|
|
|
1,293
|
|
|
1,333
|
|
|
1,384
|
|
|
1,393
|
|
|
1,430
|
|
|
1,444
|
|
|
1,447
|
|
|
1,449
|
|
2013
|
|
|
|
|
|
907
|
|
|
1,609
|
|
|
1,906
|
|
|
2,069
|
|
|
2,109
|
|
|
2,112
|
|
|
2,116
|
|
|
2,116
|
|
2014
|
|
|
|
|
|
|
|
1,455
|
|
|
3,120
|
|
|
3,678
|
|
|
4,122
|
|
|
4,291
|
|
|
4,383
|
|
|
4,396
|
|
2015
|
|
|
|
|
|
|
|
|
|
1,393
|
|
|
2,293
|
|
|
2,670
|
|
|
2,807
|
|
|
2,890
|
|
|
2,897
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
8,084
|
|
|
17,258
|
|
|
23,053
|
|
|
25,582
|
|
|
26,132
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,821
|
|
|
20,762
|
|
|
23,860
|
|
|
24,468
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,331
|
|
|
3,626
|
|
|
3,137
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5)
|
|
|
—
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
67,350
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All outstanding liabilities for unpaid claims and ALAE prior to 2011, net of reinsurance
|
|
15
|
|
Total outstanding liabilities for unpaid claims and ALAE, net of reinsurance
|
|
$
|
1,388
|
The following table provides supplementary information about the average annual percentage payout of incurred losses and ALAE, net of reinsurance, for automobile policies, as of December 31, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Annual Payout of Losses and ALAE, Net of Reinsurance
|
|
|
(Unaudited)
|
|
|
Year 1
|
|
Year 2
|
|
Year 3
|
|
Year 4
|
|
Year 5
|
|
Year 6
|
|
Year 7
|
|
Year 8
|
|
Year 9
|
|
Year 10
|
Automobile
|
|
42.3
|
%
|
|
33.5
|
%
|
|
14.2
|
%
|
|
6.2
|
%
|
|
2.3
|
%
|
|
1.2
|
%
|
|
0.3
|
%
|
|
—
|
%
|
|
—
|
%
|
|
—
|
%
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The reconciliation of the net incurred and paid development tables to the liability for unpaid losses and LAE in the consolidated balance sheets is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
2020
|
|
2019
|
|
|
(In thousands)
|
Liabilities for unpaid losses and ALAE:
|
|
|
|
|
Homeowners
|
|
$
|
149,314
|
|
|
$
|
137,168
|
|
Commercial general liability
|
|
28,328
|
|
|
17,014
|
|
Automobile
|
|
1,388
|
|
|
2,142
|
|
Flood
|
|
—
|
|
|
—
|
|
Total liabilities for unpaid losses and ALAE, net of reinsurance
|
|
179,030
|
|
|
156,324
|
|
|
|
|
|
|
Reinsurance recoverables:
|
|
|
|
|
Homeowners
|
|
353,741
|
|
|
160,578
|
|
Commercial general liability
|
|
—
|
|
|
500
|
|
Automobile
|
|
1,424
|
|
|
3,228
|
|
Flood
|
|
2,963
|
|
|
123
|
|
Total reinsurance recoverables
|
|
358,128
|
|
|
164,429
|
|
|
|
|
|
|
Unallocated loss adjustment expenses
|
|
3,209
|
|
|
3,609
|
|
Gross liability for unpaid losses and LAE
|
|
$
|
540,367
|
|
|
$
|
324,362
|
|
Management establishes a liability on an aggregate basis to provide for the estimated IBNR. The estimates of the liability for loss and LAE reserves are subject to the effect of trends in claims severity and frequency and are continually reviewed. As part of this process, we review historical data and consider various factors, including known and anticipated legal developments, 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 loss and LAE reserves. Adjustments are reflected in results of operations in the period in which they are made and the liabilities may deviate substantially from prior estimates.
Various actuarial methods are utilized to determine the reserves that are booked to our financial statements. Weightings of tests and methods at a detailed level may change from evaluation to evaluation based on a number of observations, measures and time elements. On an overall basis, changes to methods and/or assumptions underlying reserve estimations and selections as of December 31, 2020 and 2019, were not considered material, except for our commercial general liability line of business. For this line of business, we updated our actuarial assumptions to reflect the new, emerging trend relating to the increased level of new claims being reported related to construction defects, as the new development patterns are different than the historical patterns.
