SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES ACT OF 1934
For the fiscal year ended December 31, 2002
or
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period of _____________to_______________
Commission file number 0-2500111
21ST CENTURY HOLDING COMPANY
(Exact name of registrant as specified in its Charter)
Florida 65-0248866
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No)
4161 N.W. 5TH STREET, PLANTATION, FLORIDA 33317
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(Address of Principal executive offices) (Zip Code)
Registrant's telephone number, including area code (954) 581-9993
----------------
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, par value $0.01 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-X is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in the Exchange Act Rule 12b-2). Yes [ ] No [X]
The aggregate market value of the Issuer's common stock held by
non-affiliates (based on the last sale of the common stock as reported by the
Nasdaq National Market) on June 30, 2002 was: $13,298,055.
As of March 28, 2003, there were 3,012,201 shares of the common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
21st Century Holding Company's definitive proxy statement for its 2003
annual meeting of shareholders will be filed with the SEC not later than 120
days after the end of the fiscal year covered by this report on Form 10-K
pursuant to General Instruction G (3) of the Form 10-K. Information from such
definitive proxy statement will be incorporated by reference into Part III,
Items 10, 11, 12 and 13 hereof.
General information about 21st Century Holding Company (the "Company")
can be found at www.fedusa.com. The Company makes its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to these reports filed or furnished pursuant to Section 13 or 15(d) of the
Securities and Exchange Act of 1934 available free of charge on its web site, as
soon as reasonably practicable after they are electronically filed with the SEC.
FORWARD-LOOKING STATEMENTS
Statements in this report or in documents that are incorporated by
reference that are not historical fact are forward-looking statements that are
subject to certain risks and uncertainties that could cause actual events and
results to differ materially from those discussed herein. Without limiting the
generality of the foregoing, words such as "may", "will", "expect", "believe",
"anticipate", "intend", "could", "would", "estimate", or "continue" or the
negative other variations thereof or comparable terminology are intended to
identify forward-looking statements. The risks and uncertainties include,
without limitation, uncertainties related to estimates, assumptions and
projections generally; inflation and other changes in economic conditions
(including changes in interest rates and financial markets); pricing competition
and other initiatives by competitors; ability to obtain regulatory approval for
requested rate changes and the timing thereof; legislative and regulatory
developments; the outcome of litigation pending against the Company; risks
related to the nature of the Company's business; dependence on investment income
and the composition of the Company's investment portfolio; the adequacy of its
liability for loss and loss adjustment expense ("LAE"); insurance agents; claims
experience; limited experience in the insurance industry; ratings by industry
services; catastrophe losses; reliance on key personnel; weather conditions
(including the severity and frequency of storms, hurricanes, tornadoes and
hail); changes in driving patterns and loss trends; acts of war and terrorist
activities; courts decisions and trends in litigation and health care and auto
repair costs; and other matters described from time to time by the Company in
this report, and other filings with the SEC. You are cautioned not to place
reliance on these forward-looking statements, which are valid only as of the
date they were made. The Company undertakes no obligation to update or revise
any forward-looking statements to reflect new information or the occurrence of
unanticipated events or otherwise. In addition, investors should be aware that
generally accepted accounting principles prescribe when a company may reserve
for particular risks, including litigation exposures. Accordingly results for a
given reporting period could be significantly affected if and when a reserve is
established for a major contingency. Reported results may therefore appear to be
volatile in certain accounting periods.
PART I
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ITEM 1. BUSINESS
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GENERAL
The Company is a vertically integrated insurance holding company,
which, through its subsidiaries, controls substantially all aspects of the
insurance underwriting, distribution and the claims process. The Company
underwrites personal automobile insurance, homeowners insurance and mobile home
property and casualty insurance in the State of Florida through its wholly-owned
subsidiaries, Federated National Insurance Company ("Federated National") and
American Vehicle Insurance Company ("American Vehicle"). The Company internally
processes claims made by its own and third party insureds through a wholly-owned
claims adjusting company, Superior Adjusting, Inc. ("Superior"). The Company
also offers premium financing to its own and third-party insureds through its
wholly-owned subsidiary, Federated Premium Finance, Inc. ("Federated Premium").
The Company markets and distributes its own and third-party insurers'
products and its other services primarily in South Florida, through a network of
23 agencies, owned by Federated Agency Group, Inc. ("Federated Agency Group"), a
wholly-owned subsidiary, 40 franchised agencies and approximately 125
independent agents. The Company, through its wholly-owned subsidiary, FedUSA,
Inc. ("FedUSA"), franchises agencies under the FedUSA name. As of December 31,
2002, franchises were granted for 40 Fed USA agencies, of which 34 were
operating. The Company intends to focus its future expansion efforts for its
agency network on franchised agencies.
The Company offers income tax preparation software and service through
Express Tax Service, Inc. ("Express Tax"), an 80% owned subsidiary, as well as
franchise opportunities for these services through EXPRESSTAX Franchise
Corporation ("EXPRESSTAX"), a wholly-owned subsidiary of Express Tax. As of
December 31, 2002 there were 136 EXPRESSTAX franchises granted.
The Company believes that it can be distinguished from its competitors
because it generates revenue from substantially all aspects of the insurance
underwriting, distribution and claims process. The Company provides quality
service to both its agents and insureds by utilizing an integrated computer
system, which links the Company's insurance and service entities. The Company's
computer and software systems allow for automated premium quotation, policy
issuance, billing, payment and claims processing and enables the Company to
continuously monitor substantially all aspects of its business. Using these
systems, the Company's agents can access a customer's driving record, quote a
premium, offer premium financing and, if requested, generate a policy on-site.
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The Company believes that these systems have facilitated its ability to market
and underwrite insurance products on a cost-efficient basis, allow Company-owned
and franchised agencies to be a "one stop" shop for insurance, tax preparation
and other services, and will enhance the Company's ability to expand in Florida
and to other states.
The Company's primary products are standard and nonstandard personal
automobile insurance. The former is principally provided to insureds who present
an average risk profile in terms of payment history, driving record, vehicle and
other factors. The latter is principally provided to insureds who are unable to
obtain preferred or standard insurance coverage because of their payment
history, driving record, age, vehicle type or other factors, including market
conditions for preferred or standard risks. Underwriting standards for standard
insurance coverage have become more restrictive, thereby requiring more drivers
to seek coverage in the nonstandard automobile insurance market. These factors
have contributed to an increase in the size of the nonstandard personal
automobile insurance market.
The Company currently underwrites and sells insurance only in Florida;
however, the Company intends to expand to other selected states and American
Vehicle has applied to obtain a license to underwrite and sell personal
automobile insurance in South Carolina and Louisiana. The Company will select
additional states for expansion based on a number of criteria, including the
size of the personal automobile insurance market, statewide loss results,
competition and the regulatory climate. The Company's ability to expand into
other states will be subject to the prior regulatory approval of each state.
Certain states impose operating requirements upon licensee applicants, which may
impose burdens on the Company's ability to obtain a license to conduct insurance
business in those other states. There can be no assurance that the Company will
be able to obtain the required licenses, and the failure to do so would limit
the Company's ability to expand geographically.
The Company's executive offices are located at 4161 N.W. 5th Street,
Plantation, Florida and its telephone number is (954) 581-9993.
BUSINESS STRATEGY
The Company's strategy is to seek continued growth of its business by
capitalizing on the efficiencies of its vertical integration and by:
o expanding into additional states. Currently, American Vehicle
has applied to obtain a license to underwrite and sell
automobile insurance in South Carolina and Louisiana;
o expanding the Company's product offerings to include
commercial general liability insurance for businesses, subject
to regulatory approval;
o expanding its agency network primarily through the sale of
FedUSA franchises;
o employing the business practices developed and used in Florida
in its expansion to other selected states;
o maintaining a commitment to provide quality service to agents
and insureds by emphasizing customer service;
o encouraging agents to place a high volume of quality business
with the Company by providing them with attractive commission
structures tied to premium levels and loss ratios; and
o expanding its EXPRESSTAX franchises to all 50 states.
INSURANCE OPERATIONS AND RELATED SERVICES
UNDERWRITING
GENERAL. The Company underwrites its personal automobile insurance,
homeowners and mobile home property insurance and casualty insurance through
Federated National and personal automobile insurance through American Vehicle.
Federated National and American Vehicle are currently licensed to conduct
business only in Florida, although American Vehicle has applied to obtain a
license to underwrite and sell personal automobile insurance in South Carolina
and Louisiana.
The following tables set forth the amount and percentages of the
Company's gross premiums written and premiums ceded to reinsurers and net
premiums written by line of business for the periods indicated.
3
YEARS ENDED DECEMBER 31,
2002 2001 2000
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PREMIUM PERCENT PREMIUM PERCENT PREMIUM PERCENT
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(DOLLARS IN THOUSANDS)
Written:
Automobile.......................... $52,586 83.4% $ 24,743 72.2% $25,361 79.1%
Homeowners.......................... 8,670 13.8% 7,662 22.4% 4,604 14.3%
Mobile Home......................... 1,780 2.8% 1,866 5.4% 2,109 6.6%
------- ----- -------- ----- ------- -----
Total Written...................... $63,036 100.0% $ 34,271 100.0% $32,074 100.0%
Ceded:
Automobile.......................... $25,286 100.0% $(12,789) 100.0% $(7,625) 100.0%
Homeowners.......................... -- -- -- -- -- --
Mobile Home......................... -- -- -- -- -- --
------- ----- -------- ----- ------- -----
Total Ceded......................... $25,286 100.0% $(12,789) 100.0% $(7,625) 100.0%
Net:
Automobile.......................... $27,300 72.3% $11,954 55.6% $17,736 72.5%
Homeowners.......................... 8,670 23.0% 7,662 35.7% 4,604 18.8%
Mobile Home......................... 1,780 4.7% 1,866 8.7% 2,109 8.7%
------- ----- -------- ----- ------- -----
Total Net............................. $37,750 100.0% $ 21,482 100.0% $24,449 100.0%
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The Company markets its personal automobile insurance through its
network of Company-owned agencies, franchised agencies and independent agents.
STANDARD AUTOMOBILE. Standard personal automobile insurance is
principally provided to insureds who present an average risk profile in terms of
payment history, driving record, vehicle type and other factors. Limits on
standard personal automobile insurance are generally significantly higher than
those for nonstandard coverage, but typically provide for deductibles and other
restrictive terms. The Company is underwriting standard personal automobile
insurance policies providing coverage no higher than $100,000 per individual,
$300,000 per accident for bodily injury, $50,000 per accident for property
damage and comprehensive and collision up to $50,000 per accident, with
deductibles ranging from $200 to $1,000.
NONSTANDARD AUTOMOBILE. Nonstandard personal automobile insurance is
principally provided to insureds that are unable to obtain standard insurance
coverage because of their payment history, driving record, age, vehicle type or
other factors, including market conditions. Underwriting standards for preferred
and standard coverage have become more restrictive, thereby requiring more
insureds to seek nonstandard coverage and contributing to the increase in the
size of the nonstandard automobile market. Nonstandard automobile insurance,
however, generally involves the potential for increased loss exposure and higher
claims experience. Loss exposure is limited because premiums usually are at
higher rates than those charged for standard insurance coverage and because
approximately 37% of the policies issued by the company provide the minimum
coverage required of the policyholder by statute and provide no bodily injury
coverage. The Company currently underwrites nonstandard personal automobile
insurance in Florida, where the minimum limits are $10,000 per individual,
$20,000 per accident for bodily injury, $10,000 per accident for property damage
and comprehensive and $50,000 for collision. The average annual premium on
policies currently in force is approximately $717. Both Federated National and
American Vehicle underwrite this coverage on an annual and semi-annual basis.
Due to the purchasing habits of nonstandard automobile insureds (for
example, insureds seeking the least expensive insurance required of the
policyholder by statute which satisfies the requirements of state laws to
register a vehicle), policy renewal rates tend to be low compared to standard
policies. The Company's experience has been that a significant number of
existing nonstandard policyholders allow their policies to lapse and then
reapply for insurance as new policyholders. The Company's average policy renewal
rate is 35% to 40%. The success of the Company's nonstandard automobile
insurance program, therefore, depends in part on its ability to replace
non-renewing insureds with new policyholders through marketing efforts.
HOMEOWNERS. Federated National underwrites homeowners' insurance
principally in Central and Southern Florida. Homeowners' insurance generally
protects an owner of real and personal property against covered causes of loss
to that property. Limit on homeowners' insurance is generally significantly
higher than those for mobile homes, but typically provide for deductibles and
other restrictive terms. Federated National's property lines typically provide
maximum coverage in the amount of $200,000, with the average policy limit being
approximately $150,000. The average annual premium on policies currently in
force is approximately $1,050 and the typical deductible is $1,000. The Company
markets Federated National's homeowners' insurance through its network of
Company-owned agencies and independent agents.
4
FLOOD. In April 2002 the Company was authorized to write flood
insurance through the National Flood Insurance Program ("NFIP"). The Company
writes the policy for the Federal Flood program which assumes 100% of the flood
risk and the Company retains a commission for its service. The average flood
policy premium is $300 with limits not to exceed $250,000.
MOBILE HOME. Federated National underwrites homeowners insurance for
mobile homes, principally in Central and Northern Florida, where the Company
believes that the risk of catastrophe loss from hurricanes is less than in other
areas of the state. Homeowners' insurance generally protects an owner of real or
personal property against covered causes of loss to that property. Homeowners'
insurance for mobile homes generally involves the potential for above-average
loss exposure. In the absence of major catastrophe losses, loss exposure is
limited because premiums usually are at higher rates than those charged for
non-mobile home property and casualty insurance. Additionally, Federated
National's property lines typically provide maximum coverage in the amount of
$75,000, with the average policy limit being approximately $31,000. In addition,
the Company presently limits its mobile home coverage to no more than 10% of its
underwriting exposure. The average annual premium on policies currently in force
is approximately $315 and the typical deductible is $500. The Company markets
Federated National's mobile home property and casualty insurance through
independent agents.
FUTURE PRODUCTS. The Company intends to expand its product offerings by
underwriting additional insurance products and programs such as commercial
general liability insurance for businesses, and marketing them through its
distribution network. Expansion of the Company's product offerings will result
in a slight increase in expenses due to additional costs incurred in additional
actuarial rate justifications, software and personnel. Offering additional
insurance products may require regulatory approval.
ASSURANCE MGA
Assurance MGA acts as Federated National's and American Vehicle's
exclusive managing general agent. Assurance MGA currently provides all
underwriting policy administration, marketing, accounting and financial services
to Federated National, American Vehicle and the Company's agencies and
participates in the negotiation of reinsurance contracts.
Assurance MGA generates revenue through policy fee income and other
administrative fees from the marketing of companies' products through the
Company's distribution network. Although Assurance MGA recently diverted
business from an unaffiliated insurance company to American Vehicle, and ceased
acting as a third party administrator for this company, Assurance MGA plans to
establish relationships with additional carriers and add additional insurance
products in the future.
SUPERIOR ADJUSTING
The Company internally processes claims made by Federated National's
and American Vehicle's insureds through Superior. The Company-owned agencies and
independent agents have no authority to settle claims or otherwise exercise
control over the claims process. Management believes that the employment of
salaried claims personnel, as opposed to independent adjusters, results in
reduced ultimate loss payments, lower loss adjustment expenses and improved
customer service. The Company only retains independent appraisers and adjusters
on an as needed basis. Additionally, Superior currently adjusts claim files for
the Florida Insurance Guarantee Association on a flat fee per file basis as well
as adjusting claims for another unaffiliated local insurance company.
Claims settlement authority levels are established for each adjuster or
manager based on the employee's ability and level of experience. Upon receipt,
each claim is reviewed and assigned to an adjuster based on the type and
severity of the claim. The Company employs an in-house counsel to monitor
claims-related litigation. The claims policy of the Company emphasizes prompt
and fair settlement of meritorious claims and the establishment of appropriate
liability for claims. The Company believes that the internal processing of
claims enables it to provide quality customer service while controlling claims
adjustment expenses.
FEDERATED PREMIUM
Federated Premium provides premium financing to Federated National's,
American Vehicle's and third-party insureds. Premium financing is marketed
through the Company's distribution network of Company-owned and franchised
agencies (but not through independent agents). Lending operations are supported
by Federated Premium's own capital base and are currently leveraged through a
credit facility with FlatIron Funding Company LLC.
Premiums for property and casualty insurance are typically payable at
the time a policy is placed in force or renewed. Federated Premium's services
allow the insured to pay a portion of the premium when the policy is placed in
force and the balance in monthly installments over the life of the policy. As
security, Federated Premium retains a contractual right, if a premium
installment is not paid when due, to cancel the insurance policy and to receive
the unearned premium from the insurer, or in the event of insolvency of an
insurer, from the Florida Guarantee Association, subject to a $100 per policy
5
deductible. In the event of cancellation, Federated Premium applies the unearned
premium towards the payment obligation of the insured. As part of its premium
financing offered to third-party insureds, Federated Premium may advance funds
for financed premiums to independent insurance agencies that represent
third-party insurers. If remittance is not made by the agency to the third-party
insurer, advances made by Federated Premium may only be recoverable to the
extent that the agency's receipt of such advances is received by the third-party
insurer. In the past, the Company closely monitored the independent insurance
agencies it used to reduce this risk. In order to reduce the amount of charge
offs of uncollected accounts, Federated Premium discontinued financing policies
generated by independent agents in the fourth quarter of 2001. Premium financing
which the Company offers to its own insureds involves limited credit risk.
The following table sets forth the amount and percentages of premiums
financed for Federated National, American Vehicle and other insurers for the
periods indicated:
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
PREMIUMS PERCENT PREMIUMS PERCENT PREMIUMS PERCENT
-------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
Federated National........................ $22,331 55.4% $20,174 43.9% $17,006 38.4%
American Vehicle.......................... 12,850 31.9 1,066 2.3 -- --
Other insurers............................ 5,124 12.7 24,728 53.8 27,293 61.6
------- ----- ------- ----- ------- -----
Total.................................. $40,305 100.0% $45,968 100.0% $44,299 100.0%
======= ===== ======= ===== ======= =====
Federated Premium's operations are funded by a revolving loan agreement
("Revolving Agreement") with FlatIron Funding Company LLC ("FlatIron"). The
Revolving Agreement is structured as a sale of contracts receivable under a sale
and assignment agreement with FPF, Inc. (a wholly-owned subsidiary of FlatIron),
which gives FPF Inc. the right to sell or assign these contracts receivable.
Federated Premium, which services these contracts, has recorded transactions
under the Revolving Agreement as secured borrowings. The Revolving Agreement,
which was amended and revised in September 2001, allowed for a maximum credit
commitment of $7.0 million plus an initial additional amount of $700,000 for the
transition from September 30, 2001 when the previous agreement expired. The line
declined by $100,000 each month beginning November 1, 2001. In September 2002
the line was amended and revised allowing for a maximum credit commitment of
$4.0 million. The decline in the required credit commitment is due primarily to
Federated National and American Vehicle's newly developed direct bill program.
Direct billing is where the insurance company accepts from the insured, as a
receivable, a promise to pay the premium, as opposed to requiring the full
amount of the policy, either directly from the insured or from a premium finance
company. The amount of FPF's advance is subject to availability under a
borrowing base calculation, with maximum advances outstanding not to exceed the
maximum credit commitment. The annual interest rate on advances under the
Revolving Agreement is the prime rate plus additional interest varying from
1.25% to 3.25% based on the prior month's ratio of contracts receivable related
to insurance companies with an A. M. Best rating of B or worse to total
contracts receivable. The Revolving Agreement contains various operating and
financial covenants, with which the Company was in compliance at December 31,
2002 and 2001. The Revolving Agreement, as amended, expires September 30, 2004.
Outstanding borrowings under the Revolving Agreement as of December 31, 2002 and
2001 were approximately $4.3 million and $6.7 million, respectively. Outstanding
borrowings in excess of the $4.0 million commitment totaled $312,420 and are
permissible by reason of a compensating cash balance of $352,433 held for the
benefit of FPF, Inc. Interest expense on this revolving credit line for the
years ended December 31, 2002, 2001 and 2000 totaled approximately $342,000,
$592,000 and $643,000, respectively.
TAX PREPARATION SERVICES AND ANCILLARY SERVICES
The Company also offers other services at its Company-owned and
franchised agencies including tax return preparation and electronic filing and
the issuance and renewal of license tags. In August 1999, the Company acquired
an 80% interest in Express Tax. Express Tax licenses tax return preparation
software to business locations throughout the United States and also earns fees
on all electronically filed returns. Express Tax previously licensed its
software to the Company's agencies and will continue to do so in the future.
FRANCHISE OPERATIONS
FedUSA franchises insurance and financial service. FedUSA commenced the
offering of franchises in December 2000 and as of December 31, 2002 had 34
operating franchises.
The franchise agreement for each FedUSA franchise grants the franchisee
a license for the operation of a FedUSA insurance agency within an exclusive
territory to open and operate a center for a ten-year period, with two
additional ten-year options. FedUSA collects a non-refundable initial franchise
fee of $14,950, royalty fees, advertising fees, and other fees.
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In 2002, EXPRESSTAX began franchising an agency for tax return
preparation, electronic filing and related financial products. The EXPRESSTAX
franchise agreement grants the franchisee a non-exclusive license to open and
operate a center for a ten-year period, with two additional ten-year options.
EXPRESSTAX may collect a non-refundable initial franchise in addition to royalty
fees, advertising fees, and other fees. As of December 31, 2002, 136 EXPRESSTAX
franchises have been granted.
MARKETING AND DISTRIBUTION
The Company markets and distributes its own and third-party insurers'
products and its other services primarily in Central and South Florida through a
network of 23 Company-owned agencies, 34 franchised agencies and approximately
125 independent agents. Company-owned agencies are located in Miami-Dade,
Broward, Palm Beach, Martin, Orange, Osceola, Volusia and Seminole Counties,
Florida. Franchised agencies are located in Miami-Dade, Broward, Palm Beach,
Martin, St. Lucie and Orange Counties, Florida. Independent agents are located
primarily in South Florida. The Company supports its agency network by
advertising in various media in conjunction with its franchised agencies.
Whether Company-employed, franchise-employed or independent, agents
have the authority to sell and bind insurance coverages in accordance with
procedures established by Assurance MGA. Assurance MGA reviews all coverages
bound by the agents promptly and generally accepts all coverages that fall
within stated underwriting criteria. Assurance MGA also has the right, within a
period of 60 days from a policy's inception, to cancel any policy upon 45 days'
notice, even if the risk falls within its underwriting criteria.
The Company believes that its integrated computer system, which allows
for rapid automated premium quotation and policy issuance by its agents, is a
key element in providing quality service to both its agents and insureds. For
example, upon entering a customer's basic personal information, the customer's
driving record is accessed and a premium rate is quoted. If the customer chooses
to purchase the insurance, the system generates the policy on-site. Each agency,
whether company-owned or franchised, is designed to be a "one stop" shop for
insurance, tax preparation and ancillary services.
The Company believes that its distribution system will ultimately
enable it to lower its expense ratio and operate with more favorable loss
experience. A lower expense ratio will, in turn, allow the Company to more
effectively compete with larger providers of automobile insurance as well as
other forms of insurance.
The following table sets forth the amount and percentages of insurance
premiums written through Company-owned agencies, franchised agencies and
independent agents for the periods indicated:
YEARS ENDED DECEMBER 31,
2002 2001 2000
---------------------- ---------------------- ----------------------
PREMIUMS PERCENT PREMIUMS PERCENT PREMIUMS PERCENT
-------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
Through Company-owned agencies.......... 20,403 32.4% $ 9,932 29.0% $12,990 40.5%
Through franchised agencies............. 11,761 18.6% 2,659 7.7% -- --
Through independent agents.............. 30,872 49.0% 21,680 63.3% 19,084 59.5%
------ ----- ------- ---- ------- -----
Total................................ $63,036 100.0% $34,271 100.0% $32,074 100.0%
======= ===== ======= ===== ======= =====
The Company plans to continue to expand its distribution network and
market its products and services in other regions of Florida and other states by
franchising additional insurance agencies and establishing relationships with
additional independent agents. As the Company expands its insurance operations
to other states, the Company will seek to replicate its distribution network in
those states. There can be no assurance, however, that the Company will be able
to obtain the required regulatory approvals to offer additional insurance
products or expand into states other than Florida.
REINSURANCE
The Company follows industry practice of reinsuring a portion of its
risks and paying for that protection based upon premiums received on all
policies subject to such reinsurance. Reinsurance involves an insurance company
transferring or "ceding" all or a portion of its exposure on insurance
underwritten by it to another insurer, known as a "reinsurer." The reinsurer
assumes a portion of the exposure in return for a portion, or quota share, of
the premium, and pays the ceding company a commission based upon the amount of
insurance ceded. The ceding of insurance does not legally discharge the insurer
from its primary liability for the full amount of the policies. If the reinsurer
fails to meet its obligations under the reinsurance agreement, the ceding
company is still required to pay the loss.
