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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, 2003
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
- ------------------------------- ----------------
(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
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(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
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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
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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 March 29, 2004 was: $54,565,264.
As of March 29, 2004, there were 3,779,931 shares of the common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
21st Century Holding Company's definitive proxy statement for its 2004 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,
12,13 and 14 hereof.
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PART I....................................................................................................................5
ITEM 1. BUSINESS...................................................................................................5
GENERAL..............................................................................................................5
BUSINESS STRATEGY....................................................................................................5
INSURANCE OPERATIONS AND RELATED SERVICES............................................................................6
General...........................................................................................................6
Standard Automobile...............................................................................................7
Nonstandard Automobile............................................................................................7
Homeowners'.......................................................................................................7
Flood.............................................................................................................7
Mobile Home.......................................................................................................7
Commercial General Liability......................................................................................8
Future Products...................................................................................................8
Assurance MGA.....................................................................................................8
Superior Adjusting................................................................................................8
Federated Premium Finance.........................................................................................8
Tax Preparation Services and Ancillary Services..................................................................10
Franchise Operations.............................................................................................10
Marketing and Distribution..........................................................................................10
REINSURANCE.........................................................................................................11
LIABILITY FOR UNPAID LOSSES AND LAE.................................................................................12
COMPETITION.........................................................................................................15
REGULATION..........................................................................................................16
General..........................................................................................................16
Insurance Holding Company Regulation.............................................................................18
Finance Company Regulation.......................................................................................18
Franchise Company Regulation.....................................................................................18
Underwriting and Marketing Restrictions..........................................................................19
Legislation......................................................................................................19
Industry Ratings Services........................................................................................19
EMPLOYEES...........................................................................................................19
SENIOR MANAGEMENT...................................................................................................19
GLOSSARY OF SELECTED TERMS..........................................................................................19
ITEM 2. PROPERTIES...............................................................................................21
ITEM 3. LEGAL PROCEEDINGS........................................................................................21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................................................22
PART II..................................................................................................................23
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...................................23
(a) MARKET INFORMATION..........................................................................................23
(b) HOLDERS.....................................................................................................23
(c) DIVIDENDS...................................................................................................23
(d) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS..........................................23
ITEM 6. SELECTED FINANCIAL DATA...................................................................................24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL.........................................................25
CONDITION AND RESULTS OF OPERATIONS......................................................................................25
OVERVIEW............................................................................................................25
CRITICAL ACCOUNTING POLICIES........................................................................................26
ACCOUNTING CHANGES..................................................................................................26
ANALYSIS OF FINANCIAL CONDITION.....................................................................................27
AS OF DECEMBER 31, 2003 AS COMPARED TO DECEMBER 31, 2002.......................................................27
Investments.................................................................................................27
Receivable for investments sold.............................................................................27
Finance Contracts...........................................................................................27
Prepaid Reinsurance Premiums................................................................................27
Premiums Receivable.........................................................................................28
Reinsurance Recoverable - net...............................................................................28
Deferred Acquisition Costs - net............................................................................28
Income Tax Recoverable......................................................................................28
Property Plant and Equipment................................................................................28
Goodwill....................................................................................................28
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Other Assets................................................................................................28
Unpaid Losses and Loss Adjustment Expenses..................................................................29
Unearned Premium............................................................................................29
Income Taxes Payable........................................................................................29
Subordinated Debt...........................................................................................29
RESULTS OF OPERATIONS..........................................................................................29
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002..........................................29
Gross Premiums Written......................................................................................29
Gross Premiums Ceded........................................................................................29
Increase (Decrease) in Prepaid Reinsurance Premiums.........................................................30
Increase in Unearned Premiums...............................................................................30
Managing General Agent Fees.................................................................................30
Net Investment Income.......................................................................................30
Net Realized Investment Gains (Losses)......................................................................30
Losses and LAE..............................................................................................30
Salaries and Wages..........................................................................................31
Deferred Policy Acquisition Costs...........................................................................31
RESULTS OF OPERATIONS..........................................................................................31
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001..........................................31
Gross Premiums Written......................................................................................31
Gross Premiums Ceded........................................................................................31
Increase (Decrease) in Prepaid Reinsurance Premiums.........................................................31
Increase in Unearned Premiums...............................................................................31
Managing General Agent Fees.................................................................................31
Net Realized Investment Gains (Losses)......................................................................31
Losses and Loss Adjustment Expenses.........................................................................32
Deferred Policy Acquisition Costs...........................................................................32
Extraordinary Gain..........................................................................................32
LIQUIDITY AND CAPITAL RESOURCES..................................................................................32
IMPACT OF INFLATION AND CHANGING PRICES..........................................................................35
SELECTED QUARTERLY FINANCIAL DATA (Unaudited)....................................................................36
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.................................................37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................................................39
INDEPENDENT AUDITORS' REPORT........................................................................................40
CONSOLIDATED BALANCE SHEETS......................................................................................42
CONSOLIDATED STATEMENTS OF OPERATIONS............................................................................43
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS).......................44
CONSOLIDATED STATEMENTS OF CASH FLOWS............................................................................45
CONSOLIDATED STATEMENTS OF CASH FLOWS............................................................................46
Notes to Consolidated Financial Statements.......................................................................47
(1) ORGANIZATION AND BUSINESS..................................................................................47
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES...................................................47
(a) CASH AND CASH EQUIVALENTS...............................................................................47
(b) INVESTMENTS.............................................................................................47
(c) PREMIUM REVENUE.........................................................................................48
(d) DEFERRED ACQUISITION COSTS..............................................................................48
(e) PREMIUM DEPOSITS........................................................................................48
(f) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES..............................................................48
(g) COMMISSION INCOME.......................................................................................49
(h) FINANCE REVENUE.........................................................................................49
(i) CREDIT LOSSES...........................................................................................49
(j) MANAGING GENERAL AGENT FEES.............................................................................49
(k) POLICY FEES.............................................................................................49
(l) REINSURANCE.............................................................................................49
(m) INCOME TAXES............................................................................................50
(n) CONTINGENT REINSURANCE COMMISSION.......................................................................50
(o) CONCENTRATION OF CREDIT RISK............................................................................50
(p) ACCOUNTING CHANGES......................................................................................50
(q) USE OF ESTIMATES........................................................................................50
(r) NATURE OF OPERATIONS....................................................................................51
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(s) FAIR VALUE..............................................................................................51
(t) GOODWILL................................................................................................51
(u) STOCK OPTION PLANS......................................................................................52
(v) PROPERTY, PLANT AND EQUIPMENT...........................................................................53
(w) RECLASSIFICATIONS.......................................................................................53
(3) INVESTMENTS................................................................................................53
(a) FIXED MATURITIES AND EQUITY SECURITIES..................................................................53
(b) MORTGAGE LOANS..........................................................................................55
(4) FINANCE CONTRACTS, CONSUMER LOANS AND PAY ADVANCES RECEIVABLE..............................................56
(5) PROPERTY, PLANT AND EQUIPMENT..............................................................................57
(6) REINSURANCE................................................................................................58
(7) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES.................................................................59
(8) REVOLVING CREDIT OUTSTANDING...............................................................................60
(9) INCOME TAXES...............................................................................................61
(10) REGULATORY REQUIREMENTS AND RESTRICTIONS..................................................................63
(11) COMMITMENTS AND CONTINGENCIES.............................................................................64
(12) LEASES....................................................................................................65
(13) RELATED PARTY TRANSACTIONS................................................................................65
(14) NET INCOME (LOSS) PER SHARE...............................................................................65
(15) SEGMENT INFORMATION.......................................................................................66
(16) STOCK COMPENSATION PLANS..................................................................................68
(17) EMPLOYEE BENEFIT PLAN.....................................................................................70
(18) ACQUISITIONS..............................................................................................70
(19) COMPREHENSIVE INCOME (LOSS)...............................................................................71
(20) AUTHORIZATION OF PREFERRED STOCK..........................................................................72
(21) 21ST CENTURY HOLDING COMPANY.............................................................................72
(22) SUBORDINATED DEBT.........................................................................................74
(23) SCHEDULE VI - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS..................76
(24) SUBSEQUENT EVENTS.........................................................................................76
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........................77
ITEM 9A. CONTROLS AND PROCEDURES...................................................................................77
(a) Evaluation of disclosure controls and procedures......................................................77
(b) CHANGES IN INTERNAL CONTROLS................................................................................77
PART III.................................................................................................................77
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................................................77
ITEM 11. EXECUTIVE COMPENSATION....................................................................................77
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................................77
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................................77
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.................................................................77
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K...........................................78
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General information about 21st Century Holding Company can be found at
www.fedusa.com. We make our 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 our 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 us; risks related to the
nature of our business; dependence on investment income and the composition of
our investment portfolio; the adequacy of our liability for loss and loss
adjustment expense ("LAE"); insurance agents; claims experience; 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 us
in this report, and our 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. We undertake 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
We are a vertically integrated insurance holding company, which, through
our subsidiaries, controls substantially all aspects of the insurance
underwriting, distribution and claims process. We underwrite personal automobile
insurance, general liability insurance, flood insurance, homeowners' insurance
and mobile home property and casualty insurance in Florida and Georgia through
our wholly owned subsidiaries, Federated National Insurance Company and American
Vehicle Insurance Company. American Vehicle was approved in August 2003 to be a
foreign insurer in the State of Georgia. During the year ended December 31,
2003, 67.5%, 23.0%, 2.4% and 7.1% of the policies we underwrote were for
personal automobile insurance, homeowners' property and casualty insurance,
mobile home property and casualty insurance and commercial general liability
insurance, respectively. We internally process claims made by our own and third
party insureds through our wholly owned claims adjusting company, Superior
Adjusting, Inc. We also offer premium financing to our own and third-party
insureds through our wholly owned subsidiary, Federated Premium Finance, Inc.
BUSINESS STRATEGY
Our strategy is to seek continued growth of our business by capitalizing
on the efficiencies of our vertical integration and by:
o expanding into additional states. Currently, we have applied to
obtain licenses to underwrite and sell our insurance products in
Alabama, North Carolina and Louisiana;
o a shift in emphasis of our product mix away from nonstandard
automobile to a emphasis on homowners' and commercial general
liability lines of insurance and by expanding our product offerings
to include other commercially viable insurance products, subject to
regulatory approval;
o expanding our agency network primarily through the sale of FedUSA
franchises;
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o employing our business practices developed and used in Florida in
our expansion to other selected states;
o maintaining a commitment to provide quality service to our agents
and insureds by emphasizing customer service;
o encouraging agents to place a high volume of quality business with
us by providing them with attractive commission structures tied to
premium levels and loss ratios; and
o expanding our EXPRESSTAX franchises to all 50 states.
INSURANCE OPERATIONS AND RELATED SERVICES
GENERAL.
We underwrite personal automobile insurance, homeowners' and mobile home
property insurance and casualty insurance through Federated National and
personal automobile and commercial general liability insurance through American
Vehicle. Federated National and American Vehicle are both currently licensed to
conduct business in Florida. American Vehicle is licensed to conduct business in
Georgia as a foreign insurer.
The following tables set forth the amount and percentages of our gross
premiums written, premiums ceded to reinsurers and net premiums written by line
of business for the periods indicated.
Years Ended December 31,
------------------------
2003 2002 2001
----------------- ----------------- -----------------
Premium Percent Premium Percent Premium Percent
------- ------- ------- ------- ------- -------
(Dollars in Thousands)
Gross written premiums:
Automobile $49,298 67.5% $52,586 83.4% $24,743 72.2%
Homeowners 16,804 23.0% 8,670 13.8% 7,662 22.4%
Mobile Home 1,739 2.4% 1,780 2.8% 1,866 5.4%
Commercial General Liability 5,150 7.1% -- 0.0% -- 0.0%
------- ----- ------- ----- ------- -----
Total gross written premiums $72,991 100.0% $63,036 100.0% $34,271 100.0%
======= ===== ======= ===== ======= =====
Ceded premiums:
Automobile $19,498 100.0% $25,286 100.0% $12,789 100.0%
Homeowners -- 0.0% -- 0.0% -- 0.0%
Mobile Home -- 0.0% -- 0.0% -- 0.0%
Commercial General Liability -- 0.0% -- 0.0% -- 0.0%
------- ----- ------- ----- ------- -----
Total ceded premiums $19,498 100.0% $25,286 100.0% $12,789 100.0%
======= ===== ======= ===== ======= =====
Net written premiums
Automobile $29,800 55.7% $27,300 72.3% $11,954 55.6%
Homeowners 16,804 31.4% 8,670 23.0% 7,662 35.7%
Mobile Home 1,739 3.3% 1,780 4.7% 1,866 8.7%
Commercial General Liability 5,150 9.6% -- 0.0% -- 0.0%
------- ----- ------- ----- ------- -----
Total net written premiums $53,493 100.0% $37,750 100.0% $21,482 100.0%
======= ===== ======= ===== ======= =====
We market our insurance products through a network of Company-owned
agencies, franchised agencies, independent agents and general agents.
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STANDARD AUTOMOBILE.
Standard personal automobile insurance is principally provided to
insureds who present an average risk profile in terms of 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. We underwrite
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. The approximate
average premium on the policies currently in force is approximately $1,472.
NONSTANDARD AUTOMOBILE.
Nonstandard personal automobile insurance is principally provided to
insureds who are unable to obtain standard insurance coverage because of their
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 mitigated
because premiums usually are written at higher rates than those written for
standard insurance coverage and because approximately 32% of the policies issued
by the company provide the minimum coverage required of the policyholder by
statute and provide no bodily injury coverage. We currently underwrite
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 $751.
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. Our experience has been that a significant number of existing
nonstandard policyholders allow their policies to lapse and then reapply for
insurance as new policyholders. Our average policy renewal rate is 35% to 40% on
policies that mature to full term. The success of our nonstandard automobile
insurance program, therefore, depends in part on our ability to replace
non-renewing insureds with new policyholders through marketing efforts.
HOMEOWNERS'
We underwrite 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. Limits on homeowners'
insurance are generally significantly higher than those for mobile homes, but
typically provide for deductibles and other restrictive terms. Our property
insurance products typically provide maximum coverage in the amount of $200,000,
with the average policy limit being approximately $250,000. The average annual
premium on policies currently in force is approximately $1,050 and the typical
deductible is $1,000.
FLOOD.
We write flood insurance through the National Flood Insurance Program
("NFIP"). We write the policy for the Federal Flood program, which assumes 100%
of the flood risk while we retain a commission for our service. The average
flood policy premium is $300 with limits up to $250,000.
MOBILE HOME.
We underwrite homeowners' insurance for mobile homes, principally in
Central and Northern Florida, where we believe 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, however, loss exposure is limited because premiums usually
are at higher rates than those charged for non-mobile home property and casualty
insurance. Additionally, our property lines typically provide maximum coverage
in the amount of $75,000, with the average policy limit being approximately
$31,000. In addition, we presently limit our mobile home coverage to no more
than 10% of our underwriting exposure. The average annual premium on policies
currently in force is approximately $315 and the typical deductible is $500.
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COMMERCIAL GENERAL LIABILITY.
We underwrite commercial general liability insurance for approximately
250 classes of artisan contracting trades (excluding home-builders and
developers) and certain special events liability. The limits of liability range
from $100,000 per occurrence and $200,000 policy aggregate to $1 million per
occurrence and $2 million policy aggregate. The average policy premium is
approximately $1,000 with deductibles of $250 to $500 per claim. We market the
commercial general liability insurance products through a limited number of
general agencies unaffiliated with the Company.
FUTURE PRODUCTS.
We currently intend to expand our product offerings by underwriting
additional insurance products and programs and marketing them through our
distribution network. Expansion of our product offerings will result in
increases in expenses due to additional costs incurred in actuarial rate
justifications, software and personnel. Offering additional insurance products
may also require regulatory approval, further increasing our costs.
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 our 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 our products through our 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
although there can be no assurances it will be able to do so.
SUPERIOR ADJUSTING
Superior processes claims made by insureds from Federated National,
American Vehicle and third party insurance companies. Our Company-owned agencies
and independent agents have no authority to settle claims or otherwise exercise
control over the claims process. Furthermore, we believe 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 for most of our insurance products. Where this is not the case,
we retain independent appraisers and adjusters. We also employ an in-house
counsel department to cost-effectively manage claims-related litigation and to
monitor our claims handling practices for efficiency and regulatory compliance.
FEDERATED PREMIUM FINANCE
Federated Premium provides premium financing to Federated National's,
American Vehicle's and third-party's insureds. Premium financing is marketed
through our distribution network of Company-owned agencies, franchised agencies,
general agencies and a small number of independent agents whose customer base
and operational history meets our strict criteria for credit worthiness. Lending
operations are supported by Federated Premium's own capital base and are
currently leveraged through a credit facility with FlatIron Funding Company LLC,
which is described in more detail below.
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 a specified term, generally
between six and eight months. 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 deductible. In the event of cancellation, Federated
Premium applies the unearned premium towards the payment obligation of the
insured.
At times, Federated Premium may advance funds for financed premiums to
independent insurance agencies that represent third-party insurers. A risk
exists if remittance is not made by the agency to the third-party insurer, as
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
order to reduce this risk, we have in place strict criteria for the credit
worthiness of the agency's operational history and customer base. Additionally,
we closely monitor these agencies on an ongoing basis.
-8-
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,
------------------------
2003 2002 2001
------------------ ------------------ ------------------
Premium Percent Premium Percent Premium Percent
------- ------- ------- ------- ------- -------
(Dollars in Thousands)
Federated National $19,227 49.9% $22,331 55.4% $20,174 43.9%
American Vehicle 15,519 40.3% 12,850 31.9% 1,066 2.3%
Other insurers 3,767 9.8% 5,124 12.7% 24,728 53.8%
------- ----- ------- ----- ------- -----
Total $38,513 100.0% $40,305 100.0% $45,968 100.0%
======= ===== ======= ===== ======= =====
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.
Flatiron reduced the maximum credit commitment under the revolving loan
agreement due to the A.M. Best ratings of third party insurance carriers with
which we were financing policies at the time. Simultaneously, we began financing
only policies predominately underwritten by our insurance carriers (in 2003 we
began again to finance policies from a small number of independent agents whose
customer base and operational history meet our strict criteria for credit
worthiness). Additionally, during 2001, we implemented a direct bill program for
policies underwritten by our carriers. These changes markedly decreased credit
risks and made our reliance on the higher credit commitment previously offered
by FlatIron unnecessary.
Direct billing is where the insurance company accepts from the insured,
as a receivable, a promise to pay the premium, as opposed to requiring payment
of the full amount of the policy, either directly from the insured or from a
premium finance company. The direct billing program does not increase our risk
because the insurance policy, which serves as collateral, is managed by our
computer system. Underwriting criteria are designed with down payment
requirements and monthly payments that create policyholder equity, also called
unearned premium, in the insurance policy. The equity in the policy is
collateral for the extension of credit to the insured. Through our monitoring
systems, we track delinquent payments and, in accordance with the terms of the
extension of credit, cancel the policy before the policyholder's equity is
extinguished. If any excess premium remains after cancellation of the policy and
deduction of applicable penalties, this excess is refunded to the policyholder.
Premium financing which we offer to our own insureds involves limited credit
risk. By financing policies underwritten by our own insurance carriers, our
credit risks are reduced because we can more securely rely on the underwriting
processes of our own insurance carriers. Furthermore, the direct bill program
enables us to closely manage our risk while providing credit to our insureds.
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 effective interest rate on this line of credit, based on our average
outstanding borrowings under the Revolving Agreement, was 5.63%, 6.23% and 7.84%
for the years ended December 31, 2003, 2002 and 2001, respectively. The
Revolving Agreement contains various operating and financial covenants, with
which the Company was in compliance at December 31, 2003 and 2002. The Revolving
Agreement, as amended, expires September 30, 2004 and we intend to negotiate a
similar agreement to replace the expiring agreement. Outstanding borrowings
under the Revolving Agreement as of December 31, 2003 and 2002 were
approximately $4.1 million and $4.3 million, respectively. Outstanding
borrowings in excess of the $4.0 million commitment totaled $98,786 and
$312,420, respectively for December 31, 2003 and 2002. The excess amounts are
permissible by reason of a compensating cash balance of $200,430 and $352,433,
respectively for December 31, 2003 and 2002 and are held for the benefit of FPF,
Inc. and are included in other assets. Interest expense on this revolving credit
line for the years ended December 31, 2003, 2002 and 2001 totaled approximately
$203,000, $342,000 and $592,000, respectively.