IBNR reserves are established for the quarter and year-end based on a quarterly reserve analysis by our actuarial staff. Various standard actuarial tests are applied to subsets of the business at a line of business and coverage basis. Included in the analyses are the following:
•Reported Loss Development Method: A reported loss development pattern is calculated based on historical loss development data, and this pattern is then used to project the latest evaluation of cumulative reported losses for each accident year or underwriting year, as appropriate, to ultimate levels;
•Paid Development Method: A paid loss development pattern is calculated based on historical paid loss development data, and this pattern is then used to project the latest evaluation of cumulative paid losses for each accident year or underwriting year, as appropriate, to ultimate levels;
•Expected Loss Ratio Method: Expected loss ratios are applied to premiums earned, based on historical company experience, or historical insurance industry results when company experience is deemed not to be sufficient; and
•Bornhuetter-Ferguson Method: The results from the Expected Loss Ratio Method are essentially blended with either the Reported Loss Development Method or the Paid Development Method.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
10. LONG-TERM DEBT
Long-term debt consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2020
|
|
2019
|
|
(In thousands)
|
Senior unsecured fixed rate notes, due March 15, 2029, net of deferred financing costs of $1,317 and $1,478, respectively
|
$
|
98,683
|
|
|
$
|
98,522
|
|
Total long-term debt, net
|
$
|
98,683
|
|
|
$
|
98,522
|
|
As of December 31, 2020, the Company’s estimated annual aggregate amount of debt maturities includes the following:
|
|
|
|
|
|
|
|
|
|
|
Aggregate
|
|
|
Debt
|
For the Years Ending December 31,
|
|
Maturities
|
|
|
(In thousands)
|
2021
|
|
$
|
—
|
|
2022
|
|
—
|
|
2023
|
|
—
|
|
2024
|
|
—
|
|
2025
|
|
—
|
|
Thereafter
|
|
100,000
|
|
Total debt maturities
|
|
100,000
|
|
Less: deferred financing costs
|
|
1,317
|
|
Total debt maturities, net
|
|
$
|
98,683
|
|
Senior Unsecured Notes
On March 5, 2019, the Company completed a private placement offering and issued $100.0 million in principal amount of Senior Unsecured Fixed Rate Notes due 2029 (the "Notes"), pursuant to an indenture dated as of March 5, 2029 (the "Indenture"). The Notes mature on March 15, 2029 and bear interest at a fixed rate of 7.5% per year, payable semi-annually in arrears, subject to increases in the interest rate payable in the event of a downgrade below "BBB-" in the credit rating assigned to the Notes. The Notes are not convertible or exchangeable for any equity securities, other securities or assets of the Company or any subsidiary. A portion of the cash from the offering was used to redeem all $45.0 million of the Company's Senior Unsecured Fixed Rate Notes Due 2022 and the Company's Senior Notes Due 2027. We recognized $3.6 million as interest expense in our consolidated statements of operations for the year ended 2019, for prepayment fees, including the write-off unamortized debt issuance costs on the repayment.
The Company may redeem the Notes under certain circumstances as set forth in the Indenture. Prior to March 15, 2024, the Company may redeem the Notes, in whole or in part, at a redemption price equal to 100.00% of the principal amount of the Notes to be redeemed, plus the “Applicable Premium,” plus accrued and unpaid interest on such Notes, if any, on the Notes redeemed, to the applicable redemption date. The “Applicable Premium” is defined in the Indenture to mean, with respect to any Note on any applicable redemption date, the greater of (1) 1.0% of the then-outstanding principal amount of such Note and (2) the excess (if any) of: (A) the present value at such redemption date of (i) the applicable redemption price of such Note at March 15, 2024 (excluding any accrued but unpaid interest), plus (ii) all required interest payments due on such Note through March 15, 2024 (excluding accrued but unpaid interest), computed using a discount rate equal to the Treasury Rate (as defined in the Indenture) on such redemption date plus 50 basis points; over (B) the then-outstanding principal amount of such Note.
On and after March 15, 2024, the Company may redeem the Notes, in whole or in part, at 103.750% in 2024, 101.875% in 2025, and 100% in 2026 and thereafter, together with any accrued and unpaid interest on the Notes being redeemed to but excluding the date of redemption.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
If a change in control of the Company, as defined in the Indenture, occurs, the holders of the Notes will have the right to require the Company to purchase all or a portion of their Notes at a price in cash equal to 101% of the principal amount thereof, plus any accrued but unpaid interest.
The Notes are senior unsecured obligations of the Company and will rank equally with all of the Company’s other future senior unsecured indebtedness. The Indenture includes customary covenants and events of default. Among other things, the covenants restrict the ability of the Company and its subsidiaries to incur additional indebtedness or make restricted payments, including dividends, and under certain circumstances, the Company is required to maintain certain levels of reinsurance coverage while the Notes remain outstanding, and maintain certain other financial covenants. These covenants are subject to important exceptions and qualifications set forth in the Indenture. Principal and interest on the Notes are subject to acceleration in the event of certain events of default, including automatic acceleration upon certain bankruptcy-related events. The Company's debt to capital ratio exceeds 35%, therefore the Company is precluded from incurring additional debt, repurchasing shares of our common stock or paying common stock dividends. No acceleration of the related debt is mandated due to the fact that catastrophic weather events drove the ratio over 35% rather than specific actions taken by the Company. The Company's actual debt to capital ratio as of December 31, 2020 was approximately 38.4%.