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Reinsurance is ceded under separate contracts or "treaties" for the
separate lines of business underwritten. The Company collectively ceded $25.3
million in premiums written for the year ended December 31, 2002. The Company's
reinsurance for automobile insurance is primarily ceded with Transatlantic, an
A++ rated reinsurance company. Federated National ceded 40%, 50% and 30% of
automobile premiums written and losses incurred in 2002, 2001 and 2000,
respectively, to Transatlantic.
American Vehicle ceded 80% of its premiums written and losses incurred
during 2001. From January 2002 until November 2002 the Company reduced its
percentage of ceded premiums written and losses incurred to 70% and then to 40%
effective November 1, 2002.
During 2002 Federated National entered into a 10% quota-share agreement
with its affiliate American Vehicle. The agreement ceded 10% of its premium and
losses on all policies with an effective date of 2002. For presentation purposes
and in accordance with the principles of consolidation the agreement between the
two affiliated insurance companies has been eliminated.
The reinsurance programs renew annually, although the Company
continually reviews the programs and may elect to change it more frequently.
Reinsurance is placed directly by the Company on the automobile line of
business.
The Company is selective in choosing a reinsurer and considers numerous
factors, the most important of which is the financial stability of the
reinsurer, its history of responding to claims and its overall reputation. In an
effort to minimize its exposure to the insolvency of a reinsurer, the Company
evaluates the acceptability and reviews the financial condition of the reinsurer
at least annually. The Company's current policy is to use only reinsurers that
have an A.M. Best rating of "A" (Excellent) or better.
In order to minimize the effect of a natural disaster, the Company
purchases catastrophic reinsurance from both the state run Florida Hurricane
Catastrophe Fund and private re-insurers. The Company insures to the one-in-100
year event. As of December 31, 2002, Federated National would pay approximately
$3 million in claims before catastrophic reinsurance would take effect.
Afterward, the Company would pay all claims in excess of approximately $33
million.
LIABILITY FOR UNPAID LOSSES AND LAE
The Company is directly liable for loss and loss adjustment expense
("LAE") payments under the terms of the insurance policies that it writes. In
many cases there may be a time lag between the occurrence and reporting of an
insured loss to the Company and the Company's payment of that loss. As required
by insurance regulations and accounting rules, the Company reflects its
liability for the ultimate payment of all incurred losses and LAE by
establishing a liability for those unpaid losses and LAE for both reported and
unreported claims, which represent estimates of future amounts needed to pay
claims and related expenses.
When a claim involving a probable loss is reported, the Company
establishes a liability for the estimated amount of the Company's ultimate loss
and LAE payments. The estimate of the amount of the ultimate loss is based upon
such factors as the type of loss, jurisdiction of the occurrence, knowledge of
the circumstances surrounding the claim, severity of injury or damage, potential
for ultimate exposure, estimate of liability on the part of the insured, past
experience with similar claims and the applicable policy provisions.
All newly reported claims received with respect to personal automobile
policies are set up with an initial average liability. The average liability for
these claims are determined every quarter by dividing the number of closed
claims into the total amount paid during the three-month period. If a claim is
open more than 45 days, that open case liability is evaluated and the liability
is adjusted upward or downward according to the facts and damages of that
particular claim.
In addition, management provides for a liability on an aggregate basis
to provide for losses incurred but not reported ("IBNR"). The Company utilizes
independent actuaries to help establish its liability for unpaid losses and LAE.
The Company does not discount the liability for unpaid losses and LAE for
financial statement purposes.
The estimates of the liability for unpaid losses and LAE are subject to
the effect of trends in claims severity and frequency and are continually
reviewed. As part of this process, the Company reviews historical data and
considers various factors, including known and anticipated legal developments,
changes in social attitudes, inflation and economic conditions. As experience
develops and other data become available, these estimates are revised, as
required, resulting in increases or decreases to the existing liability for
unpaid losses and LAE. Adjustments are reflected in results of operations in the
period in which they are made and the liabilities may deviate substantially from
prior estimates.
8
Among the classes of insurance underwritten by the Company, the
automobile and homeowners liability claims historically tend to have longer time
lapses between the occurrence of the event, the reporting of the claim to the
Company and the final settlement than do automobile physical damage and
homeowners property claims. Liability claims often involve parties filing suit
and therefore may result in litigation. By comparison, property damage claims
tend to be reported in a relatively shorter period of time and settle in a
shorter time frame with less occurrence of litigation.
There can be no assurance that the Company's liability for unpaid
losses and LAE will be adequate to cover actual losses. If the Company's
liability for unpaid losses and LAE proves to be inadequate, the Company will be
required to increase the liability with a corresponding reduction in the
Company's net income in the period in which the deficiency is identified. Future
loss experience substantially in excess of established liability for unpaid
losses and LAE could have a material adverse effect on the Company's business,
results of operations and financial condition.
The following table sets forth a reconciliation of beginning and ending
liability for unpaid losses and LAE as shown in the Company's consolidated
financial statements for the periods indicated.
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(DOLLARS IN THOUSANDS)
Balance at January ........................................... $11,005 $ 9,766 $ 6,314
Less reinsurance recoverables............................... (4,798) (2,790) (1,886)
------- ------- -------
Net balance at January 1................................... $ 6,207 $ 6,976 $ 4,428
======= ======= =======
Incurred related to:
Current year................................................ $15,896 $13,586 $13,545
Prior years................................................. 91 2,569 1,445
------- ------- -------
Total incurred............................................. $15,987 $16,155 $14,990
======= ======= =======
Paid related to:
Current year................................................ $ 8,149 $ 8,769 $ 8,013
Prior years................................................. 4,908 8,258 4,429
------- ------- -------
Total paid................................................. $13,057 $17,027 $12,442
======= ======= =======
Balance, American Vehicle, at acquisition date................ $ -- $ 103 $ --
======= ======= =======
Net balance at end of period.................................. $ 9,136 $ 6,207 $ 6,976
Plus reinsurance recoverables............................... 7,848 4,798 2,790
------- ------- -------
Balance at end of period................................... $16,984 $11,005 $ 9,766
======= ======= =======
As shown above, as a result of the Company's review of its liability
for losses and LAE, which includes a re-evaluation of the adequacy of reserve
levels for prior year's claims, the Company increased its liability for loss and
LAE for claims occurring in prior years by $91,000, $2,569,000 and $1,445,000
for the years ended December 31, 2002, 2001 and 2000, respectively. There can be
no assurance concerning future adjustments of reserves, positive or negative,
for claims through December 31, 2002.
Based upon consultations with the Company's independent actuarial
consultants and their statement of opinion on losses and LAE, the Company
believes that the liability for unpaid losses and LAE is currently adequate to
cover all claims and related expenses which may arise from incidents reported
and IBNR.
The following table presents total unpaid loss and LAE, net, and total
reinsurance recoverables shown in the Company's consolidated financial
statements for the periods indicated.
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(DOLLARS IN THOUSANDS)
Loss and LAE, net............................................. $5,585 $2,736 $4,662
IBNR, net..................................................... 3,551 3,471 2,314
------ ------ ------
Total unpaid loss and LAE, net............................. $9,136 $6,207 $6,976
====== ====== ======
Reinsurance recoverable....................................... $4,382 $1,910 $1,861
IBNR recoverable.............................................. 3,466 2,888 929
------ ------ ------
Total reinsurance recoverable.............................. $7,848 $4,798 $2,790
====== ====== ======
9
The following table presents the liability for unpaid losses and LAE
for the Company for the years ended December 31, 1993 through 2002. The top line
of the table shows the estimated net liabilities for unpaid losses and LAE at
the balance sheet date for each of the periods indicated. These figures
represent the estimated amount of unpaid losses and LAE for claims arising in
all prior years that were unpaid at the balance sheet date, including losses
that had been incurred but not yet reported. The portion of the table labeled
"Cumulative paid as of" shows the net cumulative payments for losses and LAE
made in succeeding years for losses incurred prior to the balance sheet date.
The lower portion of the table shows the re-estimated amount of the previously
recorded liability based on experience as of the end of each succeeding year.
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000 1999 1998 1997 1996 1995 1994 1993
------ ------ ------- ------- ------ ------ ------ ------- ------- ------
(DOLLARS IN THOUSANDS)
Balance Sheet Liability $9,136 $6,207 $ 6,976 $ 4,428 $5,366 $4,635 $4,532 $ 3,688 $ 3,355 $2,507
Cumulative paid as of:
One year later.................... 5,275 8,228 4,289 3,460 2,694 2,850 3,250 2,412 1,916
Two years later................... 9,568 5,799 4,499 3,533 3,539 3,898 3,675 2,377
Three years later................. 6,328 5,111 3,972 3,882 4,164 3,901 2,817
Four years later.................. 5,387 4,241 4,107 4,300 3,997 2,897
Five years later.................. 4,325 4,223 4,404 4,054 2,928
Six years later................... 4,262 4,493 4,119 3,027
Seven years later................. 4,423 4,187 3,027
Eight years later................. 4,083 3,091
Nine years later.................. 2,936
Re-estimated net liability as of:
End of year....................... $9,136 $6,207 $ 6,976 $ 4,428 $5,366 $4,635 $4,532 $ 3,688 $ 3,355 $2,507
One year later.................... 6,954 9,445 5,875 4,676 4,360 4,332 4,728 3,654 2,375
Two years later................... 10,197 6,284 5,160 4,063 4,255 4,867 4,540 2,577
Three years later................. 6,605 5,352 4,317 4,102 4,872 4,613 2,981
Four years later.................. 5,515 4,386 4,304 4,748 4,598 3,003
Five years later.................. 4,395 4,321 4,899 4,516 3,023
Six years later................... 4,321 4,905 4,626 3,085
Seven years later................. 4,792 4,644 3,085
Eight years later................. 4,523 3,127
Nine years later.................. 3,081
Cumulative redundancy (deficiency).. $ -- $ (747) $(3,221) $(2,177) $ (149) $ 240 $ 211 $(1,104) $(1,168) $ (574)
The cumulative redundancy or deficiency represents the aggregate change
in the estimates over all prior years. A deficiency indicates that the latest
estimate of the liability for losses and LAE is higher than the liability that
was originally estimated and a redundancy indicates that such estimate is lower.
It should be emphasized that the table presents a run-off of balance sheet
liability for the periods indicated rather than accident or policy loss
development for those periods. Therefore, each amount in the table includes the
cumulative effects of changes in liability for all prior periods. Conditions and
trends that have affected liabilities in the past may not necessarily occur in
the future.
The table below sets forth the differences between Loss and LAE
reserves as disclosed for GAAP basis compared to SAP basis presentation for the
years ending 2002 and 2001.
YEARS ENDED DECEMBER 31,
2002 2001
---- ----
(DOLLARS IN THOUSANDS)
GAAP basis Loss and LAE reserves $16,984 $11,005
Less unpaid Losses and LAE ceded (7,847) (4,798)
Insurance apportionment plan 285 --
------- -------
SAP basis Loss and LAE reserves $ 9,422 $ 6,207
======= =======
The table below sets forth the differences between Loss and LAE
incurred as disclosed for GAAP basis compared to SAP basis presentation for the
years ending 2002, 2001 and 2000.
10
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(DOLLARS IN THOUSANDS)
GAAP basis Loss and LAE incurred $15,987 $16,155 $14,990
Intercompany adjusting and other expenses 2,484 1,440 1,224
Insurance apportionment plan 700 -- --
Other -- 10 --
------- ------- -------
SAP Basis Loss and LAE incurred $19,171 $17,605 $16,214
======= ======= =======
Underwriting results of insurance companies are frequently measured by
their Combined Ratios. However, investment income, Federal income taxes and
other non-underwriting income or expense are not reflected in the Combined
Ratio. The profitability of property and casualty insurance companies depends on
income from underwriting, investment and service operations. Underwriting
results are considered profitable when the Combined Ratio is under 100% and
unprofitable when the Combined Ratio is over 100%.
The following table sets forth Loss Ratios, Expense Ratios and Combined
Ratios for the periods indicated for the insurance business of Federated
National and American Vehicle for 2002. The amounts for 2001 and 2000 are for
Federated National only. The ratios, inclusive of unallocated loss adjustment
expenses ("ULAE"), are shown in the table below, and are computed based upon
SAP. The expense ratios include management fees paid to the Company in the
amount of $0, $0 and $300,000 in 2002, 2001 and 2000, respectively.
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Loss Ratio........................... 60% 82% 80%
Expense Ratio........................ 25% 25% 31%
-- --- ---
Combined Ratio....................... 85% 107% 111%
== === ===
In order to reduce losses and thereby reduce the Loss Ratio and the
Combined Ratio, both Federated National and American Vehicle raised premium
rates once in 2002, and plan to request further rate increases in 2003. The
improved loss ratio for 2002 as compared to 2001 is attributed the $2.6 million
adverse reserve development experienced in 2001 where only $.09 million was
incurred in 2002. Highlights for the improved ratios include, but are not
limited to the termination of unprofitable agency relations, increased scrutiny
over fraudulently asserted claims, streamlined paperless claims processing
system, new claims management supervision and in house legal counsel, as well as
limiting loss exposures in historically high loss areas.
American Vehicle's first full year of operations produced a Loss Ratio
of 72%, an Expense Ratio of 14% and a Combined Ratio of 86% based on SAP.
Comparing Federated National to American Vehicle's Loss, Expense and Combined
Ratios, it should be noted that 2002 was American Vehicle's first full year of
operations under ownership by the Company. As such, the earnings cycle of
American Vehicle is less mature than Federated National's earning cycle.
Generally, for a company writing policies with a term of 12 months the earnings
cycle would not be considered complete until there have been 24 months of
consecutive level written premiums.
COMPETITION
The Company operates in a highly competitive market and faces
competition from both national and regional insurance companies, many of whom
are larger and have greater financial and other resources than the Company, have
favorable A.M. Best ratings and offer more diversified insurance coverage. The
Company's competitors include other companies which market their products
through agents, as well as companies, which sell insurance directly to their
customers. Large national writers may have certain competitive advantages over
agency writers, including increased name recognition, increased loyalty of their
customer base and reduced policy acquisition costs. The Company may also face
competition from new or temporary entrants in its niche markets. In some cases,
such entrants may, because of inexperience, desire for new business or other
reasons, price their insurance below the pricing structure of the Company.
Although the Company's pricing is inevitably influenced to some degree by that
of its competitors, management of the Company believes that it is generally not
in the Company's best interest to compete solely on price, choosing instead to
compete on the basis of underwriting criteria, its distribution network and
superior service to its agents and insureds. The Company competes with respect
to automobile insurance in Florida with more than 100 companies, which
underwrite personal automobile insurance. Companies of comparable or smaller
size, which compete with the Company in the personal automobile insurance
industry, include U.S. Security Insurance Company, United Automobile Insurance
Company, Direct General Insurance Company and Security National Insurance
Company, as well as major insurers such as Progressive Casualty Insurance
Company. Competition could have a material adverse effect on the Company's
business, results of operations and financial condition.
11
REGULATION
GENERAL
The Company is subject to the laws and regulations in Florida and will
be subject to the laws and regulations of any other states in which it seeks to
conduct business in the future. The regulations cover all aspects of its
business and are generally designed to protect the interests of insurance
policyholders, as opposed to the interests of shareholders. Such regulations
relate to authorized lines of business, capital and surplus requirements,
allowable rates and forms (particularly for the nonstandard auto segment),
investment parameters, underwriting limitations, transactions with affiliates,
dividend limitations, changes in control, market conduct, maximum amount
allowable for premium financing service charges and a variety of other financial
and non-financial components of the Company's business. The failure of the
Company to comply with certain provisions of applicable insurance laws and
regulations could have a material adverse effect on the Company's business,
results of operations or financial condition. In addition, any changes in such
laws and regulations including the adoption of consumer initiatives regarding
rates charged for automobile or other insurance coverage, could materially
adversely affect the operations of the Company's, ability to expand its
operations. The Company, however, is unaware of any consumer initiatives, which
could have a material adverse effect on the Company's business, results of
operations or financial condition.
Many states have also enacted laws which restrict an insurer's
underwriting discretion, such as the ability to terminate policies, terminate
agents or reject insurance coverage applications, and many state regulators have
the power to reduce, or to disallow increases in, premium rates. These laws may
adversely affect the ability of an insurer to earn a profit on its underwriting
operations.
Most states have insurance laws requiring that rate schedules and other
information be filed with the state's insurance regulatory authority, either
directly or through a rating organization with which the insurer is affiliated.
The regulatory authority may disapprove a rate filing if it finds that the rates
are inadequate, excessive or unfairly discriminatory. Rates, which are not
necessarily uniform for all insurers, vary by class of business, hazard covered,
and size of risk. Florida and several other states have recently adopted laws or
are considering proposed legislation which, among other things, limit the
ability of insurance companies to effect rate increases or to cancel, reduce or
non-renew insurance coverage with respect to existing policies, particularly
personal automobile insurance.
Most states require licensure or regulatory approval prior to the
marketing of new insurance products. Typically, licensure review is
comprehensive and includes a review of a company's business plan, solvency,
reinsurance, character of its officers and directors, rates, forms and other
financial and non-financial aspects of a company. The regulatory authorities may
not allow entry into a new market by not granting a license or by withholding
approval.
All insurance companies must file quarterly and annual statements with
certain regulatory agencies and are subject to regular and special examinations
by those agencies. The last regulatory examination of Federated National covered
the three-year period ended on December 31, 1998. No material deficiencies were
found during this regulatory examination. In some instances, various states
routinely require deposits of assets for the protection of policy holders either
in those states or for all policyholders. As of December 31, 2002, Federated
National and American Vehicle hold investment securities with a fair value of
approximately $1,027,000 and $1,066,000, respectively, as deposits with the
State of Florida.
Under Florida law, a domestic insurer may not pay any dividend or
distribute cash or other property to its shareholders except out of that part of
its available and accumulated capital surplus funds which is derived from
realized net operating profits on its business and net realized capital gains. A
Florida domestic insurer may not make dividend payments or distributions to
shareholders without prior approval of the Florida Department of Financial
Services if the dividend or distribution would exceed the larger of (i) the
lesser of (a) 10.0% of its capital surplus or (b) net income, not including
realized capital gains, plus a two-year carryforward, (ii) 10.0% of capital
surplus with dividends payable constrained to unassigned funds minus 25% of
unrealized capital gains or (iii) the lesser of (a) 10.0% of capital surplus or
(b) net investment income plus a three-year carryforward with dividends payable
constrained to unassigned funds minus 25.0% of unrealized capital gains.
Alternatively, a Florida domestic insurer may pay a dividend or distribution
without the prior written approval of the Florida Department of Financial
Services (i) if the dividend is equal to or less than the greater of (a) 10.0%
of the insurer's capital surplus as regards policyholders derived from realized
net operating profits on its business and net realized capital gains or (b) the
insurer's entire net operating profits and realized net capital gains derived
during the immediately preceding calendar year, (ii) the insurer will have
policy holder capital surplus equal to or exceeding 115.0% of the minimum
required statutory capital surplus after the dividend or distribution, (iii) the
insurer files a notice of the dividend or distribution with the Florida
Department of Financial Services at least ten business days prior to the
dividend payment or distribution and (iv) the notice includes a certification by
an officer of the insurer attesting that, after the payment of the dividend or
distribution, the insurer will have at least 115% of required statutory capital
surplus as to policyholders. Except as provided above, a Florida domiciled
insurer may only pay a dividend or make a distribution (i) subject to prior
approval by the Florida Department of Financial Services or (ii) 30 days after
the Florida Department of Financial Services has received notice of such
dividend or distribution and has not disapproved it within such time.
12
Under these laws, Federated National would be permitted to pay
dividends of approximately $142,000 to the Company in 2003, and American Vehicle
would be permitted to pay $9,000 in dividends in 2003. Although the Company
believes that amounts required for it to meet its financial and operating
obligations will be available from sources other than dividends from insurance
subsidiaries, there can be no assurance in this regard. Further, there can be no
assurance that, if requested, the Florida Department of Financial Services will
allow any dividends in excess of the amount available, to be paid by Federated
National to the Company in the future. No dividends were paid by Federated
National or American Vehicle in 2002, 2001 or 2000, and none are anticipated in
2003.The maximum dividends permitted by state law are not necessarily indicative
of an insurer's actual ability to pay dividends or other distributions to a
parent company, which also may be constrained by business and regulatory
considerations, such as the impact of dividends on capital surplus, which could
affect an insurer's competitive position, the amount of premiums that can be
written and the ability to pay future dividends. Further, state insurance laws
and regulations require that the statutory capital surplus of an insurance
company following any dividend or distribution by it be reasonable in relation
to its outstanding liabilities and adequate for its financial needs.
While the non-insurance company subsidiaries are not subject directly
to the dividend and other distribution limitations, insurance holding company
regulations govern the amount that any affiliate within the holding company
system may charge any of the insurance companies for service (e.g., management
fees and commissions).
In order to enhance the regulation of insurer solvency, the NAIC
established risk-based capital requirements for insurance companies that are
designed to assess capital adequacy and to raise the level of protection that
statutory surplus provides for policy holders. These requirements measure three
major areas of risk facing property and casualty insurers: (i) underwriting
risks, which encompass the risk of adverse loss developments and inadequate
pricing; (ii) declines in asset values arising from credit risk; and (iii) other
business risks from investments. Insurers having less statutory surplus than
required will be subject to varying degrees of regulatory action, depending on
the level of capital inadequacy. The requirements establish various levels of
regulatory action. Based upon the 2002 statutory financial statements for
Federated National and American Vehicle, each company's statutory surplus
exceeds all regulatory action levels established by the NAIC. The Florida
Department of Financial Services, which follows these requirements, could
require Federated National or American Vehicle to cease operations in the event
they fail to maintain the required statutory capital.
The extent of regulatory intervention and action increases as the ratio
of an insurer's statutory surplus to its Authorized Control Level ("ACL"), as
calculated under the NAIC's requirements, decreases. The first action level, the
Company Action Level, requires an insurer to submit a plan of corrective actions
to the insurance regulators if statutory surplus falls below 200.0% of the ACL
amount. The second action level, the Regulatory Action Level, requires an
insurer to submit a plan containing corrective actions and permits the insurance
regulators to perform an examination or other analysis and issue a corrective
order if statutory surplus falls below 150.0% of the ACL amount. The Authorized
Control Level, the third action level, allows the regulators to rehabilitate or
liquidate an insurer in addition to the aforementioned actions if statutory
surplus falls below the ACL amount. The fourth action level is the Mandatory
Control Level, which requires the regulators to rehabilitate or liquidate the
insurer if statutory surplus falls below 70.0% of the ACL amount. Federated
National's ratio of statutory surplus to its ACL was 274.2%, 300.8% and 273.2%
at December 31, 2002, 2001 and 2000, respectively. American Vehicle's ratio of
statutory surplus to its ACL was 412.4% and 3,234.6% at December 31, 2002 and
2001, respectively. Regulatory action is triggered if surplus falls below 200.0%
of the ACL amount.
The NAIC has also developed Insurance Regulatory Information Systems
("IRIS") ratios to assist state insurance Department of Financial Services in
identifying companies, which may be developing performance or solvency problems,
as signaled by significant changes in the companies' operations. Such changes
may not necessarily result from any problems with an insurance company, but may
merely indicate changes in certain ratios outside the ranges defined as normal
by the NAIC. When an insurance company has four or more ratios falling outside
"usual ranges," state regulators may investigate to determine the reasons for
the variance and whether corrective action is warranted. As of December 31,
2002, Federated National was outside NAIC's usual ranges with respect to its
IRIS tests on 7 out of 12 ratios. Federated National was not in the "usual
ranges" primarily because of the loss stemming from its other than temporary
write down of the WorldCom bonds and because of the short fall in Federated
National's loss and LAE reserves in 2000 and 1999. IRIS ratios in excess of
"usual ranges" relative to surplus growth stemmed from the Company's infusion of
$2.1 million into Federated National. Federated National has carefully reviewed
its loss and LAE reserves and management believes that such reserves at December
31, 2002 are adequate. American Vehicle was outside NAIC's usual ranges on six
ratios primarily because American Vehicle was in operation for the entire year
2002 as compared to 2001 when it resumed business in November. Prior to 2001
American Vehicle had not written insurance policies since 1997 and was under
capitalized. Management does not currently believe that the Florida Department
of Financial Services will take any significant action with respect to Federated
National or American Vehicle regarding the IRIS ratios, although there can be no
assurance that will be the case.
13
Effective January 1, 2001, the Company's insurance subsidiaries adopted
the Codification of Statutory Accounting Principles guidance issued by the NAIC,
which provides guidance for areas where statutory accounting has been silent and
changes current accounting in some areas. The adoption of this codification did
not have a material effect on the Company's consolidated financial statements.