-9-
TAX PREPARATION SERVICES AND ANCILLARY SERVICES
We also offer other services at our Company-owned and franchised
agencies, including tax return preparation and electronic filing and the
issuance and renewal of license tags. In August 1999, we acquired an 80%
interest in Express Tax Services, Inc ("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 licenses
its software to the Company's agencies.
FRANCHISE OPERATIONS
FedUSA franchises insurance and financial services. FedUSA commenced the
offering of franchises in December 2000 and as of December 31, 2003 had 38
operating franchises and 6 pending franchises.
The franchise agreement for each FedUSA franchise grants the franchisee
a license for the operation of a FedUSA insurance agency to open and operate a
center within an exclusive territory 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.
To facilitate franchising opportunities Express Tax formed a 100% owned
subsidiary EXPRESSTAX, Inc ("EXPRESSTAX") to offer franchises for income tax
preparation. In 2002, EXPRESSTAX began franchising its 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 fee in addition to royalty fees,
advertising fees, and other fees. As of December 31, 2003, 231 EXPRESSTAX
franchises have been granted.
MARKETING AND DISTRIBUTION
We market and distribute our own and third-party insurers' products and
our other services primarily in Central and South Florida through a network of
23 Company-owned agencies, 44 franchised agencies, a select group of general
agencies and approximately 125 independent agents. Each agency, whether
Company-owned or franchised, is designed to be a "one stop" shop for several
types of insurance, tax preparation and ancillary services.
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. We support our agency network by advertising in various media in
conjunction with our franchised agencies.
Whether Company-employed, franchise-employed or independent, agents have
the authority to sell and bind insurance coverage in accordance with procedures
established by Assurance MGA. Assurance MGA reviews all coverage bound by the
agents promptly and generally accepts all coverage that falls within stated
underwriting criteria. For automobile and commercial general liability policies,
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 our underwriting criteria. For homeowner and mobile home policies
Assurance MGA has the right, within a period of 90 days from a policy's
inception, to cancel any policy upon 25 days' notice or after 90 days from
policy inception with 95 days' notice, even if the risk falls within our
underwriting criteria.
We believe that our integrated computer system, which allows for rapid
automated premium quotation and policy issuance by our agents, is a key element
in providing quality service to both our 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. We believe that our
distribution system will ultimately enable us to lower our expense ratio and
operate with more favorable loss experience. A lower expense ratio will, in
turn, allow us to more effectively compete with larger providers of automobile
insurance as well as with providers of 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:
-10-
Years Ended December 31,
------------------------
2003 2002 2001
----------------- ------------------ ------------------
Premium Percent Premium Percent Premium Percent
------- ------- ------- ------- ------- -------
(Dollars in Thousands)
Company-owned agencies 22,320 30.6% $20,403 32.3% $ 9,932 29.0%
Franchised agencies 11,630 15.9% 11,761 18.7% 2,659 7.7%
Independent agencies 39,041 53.5% 30,872 49.0% 21,680 63.3%
------ ----- ------- ----- ------- -----
Total 72,991 100.0% $63,036 100.0% $34,271 100.0%
====== ===== ======= ===== ======= =====
We plan to continue to expand our distribution network and market our
products and services in other regions of Florida and other states by
franchising additional insurance agencies and establishing relationships with
additional independent agents and general agents. As this occurs, we will seek
to replicate our distribution network in those states. There can be no
assurance, however, that we will be able to obtain the required regulatory
approvals to offer additional insurance products or expand into states other
than Florida and Georgia.
REINSURANCE
We follow industry practice of reinsuring a portion of our 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.
Reinsurance is ceded under separate contracts or "treaties" for the
separate lines of business underwritten. The Company collectively ceded $19.4
million in premiums written for the year ended December 31, 2003. The Company's
reinsurance for automobile insurance is primarily ceded with Transatlantic
Reinsurance Company ("Transatlantic"), an A++ rated reinsurance company.
Federated National ceded 40%, 40%, and 50% of automobile premiums written and
losses incurred in 2003, 2002, and 2001, respectively, to Transatlantic.
American Vehicle currently reinsures all of its automobile insurance
with Transatlantic, and ceded 80% of its auto premiums written and losses
incurred during 2001. From January 2002 until November 2002 we reduced this
percentage to 70%. Beginning in November 2002, and continuing through December
31, 2003, this percentage was reduced to 40%.
The automobile quota-share reinsurance treaties for 2003 include loss
corridors with varying layers of coverage based on ultimate incurred loss ratio
results whereby the two insurance companies will retain 100% of the losses
between incurred loss ratios of 66% and 86% for policies with an effective date
of 2003. Despite the loss corridor, the reinsurer assumes significant insurance
risk under the reinsured portions of the underlying insurance contracts and it
is reasonably possible that the reinsurer may realize a significant loss from
the transaction.
During 2002, Federated National entered into a 10% quota-share agreement
with our 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.
We are selective in choosing a reinsurer and consider numerous factors,
the most important of which is the financial stability of the reinsurer, their
history of responding to claims and their overall reputation. In an effort to
minimize our exposure to the insolvency of a reinsurer, we evaluate the
acceptability and review the financial condition of the reinsurer at least
annually. Our 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, we purchase
catastrophic reinsurance from both the state-run Florida Hurricane Catastrophe
Fund and private re-insurers. We use actuarial models to determine what level of
reinsurance would be necessary to limit our total exposure under property
insurance policies to the total amount of claims that would result from an event
expected to occur no more often than once in every 100 years. As of December 31,
2003, Federated National would pay approximately $5.5 million in claims before
catastrophic reinsurance would take effect. After the first $5.5 million,
Federated National would pay all claims in excess of approximately $42.3
million.
-11-
LIABILITY FOR UNPAID LOSSES AND LAE
We are directly liable for loss and loss adjustment expense ("LAE")
payments under the terms of the insurance policies that we write. In many cases
there may be a time lag between the occurrence and reporting of an insured loss
and our payment of that loss. As required by insurance regulations and
accounting rules, we reflect the 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, we establish a
liability for the estimated amount of our 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 is determined no less than annually by dividing the number of
reported claims into the total amount paid during the same 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 circumstances of that
particular claim.
In addition, management provides for a liability on an aggregate basis
to provide for losses incurred but not reported ("IBNR"). We utilize independent
actuaries to help establish liability for unpaid losses and LAE. We do 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, we review historical data and consider
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.
Among our classes of insurance, the automobile and homeowners' liability claims
historically tend to have longer time lapses between the occurrence of the
event, the reporting of the claim 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 settled in a shorter time frame with less occurrence of litigation.
There can be no assurance that our liability for unpaid losses and LAE
will be adequate to cover actual losses. If our liability for unpaid losses and
LAE proves to be inadequate, we will be required to increase the liability with
a corresponding reduction in our 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 our 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 our consolidated financial
statements for the periods indicated.
-12-
December 31,
------------
2003 2002 2001
---- ---- ----
(Dollars in Thousands)
Balance at January 1: $ 16,984 $ 11,005 $ 9,766
Less reinsurance recoverables (7,848) (4,798) (2,790)
-------- -------- --------
Net balance at January 1 $ 9,136 $ 6,207 $ 6,976
======== ======== ========
Incurred related to:
Current year $ 26,275 $ 15,896 $ 13,586
Prior years 1,234 91 2,569
-------- -------- --------
Total incurred $ 27,509 $ 15,987 $ 16,155
======== ======== ========
Paid related to:
Current year $ 14,205 $ 8,148 $ 8,769
Prior years 7,631 4,910 8,259
-------- -------- --------
Total paid $ 21,836 $ 13,058 $ 17,028
======== ======== ========
Balance, American Vehicle, at acquisition $ -- $ -- $ 103
======== ======== ========
Net balance at year-end $ 14,809 $ 9,136 $ 6,207
Plus reinsurance recoverables 9,761 7,848 4,798
-------- -------- --------
Balance at year-end $ 24,570 $ 16,984 $ 11,005
======== ======== ========
As shown above, as a result of our review of liability for losses and
LAE, which includes a re-evaluation of the adequacy of reserve levels for prior
year's claims, we increased the liability for loss and LAE for claims occurring
in prior years by $1,234,000, $91,000 and $2,569,000 for the years ended
December 31, 2003, 2002 and 2001, respectively. There can be no assurance
concerning future adjustments of reserves, positive or negative, for claims
through December 31, 2003.
Based upon consultations with our independent actuarial consultants and
their statement of opinion on losses and LAE, we believe 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 our consolidated financial statements for the
periods indicated.
As of December 31,
------------------
2003 2002
---- ----
Transatlantic Reinsurance Company (A++ A.M. Best Rated):
Unearned premiums $ 7,823,374 $ 11,251,193
Reinsurance recoverable on paid losses and loss
adjustment expenses 2,457,228 3,266,715
Unpaid losses and loss adjustment expenses 9,761,353 7,847,255
------------ ------------
$ 20,041,955 $ 22,365,163
============ ============
Amounts due from reinsurers consisted of amounts related to:
Unpaid losses and loss adjustment expenses $ 9,761,353 $ 7,847,255
Reinsurance recoverable on paid losses and loss
adjustment expenses 2,457,228 3,266,715
Reinsurance payable (1,339,162) (3,984,895)
------------ ------------
$ 10,879,419 $ 7,129,075
============ ============
-13-
The following table presents the liability for unpaid losses and LAE for
the years ended December 31, 1994 through 2003. 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,
-----------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999 1998 1997 1996 1995 1994
------ ------- ------- ------- ------- ------ ------ ------ ------- ------
Dollars in Thousands
Balance Sheet Liability 14,809 $ 9,136 $ 6,207 $ 6,976 $ 4,428 $5,366 $4,635 $4,532 $ 3,688 $3,355
Cumulative paid as of:
One year later 7,622 5,275 8,228 4,289 3,460 2,694 2,850 3,250 2,412
Two years later 7,222 9,568 5,799 4,499 3,533 3,539 3,898 3,675
Three years later 10,101 6,328 5,111 3,972 3,882 4,164 3,901
Four years later 6,408 5,387 4,241 4,107 4,300 3,997
Five years later 5,227 4,325 4,223 4,404 4,054
Six years later 4,121 4,262 4,493 4,119
Seven years later 3,985 4,423 4,187
Eight years later 3,786 4,083
Nine years later 4,083
Re-estimated net
liability as of:
End of year 14,809 $ 9,136 $ 6,207 $ 6,976 $ 4,428 $5,366 $4,635 $4,532 $ 3,688 $3,355
One year later 10,900 6,954 9,445 5,875 4,676 4,360 4,332 4,728 3,654
Two years later 8,589 10,197 6,284 5,160 4,063 4,255 4,867 4,540
Three years later 12,894 6,605 5,352 4,317 4,102 4,872 4,613
Four years later 8,008 5,515 4,386 4,304 4,748 4,598
Five years later 4,694 4,395 4,321 4,899 4,516
Six years later 4,002 4,321 4,905 4,626
Seven years later 3,989 4,792 4,644
Eight years later 5,389 4,523
Nine years later 4,183
Cumulative redundancy
(deficiency) $ -- $ (1,764) $ (2,382) $ (5,918) $ (3,580) $ 672 $ 633 $ 543 $ (1,701) $ (828)
Cumulative redundancy -
deficiency as a % of
reserves originally
established -19.3% -38.4% -84.8% -80.8% 12.5% 13.7% 12.0% -46.1% -24.7%
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 Statutory Accounting Principles ("SAP")
basis of presentation for the years ending 2003 and 2002.
-14-
Years Ended December 31,
------------------------
2003 2002
---- ----
GAAP basis Loss and LAE reserves 24,570 $16,984
Less unpaid Losses and LAE ceded 9,761 7,847
------- -------
Balance Sheet Liability 14,809 9,137
Add Insurance Apportionment Plan 505 285
------- -------
SAP basis Loss and LAE reserves $15,314 $ 9,422
======= =======
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 2003, 2002 and 2001.
Years Ended December 31,
------------------------
2003 2002 2001
---- ---- ----
(Dollars in Thousands)
GAAP basis Loss and LAE incurred $27,509 $15,987 $16,155
Intercompany adjusting and other expenses 3,579 2,484 1,440
Insurance apportionment plan 1,940 700 --
Other -- -- 10
------- ------- -------
SAP basis Loss and LAE incurred $33,028 $19,171 $17,605
======= ======= =======
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 2003 and 2002. The amount for 2001 is 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.
Years Ended December 31,
------------------------
2003 2002 2001
---- ---- ----
Loss Ratio 67% 60% 82%
Expense Ratio 26% 25% 25%
-- -- ---
Combined Ratio 93% 85% 107%
== == ===
The 7% increase in the SAP loss ratio from 2002 to 2003 reflects an
increase in severity primarily associated with the personal injury protection
line of automobile insurance and can be attributed to the $1.2 million adverse
development incurred in 2003 relative to accidents that occurred prior to 2003.
The improved loss ratio for 2002 as compared to 2001 is attributed the $2.6
million adverse development experienced in 2001 where only $.09 million was
incurred in 2002. Main factors for the 2003 loss ratio include unanticipated
severity associated with adjusting personal injury protection claims which were
mitigated by favorable loss experience associated with the property and
commercial general liability lines of insurance. Additionally, during 2003, both
of the insurance companies revised their respective automobile rates and the
available deductibles limits. Main factors for the improved ratios between 2002
and 2001 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, in house
legal counsel, as well as overall stricter underwriting guidelines.
-15-
COMPETITION
We operate in highly competitive markets and face competition from both
national and regional insurance companies, many of whom are larger and have
greater financial and other resources, have better A.M. Best ratings and offer
more diversified insurance coverage. Our competitors include 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. We may also
face competition from new or temporary entrants in our niche markets. In some
cases, such entrants may, because of inexperience, desire for new business or
other reasons, price their insurance below ours. Although our pricing is
inevitably influenced to some degree by that of our competitors, we believe that
it is generally not in our best interest to compete solely on price. We instead
tend to compete on the basis of underwriting criteria, our distribution network
and superior service to our agents and insureds. With respect to automobile
insurance in Florida, we compete with more than 100 companies, which underwrite
personal automobile insurance. Comparable companies which compete with us in the
personal automobile insurance market 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. Comparable companies which compete with
us in the homeowners' market include Florida Family Insurance Company, Florida
Select Insurance Company, Atlantic Preferred Insurance Company and Vanguard
Insurance Company. Comparable companies which compete with us in the general
liability insurance market include Century Surety Insurance Company, Atlantic
Casualty Insurance Company, Colony Insurance Company and Burlington/First
Financial Insurance Companies. Competition could have a material adverse effect
on our business, results of operations and financial condition.
REGULATION
GENERAL
We are subject to the laws and regulations in Florida and Georgia, and
will be subject to the laws and regulations of any other states in which we seek
to conduct business in the future. The regulations cover all aspects of our
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 our business. Our failure to comply with certain
provisions of applicable insurance laws and regulations could have a material
adverse effect on our 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 our operations or our ability to
expand. We are, however, unaware of any consumer initiatives which could have a
material adverse effect on our 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. Certain 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. The Company's experience in Florida to date, however, has been that
although legislative proposals of this type have been considered from time to
time, none have yet been adopted. Nevertheless, the Florida legislature may
adopt laws of this type in the future, which could adversely affect the
Company's business.
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 our 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, 2001. The last regulatory
examination of American Vehicle covered the three-year period ended on December
31, 2002. No material deficiencies were found during either of the regulatory
examinations. In some instances, various states routinely require deposits of
assets for the protection of policyholders either in those states or
-16-
for all policyholders. As of December 31, 2003, Federated National and American
Vehicle hold investment securities with a fair value of approximately $1,007,000
and $1,075,000, 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.
Under these laws, based on their respective 2003 surplus and income,
Federated National would be permitted to pay dividends of approximately $441,000
to 21st Century in 2004, and American Vehicle would be permitted to pay $116,000
in dividends in 2004. No dividends were paid by Federated National or American
Vehicle in 2003, 2002 or 2001, and none are anticipated in 2004. Although we
believe that amounts required to meet our 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
us in the future. 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 2003
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.
Based on Risk Based Capital requirements, 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
-17-
70.0% of the ACL amount. Federated National's ratio of statutory surplus to its
ACL was 434.2%, 274.2% and 300.8% at December 31, 2003, 2002 and 2001,
respectively. American Vehicle's ratio of statutory surplus to its ACL was
585.2%, 401.6% and 3,113.8% at December 31, 2003, 2002 and 2001, respectively.
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, 2003, Federated National was outside NAIC's usual
ranges with respect to its IRIS tests on five out of twelve ratios. The first
ratio relates to a larger than expected change in net writings, the second ratio
relates to higher surplus growth that stemmed from the parent company's capital
contributions totaling $3.9 million during the year and the third ratio relates
to an investment yield that was less than expected. The fourth and fifth ratios
involved the one and two year reserve development to policyholder surplus ratios
that were in excess of the "usual ranges" and relate to modest, but adverse,
development incurred in 2003 relating to 2002 and 2001 loss reserves.
As of December 31, 2003, American Vehicle was outside NAIC's usual
ranges for three out of twelve ratios. The first ratio relates to a larger than
expected change in net writings, the second ratio relates to higher surplus
growth that stemmed from the Parent company's capital contributions totaling
$5.9 million during the year and the third ratio relates to an investment yield
that was slightly less than expected.
We do 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.
Effective January 1, 2001, our 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 our consolidated financial statements.
INSURANCE HOLDING COMPANY REGULATION
We are subject to laws governing insurance holding companies in Florida
where Federated National and American Vehicle are domiciled. These laws, among
other things, (i) require us to file periodic information with the Florida
Department of Financial Services, including information concerning our capital
structure, ownership, financial condition and general business operations, (ii)
regulate certain transactions between us and our 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 our
voting securities without prior regulatory approval. Any purchaser of 5% or more
of the outstanding shares of our Common Stock will be presumed to have acquired
control of Federated National and American Vehicle unless the Florida Office of
Insurance Regulation, upon application, determines otherwise.
FINANCE COMPANY REGULATION
Our 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 our franchisees in good faith, prohibiting
-18-
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 us.
INDUSTRY RATINGS SERVICES
In 2003, A.M. Best Company assigned Federated National a B rating
("Fair," which is the seventh of 14 rating categories) and American Vehicle a B+
rating ("Very Good," which is the sixth of 14 rating categories). Federated
National and American Vehicle are rated "A" ("Unsurpassed," which is first of
six ratings) by Demotech, Inc. A.M. Best's and Demotech's ratings are based upon
factors of concern to agents, reinsurers and policyholders and are not primarily
directed toward the protection of investors.
EMPLOYEES
As of December 31, 2003, we had 249 employees, including five executive
officers. We are not a party to any collective bargaining agreement and we have
not experienced work stoppages or strikes as a result of labor disputes. We
consider relations with our employees to be satisfactory.
SENIOR MANAGEMENT
Set forth below is certain information concerning our executive officers
who are not also directors:
James A. Epstein was appointed Secretary of 21st Century in January
2002. Mr. Epstein joined 21st Century as General Counsel in September 2000. From
1997 to 1999, Mr. Epstein was an attorney with Conrad & Scherer in Fort
Lauderdale, Florida, and from June 1999 to September 2000, Mr. Epstein was
General Counsel for 186K.Net, Co., a private company in Boca Raton, Florida.
Kent M. Linder assumed the position of Chief Operating Officer of 21st
Century in September 2003. Prior to this position, Mr. Linder served 21st
Century as Director of Franchise Development and previous to that as the
President of Federated Agency Group, Inc. Prior to joining our management team,
Mr. Linder owned and operated a group of 18 insurance agencies in the Orlando,
Florida area. Mr. Linder acquired his management experience while spending 12
years with United Parcel Service, in which he served in various management
positions. Mr. Linder holds a bachelor's degree from the University of South
Florida in Finance and is a licensed 220 property and casualty agent and 215
life agent.
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.
-19-
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.
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.
-20-
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) under 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.
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
- ------------------
As of December 31, 2003, Federated National owned and partially occupied
a three-story building with approximately 39,250 square feet of office space in
Lauderdale Lakes, Florida. During the fourth quarter of 2003 Federated National
sold its two-story, 13,960 square foot office building in Plantation, Florida to
unrelated investors for a gain on its investment of approximately $108,000.
Executive headquarters, underwriting and the mailroom departments remain located
there under a one-year lease arrangement with the new owners. Our operations,
including claims, accounting and premium finance, were relocated to the
Lauderdale Lakes property. Approximately 59.1% of the Lauderdale Lakes building
is occupied by our operations and 40.9% is leased to third parties or is vacant.