11. INCOME TAXES
The components of income tax expense (benefit) include the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Federal:
|
|
|
|
|
|
|
Current
|
|
$
|
(29,449)
|
|
|
$
|
(982)
|
|
|
$
|
5,162
|
|
Deferred
|
|
(3,494)
|
|
|
567
|
|
|
(751)
|
|
Federal income tax expense (benefit)
|
|
(32,943)
|
|
|
(415)
|
|
|
4,411
|
|
State:
|
|
|
|
|
|
|
Current
|
|
(403)
|
|
|
241
|
|
|
1,383
|
|
Deferred
|
|
(150)
|
|
|
(124)
|
|
|
(296)
|
|
State income tax expense (benefit)
|
|
(553)
|
|
|
117
|
|
|
1,087
|
|
Total income tax expense (benefit)
|
|
$
|
(33,496)
|
|
|
$
|
(298)
|
|
|
$
|
5,498
|
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The actual income tax expense (benefit) differs from the “expected” income tax expense (benefit) (computed by applying the combined applicable effective federal and state tax rates to income before income tax expense) as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Computed expected tax expense provision, at federal rate
|
|
$
|
(23,447)
|
|
|
$
|
150
|
|
|
$
|
4,244
|
|
State tax, net of federal tax benefit
|
|
(3,157)
|
|
|
(122)
|
|
|
761
|
|
Tax-exempt interest
|
|
(5)
|
|
|
(3)
|
|
|
(134)
|
|
Income subject to dividends-received deduction
|
|
(26)
|
|
|
(34)
|
|
|
(13)
|
|
Goodwill impairment
|
|
2,309
|
|
|
—
|
|
|
—
|
|
Return to provision
|
|
(3,407)
|
|
|
(307)
|
|
|
158
|
|
|
|
|
|
|
|
|
Executive compensation
|
|
41
|
|
|
230
|
|
|
436
|
|
Meals and entertainment
|
|
13
|
|
|
43
|
|
|
28
|
|
Uncertain tax position
|
|
(179)
|
|
|
(203)
|
|
|
—
|
|
Rate difference on NOL carryback
|
|
(8,785)
|
|
|
(113)
|
|
|
—
|
|
Change in valuation allowance
|
|
2,968
|
|
|
—
|
|
|
—
|
|
Other
|
|
179
|
|
|
61
|
|
|
18
|
|
Total income tax expense (benefit)
|
|
$
|
(33,496)
|
|
|
$
|
(298)
|
|
|
$
|
5,498
|
|
In response to COVID-19, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law on March 27, 2020. The CARES Act contains several relief provisions for corporations and lifts certain deduction limitations originally imposed by the U.S. Tax Cuts and Jobs Act of 2017 (the “Tax Act”) signed into law on December 22, 2017. The CARES Act, among other things, includes temporary changes regarding the prior and future utilization of net operating losses (“NOL”), temporary changes to the prior and future limitations on interest deductions, temporary suspension of certain payment requirements for the employer portion of Social Security taxes and the creation of certain refundable employee retention credits. The Company utilized the NOL provision in the current year.
Our effective income tax rate is the ratio of income tax expense (benefit) over our income (loss) before income taxes. For the years ended December 31, 2020, 2019 and 2018, the effective income tax rate was 30.0%, (41.8)% and 27.2%, respectively. Differences in the effective tax and the statutory Federal income tax rate of 21% in 2020, 2019 and 2018, are driven by state income taxes and anticipated annual permanent differences, including estimates for tax-exempt interest, dividends received deduction, executive compensation as well as the NOL provision in the current year, as discussed above.
As of December 31, 2020, we had NOL carryforwards for Federal tax purposes of $11.1 million. As of December 31, 2020, we had NOL carryforwards for state tax purposes of $73.0 million expiring between 2037 and 2040 and $12.0 million that do not expire. The amount and timing of realizing these NOL carryforwards depend on future taxable income and limitations imposed by tax laws.
The Company has a valuation allowance of $3.0 million and $0 on its deferred income tax asset as of December 31, 2020 and 2019, respectively.
We recognize accrued interest and penalties related to unrecognized tax benefits in income tax expense (benefit) in the consolidated statements of operations and statements of comprehensive income (loss). A reconciliation of these uncertain tax positions was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Balance at January 1
|
|
$
|
382
|
|
|
$
|
585
|
|
|
$
|
585
|
|
Increases/(decreases) for uncertain tax positions taken during the prior years
|
|
(179)
|
|
|
(203)
|
|
|
—
|
|
Balance at December 31
|
|
$
|
203
|
|
|
$
|
382
|
|
|
$
|
585
|
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred income tax asset (liability), net include the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
2020
|
|
2019
|
|
|
(In thousands)
|
Deferred income tax assets:
|
|
|
|
|
Unearned premiums
|
|
$
|
5,611
|
|
|
$
|
10,232
|
|
Unpaid losses and loss adjustment expenses
|
|
581
|
|
|
1,596
|
|
Accrued expenses
|
|
236
|
|
|
216
|
|
Net operating loss carryforwards
|
|
5,350
|
|
|
2,095
|
|
|
|
|
|
|
Share-based compensation
|
|
232
|
|
|
161
|
|
|
|
|
|
|
Depreciation and amortization
|
|
412
|
|
|
—
|
|
Lease liability
|
|
1,783
|
|
|
1,655
|
|
Other
|
|
69
|
|
|
23
|
|
Gross deferred income tax assets
|
|
14,274
|
|
|
15,978
|
|
Valuation allowance
|
|
(2,968)
|
|
|
—
|
|
Total deferred income tax assets
|
|
11,306
|
|
|
15,978
|
|
|
|
|
|
|
Deferred income tax liabilities:
|
|
|
|
|
Deferred acquisition costs and other
|
|
(6,387)
|
|
|
(12,703)
|
|
Depreciation and amortization
|
|
—
|
|
|
(1,679)
|
|
Unrealized gains on investment securities
|
|
(2,865)
|
|
|
(3,270)
|
|
Lease asset
|
|
(1,783)
|
|
|
(1,655)
|
|
Other
|
|
(213)
|
|
|
(257)
|
|
Total deferred income tax liabilities
|
|
(11,248)
|
|
|
(19,564)
|
|
|
|
|
|
|
Deferred income tax asset (liability), net
|
|
$
|
58
|
|
|
$
|
(3,586)
|
|
The deferred income tax asset (liability), net along with income tax receivable, net is included in current and deferred income taxes, net on our Consolidated Balance Sheets.
The Company files a federal income tax return and various state and local tax returns. The Company’s consolidated federal and state income tax returns for 2015 and 2017 - 2019 are open for review by the Internal Revenue Service and other state taxing authorities.