INSURANCE HOLDING COMPANY REGULATION
The Company is subject to laws governing insurance holding companies in
Florida where Federated National and American Vehicle are domiciled. These laws,
among other things, (i) require the Company to file periodic information with
the Florida Department of Financial Services, including information concerning
its capital structure, ownership, financial condition and general business
operations, (ii) regulate certain transactions between the Company and its
affiliates, including the amount of dividends and other distributions and the
terms of surplus notes and (iii) restrict the ability of any one person to
acquire certain levels of the Company's voting securities without prior
regulatory approval. Any purchaser of 5% or more of the outstanding shares of
Common Stock of the Company will be presumed to have acquired control of
Federated National and American Vehicle unless the Florida Insurance
Commissioner, upon application, determines otherwise.
FINANCE COMPANY REGULATION
The Company's premium financing program is also subject to certain laws
governing the operation of premium finance companies. These laws pertain to such
matters as books and records that must be kept, forms, licensing, fees and
charges. For example, in Florida, the maximum late payment fee Federated Premium
may charge is the greater of $10 per month or 5% of the amount of the overdue
payment.
FRANCHISE COMPANY REGULATION
FedUSA and EXPRESSTAX are subject to Federal Trade Commission ("FTC")
regulation, and state and international laws, which regulate the offer and sale
of franchises. FedUSA and EXPRESSTAX are also subject to a number of state laws,
which regulate substantive aspects of the franchisor-franchisee relationship.
The FTC's Trade Regulation Rule on Franchising (the "FTC Rule") require FedUSA
and EXPRESSTAX to furnish to prospective franchisees a franchise offering
circular containing information prescribed by the FTC Rule.
State laws that regulate the offer and sale of franchises and the
franchisor-franchisee relationship presently exist in a substantial number of
states. Such laws often require registration of the franchise offering with
state authorities and regulate the franchise relationship by, for example,
requiring the franchisor to deal with its franchisees in good faith, prohibiting
interference with the right of free association among franchisees, limiting the
imposition of standards of performance on a franchisee and regulating
discrimination among franchisees in charges, royalties or fees.
UNDERWRITING AND MARKETING RESTRICTIONS
During the past several years, various regulatory and legislative
bodies have adopted or proposed new laws or regulations to address the cyclical
nature of the insurance industry, catastrophic events and insurance capacity and
pricing. These regulations include (i) the creation of "market assistance plans"
under which insurers are induced to provide certain coverages, (ii) restrictions
on the ability of insurers to rescind or otherwise cancel certain policies in
mid-term, (iii) advance notice requirements or limitations imposed for certain
policy non-renewals and (iv) limitations upon or decreases in rates permitted to
be charged.
LEGISLATION
From time to time, new regulations and legislation are proposed to
limit damage awards, to control plaintiffs' counsel fees, to bring the industry
under regulation by the Federal government, to control premiums, policy
terminations and other policy terms and to impose new taxes and assessments. It
is not possible to predict whether, in what form or in what jurisdictions, any
of these proposals might be adopted, or the effect, if any, on the Company.
INDUSTRY RATINGS SERVICES
Federated National received a B rating and American Vehicle received a
B+ rating from A.M. Best during 2002. A.M. Best's ratings are based upon factors
of concern to agents, reinsurers and policyholders and are not primarily
directed toward the protection of investors. Federated National and American
Vehicle are both rated "A" (Exceptional) by Demotech, Inc.
14
EMPLOYEES
As of December 31, 2002, the Company and its subsidiaries had 233
employees, including four executive officers. The Company is not a party to any
collective bargaining agreement and has not experienced work stoppages or
strikes as a result of labor disputes. The Company considers relations with its
employees to be satisfactory.
EXECUTIVE OFFICERS
Set forth below is certain information concerning an executive officer
of the Company who is not also a director of the Company:
James Gordon Jennings, III was appointed Chief Financial Officer of the
Company in August 2002. Mr. Jennings became the Company's Controller in May 2000
and for approximately ten years prior thereto was employed by American Vehicle,
where he was formally involved with all aspects of property and casualty
insurance since then. Mr. Jennings', formerly a certified public accountant,
also holds a Certificate in General Insurance and an Associate in Insurance
Services as designated by the Insurance Institute of America.
James A. Epstein was appointed Secretary in January 2002. Mr. Epstein
joined the Company as General Counsel in September 2002.
GLOSSARY OF SELECTED TERMS
CEDE To transfer to an insurer or reinsurer all
or part of the insurance written by an
insurance entity.
CEDING COMMISSION A payment by a reinsurer to the ceding
company, generally on a proportional basis,
to compensate the ceding company for its
policy acquisition costs.
COMBINED RATIO The total of the Loss Ratio plus the Expense
Ratio on either SAP or GAAP basis.
EXPENSE RATIO Under SAP, the ratio of underwriting
expenses to net written premiums. Using GAAP
basis, the ratio of underwriting expenses to
net premiums earned.
GENERALLY ACCEPTED ACCOUNTING Accounting practices and principles, as
PRINCIPLES ("GAAP") defined principally by the American
Institute of Certified Public Accountants,
the Financial Accounting Standards Board.
GAAP is the method of accounting typically
used by the Company for reporting to persons
or entities other than insurance regulatory
authorities.
GROSS PREMIUMS WRITTEN The total of premiums received or to be
received for insurance written by an insurer
during a specific period of time without any
reduction for reinsurance ceded.
HARD MARKET The portion of the market cycle of the
property and casualty insurance industry
characterized by constricted industry
capital and underwriting capacity,
increasing premium rates and, typically,
enhanced underwriting performance.
INCURRED BUT NOT REPORTED LOSSES The estimated liability of an insurer, at a
("IBNR") given point in time, with respect to losses
that have been incurred but not yet reported
to the insurer, and for potential future
developments on reported claims.
INSURANCE REGULATORY INFORMATION A system of ratio analysis developed by the
SYSTEM ("IRIS") NAIC primarily intended to assist state
insurance Department of Financial Services
in executing their statutory mandates to
oversee the financial condition of insurance
companies.
LOSS ADJUSTMENT EXPENSE ("LAE") The expense of investigating and settling
claims, including legal fees, outside
adjustment expenses and other general
expenses of administering the claims
adjustment process.
LOSS RATIO Under both SAP and GAAP, net losses and LAE
incurred, divided by net premiums earned,
expressed as a percentage.
15
LOSS RESERVES The estimated liability of an insurer, at a
given point in time, with respect to unpaid
incurred losses, including losses, which are
IBNR and related LAE.
LOSSES INCURRED The total of all policy losses sustained by
an insurance company during a period,
whether paid or unpaid. Incurred losses
include a provision for claims that have
occurred but have not yet been reported to
the insurer.
NATIONAL ASSOCIATION OF INSURANCE A voluntary organization of state insurance
COMMISSIONERS ("NAIC") officials that promulgates model laws
regulating the insurance industry, values
securities owned by insurers, develops and
modifies insurer financial reporting,
statements and insurer performance criteria
and performs other services with respect to
the insurance industry.
NET PREMIUMS EARNED The amount of net premiums written allocable
to the expired period of an insurance policy
or policies.
NET PREMIUMS WRITTEN The gross premiums written during a specific
period of time, less the portion of such
premiums ceded to (reinsured by) other
insurers.
NONSTANDARD Risks that generally have been found
unacceptable by standard lines insurers for
various underwriting reasons.
REINSURANCE A procedure whereby a primary insurer
transfers (or "cedes") a portion of its risk
to a reinsurer in consideration of a payment
of premiums by the primary insurer to the
reinsurer for their assumption of such
portion of the risk. Reinsurance can be
affected by a treaty or individual risk
basis. Reinsurance does not legally
discharge the primary insurer from its
liabilities with respect to its obligations
to the insured.
REINSURERS Insurers (known as the reinsurer or assuming
company) who agree to indemnify another
insurer (known as the reinsured or ceding
company) against all or part of a loss that
the latter may incur under a policy or
policies it has issued.
RISK-BASED CAPITAL REQUIREMENTS Capital requirements for property and
("RBC") casualty insurance companies adopted by the
NAIC to assess minimum capital requirements
and to raise the level of protection that
statutory surplus provides for policy holder
obligations.
SOFT MARKET The portion of the market cycle of the
property and casualty insurance industry
characterized by heightened premium rate
competition among insurers, increased
underwriting capacity and, typically,
depressed underwriting performance.
STANDARD AUTOMOBILE INSURANCE Personal automobile insurance written for
those individuals presenting an average risk
profile in terms of loss history, driving
record, type of vehicle driven and other
factors.
STATUTORY ACCOUNTING PRACTICES Those accounting principles and practices
("SAP") which provide the framework for the
preparation of financial statements, and the
recording of transactions, in accordance
with the rules and procedures adopted by
regulatory authorities, generally
emphasizing solvency consideration rather
than a going concern concept of accounting.
The principal differences between SAP and
GAAP are as follows: (a) SAP, certain assets
(non-admitted assets) are eliminated from
the balance sheet; (b) under SAP, policy
acquisition costs are expensed upon policy
inception, while under GAAP they are
deferred and amortized over the term of the
policies; and (c) under SAP, certain
reserves are recognized which are not
recognized under GAAP.
16
UNDERWRITING The process whereby an underwriter reviews
applications submitted for insurance
coverage and determines whether it will
provide all or part of the coverage being
requested, and the price of such premiums.
Underwriting also includes an ongoing review
of existing policies and their pricing.
UNDERWRITING EXPENSE The aggregate of policy acquisition costs,
including that portion of general and
administrative expenses attributable to
underwriting operations.
UNEARNED PREMIUMS The portion of premiums written representing
unexpired policy terms as of a certain date.
ITEM 2. PROPERTIES
- ------- ----------
Federated National owns the Company's current headquarters in
Plantation, Florida, a two-story building with approximately 13,960 square feet
of office space. Federated National also owns and partially occupies a
three-story building with approximately 39,250 square feet of office space in
Lauderdale Lakes, Florida. Approximately 75.5% of the Lauderdale Lakes building
is leased to third parties and the remainder is occupied by Federated National
or is vacant.
The Company's agencies are primarily located in leased locations
pursuant to leases expiring at various times through February 2016. The
aggregate annual rental for the facilities is approximately $371,000. Two
locations are owned by the Company.
The Company believes that these facilities are adequate for its current
needs.
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations, or liquidity.
In June 2000, a lawsuit was filed against the Company and its directors
and executive officers seeking compensatory damages on the basis of allegations
that the Company's amended registration statement dated November 4, 1998 was
inaccurate and misleading concerning the manner in which the Company recognized
ceded insurance commission income, in violation of Sections 11 and 15 of the
Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934. The lawsuit was filed in the United States District Court for the
Southern District of New York and seeks class action status. The plaintiff class
purportedly includes purchasers of the Company's common stock between November
5, 1998 and August 13, 1999. The Company believes that the lawsuit is without
merit and is vigorously defending such action. The Court recently denied the
Company's Motion to Dismiss the plaintiff's First Amended Complaint and the
Company filed an Answer and Affirmative Defenses.
Prior to its acquisition by the Company in 2001, American Vehicle was
involved in litigation with a former officer and director. The litigation was
adjudicated and American Vehicle, among others, was found liable and paid the
final judgment. A petition was filed seeking costs of $136,000 and appellate
attorneys fees in excess of $2.0 million for fees American Vehicle's previous
owners have agreed to indemnify the Company against any such fees and costs and,
the $500,000 purchase price for American Vehicle is held in escrow pending
settlement of the fees and costs issued. On February 26, 2003, the 11th Judicial
Circuit in Miami, Florida entered an amended final judgment awarding the
plaintiffs $1,140,387 in attorney fees and costs. Both parties are appealing
this judgment. Management anticipates that there will be no costs associated
with the settlement of this case, consequently, no liability for fees and costs
have been accrued.
The Company, as a direct premium writer in the State of Florida, is
required to participate in certain insurer solvency pools under Florida Statutes
631.57(3)(a). Participation in these pools is based on the Company's written
premium by line of business to total premiums written statewide by all insurers.
Participation may result in assessments against the Company. The Company was
assessed $258,000 and $203,000, for the years ended December 31, 2002 and 2001,
respectively. During 2002 the Company recovered $180,000 of the 2001 assessment
and is entitled to recover all of these assessments as permitted by the state of
Florida through policy surcharges in 2003. For the years ended December 31, 2000
and 1999, no amounts were assessed against the Company.
Federated National and American Vehicle are also required to
participate in an insurance apportionment plan under Florida Statutes 627.351
referred to as a Joint Underwriting Association Plan ("JUA Plan"). The "JUA
Plan" shall provide for the equitable apportionment of any profits realized, or
losses and expenses incurred, among participating insurers. In the event of an
underwriting deficit incurred by the "JUA Plan" and the deficit is not recovered
17
through the policyholders in the "JUA Plan", such deficit shall be recovered
from the companies participating in the "Plan" in the proportion that the net
direct premiums of each such member written during the preceding calendar year
bear to the aggregate net direct premiums written in this state by all members
of the joint underwriting "JUA Plan".
No assessments by have been incurred by either insurance company
through the date of issuance of this report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
None
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
- ------- -------------------------------------------------
STOCKHOLDER MATTERS
-------------------
(a) MARKET INFORMATION
The Company's common stock has been listed for trading on the Nasdaq
National Market under the symbol "TCHC" since November 5, 1998. For the calendar
quarters indicated, the table below sets forth the high and low closing prices
per share of the common stock based on published financial resources.
QUARTER ENDED HIGH LOW
------------- ---- ---
March 31, 2002 $ 4.89 $3.04
June 30, 2002 $12.20 $4.55
September 30, 2002 $ 7.45 $4.29
December 31, 2002 $13.61 $6.68
March 31, 2001 $ 3.38 $1.91
June 30, 2001 $ 3.10 $2.03
September 30, 2001 $ 2.65 $0.98
December 31, 2001 $ 3.15 $1.50
(b) HOLDERS
As of March 28, 2003, there were approximately 37 holders of record of
the Company's common stock. The Company believes that the number of beneficial
owners of its Common Stock is in excess of 850.
(c) DIVIDENDS
The Company paid a quarterly dividend of $0.02 per share on its common
stock from the fourth quarter of 2000, until the third quarter of 2002. The
Company declared a $0.05 per share dividend in the third quarter of 2002 and a
$0.06 per share dividend in the fourth quarter of 2002. The Company expects to
continue to pay a quarterly dividend in the future. However, payment of
dividends in the future will depend on the Company's earnings and financial
position and such other factors, as the Company's Board of Directors deems
relevant. Moreover, the ability of the Company to continue to pay dividends may
be restricted by regulatory limits on the amount of dividends that Federated
National and American Vehicle are permitted to pay to the Company.
(d) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The section under the heading "Executive Compensation" entitled "Equity
Compensation Plan Information for Fiscal 2003" in the Company's proxy statement
for the 2003 annual meeting of shareholders is incorporated herein by reference.
For additional information concerning the Company's capitalization
please see Note 16, "Stock Compensation Plans" of the Notes to the Consolidated
Financial Statements included in Item 8.
18
ITEM 6. SELECTED FINANCIAL DATA
- ------- -----------------------
As of or for the year ended December 31,
---------------------------------------
OPERATIONS DATA: 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Revenue:
Gross premiums written ........................ $ 63,036,468 $ 34,271,338 $ 32,073,768 $ 19,273,561 $ 21,195,144
Gross premiums ceded .......................... (25,286,828) (12,789,404) (7,625,095) (6,221,853) (6,628,270)
------------ ------------ ------------ ------------ ------------
Net premiums written ...................... 37,749,640 21,481,934 24,448,673 13,051,708 14,566,874
Decrease (increase) in unearned premiums,
net of prepaid reinsurance premiums ......... (8,356,636) (1,226,373) (4,127,334) 404,640 (604,143)
------------ ------------ ------------ ------------ ------------
Net premiums earned ....................... 29,393,004 20,255,561 20,321,339 13,456,348 13,962,731
Commission income ............................. 1,905,936 2,828,779 2,780,869 4,410,856 2,036,637
Finance revenue ............................... 4,452,626 5,267,523 5,709,848 3,696,843 1,825,268
Managing general agent fees ................... 1,970,226 5,871,388 5,410,500 963,797 971,794
Net investment income ......................... 1,253,765 1,066,641 1,225,413 853,659 983,592
Net realized investment gains (losses) ........ (1,369,961) (2,911,658) (109,256) 952,153 441,810
Other income .................................. 2,973,950 3,098,332 2,214,894 1,043,798 446,635
------------ ------------ ------------ ------------ ------------
Total revenue ............................. 40,579,545 35,476,566 37,553,607 25,377,454 20,668,467
------------ ------------ ------------ ------------ ------------
Expenses:
Losses and loss adjustment expenses ........... 15,987,125 16,154,902 14,990,118 8,094,677 9,133,332
Operating and underwriting expenses ........... 10,778,990 11,644,183 11,892,577 7,032,428 4,291,613
Salaries and wages ............................ 8,004,694 8,478,771 9,375,775 7,474,572 4,042,226
Amortization of deferred acquisition costs, net (2,064,314) 1,467,238 1,673,754 (18,563) 179,057
Amortization of goodwill ...................... -- 540,010 606,653 547,548 239,619
------------ ------------ ------------ ------------ ------------
Total expenses ............................ 32,706,495 38,285,104 38,538,877 23,130,662 17,885,847
------------ ------------ ------------ ------------ ------------
Income (loss) before provision for income
tax expense and extraordinary gain ............ 7,873,050 (2,808,538) (985,270) 2,246,792 2,782,620
(Provision) benefit for income tax expense ....... (3,302,849) 630,553 462,396 (680,061) (965,000)
------------ ------------ ------------ ------------ ------------
Net income (loss) and extraordinary gain .. 4,570,201 (2,177,985) (522,874) 1,566,731 1,817,620
Extraordinary gain ............................... -- 1,185,895 -- -- --
------------ ------------ ------------ ------------ ------------
Net income (loss) ......................... $ 4,570,201 $ (992,090) $ (522,874) $ 1,566,731 $ 1,817,620
============ ============ ============ ============ ============
Basic net income (loss) per share
before extraordinary gain ..................... $ 1.52 $ (0.69) $ (0.15) $ 0.46 $ 0.79
============ ============ ============ ============ ============
Extraordinary gain ............................... -- 0.38 -- -- --
============ ============ ============ ============ ============
Basic net income (loss) per share ................ $ 1.52 $ (0.31) $ (0.15) $ 0.46 $ 0.79
============ ============ ============ ============ ============
Cash dividends declared per share ................ $ 0.15 $ 0.08 $ 0.02 -- --
============ ============ ============ ============ ============
BALANCE SHEET DATA:
Total assets ..................................... $ 75,318,011 $ 56,228,577 $ 55,412,969 $ 38,686,404 $ 38,176,403
Investments ................................... 25,377,796 17,507,422 18,965,798 13,916,571 17,705,266
Finance contracts, consumer loans and
pay advances receivable, net ................ 7,217,873 10,813,881 13,792,791 9,642,163 7,093,593
Total liabilities ................................ 57,220,348 42,019,446 40,456,972 22,932,516 23,208,580
Unpaid losses and loss adjustment expenses .... 16,983,756 11,005,337 9,765,848 6,314,307 7,603,460
Unearned premiums ............................. 28,934,486 14,951,228 13,038,417 8,037,083 8,534,320
Revolving credit outstanding .................. 4,312,420 6,676,817 8,091,034 4,650,026 2,062,948
Total shareholders' equity ....................... $ 18,097,664 $ 14,209,131 $ 14,955,997 $ 15,753,888 $ 14,967,823
Book value per share ............................. $ 6.02 $ 4.69 $ 4.49 $ 4.67 $ 4.47
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
- ------- -----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
OVERVIEW
The Company is a vertically integrated insurance holding company,
which, through its subsidiaries, controls substantially all aspects of the
insurance underwriting, distribution and claims process. The Company underwrites
personal automobile insurance and homeowners and mobile home property and
casualty insurance in the State of Florida through its subsidiaries, Federated
National and American Vehicle. The Company internally processes claims made by
its own and third party insureds through a wholly-owned claims adjusting
company, Superior. The Company also offers premium financing to its own and
third-party insureds through its wholly-owned subsidiary, Federated Premium.
The Company markets and distributes its own and third-party insurers'
products and its other services primarily in South Florida, through a network of
23 agencies owned by Federated Agency Group, a wholly-owned subsidiary, 34
franchised agencies and approximately 125 independent agents. The Company,
through its wholly-owned subsidiary, FedUSA, franchises agencies under the
FedUSA name. The Company intends to focus its future expansion efforts for its
agency network on franchised agencies.
The Company offers income tax preparation software and service through
Express Tax, its 80% owned subsidiary, as well as franchise opportunities for
these services through EXPRESSTAX, a wholly-owned subsidiary of Express Tax. As
of December 31, 2002, there were 136 EXPRESSTAX franchises granted.
The Company's business, results of operations and financial condition
are subject to fluctuations due to a variety of factors. Abnormally high
severity or frequency of claims in any period could have a material adverse
effect on the Company's business, results of operations and financial condition.
Also, if the Company's estimated liabilities for unpaid losses and LAE are less
than actual losses and LAE, the Company will be required to increase reserves
with a corresponding reduction in the Company's net income in the period in
which the deficiency is identified.
The Company operates in a highly competitive market and faces
competition from both national and regional insurance companies, many of whom
are larger and have greater financial and other resources than the Company, have
favorable A.M. Best ratings and offer more diversified insurance coverage. The
Company's competitors include other companies that market their products through
agents, as well as companies that sell insurance directly to their customers.
Large national writers may have certain competitive advantages over agency
writers, including increased name recognition, increased loyalty of their
customer base and reduced policy acquisition costs. The Company may also face
competition from new or temporary entrants in its niche markets. In some cases,
such entrants may, because of inexperience, desire for new business or other
reasons, price their insurance below the pricing structure of the Company.
Although the Company's pricing is inevitably influenced to some degree by that
of its competitors, management of the Company believes that it is generally not
in the Company's best interest to compete solely on price, choosing instead to
compete on the basis of underwriting criteria, its distribution network and
superior service to its agents and insureds. The Company competes with respect
to automobile insurance in Florida with more than 100 companies, which
underwrite personal automobile insurance. Companies of comparable or smaller
size, which compete with the Company in the personal automobile insurance
industry, include U.S. Security Insurance Company, United Automobile Insurance
Company, Direct General Insurance Company and Security National, as well as
major insurers such as Progressive Casualty Insurance Company. Competition could
have a material adverse effect on the Company's business, results of operations
and financial condition.
CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are more fully described in Note 2 of
Notes to Consolidated Financial Statements. As disclosed therein, the
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions about future events that affect the amounts
reported in the financial statements and accompanying notes. Future events and
their effects cannot be determined with absolute certainty. Therefore, the
determination of estimates requires the exercise of judgment. Actual results
inevitably will differ from those estimates, and such differences may be
material to the financial statements.
The most significant accounting estimates inherent in the preparation
of the Company's financial statements include estimates associated with
management's evaluation of the determination of liability for unpaid losses and
loss adjustment expense and the recoverability of goodwill. In addition,
significant estimates form the bases for the Company's reserves with respect to
finance contracts, premiums receivable and deferred income taxes. Various
assumptions and other factors underlie the determination of these significant
estimates. The process of determining significant estimates is fact specific and
takes into account factors such as historical experience, current and expected
economic conditions, and in the case of unpaid losses and loss adjustment
expense, an actuarial valuation. Management constantly reevaluates these
significant factors and makes adjustments where facts and circumstances dictate.
See Note 2 of Notes to Consolidated Financial Statements.
20
ACCOUNTING CHANGES. In June 2000, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standard No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities -- an amendment of
Financial Accounting Standards Board Statement No. 133," which because of the
Company's early adoption of Statement of Financial Accounting Standard No. 133,
was effective for all fiscal quarters beginning after June 15, 2000. This
statement amends the accounting and reporting standards of Statement of
Financial Accounting Standard No. 133 for certain derivative instruments and
certain hedging activities. Because the Company has limited involvement with
derivative financial instruments and does not engage in the derivative market
for hedging purposes, the adoption of Statement of Financial Accounting Standard
No. 138 did not have a material effect on the Company's financial statements.
Effective January 1, 2000, the Company adopted Statement of Position
98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts
That Do Not Transfer Insurance Risk." The Statement of Position provides
guidance on accounting for insurance and reinsurance contracts that do not
transfer insurance risk. All of the Company's reinsurance agreements are
risk-transferring arrangements, accounted for according to Statement of
Financial Accounting Standard No. 113, "Accounting and Reporting for Reinsurance
of Short-Duration and Long-Duration Contracts." The adoption of Statement of
Position 98-7 had no effect on the Company's financial statements.