Our agencies are primarily located in leased locations pursuant to
leases expiring at various times through February 2007. The aggregate annual
rental for the facilities is approximately $799,000. Two of the locations are
owned by us.
We believe that these facilities are adequate for our current needs.
-21-
ITEM 3. LEGAL PROCEEDINGS
- -------------------------
We are 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 our
consolidated financial position, results of operations, or liquidity.
In June 2000, a lawsuit was filed against us, our directors and our
executive officers seeking compensatory damages in an undisclosed amount on the
basis of allegations that our amended registration statement dated November 4,
1998 was inaccurate and misleading concerning the manner in which we 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. The plaintiff class purportedly includes
purchasers of our common stock between November 5, 1998 and August 13, 1999. The
Court recently granted the plaintiffs class status.
Specifically, the plaintiffs allege that we recognized ceded commission
income on a written basis, rather than amortized on a pro rata basis. The
plaintiffs allege that this was contrary to the Statement of Financial
Accounting Concepts Nos. 1, 2 and 5. We believe, however, that the lawsuit is
without merit and we have vigorously defended the action, because we reasonably
relied upon outside subject matter experts to make these determinations at the
time. We have also since accounted for ceded commission on a pro rata basis and
have done so since these matters were brought to our attention in 1998.
Nevertheless, we have also continued to actively participate in settlement
negotiations with the plaintiffs and have tentatively agreed to settle the case.
The parties are currently negotiating the final terms of a Memorandum of
Understanding, which will have to be executed by the parties and then approved
by the court. We have reserved and charged against current year earnings
$600,000 for the potential settlement and associated costs.
Prior to its acquisition 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. American Vehicle's previous owners have agreed
to indemnify us 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.
As a direct premium writer in the State of Florida, we are required to
participate in certain insurer solvency pools under Florida Statutes
631.57(3)(a). Participation in these pools is based on our written premium by
line of business to total premiums written statewide by all insurers.
Participation may result in assessments against us. We were assessed $258,000
and $203,000, for the years ended December 31, 2002 and 2001, respectively.
There was no assessment made for the year ended December 31, 2003. We are
entitled to recover all of these assessments as permitted by the State of
Florida through policy surcharges. During 2002 we recovered $180,000 of the 2001
assessment and during 2003 we recovered the balance of the 2001 assessment and
$142,000 of the 2002 assessment. Of the 2002 assessment, $16,000 will not be
passed through as policy surcharges and $99,000 remains to be collected through
policy surcharges as of December 31, 2003.
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 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
-22-
PART II
- -------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -----------------------------------------------------------------------------
(A) MARKET INFORMATION
Our 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, 2003 $13.99 $9.00
June 30, 2003 $16.75 $10.46
September 30, 2003 $18.75 $13.90
December 31, 2003 $23.59 $14.00
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
(B) HOLDERS
As of March 29, 2004, there were approximately 43 holders of record of
our common stock. We believe that the number of beneficial owners of our common
stock is in excess of 2000.
(C) DIVIDENDS
We paid a quarterly dividend of $0.02 per share on our common stock from
the fourth quarter of 2000, until the third quarter of 2002. We 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. During 2003, we declared a $0.07, $0.09, $0.10
and $0.12 dividend for the first, second, third and fourth quarters,
respectively. We expect to continue to pay a quarterly dividend in the future.
However, payment of dividends in the future will depend on our earnings and
financial position and such other factors, as our Board of Directors deems
relevant. Moreover, our ability 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 parent company.
(D) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The section under the heading "Executive Compensation" entitled "Equity
Compensation Plan Information for Fiscal 2004" in our proxy statement for the
2004 annual meeting of shareholders is incorporated herein by reference.
For additional information concerning our capitalization please see Note
16, "Stock Compensation Plans" of the Notes to the Consolidated Financial
Statements included in Item 8.
-23-
ITEM 6. SELECTED FINANCIAL DATA
- -------------------------------
As of or for the year ended December 31,
----------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
OPERATIONS DATA:
Revenue:
Gross premiums written $72,991,434 $63,036,468 $34,271,338 $32,073,768 $ 19,273,561
Gross premiums ceded (19,498,209) (25,286,828) (12,789,404) (7,625,095) (6,221,853)
----------- ----------- ----------- ----------- ------------
Net premiums written 53,493,225 37,749,640 21,481,934 24,448,673 13,051,708
Increase (decrease) in prepaid
reinsurance premiums (3,427,818) 5,691,284 686,438 874,000 (92,597)
(Increase) decrease in unearned premiums (5,188,177) (14,047,919) (1,912,811) (5,001,334) 497,237
----------- ----------- ----------- ----------- ------------
Net change in prepaid reinsurance
premiums and unearned premiums (8,615,995) (8,356,635) (1,226,373) (4,127,334) 404,640
----------- ----------- ----------- ----------- ------------
Net premiums earned 44,877,230 29,393,005 20,255,561 20,321,339 13,456,348
Commission income 1,380,145 1,905,936 2,828,779 2,780,869 4,410,856
Finance revenue 4,327,675 4,452,626 5,267,523 5,709,848 3,696,843
Managing general agent fees 2,328,681 1,970,226 5,871,388 5,410,500 963,797
Net investment income 1,624,216 1,253,765 1,066,641 1,225,413 853,659
Net realized investment gains (losses) 2,231,333 (1,369,961) (2,911,658) (109,256) 952,153
Other income 3,347,020 2,973,949 3,098,332 2,214,894 1,043,798
----------- ----------- ----------- ----------- ------------
Total revenue 60,116,300 40,579,546 35,476,566 37,553,607 25,377,454
Expenses:
Loss and loss adjustment expenses 27,508,979 15,987,125 16,154,902 14,990,118 8,094,677
Operating and underwriting expenses 11,415,436 10,425,765 11,056,529 11,229,768 6,595,937
Salaries and wages 9,152,028 8,004,694 8,478,771 9,375,775 7,474,572
Interest expense 606,910 353,225 587,654 662,809 436,491
Amortization of deferred acquisition
costs, net (854,279) (2,064,314) 1,467,238 1,673,754 (18,563)
Amortization of goodwill -- -- 540,010 606,653 547,548
----------- ----------- ----------- ----------- ------------
Total expenses 47,829,074 32,706,495 38,285,104 38,538,877 23,130,662
----------- ----------- ----------- ----------- ------------
Income (loss) before provision for income
tax expense 12,287,226 7,873,051 (2,808,538) (985,270) 2,246,792
Provision (benefit) for income tax expense (3,922,350) (3,302,849) 630,553 462,396 (680,061)
----------- ----------- ----------- ----------- ------------
Net income (loss) before
extraordinary gain 8,364,876 4,570,202 (2,177,985) (522,874) 1,566,731
Extraordinary gain -- -- 1,185,895 -- --
----------- ----------- ----------- ----------- ------------
Net income (loss) $ 8,364,876 $ 4,570,202 $ (992,090) $ (522,874) $ 1,566,731
=========== =========== =========== =========== ============
Basic net income (loss) per share $ 2.64 $ 1.52 $ (0.69) $ (0.15) $ 0.46
=========== =========== =========== =========== ============
Extraordinary gain $ -- $ -- $ 0.38 $ -- $ --
=========== =========== =========== =========== ============
Basic net income (loss) per share after
extraordinary gain $ 2.64 $ 1.52 $ (0.31) $ (0.15) $ 0.46
=========== =========== =========== =========== ============
Fully diluted net income (loss) per share $ 2.50 $ 1.52 $ (0.31) $ (0.15) $ 0.46
=========== =========== =========== =========== ============
Cash dividends declared per share $ 0.38 $ 0.15 $ 0.08 $ 0.02 $ --
=========== =========== =========== =========== ============
BALANCE SHEET DATA
Total assets $106,695,593 $75,318,011 $56,228,577 $55,412,969 $ 38,686,404
Investments 47,290,420 25,377,796 17,507,422 18,965,798 13,916,571
Finance contracts, consumer loans and
pay advances receivable, net 9,891,642 7,217,873 10,813,881 13,792,791 9,642,163
Total liabilities 74,649,217 57,220,348 42,019,446 40,456,972 22,932,516
Unpaid losses and loss adjustment
expenses 24,570,198 16,983,756 11,005,337 9,765,848 6,314,307
Unearned premiums 34,122,663 28,934,486 14,951,228 13,038,417 8,037,083
Revolving credit outstanding 4,098,786 4,312,420 6,676,817 8,091,034 4,650,026
Total shareholders' equity $32,046,376 $18,097,664 $14,209,131 $14,955,997 $ 15,753,888
Book value per share $ 8.84 $ 6.05 $ 4.69 $ 4.49 $ 4.67
-24-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
- -------------
OVERVIEW
We are a vertically integrated insurance holding company, which, through
our subsidiaries, controls substantially all aspects of the insurance
underwriting, distribution and claims process. We underwrite personal automobile
insurance, general liability insurance, flood insurance, homeowners' insurance
and mobile home property and casualty insurance in Florida and Georgia through
our wholly owned subsidiaries, Federated National Insurance Company and American
Vehicle Insurance Company. American Vehicle was approved in August 2003 to be a
foreign insurer in the State of Georgia. During the year ended December 31,
2003, 67.2%, 23.4%, 2.4% and 7.0% of the policies we underwrote were for
personal automobile insurance, homeowners' property and casualty insurance,
mobile home property and casualty insurance, and commercial general liability,
respectively. We internally process claims made by our own and third party
insureds through our wholly owned claims adjusting company, Superior Adjusting,
Inc. We also offer premium financing to our own and third-party insureds through
our wholly owned subsidiary, Federated Premium Finance, Inc.
We market and distribute our own and third-party insurers' products and
our other services primarily in Central and South Florida, through a network of
23 agencies owned by Federated Agency Group, Inc., a wholly owned subsidiary, 44
franchised agencies, and approximately 125 independent agents. Through our
wholly owned subsidiary, FedUSA, Inc., we franchise agencies under the FedUSA
name. As of December 31, 2003, franchises were granted for 44 FedUSA agencies,
of which 38 were operating. We intend to focus our future expansion efforts for
our agency network on franchised agencies.
Assurance Managing General Agents, Inc., a wholly owned subsidiary, 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 our 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 replaced
business from an unaffiliated insurance company with business from 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.
We offer electronic tax filing services through Express Tax Service,
Inc., an 80%-owned subsidiary, as well as franchise opportunities for these
services. As of December 31, 2003, there were 231 franchises granted in 18
states. Revenue is generated through franchise sales, collection of royalties on
tax preparation fees, incentives from business partners as well as fees from the
preparation of income tax returns and income tax refund anticipation loans. In
addition, Express Tax offers tax preparation services through more than 500
licensees nationwide.
Our 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 our
business, results of operations and financial condition. Also, if our estimated
liabilities for unpaid losses and LAE are less than actual losses and LAE, we
will be required to increase reserves with a corresponding reduction in our net
income in the period in which the deficiency is identified.
We operate in a highly competitive market and face competition from both
national and regional insurance companies, many of whom are larger and have
greater financial and other resources, have better A.M. Best ratings and offer
more diversified insurance coverage. Our 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. We may also face competition from new or temporary entrants
in our niche markets. In some cases, such entrants may, because of inexperience,
desire for new business or other reasons, price their insurance below ours.
Although our pricing is inevitably influenced to some degree by that of our
competitors, we believe that it is generally not in our best interest to compete
solely on price. We instead tend to compete on the basis of underwriting
criteria, our distribution network and superior service to our agents and
insureds. We compete with respect to automobile insurance in Florida with more
than 100 companies, which underwrite personal automobile insurance. Comparable
companies which compete with us in the personal automobile insurance market
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.
Comparable companies which compete with us in the homeowners' market include
Florida Family Insurance Company, Florida Select Insurance Company, Atlantic
Preferred Insurance Company and Vanguard Insurance Company. Comparable companies
which compete with us in the general liability insurance market include Century
Surety Insurance Company, Atlantic Casualty Insurance Company, Colony Insurance
Company and Burlington/First Financial Insurance Companies. Competition could
have a material adverse effect on our business, results of operations and
financial condition.
-25-
CRITICAL ACCOUNTING POLICIES
Our 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
our financial statements include estimates associated with management's
evaluation of the determination of liability for unpaid losses and loss
adjustment expense, the recoverability of goodwill and amortization of deferred
policy acquisition costs. 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 the Notes to Consolidated
Financial Statements.
ACCOUNTING CHANGES
In January 2003, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN
46"), which requires the consolidation of certain entities considered to be
variable interest entities ("VIEs"). An entity is considered to be a VIE when it
has equity investors who lack the characteristics of having a controlling
financial interest, or its capital is insufficient to permit it to finance its
activities without additional subordinated financial support. Consolidation of a
VIE by an investor is required when it is determined that the investor will
absorb a majority of the VIE's expected losses if they occur, receive a majority
of the entity's expected residual returns if they occur, or both. The adoption
of Interpretation No. 46 did not have any impact on our Consolidated Financial
Statements.
In May 2003, the FASB issued Statement of Financial Accounting Standard
Number 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity." This Statement establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity and it requires that an issuer
classify a financial instrument that is within its scope as a liability because
the financial instrument embodies an obligation of the issuer. This Statement is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective in the first interim period beginning after June 15,
2003. On July 31, 2003, we completed a private placement of our 6% Senior
Subordinated Notes (the "Notes"), which were offered and sold to accredited
investors as units consisting of one Note with a principal amount of $1,000 and
warrants (the "Warrants") to purchase shares of the Company's Common Stock.
These Notes fall within the definition of financial instruments as described in
Financial Accounting Standard Number 150 and were originally presented as a
liability in conformity with Statement of Financial Accounting Standard Number
150. As such, the adoption of this Statement did not have any impact on our
Consolidated Financial Statements.
-26-
ANALYSIS OF FINANCIAL CONDITION
AS OF DECEMBER 31, 2003 AS COMPARED TO DECEMBER 31, 2002
INVESTMENTS.
Investments increased $21.9 million or 86% to $47.3 million as of
December 31, 2003 from $25.4 million as of December 31, 2002 primarily as a
result an increase in written insurance premiums and positive underwriting
experience. An investment impairment of $2.0 million was charged to operations
in 2002 for WorldCom bonds held by the Company and reflecting WorldCom's
bankruptcy. These bonds were marked to market from $2.5 million to $0.5 million
based on our estimate of the ultimate realizable value of the bonds. As of
December 31, 2003 we have one-half remaining of our $0.5 million investment in
WorldCom, the balance of which was liquidated during 2003 with a realized gain
of $0.2 million.
As a result of the adverse market conditions which occurred in 2002,
management more carefully monitors its concentrations, industries and asset
allocations. There were no other instances of large concentrations of investment
securities requiring write-downs. We did not hold any non-traded investment
securities during 2003 or 2002.
Below is a summary of unrecognized impairment loss at December 31, 2003
and 2002 by category.
Net Unrealized Gains (Losses)
Years Ended December 31,
------------------------
2003 2002
---- ----
Fixed maturities:
U.S. government obligations $(793,613) $ 425
Obligations of states and political
subdivisions (4,840) 33,610
--------- ---------
(798,453) 34,035
--------- ---------
Corporate securities:
Communications 209,226 (332,383)
Financial 14,694 62,101
Other 45,475 28,703
--------- ---------
269,395 (241,579)
--------- ---------
Equity securities:
Preferred stocks 400 (316)
Common stocks 3,154 (23,843)
--------- ---------
3,554 (24,159)
--------- ---------
Total fixed, corporate and equity securities $(525,504) $(231,703)
========= =========
RECEIVABLE FOR INVESTMENTS SOLD.
Receivable for investments sold increased $2.1 million or 100% from
nothing as of December 31, 2002 to $2.1 million as of December 31, 2003. The
increase is a result of investment trading activity that occurred in late
December 2003 and did not settle until early January 2004.
FINANCE CONTRACTS.
Finance contracts receivable increased $2.7 million or 37.0% from $7.2
million as of December 31, 2002 to $9.9 million as of December 31, 2003. The
increase of the finance contracts receivable is the result of insureds financing
the commercial general liability policies offered by American Vehicle and an
increase in outstanding finance contracts for policies with a twelve month term
coupled with a renewed interest in financing a specific non-affiliated insurance
company.
PREPAID REINSURANCE PREMIUMS.
Prepaid reinsurance premiums decreased $3.4 million or 30.5% to $7.8
million as of December 31, 2003 from $11.3 million as of December 31, 2002.
Approximately $2.7 million of this decrease reflects the decrease in American
Vehicle's ceded quota-share reinsurance from 70% of its premiums written to 40%
effective November 1, 2002. Approximately $0.7 million of the decrease reflects
the decrease in Federated National's ceded quota-share reinsurance from 40% of
automobile premiums written in 2002 to 30% for automobile premiums written in
the first quarter of 2003. Subsequent to the first quarter of 2003, Federated
National increased its ceded quota-share reinsurance to 40% of automobile
premiums written for the whole year. American Vehicle's reinsurance treaty did
not change.
-27-
PREMIUMS RECEIVABLE.
Premiums receivable were $7.3 million as of December 31, 2003, a
decrease of $1.1 million or 12.5% as compared to $8.4 million outstanding as of
December 31, 2002. The decline can be attributed to the decline in automobile
written premiums and the diversification of our product lines. The predominate
user of the finance products is the automobile customer. There is less of a
tendency to finance homeowner premiums due to policyholder mortgage escrow
arrangements and only a modest need to finance commercial general liability
insurance.
REINSURANCE RECOVERABLE - NET.
Reinsurance recoverable increased $3.7 million or 48.2% to $11.6 million
as of December 31, 2003 from $7.9 million as of December 31, 2002. This increase
is the result of the increase in loss and loss adjustment expenses incurred and,
to a lesser extent, the timing of settlements with our reinsurer. All amounts
are considered current.
DEFERRED ACQUISITION COSTS - NET.
Deferred acquisition costs increased $1.7 million to $1.7 million as of
December 31, 2003 from $7,721 as of December 31, 2002. At December 31, 2003,
commission expense and commissions income, net were approximately $1.2 million
and expenses connected with the writing of premiums such as salaries and premium
taxes, net of policy fees totaled approximately $0.5 million. Deferred policy
acquisition costs, net, increased primarily due to a $0.84 million increase of
deferred commission expenses and a $0.82 million decrease in ceded unearned
commissions income during the year ended December 31, 2003. The increase of
deferred commission expenses primarily related to the increase in lines of
insurance other than automobile, which are not subject to quota-share
agreements. The decrease in ceded commissions income is due to a $3.4 million
decline of ceded commissions.
The December 31, 2002 balance was composed of commission expense offset
by ceded commissions income of approximately $(423,000) and other expenses
connected with the writing of premiums such as salaries, payroll taxes and
premium taxes, and offset by policy fees of approximately $431,000. The decrease
in ceded unearned commissions in 2003 as compared to 2002 relates to the decline
in reliance on quota-share reinsurance associated with the insurance company's
automobile premiums as detailed in the discussion of Prepaid Reinsurance
Premiums noted above.
INCOME TAX RECOVERABLE.
Income tax recoverable increased by 100% to $1.1 million primarily due
to payment patterns established by our estimations of taxable income.
PROPERTY PLANT AND EQUIPMENT.
Property plant and equipment, net of accumulated depreciation and
amortization declined by $0.6 million to $4.2 million as of December 31, 2003 to
$4.8 as of December 31, 2002. The decline is primarily attributable to the sale
of one of our occupied properties.
GOODWILL.
Goodwill declined by approximately $49,000, or 2.8% to approximately
$1,740,000 as of December 31, 2003 as compared to approximately $1,789,000 as of
December 31, 2002 due to net conversions of our agencies to franchised
operations. Goodwill otherwise remained unchanged during 2003 due to the
adoption of SFAS 142, wherein our assessment of goodwill indicated no
impairment.
OTHER ASSETS.
Other assets increased by $0.5 million, or 29.5% to $2.3 million as of
December 31, 2003 as compared to $1.8 million as of December 31, 2002. Major
components of other assets are as follows:
December 31,
------------
2003 2002
---- ----
Accrued interest income $ 680,017 $ 364,335
Notes receivable 460,145 405,992
Unamortized loan costs 430,803 --
Compensating cash balances 200,430 352,433
Other 568,262 684,364
---------- ----------
Total $2,339,656 $1,807,123
========== ==========
-28-
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES.