12. COMMITMENTS AND CONTINGENCIES
Litigation and Legal Proceedings
In the ordinary course of business, the Company is involved in various legal proceedings, specifically claims litigation. The Company’s insurance subsidiaries participate in most of these proceedings by either defending third-party claims brought against insureds or litigating first-party coverage claims. The Company accounts for such activity through the establishment of loss and LAE reserves. The Company’s management believes that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, is immaterial to the Company’s consolidated financial statements. The Company is also occasionally involved in other legal and regulatory proceedings, some of which may assert claims for substantial amounts, making the Company party to individual actions in which extra contractual damages, punitive damages or penalties, such as claims alleging bad faith in the handling of insurance claims, are sought.
The Company reviews the outstanding matters, if any, on a quarterly basis. The Company accrues for estimated losses and contingent obligations in the consolidated financial statements if and when the obligation or potential loss from any litigation, legal proceeding or claim is considered probable and the amount of the potential exposure is reasonably estimable. The Company records such probable and estimable losses, through the establishment of legal expense reserves. As events evolve, facts concerning litigation and contingencies become known and as additional information becomes available, the Company’s management reassesses its potential
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
liabilities related to pending claims and litigation and may revise its previous estimates and make appropriate adjustment to the financial statements. Estimates that require judgment are subject to change and are based on management’s assessment, including the advice of legal counsel, the expected outcome of litigation and legal proceedings or other dispute resolution proceedings or the expected resolution of contingencies. The Company’s management believes that the Company’s accruals for probable and estimable losses are reasonable and that the amounts accrued do not have a material effect on the Company’s consolidated financial statements.
Regarding the matter involving the Co-Existence Agreement effective as of August 30, 2013 with Federated Mutual Insurance Company ("Mutual") and the related arbitration (please see Note 9 of our 2018 Form 10-K for more information), the Company and Mutual have exchanged releases and all remaining pending proceedings have been resolved by an agreed order entered by the U.S. District Court for the Northern District of Illinois on November 22, 2019.
Assessment Related Activity
The Company operates in a regulatory environment where certain entities and organizations have the authority to require us to participate in assessments. Currently these entities and organizations include: Florida Insurance Guaranty Association (“FIGA”), Citizens Property Insurance Corporation (“Citizens”), FHCF, Georgia Insurers Insolvency Pool (“GIIP”), Special Insurance Fraud Fund (“SIIF”), Fair Access to Insurance Requirements Plan (“FAIRP”), Property Insurance Association of Louisiana (“PIAL”), South Carolina Property & Casualty Insurance Guaranty Association (“SCPCIGA”), Texas Property and Casualty Insurance Guaranty Association (“TPCIGA”), Texas Windstorm Insurance Association (“TWIA”), Alabama Insurance Guaranty Association (“AIGA”), and Alabama Insurance Underwriters Association (“AIUA”). As a direct premium writer, we are required to participate in certain insurer solvency associations under the applicable laws in the states which we do business. One form of assessment requires us to collect the assessment from our policyholders and then remit the collected amounts to the assessing entity, which does not have any impact on our financial results. We are also subject to assessments that require us to pay the full amount of the assessment to the assessing entity and then we are permitted to make rate filings to allow us to recoup the amount of the assessment from our policyholders over time.
In connection with its automobile line of business, which is currently winding down, FNIC is also required to participate in an insurance apportionment plan under Florida law, which is referred to as a JUA Plan. The JUA Plan provides for the equitable apportionment of any profits realized, or losses and expenses incurred, among participating automobile insurers. In the event of an underwriting deficit incurred by the JUA Plan, which is not recovered through the policyholders in the JUA Plan, such deficit shall be recovered from the companies participating in the JUA Plan in the proportion that the net direct written premiums of each such member during the preceding calendar year bear to the aggregate net direct premiums written in this state by all members of the JUA Plan. There were no material assessments by the JUA Plan as of December 31, 2020. Future assessments by the JUA and the JUA Plan are indeterminable at this time.
Leases
The Company is committed under various operating lease agreements for office space. FNHC and its subsidiaries lease certain facilities, furniture and equipment under long-term lease agreements. Rental expense for the years ended December 31, 2020, 2019 and 2018 was $1.1 million, $1.0 million and $0.7 million, respectively.
Future minimum lease payments under these agreements are as follows:
|
|
|
|
|
|
|
|
|
|
|
Aggregate
|
|
|
Minimum
|
Year Ended December 31,
|
|
Lease Payments
|
|
|
(In thousands)
|
2021
|
|
$
|
1,066
|
|
2022
|
|
1,098
|
|
2023
|
|
1,131
|
|
2024
|
|
1,164
|
|
2025
|
|
1,115
|
|
Thereafter
|
|
3,318
|
|
Total
|
|
$
|
8,892
|
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
The right-of-use asset is reflected in other assets and the lease liability is reflected in other liabilities on our consolidated balance sheets. Lease expense, net of sublease income is reflected in general and administrative expenses on our consolidated statements of operations.