Effective July 1, 2000, the Company adopted Financial Accounting
Standards Board Interpretation No. 44, "Accounting for Certain Transactions
Including Stock Compensation (an Interpretation of Accounting Principles Board
Opinion No. 25)." Financial Accounting Standards Board Interpretation No. 44
clarifies the application of Accounting Principles Board Opinion No. 25 for only
certain issues, such as: (a) the definition of employee for purposes of applying
Accounting Principles Board Opinion No. 25; (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan; (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award; and (d) the accounting for an exchange of stock compensation
awards in a business combination. The adoption of Financial Accounting Standards
Board Interpretation No. 44 did not have a material effect on the Company's
financial statements.
Effective December 31, 2000, the Company adopted Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements." The Staff
Accounting Bulletin summarizes the SEC staff's views on applying accounting
principles generally accepted in the United States to the recognition of revenue
in financial statements. The adoption of Staff Accounting Bulletin No. 101 had
no effect on the Company's financial statements.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 141, "Business Combinations," which became
effective January 1, 2002. Statement of Financial Accounting Standard No. 141
requires all business combinations initiated after September 30, 2001 to be
accounted for using the purchase method. Additionally, Statement of Financial
Accounting Standard No. 141 requires an acquired intangible asset, whenever
acquired, to be recognized separately from goodwill if the benefit of the
intangible asset is obtained through contractual or other legal rights or if the
intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets,"
which became effective January 1, 2002. Statement of Financial Accounting
Standard No. 142 eliminates the amortization of goodwill over its estimated
useful life, but requires goodwill to be subject to at least an annual
assessment for impairment by applying a fair-value-based test. Upon adoption of
Financial Accounting Standards No.142 January 1, 2002, the Company ceased
amortization of goodwill. See footnote (t) GOODWILL for additional information.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 143, "Accounting for Asset Retirement
Obligations," which became effective for fiscal years beginning after June 15,
2002. Statement of Financial Accounting Standard No. 143 addresses financial
accounting and reporting for obligations associated with the retirement of
tangible, long-lived assets and the associated asset retirement costs. Adoption
of this statement has had no material effect on the Company's financial
statements.
In October 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which became effective for fiscal
years beginning after December 15, 2001, and interim periods within those fiscal
years. Statement of Financial Accounting Standard No. 144 revises and clarifies
the existing professional guidance addressing: (a) recognition and measurement
of the impairment of long-lived assets to be held and used; (b) the measurement
of long-lived assets to be disposed of by sale; and (c) the reporting of
discontinued operations and components of an entity that either has been
disposed of (by sale, by abandonment, or in a distribution to owners) or is
classified as held for sale. The adoption of Statement of Financial Accounting
Standard No. 144 had no effect on the Company's financial statements.
21
In April 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 145, "Rescission of Financial
Accounting Standards Board Statements No. 4, 44 and 64, Amendment of Financial
Accounting Standards Board Statement No. 13, and Technical Corrections," which
became effective for fiscal years beginning after May 15, 2002. The rescission
of Statement of Financial Accounting Standard No. 4, "Reporting Gains and Losses
from Extinguishment of Debt," and Statement of Financial Accounting Standard No.
64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements," which
had amended Statement of Financial Accounting Standard No. 4, will affect income
statement classification of gains and losses from extinguishment of debt.
Statement of Financial Accounting Standard No. 4 required material gains and
losses from extinguishment of debt to be classified as extraordinary items.
Under Statement of Financial Accounting Standard No. 145, extinguishment of debt
is now considered a risk management strategy by the reporting enterprise, and
the Financial Accounting Standards Board does not believe it should be
considered extraordinary under the criteria in Accounting Principles Board
Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," unless the debt extinguishment meets the
unusual-in-nature and infrequency-of-occurrence criteria in Accounting
Principles Board Opinion No. 30. The Company has not yet determined the impact
that the adoption of this statement will have on the financial statements.
In July 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No.146, "Accounting for Costs Associated with
Exit or Disposal Activities." Statement of Financial Accounting Standard No. 146
supersedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." Statement of Financial
Accounting Standard No. 146 requires that, in certain instances, costs
associated with an exit or disposal plan be recognized when incurred rather than
at the date of a commitment to an exit or disposal plan. Statement of Financial
Accounting Standard No. 146 is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The Company has not yet determined
the impact that the adoption of this statement will have on the financial
statements.
In October 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 147, "Acquisitions of Certain
Financial Institutions," which clarifies the accounting treatment for
acquisitions of financial institutions. In addition, this Statement amends
Statement of Financial Accounting Standard No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets and credit cardholder
intangible assets. Statement of Financial Accounting Standard No. 147 is
effective on October 1, 2002. The adoption of Statement of Financial Accounting
Standard No. 147 will have no effect on the Company's financial statements.
In December 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amended Statement of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation." The new
standard provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
Additionally, the statement amends the disclosure requirements of
Statement of Financial Accounting Standard No. 123 to require prominent
disclosures in the annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. This statement is effective for financial statements
for fiscal years ending after December 15, 2002. In compliance with Statement of
Financial Accounting Standard No. 148, the Company has elected to continue to
follow the intrinsic value method in accounting for stock-based employee
compensation arrangement as defined by Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," and have made the applicable
disclosures in the "Stock-Based Compensation" section, see Note 16.
ANALYSIS OF FINANCIAL CONDITION
AS OF DECEMBER 31, 2002 AS COMPARED TO DECEMBER 31, 2001
INVESTMENTS. Investments increased $7.9 million to $25.4 million as of
December 31, 2002 from $17.5 million as December 31, 2001 primarily as a result
an increase in written insurance premiums.
FINANCE CONTRACTS. Finance contracts receivable decreased $3.6 million
from $10.8 million as of December 31, 2001 to $7.2 million as of December 31,
2002 primarily because, beginning in the third quarter 2001, the Company now
only finances contracts from Company owned agencies and Company franchised
agencies and no longer finances contracts originated by third party agencies.
During 2002 continued emphasis was placed on direct bill premium financing.
PREPAID REINSURANCE PREMIUMS. Prepaid reinsurance premiums increased
$5.7 million to $11.3 million as of December 31, 2002 from $5.6 million as of
December 31, 2001 primarily due the acquisition of American Vehicle in November
2001.
22
REINSURANCE RECOVERABLE - NET. Reinsurance recoverable increased $0.8
million to $7.9 million as of December 31, 2002 from $7.1 million as of December
31, 2001. This increase is the result of the addition of American Vehicle offset
in part by the timing of settling monthly quota share treaties for the
respective insurance companies.
PREMIUMS RECEIVABLE. Premiums receivable were $8.4 million as of
December 31, 2002, an increase of $6.8 million as compared to $1.6 million
outstanding as of December 31, 2001. This increase is the result of added
emphasis placed on direct bill premium financing by both Federated National and
American Vehicle.
DEFERRED ACQUISITION COSTS - NET. Deferred acquisition costs decreased
from $12,000 as of December 31, 2001 to $8,000 as of December 31, 2002. Included
in the December 31, 2001 balance were deferred commissions of $1.7 million
offset by unearned ceded commissions of $1.7 million. As of December 31, 2002,
deferred commissions were $3.0 million offset by unearned ceded commissions of
$3.0 million. The increase in unearned ceded commissions is related to the
increase in reinsurance recoverable discussed above.
DEFERRED INCOME TAXES. The deferred income tax asset increased $0.4
million to $2.7 million as of December 31, 2002 from $2.3 million as of December
31, 2001, primarily due to the increase of discounted unearned premiums from
American Vehicle and the other than temporary write down of the Company's
position held with WorldCom, Inc.
GOODWILL. Goodwill remained unchanged during 2002 due to the adoption
of SFAS 142 where-in the Company's assessment of goodwill indicated no
impairment.
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES. Unpaid loss and loss
adjustment expenses increased $6.0 million, from $11.0 million at December 31,
2001 to $17.0 million as of December 31, 2002. This increase is primarily due to
the addition of American Vehicle's loss reserves which represent a full year's
experience for 2002.
UNEARNED PREMIUM. Unearned premium increased $14.0 million from $15.0
million as of December 31, 2001 to $29.0 million as of December 31, 2002. The
balance of unearned premium is determined by the amount and timing of when
policies are written. The increase in 2002 is primarily attributable to the
addition of American Vehicle's operations.
REVOLVING CREDIT OUTSTANDING. Revolving credit outstanding decreased
$2.4 million to $4.3 million as of December 31, 2002 from $6.7 million as of
December 31, 2001. This decrease is related to the decrease in finance contracts
due the Company's continued emphasis on direct bill insurance premiums in 2002.
UNEARNED COMMISSIONS. Unearned commissions declined in 2002 from $1.2
million to $19,000 due to the completion of Assurance MGA's underwriting an
insurance program as a third party administrator.
PREMIUM DEPOSITS. Premium deposits were $0.7 million as of December 31,
2002 as compared $1.1 million as of December 31, 2001. This change is caused
primarily by the timing of disbursements for cancelled policies and the timing
of receipt of premium dollars as compared to the receipt of the policy from the
agents.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
GROSS PREMIUMS WRITTEN. Gross premiums written increased $28.8 million,
or 84%, to $63.0 million for the year ended December 31, 2002 as compared to
$34.2 million in 2001. The increase is due to the addition of American Vehicle's
operations composing $19.9 million of the increase and $8.9 in increased written
premiums by Federated National, which were the result of increased premium
volume due to additional capacity created by increased surplus.
GROSS PREMIUMS CEDED. Gross premiums ceded increased from $12.8 million
for the year ended December 31, 2001, to $25.3 million for the year ended
December 31, 2002. The increase of $12.5 million is primarily due to the
addition of American Vehicle and its 70% quota-share reinsurance treaty.
DECREASE (INCREASE) IN UNEARNED PREMIUMS, NET OF PREPAID REINSURANCE
PREMIUMS. The increase in unearned premiums, net of prepaid reinsurance
premiums, was $7.1 million for the year ended December 31, 2002. The increase is
primarily due to the addition of a full year of operations for American Vehicle
as compared to two months of operations in 2001.
MANAGING GENERAL AGENT FEES. Managing General Agent Fees declined $3.9
million to $2.0 million for the year ended 2002. The decline is a result of
Assurance MGA's completion of underwriting insurance for an unaffiliated
insurance company.
23
NET REALIZED INVESTMENT GAINS (LOSSES). The Company experienced net
losses of $1.4 million for the year ended December 31, 2002 as compared to $2.9
million for the same period in 2001. Once thought to be only a function of the
equity market, segments of the highly rated bond market proved to be unsound in
2002. During 2002, the Company incurred an "other than temporary" decline in
value of $2.0 million in its investment in WorldCom, Inc. bonds.
LOSSES AND LAE. The Company's loss ratio, combining the results of both
insurance companies, as determined in accordance with GAAP, for the year ended
December 31, 2002 was 54.4% compared with 79.8% for 2001. Losses and LAE
incurred decreased $168,000 to $16.0 million for 2002 from $16.2 million for
2001. Losses and LAE, the Company's most significant expense, represent actual
payments made and changes in estimated future payments to be made to or on
behalf of its policyholders, including expenses required to settle claims and
losses.
DEFERRED POLICY ACQUISITION COSTS. The Company's deferred policy
acquisition costs declined by $3.1 million to a credit balance of $2.1 million
as compared to a charge against income of $1.0 million in 2001. The increase is
associated with the shift in business underwritten by Assurance MGA away from an
unaffiliated insurance company to American Vehicle.
EXTRAORDINARY GAIN. In August 2001, the Company recorded an
extraordinary gain of $1.2 million which represents the excess of the fair value
of the net assets purchased over the purchase price, when the Company acquired
American Vehicle.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
GROSS PREMIUMS WRITTEN. Gross premiums written increased $2.2 million,
or 6.9%, to $34.3 million for the year ended December 31, 2001 as compared to
$32.1 million in 2000. The increase is primarily due to an increase in
homeowners premiums written, which increased to $7.7 million in 2001 from $4.6
million in 2000.
GROSS PREMIUMS CEDED. Gross premiums ceded increased from $7.6 million
for the year ended December 31, 2000, to $12.8 million for the year ended
December 31, 2001. In 2000, the Company had 30% automobile quota-share
reinsurance as compared to 50% automobile quota-share reinsurance in 2001.
DECREASE (INCREASE) IN UNEARNED PREMIUMS, NET OF PREPAID REINSURANCE
PREMIUMS. The decrease in unearned premiums, net of prepaid reinsurance
premiums, was $1.2 million for the year ended December 31, 2001 compared to $4.1
million for the year ended December 31, 2000. This decrease is due primarily to
the change in quota-share reinsurance discussed above.
NET REALIZED INVESTMENT GAINS (LOSSES). The Company experienced net
losses of $2.9 million for the year ended December 31, 2001 compared to $109,000
for the same period in 2000. Realized gains or losses are primarily a function
of the equity markets. In August 2001, the Company divested itself of its
investments in common stock and does not intend to invest in common stock in the
future.
OTHER INCOME. Other income increased $883,000 to $3.1 million for the
year ended December 31, 2001 from $2.2 million for 2000. This increase is
primarily attributable to an increase in adjusting fees due to the addition in
2000 of two nonaffiliated insurance companies as claims adjusting customers.
LOSSES AND LAE. The Company's loss ratio, as determined in accordance
with GAAP, for the year ended December 31, 2001 was 79.8% compared with 73.8%
for 2000. Losses and LAE incurred increased $1.2 million to $16.2 million for
2001 from $15.0 million for 2000. Losses and LAE, the Company's most significant
expense, represent actual payments made and changes in estimated future payments
to be made to or on behalf of its policyholders, including expenses required to
settle claims and losses. In 2001, the Company experienced a significant
increase in lawsuits relating to automobile claims. Management believes this
increase in lawsuits was in anticipation of the effective date of recent
legislation passed by the Florida legislature. This legislation, which became
effective October 1, 2001, includes the establishment of a pre-suit notice
requirement for no fault claims, fee schedules for certain medical procedures,
the licensing of health care clinics, and toughened criminal sanctions for
fraud.
EXTRAORDINARY GAIN. In August 2001, the Company recorded an
extraordinary gain of $1.2 million which represents the excess of the fair value
of the net assets purchased over the purchase price, when the Company acquired
American Vehicle.
24
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital are revenues generated from
operations, investment income and borrowings under a revolving agreement
discussed below. Because the Company is a holding company, it is largely
dependent upon management fees and /or dividends from its subsidiaries for cash
flow.
Federated Premium's operations are funded by a revolving loan agreement
("Revolving Agreement") with FlatIron Funding Company LLC ("FlatIron"). The
Revolving Agreement is structured as a sale of contracts receivable under a sale
and assignment agreement with FPF, Inc. (a wholly-owned subsidiary of FlatIron),
which gives FPF Inc. the right to sell or assign these contracts receivable.
Federated Premium, which services these contracts, has recorded transactions
under the Revolving Agreement as secured borrowings. The Revolving Agreement,
which was amended and revised in October 2001, allowed for a maximum credit
commitment of $7.0 million plus an initial additional amount of $700,000 for the
transition from September 30, 2001 when the previous agreement expired. The line
declined by $100,000 each month beginning November 1, 2001. In September 2002
the line was amended and revised allowing for a maximum credit commitment of
$4.0 million. The decline in the required credit commitment is due primarily to
Federated National and American Vehicle's newly developed direct bill program.
Direct billing is where the insurance company accepts from the insured, as a
receivable, a promise to pay the premium, as opposed to requiring the full
amount of the policy, either directly from the insured or from a premium finance
company. The amount of FPF's advance is subject to availability under a
borrowing base calculation, with maximum advances outstanding not to exceed the
maximum credit commitment. The annual interest rate on advances under the
Revolving Agreement is the prime rate plus additional interest varying from
1.25% to 3.25% based on the prior month's ratio of contracts receivable related
to insurance companies with an A. M. Best rating of B or worse to total
contracts receivable. The Revolving Agreement contains various operating and
financial covenants, with which the Company was in compliance at December 31,
2002 and 2001. The Revolving Agreement, as amended, expires September 30, 2004.
Outstanding borrowings under the Revolving Agreement as of December 31, 2002 and
2001 were approximately $4.3 million and $6.7 million, respectively. Outstanding
borrowings in excess of the $4.0 million commitment totaled $312,420 and are
permissible by reason of a compensating cash balance of $352,433 held for the
benefit of FPF, Inc. Interest expense on this revolving credit line for the
years ended December 31, 2002, 2001 and 2000 totaled approximately $342,000,
$592,000 and $643,000, respectively.
For the year ended December 31, 2002, operations generated a cash flow
of $15.0 million as compared to a cash flow deficit of $946,000 in 2001. The
Company's investment portfolio, which is highly liquid as it consists almost
entirely of readily marketable securities, is available to offset any cash flow
deficits. The cash flow deficit from investing activities from 2002 was $6.9
million and used to enhance its portfolio. In 2001 the Company used $2.5 million
to offset deficits in operating and financing cash flows. Cash flow used by
financing activities was $5.7 million in 2002, as the Company reduced its
revolving credit outstanding and purchased shares of its common stock in the
open market. Future financing activities may use cash, if the Company believes
its stock is undervalued and decides to continue to purchase shares in the open
market. The Board of Directors has authorized the purchase in the open market of
approximately $1.0 million of additional shares. During 2002, the Company
acquired 43,400 shares for a total cost of $253,446. The Company believes that
its current capital resources, together with cash flow from its operations and
investing activities will be sufficient to meet its anticipated working capital
requirements for the foreseeable future. There can be no assurances, however,
that such will be the case.
To retain its certificate of authority, the Florida insurance laws and
regulations require that Federated National and American Vehicle maintain
capital surplus equal to the greater of 10% of its liabilities or the 2002
statutory minimum capital and surplus requirement of $3.25 million as defined in
the Florida Insurance Code. The Companies are in compliance with this
requirement. The Companies are also required to adhere to prescribed net
premium-to-capital surplus ratios and for the year ended December 31, 2002, the
Companies were in compliance with these ratios.
The maximum amount of dividends that can be paid by Florida insurance
companies without prior approval of the Florida Commissioner, is subject to
restrictions relating to statutory surplus. The maximum dividend that may be
paid in 2002, by the insurance companies without prior approval is limited to
the lesser of statutory net income from operations of the preceding calendar
year or 10% of statutory unassigned capital surplus as of the preceding December
31. No dividends were paid by Federated National or American Vehicle during
2002, 2001 or 2000.
The Company is required to comply with the NAIC's risk-based capital
requirements. The NAIC's risk-based capital requirements are a method of
measuring the amount of capital appropriate for an insurance company to support
its overall business operations in light of its size and risk profile. NAIC's
risk-based capital standards are used by regulators to determine appropriate
regulatory actions relating to insurers who show signs of weak or deteriorating
condition. As of December 31, 2002, based on calculations using the appropriate
NAIC formula, the Company's total adjusted capital is in excess of ratios that
would require any form of regulatory action. GAAP differs in some respects from
reporting practices prescribed or permitted by the Florida Department of
Financial Services. Federated National's statutory capital surplus was
approximately $9.2 million as of December 31, 2002 and $5.7 million as of
25
December 31, 2001. Statutory net income was $2.2 million, $2.1 million, and $1.4
million for the years ended December 31, 2002, 2001 and 2000, respectively.
American Vehicle had statutory capital surplus of $4.0 million for the year
ended December 31, 2002 and approximately $3.1 million as of December 31, 2001
and had statutory net income of $135,000 and $64,000 in 2002 and 2001,
respectively.
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. The primary assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a more significant impact on the
Company's 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 cost of paying losses and LAE.
Insurance premiums are established before the Company knows the amount
of loss and LAE and the extent to which inflation may affect such expenses.
Consequently, the Company attempts to anticipate the future impact of inflation
when establishing rate levels. While the Company attempts to charge adequate
rates, the Company may be limited in raising its premium levels for competitive
and regulatory reasons. Inflation also affects the market value of the Company's
investment portfolio and the investment rate of return. Any future economic
changes which result in prolonged and increasing levels of inflation could cause
increases in the dollar amount of incurred loss and LAE and thereby materially
adversely affect future liability requirements.
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Year ended December 31, 2002
------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ------------ ------------ ------------
Revenue:
Net premiums earned ........................... $ 5,434,494 $ 6,485,963 $ 8,464,577 $ 9,007,970
Other revenue ................................. 4,072,506 2,130,890 3,358,590 1,630,789
------------ ------------ ------------ ------------
Total revenue .............................. 9,507,000 8,616,853 11,823,167 10,638,759
Expenses:
Losses and loss adjustment expenses ........... 3,184,631 3,330,196 4,228,536 5,243,762
Other expenses ................................ 4,778,133 4,363,266 4,801,183 2,783,022
------------ ------------ ------------ ------------
Total expenses ............................. 7,962,764 7,693,462 9,029,719 8,026,784
Income (loss) before provision for income tax
expense and extraordinary gain ............... 1,544,236 923,391 2,793,448 2,611,975
(Provision) benefit for income tax expense ...... (552,866) (891,350) (1,046,718) (811,915)
------------ ------------ ------------ ------------
Net income (loss) before extraordinary gain 991,370 32,041 1,746,730 1,800,060
Extraordinary gain .............................. -- -- -- --
------------ ------------ ------------ ------------
Net income (loss) .......................... $ 991,370 $ 32,041 $ 1,746,730 $ 1,800,060
============ ============ ============ ============
Basic net income (loss) per share ............... $ 0.33 $ 0.01 $ 0.58 $ 0.60
============ ============ ============ ============
Year ended December 31, 2001
------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ------------ ------------ ------------
Revenue:
Net premiums earned ........................... $ 4,683,724 $ 5,191,369 $ 5,273,233 $ 5,107,235
Other revenue ................................. 4,864,426 2,971,661 3,400,731 3,984,187
------------ ------------ ------------ ------------
Total revenue .............................. 9,548,150 8,163,030 8,673,964 9,091,422
------------ ------------ ------------ ------------
Expenses:
Losses and loss adjustment expenses ........... 3,331,245 5,257,370 3,620,297 3,945,990
Other expenses ................................ 5,450,816 5,328,624 6,376,311 4,974,451
------------ ------------ ------------ ------------
Total expenses ............................. 8,782,061 10,585,994 9,996,608 8,920,441
------------ ------------ ------------ ------------
Income (loss) before provision for income tax
expense and extraordinary gain ............... 766,089 (2,422,964) (1,322,644) 170,981
(Provision) benefit for income tax expense ...... (267,343) 933,293 (12,133) (23,264)
------------ ------------ ------------ ------------
Net income (loss) before extraordinary gain 498,746 (1,489,671) (1,334,777) 147,717
Extraordinary gain .............................. -- -- 1,185,895 --
------------ ------------ ------------ ------------
Net income (loss) .......................... $ 498,746 $ (1,489,671) $ (148,882) $ 147,717
============ ============ ============ ============
Basic net income (loss) per share before
extraordinary gain ........................... $ 0.15 $ (0.47) $ (0.43) $ 0.05
Extraordinary gain per share .................... -- -- 0.38 --
============ ============ ============ ============
Basic net income (loss) per share ............... $ 0.15 $ (0.47) $ (0.05) $ 0.05
============ ============ ============ ============
26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- -------- ---------------------------------------------------------
The Company's investment objective is to maximize total rate of return
after Federal income taxes while maintaining liquidity and minimizing risk. The
Company's current investment policy limits investment in non-investment grade
fixed maturity securities (including high-yield bonds), and limits total
investments in preferred stock, common stock and mortgage notes receivable. The
Company also complies with applicable laws and regulations, which further
restrict the type, quality and concentration of investments. In general, these
laws and regulations permit investments, within specified limits and subject to
certain qualifications, in Federal, state and municipal obligations, corporate
bonds, preferred and common equity securities and real estate mortgages.
The Company's investment policy is established by its Board of
Directors or Investment Committee and is reviewed on a regular basis. Pursuant
to this investment policy, as of December 31, 2002, approximately 97.3% of the
Company's investments were in fixed income securities and short-term
investments, which are considered to be available for sale, based upon the
Company's intent at the time of purchase. Fixed maturities are considered
available for sale and are marked to market. The Company may in the future also
consider fixed maturities to be held to maturity and carried at amortized cost.
The Company does not use any material swaps, options, futures or forward
contracts to hedge or enhance its investment portfolio.
The Company's investment portfolio is managed by the Company's
Investment Committee consisting of the Company's President and two directors, in
accordance with guidelines established by the Florida Department of Financial
Services.
The table below sets forth investment results for the periods
indicated.
YEARS ENDED DECEMBER 31,
2002 2001 2000
------- ------- -------
(DOLLARS IN THOUSANDS)
Interest on fixed maturities ............ $ 1,190 $ 485 $ 552
Dividends on equity securities .......... 18 13 44
Interest on short-term investments ...... 59 559 647
Other ................................... 17 39 10
------- ------- -------
Total investment income ................. 1,284 1,096 1,253
Investment expense ...................... (30) (29) (28)
------- ------- -------
Net investment income ................... $ 1,254 $ 1,067 $ 1,225
======= ======= =======
Net realized gain (loss) ................ ($1,370) $(2,912) $ (109)
======= ======= =======
The following table summarizes, by type, the investments of the Company
as of December 31, 2002.