Unpaid losses and loss adjustment expenses increased $7.6 million or
44.7% to $24.6 million as of December 31, 2003 as compared to $17.0 million as
of December 31, 2002. The increase is associated with an increase in frequency
and severity of claims activity associated with our automobile business.
Federated National's reserves increased by $2.7 million in 2003 as compared to
2002 and represents 33.6% of the total reserve increase and American Vehicle's
reserves increased by $4.9 million in 2003 as compared to 2002 and represents
59.6% of the total reserve increase. Factors that affect unpaid losses and loss
adjustment expenses include the estimates made on a claim-by-claim basis known
as case reserves coupled with bulk estimates known as "incurred but not
reported" (IBNR). Periodic estimates by management of the ultimate costs
required to settle all claim files are based on the Company's analysis of
historical data and estimations of the impact of numerous factors such as (i)
per claim information; (ii) company and industry historical loss experience;
(iii) legislative enactments, judicial decisions, legal developments in the
awarding of damages, and changes in political attitudes; and (iv) trends in
general economic conditions, including the effects of inflation. Management
revises its estimates based on the results of its analysis. This process assumes
that past experience, adjusted for the effects of current developments and
anticipated trends, is an appropriate basis for estimating the ultimate
settlement of all claims. There is no precise method for subsequently evaluating
the impact of any specific factor on the adequacy of the reserves, because the
eventual redundancy or deficiency is affected by multiple factors. For further
discussion see Loss and Loss Adjustment Expenses.
UNEARNED PREMIUM.
Unearned premiums increased by $5.2 million or 17.9% to $34.1 million as
of December 31, 2003 as compared to $28.9 million as of December 31, 2002. The
increase was due to a $5.7 million increase in unearned homeowner's insurance
premiums and $3.8 million in unearned premiums associated with the newly
launched commercial liability program. Offsetting these increases was a $4.3
million decrease in automobile unearned premiums. These changes reflect our
emphasis in 2003 on property and commercial general liability insurance
products.
INCOME TAXES PAYABLE.
Income taxes payable decreased by 100% as compared to 2002 primarily due
to payment patterns established by our estimations of taxable income.
SUBORDINATED DEBT
On July 31, 2003, we completed a private placement of our Notes, which
were offered and sold to accredited investors as units consisting of one Note
with a principal amount of $1,000 and one Warrant to purchase one half a share
of our Common Stock. We sold an aggregate of $7.5 million of Notes in this
placement, which resulted in proceeds to the Company (net of placement agent
fees of $450,724 and offering expenses of $110,778) of $6,938,498. See footnote
number 22, SUBORDINATED DEBT.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
GROSS PREMIUMS WRITTEN.
Gross premiums written increased $10.0 million, or 15.8%, to $73.0
million for the year ended December 31, 2003, as compared to $63.0 million for
the comparable period in 2002. The following table denotes gross premiums
written by major product line.
Twelve months ended Decemder 31,
--------------------------------
2003 2002
---- ----
Automobile $49,297,915 67.5% $52,586,436 83.4%
Homeowners 16,804,497 23.0% 8,669,642 13.8%
Commercial liability 5,149,944 7.1% -- 0.0%
Mobile home owners 1,739,078 2.4% 1,780,390 2.8%
----------- ----- ----------- -----
Gross written premiums $72,991,434 100.0% $63,036,468 100.0%
=========== ===== =========== =====
This table reflects the success of our efforts to expand our line of
insurance products to include products other than automobile insurance.
GROSS PREMIUMS CEDED.
Gross premiums ceded decreased $5.8 million or 22.9% to $19.5 million
for the year ended December 31, 2003, from $25.3 million for the year ended
December 31, 2002. The decrease is primarily due to the decline in our ceded
quota-share reinsurance associated with our automobile insurance.
-29-
INCREASE (DECREASE) IN PREPAID REINSURANCE PREMIUMS.
Prepaid reinsurance premiums decreased $9.1 million or 160.2%, to ($3.4)
million as of December 31, 2003, from $5.7 million for the year ended December
31, 2002. The decrease is due primarily to American Vehicle's decreased reliance
on quota-share reinsurance on its automobile insurance products.
INCREASE IN UNEARNED PREMIUMS.
The increase in unearned premiums declined by $8.8 million, or 63.1% to
($5.2) million as of December 31, 2003, as compared to ($14.0) million as of
December 31, 2002. The unearned premium liability increase of $5.2 million
during 2003 is net of homeowner and commercial liability unearned premiums
increases of $5.7 million and $3.8 million, respectively, and is offset by
automobile unearned premiums decreases of $4.3 million. These changes reflect
our emphasis in 2003 on property and commercial general liability insurance
products.
MANAGING GENERAL AGENT FEES.
Managing General Agent Fees increased modestly from $2.0 million for the
year ended 2002 to $2.3 million for the year ended December 31, 2003. The
increase reflects an overall increase in the production of insurance policies.
NET INVESTMENT INCOME.
Net investment income increased by $0.3 million or 29.5% to $1.6 million
for the year ending December 31, 2003, as compared to $1.3 million for the year
ended December 31, 2002. The increase in investment income is a result of the
additional amounts of invested assets. Although the Company's net investment
income has increased during 2003 compared to 2002, our overall investment yield
declined by 1.5%, from 4.9% for the year ending December 31, 2002 to 3.4% for
the year ended December 31, 2003.
NET REALIZED INVESTMENT GAINS (LOSSES).
Net realized investment gains increased by $3.6 million to $2.2 million
for the year ended December 31, 2003 as compared to a loss of $1.4 million for
the year ended December 31, 2002. The table below reflects the gains and losses
by investment category.
For the year ending December 31,
--------------------------------
2003 2002
---- ----
Realized gains:
Fixed securities $ 1,590,935 $ 774,931
Equity securities 1,230,118 123,232
----------- -----------
Total realized gains 2,821,053 898,163
----------- -----------
Realized losses:
Fixed securities (508,299) (2,164,790)
Equity securities (81,422) (103,334)
----------- -----------
Total realized losses (589,721) (2,268,124)
----------- -----------
Net realized gains (losses) on investments $ 2,231,332 $ 1,369,961
=========== ===========
LOSSES AND LAE.
Loss and loss adjustment expenses increased by $11.5 million, or 72.1%,
to $27.5 million for the year ending December 31, 2003, as compared to $16.0
million as of December 31, 2002. The increase is predominately due to the
increase in net premiums earned. The Company's loss ratio, as determined in
accordance with GAAP, for the year ended December 31, 2003 was 60.8% compared
with 54.4% for the same period in 2002. The table below reflects the loss ratios
by product line.
For the year ending December 31,
--------------------------------
2003 2002
---- ----
Automobile 79.51% 70.55%
Home owners 21.30% 21.64%
Commercial liability 18.50% 0.00%
Mobile home owners 28.74% 33.37%
All Product Lines 61.30% 54.39%
-30-
Losses and loss adjustment expenses, 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. Management revises its estimates based on the results
of its analysis of estimated future payments to be made. This process assumes
that past experience, adjusted for the effects of current developments and
anticipated trends, is an appropriate basis for predicting future events. The
Company attributes the overall increase in the loss ratio primarily to its
liability lines of insurance associated with automobile claims and the related
estimates of the costs necessary to settle the claims. The estimated cost to
close all claim files, for accidents that occurred in years other than the
accidents that occurred in the current year ending December 31, 2003 and net of
reinsurance recoveries, has increased by a total of $1.2 million over the
ultimate estimates made as of December 31, 2002, primarily due to a decrease of
claim frequency and claim severity and periodic estimates made by management of
the ultimate costs required to settle all claims, both reported and not yet
reported.
SALARIES AND WAGES.
Salaries and wages increased $1.2 million, or 14.3%, to $9.2 million for
the year ending December 31, 2003, as compared to $8.0 million for the year
ending December 31, 2002. Management believes that the increase in salaries and
wages is consistent with retaining quality management and increased premium
production.
DEFERRED POLICY ACQUISITION COSTS.
Amortization of deferred policy acquisition costs increased by $1.2
million, or 58.6%, to a credit of $0.9 million for the year ending December 31,
2003, as compared to a credit of $2.1 million as of December 31, 2002.
Amortization of deferred policy acquisition costs consists of the actual policy
acquisition costs, including commissions, payroll and premium taxes, less
commissions earned on reinsurance ceded and policy fees earned. During the
twelve months ending December 31, 2003, the difference between the ceded
commissions earned of $6.7 million and amortized costs of $5.8 million resulted
in a credit to earnings of $0.9 million. The $1.2 million increase in the
amortization of deferred policy acquisition costs in the 2003 period as compared
to the 2002 period is attributable to the increase in ceded commissions earned
during the twelve months ending December 31, 2003 totaling $1.0 million, netted
against amortized costs of $2.2 million during the same twelve month period.
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 acquisition of American
Vehicle and its 70% quota-share reinsurance treaty, which we entered into in
order to maintain the ratio of premiums written to surplus mandated by the State
of Florida.
INCREASE (DECREASE) IN PREPAID REINSURANCE PREMIUMS.
Prepaid reinsurance premiums increased by $5.0 to $5.7 million for the
year ended December 31, 2002 as compared to $0.7 million as of December 31,
2001. 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.
INCREASE IN UNEARNED PREMIUMS.
The change to unearned premiums increased by $12.1 million to $14.0
million as of December 31, 2002 as compared to $1.9 million as of December 31,
2001. Again, the predominate reason for the increase was 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 are charged at a rate of $25.00 per policy,
which is the maximum currently permitted under Florida law. These 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.
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, we incurred an "other
than temporary" decline in value of $2.0 million in our investment in WorldCom,
Inc. bonds.
-31-
LOSSES AND LOSS ADJUSTMENT EXPENSES.
Our 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 loss adjustment expenses incurred
decreased $168,000 to $16.0 million for 2002 from $16.2 million for 2001. Losses
and loss adjustment expenses, our most significant expenses, represent actual
payments made and changes in estimated future payments to be made to or on
behalf of policyholders, including expenses required to settle claims and
losses.
DEFERRED POLICY ACQUISITION COSTS.
Our 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, we 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 we acquired American Vehicle.
LIQUIDITY AND CAPITAL RESOURCES
The following summarizes future cash outflows related to our contractual
obligations required to be disclosed herein at December 31, 2003 (in thousands):
------------------------------------------------------
Payments due by period
------------------------------------------------------
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
----- --------- --------- --------- ---------
Contractual Obligations
Long-term debt obligations (1) $6,875 $2,500 $4,375 -- --
Operating lease obligations 592 303 289 -- --
------ ------ ------
Total $7,467 $2,803 $4,664 -- --
====== ====== ======
(1) Represents the private placement in July 2003 of our Notes, which were
offered and sold to accredited investors as units consisting of one Note
with a principal amount of $1,000 and one Warrant to purchase one half a
share of our Common Stock. We sold an aggregate of $7.5 million of Notes
in this placement, which resulted in proceeds to the Company (net of
placement agent fees of $450,724 and offering expenses of $110,778) of
$6,938,498. The $7.5 million principle amount was reduced by the first
quarterly installment payment of $625,000 due November 1, 2003.
Our primary sources of capital in 2003 were revenues generated from
operations, issuance of debt securities, investment income and borrowings under
the Revolving Loan Agreement ("Revolving Agreement"), described below. Because
we are a holding company, we are largely dependent upon fees from our
subsidiaries for cash flow.
Federated Premium's operations are funded by the 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.
FlatIron reduced the maximum credit commitment under the Revolving
Agreement due to the A.M. Best ratings of third party insurance carriers with
which we were financing policies at the time. Simultaneously, however, we ceased
financing policies underwritten by third party insurance carriers altogether and
began financing only those policies underwritten by our insurance carriers (in
2003 we began again to finance policies from a small number of independent
agents whose customer base and operational history meet our strict criteria for
credit worthiness). Additionally, in 2002, we implemented a direct bill program
for policies underwritten by our carriers. These changes markedly decreased
credit risks and made our reliance on the higher credit commitment previously
offered by FlatIron unnecessary.
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
-32-
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 effective interest rate on this line of credit, based on our average
outstanding borrowings under the Revolving Agreement, was 5.63%, 6.23% and 7.84%
for the years ended December 31, 2003, 2002 and 2001, respectively. The
Revolving Agreement contains various operating and financial covenants, with
which the Company was in compliance at December 31, 2003 and 2002. The Revolving
Agreement, as amended, expires September 30, 2004 and we intend to negotiate a
similar agreement to replace the expiring agreement. Outstanding borrowings
under the Revolving Agreement as of December 31, 2003 and 2002 were
approximately $4.1 million and $4.3 million, respectively. Outstanding
borrowings in excess of the $4.0 million commitment totaled $98,786 and
$312,420, respectively for December 31, 2003 and 2002. The excess amounts are
permissible by reason of a compensating cash balance of $200,430 and $352,433,
respectively for December 31, 2003 and 2002 and are held for the benefit of FPF,
Inc. and are included in other assets. Interest expense on this revolving credit
line for the years ended December 31, 2003, 2002 and 2001 totaled approximately
$203,000, $342,000 and $592,000, respectively.
As an alternative to premium finance we offer direct billing 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 advantage of
direct billing a policyholder by the insurance company is that we are not
reliant on our credit facility, but remain able to charge and collect interest
from the policyholder.
On July 31, 2003, we completed a private placement of our Notes, which
were offered and sold to accredited investors as units consisting of one Note
with a principal amount of $1,000 and one Warrant to purchase one half a share
of our Common Stock. We sold an aggregate of $7.5 million of Notes in this
placement, which resulted in proceeds to the Company (net of placement agent
fees of $450,724 and offering expenses of $110,778) of $6,938,498. On or about
October 31, 2003, we exercised our option to make a quarterly payment in shares
of our Common Stock and issued a total of 41,195 shares of Common Stock to the
purchasers of the Notes.
The Notes pay interest at the annual rate of 6%, are subordinated to
senior debt, and mature on July 31, 2006. Quarterly payments of principal and
interest due on the Notes may be made in cash or, at our option, in shares of
our Common Stock. If paid in shares of Common Stock, the number of shares to be
issued shall be determined by dividing the payment due by 95% of the
weighted-average volume price for the Common Stock on Nasdaq as reported by
Bloomberg Financial Markets ("Bloomberg") for the 20 consecutive trading days
preceding the payment date.
We issued Warrants to purchase shares of the Company's Common Stock to
the purchasers of the Notes and to the placement agent in the offering, J.
Giordano Securities Group ("J. Giordano"). Each Warrant entitles the holder to
purchase one-half of one share of the Company's Common Stock. The total number
of shares issuable upon exercise of Warrants issued to the purchasers of the
Notes and to J. Giordano was determined after the expiration of 60 consecutive
trading days following July 31, 2003, which was the date of closing, and totaled
408,050. The number of shares issuable upon exercise of the Warrants issued to
purchasers equaled $7.5 million divided by the exercise price of the Warrants,
and totaled 392,356. The number of shares issuable upon exercise of the Warrants
issued to J. Giordano equaled $300,000 divided by the exercise price of the
Warrants, and totaled 15,694. The exercise price of the warrants equaled 115% of
the weighted-average volume price of the Common Stock on Nasdaq as reported by
Bloomberg, for the 60 consecutive trading days following July 31, 2003, with a
maximum of $25.00 per share and a minimum of $15.00 per share. As computed, the
exercise price of the Warrants is $19.1153. The terms of the Warrants provide
for adjustment of the exercise price and the number of shares issuable
thereunder upon the occurrence of certain events typical for private offerings
of this type. The Warrants will be exercisable until July 31, 2006. We have the
option to redeem the Warrants beginning July 31, 2004.
For the twelve months ended December 31, 2003 and 2002, operations
generated net operating cash flow of $12.3 million and $17.2 million,
respectively. During the year ended December 31, 2003 gross cash flow from
operations generated approximately $18.9 million, mostly by an increase in
unpaid loss and loss adjustment expenses totaling $7.6 million, increased
unearned premiums liability totaling $5.2 million, increased prepaid reinsurance
premiums totaling $3.4 million and a $1.0 million decrease in premiums
receivable, all in conjunction with net income of $8.4 million.
Operations for the twelve month period ending December 31, 2003 used
$15.0 million of gross cash flow primarily for net realized investment gains of
$2.0 million, a $3.8 million increase to reinsurance recoverable, net, a $3.5
million increase of finance contract receivable, $1.7 million used to reduce
income taxes payable and $0.3 million used to decrease accounts payable and
accrued expenses. Additionally, $1.7 million was used to pay agent commissions
and other costs, where-in the underlying policy term is un-expired as of
December 31, 2003.
Net operating cash flow is currently expected to be positive in both the
short-term and the reasonably foreseeable future.
-33-
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
investment portfolio, which is highly liquid as it consists almost entirely of
readily marketable securities, is available to offset any cash flow deficits
from operations. The 2002 cash flow deficit from investing activities was $6.9
million and was used to purchase investment securities. In 2001 we 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 we reduced the revolving
credit outstanding and purchased shares of our Common Stock in the open market.
Future financing activities may use cash, if we believe our stock is undervalued
and decide 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 2003, we acquired 42,400 shares for a total
cost of $681,842. During 2002, we acquired 40,800 shares for a total cost of
$253,446.
In addition, our investment portfolio is highly liquid as it consists
almost entirely of readily marketable securities. Cash flow used in net
investing activities was $21.9 million for the year ended December 31, 2003, as
we invested the cash flow from operating and financing activities. While in a
period in which written premiums are increasing, it is reasonably expected that
cash from premiums will be used for investing activities. Proceeds from the sale
of property and certain owned agencies generated $1.6 million during the year.
In the future, we expect a continued cash flow deficit from investing
activities, as we invest cash from operations.
Net cash generated from financing activities was $12.2 million for the
twelve months ended December 31, 2003. The source of cash from financing
activities is primarily reflected by the receipt of $7.5 million from the
issuance of the Notes and proceeds from exercised stock options totaling $6.9
million, offset by $1.2 million paid in dividends, $0.7 million used to retire
outstanding shares of stock and $0.2 million used to reduce the revolving credit
outstanding.
The Revolving Agreement, as amended, expires September 30, 2004 and we
intend to negotiate a similar agreement to replace the expiring agreement.
We believe that our current capital resources, including the net
proceeds from the sale of our Notes described above, together with cash flow
from operations, will be sufficient to meet currently anticipated working
capital requirements. There can be no assurances, however, that such will be the
case.
To retain a 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 liabilities or the 2003 statutory
minimum capital and surplus requirement of $3.60 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, 2003, the companies were in
compliance with these ratios.
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.
Under these laws, Federated National would have been permitted to pay
dividends of approximately $441,000 to 21st Century in 2004, and American
Vehicle would be permitted to pay approximately $116,000 in dividends to 21st
Century in 2004. No dividends were paid by Federated National or American
Vehicle in 2003, 2002, or 2001 and none are anticipated in 2004. Although we
believe that amounts required to meet 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
-34-
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 or American Vehicle in the future. 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.
Insurance companies are required to comply with the risk-based capital
requirements of the NAIC. 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. Based on calculations using the appropriate NAIC
formula and the respective insurance company data for the year ending December
31, 2003, both insurance companies' total adjusted capital was in excess of
ratios that would require regulatory action. GAAP differs in some respects from
statutory reporting practices prescribed or permitted by the Florida Department
of Financial Services. Federated National's and American Vehicle's statutory
capital surplus levels as of December 31, 2003 were approximately $16.7 million
and $10.7 million, respectively, and their statutory net income for the twelve
months ended December 31, 2003 was $2.9 million and $0.8 million, respectively.
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 effect of the
agreement between the two affiliated insurance companies has been eliminated.
At December 31, 2003 and 2002, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as "structured finance" or "special purpose" entities, which were
established for the purpose of facilitating off-balance-sheet arrangements or
other contractually narrow or limited purposes. As such, management believes
that we currently are not exposed to any financing, liquidity, market or credit
risks that could arise if we had engaged in transactions of that type requiring
disclosure herein.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and related data presented herein
have been prepared in accordance with GAAP which requires the measurement of
financial position and operating results in terms of historical dollars without
considering changes in the relative purchasing power of money over time due to
inflation. Our primary assets and liabilities are monetary in nature. As a
result, interest rates have a more significant impact on performance than the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or with the same magnitude as the inflationary effect on
the cost of paying losses and LAE.
Insurance premiums are established before we know the amount of loss and
LAE and the extent to which inflation may affect such expenses. Consequently, we
attempt to anticipate the future impact of inflation when establishing rate
levels. While we attempt to charge adequate premiums, we may be limited in
raising premium levels for competitive and regulatory reasons. Inflation also
affects the market value of our 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.