Additional information related to our operating lease agreement for office space consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
2020
|
|
2019
|
|
|
(In thousands)
|
Right-of-use asset
|
|
$
|
7,430
|
|
|
$
|
8,096
|
|
Accrued rent
|
|
(259)
|
|
|
(317)
|
|
Right-of-use asset, net
|
|
$
|
7,171
|
|
|
$
|
7,779
|
|
|
|
|
|
|
Lease liability
|
|
$
|
7,430
|
|
|
$
|
8,096
|
|
|
|
|
|
|
Weighted average discount rate
|
|
4.70
|
%
|
|
4.70
|
%
|
Weighted average remaining years of lease term
|
|
7.7
|
|
8.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
|
|
|
(In thousands)
|
Lease expense
|
|
$
|
1,118
|
|
|
$
|
1,046
|
|
|
|
Sublease income
|
|
(466)
|
|
|
(229)
|
|
|
|
Lease expense, net
|
|
$
|
652
|
|
|
$
|
817
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities
|
|
$
|
(555)
|
|
|
$
|
(573)
|
|
|
|
The interest rates implicit in our leases were not known, therefore the weighted-average discount rate above was determined by what FedNat would have had to pay to borrow the lease payments in a similar economic environment that existed at inception of our leases while considering our general credit and the theoretical collateral of the office space. In the event of a change to lease term, the Company would re-evaluate all inputs and assumptions, including the discount rate.
Refer to Note 2 above for additional information regarding the implementation of new lease accounting rules on January 1, 2019.
13. SHAREHOLDERS’ EQUITY
Common Stock Repurchases
The Company has previously repurchased shares of its common stock in open market transactions complying with Rules 10b-18 and 10b5-1 under the Exchange Act. These repurchases were based on assessments of the Company’s capital needs at the time, the market prices of the Company’s common stock, and general market conditions. The amount and timing of such repurchases were subject to market conditions, applicable legal requirements and other factors. At the present time, the Company is prohibited from undertaking any share repurchases under the terms of its senior note indenture.
In December 2017, the Company’s Board of Directors authorized an additional share repurchase program under which the Company may repurchase up to $10.0 million (plus $0.8 million remaining from previous authorization which was fully expended as of March 31, 2018) of its outstanding shares of common stock through December 31, 2018. The unused portion of this authorization expired on December 31, 2018.
In December 2018, the Company’s Board of Directors authorized an additional share repurchase program under which the Company may repurchase up to $10.0 million of its outstanding shares of common stock through December 31, 2019. During the year ended
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
December 31, 2019, the Company repurchased 237,647 shares of its common stock at a total cost of $3.9 million, which is an average price per share of $16.27. The unused portion of this authorization expired on December 31, 2019.
In December 2019, the Company's Board of Directors authorized a new share repurchase program under which the Company may repurchase up to $10 million of its outstanding shares of common stock from January 1, 2020 through December 31, 2020. In March 2020, the Company’s Board of Directors authorized an additional $10.0 million increase to the share repurchase program. This increased authorization allowed the Company to purchase up to $20 million of shares outstanding through December 31, 2020. During the year ended December 31, 2020, the Company repurchased 800,235 shares of its common stock at a total cost of $10.0 million, which is an average price per share of $12.50. The unused portion of this authorization expired on December 31, 2020.
Securities Offerings
In June 2018, the Company filed with the Securities and Exchange Commission (“SEC”) on Form S-3, a shelf registration statement enabling the Company to offer and sell, from time to time, up to an aggregate of $150.0 million of securities. Refer to Note 18 for information on securities that were recently sold under this registration statement.
Stock Compensation Plan
In June 2018, the Company filed with the SEC on Form S-8, a registration statement registering 800,000 shares of common stock reserved for issuance under the Company’s 2018 Omnibus Incentive Compensation Plan (the “2018 Plan”). The 2018 Plan, which was approved by the Company’s shareholders at the 2018 annual meeting is an equity compensation plan that may be used for our employees, non-employee directors, consultants and advisors.
Share-Based Compensation Expense
Share-based compensation arrangements include the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
(In thousands)
|
Restricted stock
|
|
$
|
1,409
|
|
|
$
|
1,841
|
|
|
$
|
2,134
|
|
Performance stock
|
|
171
|
|
|
335
|
|
|
233
|
|
Total share-based compensation expense
|
|
$
|
1,580
|
|
|
$
|
2,176
|
|
|
$
|
2,367
|
|
|
|
|
|
|
|
|
Recognized tax benefit
|
|
$
|
634
|
|
|
$
|
534
|
|
|
$
|
600
|
|
Intrinsic value of options exercised
|
|
110
|
|
|
2
|
|
|
229
|
|
Fair value of restricted stock vested
|
|
1,659
|
|
|
1,977
|
|
|
2,360
|
|
The intrinsic value of options exercised represents the difference between the stock option exercise price and the weighted-average closing stock price of FNHC common stock on the exercise dates, as reported on the NASDAQ Global Market.