CARRYING PERCENT
AMOUNT OF TOTAL
------ --------
(DOLLARS IN THOUSANDS)
Fixed maturities, at market:
U.S. government agencies and authorities ..... $ 105 .41%
Obligations of states and
political subdivisions ..................... 8,587 33.83%
Corporate securities ......................... 16,001 63.03%
------- ------
Total fixed maturities ..................... 24,693 97.27%
Equity securities, at market ................. 547 2.15%
Mortgage notes receivable .................... 145 .58%
------- ------
Total investments ........................... $25,385 100.0%
======= ======
Fixed maturities are carried on the Company's balance sheet at market.
At December 31, 2002, fixed maturities had the following quality ratings (by
Moody's Investors Service, Inc. ("Moody's") and for securities not assigned a
rating by Moody's, by Standard and Poor's Corporation):
CARRYING PERCENT OF
AMOUNT TOTAL
------ -----
(DOLLARS IN THOUSANDS)
AAA................... $3,048 12.3%
AA.................... 4,219 17.1%
A..................... 2,558 10.4%
BBB................... 12,304 49.8%
BB++.................. 2,564 10.4%
Not rated............. -- --
------- -----
$24,693 100.0%
======= =====
27
The following table summarizes, by maturity, the fixed maturities of
the Company as of December 31, 2002.
CARRYING PERCENT OF
AMOUNT TOTAL
------ -----
(DOLLARS IN THOUSANDS)
Matures In:
One year or less..................................... $1,358 6.0%
One year to five years............................... 13,213 54.0%
Five years to 10 years............................... 7,590 30.0%
More than 10 years................................... 2,532 10.0%
------- -----
Total fixed maturities........................... $24,693 100.0%
======= =====
At December 31, 2002, the weighted average maturity of the fixed
maturities portfolio was approximately 4.5 years.
The following table provides information about the Company's financial
instruments as of December 31, 2002 that are sensitive to changes in interest
rates. The table presents principal cash flows and the related weighted average
interest rate by expected maturity date:
Carrying
2003 2004 2005 2006 2007 Thereafter Total Amount
------- ------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Principal amount by expected maturity:
U.S. government agencies and authorities $ -- $ 100 $ -- $ -- $ -- $ -- $ 100 $ 105
Obligations of states and political subdivisions 100 -- 425 -- -- 7,320 7,845 8,587
Corporate securities 2,250 5,720 4,507 3,700 500 1,584 18,261 16,001
Collateralized mortgage obligations -- -- -- -- -- -- -- --
Equity securities, at market -- -- -- -- -- -- -- 547
Mortgage notes receivable 7 7 8 9 9 104 144 144
------- ------- ------- ------- ------- ------- ------- -------
Total investments $ 2,357 $ 5,827 $ 4,940 $ 3,709 $ 509 $ 9,008 $26,350 $25,384
======= ======= ======= ======= ======= ======= ======= =======
Weighted average interest rate by expected maturity:
U.S. government agencies and authorities --% 5.88% --% --% -- --% 5.88%
Obligations of states and political subdivisions 4.60 -- 5.00 -- -- 5.36 5.33
Corporate securities 5.72 6.36 6.49 6.66 5.88 6.54 5.84
Collateralized mortgage obligations -- -- -- -- -- -- --
Equity securities, at market -- -- -- -- -- 5.49 5.49
Mortgage notes receivable 8.50 8.50 8.50 8.50 8.50 8.50 8.50
------- ------- ------- ------- ------- ------- -------
Total investments 5.68% 6.36% 6.37% 6.66% 5.93% 5.60% 5.57%
======= ======= ======= ======= ======= ======= =======
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ------- -------------------------------------------
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Reports.................................................................................29
Consolidated Balance Sheets
as of December 31, 2002 and 2001............................................................................31
Consolidated Statements of Operations
For the years ended December 31, 2002, 2001 and 2000........................................................32
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income (Loss)
For the years ended December 31, 2002, 2001 and 2000........................................................33
Consolidated Statements of Cash Flows
For the years ended December 31, 2002, 2001 and 2000........................................................34
Notes to Consolidated Financial Statements....................................................................35
28
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
21st Century Holding Company:
We have audited the accompanying consolidated balance sheet of 21st Century
Holding Company and Subsidiaries ("the Company" and a Florida Corporation) as of
December 31, 2002, and the related consolidated statement of operations, changes
in shareholders' equity and comprehensive income (loss) and cash flow for the
year then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of 21st Century Holding
Company and Subsidiaries as of December 31, 2002, and the result of their
operations and their cash flow for the year then ended in conformity with
accounting principles generally accepted in the United States of America.
De Meo, Young, McGrath
Boca Raton, Florida,
March 30, 2003.
29
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
21st Century Holding Company:
We have audited the accompanying consolidated balance sheet of 21st Century
Holding Company and Subsidiaries ("the Company" and a Florida corporation) as of
December 31, 2001, and the related consolidated statements of operations,
changes in shareholders' equity and comprehensive income and cash flows for the
years ended December 31, 2001 and 2000. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of 21st Century Holding
Company and Subsidiaries as of December 31, 2001, and the results of their
operations and their cash flows for the years ended December 31, 2001 and 2000,
in conformity with accounting principles generally accepted in the United States
of America.
McKEAN, PAUL, CHRYCY, FLETCHER & CO.
Plantation, Florida,
March 29, 2002.
30
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
2002 2001
---- ----
ASSETS
Investments
Fixed maturities, available for sale, at fair value ......................... $ 24,693,047 $ 16,713,321
Equity securities ........................................................... 539,706 192,500
Mortgage loans .............................................................. 145,043 601,601
------------ ------------
Total investments ....................................................... 25,377,796 17,507,422
------------ ------------
Cash and cash equivalents ..................................................... 4,478,383 2,150,665
Finance contracts, consumer loans and pay advances receivable, net of allowance
for credit losses of $404,356 in 2002 and $723,756 in 2001 .................. 7,217,873 10,813,881
Prepaid reinsurance premiums .................................................. 11,251,193 5,559,909
Premiums receivable, net of allowance for credit losses of $201,000 and
$235,000, respectively ...................................................... 8,373,104 1,560,914
Reinsurance recoverable, net .................................................. 7,856,972 7,053,329
Deferred acquisition costs, net ............................................... 7,721 11,952
Income taxes recoverable ...................................................... -- 441,550
Deferred income taxes ......................................................... 2,691,309 2,252,176
Property, plant and equipment, net ............................................ 4,819,617 5,086,884
Goodwill, net ................................................................. 1,789,353 1,789,353
Other assets .................................................................. 1,454,690 2,000,542
------------ ------------
Total assets ............................................................ $ 75,318,011 $ 56,228,577
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses .................................... $ 16,983,756 $ 11,005,337
Unearned premiums ............................................................. 28,934,486 14,951,228
Premium deposits .............................................................. 655,713 1,133,977
Revolving credit outstanding .................................................. 4,312,420 6,676,817
Bank overdraft ................................................................ 844,947 3,522,512
Unearned commissions .......................................................... 18,721 1,197,202
Income taxes payable .......................................................... 1,676,020 --
Accounts payable and accrued expenses ......................................... 3,746,030 2,931,621
Drafts payable to insurance companies ......................................... 48,254 600,752
------------ ------------
Total liabilities ....................................................... 57,220,347 42,019,446
------------ ------------
Commitments and contingencies
Shareholders' equity:
Common stock of $0.01 par value. Authorized 25,000,000 shares; issued
3,411,667 and 3,410,667 shares respectively;
Outstanding 2,990,201 and 3,030,001 shares, respectively ................. 34,117 34,107
Additional paid-in capital .................................................. 12,855,543 12,833,146
Accumulated other comprehensive deficit ..................................... (227,091) (218,137)
Retained earnings ........................................................... 6,521,027 2,400,301
Treasury stock, 421,466 and 380,666 shares, respectively, at cost ........... (1,085,932) (840,286)
------------ ------------
Total shareholders' equity .............................................. 18,097,664 14,209,131
------------ ------------
Total liabilities and shareholders' equity .............................. $ 75,318,011 $ 56,228,577
============ ============
See accompanying notes to consolidated financial statements.
31
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- -----
Revenue:
Gross premiums written .................................. $ 63,036,468 $ 34,271,338 $ 32,073,768
Gross premiums ceded .................................... (25,286,828) (12,789,404) (7,625,095)
------------ ------------ ------------
Net premiums written ........................... 37,749,640 21,481,934 24,448,673
Decrease (increase) in unearned premiums, net
of prepaid reinsurance premiums ...................... (8,356,636) (1,226,373) (4,127,334)
------------ ------------ ------------
Net premiums earned ............................ 29,393,004 20,255,561 20,321,339
Commission income ....................................... 1,905,936 2,828,779 2,780,869
Finance revenue ......................................... 4,452,626 5,267,523 5,709,848
Managing general agent fees ............................. 1,970,226 5,871,388 5,410,500
Net investment income ................................... 1,253,765 1,066,641 1,225,413
Net realized investment gains (losses) .................. (1,369,961) (2,911,658) (109,256)
Other income ............................................ 2,973,949 3,098,332 2,214,894
------------ ------------ ------------
Total revenue .................................. 40,579,545 35,476,566 37,553,607
------------ ------------ ------------
Expenses:
Losses and loss adjustment expenses ..................... 15,987,125 16,154,902 14,990,118
Operating and underwriting expenses ..................... 10,778,990 11,644,183 11,892,577
Salaries and wages ...................................... 8,004,694 8,478,771 9,375,775
Amortization of deferred acquisition costs, net ......... (2,064,314) 1,467,238 1,673,754
Amortization of goodwill ................................ -- 540,010 606,653
------------ ------------ ------------
Total expenses ................................. 32,706,495 38,285,104 38,538,877
------------ ------------ ------------
Income (loss) before provision for income tax expense
and extraordinary gain .................................. 7,873,050 (2,808,538) (985,270)
(Provision) benefit for income tax expense ................ (3,302,849) 630,553 462,396
------------ ------------ ------------
Net income (loss) before extraordinary gain .... 4,570,201 (2,177,985) (522,874)
Extraordinary gain ........................................ -- 1,185,895 --
------------ ------------ ------------
Net income (loss) .............................. $ 4,570,201 $ (992,090) $ (522,874)
============ ============ ============
Basic net income (loss) per share before extraordinary gain $ 1.52 $ (0.69) $ (0.15)
============ ============ ============
Extraordinary gain ........................................ -- 0.38 --
============ ============ ============
Basic net income (loss) per share ......................... $ 1.52 $ (0.31) $ (0.15)
============ ============ ============
See accompanying notes to consolidated financial statements.
32
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Accumulated
Additional Other Total
Comprehensive Common Paid-In Comprehensive Retained Treasury Shareholders'
DESCRIPTION Income Stock Capital Deficit Earnings Stock Equity
- ----------- ------ ----- ------- ------- -------- ----- ------
Balance as of December 31, 1999 ... 33,700 12,690,087 (1,244,830) 4,297,994 (23,063) 15,753,888
Net loss .......................... $ (522,874) -- -- (522,874) -- (522,874)
Cash dividends ................... -- -- -- -- (133,054) -- (133,054)
Acquisition of common shares ..... -- (291,339) (291,339)
Stock issued ...................... -- 407 204,543 -- -- -- 204,950
Net unrealized change in investments,
net of tax effect of $33,530 ... (55,574) -- -- (55,574) -- -- (55,574)
------------
Comprehensive loss ................. $ (578,448)
============
--------- ------------ ------------ ------------ ------------ ------------
Balance as of December 31, 2000 .... 34,107 12,894,630 (1,300,404) 3,642,066 (314,402) 14,955,997
Net loss .......................... $ (992,090) -- -- -- (992,090) -- (992,090)
Cash dividends .................... -- -- -- -- (249,675) -- (249,675)
Acquisition of common shares ...... -- -- -- -- -- (784,798) (784,798)
Stock issued to employees ........ -- -- (78,814) -- -- 258,914 180,100
Stock option expense .............. -- -- 17,330 -- -- -- 17,330
Net unrealized change in investments,
net of tax effect of $784,079 1,082,267 -- -- 1,082,267 -- -- 1,082,267
------------
Comprehensive income .............. $ 90,177
============
--------- ------------ ------------ ------------ ------------ ------------
Balance as of December 31, 2001 .... $ 34,107 $ 12,833,146 $ (218,137) $ 2,400,301 $ (840,286) $ 14,209,131
Net Income ......................... $ 4,570,201 -- -- -- 4,570,201 -- 4,570,201
Cash dividends ................... -- -- -- -- (449,475) -- (449,475)
Acquisition of common shares ..... -- -- -- -- -- (253,446) (253,446)
Stock issued to employees ........ -- 10 990 -- -- 7,800 8,800
Stock option expense ............. -- -- 21,407 -- -- -- 21,407
Net unrealized change in investments,
net of tax effect of $4,613 .. (8,954) -- -- (8,954) -- -- (8,954)
------------
Comprehensive income ............. $ 4,561,247
============
--------- ------------ ------------ ------------ ------------ ------------
Balance as of December 31, 2002 .... $ 34,117 $ 12,855,543 $ (227,091) $ 6,521,027 $ (1,085,932) $ 18,097,664
========= ============ ============ ============ ============ ============
See accompanying notes to consolidated financial statements.
33
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- ----
Cash flow from operating activities:
Net income (loss) ........................................................... $ 4,570,201 $ (992,090) $ (522,874)
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Amortization (accretion) of investment premium (discount), net ........... 84,360 (50,738) (10,592)
Depreciation and amortization of property plant and equipment ............ 376,516 396,047 323,743
Amortization of goodwill ................................................. -- 540,010 606,653
Deferred income tax expense .............................................. (1,107,092) (132,284) (1,096,850)
Net realized investment (gains) losses ................................... 1,369,961 2,911,658 109,256
Amortization of deferred acquisition costs, net .......................... (2,064,314) 1,467,238 1,673,754
Provision for credit losses, net ......................................... 1,036,092 2,506,757 1,994,274
Provision for uncollectible premiums receivable .......................... 33,663 421,349 432,052
Extraordinary Gain ....................................................... -- (1,185,895) --
Other .................................................................... 30,207 30,528 --
Changes in operating assets and liabilities:
Premiums receivable .................................................. (6,845,853) (1,735,476) 577,646
Prepaid reinsurance premiums ......................................... (5,691,284) (2,635,827) (319,475)
Reinsurance recoverable, net ......................................... (803,643) (3,911,090) (1,471,390)
Deferred acquisition costs, net ...................................... 2,068,545 (286,930) (2,876,257)
Other assets ......................................................... 992,645 (550,666) (447,261)
Unpaid losses and loss adjustment expenses ........................... 5,978,419 1,136,120 3,451,541
Unearned premiums .................................................... 13,983,258 1,912,811 5,001,334
Premium deposits ..................................................... (478,264) 751,919 24,872
Unearned commissions ................................................. (2,080,087) (406,882) 1,702,933
Income taxes payable ................................................. 1,907,042 -- (350,384)
Accounts payable and accrued expenses ................................ 2,157,566 (945,983) 2,545,770
Drafts payable to insurance companies ................................ (552,498) (186,123) 474,224
------------ ------------ ------------
Net cash (used in) provided by operating activities ............................. 14,965,440 (945,547) 11,822,969
------------ ------------ ------------
Cash flow from investing activities:
Proceeds from sale of investment securities available for sale .............. 41,293,545 62,419,076 49,110,449
Purchases of investment securities available for sale ....................... (51,088,365) (59,713,976) (54,081,724)
Finance contracts receivable, consumer loans and pay
advances receivable ....................................................... 2,559,916 472,153 (6,144,902)
Mortgage loans .............................................................. (10,000) (450,000) (272,773)
Sale of and collection of mortgage loans .................................... 461,314 233,423 7,053
Purchases of property and equipment ......................................... (308,936) (153,387) (3,191,018)
Net cash used in acquisitions ............................................... 199,687 (301,330) --
------------ ------------ ------------
Net cash provided by (used in) investing activities ............................. (6,892,839) 2,505,959 (14,572,915)
------------ ------------ ------------
Cash flow from financing activities:
Bank overdraft .............................................................. (2,677,565) 309,550 1,684,226
Dividends paid .............................................................. (449,475) (188,807) (67,260)
Purchases of treasury stock ................................................. (253,446) (743,314) (291,339)
Repayment of indebtedness ................................................... -- -- (312,823)
Revolving credit outstanding ................................................ (2,364,397) (1,414,217) 3,441,008
------------ ------------ ------------
Net cash (used in) provided by financing activities ............................. (5,744,883) (2,036,788) 4,453,812
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents ............................ 2,327,718 (476,376) 1,703,866
Cash and cash equivalents at beginning of year .................................. 2,150,665 2,627,041 923,175
------------ ------------ ------------
Cash and cash equivalents at end of year ........................................ $ 4,478,383 $ 2,150,665 $ 2,627,041
============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid (received) during the year for:
Interest .................................................................... $ 354,572 $ 591,618 $ 662,809
============ ============ ============
Income taxes ............................................................. $ 1,565,069 $ (915,037) $ 1,529,690
============ ============ ============
Non-cash investing and financing activities:
Accrued dividend payable .................................................... $ 179,947 $ 60,868 $ 65,794
============ ============ ============
Stock issued to employees ................................................... $ 7,800 $ 180,100 $ 100,000
============ ============ ============
Stock received for sale of agency ........................................... $ -- $ 41,484 $ --
============ ============ ============
Notes receivable, net of deferred gains, received for sales of agencies ..... $ (35,523) $ 463,941 $ --
============ ============ ============
Shares issued for settlement of note payable ................................ $ -- $ -- $ 104,950
============ ============ ============
See accompanying notes to consolidated financial statements.
34
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(1) ORGANIZATION AND BUSINESS
The accompanying consolidated financial statements include the accounts
of 21st Century Holding Company and its subsidiaries (collectively referred to
as the "Company"). All significant intercompany balances and transactions have
been eliminated in consolidation.
The Company is a vertically integrated insurance holding company,
which, through its subsidiaries, controls substantially all aspects of the
insurance underwriting, distribution and claims process. The Company underwrites
personal automobile insurance, homeowners insurance and mobile home property and
casualty insurance in the State of Florida through its wholly-owned
subsidiaries, Federated National Insurance Company ("Federated National") and
American Vehicle Insurance Company ("American Vehicle"). The Company has
underwriting authority for third-party insurance companies, which it represents
through a wholly owned managing general agent, Assurance Managing General
Agents, Inc. ("Assurance MGA"). The Company internally processes claims made by
its own and third party insureds through a wholly-owned claims adjusting
company, Superior Adjusting, Inc. ("Superior"). The Company also offers premium
financing to its own and third-party insureds through its wholly-owned
subsidiary, Federated Premium Finance, Inc. ("Federated Premium").
The Company markets and distributes its own and third-party insurers'
products and its other services primarily in South Florida, through a network of
23 agencies, owned by Federated Agency Group, Inc. ("Federated Agency Group"), a
wholly-owned subsidiary, 34 franchised agencies and approximately 125
independent agents. The Company, through its wholly-owned subsidiary, FedUSA,
Inc. ("FedUSA"), franchises agencies under the FedUSA name. As of December 31,
2002, franchises were granted for 40 Fed USA agencies, of which 34 were
operating. The Company intends to focus its future expansion efforts for its
agency network on franchised agencies.
The Company offers income tax preparation software and service through
its Express Tax Service, Inc. ("Express Tax"), an 80% owned subsidiary, as well
as franchise opportunities for these services through EXPRESSTAX Franchise
Corporation ("EXPRESSTAX"), a wholly-owned subsidiary of Express Tax. As of
December 31, 2002 there were 136 EXPRESSTAX franchises granted.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) CASH AND CASH EQUIVALENTS
The Company considers all short-term highly liquid investments with
original maturities of three months or less to be cash equivalents.
(B) INVESTMENTS
All of the Company's investment securities have been classified as
available-for-sale because all of the Company's securities are available to be
sold in response to the Company's liquidity needs, changes in market interest
rates and asset-liability management strategies, among other reasons.
Investments available-for-sale are stated at fair value on the balance sheet.
Unrealized gains and losses are excluded from earnings and are reported as a
component of other comprehensive income within shareholders' equity, net of
related deferred income taxes.
A decline in the fair value of an available-for-sale security below
cost that is deemed other than temporary results in a charge to income,
resulting in the establishment of a new cost basis for the security. For the
year ended December 31, 2002, the unrealized losses for declines in fair market
value deemed to be other than temporary were $2.0 million and are reported as a
component of net realized investment gains (losses) on the consolidated
statements of operations. For the years ended December 31, 2001 and 2000, there
were no unrealized losses deemed to be other than temporary.
Premiums and discounts are amortized or accreted, respectively, over
the life of the related fixed maturity security as an adjustment to yield using
a method that approximates the effective interest method. Dividends and interest
income are recognized when earned. Realized gains and losses are included in
earnings and are derived using the specific-identification method for
determining the cost of securities sold.
35
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(C) PREMIUM REVENUE
Premium revenue on property and casualty insurance is earned on a pro
rata basis over the life of the policies. Unearned premiums represent the
portion of the premium related to the unexpired policy term.
(D) DEFERRED ACQUISITION COSTS
Deferred acquisition costs represent primarily commissions paid to the
Company's outside agents at the time of policy issuance (to the extent they are
recoverable from future premium income) net of ceded premium commission earned
from reinsurers, and are amortized over the life of the related policy in
relation to the amount of premiums earned. The method followed in computing
deferred acquisition costs limits the amount of such deferred costs to their
estimated realizable value, which gives effect to the premium to be earned,
related investment income, unpaid losses and loss adjustment expenses and
certain other costs expected to be incurred as the premium is earned. There is
no indication that these costs will not be fully recoverable in the near term.
An analysis of deferred acquisition costs follows:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Balance, beginning of period $ 11,952 $ 1,192,260 $ (10,243)
Acquisition costs deferred (2,068,545) 286,930 2,876,257
Amortized to expense during period 2,064,314 (1,467,238) (1,673,754)
----------- ----------- -----------
Balance, end of period $ 7,721 $ 11,952 $ 1,192,260
=========== =========== ===========
(E) PREMIUM DEPOSITS
Premium deposits represent premiums received on policies not yet
written. The Company takes approximately 30 working days to write the policy
from the date the cash and policy application are received.
(F) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Unpaid losses and loss adjustment expenses are provided for through the
establishment of liabilities in amounts estimated to cover incurred losses and
loss adjustment expenses. Such liabilities are determined based upon the
Company's assessment of claims pending and the development of prior years' loss
liability. These amounts include liabilities based upon individual case
estimates for reported losses and loss adjustment expenses and estimates of such
amounts that are incurred but not reported. Changes in the estimated liability
are charged or credited to operations as the estimates are revised. Unpaid
losses and loss adjustment expenses are reported net of estimates for salvage
and subrogation recoveries, which totaled approximately $550,000, $544,000 and
$559,000, net of reinsurance, at December 31, 2002, 2001 and 2000, respectively.
The estimates of unpaid losses and loss adjustment expenses are subject
to the effect of trends in claims severity and frequency and are continually
reviewed. As part of the process, the Company reviews historical data and
considers various factors, including known and anticipated legal developments,
changes in social attitudes, inflation and economic conditions. As experience
develops and other data becomes available, these estimates are revised, as
required, resulting in increases or decreases to the existing unpaid losses and
loss adjustment expenses. Adjustments are reflected in results of operations in
the period in which they are made and the liabilities may deviate substantially
from prior estimates.
There can be no assurance that the Company's unpaid losses and loss
adjustment expenses will be adequate to cover actual losses. If the Company's
unpaid losses and loss adjustment expenses prove to be inadequate, the Company
will be required to increase the liability with a corresponding reduction in the
Company's net income in the period in which the deficiency is identified. Future
loss experience substantially in excess of the established unpaid losses and
loss adjustment expenses could have a material adverse effect on the Company's
business, results of operations and financial condition.
The Company does not discount unpaid losses and loss adjustment
expenses for financial statement purposes.
36
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(G) COMMISSION INCOME
Commission income consists of fees earned by the Company-owned agencies
placing business with third party insurers and third party premium finance
companies. Commission income is earned on a pro rata basis over the life of the
policies. Unearned commissions represent the portion of the commissions related
to unexpired policy terms. During 2002 Assurance MGA completed its program for
underwriting insurance for an unaffiliated insurance company.
(H) FINANCE REVENUE
Interest and service income, resulting from the financing of insurance
premiums, is recognized using a method that approximates the effective interest
method. Late charges are recognized as income when chargeable.
(I) CREDIT LOSSES
Provisions for credit losses are charged to operations in amounts
sufficient to maintain the allowance for credit losses at a level considered
adequate to cover anticipated losses. Generally, accounts that are over 90 days
old are written off to the allowance for credit losses.