-35-
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Year Ended December 31, 2003
----------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Revenue:
Net premiums earned $10,456,944 $10,949,001 $11,850,497 $11,620,788
Other revenue 4,405,066 3,995,778 3,170,924 3,667,302
----------- ----------- ----------- -----------
Total revenue 14,862,010 14,944,779 15,021,421 15,288,090
----------- ----------- ----------- -----------
Expenses:
Losses and loss adjustment expenses 6,787,709 7,493,747 6,322,281 6,905,242
Other expenses 4,467,432 4,302,036 5,626,485 5,924,142
----------- ----------- ----------- -----------
Total expenses 11,255,141 11,795,783 11,948,766 12,829,384
----------- ----------- ----------- -----------
Income (loss) before provision for income tax
expense and extraordinary gain 3,606,869 3,148,996 3,072,655 2,458,706
Provision for income tax expense 1,298,468 1,035,062 1,081,824 506,996
----------- ----------- ----------- -----------
Net income (loss) $ 2,308,401 $ 2,113,934 $ 1,990,831 $ 1,951,710
=========== =========== =========== ===========
Basic net income(loss) per share $ 0.77 $ 0.69 $ 0.63 $ 0.55
=========== =========== =========== ===========
Fully diluted net income per share $ 0.75 $ 0.66 $ 0.56 $ 0.53
=========== =========== =========== ===========
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 for income tax expense 552,866 891,350 1,046,718 811,915
----------- ----------- ----------- -----------
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
=========== =========== =========== ===========
-36-
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- ------------------------------------------------------------------
Our investment objective is to maximize total rate of return after
Federal income taxes while maintaining liquidity and minimizing risk. Our
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. We also comply
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.
Our investment policy is established by the Board of Directors or the
Investment Committee and is reviewed on a regular basis. Pursuant to this
investment policy, as of December 31, 2003, approximately 92.0% of investments
were in fixed income securities and short-term investments, which are considered
to be available for sale, based upon our intent at the time of purchase. Fixed
maturities are considered available for sale and are marked to market. We may in
the future also consider fixed maturities to be held to maturity and carried at
amortized cost. We do not use any material swaps, options, futures or forward
contracts to hedge or enhance our investment portfolio.
The investment portfolio is managed by the Investment Committee
consisting of our 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,
------------------------
2003 2002 2001
---- ---- ----
(Dollars in Thousands)
Interest on fixed maturities $ 1,463 $ 1,190 $ 485
Dividends on equity securities 109 18 13
Interest on short-term securities 27 59 559
Other 118 17 39
---------- --------------- -------------
Total investment income 1,717 1,284 1,096
Investment expense (93) (30) (29)
---------- --------------- -------------
Net investment income $ 1,624 $ 1,254 $ 1,067
========== =============== =============
Net realized gain (loss) $ 2,231 $ (1,370) $ (2,912)
========== =============== =============
The following table summarizes, by type, our investments as of December
31, 2003.
Carrying Percent
Amount of Total
-------------------------
(Dollars in Thousands)
Fixed maturities, at market:
U.S. government agencies and authorities $ 25,544 54.02%
Obligations of states and political subdivisions 7,634 16.14%
Corporate securities 10,311 21.80%
---------- -------------
Total fixed maturities 43,489 91.96%
Equity securities, at market 3,663 7.75%
Mortgage notes receivable 138 0.29%
---------- -------------
Total investments $ 47,290 100.00%
============= ==========
-37-
Fixed maturities are carried on the balance sheet at market. At December
31, 2003, 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
Amount of Total
----------- --------
(Dollars in
Thousands)
AAA $ 31,485 72.40%
AA 226 0.52%
A 7,135 16.41%
BBB 3,925 9.03%
BB++ 300 0.69%
Not rated 419 0.95%
----------- --------
$ 43,490 100.00%
=========== ========
The following table summarizes, by maturity, the fixed maturities as of
December 31, 2003.
Carrying Percent
Amount of Total
-------- --------
(Dollars in
Thousands)
Matures In:
One year or less $ 4,038 9.29%
One year to five years 6,078 13.97%
Five years to 10 years 22,373 51.44%
More than 10 years 11,001 25.30%
-------- --------
Total fixed maturities $43,490 100.00%
======== ========
At December 31, 2003, the weighted average maturity of the fixed
maturities portfolio was approximately 11 years.
The following table provides information about the financial instruments
as of December 31, 2003 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:
2004 2005 2006 2007
---- ---- ---- ----
(Dollars in Thousands)
Principal amount by expected maturity:
U.S. government agencies and authorities $ 100 $ 0 $ 100 $ 0
Obligations of states and political subdivisions -- -- -- 950
Corporate securities 4,720 1,407 900 --
Collateralized mortgage obligations -- -- -- --
Equity securities, at market -- -- -- --
Mortgage notes receivable 7 8 9 9
--------- ---------- ---------- -------
All investments $ 4,827 $ 1,415 $ 1,009 $ 959
========= ========== ========== =======
Weighted average interest rate by expected maturity:
U.S. government agencies and authorities 5.88% 0.00% 7.25% 0.00%
Obligations of states and political subdivisions 0.00% 0.00% 0.00% 4.58%
Corporate securities 6.30% 6.18% 4.00% 0.00%
Collateralized mortgage obligations 0.00% 0.00% 0.00% 0.00%
Equity securities, at market 0.00% 0.00% 0.00% 0.00%
Mortgage notes receivable 8.50% 8.50% 8.50% 8.50%
All investments 6.29% 6.19% 4.36% 4.62%
[restubbed]
Carrying
2008 Thereafter Total Amount
---- ---------- ----- ------
Principal amount by expected maturity:
U.S. government agencies and authorities $ 0 $ 24,500 $ 24,700 $25,544
Obligations of states and political subdivisions 745 5,585 7,280 7,634
Corporate securities 1,700 2,250 10,977 10,311
Collateralized mortgage obligations -- -- -- --
Equity securities, at market -- -- -- 3,663
Mortgage notes receivable 9 96 138 138
--------- ---------- ---------- -------
All investments $ 2,454 $ 32,431 $ 43,095 $47,290
========= ========== ========== =======
Weighted average interest rate by expected maturity:
U.S. government agencies and authorities 0.00% 4.61% 4.62%
Obligations of states and political subdivisions 4.74% 4.48% 4.52%
Corporate securities 5.84% 2.88% 5.04%
Collateralized mortgage obligations 0.00% 0.00% 0.00%
Equity securities, at market 0.00% 0.00% 0.00%
Mortgage notes receivable 8.50% 8.50% 8.50%
All investments 5.52% 4.46% 4.71%
-38-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Reports................................................................... 40
Consolidated Balance Sheets
as of December 31, 2003 and 2002.............................................................. 42
Consolidated Statements of Operations
For the years ended December 31, 2003, 2002 and 2001.......................................... 43
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income (Loss)
For the years ended December 31, 2003, 2002 and 2001.......................................... 44
Consolidated Statements of Cash Flows
For the years ended December 31, 2003, 2002 and 2001.......................................... 45
Notes to Consolidated Financial Statements...................................................... 47
-39-
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
21st Century Holding Company:
We have audited the accompanying consolidated balance sheets of 21st Century
Holding Company and Subsidiaries ("the Company" and a Florida Corporation) as of
December 31, 2003, and 2002 and the related consolidated statements of
operations, changes in shareholders' equity and comprehensive income (loss) and
cash flows for the years 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 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, 2003 and 2002, and the results of
their operations and their cash flows for the years then ended in conformity
with accounting principles generally accepted in the United States of America.
De Meo, Young, McGrath
Boca Raton, Florida,
April 2, 2004.
-40-
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
21st Century Holding Company:
We have audited the accompanying consolidated statements of operations, changes
in shareholders' equity and comprehensive income and cash flows of 21st Century
Holding Company and Subsidiaries ("the Company" and a Florida corporation) for
the year ended December 31, 2001. 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 results of their operations and their cash
flows of 21st Century Holding Company and Subsidiaries for the year ended
December 31, 2001, , in conformity with accounting principles generally accepted
in the United States of America.
McKEAN, PAUL, CHRYCY, FLETCHER & CO.
Plantation, Florida,
March 29, 2002.
-41-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
December 31, 2003 December 31, 2002
----------------- -----------------
ASSETS
Investments
Fixed maturities, available for sale, at fair value $ 43,489,598 $ 24,693,047
Equity securities 3,663,251 539,706
Mortgage loans 137,571 145,043
------------- -------------
Total investments 47,290,420 25,377,796
------------- -------------
Cash and cash equivalents 6,770,169 4,125,950
Receivable for investments sold 2,118,595 --
Finance contracts, net of allowance for credit
losses of $562,558 in 2003 and $404,356 in 2002 9,891,642 7,217,873
Prepaid reinsurance premiums 7,823,374 11,251,193
Premiums receivable, net of allowance for credit
losses of $123,000 and $201,000, respectively 7,328,256 8,373,104
Reinsurance recoverable, net 11,645,468 7,856,972
Deferred acquisition costs, net 1,739,685 7,721
Income taxes recoverable 824,787 --
Deferred income taxes 3,030,183 2,691,309
Property, plant and equipment, net 4,153,643 4,819,617
Goodwill, net 1,739,715 1,789,353
Other assets 2,339,656 1,807,123
------------- -------------
Total assets $ 106,695,593 $ 75,318,011
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses $ 24,570,198 $ 16,983,756
Unearned premiums 34,122,663 28,934,486
Premiums deposits 621,777 655,713
Revolving credit outstanding 4,098,786 4,312,420
Income taxes payable -- 1,676,020
Subordinated debt 6,875,000 --
Accounts payable and accrued expenses 4,360,793 4,657,952
------------- -------------
Total liabilities 74,649,217 57,220,347
------------- -------------
Commitments and contingencies
Shareholders' equity:
Common stock of $0.01 par value. Authorized 25,000,000 shares;
issued 4,088,924 and 3,411,667 shares, respectively;
Outstanding 3,625,058 and 2,990,201 shares, respectively 40,889 34,117
Additional paid-in capital 20,454,917 12,855,543
Accumulated other comprehensive income (deficit) (324,881) (227,091)
Retained earnings 13,643,225 6,521,027
Treasury stock, 463,866 and 421,466 shares, respectively, at cost (1,767,774) (1,085,932)
------------- -------------
Total shareholders' equity 32,046,376 18,097,664
------------- -------------
Total liabilities and shareholders' equity $ 106,695,593 $ 75,318,011
============= =============
See accompanying notes to consolidated financial statements.
-42-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
------------ ------------ --------------
Revenue:
Gross premiums written $ 72,991,434 $ 63,036,468 $ 34,271,338
Gross premiums ceded (19,498,209) (25,286,828) (12,789,404)
------------ ------------ ------------
Net premiums written 53,493,225 37,749,640 21,481,934
------------ ------------ ------------
Increase (decrease) in prepaid reinsurance premiums (3,427,818) 5,691,283 686,439
Increase in unearned premiums (5,188,177) (14,047,919) (1,912,812)
------------ ------------ ------------
Net change in prepaid reinsurance premiums and unearned premiums (8,615,995) (8,356,636) (1,226,373)
------------ ------------ ------------
Net premiums earned 44,877,230 29,393,004 20,255,561
Commission income 1,380,145 1,905,936 2,828,779
Finance revenue 4,327,675 4,452,626 5,267,523
Managing general agent fees 2,328,681 1,970,226 5,871,388
Net investment income 1,624,216 1,253,765 1,066,641
Net realized investment gains (losses) 2,231,333 (1,369,961) (2,911,658)
Other income 3,347,020 2,973,949 3,098,332
------------ ------------ ------------
Total revenue 60,116,300 40,579,545 35,476,566
------------ ------------ ------------
Expenses:
Loss and loss adjustment expenses 27,508,979 15,987,125 16,154,902
Operating and underwriting expenses 11,415,436 10,425,765 11,056,529
Salaries and wages 9,152,028 8,004,694 8,478,771
Interest expense 606,910 353,225 587,654
Amortization of deferred acquisition costs, net (854,279) (2,064,314) 1,467,238
Amortization of goodwill -- -- 540,010
------------ ------------ ------------
Total expenses 47,829,074 32,706,495 38,285,104
Income before provision for income tax expense
and extraordinary gain 12,287,226 7,873,050 (2,808,538)
(Provision) benefit for income tax expense (3,922,350) (3,302,849) 630,553
------------ ------------ ------------
Net income (loss) before extraordinary gain 8,364,876 4,570,201 (2,177,985)
Extraordinary gain -- -- 1,185,895
------------ ------------ ------------
Net income (loss) $ 8,364,876 $ 4,570,201 $ (992,090)
============ ============ ============
Basic net income (loss) per share before extraordinary gain $ 2.64 $ 1.52 ($ 0.69)
============ ============ ============
Extraordinary gain $ 0.00 $ 0.00 $ 0.38
============ ============ ============
Basic net income (loss) per share after extraordinary gain $ 2.64 $ 1.52 $ (0.31)
============ ============ ============
Weighted average number of common shares outstanding 3,171,315 3,005,626 3,153,640
============ ============ ============
Fully diluted net income (loss) per share $ 2.50 $ 1.52 $ (0.31)
============ ============ ============
Weighted average number of common shares outstanding (assuming dilution) 3,348,625 3,005,626 3,153,640
============ ============ ============
Dividends declared per share $ 0.38 $ 0.15 $ 0.08
============ ============ ============
See accompanying notes to consolidated financial statements.
-43-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Additional
Comprehensive Common Paid-In Comprehensive
Description Income Stock Capital Deficit
-------------- ------------ ------------ ------------
Balance as of December 31, 2000 -- $ 34,107 $ 12,894,630 ($ 1,300,404)
Net Loss (992,090) -- -- --
Cash Dividends -- -- -- --
Acqusition of common shares -- -- -- --
Stock issued to employees -- -- (78,814) --
Stock option expense -- -- 17,330 --
Net unrealized change in investments,
net of tax effect of $784,079 1,082,267 -- -- 1,082,267
------------
Comprehensive income $ 90,177 -- -- --
============
------------ ------------ ------------
Balance as of December 31, 2001 -- 34,107 12,833,146 (218,137)
Net Income 4,570,201 -- -- --
Cash Dividends -- -- -- --
Acqusition of common shares -- -- -- --
Stock issued to employees -- 10 990 --
Stock option expense -- -- 21,407 --
Net unrealized change in investments,
net of tax effect of $4,613 (8,954) -- -- (8,954)
------------
Comprehensive income $ 4,561,247 -- -- --
============
------------ ------------ ------------
Balance as of December 31, 2002 -- 34,117 12,855,543 (227,091)
Net Income 8,364,876 -- -- --
Cash Dividends -- -- -- --
Acqusition of common shares -- -- -- --
Stock options exercised -- 6,360 6,862,286 --
Stock issued in lieu of cash payment
for principle and interest associated
with our Notes -- 412 737,088 --
Stock option expense -- -- -- --
Net unrealized change in investments,
net of tax effect of $196,012 (97,790) -- -- (97,790)
------------
Comprehensive income $ 8,267,086 -- -- --
============
------------ ------------ ------------
Balance as of December 31, 2003 $ 40,889 $ 20,454,917 ($ 324,881)
============ ============ ============
[RESTUBBED]
Accumulated Total
Other Retained Treasury Shareholders'
Description Earnings Stock Equity
------------ ------------ ------------
Balance as of December 31, 2000 $ 3,642,066 ($ 314,402) $ 14,955,997
Net Loss (992,090) -- (992,090)
Cash Dividends (249,675) -- (249,675)
Acqusition of common shares -- (784,798) (784,798)
Stock issued to employees -- 258,914 180,100
Stock option expense -- -- 17,330
Net unrealized change in investments,
net of tax effect of $784,079 -- -- 1,082,267
Comprehensive income -- -- --
------------ ------------ ------------
Balance as of December 31, 2001 2,400,301 (840,286) 14,209,131
Net Income 4,570,201 -- 4,570,201
Cash Dividends (449,475) -- (449,475)
Acqusition of common shares -- (253,446) (253,446)
Stock issued to employees -- 7,800 8,800
Stock option expense -- -- 21,407
Net unrealized change in investments,
net of tax effect of $4,613 -- -- (8,954)
Comprehensive income -- -- --
------------ ------------ ------------
Balance as of December 31, 2002 6,521,027 (1,085,932) 18,097,664
Net Income 8,364,876 -- 8,364,876
Cash Dividends (1,242,678) -- (1,242,678)
Acqusition of common shares -- (681,842) (681,842)
Stock options exercised -- -- 6,868,646
Stock issued in lieu of cash payment
for principle and interest associated
with our Notes -- -- 737,500
Stock option expense -- -- --
Net unrealized change in investments,
net of tax effect of $196,012 -- -- (97,790)
Comprehensive income -- -- --
------------ ------------ ------------
Balance as of December 31, 2003 $ 13,643,225 ($ 1,767,774) $ 32,046,376
============ ============ ============
See accompanying notes to consolidated financial statements.
-44-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
------------- ------------- -------------
Cash flow from operating activities:
Net income (loss) $ 8,364,876 $ 4,570,201 $ (992,090)
Adjustments to reconcile net (loss) income to net cash
(used in) provided by operating activities:
Amortization (accretion) of investment premium, net 290,987 84,360 (50,738)
Depreciation and amortization of property plant and equipment 437,356 376,516 396,047
Deferred income tax expense (338,874) (1,107,092) (132,284)
Net realized investment (gains) losses (2,042,607) 1,369,961 2,911,658
Amortization of deferred acquisition costs, net (854,279) (2,064,314) 1,467,238
Common Stock issued for interest on Notes 112,500 -- --
Provision for credit losses, net 819,868 1,036,092 2,506,757
Provision for uncollectible premiums receivable 45,424 33,663 421,349
Extraordinary gain -- -- (1,185,895)
Other -- 30,207 30,528
Changes in operating assets and liabilities:
Premiums receivable 999,424 (6,845,853) (1,735,476)
Prepaid reinsurance premiums 3,427,819 (5,691,284) (2,635,827)
Due from reinsurers, net (3,788,496) (803,643) (3,911,090)
Deferred acquisition costs, net (877,685) 2,068,545 (286,930)
Goodwill (242,746) -- 540,010
Finance contracts receivable, consumer loans and pay
advances receivable (3,493,637) 2,559,916 472,153
Other assets (532,533) 640,212 (550,666)
Unpaid losses and loss adjustment expenses 7,586,442 5,978,419 1,136,120
Unearned premiums 5,188,177 13,983,258 1,912,811
Premium deposits (33,936) (478,264) 751,919
Income taxes recoverable (824,787) -- --
Income taxes payable (1,676,020) 1,907,042 --
Accounts payable and accrued expenses (297,159) (3,152,584) (1,229,438)
------------- ------------- -------------
Net cash (used in) provided by operating activities 12,270,114 14,495,358 (163,844)
------------- ------------- -------------
Cash flow from investing activities:
Proceeds from sale of investment securities available for sale 167,978,275 41,293,545 62,419,076
Purchases of investment securities available for sale (188,055,815) (51,088,365) (59,713,976)
Receivable for investments sold (2,118,595) -- --
Mortgage loans -- (10,000) (450,000)
Sale of and collection of mortgage loans 7,472 461,314 233,423
Purchases of property and equipment (1,289,108) (308,936) (153,387)
Proceeds from sale (acquisitions) of assets 1,621,384 199,687 (301,330)
------------- ------------- -------------
Net cash (used in) provided by investing activities (21,856,387) (9,452,755) 2,033,806
------------- ------------- -------------
Cash flow from financing activities:
Subordinated debt 7,500,000 -- --
Exercised stock options 6,868,646 -- --
Dividends paid (1,242,678) (449,475) (188,807)
Purchases of treasury stock (681,842) (253,446) (743,314)
Revolving credit outstanding (213,634) (2,364,397) (1,414,217)
------------- ------------- -------------
Net cash provided by (used in) financing activities 12,230,492 (3,067,318) (2,346,338)
------------- ------------- -------------
Net (decrease) increase in cash and cash equivalents 2,644,219 1,975,285 (476,376)
Cash and cash equivalents at beginning of year 4,125,950 2,150,665 2,627,041
------------- ------------- -------------
Cash and cash equivalents at end of year $ 6,770,169 $ 4,125,950 $ 2,150,665
============= ============= =============
See accompanying notes to consolidated financial statements.