The unamortized share-based compensation expense is $3.4 million as of December 31, 2020, which will be recognized over the remaining weighted average vesting period of approximately 1.96 years.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Stock Option Awards
A summary of the Company’s stock option activity includes the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
Average
|
|
|
Number of
|
|
Option
|
|
|
Shares
|
|
Exercise Price
|
Outstanding at January 1, 2018
|
|
50,351
|
|
|
$
|
3.72
|
|
Granted
|
|
—
|
|
|
—
|
|
Exercised
|
|
(10,834)
|
|
|
3.47
|
|
Cancelled
|
|
(500)
|
|
|
2.45
|
|
Outstanding at December 31, 2018
|
|
39,017
|
|
|
3.80
|
|
Granted
|
|
—
|
|
|
—
|
|
Exercised
|
|
(167)
|
|
|
2.45
|
|
Cancelled
|
|
—
|
|
|
—
|
|
Outstanding at December 31, 2019
|
|
38,850
|
|
|
3.80
|
|
Granted
|
|
—
|
|
|
—
|
|
Exercised
|
|
(13,433)
|
|
|
3.16
|
|
Cancelled
|
|
—
|
|
|
—
|
|
Outstanding at December 31, 2020
|
|
25,417
|
|
|
$
|
4.01
|
|
Stock options outstanding and exercisable in a select price range is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding and Exercisable
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
|
|
Shares Outstanding
|
|
Contractual Life
|
|
Weighted Average
|
|
Aggregate
|
Range of Exercise Price
|
|
and Exercisable
|
|
(years)
|
|
Exercise Price
|
|
Intrinsic Value
|
$2.45 - $4.40
|
|
25,417
|
|
1.14
|
|
$4.01
|
|
48,546
|
Restricted Stock Awards
The Company recognizes share-based compensation expense for all RSAs held by the Company’s directors, executives and other key employees. For all RSA awards, excluding grants based on total relative shareholder return ("TSR"), the accounting charge is measured at the grant date as the fair value of FNHC common stock and expensed as non-cash compensation over the vesting term using the straight-line basis for service awards and over successive one-year requisite service periods for performance-based awards. Our expense for our performance awards depends on achievement of specified results; therefore the ultimate expense can range from 0% to 250% of target. Our TSR-based cliff vesting awards contain performance criteria which are tied to the achievement of certain market conditions. The TSR grant date fair value was determined using a Monte Carlo simulation and, unlike the performance condition awards, the expense is not reversed if the performance condition is not met. This value is recognized as expense over the requisite service period using the straight-line recognition method.
During the years ended December 31, 2020 and 2019, the Board of Directors granted 210,272 and 140,156 RSAs, respectively, vesting over three or five years, to the Company’s directors, executives and other key employees.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
RSA activity includes the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
Average
|
|
|
Number of
|
|
Grant Date
|
|
|
Shares
|
|
Fair Value
|
Outstanding at January 1, 2018
|
|
297,543
|
|
|
$
|
20.54
|
|
Granted
|
|
133,060
|
|
|
16.31
|
|
Vested
|
|
(112,071)
|
|
|
21.06
|
|
Cancelled
|
|
(56,198)
|
|
|
17.87
|
|
Outstanding at December 31, 2018
|
|
262,334
|
|
|
18.78
|
|
Granted
|
|
140,156
|
|
|
18.03
|
|
Vested
|
|
(94,755)
|
|
|
20.87
|
|
Cancelled
|
|
(52,390)
|
|
|
17.66
|
|
Outstanding at December 31, 2019
|
|
255,345
|
|
|
17.82
|
|
Granted
|
|
210,272
|
|
|
11.82
|
|
Vested
|
|
(89,889)
|
|
|
18.46
|
|
Cancelled
|
|
—
|
|
|
—
|
|
Outstanding at December 31, 2020
|
|
375,728
|
|
|
$
|
14.32
|
|
The weighted average grant date fair value is measured using the closing price of FNHC common stock on the grant date, as reported on the NASDAQ Global Market.
Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) associated with debt securities - available-for-sale consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
|
Before
Tax
|
|
Income
Tax
|
|
Net
|
|
Before
Tax
|
|
Income
Tax
|
|
Net
|
|
|
(In thousands)
|
Accumulated other comprehensive income (loss), beginning-of-period
|
|
$
|
13,621
|
|
|
$
|
(3,340)
|
|
|
$
|
10,281
|
|
|
$
|
(5,023)
|
|
|
$
|
1,273
|
|
|
$
|
(3,750)
|
|
Other comprehensive income (loss) due to debt securities - held to maturity reclassified to available-for-sale
|
|
(58)
|
|
|
14
|
|
|
(44)
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss) before reclassification
|
|
19,114
|
|
|
(4,688)
|
|
|
14,426
|
|
|
20,809
|
|
|
(5,144)
|
|
|
15,665
|
|
Reclassification adjustment for realized losses (gains) included in net income
|
|
(17,591)
|
|
|
4,314
|
|
|
(13,277)
|
|
|
(2,165)
|
|
|
531
|
|
|
(1,634)
|
|
|
|
1,523
|
|
|
(374)
|
|
|
1,149
|
|
|
18,644
|
|
|
(4,613)
|
|
|
14,031
|
|
Accumulated other comprehensive income (loss), end-of-period
|
|
$
|
15,086
|
|
|
$
|
(3,700)
|
|
|
$
|
11,386
|
|
|
$
|
13,621
|
|
|
$
|
(3,340)
|
|
|
$
|
10,281
|
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
14. EMPLOYEE BENEFIT PLAN
The Company sponsors a profit sharing plan under Section 401(K) of the Internal Revenue Code, which is a defined contribution plan that allows employees to defer compensation through contributions to the 401(K) Plan. This plan covers substantially all employees who meet specified service requirements and includes a 100% match up to the first 6% of an employee’s salary, not to exceed statutory limits. Additionally, the Company may make additional profit-sharing contributions.
For the years ended December 31, 2020, 2019 and 2018, the Company made no additional profit-sharing contribution.
The Company’s total contributions to the 401(K) Plan were $1.2 million, $0.9 million and $1.0 million for the years ended December 31, 2020, 2019 and 2018, respectively.
15. RELATED PARTY TRANSACTIONS
Related to an equity method investment in Southeast Catastrophe Consulting Company, LLC, based in Mobile, Alabama, the Company recorded pre-tax claims adjustment service fees and other expenses of $6.7 million for the year ended December 31, 2018. Additionally, the Company recognized other income in the consolidated statements of operations, of $2.2 million, $0.3 million, $0.3 million for the years ended December 31, 2020, 2019 and 2018, respectively.