The activity in the allowance for credit losses for premiums receivable
was as follows for the years ended December 31, 2002, 2001 and 2000:
2002 2001 2000
---- ---- ----
Allowance for credit losses at beginning of year $235,000 $325,000 $50,000
Additions charged to bad debt expense 34,710 421,349 432,052
Write-downs charged against the allowance (68,710) (511,349) (157,052)
------- ------- --------
Allowance for credit losses at end of year $201,000 $235,000 $325,000
======== ======== ========
See Note 4 for the activity in the allowance for credit losses for finance
contracts and pay advances receivable.
(J) MANAGING GENERAL AGENT FEES
If substantially all the costs associated with the MGA contract are
incurred during the underwriting process, then the MGA fees and the related
acquisition costs are recognized at the time the policy is underwritten, net of
estimated cancellations. If the MGA contract requires significant involvement
subsequent to the completion of the underwriting process, then the MGA fees and
related acquisition costs are deferred and recognized over the life of the
policy.
(K) POLICY FEES
Policy fees represent a $25 non-refundable application fee for
insurance coverage, which is intended to reimburse the Company for the costs
incurred to underwrite the policy. The fees and related costs are recognized
when the policy is underwritten. These underwriting costs are not included as a
component of deferred acquisition costs.
(L) REINSURANCE
The Company recognizes the income and expense on reinsurance contracts
principally on a pro-rata basis over the life of the policies covered under the
reinsurance agreements. The Company is reinsured under separate reinsurance
agreements for the different lines of business underwritten. Reinsurance
contracts do not relieve the Company from its obligations to policyholders. The
Company continually monitors its reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies. The Company only cedes risks to
reinsurers whom the Company believes to be financially sound. At December 31,
2002, all reinsurance recoverables are considered collectible.
37
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(M) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the 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 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 in the period that includes the
enactment date.
(N) CONTINGENT REINSURANCE COMMISSION
The Company's reinsurance contracts provide ceding commissions for
premiums written which are subject to adjustment. The amount of ceding
commissions is determined by the loss experience for the reinsurance agreement
term. The reinsurer provides commissions on a sliding scale with maximum and
minimum achievable levels. The reinsurer provides the Company with the
provisional commissions. The Company has recognized the commissions based on the
current loss experience for the policy year premiums. This results in
establishing a liability for the excess of provisional commissions retained
compared to amounts recognized, which is subject to variation until the ultimate
loss experience is determinable. For the years ended December 31, 2002 and
December 31, 2001, respectively, there were $369,000 and $42,000 of contingent
ceding commissions recognized.
(O) CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially expose the Company to
concentrations of credit risk consist primarily of investments, premiums
receivable, amounts due from reinsurers on paid and unpaid losses, and finance
contracts, consumer loans and pay advances receivable. The Company has not
experienced significant losses related to premiums receivable from individual
policyholders or groups of policyholders in a particular industry or geographic
area. The Company has not experienced significant losses related to consumer
loans or pay advances receivable. Management believes no credit risk beyond the
amounts provided for collection losses is inherent in the Company's premiums
receivable or finance contracts, consumer loans and pay advances receivable. In
order to reduce credit risk for amounts due from reinsurers, the Company seeks
to do business with financially sound reinsurance companies and regularly
reviews the financial strength of all reinsurers used.
(P) ACCOUNTING CHANGES
In June 2000, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities -- an amendment of Financial
Accounting Standards Board Statement No. 133," which because of the Company's
early adoption of Statement of Financial Accounting Standard No. 133, was
effective for all fiscal quarters beginning after June 15, 2000. This statement
amends the accounting and reporting standards of Statement of Financial
Accounting Standard No. 133 for certain derivative instruments and certain
hedging activities. Because the Company has limited involvement with derivative
financial instruments and does not engage in the derivative market for hedging
purposes, the adoption of Statement of Financial Accounting Standard No. 138 did
not have a material effect on the Company's financial statements.
Effective January 1, 2000, the Company adopted Statement of Position
98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts
That Do Not Transfer Insurance Risk." The Statement of Position provides
guidance on accounting for insurance and reinsurance contracts that do not
transfer insurance risk. All of the Company's reinsurance agreements are
risk-transferring arrangements, accounted for according to Statement of
Financial Accounting Standard No. 113, "Accounting and Reporting for Reinsurance
of Short-Duration and Long-Duration Contracts." The adoption of Statement of
Position 98-7 had no effect on the Company's financial statements.
38
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Effective July 1, 2000, the Company adopted Financial Accounting
Standards Board Interpretation No. 44, "Accounting for Certain Transactions
Including Stock Compensation (an Interpretation of Accounting Principles Board
Opinion No. 25)." Financial Accounting Standards Board Interpretation No. 44
clarifies the application of Accounting Principles Board Opinion No. 25 for only
certain issues, such as: (a) the definition of employee for purposes of applying
Accounting Principles Board Opinion No. 25; (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan; (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award; and (d) the accounting for an exchange of stock compensation
awards in a business combination. The adoption of Financial Accounting Standards
Board Interpretation No. 44 did not have a material effect on the Company's
financial statements.
Effective December 31, 2000, the Company adopted Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements." The Staff
Accounting Bulletin summarizes the SEC staff's views on applying accounting
principles generally accepted in the United States to the recognition of revenue
in financial statements. The adoption of Staff Accounting Bulletin No. 101 had
no effect on the Company's financial statements.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 141, "Business Combinations," which became
effective January 1, 2002. Statement of Financial Accounting Standard No. 141
requires all business combinations initiated after September 30, 2001 to be
accounted for using the purchase method. Additionally, Statement of Financial
Accounting Standard No. 141 requires an acquired intangible asset, whenever
acquired, to be recognized separately from goodwill if the benefit of the
intangible asset is obtained through contractual or other legal rights or if the
intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets,"
which became effective January 1, 2002. Statement of Financial Accounting
Standard No. 142 eliminates the amortization of goodwill over its estimated
useful life, but requires goodwill to be subject to at least an annual
assessment for impairment by applying a fair-value-based test. See footnote (t)
GOODWILL for additional information. Upon adoption of Financial Accounting
Standards No.142 January 1, 2002, the Company ceased amortization of goodwill.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 143, "Accounting for Asset Retirement
Obligations," which became effective for fiscal years beginning after June 15,
2002. Statement of Financial Accounting Standard No. 143 addresses financial
accounting and reporting for obligations associated with the retirement of
tangible, long-lived assets and the associated asset retirement costs. Adoption
of this statement has had no material effect on the Company's financial
statements.
In October 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which became effective for fiscal
years beginning after December 15, 2001, and interim periods within those fiscal
years. Statement of Financial Accounting Standard No. 144 revises and clarifies
the existing professional guidance addressing: (a) recognition and measurement
of the impairment of long-lived assets to be held and used; (b) the measurement
of long-lived assets to be disposed of by sale; and (c) the reporting of
discontinued operations and components of an entity that either has been
disposed of (by sale, by abandonment, or in a distribution to owners) or is
classified as held for sale. The adoption of Statement of Financial Accounting
Standard No. 144 had no effect on the Company's financial statements.
In April 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 145, "Rescission of Financial
Accounting Standards Board Statements No. 4, 44 and 64, Amendment of Financial
Accounting Standards Board Statement No. 13, and Technical Corrections," which
became effective for fiscal years beginning after May 15, 2002. The rescission
of Statement of Financial Accounting Standard No. 4, "Reporting Gains and Losses
from Extinguishment of Debt," and Statement of Financial Accounting Standard No.
64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements," which
had amended Statement of Financial Accounting Standard No. 4, will affect income
statement classification of gains and losses from extinguishment of debt.
Statement of Financial Accounting Standard No. 4 required material gains and
losses from extinguishment of debt to be classified as extraordinary items.
Under Statement of Financial Accounting Standard No. 145, extinguishment of debt
is now considered a risk management strategy by the reporting enterprise, and
the Financial Accounting Standards Board does not believe it should be
considered extraordinary under the criteria in Accounting Principles Board
Opinion No. 30, "Reporting the Results of Operations--
39
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions," unless the debt
extinguishment meets the unusual-in-nature and infrequency-of-occurrence
criteria in Accounting Principles Board Opinion No. 30. The Company has not yet
determined the impact that the adoption of this statement will have on the
Company's financial statements.
In July 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No.146, "Accounting for Costs Associated with
Exit or Disposal Activities." Statement of Financial Accounting Standard No. 146
supersedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." Statement of Financial
Accounting Standard No. 146 requires that, in certain instances, costs
associated with an exit or disposal plan be recognized when incurred rather than
at the date of a commitment to an exit or disposal plan. Statement of Financial
Accounting Standard No. 146 is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The Company has not yet determined
the impact that the adoption of this statement will have on the financial
statements.
In October 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 147, "Acquisitions of Certain
Financial Institutions," which clarifies the accounting treatment for
acquisitions of financial institutions. In addition, this Statement amends
Statement of Financial Accounting Standard No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets and credit cardholder
intangible assets. Statement of Financial Accounting Standard No. 147 is
effective on October 1, 2002. The adoption of Statement of Financial Accounting
Standard No. 147 will have no effect on the Company's financial statements.
In December 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amended Statement of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation." The new
standard provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
Additionally, the statement amends the disclosure requirements of
Statement of Financial Accounting Standard No. 123 to require prominent
disclosures in the annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. This statement is effective for financial statements
for fiscal years ending after December 15, 2002. In compliance with Statement of
Financial Accounting Standard No. 148, the Company has elected to continue to
follow the intrinsic value method in accounting for the Company's stock-based
employee compensation arrangement as defined by Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and have made the
applicable disclosures in the "Stock-Based Compensation" section, see Note 16.
(Q) USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity
with general accepted accounting principles requires management to make
estimates and assumptions that affect the reported financial statement balances
as well as the disclosure of contingent assets and liabilities. Actual results
could differ materially from those estimates used.
Similar to other property and casualty insurers, the Company's
liability for unpaid losses and loss adjustment expenses, 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, management believes that this liability is
adequate. Estimates are reviewed regularly and adjusted as necessary. Such
adjustments are reflected in current operations. In addition, the realization of
the Company's deferred income tax assets is dependent on generating sufficient
future taxable income. It is reasonably possible that the expectations
associated with these accounts could change in the near term and that the effect
of such changes could be material to the Consolidated Financial Statements.
(R) NATURE OF OPERATIONS
The following is a description of the most significant risks facing the
Company and how it mitigates those risks:
40
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(I) LEGAL/REGULATORY RISKS--the risk that changes in the
regulatory environment in which an insurer operates will create additional
expenses not anticipated by the insurer in pricing its products. That is,
regulatory initiatives designed to reduce insurer profits, restrict underwriting
practices and risk classifications, mandate rate reductions and refunds, and new
legal theories or insurance company insolvencies through guaranty fund
assessments may create costs for the insurer beyond those recorded in the
financial statements. The Company attempts to mitigate this risk by monitoring
proposed regulatory legislation and by assessing the impact of new laws. As the
Company writes business only in the state of Florida, it is more exposed to this
risk than some of its more geographically balanced competitors.
(II) CREDIT RISK--the risk that issuers of securities owned by
the Company will default or that other parties, including reinsurers to whom
business is ceded, which owe the Company money, will not pay. The Company
attempts to minimize this risk by adhering to a conservative investment
strategy, maintaining reinsurance agreements with financially sound reinsurers,
and by providing for any amounts deemed uncollectible.
(III) INTEREST RATE RISK--the risk that interest rates will
change and cause a decrease in the value of an insurer's investments. To the
extent that liabilities come due more quickly than assets mature, an insurer
might have to sell assets prior to maturity and potentially recognize a gain or
a loss.
(S) FAIR VALUE
The fair value of the Company's investments are estimated based on
prices published by financial services or quotations received from securities
dealers and is reflective of the interest rate environment that existed as of
the close of business on December 31, 2002 and 2001. Changes in interest rates
subsequent to December 31, 2002 may affect the fair value of the Company's
investments. Refer to Note 3(a) for details.
The carrying amounts for the following financial instrument categories
approximate their fair values at December 31, 2002 and 2001 because of their
short-term nature: cash and cash equivalents, premiums receivable, finance
contracts, consumer loans and pay advance receivable, due from reinsurers,
drafts payable to insurance companies, revolving credit outstanding, bank
overdraft, and accounts payable and accrued expenses.
The fair value of mortgage loans is estimated using the present value
of future cash flows based on the market rate for similar types of loans.
Carrying value approximates market value as rates used are commensurate with
market rate.
(T) GOODWILL
In July 2001, the FASB issued SFAS 141 "Business Combinations,"
effective for all business combinations initiated after June 30, 2001, and SFAS
142 "Accounting for Goodwill and Other Intangible Assets," effective for fiscal
years beginning after December 15, 2001. SFAS 141 requires the purchase method
of accounting be used for all business combinations. Goodwill and
indefinite-lived intangible assets will remain on the balance sheet and not be
amortized. Intangible assets with a definite life will continue to be amortized
over their estimated useful lives. SFAS 142 establishes a new method of testing
goodwill for impairment. On an annual basis, and when there is reason to suspect
that their values may have been diminished or impaired, these assets must be
tested for impairment. The amount of goodwill determined to be impaired will be
expensed to current operations. Prior to the adoption of SFAS 141 and 142,
goodwill was amortized on a straight-line basis for financial statement purposes
over periods ranging from 10 to 20 years. Periodic reviews of the recoverability
of goodwill were performed by assessing undiscounted cash flows of future
operations.
Amortization of goodwill was $-0- for 2002, compared to $540,010 in
2001 and $606,653 in 2000. The decrease is the result of no longer amortizing
goodwill, subsequent to the adoption of SFAS 142.
Goodwill is stated separately on the balance sheet and totaled
$1,789,353 at December 31, 2002 and 2001, net of $1,725,622 of accumulated
amortization. Goodwill relates to the Company's insurance segment. Impairment
testing was performed during the fourth quarter of 2002, pursuant to the
requirements of SFAS 142. Based upon this valuation analysis, goodwill does not
appear to be impaired. Impairment testing will continue to be performed on no
less than an annual basis, or when there is reason to suspect the value of these
assets has diminished or is impaired.
Below is a calculation of the pro forma effects of eliminating the
amortization of goodwill for each of the years in the three-year period ended
December 31, 2002.
41
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
For the Year
Ended December 31
------------------------------------------
2002 2001 2000
------------- ----------- -----------
Reported net income (loss) $ 4,570,201 $ (992,090) $ (522,874)
Add back: goodwill amortization -- 540,010 606,653
------------- ----------- -----------
Adjusted net income (loss) $ 4,570,201 $ (452,080) $ 83,779
============= =========== ===========
BASIC EARNINGS PER SHARE:
Reported net income $ 1.52 $ (0.31) $ (0.15)
Goodwill amortization -- 0.14 0.18
------------- ----------- -----------
Adjusted net income $ 1.52 $ (0.17) $ 0.03
============= =========== ===========
(U) STOCK OPTION PLAN
The Company accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". Compensation cost for stock options,
if any, is measured as the excess of the quoted market price of the Company's
stock at the date of grant over the amount an employee must pay to acquire the
stock.
SFAS No. 123, "Accounting for Stock-Based Compensation", establishes
accounting and disclosure requirements using a fair value-based method of
accounting for stock-based employee compensation plans.
The FASB Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (FAS 123) establishes financial
accounting and reporting standards for stock-based compensation plans. As
permitted by FAS 123, the Company uses the accounting method prescribed by
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" (APB 25) to account for its stock-based compensation plans. Companies
using APB 25 are required to make pro forma footnote disclosures of net income
and earnings per share as if the fair value method of accounting, as defined in
FAS 123, had been applied. See Note 16 for more information.
As of December 31, 2002 the Company adopted the FASB Statement of
Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation
- - Transition and Disclosure" (FAS 148). FAS 148 amends FAS 123 to provide
alternative methods of transition to FAS 123's fair value method of accounting
for stock-based compensation. FAS 148 also amends the disclosure provisions of
FAS 123 to require disclosure in the Summary of Significant Accounting Policies
footnote the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share.
(V) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation on property, plant and equipment is calculated on a
straight-line basis over the following estimated useful lives: building and
improvements - 30 years and furniture and fixtures 7 years. The Company
capitalizes an expenditure in excess of $500 if the asset is expected to have a
useful life greater than one year. The carrying value of property, plant and
equipment is periodically reviewed by the Company based on the expected future
undiscounted operating cash flows of the related item. Based upon its most
recent analysis, the Company believes that no impairment of property, plant and
equipment exists at December 31, 2002.
(W) RECLASSIFICATIONS
Certain 2001 and 2000 financial statement amounts have been
reclassified to conform with 2002 presentation.
(3) INVESTMENTS
(A) FIXED MATURITIES AND EQUITY SECURITIES
A summary of the amortized cost, estimated fair value, gross unrealized
gains and losses of fixed maturities and equity securities at December 31, 2002
and 2001 is as follows:
42
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ----------- ----------- -----------
DECEMBER 31, 2002
Fixed Maturities:
U. S. Government obligations ....... $ 104,731 $ 425 $ -- $ 105,156
Obligations of states and political
subdivisions .................... 8,553,603 33,610 -- 8,587,213
Corporate securities ............... 16,242,258 -- 241,580 16,000,678
----------- ----------- ----------- -----------
$24,900,592 $ 34,035 $ 241,580 $24,693,047
=========== =========== =========== ===========
Equity securities - preferred stocks $ 208,316 $ -- $ 316 $ 208,000
common stocks ....... 355,549 -- 23,843 331,706
----------- ----------- ----------- -----------
$ 563,865 $ -- $ 24,159 $ 539,706
=========== =========== =========== ===========
DECEMBER 31, 2001
Fixed Maturities:
Mortgage-backed securities ......... $ 152,569 $ -- $ 9,794 $ 142,775
U. S. Government obligations ....... 2,604,780 25,144 -- 2,629,924
Obligations of states and political
subdivisions .................... 6,122,521 -- 136,017 5,986,504
Corporate securities ............... 8,035,773 -- 81,655 7,954,118
----------- ----------- ----------- -----------
$16,915,643 $ 25,144 $ 227,466 $16,713,321
=========== =========== =========== ===========
Equity securities - preferred stocks $ 208,316 $ -- $ 15,816 $ 192,500
=========== =========== =========== ===========
Below is a summary of fixed maturities at December 31, 2002 and 2001 by
contractual or expected maturity periods. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
DECEMBER 31, 2002 DECEMBER 31, 2001
AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE
----------- ----------- ----------- -----------
Due in one year or less ........ $ 1,355,968 $ 1,358,268 $ 430,713 $ 434,338
Due after one year through
five years .................... 13,490,634 13,213,114 7,399,113 7,406,880
Due after five years through ten
years ......................... 7,470,221 7,589,673 3,701,348 3,642,922
Due after ten years ............ 2,581,221 2,531,992 5,384,469 5,229,181
----------- ----------- ----------- -----------
$24,898,044 $24,693,047 $16,915,643 $16,713,321
=========== =========== =========== ===========
Political subdivision bonds with an amortized cost of approximately
$100,756 and a fair market value of approximately $101,385 were on deposit with
the Florida Department of Financial Services as of December 31, 2002, as
required by law.
A summary of the sources of net investment income follows:
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Fixed maturities ............... $ 1,189,683 $ 484,913 $ 551,973
Equity securities .............. 18,009 13,301 44,343
Cash and cash equivalents ...... 59,182 559,017 646,780
Other .......................... 17,328 38,390 10,459
----------- ----------- -----------
Total investment income ..... 1,284,202 1,095,621 1,253,555
Less investment expenses ....... (30,437) (28,980) (28,142)
----------- ----------- -----------
Net investment income ....... $ 1,253,765 $ 1,066,641 $ 1,225,413
=========== =========== ===========
Proceeds from sales of fixed maturities and equity securities for the
years ending December 31, 2002, 2001 and 2000 were $41,293,545, $62,419,076 and
$49,110,449, respectively.
43
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
A summary of realized investment gains (losses) and (increases)
decreases in net unrealized losses follows:
YEARS ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Net realized gains (losses):
Fixed maturities .......................... $(1,389,860)* $ 173,294 $ (14,937)
Equity securities ......................... 19,899 (3,084,952) (94,319)
----------- ----------- -----------
Total .................................. $(1,369,961) $(2,911,658) $ (109,256)
=========== =========== ===========
* Includes a $2,000,000 impairment loss
Change in net unrealized losses:
Fixed maturities .......................... $ (12,124) $ 156,042 $ 1,112,530
Equity securities ......................... (1,443) 1,710,304 (1,201,634)
----------- ----------- -----------
Total .................................. $ (13,567) $ 1,866,346 $ (89,104)
=========== =========== ===========
(B) MORTGAGE LOANS
2002 2001 2000
---- ---- ----
Mortgage receivable January 1 $ 601,601 $ 385,024 $ 119,304
New mortgages -- 450,000 272,773
Principle payments (456,558) (233,423) (7,053)
----------- ----------- -----------
Mortgage receivable December 31 $ 145,043 $ 601,601 $ 385,024
=========== =========== ===========
A portion of these amounts represents outstanding balances from related
party transactions. Refer to Note 13 for details.
(4) FINANCE CONTRACTS, CONSUMER LOANS AND PAY ADVANCES RECEIVABLE
Below is a summary of the components of the finance contracts consumer
loans and pay advances receivable balance:
DECEMBER 31,
2002 2001
---- ----
Finance contracts receivable $7,776,553 $11,678,176
Pay advances receivable -- 322,763
---------- -----------
7,776,553 12,000,939
Less: Unearned income (154,324) (463,302)
Allowance for credit losses (404,356) (723,756)
---------- -----------
Finance contracts, consumer loans and
pay advances receivable, net $7,217,873 $10,813,881
========== ===========
The activity in the allowance for credit losses was as follows for the
years ended December 31, 2002, 2001 and 2000:
2002 2001 2000
---- ---- ----
Allowance for credit losses at beginning of year $ $723,756 $ $832,231 $ $272,192
Additions charged to bad debt expense 1,036,092 2,506,757 1,994,274
Write-downs charged against the allowance (1,355,492) (2,615,232) (1,434,235)
----------- ----------- -----------
Allowance for credit losses at end of year $ 404,356 $ 723,756 $ 832,231
=========== =========== ===========
As security, Federated Premium retains a contractual right, if a
premium installment is not paid when due, to cancel the insurance policy and to
receive the unearned premium from the insurer.
44
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(5) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 31, 2002 and 2001 consist of
the following:
2002 2001
---- ----
Land $ 787,144 $ 917,369
Building and Improvements 3,775,208 3,643,515
Furniture and Fixtures 1,729,033 1,633,994
----------- -----------
6,291,385 6,194,878
Accumulated Depreciation (1,471,768) (1,107,994)
----------- -----------
$ 4,819,617 $ 5,086,884
=========== ===========
Depreciation of property, plant, and equipment was $376,516, $396,047
and $323,743 during 2002, 2001 and 2000, respectively.
(6) REINSURANCE
The Company reinsures (cedes) a portion of its written premiums on a
quota-share basis to nonaffiliated insurance companies in order to limit its
loss exposure. The Company also maintains coverages to limit losses from large
exposures, which the Company believes are adequate for its current volume. To
the extent that reinsuring companies are unable to meet their obligations
assumed under the reinsurance agreements, the Company remains primarily liable
to its policyholders.
The impact of reinsurance on the financial statements is as follows:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Premiums written:
Direct............................... $63,036,468 $34,271,338 $32,073,768
Ceded................................ (25,286,828) (12,789,404) (7,625,095)
---------- ----------- ----------
$37,749,640 $21,481,934 $24,448,673
=========== =========== ===========
Premiums earned:
Direct............................... $48,988,774 $32,358,300 $27,072,339
Ceded................................ (19,595,770) (12,102,739) (6,751,000)
---------- ----------- ----------
$29,393,004 $20,255,561 $20,321,339
=========== =========== ===========
Losses and loss adjustment expenses incurred:
Direct............................... $29,776,770 $29,064,763 $21,003,683
Ceded................................ (13,789,645) (12,909,861) (6,013,565)
---------- ----------- ----------
$15,987,125 $16,154,902 $14,990,118
=========== =========== ===========
AS OF DECEMBER 31,
2002 2001
---- ----
Unpaid losses and loss adjustment expenses, net:
Direct.............................. $16,983,756 $11,005,337
Ceded .............................. 7,847,421 (4,798,556)
----------- -----------
$ 9,136,335 $ 6,206,781
=========== ===========
Unearned premiums:
Direct.............................. $28,934,486 $14,951,228
Ceded .............................. 11,251,193 (5,559,909)
----------- -----------
$17,683,293 $ 9,391,319
=========== ===========
The Company received approximately $6.8 million, $3.8 million and $2.3
million in commissions on premiums ceded during the years ended December 31,
2002, 2001 and 2000, respectively. Had all of the Company's reinsurance
agreements been canceled at December 31, 2002, the Company would have returned a
total of approximately $3.3 million in reinsurance commissions to its
reinsurers; in turn, its reinsurers would have returned approximately $11.2
million in unearned premiums to the Company.