-45-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 393,729 $ 354,572 $ 591,618
============= ============= =============
Income taxes $ 4,784,502 $ 1,565,069 $ (915,037)
============= ============= =============
Non-cash investing and finance activities:
Accrued dividends payable $ 422,890 $ 179,947 $ 60,868
============= ============= =============
Retirement of subordinated debt $ 625,000 $ -- $ --
============= ============= =============
Stock issued to employees $ -- $ 7,800 $ 180,100
============= ============= =============
Stock received for sale of agemcy $ -- $ -- $ 41,484
============= ============= =============
Notes reveivable, net of deferred gains,
received for sale of agencies $ 187,790 $ (35,523) $ 463,941
============= ============= =============
-46-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(1) ORGANIZATION AND BUSINESS
The accompanying consolidated financial statements include the accounts
of 21st Century Holding Company and its subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
We are a vertically integrated insurance holding company, which,
through our subsidiaries, controls substantially all aspects of the insurance
underwriting, distribution and claims process. We underwrite personal automobile
insurance, general liability insurance, flood insurance, homeowners' insurance
and mobile home property and casualty insurance in Florida and Georgia through
our wholly owned subsidiaries, Federated National Insurance Company and American
Vehicle Insurance Company. American Vehicle was approved in August 2003 to be a
foreign insurer in the State of Georgia. During the year ended December 31,
2003, 67.2%, 23.4%, 2.4% and 7.0% of the policies we underwrote were for
personal automobile insurance, homeowners' property and casualty insurance,
mobile home property and casualty insurance and commercial general liability,
respectively. We internally process claims made by our own and third party
insureds through our wholly owned claims adjusting company, Superior Adjusting,
Inc. We also offer premium financing to our own and third-party insureds through
our wholly owned subsidiary, Federated Premium Finance, Inc.
We market and distribute our own and third-party insurers' products and
our other services primarily in Central and South Florida, through a network of
23 agencies owned by Federated Agency Group, Inc., a wholly owned subsidiary, 44
franchised agencies, approximately 125 independent agents and a select number of
general agents. Through our wholly owned subsidiary, FedUSA, Inc., we franchise
agencies under the FedUSA name. As of December 31, 2003, franchises were granted
for 44 FedUSA agencies, of which 38 were operating and 6 are pending. We intend
to focus our future expansion efforts for our agency network on franchised
agencies.
Assurance Managing General Agents, Inc., a wholly owned subsidiary, 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 our 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 replaced
business from an unaffiliated insurance company with business from 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.
We offer electronic tax filing services through Express Tax Service,
Inc., an 80%-owned subsidiary, as well as franchise opportunities for these
services through EXPRESSTAX. As of December 31, 2003, there were 231 franchises
granted in 18 states. Revenue is generated through franchise sales, collection
of royalties on tax preparation fees, incentives from business partners as well
as fees from the preparation of income tax returns and income tax refund
anticipation loans. In addition, Express Tax offers tax preparation services
through more than 500 licensees nationwide.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) CASH AND CASH EQUIVALENTS
We consider all short-term highly liquid investments with original
maturities of three months or less to be cash equivalents.
(B) INVESTMENTS
Our investment securities have been classified as available-for-sale
because all of the securities are available to be sold in response to our
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. 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
-47-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
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.
(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
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, salaries and premium taxes net of policy fees, 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:
Years Ended December 31,
----------------------------------------
2003 2002 2001
----------- ----------- -----------
Balance, beginning of year $ 7,721 $ 11,952 $ 1,192,260
Acquisition costs deferred 885,406 (2,068,545) 286,930
Amortization expense during year 854,279 2,064,314 (1,467,238)
----------- ----------- -----------
Balance, end of year $ 1,747,406 $ 7,721 $ 11,952
=========== =========== ===========
(E) PREMIUM DEPOSITS
Premium deposits represent premiums received on policies not yet
written. We take approximately 30 working days to issue 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 determined by
establishing liabilities in amounts estimated to cover incurred losses and loss
adjustment expenses. Such liabilities are determined based upon our 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 $859,000, $550,000 and $544,000, net of
reinsurance, at December 31, 2003, 2002 and 2001, 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, we review historical data and consider 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 our unpaid losses and loss adjustment
expenses will be adequate to cover actual losses. If our unpaid losses and loss
adjustment expenses prove to be inadequate, we will be required to increase the
liability with a corresponding reduction in our 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 our business, results of operations and financial
condition.
-48-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
We do not discount unpaid losses and loss adjustment expenses for
financial statement purposes.
(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 provided for 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:
Year Ended December 31,
2003 2002 2001
--------- --------- ---------
Allowance for credit losses at beginning of year $ 201,000 $ 235,000 $ 325,000
Additions charged to bad debt expense 11,259 34,710 421,349
Write-downs charged against the allowance (89,259) (68,710) (511,349)
--------- --------- ---------
Allowance for credit losses at end of year $ 123,000 $ 201,000 $ 235,000
========= ========= =========
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 contracts which
do not involve affiliated insurers 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 not
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 are intended to reimburse us for the costs incurred to
underwrite the policy. The fees and related costs are recognized when the policy
is underwritten. These underwriting costs are included as a component of
deferred acquisition costs.
(L) REINSURANCE
We recognize the income and expense on reinsurance contracts principally
on a pro-rata basis over the life of the policies covered under the reinsurance
agreements. We are reinsured under separate reinsurance agreements for the
different lines of business underwritten. Reinsurance contracts do not relieve
us from our obligations to policyholders. We continually monitor our reinsurers
to minimize our exposure to significant losses from reinsurer insolvencies. We
only cede risks to reinsurers whom we believe to be financially sound. At
December 31, 2003, all reinsurance recoverables are considered collectible.
-49-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(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
Our 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 us with the provisional commissions.
We have 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. There
were no contingent ceding commissions recognized for the year ending December
31, 2003 due to the provisions contained in the reinsurance contract allowing
for a flat rate commission schedule. 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 us to concentrations of
credit risk, consist primarily of investments, premiums receivable, amounts due
from reinsurers on paid and unpaid losses, finance contracts, consumer loans and
pay advances receivable. We have not experienced significant losses related to
premiums receivable from individual policyholders or groups of policyholders in
a particular industry or geographic area. We have not experienced significant
losses related to consumer loans or pay advances receivable. We believe no
credit risk beyond the amounts provided for collection losses is inherent in our
premiums receivable or finance contracts, consumer loans and pay advances
receivable. In order to reduce credit risk for amounts due from reinsurers, we
seek to do business with financially sound reinsurance companies and regularly
review the financial strength of all reinsurers used.
(P) ACCOUNTING CHANGES
In January 2003, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN
46"), which requires the consolidation of certain entities considered to be
variable interest entities ("VIEs"). An entity is considered to be a VIE when it
has equity investors who lack the characteristics of having a controlling
financial interest, or its capitalis insufficient to permit it to finance its
activities without additional subordinated financial support. Consolidation of a
VIE by an investor is required when it is determined that the investor will
absorb a majority of the VIE's expected losses if they occur, receive a majority
of the entity's expected residual returns if they occur, or both. The adoptionof
Interpretation No. 46 did not have any impact on our Consolidated Financial
Statements.
In May 2003, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard Number 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity and it
requires that an issuer classify a financial instrument that is within its scope
as a liability because the financial instrument embodies an obligation of the
issuer. This Statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective in the first interim
period beginning after June 15, 2003. On July 31, 2003, we completed a private
placement of our 6% Senior Subordinated Notes (the "Notes"), which were offered
and sold to accredited investors as units consisting of one note with a
principal amount of $1,000 and warrants (the "warrant") to purchase one half a
share of the Company's Common Stock. These Notes fall within the definition of
financial instruments as described in Financial Accounting Standard Number 150
and were originally presented as a liability in conformity with Statement of
Financial Accounting Standard Number 150. As such, the adoption of this
Statement did not have any impact on our Consolidated Financial Statements.
-50-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(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, our 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, we believe 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 our 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 us
and how we mitigate those risks:
(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.
We attempt to mitigate this risk by monitoring proposed regulatory legislation
and by assessing the impact of new laws. As we write business only in the states
of Florida and Georgia, we are more exposed to this risk than some of our more
geographically balanced competitors.
(II) CREDIT RISK--the risk that issuers of securities owned by us will
default or that other parties, including reinsurers to whom business is ceded,
which owe us money, will not pay. We attempt 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.
(IV) CATASTOPHIC EVENT RISK--the risk associated with writing insurance
policies covering automobile owners, home owners, and business owners for losses
that result from catastrophes, including hurricanes, tropical storms, tornadoes
or other weather related events. Although we have not experienced significant
claims due to a weather event, the occurrence of a catastrophe in an area where
we have a concentration of policy holders could substantially harm us by causing
claims to exceed our reinsurance coverage.
(S) FAIR VALUE
The fair value of our investments is 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, 2003 and 2002. Changes in interest rates subsequent to
December 31, 2003 may affect the fair value of our investments. Refer to Note
3(a) for details.
The carrying amounts for the following financial instrument categories
approximate their fair values at December 31, 2003 and 2002 because of their
short-term nature: cash and cash equivalents, premiums receivable, finance
contracts, consumer loans and pay advance receivables, due from reinsurers,
drafts payable to insurance companies, revolving credit outstanding, bank
overdrafts, 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.
-51-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(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 2003 and 2002, compared to
$540,010 in 2001. 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 $
1,739,715 and $1,789,353 at December 31, 2003 and 2002, respectively, net of
$1,726,530 and $1,725,622 of accumulated amortization as of December 31, 2003
and 2002, respectively. Goodwill relates to our insurance segment. The
impairment computation for 2003 and 2002 indicated there was no impairment of
goodwill. Impairment testing was performed during the fourth quarter of 2003,
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, 2003.
Year Ended December 31,
-----------------------
2003 2002 2001
------------- ------------- -----------
Reported net income (loss) $ 8,364,876 $ 4,570,201 $ (992,090)
Add back goodwill amortization -- -- 540,010
------------- ------------- -----------
Adjusted net income (loss) $ 8,364,876 $ 4,570,201 $ (452,080)
============= ============= ===========
Basic earnings per share:
Reported net income $ 2.64 $ 1.52 (0.31)
Goodwill amortization $ -- $ -- $ 0.14
------------- ------------- -----------
Adjusted net income $ 2.64 $ 1.52 $ (0.17)
============= ============= ===========
(U) STOCK OPTION PLANS
We account 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 our stock at the date of grant over
the amount an employee must pay to acquire the stock.
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, we use the accounting method prescribed by Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB
25) to account for our 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 we 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
-52-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
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.
We continue 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 our stock compensation plan been determined based upon fair values
at the grant dates for awards under the plan in accordance with SFAS No. 123,
our 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.
December 31,
------------
Net income (loss) 2003 2002 2001
------------- ------------- -------------
As reported $ 8,364,876 $ 4,570,201 $ (992,090)
Compensation, net of tax effect $ 4,783,080 $ 1,750,528 $ 189,765
------------- ------------- -------------
Pro forma net income (loss) $ 3,581,796 $ 2,819,673 $ (1,181,855)
============= ============= =============
Net income (loss) per share
As reported - Basic $ 2.64 $ 1.52 $ (0.31)
As reported - Diluted $ 2.50 $ 1.52 $ (0.31)
Pro forma - Basic $ 1.13 $ 0.94 $ (0.37)
Pro forma - Diluted $ 1.07 $ 0.94 $ (0.37)
(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. We capitalize
betterments and any other 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 based on the expected future
undiscounted operating cash flows of the related item. Based upon our most
recent analysis, we believe that no impairment of property, plant and equipment
exists at December 31, 2003.
(W) RECLASSIFICATIONS
Certain 2002 financial statement amounts have been reclassified to
conform with the 2003 presentations.
(3) INVESTMENTS
(A) FIXED MATURITIES AND EQUITY SECURITIES
The following table shows the realized gains (losses) for fixed and
equity securities for the years ended December 31, 2003 and 2002:
Year Ended December 31,
Gains (Losses) Fair Value Gains (Losses) Fair Value
2003 At Sale 2002 At Sale
------------- ------------ ------------- ------------
Fixed securities $ 1,590,935 $102,966,845 $ 774,931 $ 48,454,705
Equity securities 1,230,118 38,847,014 123,232 --
Total realized gains 2,821,053 141,813,859 898,163 48,454,705
------------ ------------ ------------ ------------
Fixed securities (508,299) 17,213,554 (2,164,790) 3,384,068
Equity securities (81,422) 7,555,755 (103,334) 1,680,203
------------ ------------ ------------ ------------
Total realized losses (589,721) 24,769,309 (2,268,124) 5,064,271
------------ ------------ ------------ ------------
Net realized gains (losses) on investments $ 2,231,332 $166,583,168 $ (1,369,961) $ 53,518,976
============ ============ ============ ============
-53-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
A summary of the amortized cost, estimated fair value, gross unrealized
gains and losses of fixed maturities and equity securities at December 31, 2003
and 2002 is as follows:
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
-----------------------------------------------------
December 31, 2003
Fixed Maturities:
U.S. government obligations $26,337,724 $ 63,038 $ 856,651 $25,544,111
Obligations of states and political
subdivisions 7,639,293 60,501 65,342 $ 7,634,452
Corporate securities 10,041,640 298,631 29,236 10,311,035
----------- ----------- ----------- -----------
$44,018,657 $ 422,170 $ 951,229 $43,489,598
=========== =========== =========== ===========
Equity securities - preferred stocks $ 250,000 $ 400 $ -- $ 250,400
common stocks 3,409,697 5,000 1,846 3,412,851
----------- ----------- ----------- -----------
$ 3,659,697 $ 5,400 $ 1,846 $ 3,663,251
=========== =========== =========== ===========
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
=========== =========== =========== ===========
Below is a summary of fixed maturities at December 31, 2003 and 2002 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, 2003 December 31, 2002
----------------- -----------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
----------- ----------- ----------- -----------
Due in one year or less $ 3,823,434 $ 4,039,356 $ 1,355,968 $ 1,358,268
Due after one year through
five years 5,975,696 6,077,534 13,490,634 13,213,114
Due after five years through ten
years 22,835,339 22,372,081 7,470,221 7,589,673
Due after ten years 11,384,188 11,000,627 2,581,221 2,531,992
----------- ----------- ----------- -----------
$44,018,658 $43,489,598 $24,898,044 $24,693,047
=========== =========== =========== ===========
-54-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
Political subdivision bonds with an amortized cost of approximately
$502,000 and a fair market value of approximately $506,000 were on deposit with
the Florida Department of Financial Services as of December 31, 2003, as
required by law.
A summary of the sources of net investment income follows:
Years Ended December 31,
------------------------
2003 2002 2001
----------- ----------- -----------
Fixed maturities $ 1,462,919 $ 1,189,683 $ 484,913
Equity maturities 108,983 18,009 13,301
Cash and cash equivalents 26,676 59,182 559,017
Other 118,057 17,328 38,390
----------- ----------- -----------
Total investment income 1,716,635 1,284,202 1,095,621
Less investment expenses (92,419) (30,437) (28,980)
----------- ----------- -----------
Net investment income $ 1,624,216 $ 1,253,765 $ 1,066,641
=========== =========== ===========
Proceeds from sales of fixed maturities and equity securities for the
years ending December 31, 2003, 2002 and 2001 were approximately $168 million,
$41 million and $62 million, respectively.
A summary of realized investment gains (losses) and (increases)
decreases in net unrealized losses follows:
Years Ended December 31,
------------------------
2003 2002 2001
----------- ----------- -----------
Net realized gains (losses):
Fixed maturities $ 1,082,636 $(1,389,860)* $ 173,294
Equity maturities 1,148,696 19,899 (3,084,952)
----------- ----------- -----------
Total $ 2,231,332 $(1,369,961) $(2,911,658)
=========== =========== ===========
*Includes a $2,000,000 impairment loss
Change in net unrealized losses:
Fixed maturities $ (321,514) $ (12,124) $ 156,042
Equity maturities 27,712 (1,443) 1,710,304
----------- ----------- -----------
Total $ (293,802) $ (13,567) $ 1,866,346
=========== =========== ===========
(B) MORTGAGE LOANS
Years Ended December 31,
------------------------
2003 2002 2001
--------- --------- ---------
Mortgage receivable beginning of year $ 145,043 $ 601,601 $ 385,024
New mortgages -- -- 450,000
Principal payments received (7,472) (456,558) (233,423)
--------- --------- ---------
Mortgage receivable end of year $ 137,571 $ 145,043 $ 601,601
========= ========= =========
-55-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
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:
Years Ended December 31,
------------------------
2003 2002
---- ----
Finance contracts receivable $ 10,990,446 $ 7,776,553
------------ ------------
Pay advances receivable -- --
Subtotal 10,990,446 7,776,553
Less:
Unearned income (536,246) (154,324)
Allowance for credit losses (562,558) (404,356)
------------ ------------
Finance contracts, consumer loans and pay advances receivable, net $ 9,891,642 $ 7,217,873
============ ============
The activity in the allowance for credit losses was as follows:
Years Ended December 31,
------------------------
2003 2002 2001
----------- ----------- -----------
Allowance for credit losses at beginning of year $ 404,356 $ 723,756 $ 832,231
Additions charged to bad debt expense 819,868 1,036,092 2,506,757
Write-offs charged against the allowance (661,666) (1,355,492) (2,615,232)
----------- ----------- -----------
Allowance for credit losses at end of year $ 562,558 $ 404,356 $ 723,756
=========== =========== ===========
As of December 31, 2003, we have approximately $1.4 million, or 12.7%,
of the gross premium finance receivables (before the allowances for credit
losses and unearned premium finance charges) that comprises policies from an
unrelated insurer. This unrelated insurance company currently is rated "B-"
(Fair) by A.M. Best.
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.
-56-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(5) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
Years Ended December 31,
2003 2002
----------- -----------
Land $ 632,144 $ 787,144
Building and improvements 2,823,400 3,775,208
Furniture and fixtures 2,385,083 1,729,033
----------- -----------
Property, plant and equipment, gross 5,840,627 6,291,385
Accumulated depreciation (1,686,984) (1,471,768)
----------- -----------
Property, plant and equipment, net $ 4,153,643 $ 4,819,617
=========== ===========
Depreciation of property, plant, and equipment was $437,356, $376,516
and $396,047 during 2003, 2002 and 2001, respectively.
-57-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(6) REINSURANCE
We reinsure (cede) a portion of written premiums on a quota-share basis
to nonaffiliated insurance companies in order to limit our loss exposure. We
also maintain coverages to limit losses from large exposures, which we believe
are adequate for current volume. To the extent that reinsuring companies are
unable to meet their obligations assumed under the reinsurance agreements, we
remain primarily liable to our policyholders.
The impact of reinsurance on the financial statements is as follows:
Years Ended December 31,
------------ ------------ ------------
2003 2002 2001
------------ ------------ ------------
Premium written:
Direct $ 72,991,434 $ 63,036,468 $ 34,271,338
Ceded (19,498,209) (25,286,828) (12,789,404)
------------ ------------ ------------
$ 53,493,225 $ 37,749,640 $ 21,481,934
============ ============ ============
Premiums earned:
Direct $ 67,803,257 $ 48,988,774 $ 32,358,300
Ceded (22,926,027) (19,595,770) (12,102,739)
------------ ------------ ------------
$ 44,877,230 $ 29,393,004 $ 20,255,561
============ ============ ============
Losses and loss adjustment expenses incurred:
Direct $ 46,035,627 $ 29,776,770 $ 29,064,763
Ceded (18,526,648) (13,789,645) (12,909,861)
------------ ------------ ------------
$ 27,508,979 $ 15,987,125 $ 16,154,902
============ ============ ============
As of December 31,
----------------------------
2003 2002
------------ ------------
Unpaid losses and loss adjustment expenses, net:
Direct $ 24,570,198 $ 16,983,756
Ceded (9,761,353( (7,847,421)
------------ ------------
$ 14,808,845 $ 9,136,335
============ ============
Unearned premiums:
Direct $ 34,122,663 $ 28,934,486
Ceded (7,823,374) (11,251,193)
------------ ------------
$ 26,299,289 $ 17,683,293
============ ============
We received approximately $6.7 million, $6.8 million and $3.8 million in
commissions on premiums ceded during the years ended December 31, 2003, 2002 and
2001, respectively. Had all of our reinsurance agreements been canceled at
December 31, 2003, we would have returned a total of approximately $2.5 million
in reinsurance commissions to our reinsurers; in turn, our reinsurers would have
returned approximately $7.8 million in unearned premiums to us.