16. EARNINGS PER SHARE
Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the period, including vested restricted stock awards during the period. Diluted EPS is computed by dividing net income by the weighted average number of shares outstanding, noted above, adjusted for the dilutive effect of stock options and unvested restricted stock awards. Dilutive securities are common stock equivalents that are freely exercisable into common stock at less than market prices or otherwise dilute earnings if converted. The net effect of common stock equivalents is based on the incremental common stock that would be issued upon the assumed exercise of common stock options and the vesting of RSAs using the treasury stock method. Common stock equivalents are not included in diluted earnings per share when their inclusion is antidilutive.
The following table presents the calculation of basic and diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2020
|
|
2019
|
|
2018
|
|
|
(In thousands, except per share data)
|
Net income (loss) attributable to FedNat Holding Company shareholders
|
|
$
|
(78,158)
|
|
|
$
|
1,011
|
|
|
$
|
14,928
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding - basic
|
|
13,846
|
|
|
12,977
|
|
|
12,775
|
|
|
|
|
|
|
|
|
Net income (loss) per common share - basic
|
|
($5.64)
|
|
|
$0.08
|
|
|
$1.17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding - basic
|
|
13,846
|
|
|
12,977
|
|
|
12,775
|
|
Dilutive effect of stock compensation plans
|
|
—
|
|
|
46
|
|
|
92
|
|
Weighted average number of common shares outstanding - diluted
|
|
13,846
|
|
|
13,023
|
|
|
12,867
|
|
|
|
|
|
|
|
|
Net income (loss) per common share - diluted
|
|
$
|
(5.64)
|
|
|
$
|
0.08
|
|
|
$
|
1.16
|
|
|
|
|
|
|
|
|
Dividends per share
|
|
$
|
0.36
|
|
|
$
|
0.33
|
|
|
$
|
0.24
|
|
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Dividends Declared
In February 2020, our Board of Directors declared a $0.09 per common share dividend, payable in March 2020, to shareholders of record on February 14, 2020. amounting to $1.3 million.
In April 2020, our Board of Directors declared a $0.09 per common share dividend, payable in June 2020, to shareholders of record on May 15, 2020, amounting to $1.3 million.
In July 2020, our Board of Directors declared a $0.09 per common share dividend, payable in September 2020, to shareholders of record on August 14, 2020, amounting to $1.2 million.
In November 2020, our Board of Directors declared a $0.09 per common share dividend, payable in December 2020, to shareholders of record on November 16, 2020, amounting to $1.3 million.
17. STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS
The Company’s insurance companies are subject to regulations and standards of the Florida Office of Insurance Regulation (the "Florida OIR") and Louisiana Department of Insurance (the "LDI"). These standards require that insurance companies prepare statutory-basis financial statements in accordance with the National Association of Insurance Commissioners (“NAIC”) Accounting Practices and Procedures Manual. The Company did not use any prescribed or permitted statutory accounting practices that differed from the NAIC’s statutory accounting practices as of December 31, 2020.
The Company’s insurance companies are required to report their risk-based capital (“RBC”) each December 31. Failure to maintain an adequate RBC could subject the Company to regulatory action and could restrict the payment of dividends. As of December 31, 2020, the RBC levels of the Company’s insurance companies did not subject them to any regulatory action.
Additionally, Florida Statutes require the Company’s Florida domiciled insurance companies to maintain specified levels of statutory capital and restrict the timing and amount of dividends and other distributions that may be paid to the parent company. These standards require dividends to be paid only from statutory unassigned surplus. The maximum dividend that may be paid by the Company’s insurance companies to their parent company, without prior regulatory approval is limited to the lesser of statutory net income from operations of the preceding calendar year, not including realized capital gains, plus a 2 years carryforward or 10% of statutory unassigned surplus as of the preceding year end. A dividend may also be taken without prior regulatory approval if (a) the dividend is equal to or less than the greater of (i) 10% of the insurer’s surplus as to policyholders derived from realized net operating profits on its business and net realized capital gains; or (ii) the insurer’s entire net operating profits and realized net capital gains derived during the immediately preceding calendar year; (b) the insurer will have surplus as to policyholders equal to or exceeding 115 percent of the minimum required statutory surplus as to policyholders after the dividend or distribution is made; and (c) the insurer has filed notice with the Florida OIR at least 10 business days prior to the dividend payment or distribution, or such shorter period of time as approved by the Florida OIR on a case-by-case basis. These dividends are referred to as “ordinary dividends.” However, if a dividend, together with other dividends paid within the preceding 12 months, exceeds this statutory limit or is paid from sources other than earned surplus, the entire dividend is generally considered an “extraordinary dividend” and must receive prior regulatory approval before such dividend can be paid.