At December 31, 2002 and 2001, the Company had an unsecured aggregate
recoverable for paid and unpaid losses and loss adjustment expenses and unearned
premiums with the following reinsurers:
45
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
DECEMBER 31,
2002 2001
---- ----
Transatlantic Reinsurance Company (A++ A.M. Best Rated):
Unearned premiums........................................................ $11,251,193 $ 5,559,909
Reinsurance recoverable on paid losses and loss adjustment expenses...... 3,266,549 4,176,436
Unpaid losses and loss adjustment expenses............................... 7,847,421 4,798,556
----------- -----------
$22,365,163 $14,534,901
=========== ===========
Amounts due from reinsurers consisted of amounts related to:
Unpaid losses and loss adjustment expenses............................... $ 7,847,255 $ 4,798,556
Reinsurance recoverable on paid losses and loss adjustment expenses...... 3,266,715 4,176,436
Reinsurance payable...................................................... (3,984,895) (1,921,663)
----------- -----------
$ 7,129,075 $ 7,053,329
=========== ===========
(7) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The liability for unpaid losses and loss adjustment expenses is
determined on an individual-case basis for all incidents reported. The liability
also includes amounts for unallocated expenses, anticipated future claim
development and IBNR.
Activity in the liability for unpaid losses and loss adjustment
expenses is summarized as follows:
DECEMBER 31,
2002 2001 2000
---- ---- ----
Balance at January 1 .................... $ 11,005,337 $ 9,765,848 $ 6,314,307
Less reinsurance recoverables .......... (4,798,556) (2,789,619) (1,886,226)
------------ ------------ ------------
Net balance at January 1 ............. $ 6,206,781 $ 6,976,229 $ 4,428,081
============ ============ ============
Incurred related to:
Current year ........................... $ 15,896,251 $ 13,586,426 $ 13,545,562
Prior years ............................ 90,874 2,568,476 1,444,556
------------ ------------ ------------
Total incurred ....................... $ 15,987,125 $ 16,154,902 $ 14,990,118
============ ============ ============
Paid related to:
Current year ........................... $ 8,149,079 $ 8,768,672 $ 8,012,742
Prior years ............................ 4,908,492 8,259,045 4,429,228
------------ ------------ ------------
Total paid ........................... $ 13,057,571 $ 17,027,717 $ 12,441,970
============ ============ ============
Balance, American Vehicle, at acquisition $ -- $ 103,367 $ --
============ ============ ============
Net balance at year end ................. $ 9,136,335 $ 6,206,781 $ 6,976,229
Plus reinsurance recoverables .......... 7,847,421 4,798,556 2,789,619
------------ ------------ ------------
Balance at year end .................. $ 16,983,756 $ 11,005,337 $ 9,765,848
============ ============ ============
Based upon consultations with the Company's independent actuarial
consultants and their statement of opinion on losses and loss adjustment
expenses, the Company believes that the liability for unpaid losses and loss
adjustment expenses is adequate to cover all claims and related expenses which
may arise from incidents reported.
As a result of the Company's review of its liability for losses and
LAE, which includes a re-evaluation of the adequacy of reserve levels for prior
year's claims, the Company increased its liability for loss and LAE for claims
occurring in prior years by $90,874 for the year ended December 31, 2002,
increased its liability for loss and LAE for claims occurring in prior years by
$2,568,000 for the year ended December 31, 2001, and increased its liability for
loss and LAE for claims occurring in prior years by $1,445,000 for the year
ended December 31, 2000. The adjustments in the liability were primarily
attributable to loss development with respect to the Company's personal
automobile insurance program. There can be no assurance concerning future
adjustments of reserves, positive or negative, for claims through December 31,
2002.
46
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(8) REVOLVING CREDIT OUTSTANDING
Federated Premium's operations are funded by a revolving loan agreement
("Revolving Agreement") with FlatIron Funding Company LLC ("FlatIron"). The
Revolving Agreement is structured as a sale of contracts receivable under a sale
and assignment agreement with FPF, Inc. (a wholly-owned subsidiary of FlatIron),
which gives FPF, Inc. the right to sell or assign these contracts receivable.
Federated Premium, which services these contracts, has recorded transactions
under the Revolving Agreement as secured borrowings. The Revolving Agreement,
which was amended and revised in September 2001, allowed for a maximum credit
commitment of $7.0 million plus an initial additional amount of $700,000 for the
transition from September 30, 2001 when the previous agreement expired. The line
declined by $100,000 each month beginning November 1, 2001. In September 2002
the line was amended and revised allowing for a maximum credit commitment of
$4.0 million. The decline in the required credit commitment is due primarily to
Federated National and American Vehicle's newly developed direct bill program.
Direct billing is where the insurance company accepts from the insured, as a
receivable, a promise to pay the premium, as opposed to requiring the full
amount of the policy, either directly from the insured or from a premium finance
company. The amount of FPF's advance is subject to availability under a
borrowing base calculation, with maximum advances outstanding not to exceed the
maximum credit commitment. The annual interest rate on advances under the
Revolving Agreement is the prime rate plus additional interest varying from
1.25% to 3.25% based on the prior month's ratio of contracts receivable related
to insurance companies with an A. M. Best rating of B or worse to total
contracts receivable. The Revolving Agreement contains various operating and
financial covenants, with which the Company was in compliance at December 31,
2002 and 2001. The Revolving Agreement, as amended, expires September 30, 2004.
Outstanding borrowings under the Revolving Agreement as of December 31, 2002 and
2001 were approximately $4.3 million and $6.7 million, respectively. Outstanding
borrowings in excess of the $4.0 million commitment totaled $312,420 and are
permissible by reason of a compensating cash balance of $352,433 held for the
benefit of FPF, Inc. Interest expense on this revolving credit line for the
years ended December 31, 2002, 2001 and 2000 totaled approximately $342,000,
$592,000 and $643,000, respectively.
(9) INCOME TAXES
A summary of the provision for income tax expense (benefit) for the
years ended December 31, 2002, 2001 and 2000 is as follows:
2002 2001 2000
---- ---- ----
Federal:
Current................................. $3,323,281 $(453,263) $ 583,772
Deferred................................ (453,708) (103,197) (1,001,203)
---------- --------- -----------
2,869,573 (556,460) (417,431)
---------- --------- -----------
State:
Current................................. 510,941 (56,428) 126,421
Deferred................................ (77,665) (17,665) (171,386)
---------- --------- -----------
433,276 (74,093) (44,965)
---------- --------- -------
$3,302,849 $(630,553) $ (462,396)
========== ========= ===========
The actual income tax expense (benefit) differs from the "expected"
income tax expense (benefit) for the years ended December 31, 2002, 2001 and
2000 (computed by applying the combined applicable effective federal and state
tax rates to income (loss) before provision for income tax expense (benefit)) as
follows:
2002 2001 2000
---- ---- ----
Computed "expected" tax (benefit), at federal rate $ 2,437,254 $ (954,903) $ (334,992)
State tax, net of federal deduction benefit ...... 443,276 (48,901) (29,676)
Tax-exempt interest .............................. (95,564) (125,321) (156,459)
Amortization of goodwill ......................... 54,641 55,335 60,747
Dividend received deduction ...................... (5,205) (4,522) (14,257)
Valuation allowance for capital loss carry forward 256,083 482,491 --
Other, net ....................................... 212,364 (34,732) 12,241
----------- ----------- -----------
Income tax expense (benefit), as reported ........ $ 3,302,849 $ (630,553) $ (462,396)
=========== =========== ===========
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 net deferred tax asset as of December 31, 2002 and
2001 are as follows:
47
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
DECEMBER 31,
2002 2001
---- ----
Deferred tax assets:
Unpaid losses and loss adjustment expenses $ 265,695 $ 208,313
Unearned premiums ......................... 1,330,845 713,046
Unrealized loss on investment securities .. 85,454 --
Allowance for credit losses ............... 227,795 360,780
Unearned Commissions ...................... 333,941 789,782
Goodwill .................................. 190,315 202,999
Unearned adjusting income ................. 40,640 --
Capital loss carryforward - Impairment loss 752,600 --
Capital loss carryforward ................. 405,746 482,491
----------- -----------
Total gross deferred tax assets ........... 3,633,031 2,757,411
----------- -----------
Deferred tax liabilities:
Prepaid Florida Hurricane Catastrophe Fund (169,335) --
Deferred acquisition costs, net ........... (2,905) (4,498)
Depreciation .............................. (30,908) (18,246)
----------- -----------
Total gross deferred tax liabilities .... (203,148) (22,744)
----------- -----------
Valuation for deferred tax asset ........ (738,574) (482,491)
----------- -----------
Net deferred tax asset .................. $ 2,691,309 $ 2,252,176
=========== ===========
In assessing the net realizable value of deferred tax assets,
management considers whether it is more likely than not that some portion or all
of the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income
during the periods in which those temporary differences become deductible.
Management considers the scheduled reversal of deferred tax liabilities,
projected future taxable income and tax planning strategies in making this
assessment. At December 31, 2002 and 2001, based upon the level of historical
taxable income and projections for future taxable income over the periods in
which the deferred tax assets are deductible, management believes it is more
likely than not that the Company will realize the benefits of these deductible
differences with the exception of the capital loss carryforward, for which a
reserve has been provided as of December 31, 2002.
(10) REGULATORY REQUIREMENTS AND RESTRICTIONS
To retain its certificate of authority, the Florida Insurance Code (the
"Code") requires that Federated National and American Vehicle maintain capital
and surplus equal to the greater of 10 percent of its liabilities or the
statutory minimum capital and surplus requirement of $3.0 million as defined in
the Code. In 2002, 2001 and 2000, Federated National and American Vehicle were
required to have capital surplus of $3.25 million, $3.0 million and $2.75
million, each, respectively. At December 31, 2002, 2001 and 2000, Federated
National's capital surplus was $9.2 million, $5.7 million and $6.2 million,
respectively. At December 31, 2002 and 2001, American Vehicle had capital
surplus of $4.0 million and $3.1 million, respectively. Further, the Companies
were also required to adhere to a prescribed net premium-to-surplus ratio. For
the year ended December 31, 2002, both Companies were in compliance with this
requirement.
As of December 31, 2002, to meet regulatory requirements, the Company
had bonds with a carrying value of approximately $1,994,000 pledged to the
Insurance Commissioner of the State of Florida.
Under Florida law, a domestic insurer may not pay any dividend or
distribute cash or other property to its shareholders except out of that part of
its available and accumulated capital surplus funds which is derived from
realized net operating profits on its business and net realized capital gains. A
Florida domestic insurer may not make dividend payments or distributions to
shareholders without prior approval of the Florida Department of Financial
Services if the dividend or distribution would exceed the larger of (i) the
lesser of (a) 10 percent of capital surplus (b) net income, not including
realized capital gains, plus a two-year carryforward, (ii) 10 percent of capital
surplus with dividends payable constrained to unassigned funds minus 25 percent
of unrealized capital gains of (iii) the lesser of (a) 10 percent of capital
surplus or (b) net investment income plus a three-year carryfoward with
dividends payable constrained to unassigned funds minus 25 percent of unrealized
capital gains. Alternatively, a Florida domestic insurer may pay a dividend or
distribution without the prior written approval of the Florida Department of
Financial Services (i) if the dividend is equal to or less than the greater of
(a) 10 percent of the insurer's capital surplus as regards policyholders derived
from realized net operating profits on its business and net realized capital
gains or (b) the insurer's entire net operating profits and realized net capital
gains derived during the immediately preceding calendar year, (ii) the insurer
will have policyholder capital surplus equal to or exceeding 115 percent of the
minimum required statutory capital surplus after the dividend or distribution,
(iii) the insurer files a notice of the dividend or distribution with the
Florida Department of Financial Services at least ten business days prior to the
dividend
48
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
payment or distribution and (iv) the notice includes a certification by an
officer of the insurer attesting that, after the payment of the dividend or
distribution, the insurer will have at least 115 percent of required statutory
capital surplus as to policyholders. Except as provided above, a Florida
domiciled insurer may only pay a dividend or make a distribution (i) subject to
prior approval by the Florida Department of Financial Services or (ii) 30 days
after the Florida Department of Financial Services has received notice of such
dividend or distribution and has not disapproved it within such time. No
dividends were declared or paid in 2002, 2001 or 2000.
Under these laws, Federated National would be permitted to pay
dividends of approximately $142,000 to the Company in 2003, and American Vehicle
would be permitted to pay $9,000 in dividends in 2003. Dividends in excess of
this amount require approval by the Florida Department of Financial Services.
There can be no assurance that, if requested, the Florida Department of
Financial Services will allow any dividends in excess of this amount to be paid
by Federated National.
The Company is required to comply with NAIC RBC requirements. RBC is a
method of measuring the amount of capital appropriate for an insurance company
to support its overall business operations in light of its size and risk
profile. NAIC's RBC standards are used by regulators to determine appropriate
regulatory actions relating to insurers who show signs of weak or deteriorating
condition. As of December 31, 2002, based on calculations using the appropriate
NAIC formula, both Federated National's and American Vehicle's total adjusted
capital are in excess of ratios, which would require any form of regulatory
action.
The NAIC has also developed IRIS ratios to assist state insurance
Department of Financial Services in identifying companies, which may be
developing performance or solvency problems, as signaled by significant changes
in the companies' operations. Such changes may not necessarily result from any
problems with an insurance company, but may merely indicate changes in certain
ratios outside the ranges defined as normal by the NAIC. When an insurance
company has four or more ratios falling outside "usual ranges," state regulators
may investigate to determine the reasons for the variance and whether corrective
action is warranted. As of December 31, 2002, Federated National was outside
NAIC's usual ranges with respect to its IRIS tests on 7 out of 12 ratios.
Federated National was not in the "usual ranges" primarily because of the loss
stemming from its other than temporary write down of the WorldCom bonds and
because of the short fall in Federated National's loss and LAE reserves in 2000
and 1999. IRIS ratios in excess of "usual ranges" relative to surplus growth
stemmed from the Company's infusion of $2.1 million into Federated National.
Federated National has carefully reviewed its loss and LAE reserves and
management believes that such reserves at December 31, 2002 are adequate.
American Vehicle was outside NAIC's usual ranges on six ratios primarily because
American Vehicle was in operation for the entire year 2002 as compared to 2001
when it resumed business in November. Prior to 2001 American Vehicle had not
written insurance policies since 1997 and was under capitalized. Management does
not currently believe that the Florida Department of Financial Services will
take any significant action with respect to Federated National or American
Vehicle regarding the IRIS ratios, although there can be no assurance that will
be the case.
Generally accepted accounting principles differ in some respects from
reporting practices prescribed or permitted by the Florida Department of
Financial Services. Federated National's statutory capital and surplus was $9.2
million and $5.7 million as of December 31, 2002 and 2001, respectively.
Federated National's statutory net loss was $2.1 million and $1.4 million for
the years ended December 31, 2001 and 2000, respectively. Statutory non-admitted
assets were approximately $45,000 and $395,000 as of December 31, 2002 and 2001,
respectively. American Vehicle's statutory capital and surplus was $4.0 million
and $3.1 million as of December 31, 2002 and 2001, respectively, and its
statutory net income was $135,000 and $64,000 for the years ended December 31,
2002 and 2001, respectively. Statutory non-admitted assets were approximately
$16,000 and $13,000 as of December 31, 2002 and 2001, respectively.
(11) COMMITMENTS AND CONTINGENCIES
In June 2000, a lawsuit was filed against the Company and its directors
and executive officers seeking compensatory damages on the basis of allegations
that the Company's amended registration statement dated November 4, 1998 was
inaccurate and misleading concerning the manner in which the Company recognized
ceded insurance commission income, in violation of Sections 11 and 15 of the
Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934. The lawsuit was filed in the United States District Court for the
Southern District of New York and seeks class action status. The plaintiff class
purportedly includes purchasers of the Company's common stock between November
5, 1998 and August 13, 1999. The Company believes that the lawsuit is without
merit and is vigorously defending such action. The Court recently denied the
Company's Motion to Dismiss the plaintiff's First Amended Complaint and the
Company filed an Answer and Affirmative Defenses.
49
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Prior to its acquisition by the Company in 2001, American Vehicle was
involved in litigation with a former officer and director. The litigation was
adjudicated and American Vehicle, among others, was found liable and paid the
final judgment. A petition was filed seeking costs of $136,000 and appellate
attorneys fees in excess of $2.0 million for fees American Vehicle's previous
owners have agreed to indemnify the Company against any such fees and costs and,
the $500,000 purchase price for American Vehicle is held in escrow pending
settlement of the fees and costs issued. On February 26, 2003, the 11th Judicial
Circuit in Miami, Florida entered an amended final judgment awarding the
plaintiffs $1,140,387 in attorney fees and costs. Both parties are appealing
this judgment. Management anticipates that there will be no costs associated
with the settlement of this case, consequently, no liability for fees and costs
have been accrued.
The Company is involved in other claims and legal actions arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations, or liquidity.
The Company, as a direct premium writer in the State of Florida, is
required to participate in certain insurer solvency pools under Florida Statutes
631.57(3)(a). Participation in these pools is based on the Company's written
premium by line of business to total premiums written statewide by all insurers.
Participation may result in assessments against the Company. The Company was
assessed $258,000 and $203,000, for the years ended December 31, 2002 and 2001,
respectively. During 2002 the Company recovered $180,000 of the 2001 assessment
and is entitled to recover all of these assessments as permitted by the state of
Florida through policy surcharges in 2003. For the years ended December 31, 2000
and 1999, no amounts were assessed against the Company.
Federated National and American Vehicle are also required to
participate in an insurance apportionment plan under Florida Statutes 627.351
referred to as a Joint Underwriting Association Plan ("JUA Plan"). The "JUA
Plan" shall provide for the equitable apportionment of any profits realized, or
losses and expenses incurred, among participating insurers. In the event of an
underwriting deficit incurred by the "JUA Plan" and the deficit is not recovered
through the policyholders in the "JUA Plan", such deficit shall be recovered
from the companies participating in the "Plan" in the proportion that the net
direct premiums of each such member written during the preceding calendar year
bear to the aggregate net direct premiums written in this state by all members
of the joint underwriting "JUA Plan".
No assessments by have been incurred by either insurance company
through the date of issuance of this report.
(12) LEASES
The Company leases office space under various lease agreements with
expiration dates through September 2016. Rental expense associated with
operating leases is charged to expense in the period incurred. Rental expenses
for 2002, 2001 and 2000 were approximately $756,000, $797,000 and $962,000,
respectively, and are included in operating and underwriting expenses in the
accompanying consolidated statements of operations.
At December 31, 2002, the minimum aggregate rental commitments are as
follows:
FISCAL YEAR LEASES
----------- ------
2003 $371,433
2004 250,693
2005 159,249
2006 67,885
Thereafter 236,547
----------
Total $1,085,807
==========
50
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(13) RELATED PARTY TRANSACTIONS
One of the Company's directors is a partner at a law firm that handles
the Company's claims litigation. Fees paid to this law firm amounted to
approximately $266,000, $530,000 and $533,000 for the years ended December 31,
2002, 2001 and 2000, respectively.
In September 2002, one of the Company's directors, who is also on the
Investment Committee, began to oversee an investment account for the Company.
Commission fees paid to this director in 2002 totaled $1,250.
Mortgage loan receivables in the amount of $227,391 as of December 31,
2000, represent secured loans to relatives of an officer of the Company.
(14) NET INCOME (LOSS) PER SHARE
Net income (loss) per share is computed by dividing net income (loss)
by the weighted average number of shares of common stock and common stock
equivalents outstanding during the periods presented. Options granted in
accordance with the Company's stock option plan are anti-dilutive and are not
taken into account in the computation.
At December 31, 2002, 2001 and 2000, warrants issued to two employees
to purchase 62,500 shares of common stock at $9 per share were outstanding. At
December 31, 2002, 2001 and 2000, warrants sold as part of an underwriting
agreement at a price of $0.0001 per warrant, entitling the holder to purchase
125,000 shares of common stock at $10.86 per share, were outstanding. All of
these potential common shares were excluded from the computation of net income
(loss) per share for 2002, 2001 and 2000 because their inclusion would have an
anti-dilutive effect.
A summary of the numerator and denominator of the basic net income
(loss) per share is presented below:
INCOME (LOSS) SHARE PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
For the year ended December 31, 2002:
Basic net (loss) per share ....... $ 4,570,201 3,005,626 $ 1.52
=========== ========= ========
For the year ended December 31, 2001:
Basic net (loss) per share ....... $ (992,090) 3,153,640 $ (0.31)
=========== ========= ========
For the year ended December 31, 2000:
Basic net (loss) per share ....... $ (522,874) 3,375,498 $ (0.15)
=========== ========= ========
(15) SEGMENT INFORMATION
The Company and its subsidiaries operate principally in two business
segments consisting of insurance and financing. The insurance segment consists
of underwriting through Federated National and American Vehicle, managing
general agent operations through Assurance MGA, claims processing through
Superior Adjusting and marketing and distribution through Federated Agency
Group, franchised agencies and independent agents. The insurance segment sells
primarily standard and nonstandard personal automobile insurance, as well as
homeowners and mobile home property and casualty insurance, and includes
substantially all aspects of the insurance, distribution and claims process. The
financing segment consists of premium financing through Federated Premium
Finance. The financing segment provides premium financing to the Company's
insureds, and is marketed through the Company's distribution network of
Company-owned agencies and franchised agencies.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies and practices. The Company
evaluates its business segments based on GAAP pretax operating earnings.
Corporate overhead expenses are not allocated to business segments. Transactions
between reportable segments are accounted for at fair value.
Operating segments that are not individually reportable are included in
the "All Other" category, which includes the operations of the parent holding
company.
51
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Information regarding components of operations for the years ended
December 31, 2002, 2001 and 2000 follows:
2002 2001 2000
---- ---- ----
TOTAL REVENUES
Insurance Segment
Earned Premiums $ 29,393,004 $ 20,255,561 $ 20,321,339
Investment Income (Loss) 1,253,215 (1,368,347) 499,331
Adjusting Income 2,886,838 2,605,893 1,858,326
MGA Fee Income 1,970,226 5,843,078 5,410,500
Commission Income 2,568,600 5,524,379 6,355,081
Other Income 812,622 342,044 142,439
------------ ------------ ------------
Total Insurance Revenue 38,884,505 33,202,608 34,587,016
------------ ------------ ------------
Financing Segment:
Premium finance income 3,657,942 4,503,994 4,575,674
Consumer loan interest -- 35,340 334,963
Pay advance interest 56,584 567,233 783,843
Miscellaneous Income -- (15,885) 15,368
------------ ------------ ------------
Total Financing Revenues 3,714,526 5,090,682 5,709,848
All Other 2,938,991 1,332,819 2,140,538
------------ ------------ ------------
Total Operating Segments 45,538,022 39,626,109 42,437,402
Intercompany Eliminations (4,958,477) (4,149,543) (4,883,795)
------------ ------------ ------------
Total Revenues $ 40,579,545 $ 35,476,566 $ 37,553,607
============ ============ ============
EARNINGS (LOSS) BEFORE INCOME TAXES
Insurance Segment $ 6,104,883 $ (4,813,846) $ (2,495,974)
Financing Segment 1,421,302 723,505 1,165,769
All Other 346,865 1,281,803 344,935
------------ ------------ ------------
Total Operating Segments 7,873,050 (2,808,538) (985,270)
Intercompany Eliminations -- -- --
------------ ------------ ------------
Total Earnings (Loss) before Income Taxes $ 7,873,050 $ (2,808,538) $ (985,270)
============ ============ ============
Information regarding total assets as of December 31, 2002 and 2001
follows:
TOTAL ASSETS 2002 2001
---- ----
Insurance Segment $66,663,775 $42,016,846
Finance Segment 7,548,841 10,556,012
All Others 3,003,827 3,633,623
----------- -----------
Total Operating Segments 77,216,443 56,206,481
Intercompany Eliminations (1,898,432) 22,096
----------- -----------
Total Assets $75,318,011 $56,228,577
=========== ===========
Supplemental segment information as of and for the year ended December
31, 2002, 2001 and 2000 follows:
2002 2001 2000
---- ---- ----
Deferred Policy Acquisition Costs -
Insurance Segment $ 7,721 $ 11,952 $ 1,192,260
Reserves for Unpaid Claims and Claim Adjustment
Expense - Insurance Segment 16,983,756 11,005,337 9,765,848
Unearned Premiums- Insurance Segment 28,934,486 14,951,228 13,038,417
Earned Premiums- Insurance Segment 29,393,004 20,255,561 20,321,339
Net Investment Income (Loss)
Insurance Segment (116,196) (1,368,347) 499,331
Other -- (476,670) 616,826
------------ ------------ ------------
Total Net Investment Income (Loss) (116,196) (1,845,017) 1,116,157
Claims and Adjustment Expenses Incurred Related
to Current Years- Insurance Segment 15,896,251 13,586,426 13,545,562
Claims and Adjustment Expenses Incurred Related
to Prior Years- Insurance Segment 90,874 2,568,476 1,444,556
Amortization of Deferred Acquisition Costs
Insurance Segment 4,450,127 4,210,523 4,617,951
Financing Segment 213,326 406,088 668,284
Eliminations (2,060,818) (3,149,373) (3,612,480)
------------ ------------ ------------
Total Amortization of
Deferred Acquisition Costs (2,064,314) 1,467,238 1,673,754
Paid Claims and Claim Adjustment Expense -
Insurance Segment 13,057,569 17,013,886 12,441,970
Net Premiums Written- Insurance Segment 37,749,640 21,481,934 24,448,673
52
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(16) STOCK COMPENSATION PLANS
On December 1998, the Company issued warrants to two employees to
purchase 62,500 shares of common stock of the Company at $9 per share. The
warrants vested immediately and are exercisable between December 1999 and
December 2004, at which time if they have not been exercised, they will be
canceled. The estimated fair value of these warrants at the date issued was
approximately $226,000 using a Black-Scholes option pricing model and
assumptions similar to those used for valuing the Company's stock options as
described below. As of December 31, 2002, no warrants have been exercised.