-58-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
At December 31, 2003 and 2002, the Company had an unsecured aggregate
recoverable for paid and unpaid losses and loss adjustment expenses and unearned
premiums with the following reinsurers:
As of December 31,
----------------------------
2003 2002
------------ ------------
Transatlantic Reinsurance Company (A++ A.M. Best Rated):
Unearned premiums $ 7,823,374 $ 11,251,193
Reinsurance recoverable on paid losses and loss adjustment expenses 2,457,228 3,266,715
Unpaid losses and loss adjustment expenses 9,761,353 7,847,255
------------ ------------
$ 20,041,955 $ 22,365,163
============ ============
Amounts due from reinsurers consisted of amounts related to:
Unpaid losses and loss adjustment expenses $ 9,761,353 $ 7,847,255
Reinsurance recoverable on paid losses and loss adjustment expenses 2,457,228 3,266,715
Reinsurance payable (1,339,162) (3,984,895)
------------ ------------
$ 10,879,419 $ 7,129,075
============ ============
(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,
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
Balance at January 1: $ 16,983,756 $ 11,005,337 $ 9,765,848
Less reinsurance recoverables (7,847,421) (4,798,556) (2,789,619)
------------ ------------ ------------
Net balance at January 1 $ 9,136,335 $ 6,206,781 $ 6,976,229
============ ============ ============
Incurred related to:
Current year $ 26,274,932 $ 15,896,251 $ 13,586,426
Prior years 1,234,047 90,874 2,568,476
------------ ------------ ------------
Total incurred $ 27,508,979 $ 15,987,125 $ 16,154,902
============ ============ ============
Paid related to:
Current year $ 14,205,212 $ 8,149,079 $ 8,768,672
Prior years 7,631,258 4,908,492 8,259,045
------------ ------------ ------------
Total paid $ 21,836,470 $ 13,057,571 $ 17,027,717
============ ============ ============
Balance, American Vehicle, at acquisition $ -- $ -- $ 103,367
Net balance at year-end $ 14,808,845 $ 9,136,335 $ 6,206,781
Plus reinsurance recoverables 9,761,354 7,847,421 4,798,556
------------ ------------ ------------
Balance at year-end $ 24,570,198 $ 16,983,756 $ 11,005,337
============ ============ ============
-59-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
Based upon consultations with our independent actuarial consultants and
their statement of opinion on losses and loss adjustment expenses, we believe
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 our review of our liability for losses and LAE, which
includes a re-evaluation of the adequacy of reserve levels for prior year's
claims, we increased the liability for loss and LAE for claims occurring in
prior years by $1,234,047, $90,874 and $2,568,476 for the year ended December
31, 2003, 2002 and 2001, respectively. The adjustments in the liability were
primarily attributable to loss development with respect to our personal
automobile insurance program. There can be no assurance concerning future
adjustments of reserves, positive or negative, for claims through December 31,
2003.
(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.
Flatiron reduced the maximum credit commitment under the Revolving
Agreement due to the A.M. Best ratings of third party insurance carriers with
which we were financing policies at the time. Simultaneously, however, we ceased
financing policies underwritten by third party insurance carriers altogether and
began financing only those policies underwritten by our insurance carriers (in
2003 we began again to finance policies from a small number of independent
agents whose customer base and operational history meet our strict criteria for
credit worthiness). Additionally, we implemented a direct bill program for
policies underwritten by our carriers. These changes markedly decreased credit
risks and made our reliance on the higher credit commitment previously offered
by FlatIron unnecessary.
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 effective interest rate on this line of credit, based
on our average outstanding borrowings under the Revolving Agreement, was 5.63%,
6.23% and 7.84% for the years ended December 31, 2003, 2002 and 2001,
respectively. The Revolving Agreement contains various operating and financial
covenants, with which the Company was in compliance at December 31, 2003 and
2002. The Revolving Agreement, as amended, expires September 30, 2004 and we
intend to negotiate a similar agreement to replace the expiring agreement.
Outstanding borrowings under the Revolving Agreement as of December 31, 2003 and
2002 were approximately $4.1 million and $4.3 million, respectively. Outstanding
borrowings in excess of the $4.0 million commitment totaled $98,786 and
$312,420, respectively for December 31, 2003 and 2002. The excess amounts are
permissible by reason of a compensating cash balance of $200,430 and $352,433,
respectively for December 31, 2003 and 2002 and are held for the benefit of FPF,
Inc. and are included in other assets. Interest expense on this revolving credit
line for the years ended December 31, 2003, 2002 and 2001 totaled approximately
$203,000, $342,000 and $592,000, respectively.
-60-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(9) INCOME TAXES
A summary of the provision for income tax expense (benefit) is as
follows:
Year Ended December 31,
-----------------------------------------
2003 2002 2001
----------- ----------- -----------
Federal:
Current $ 3,404,982 $ 3,323,281 $ (453,263)
Deferred (39,283) (453,708) (103,197)
----------- ----------- -----------
Provision (benefit)for Federal income tax expense 3,365,699 2,869,573 (556,460)
----------- ----------- -----------
State:
Current 563,375 510,941 (56,428)
Deferred (6,724) (77,665) (17,665)
----------- ----------- -----------
Provision (benefit) for state income tax expense 556,651 433,276 (74,093)
----------- ----------- -----------
Provision for income (benefit) tax expense $ 3,922,350 $ 3,302,849 $ (630,553)
=========== =========== ===========
The actual income tax expense (benefit) differs from the "expected"
income tax expense (benefit) (computed by applying the combined applicable
effective federal and state tax rates to income (loss) before provision for
income tax expense (benefit)) as follows:
Year Ended December 31,
-----------------------------------------
2003 2002 2001
----------- ----------- -----------
Computed expected tax (benefit), at federal rate $ 4,177,657 $ 2,437,254 $ (954,903)
State tax, net of federal deduction benefit 556,651 443,276 (48,901)
Tax-exempt interest (122,275) (95,564) (125,321)
Amortization of goodwill 53,536 54,641 55,335
Dividend received deduction (42,612) (5,205) (4,522)
Capital loss carryforward (371,847) -- --
Disposition of financially impaired bond (340,000) -- --
Valuation allowance for capital loss carry forward -- 256,083 482,491
Other, net 11,240 212,364 (34,732)
----------- ----------- -----------
Income tax expense (benefit), as reported $ 3,922,350 $ 3,302,849 $ (630,553)
=========== =========== ===========
-61-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
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 our net deferred tax asset are as follows:
Year Ended December 31,
--------------------------
2003 2002
----------- -----------
Deferred tax assets:
Unpaid losses and loss adjustment expenses $ 501,190 $ 265,695
Unearned premiums 1,979,284 1,330,845
Unrealized loss on investment securities 196,012 85,454
Allowance for credit losses 257,975 227,795
Unearned commissions 189,222 333,941
Accrued class action settlement 225,780 --
Deferred commissions 75,260 --
Goodwill 131,063 190,315
Unearned adjusting income 20,456 40,640
Capital loss carryforward - Impairment loss 376,300 752,600
Capital loss carryforward -- 405,746
----------- -----------
Total deferred tax assets 3,952,542 3,633,031
----------- -----------
Deferred tax liabilities:
Prepaid Florida Hurricane Catastrophic Fund (222,664) (169,335)
Deferred acquisition costs, net (661,262) (2,905)
Depreciation (38,433) (30,908)
----------- -----------
Total deferred tax liabilities (922,359) (203,148)
----------- -----------
Valuation for deferred tax asset -- (738,574)
----------- -----------
Net deferred tax asset $ 3,030,183 $ 2,691,309
=========== ===========
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, 2003 and 2002, 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.
-62-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(10) REGULATORY REQUIREMENTS AND RESTRICTIONS
To retain our certificate of authority, the Florida Insurance Code (the
"Code") requires Federated National and American Vehicle to maintain capital and
surplus equal to the greater of 10 percent of their liabilities or a statutory
minimum capital and surplus as defined in the Code. In 2003, 2002 and 2001,
Federated National and American Vehicle were required to have capital surplus of
$3.6 million, $3.25 million and $3.0 million, each, respectively. At December
31, 2003, 2002 and 2001, Federated National's statutory capital surplus was
$16.7 million, $9.2 million and $5.7 million, respectively. At December 31,
2003, 2002 and 2001, American Vehicle had statutory capital surplus of $10.7
million, $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, 2003, both companies were in compliance with this
requirement.
As of December 31, 2003, to meet regulatory requirements, we had bonds
with a carrying value of approximately $1,983,000 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 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 2003, 2002 or 2001.
Under these laws, Federated National would be permitted to pay
dividends of approximately $441,000 to 21st Century in 2004, and American
Vehicle would be permitted to pay $116,000 in dividends in 2004. 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 or American Vehicle.
We are 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, 2003, 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.
As of December 31, 2003, Federated National was outside NAIC's usual
ranges with respect to its IRIS tests on five out of twelve ratios. The first
ratio relates to a larger than expected change in net writings, the second ratio
relates to higher surplus growth that stemmed from the Parent company's capital
contributions totaling $3.9 million during the year and the third ratio relates
to an investment yield that was less than expected. The fourth and fifth ratios
involved the one and two year reserve development to policyholder surplus ratios
that were in excess of the "usual ranges" and relate to modest, but adverse,
development which incurred in 2003 relating to 2002 and 2001 loss reserves.
-63-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
As of December 31, 2003, American Vehicle was outside NAIC's usual
ranges for three out of twelve ratios. The first ratio relates to a larger than
expected change in net writings, the second ratio relates to higher surplus
growth that stemmed from the Parent company's capital contributions totaling
$5.9 million during the year and the third ratio relates to an investment yield
that was slightly less than expected.
We do 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, though 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 $16.7
million and $9.2 million as of December 31, 2003 and 2002, respectively.
Federated National's statutory net income was $2.9 and $2.2 million for the
years ended December 31, 2003 and 2002, respectively. Federated National
incurred a statutory net loss of $2.1 million for the year ended December 31,
2001. Federated National's statutory non-admitted assets were approximately
$504,000 and $45,000 as of December 31, 2003 and 2002, respectively. American
Vehicle's statutory capital and surplus was $10.7 million and $4.0 million as of
December 31, 2003 and 2002, respectively. American Vehicle's statutory net
income was approximately $848,000, $135,000 and $64,000 for the years ended
December 31, 2003, 2002 and 2001 respectively. American Vehicle's statutory
non-admitted assets were approximately $161,000 and $16,000 as of December 31,
2003 and 2002, respectively.
(11) COMMITMENTS AND CONTINGENCIES
In June 2000, a lawsuit was filed against us, our directors and our
executive officers seeking compensatory damages in an undisclosed amount on the
basis of allegations that our amended registration statement dated November 4,
1998 was inaccurate and misleading concerning the manner in which we 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. The plaintiff class purportedly includes
purchasers of our common stock between November 5, 1998 and August 13, 1999. The
Court recently granted the plaintiffs class status.
Specifically, the plaintiffs allege that we recognized ceded commission
income on a written basis, rather than amortized on a pro rata basis. The
plaintiffs allege that this was contrary to the Statement of Financial
Accounting Concepts Nos. 1, 2 and 5. We believe, however, that the lawsuit is
without merit and we have vigorously defended the action, because we reasonably
relied upon outside subject matter experts to make these determinations at the
time. We have also since accounted for ceded commission on a pro rata basis and
have done so since these matters were brought to our attention in 1998.
Nevertheless, we have also continued to actively participate in settlement
negotiations with the plaintiffs and have tentatively agreed to settle the case.
The parties are currently negotiating the final terms of a Memorandum of
Understanding, which will have to be executed by the parties and then approved
by the court. We have reserved and charged against current year earnings
$600,000 for the potential settlement and associated costs.
Prior to its acquisition 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. American Vehicle's previous owners have agreed
to indemnify us 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.
We are 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 our
consolidated financial position, results of operations, or liquidity.
As a direct premium writer in the State of Florida, we are required to
participate in certain insurer solvency pools under Florida Statutes
631.57(3)(a). Participation in these pools is based on our written premium by
line of business to total premiums written statewide by all insurers.
Participation may result in assessments against us. We were assessed $258,000
and $203,000, for the years ended December 31, 2002 and 2001, respectively.
There was no assessment made for the year ended December 31, 2003. We are
entitled to recover all of these assessments as permitted by the State of
Florida through
-64-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
policy surcharges. During 2002, we recovered $180,000 of the 2001 assessment and
during 2003 we recovered the balance of the 2001 assessment and $142,000 of the
2002 assessment. Of the 2002 assessment, $16,000 will not be passed through as
policy surcharges and $99,000 remains to be collected through policy surcharges
as of December 31, 2003.
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 have been incurred by either insurance company through
the date of issuance of this report.
(12) LEASES
We lease office space under various lease agreements with expiration
dates through September 2007. Rental expense associated with operating leases is
charged to expense in the period incurred. Rental expenses for 2003, 2002 and
2001 were approximately $733,000, $756,000 and $797,000, respectively, and are
included in operating and underwriting expenses in the accompanying consolidated
statements of operations.
At December 31, 2003, the minimum aggregate rental commitments are as
follows:
Fiscal Year Leases
----------- ------
2004 $ 303,366
2005 157,871
2006 81,695
2007 49,146
Thereafter --
----------
Total $ 592,078
==========
(13) RELATED PARTY TRANSACTIONS
One of our directors is a partner at a law firm that handles the
Company's claims litigation. Fees paid to this law firm amounted to
approximately $219,000, $266,000 and $530,000 for the years ended December 31,
2003, 2002 and 2001, respectively.
In September 2002, one of our directors, who is also on the Investment
Committee, began to oversee an investment account for the Company. The oversight
arrangement was subsequently terminated in March of 2003. Fees paid to this
director in 2003 and 2002 totaled $7,500 and $1,250, respectively.
(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 stock option plan were anti-dilutive for the years ended
December 31, 2002 and 2001 and were not taken into account in the computation.
At December 31, 2003, 2002 and 2001, warrants issued to two employees to
purchase 7,800, 62,500 and 62,500 shares, respectively of common stock at $9 per
share were outstanding. During 2003 54,700 warrants were exercised. At December
31, 2002 and 2001, 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. During 2003, 100% of the
125,000 shares were exercised. All of these potential common shares were
excluded from the computation of net income (loss) per share for 2002 and
2001 because their inclusion would have an anti-dilutive effect.
A summary of the numerator and denominator of the basic and fully
diluted (2003 only) net income (loss) per share is presented below:
-65-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
Income (Loss) Shares Outstanding Per-share
(Numerator) (Denominator) Amount
=========== ========= ========
For the year ended December 31, 2003:
Basic net income per share $ 8,364,876 3,171,315 $ 2.64
=========== ========= ========
Fully diluted income per share $ 8,364,876 3,348,625 $ 2.50
=========== ========= ========
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)
=========== ========= ========
(15) SEGMENT INFORMATION
We 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, homeowners' insurance, mobile home property and casualty
insurance, and general liability insurance. This segment 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 our insureds and third party
carrier insureds, and is marketed through our distribution network.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies and practices. We evaluate
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.
-66-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
Information regarding components of operations for the years ended
December 31, 2003, 2002 and 2001 follows:
Years Ended December 31,
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
Total Revenues
Insurance Segment:
Earned premium $ 44,877,230 $ 29,393,004 $ 20,255,561
Investment income (loss) 5,815,074 1,253,215 (1,368,347)
Adjusting income 4,172,084 2,886,838 2,605,893
MGA fee income 2,304,126 1,970,226 5,843,078
Commision income 4,912,253 2,568,600 5,524,379
Other income 192,864 812,622 342,044
------------ ------------ ------------
Total insurance revenue 62,273,631 38,884,505 33,202,608
------------ ------------ ------------
Financing Segment:
Premium finance income 2,622,745 3,657,942 4,503,994
Consumer loan interest -- -- 35,340
Pay day advances -- 56,584 567,233
Miscellaneous income -- -- (15,885)
------------ ------------ ------------
Total financing revenue 2,622,745 3,714,526 5,090,682
------------ ------------ ------------
All other segment revenue 4,986,570 2,938,991 1,332,819
------------ ------------ ------------
Total operating revenue 69,882,946 45,538,022 39,626,109
Intercompany eliminations (9,766,646) (4,958,477) (4,149,543)
------------ ------------ ------------
Total revenues $ 60,116,300 $ 40,579,545 $ 35,476,566
============ ============ ============
Earnings (loss) before income taxes:
Insurance segment $ 11,289,169 $ 6,104,883 $ (4,813,846)
Financing segment 622,740 1,421,302 723,505
All other segments 375,317 346,865 1,281,803
------------ ------------ ------------
Total earnings (loss) before income taxes $ 12,287,226 $ 7,873,050 $ (2,808,538)
============ ============ ============
Information regarding total assets as of December 31, 2003 and 2002
follows:
Years Ended December 31,
---------------------------------
2003 2002
------------- -------------
Assets by segment
Insurance segment $ 93,301,125 $ 66,663,775
Financing segment 10,105,548 7,548,841
All other segments 3,602,606 3,003,827
------------- -------------
Total assets by segment 107,009,279 77,216,443
Intercompany eliminations (313,686) (1,898,432)
------------- -------------
Total assets by segment $ 106,695,593 $ 75,318,011
============= =============
-67-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
Supplemental segment information as of and for the year ended December
31, 2003, 2002 and 2001 follows:
Years Ended December 31,
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
Insurance segment
Deferred policy acquisition costs - $ 1,739,685 $ 7,721 $ 11,952
Reserves for unpaid loss and LAE $ 16,983,756 $ 16,983,756 $ 11,005,337
Unearned premiums $ 34,122,663 $ 28,934,486 $ 14,951,228
Earned premiums $ 44,877,230 $ 29,393,004 $ 20,255,561
Net investment income (loss)
Insurance segment $ 5,815,074 $ 1,253,215 $ (1,368,347)
All other segments -- -- (476,670)
------------ ------------ ------------
Total net investment income (loss) $ 5,815,074 $ 1,253,215 $ (1,845,017)
============ ============ ============
Claims and adjustment expenses incurred related to current years -
Insurance segment $ 26,274,932 $ 15,896,251 $ 13,586,426
============ ============ ============
Claims and adjustment expenses incurred related to prior years -
Insurance segment $ 1,234,047 $ 90,874 $ 2,568,476
============ ============ ============
Amortization of deferred acquisition costs - Insurance segment
Insurance segment $ 2,436,813 $ 776,172 $ 4,210,523
Financing segment 212,285 (237,851) 406,088
Eliminations (3,503,376) (2,602,634) (3,149,373)
------------ ------------ ------------
Total amortization of deferred acquisition costs: $ (854,278) $ (2,064,314) $ 1,467,238
============ ============ ============
Paid claims and claim adjustment expense - Insurance segment $ 21,836,470 $ 13,057,571 $ 17,013,886
============ ============ ============
Net premiums written - Insurance segment $ 53,493,225 $ 37,749,640 $ 21,481,934
============ ============ ============
(16) STOCK COMPENSATION PLANS
In December 1998, we 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. During 2003, 54,700 of
these warrants were exercised and 7,800 remain to be exercised.
We 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 our success 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, we are
authorized to grant options to purchase up to 600,000 common shares, and, as of
December 31, 2003, we had outstanding exercisable options to purchase 272,353
shares.
In 2001, we 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 our interests 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
-68-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
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, we are authorized to
grant options to purchase up to 659,000 common shares, and, as of December 31,
2003, we had outstanding exercisable options to purchase 26,640 shares.
In 2002, we implemented the 2002 Option Plan. The purpose of this Plan
is to advance our interests 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 our success is largely dependent,
by authorizing the grant of options to purchase Common Stock to persons who are
eligible to participate hereunder, thereby encouraging stock ownership 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, we are authorized to
grant options to purchase up to 1,200,000 common shares, and, as of December 31,
2003, we had outstanding exercisable options to purchase 625,400 shares.