With respect to the Company's Louisiana domiciled insurer, Louisiana law restricts a domestic insurer from declaring and paying any dividends to its stockholders unless its capital is fully paid in cash and is unimpaired and it has a surplus beyond its capital stock and the initial minimum surplus required and all other liabilities equal to fifteen percent of its capital stock, provided that this restriction shall not apply when an insurer's paid-in capital and surplus exceeds the minimum required by Louisiana law by one hundred percent or more. No extraordinary dividend or other extraordinary distribution to its shareholders may be made until 30 days after the commissioner of insurance has received notice of the declaration thereof and has not within that period disapproved the payment, or has approved the payment within the thirty-day period. An extraordinary dividend or distribution includes any dividend or distribution of cash or other property, whose fair market value together with that of other dividends or distributions made within the preceding twelve months exceeds the lesser of (a) 10% percent of the insurer's surplus as regards policyholders as of the 31st day of December next preceding; or (b) the net income, not including realized capital gains, for the twelve-month period ending the 31st day of December next preceding, but shall not include pro rata distributions of any class of the insurer's own securities. In determining whether a dividend or distribution is extraordinary, an insurer may carry forward net income from the previous two calendar years that has not already been paid out as dividends. This carryforward shall be computed by taking the net income from the second and third preceding calendar years, not including realized capital gains, less dividends paid in the second and immediate preceding calendar years.
FedNat Holding Company and Subsidiaries
Notes to Consolidated Statements (Continued)
December 31, 2020
Notwithstanding the foregoing, an insurer may declare an extraordinary dividend or distribution which is conditional upon regulatory approval. and the declaration shall confer no rights upon shareholders until either the payment is approved or has not been disapproved within the 30-day period referred to above. As noted above, authorization to issue dividends from the insurance companies is based on achieving certain financial results and regulatory approvals. Due to the financial results, we have neither applied for regulatory approval nor are we authorized to issue dividends from the insurance carriers at this time.
As of December 31, 2020 and 2019, on a combined statutory basis, the capital and surplus of the Company’s insurance companies was $145.2 million and $192.5 million, respectively. Combined statutory operational results of the Company’s insurance companies was a net loss of $57.5 million, net loss of $36.8 million and net income of $2.9 million for the years ended December 31, 2020, 2019 and 2018, respectively. Statutory capital and surplus exceeds amounts necessary to satisfy regulatory requirements.
18. SUBSEQUENT EVENTS
Rate Increases
The Company applied for and was approved by the LDI for a state-wide average rate increase of 9.9% for FNIC's Louisiana homeowners multiple-peril insurance policies, which became effective for new and renewal policies in January 2021.
The Company applied for and was approved by the Texas Department of Insurance for a state-wide average rate increase of 12.3% for MIC's Texas homeowners multiple-peril insurance policies, which became effective for new and renewal policies in February 2021.
The Company applied for and was approved by the Florida OIR for a state-wide average rate increase of 6.7% for Florida homeowners multiple-peril insurance policies, which is expected to become effective for new and renewal policies in March 2021.
The Company applied for a "use and file" rate filing with the Florida OIR to implement a state-wide average increase of 7.0% for Florida homeowners multiple-peril insurance policies and 6.0% for dwelling fire insurance policies, which is expected to become effective for new and renewal policies in April 2021. The revised rates are not deemed approved or final until so affirmed by the Florida OIR, at their discretion.
Reinsurance
Effective January 1, 2021, the Company secured a new aggregate excess of loss reinsurance for calendar year 2021 for MIC, which provides non-named storm coverage of 65% of $15 million excess of $10 million with a $0.9 million occurrence deductible and a $4.2 million occurrence limit at an approximate annual cost of $2.3 million. Refer to Note 6 above for further information.
Effective March 1, 2021, the Company secured additional reinsurance limit of 50% of $70 million excess of $25 million and 100% of $15 million excess of $10 million at an approximate cost of $13 million. This limit is available for any subsequent events through May 31, 2021 for all carriers and all states, with a portion excluding named storms.
Winter Storm Uri
On approximately February 13, 2021, Winter Storm Uri ("Uri") hit the Southern Plains causing heavy residential damage in Texas, primarily associated with freezing temperatures causing widespread instances of burst water pipes. The Company expects to incur claims in excess of its aggregate reinsurance retention, which is approximately $23 million for this event. In addition, the Company has a co-participation within its reinsurance tower which arose in early February 2021 when, in conjunction with year end 2020 financial reporting, we strengthened ultimate loss and LAE reserves for the five hurricane events that occurred in 2020. Due to this increase in hurricane reserves, the Company has a co-participation of approximately $18 million in excess of $61 million, which results from the portion of our reinsurance program that does not embody the cascading feature where unused limit drops down for subsequent events. Combined with the $23 million retention, the Company's total exposure to Uri including reinstatement premium is currently estimated to be $41 million, pre-tax, before anticipated quota share recoveries.
Capital Raise
On March 15, 2021, the Company closed an underwritten public offering of 3,500,000 shares of its common stock at a price of $4.75 per share for gross proceeds of $16.6 million. The offering generates net proceeds to the Company of approximately $15.2 million, after deducting the underwriter’s discount and estimated offering expenses payable by the Company.
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of
FedNat Holding Company
Opinion on Internal Control over Financial Reporting
We have audited FedNat Holding Company and subsidiaries’ internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, because of the effect of the material weakness described below on the achievement of the objectives of the control criteria, FedNat Holding Company and subsidiaries (the Company) has not maintained effective internal control over financial reporting as off December 31, 2020, based on the COSO criteria.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment. Management has identified certain design and operating effectiveness deficiencies in the Company’s internal controls, which when evaluated collectively, aggregated to a material weakness in internal control. The deficiencies in the Company’s internal controls included deficiencies related to management’s controls over the calculation of reinsurance related balances and a profit share arrangement with the same third party.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and the financial statement schedules listed in the index at Item 15. This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of the 2020 consolidated financial statements, and this report does not affect our report dated March 29, 2021 which expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
Charlotte, North Carolina
March 29, 2021