The Company implemented a stock option plan in November 1998 that
provides for the granting of stock options to officers, key employees and
consultants. The objectives of this plan includes attracting and retaining the
best personnel, providing for additional performance incentives, and promoting
the success of the Company by providing employees the opportunity to acquire
common stock. Options outstanding under this plan have been granted at prices,
which are either equal to or above the market value of the stock on the date of
grant, vest over a four-year period, and expire ten years after the grant date.
Under this plan, the Company is authorized to grant options to purchase up to
600,000 common shares, and, as of December 31, 2002, the Company had granted
options to purchase 534,338 shares.
In 2001, the Company implemented a franchisee stock option plan that
provides for the granting of stock options to individuals purchasing Company
owned agencies which are then converted to franchised agencies. The purpose of
the plan is to advance the interests of the Company by providing an additional
incentive to encourage managers of Company owned agencies to purchase the
agencies and convert them to franchises. Options outstanding under the plan have
been granted at prices, which are above the market value of the stock on the
date of grant, vest over a ten-year period, and expire ten years after the grant
date. Under this plan, the Company is authorized to grant options to purchase up
to 689,000 common shares, and, as of December 31, 2002, the Company had granted
options to purchase 78,155 shares.
In 2002, the Company implemented its 2002 Option Plan. The purpose of
this Plan is to advance the interests of the Company, by providing an additional
incentive to attract, retain and motivate highly qualified and competent persons
who are key to the Company, including key employees, consultants, independent
contractors, Officers and Directors, upon whose efforts and judgment the success
of the Company and its Subsidiaries is largely dependent, by authorizing the
grant of options to purchase Common Stock of the Company to persons who are
eligible to participate hereunder, thereby encouraging stock ownership in the
Company by such persons, all upon and subject to the terms and conditions of the
Plan. Options outstanding under the plan have been granted at prices, which are
above the market value of the stock on the date of grant, vest over a five-year
period, and expire six years after the grant date. Under this plan, the Company
is authorized to grant options to purchase up to 1,200,000 common shares, and,
as of December 31, 2002, the Company had granted options to purchase 727,000
shares.
Activity in the Company's stock option plans for the period from
January 1, 2000 to December 31, 2002 is summarized below:
1998 PLAN 2001 FRANCHISE PLAN 2002 PLAN
--------- ------------------- ---------
Weighted Weighted Weighted
Number Avg. Option Number Avg. Option Number Avg. Option
of Shares Exercise Price of Shares Exercise Price of Shares Exercise Price
Outstanding at December 31, 1999 472,510 $10
Granted 136,500 $10
Exercised --
Canceled (121,039) $10
--------
Outstanding at December 31, 2000 487,971 $10 --
Granted 20,000 $10 83,830 $10
Exercised -- --
Canceled (95,399) $10 --
-------- --
Outstanding at December 31, 2001 412,572 $10 83,830 $10
Granted 228,265 $10 -- 783,000 $13.35
Exercised (1,000) $10 -- --
Canceled (105,499) $10 (5,675) $10 (56,000) $13.35
-------- ------ -------
Outstanding at December 31, 2002 534,338 $10 78,155 $10 727,000 $13.35
======== ====== =======
53
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Options outstanding as of December 31, 2002 are exercisable as follows:
1998 PLAN 2001 FRANCHISE PLAN 2002 PLAN
--------- ------------------- ---------
Weighted Weighted Weighted
Number Avg. Option Number Avg. Option Number Avg. Option
Options Exercisable at: of Shares Exercise Price of Shares Exercise Price of Shares Exercise Price
2002 291,509 $10 7,815 --
2003 84,991 $10 6,016 $10 143,000 $13.35
2004 64,705 $10 6,915 $10 143,000 $13.35
2005 48,316 $10 6,916 $10 143,000 $13.35
2006 44,817 $10 6,915 $10 143,000 $13.35
Thereafter -- -- 43,578 $10 155,000 $13.35
------- ------ -------
534,338 $10 78,155 $10 727,000 $13.35
======= ====== =======
The Company continues to account for stock-based compensation using the
intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,
under which no compensation cost for stock options is recognized for stock
option awards granted to employees at or above fair market value. Had
compensation expense for the Company's stock compensation plan been determined
based upon fair values at the grant dates for awards under the plan in
accordance with SFAS No. 123, the Company's net income (loss) and net income
(loss) per share would have been reduced (increased) to the pro forma amounts
indicated below. Additional stock option awards are anticipated in future years.
Net income (loss) 2002 2001 2000
---- ---- ----
As reported $4,570,201 $(992,090) $(522,874)
Pro forma $2,819,673 $(1,181,855) $(741,191)
Net income (loss) per share
As reported $1.52 $(0.31) $(0.15)
Pro forma $0.94 $(0.37) $(0.22)
The weighted average fair value of options granted during 2002, 2001
and 2000 estimated on the date of grant using the Black-Scholes option-pricing
model was $2.17 to $8.06 in 2002; $2.38 to $2.92 in 2001; and $2.79 to $6.23 in
2000. The fair value of options granted is estimated on the date of grant using
the following assumptions:
2002 2001 2000
---- ---- ----
Dividend yield .073%-3.50% 2.68%-3.20% 0.00%
Expected volatility 120.22% 136%-152% 73%-93%
Risk-free interest rate 4.49%-5.82% 4.89%-5.29% 5.75%
Expected life (in years) 4.83-7.02 10 10
Summary information about the Company's stock options outstanding at
December 31, 2002:
Weighted Average Weighted
Range of Outstanding Contractual Average Exercisable
Exercise Price at 12/31/02 Periods in Years Exercise Price at 12/31/02
-------------- ----------- ---------------- -------------- -----------
1998 Plan $10.00 534,338 7.2 $10.00 291,509
2001 Franchise Plan $10.00 78,155 7.5 $10.00 7,815
2002 Plan $12.50-$13.75 727,000 5.4 $13.35 --
(17) EMPLOYEE BENEFIT PLAN
The Company has established a profit sharing plan under Section 401(k)
of the Internal Revenue Code. This plan allows eligible employees to contribute
up to 15 percent of their compensation on a pre-tax basis, not to exceed
statutory limits. For the years ended December 31, 2002 and 2001, the Company
did not contribute to the plan. For the year ended December 31, 2000, the
Company declared a discretionary match of 50 percent of the first 6 percent of
the employees' contribution. Such matching Company contributions are vested
incrementally over five years. The charge to operations for the Company's
matching contribution was approximately $143,000 in 2000.
54
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(18) ACQUISITIONS
In August 2001, the Company purchased all of the outstanding stock and
all of the outstanding surplus notes of American Vehicle for $500,000 in cash.
In addition, the Company agreed to pay two executives of American Vehicle a
finders' fee of $400,000 over a period of three years. Income and expenses of
American Vehicle beginning September 1, 2001 are included in the Company's
Consolidated Statements of Operations. The fair value of the net assets (which
consisted primarily of marketable securities) of American Vehicle at the date of
acquisition was approximately $2.1 million. In accordance with SFAS No. 141,
Business Combinations, the excess of the fair value of the net assets purchased
over the purchase price has been reported as an extraordinary gain in the
accompanying Consolidated Statements of Operations.
American Vehicle was organized and incorporated as a multi-line
property and casualty insurance company and primarily wrote nonstandard private
passenger automobile liability and physical damage coverage. Pursuant to a
January 8, 1998, consent order entered into with the Florida Department of
Financial Services, American Vehicle ceased writing new or renewal business and
pursuant to an additional consent order, the Company had been placed in
Administrative Supervision effective March 2, 2001. Pursuant to a third consent
order as of August 30, 2001, the two previous consent orders were vacated and
the Florida Department of Financial Services approved this acquisition. Also,
pursuant to the third consent order, American Vehicle is not allowed to pay
dividends for three years without the Florida Department of Financial Services
approval and all contracts with affiliates must also be approved by the Florida
Department of Financial Services.
The Consolidated Balance Sheet at December 31, 2001 includes the
balance sheet of American Vehicle. The Consolidated Statements of Operations for
the year ended December 31, 2001 and the Consolidated Statement of Cash Flow for
the year ended December 31, 2001 include American Vehicle from the acquisition
date (August 30, 2001) through December 31, 2001.
Unaudited pro forma results of operations giving effect to the
acquisition as of the beginning of each year presented are as follows:
2001 2000
---- ----
Revenue $35,545,435 $37,813,233
Income before extraordinary gain (2,270,396) (637,823)
Extraordinary gain 1,185,895 1,185,895
Net income (1,084,501) 548,072
Earnings (loss) per share and earnings
(loss) per share assuming dilution
Net income (loss) before
extraordinary gain $(0.72) $(0.19)
Extraordinary gain 0.38 0.35
Net income (loss) (0.34) 0.16
The above pro forma information is not necessarily indicative of the
results of operations that would have occurred had the acquisition taken place
as of the beginning of each period reported, or of results, which may occur in
the future.
(19) COMPREHENSIVE INCOME (LOSS)
Reclassification adjustments related to the investment securities
included in comprehensive income (loss) for the years ended December 31, 2002,
2001 and 2000 are as follows:
2002 2001 2000
---- ---- ----
Unrealized holdings net gains (losses) arising
during the year $(103,764) $ 143,925 $(665,931)
Reclassification adjustment for (gains) losses
included in net income 90,197 1,722,421 576,827
--------- ---------- - -------
(13,567) 1,866,346 (89,104)
Tax effect 4,613 784,079 33,530
--------- ---------- ---------
Net depreciation on investment securities $ (8,954) $1,082,267 $ (55,574)
========= ========== =========
55
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(20) AUTHORIZATION OF PREFERRED STOCK
The Company's Amended and Restated Articles of Incorporation authorize
the issuance of one million shares of preferred stock with designations, rights
and preferences determined from time to time by its board of directors.
Accordingly, the Company's board of directors is empowered, without shareholder
approval, to issue preferred stock with dividends, liquidation, conversion,
voting or other rights that could adversely affect the voting power or other
rights of the holders of common stock. The Company has not issued preferred
shares as of December 31, 2002.
(21) 21ST CENTURY HOLDING COMPANY
The following summarizes the major categories of 21st Century Holding
Company's (parent company only) financial statements:
Condensed Balance Sheets
ASSETS 2002 2001
---- ----
Cash and cash equivalents ..................................... $ 22,349 $ 3,853
Investments and advances to subsidiaries ...................... 16,198,995 11,664,309
Deferred income taxes ......................................... 800,077 1,414,829
Property, plant and equipment, net ............................ 820,466 939,213
Other assets .................................................. 843,095 909,315
------------ ------------
Total assets ............................................. $ 18,684,982 $ 14,931,519
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Bank overdraft ................................................ $ 11,372 $ 83,583
Other liabilities ............................................. 580,549 638,805
------------ ------------
Total liabilities ........................................ 591,921 722,388
------------ ------------
Shareholders' equity:
Common stock ................................................ 34,117 34,107
Additional paid-in capital .................................. 12,855,553 12,833,146
Accumulated other comprehensive deficit ..................... (231,704) (218,137)
Retained earnings ........................................... 6,521,027 2,400,301
Treasury stock .............................................. (1,085,932) (840,286)
------------ ------------
Total shareholders' equity ............................... 18,093,061 14,209,131
------------ ------------
Total liabilities and shareholders' equity ............... $ 18,684,982 $ 14,931,519
============ ============
Condensed Statements of Operations
2002 2001 2000
---- ---- ----
Revenue:
Management fees from subsidiaries ................. $ 1,885,000 $ 2,939,000 $ 3,452,500
Equity in income (loss) of subsidiaries ........... 5,605,148 (2,933,999) (1,497,354)
Net investment income (loss) ...................... -- (477,445) 688,547
Other income ...................................... 95,283 155,149 101,280
----------- ----------- -----------
Total revenue .................................. 7,585,431 (317,295) 2,744,973
----------- ----------- -----------
Expenses:
Advertising ....................................... 140,287 958,082 1,477,055
Salaries and wages ................................ 457,856 173,777 938,906
Other expenses .................................... 733,811 886,536 1,568,118
----------- ----------- -----------
Total expenses ................................. 1,331,954 2,018,395 3,984,079
----------- ----------- -----------
Income (loss) before provision for income tax expense
and extraordinary gain ............................ 6,253,477 (2,335,690) (1,239,106)
Benefit (expense) for income tax .................... (1,683,276) 157,705 716,232
----------- ----------- -----------
Net income (loss) before extraordinary gain .... 4,570,201 (2,177,985) (522,874)
Extraordinary gain .................................. -- 1,185,895 --
----------- ----------- -----------
Net income (loss) .............................. $ 4,570,201 $ (992,090) $ (522,874)
=========== =========== ===========
56
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Condensed Statements of Cash Flow
2002 2001 2000
---- ---- ----
Cash flow from operating activities:
Net income (loss) .............................................. $ 4,570,201 $ (992,090) $ (522,874)
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Equity in income (loss) of subsidiaries ..................... (2,505,148) 2,933,999 1,497,354
Depreciation and amortization of property plant and equipment 126,295 174,646 209,917
Deferred income tax expense ................................. (497,655) (132,284) (1,096,850)
Net realized investment (gains) losses ...................... -- 477,445 (687,397)
Extraordinary Gain .......................................... -- (1,185,895) --
Changes in operating assets and liabilities:
Other assets ............................................ 66,220 (37,347) 92,573
Other Liabilities ....................................... (58,256) 231,246 488,511
------------ ------------ ------------
Net cash provided by (used in) operating activities ................ 1,701,657 1,469,720 (18,766)
------------ ------------ ------------
Cash flow from investing activities:
Proceeds from sale of investment securities available for sale . -- 31,944,339 18,526,882
Purchases of investment securities available for sale .......... -- (31,382,730) (18,878,539)
Purchases of property and equipment ............................ (13,322) -- (254,629)
Increased capital of subsidiaries .............................. (3,100,000) -- --
Cash dividends received from subsidiaries ...................... -- 2,300,000 --
Net cash used in acquisitions .................................. -- (900,000) --
------------ ------------ ------------
Net cash provided by (used in) investing activities ................ (3,113,322) 1,961,609 (606,286)
------------ ------------ ------------
Cash flow from financing activities:
Bank overdraft ................................................. (72,211) 83,583 (35,969)
Dividends paid ................................................. (449,475) (249,675) (67,260)
Purchases of treasury stock .................................... (245,646) (784,798) (291,339)
Advances from (to) subsidiaries ................................ 2,197,493 (2,812,133) 1,667,990
Repayment of indebtedness ...................................... -- -- (312,823)
------------ ------------ ------------
Net cash provided by (used in) financing activities ................ 1,430,161 (3,763,023) 960,599
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents ............... 18,496 (331,694) 335,547
Cash and cash equivalents at beginning of year ..................... 3,853 335,547 --
------------ ------------ ------------
Cash and cash equivalents at end of year ........................... $ 22,349 $ 3,853 $ 335,547
============ ============ ============
(22) SUBSEQUENT EVENTS
Subsequent to December 31, 2002 and the date of presentation 26, 600
options were exercised for $266,000 and two FedUSA franchise agreements were
terminated.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
- ------- ---------------------------------------------
ON ACCOUNTING AND FINANCIAL DISCLOSURE
--------------------------------------
Previously reported on Form 8-K as amended.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
- -------- ----------------------------------------------------
PERSONS, COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
----------------------------------------------------------
The information contained under the caption "Election of Directors" to
appear in the Company's definitive proxy statement relating to the Company's
Annual Meeting of Shareholders, which definitive proxy statement will be filed
with the Securities and Exchange Commission not later than 120 days after the
end of the Company's fiscal year covered by this report on Form 10-K (herein
referred to as the "Annual Meeting Proxy Statement") is incorporated herein by
reference.
Information regarding executive officers is included in Part I of this
Form 10-K as permitted by General Instruction G (3).
57
ITEM 11. EXECUTIVE COMPENSATION
- -------- ----------------------
The information contained under the caption "Executive Compensation" to
appear in the Annual Meeting Proxy Statement is incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------- --------------------------------------------------------------
The information contained under the caption "Beneficial Security
Ownership" to appear in the Annual Meeting Proxy Statement is incorporated by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------- ----------------------------------------------
The information contained under the caption "Certain Transactions" to
appear in the Annual Meeting Proxy Statement is incorporated by reference.
ITEM 14. INTERNAL CONTROLS
- -------- -----------------
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
An evaluation of the effectiveness of the design and operation of the
Company's disclosure controls and procedures within 90 days of this report was
carried out by the Company under the supervision and with the participation of
the Company's management, including the Chief Executive Officer and Chief
Financial Officer. Based on that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures have been designed and are being operated in a manner that provides
reasonable assurance that the information required to be disclosed by the
Company in reports filed under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms. A controls system, no matter how well designed and
operated, cannot provide absolute assurance that the objectives of the controls
system are met, and no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, within a company have
been detected.
(b) CHANGES IN INTERNAL CONTROLS
Subsequent to the date of the most recent evaluation of the Company's
internal controls, there were no significant changes in the Company's internal
controls or in other factors that could significantly affect the internal
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
58
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K
- -------- ---------------------------------------------------------------
(a) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT:
(1) Financial Statements
The following consolidated financial statements of the Company
and the reports of independent auditors thereon are filed with
this report:
Independent Auditors' Report (De Meo, Young, McGrath).
Independent Auditors' Report (McKean, Paul, Chrycy, Fletcher &
Co.).
Consolidated Balance Sheets as of December 31, 2002 and 2001.
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000.
Consolidated Statements of Shareholders' Equity and
Comprehensive Income (Loss) for the years ended December 31,
2002, 2001 and 2000.
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000.
Notes to Consolidated Financial Statements for the years ended
December 31, 2002, 2001 and 2000.
(2) Financial Statement Schedules.
Schedules are omitted because the conditions requiring their
filing are not applicable or because the required information
is provided in the Consolidated Financial Statements,
including the Notes thereto.
(3) Exhibits
59
EXHIBIT DESCRIPTION
------- -----------
3.1 Amended and Restated Articles of Incorporation (1)
3.2 Form of Registrant's Amended and Restated Bylaws (1)
4.1 Specimen of Common Stock Certificate (1)
4.2 Revised Representative's Warrant Agreement including form of
Representative's Warrant (2)
10.1 Stock Option Plan, as amended (3)*
10.2 Employment Agreement between the Registrant and Edward J.
Lawson (1)*
10.3 Employment Agreement between the Registrant and Michele V.
Lawson (1)*
10.4 Form of Indemnification Agreement between the Registrant and
its directors and executive officers (1)*
10.5 Revolving Credit and Term Loan Agreement between FlatIron
Funding Company, LLC and FPF, Inc., as amended (1)
10.9 Employment Agreement between Registrant and Richard A.
Widdicombe (4)*
10.12 Third Modification Agreement to Revolving Credit and Term Loan
Agreement between FlatIron Funding Company, LLC and FPF, Inc.,
and Sale and Assignment Agreement between Federated Premium
and FPF, Inc. (5)
10.13 Fourth Modification Agreement to Revolving Credit and Term
Loan Agreement between Federated Premium Finance, Inc.,
FlatIron Funding Company, LLC, FlatIron Funding Company and
FlatIron Credit Company, Inc. (6)
10.14 Sale and Assignment Agreement between Federated Premium
Finance, Inc. and FPF, Inc. (6)
10.15 Premium Receivable Servicing Agreement between Federated
Premium Finance, Inc. and FPF, Inc. (6)
10.21 First Modification Agreement between Federated Premium
Finance, Inc. and FPF, Inc. (7)
16.1 Letter from McKean, Paul, Chrycy, Fletcher & Co. (8)
21.1 Subsidiaries of the Registrant (6)
23.1 Consent of McKean, Paul, Chrycy, Fletcher & Co., Independent
Certified Public Accountants (9)
23.2 Consent of KPMG LLP, Independent Certified Public Accountants
(9)
99.1 Statements Required by 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (7)
99.2 Form S-8 filed January 14, 2003 to register 1998 Stock Option
Plan as amended, 2001 Franchise Program Stock Option Plan,
2002 Stock Option Plan, Warrant to Purchase 12,500 Shares of
Common Stock, and Warrant to Purchase 50,000 Shares of Common
Stock and incorporated herein by reference.
- ------------------
* Management Compensation Plan or Arrangement
(1) Previously filed exhibit of the same number to the Registrant's
Registration Statement on Form SB-2 (File No. 333-63623) and
incorporated herein by reference.
(2) Previously filed exhibit of the same number of the 1998 Annual Report
on Form 10-KSB.
(3) Previously as an exhibit on the Company's 2000 Annual Meeting Proxy
Statement.
(4) Previously filed exhibit of the same number of the 1999 Annual Report
on Form 10-KSB.
(5) Previously filed exhibit of the same number of the 2000 Annual Report
on Form 10-KSB.
(6) Previously filed exhibit of the same number of the 2001 Annual Report
on Form 10-K.
(7) Filed herewith.
(8) Previously filed exhibit of the same number of Form 8-K
(File No. 000-25001).
(9) Previously filed exhibit of the same number of Form S-8, filed on
January 16, 2003.
(b) REPORTS ON FORM 8-K
On December 3, 2002, the Board of Directors of 21st Century
Holding Company (the "Company") recommended and approved the
replacement of its principal accountants, McKean, Paul, Chrycy,
Fletcher and Co. ("McKean"). Also, on December 3, 2002 the Board of
Directors recommended and approved the replacement firm of De Meo,
Young, McGrath as its independent auditors, effective December 5, 2002.
60
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereto duly authorized.
21ST CENTURY HOLDING COMPANY
By: /s/ Edward J. Lawson
--------------------------------------------------
Edward J. Lawson, Chairman of the Board,
President and Chief Executive Officer
/s/ James G. Jennings III
--------------------------------------------------
James G. Jennings III, Chief Financial Officer
Dated: April 10, 2003
Pursuant to the requirements of the Exchange Act of 1934, this Report
has been signed by the following persons on behalf of he registrant and in the
capacities and on the date indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Edward J. Lawson Chairman of the Board, April 10, 2003
- --------------------------- President and Chief Executive
Edward J. Lawson Officer (Principal Executive Officer)
/s/ James G. Jennings III Chief Financial Officer (Principal April 10, 2003
- --------------------------- Financial and Accounting Officer)
James G. Jennings III
/s/ Michele V. Lawson Treasurer and Director April 10, 2003
- ---------------------------
Michele V. Lawson
/s/ Richard A. Widdicombe President, Federated National, American April 10, 2003
- --------------------------- Vehicle, Assurance MGA and Director
Richard A. Widdicombe
/s/ Carl Dorf Director April 11, 2003
- ---------------------------
Carl Dorf
/s/ Bruce Simberg Director April 11, 2003
- ---------------------------
Bruce Simberg
/s/ Charles B. Hart, Jr. Director April 11, 2003
- ---------------------------
Charles B. Hart, Jr.
/s/ Richard W. Wilcox, Jr. Director April 11, 2003
- ---------------------------
Richard W. Wilcox, Jr.
/s/ James DePelisi Director April 11, 2003
- ---------------------------
James DePelisi
61
CERTIFICATIONS
I, Edward J. Lawson, certify that:
- ----------------------------------
1. I have reviewed this annual report on Form 10-K of 21st Century Holding
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 10, 2003.
/s/ Edward J. Lawson
- -----------------------
Chief Executive Officer
62
CERTIFICATIONS - (CONTINUED)
I, James G. Jennings III, certify that:
1. I have reviewed this annual report on Form 10-K of 21st Century Holding
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 10, 2003.
/s/ J. G. Jennings, III
- -----------------------
Chief Financial Officer
63