Activity in our stock option plans for the period from January 1, 2001
to December 31, 2003 is summarized below:
1998 Plan 2001 Franchisee Plan 2002 Plan
------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Option Option Option
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
--------- ----- --------- ----- --------- -----
Outstanding at December 31, 2000 487,971 $ 10.00 --
Granted 20,000 $ 10.00 83,830 $ 10.00
Exercised -- --
Cancelled (95,399) $ 10.00 --
-------- -------
Outstanding at December 31, 2001 412,572 $ 10.00 83,830 $ 10.00 --
Granted 228,265 $ 10.00 783,000 $ 13.37
Exercised (1,000) --
Cancelled (105,499) $ 10.00 (5,675) $ 10.00 (56,000) $ 13.53
-------- ------- --------
Outstanding at December 31, 2002 534,338 $ 10.00 78,155 $ 10.00 727,000 $ 13.35
Granted -- $ 10.00 10,000 $ 13.75 101,500 $ 15.77
Exercised (250,247) $ 10.00 (61,515) $ 10.00 (144,600) $ 12.85
Cancelled (11,738) $ 10.00 -- (58,500) $ 14.05
-------- ------- --------
Outstanding at December 31, 2003 272,353 $ 10.00 26,640 $ 11.41 625,400 $ 13.80
======== ======= =======
Options outstanding as of December 31, 2002 are exercisable as follows:
1998 Plan 2001 Franchisee Plan 2002 Plan
------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Option Option Option
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
--------- ----- --------- ----- --------- -----
December 31, 2003 139,015 $ 10.00 20,592 $ 10.00 259,500 $ 13.35
December 31, 2004 56,838 $ 10.00 3,402 $ 10.00 61,400 $ 13.35
December 31, 2005 38,250 $ 10.00 378 $ 10.00 89,200 $ 13.35
December 31, 2006 38,250 $ 10.00 378 $ 10.00 89,200 $ 13.35
December 31, 2007 -- $ 10.00 378 $ 10.00 89,200 $ 13.35
Thereafter -- 1,512 $ 10.00 36,900 $ 13.35
-------- ------- ----------
Total options exercisible 272,353 26,640 625,400
======== ======= ==========
-69-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
We continue 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 our stock compensation plan been determined based upon fair values
at the grant dates for awards under the plan in accordance with SFAS No. 123,
our 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.
December 31,
---------------------------------------------
Net income (loss) 2003 2002 2001
------------- ------------- -------------
As reported $ 8,364,876 $ 4,570,201 $ (992,090)
Compensation, net of tax effect 4,783,080 $ 1,750,528 $ 189,765
------------- ------------- -------------
Pro forma net income (loss) $ 3,581,796 $ 2,819,673 $ (1,181,855)
============= ============= =============
Net income (loss) per share
As reported - Basic $ 2.64 $ 1.52 $ (0.31)
As reported - Diluted $ 2.50 $ 1.52 $ (0.31)
Pro forma - Basic $ 1.13 $ 0.94 $ (0.37)
Pro forma - Diluted $ 1.07 $ 0.94 $ (0.37)
The weighted average fair value of options granted during 2003, 2002 and
2001 estimated on the date of grant using the Black-Scholes option-pricing model
was $6.32 to $12.46; $2.17 to $8.06 in 2002 and $2.38 to $2.92 in 2001. The fair
value of options granted is estimated on the date of grant using the following
assumptions:
2003 2002 2001
---- ---- ----
Dividend yield 1.96% to 2.10% .073% to 3.50% 2.68% to 3.20%
Expected volatility 105.91% to 108.73% 120.22% 136% to 152%
Risk-free interest rate 2.30% to 3.94% 4.49% to 5.82% 4.89% to 5.29%
Expected life (in years) 3.00 to 6.36 4.83 to 7.02 10
Summary information about the Company's stock options outstanding at
December 31, 2003:
Weighted Average Weighted
Range of Outstanding Contractual Average Exercisable
Exercise Price at 12/31/03 Periods in Years Exercise Price at 12/31/03
-------------- ----------- ---------------- -------------- -----------
1998 Plan $10.00 272,353 3.01 $10.00 139,015
2001 Franchise Plan $10.00 to $13.75 26.640 6.36 $11.41 20,595
2002 Plan $12.50 to $20.00 625,400 3.95 $13.80 259,500
(17) EMPLOYEE BENEFIT PLAN
We have 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, 2003, 2002 and 2001, we did not
contribute to the plan. Our contributions, if any, are vested incrementally over
five years.
(18) ACQUISITIONS
In August 2001, we purchased all of the outstanding stock and all of the
outstanding surplus notes of American Vehicle for $500,000 in cash. In addition,
we 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 our 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
-70-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
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 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
----
Revenue $35,545,435
Income before extraordinary gain (2,270,396)
Extraordinary gain 1,185,895
Net income (1,084,501)
Earnings (loss) per share and earnings
(loss) per share assuming dilution
Net income (loss) before extraordinary
gain $ (0.72)
Extraordinary gain 0.38
Net income (loss) (0.34)
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, 2003,
2002 and 2001 are as follows:
December 31,
-----------------------------------------
2003 2002 2001
----------- ----------- -----------
Unrealized holdings net gains (losses) arising
during the year $ (570,501) $ (103,764) $ 143,925
Reclassification adjustment for (gains)
losses included in net income 276,699 90,197 1,722,421
----------- ----------- -----------
(293,802) (13,567) 1,866,346
Tax effect 196,012 4,613 (784,079)
----------- ----------- -----------
Net depreciation on investment securities $ (97,790) $ (8,954) $ 1,082,267
=========== =========== ===========
-71-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(20) AUTHORIZATION OF PREFERRED STOCK
Our 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 our board of directors. Accordingly,
our 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. We have not issued preferred shares as of December 31, 2003.
(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 2003 2002
------------ ------------
Cash and cash equivalents $ 547,760 $ 22,349
Investments and advances to subsidiaries 28,893,129 16,198,995
Deferred income taxes 824,171 800,077
Income taxes recoverable 765,634 --
Property, plant and equipment, net 699,919 820,466
Loan costs, net of amortization 430,803 --
Other assets 258,280 843,095
------------ ------------
Total assets $ 32,419,696 $ 18,684,982
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Bank overdraft $ -- $ 11,372
Subordinated debt 6,875,000 --
Dividends payable 422,890 179,947
Other liabilities 909,171 400,602
------------ ------------
Total liabilities 8,207,061 591,921
------------ ------------
Shareholders' equity:
Common stock 40,889 34,117
Additional paid-in capital 21,181,048 12,855,553
Accumulated other comprehensive deficit (525,506) (231,704)
Retained earnings 5,283,978 6,521,027
Treasury stock (1,767,774) (1,085,932)
------------ ------------
Total shareholders' equity 24,212,635 18,093,061
------------ ------------
Total liabilities and shareholders' equity $ 32,419,696 $ 18,684,982
============ ============
-72-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
Condensed Statements of Operations
2003 2002 2001
------------ ------------ ------------
Revenue:
Management fees from subsidiaries $ 1,993,500 $ 1,885,000 $ 2,939,000
Equity in income (loss) of subsidiaries 12,871,893 5,605,148 (2,933,999)
Net investment income (loss) 308 -- (477,445)
Other income 336,194 95,283 155,149
------------ ------------ ------------
Total revenue 15,201,895 7,585,431 (317,295)
------------ ------------ ------------
Expenses:
Advertising 315,125 140,287 958,082
Salaries and wages 519,456 457,856 173,777
Legal fees 855,573 50,304 117,698
Interest expense and amortization of loan costs 403,952 8,853 1,653
Other expenses 836,921 674,654 767,185
------------ ------------ ------------
Total expenses 2,931,027 1,331,954 2,018,395
------------ ------------ ------------
Income (loss) before provision for income tax expense and extraordinary gain 12,270,868 6,253,477 (2,335,690)
Benefit (expense) for income tax (3,905,992) (1,683,276) 157,705
------------ ------------ ------------
Net income (loss) before extraordinary gain 8,364,876 4,570,201 (2,177,985)
Extraordinary gain -- -- 1,185,895
------------ ------------ ------------
Net income (loss) $ 8,364,876 $ 4,570,201 $ (992,090)
============ ============ ============
-73-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
Condensed Statement of Cash Flow
2003 2002 2001
------------ ------------ ------------
Cash flow from operating activities:
Net income (loss) $ 8,364,876 $ 4,570,201 $ (992,090)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Equity in income (loss) of subsidiaries (3,096,893) (2,505,148) 2,933,999
Depreciation and amortization of property plant and equipment 138,151 126,295 174,646
Common Stock issued for interest on Notes 112,500 -- --
Deferred income tax expense (24,094) (497,655) (132,284)
Income tax recoverable (765,634) -- --
Net realized investment (gains) losses -- -- 477,445
Extraordinary Gain -- -- (1,185,895)
Dividends payable (242,943) (119,079) 4,926
Changes in operating assets and liabilities:
Other assets 154,012 66,220 (37,347)
Other Liabilities 497,197 (11,388) 309,903
------------ ------------ ------------
Net cash provided by operating activities 5,137,172 1,629,446 1,553,303
------------ ------------ ------------
Cash flow from investing activities:
Proceeds from sale of investment securities available for sale -- -- 31,944,339
Purchases of investment securities available for sale -- -- (31,382,730)
Purchases of property and equipment (17,604) (13,322) --
Increased capital of subsidiaries (9,775,000) (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 (9,792,604) (3,113,322) 1,961,609
------------ ------------ ------------
Cash flow from financing activities:
Dividends paid (999,106) (449,475) (249,675)
Subordinated debt 7,500,000 -- --
Stock options exercised 6,868,646 -- --
Purchases of treasury stock (681,842) (245,646) (784,798)
Advances from (to) subsidiaries (7,506,855) 2,197,493 (2,812,133)
------------ ------------ ------------
Net cash provided by (used in) financing activities 5,180,843 1,502,372 (3,846,606)
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents 525,411 18,496 (331,694)
Cash and cash equivalents at beginning of year 22,349 3,853 335,547
------------ ------------ ------------
Cash and cash equivalents at end of year $ 547,760 $ 22,349 $ 3,853
============ ============ ============
(22) SUBORDINATED DEBT
On July 31, 2003, we completed a private placement of our 6% Senior
Subordinated Notes (the "Notes"), which were offered and sold to accredited
investors as units consisting of one note with a principal amount of $1,000 and
one warrant (the "warrant") to purchase one half a share of our Common Stock. We
sold an aggregate of $7.5 million of Notes in this placement, which resulted in
proceeds to the Company (net of placement agent fees of $450,724 and offering
expenses of $110,778) of $6,938,498.
The Notes pay interest at the annual rate of 6%, are subordinated to
senior debt, and mature on July 31, 2006. Quarterly payments of principal and
interest due on the Notes may be made in cash or, at our option, in shares of
our Common Stock. If paid in shares of Common Stock, the number of shares to be
issued shall be determined by dividing the payment due by 95% of the
weighted-average volume price for the Common Stock on Nasdaq as reported by
Bloomberg Financial Markets ("Bloomberg") for the 20 consecutive trading days
preceding the payment date.
We issued warrants to purchase shares of the Company's Common Stock to
the purchasers of the Notes and to the placement agent in the offering, J.
Giordano Securities Group ("J. Giordano"). Each warrant entitles the holder to
purchase one-half of one share of the Company's Common Stock. The total number
of shares issuable upon exercise of warrants
-74-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
issued to the purchasers of the Notes and to J. Giordano was determined after
the expiration of 60 consecutive trading days following July 31, 2003, which was
the date of closing, and totaled 408,050. The number of shares issuable upon
exercise of the warrants issued to purchasers equaled $7.5 million divided by
the exercise price of the warrants, and totaled 392,356. The number of shares
issuable upon exercise of the warrants issued to J. Giordano equaled $300,000
divided by the exercise price of the warrants, and totaled 15,694. The exercise
price of the warrants equaled 115% of the weighted-average volume price of the
Common Stock on Nasdaq as reported by Bloomberg, for the 60 consecutive trading
days following July 31, 2003, with a maximum of $25.00 per share and a minimum
of $15.00 per share. As computed, the exercise price of the warrants is
$19.1153. The terms of the warrants provide for adjustment of the exercise price
and the number of shares issuable thereunder upon the occurrence of certain
events typical for private offerings of this type. The warrants will be
exercisable until July 31, 2006. We have the option to redeem the warrants
beginning on July 31, 2004. On or about October 31, 2003, we exercised our
option to make a quarterly payment in shares of the Company's Common Stock and
issued a total of 41,195 shares of common stock to the purchasers of the Notes.
The first payments totaling approximately $0.7 million were due on
October 31, 2003 and quarterly thereafter for three years with the last
installment due on July 31, 2006. The scheduled loan payments for the next three
years are as follows:
For the year ending
2004 2,500,000
2005 2,500,000
2006 1,875,000
-----------
Total $ 6,875,000
===========
-75-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, 2001
(23) SCHEDULE VI - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY
INSURANCE OPERATIONS
Amortization Paid losses
Loss and loss Loss and loss deferred policy and loss
adjustment expenses adjustment expenses acquisition adjustment Net premiums
- Current Year - Prior Year expenses expenses written
-------------- ------------ ------------- ----------- ------------
2003 $26,274,932 $ 1,234,047 $ (854,279) $21,836,470 $53,493,225
=========== =========== =========== =========== ===========
2002 $15,896,251 $ 90,874 $(2,064,314) $13,057,571 $37,749,640
=========== =========== =========== =========== ===========
2001 $13,586,426 $ 2,568,476 $ 1,467,238 $17,027,717 $21,481,934
=========== =========== =========== =========== ===========
Discount
if any,
Deferred Reserves for deducted
Affiliation policy losses and from Net Net
with acquisition loss adjustment previous Unearned premiums invesment
registrant costs expenses column premiums earned income
----------- ----------- ------- ----------- ----------- -----------
Consolidated
Property and
Casualty
Subsidiaries
2003 $ 1,739,685 $24,570,198 $ -- $34,122,663 $44,877,230 $ 1,624,216
=========== =========== ======= =========== =========== ===========
2002 $ 7,721 $16,983,756 $ -- $28,934,486 $29,393,004 $ 1,253,765
=========== =========== ======= =========== =========== ===========
2001 $ 11,952 $11,005,337 $ -- $14,951,228 $20,255,561 $ 1,066,641
=========== =========== ======= =========== =========== ===========
(24) SUBSEQUENT EVENTS
Subsequent to December 31, 2003 and the date of presentation the Company
received notice from the Louisiana Department of Insurance that American Vehicle
has been admitted and licensed to underwrite homeowner and commercial general
liability lines of insurance.
-76-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- -----------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
None.
ITEM 9A. CONTROLS AND PROCEDURES
- --------------------------------
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
An evaluation of the effectiveness of the design and operation of our
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 our 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 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 our internal
controls, there were no significant changes in our 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.
PART III
- --------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------
The information contained under the caption "Election of Directors" to
appear in our definitive proxy statement relating to the 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 our 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).
ITEM 11. EXECUTIVE COMPENSATION
- -------------------------------
The information contained under the caption "Executive Compensation" to
appear in the Annual Meeting Proxy Statement is incorporated herein 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
herein 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 herein by
reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
- -----------------------------------------------
The information contained under the caption "Principal Accounting Fees
and Services" to appear in the Annual Meeting Proxy Statement is incorporated by
reference.
-77-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
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, 2003 and
2002.
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001.
Consolidated Statements of Shareholders' Equity and
Comprehensive Income (Loss) for the years ended December 31,
2003, 2002 and 2001.
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001.
Notes to Consolidated Financial Statements for the years
ended December 31, 2003, 2002 and 2001.
(2) Financial Statement Schedules.
Schedule VI, Supplemental information concerning
property-casualty insurance operations, is included herein
under Item 8, Financial Statements and Supplementary Data.
(3) Exhibits
-78-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
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)
4.3 Amendment dated October 1, 2003 to Warrant Agreement (3)
4.4 Form of 6% Senior Subordinated Note due July 31, 2006 (4)
4.5 Form of Redeemable Warrant dated July 31, 2003 (4)
4.6 Unit Purchase Agreement dated July 31, 2003 between the Company and the
Purchasers of the 6% Senior Subordinated Notes (5)
4.7 Amendment to Unit Purchase Agreement and Registration Rights Agreement
dated October 15, 2003 between the Company and the Purchasers of the 6%
Senior Subordinated Notes (6) 10.1 Stock Option Plan, as amended (7)*
10.1 Stock Option Plan, as amended (7)*
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 (8)*
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. (9)
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. (10) 10.14 Sale and Assignment Agreement between Federated Premium
Finance, Inc. and FPF, Inc.
10.14 Sale and Assignment Agreement between Federated Premium Finance, Inc.
and FPF. Inc.
10.15 Premium Receivable Servicing Agreement between Federated Premium
Finance, Inc. and FPF, Inc. (10)
10.21 First Modification Agreement between Federated Premium Finance, Inc.
and FPF, Inc. (11)
10.22 General Agency Agreement dated August 1, 1998 between Federated
National Insurance Company and Assurance Managing General Agents, Inc.
(12)
10.23 Managing General Agency Agreement dated September 4, 2001 between
American Vehicle Insurance Company and Assurance Managing General
Agents, Inc. (12)
10.24 Commercial and Private Passenger Automobile Quota Share Treaty dated
July 18, 2002 between Federated National Insurance Company and
TransAtlantic Reinsurance Company (11)
10.25 Addendum No. 1 dated August 22, 2002 to Commercial and Private
Passenger Automobile Quota Share Treaty between Federated National
Insurance Company and TransAtlantic Reinsurance Company (11)
10.26 Private Passenger Automobile Quota Share Treaty dated April 29, 2002
between American Vehicle Insurance Company and TransAtlantic
Reinsurance Company (11)
10.27 Addendum No. 1 dated August 8, 2002 to Private Passenger Automobile
Quota Share Treaty between American Vehicle Insurance Company and
TransAtlantic Reinsurance Company (11)
10.28 Commercial and Private Passenger Automobile Quota Share Treaty dated
December 31, 2003 between Federated National Insurance Company and
TransAtlantic Reinsurance Company (13)
10.29 Private Passenger Automobile Quota Share Treaty dated January 1, 2003
between American Vehicle Insurance Company and TransAtlantic
Reinsurance Company (13)
10.30 Addendum No. 1 dated September 1, 2003 to Private Passenger Automobile
Quota Share Treaty between American Vehicle Insurance Company and
TransAtlantic Reinsurance Company (9)
10.31 Employment Agreement dated November 1, 2003 between Registrant and
Richard A. Widdicombe (13)*
16.1 Letter from McKean, Paul, Chrycy, Fletcher & Co. (14)
21.1 Subsidiaries of the Registrant (10)
23.1 Consent of McKean, Paul, Chrycy, Fletcher & Co., Independent Certified
Public Accountants (13)
23.2 Consent of De Meo, Young, McGrath, Independent Certified Public
Accountants (13)
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act (13)
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act (13)
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act (13)
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act (13)
-79-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
99.1 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.
99.2 Form S-3/A filed November 4, 2003 to register 125,000 shares of our
common stock being offered upon the exercise of warrants to purchase
common stock at a price of $10.875 per share expiring November 10,
2003, issued to the managing underwriter of our initial public
offering, and incorporated herein by reference.
99.3 Form S-3/A filed December 8, 2003 to register 41,195 shares of our
common stock issued by us as payment of principal and interest due on
our 6% Senior Subordinated Notes due July 31, 2006, and incorporate
herein by reference.
99.4 Form S-3/A filed December 18, 2003 to register the resale of 816,100
redeemable warrants issued to the purchasers of our 6% senior
subordinated Notes due July 31, 2006 the issuance of 408,050 shares of
our common stock that will be issued to holders of our warrants upon
exercise of the warrants, and incorporated herein by reference.
99.5 Form S-3/A filed February 9, 2004 to register 36,009 shares of our
common stock issued by us as payment of principal and interest due on
our 6% Senior Subordinated Notes due July 31, 2006, and incorporated
herein by reference.
- ----------
* Management Compensation Plan or Arrangement
(1) Previously filed as an 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 as an exhibit of the same number of the 1998 Annual
Report on Form 10-KSB.
(3) Previously filed as an exhibit of the same number to the Registrant's
Registration Statement on Form S-3 (File No. 333-105221) and
incorporated herein by reference.
(4) Previously filed as Exhibits 4.1 and 4.2, respectively, to the
Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 and
incorporated herein by reference.
(5) Previously filed as Exhibit 4.5 to the Registrant's Registration
Statement on Form S-3 (File No 333-109313) and incorporated herein by
reference.
(6) Previously filed exhibit of the same number to the Registrant's
Registration Statement on Form S-3 (File No. 333-108739) and
incorporated herein by reference.
(7) Previously filed as an exhibit to the Company's 2000 Annual Meeting
Proxy Statement.
(8) Previously filed as an exhibit of the same number of the 1999 Annual
Report on Form 10-KSB.
(9) Previously filed as an exhibit of the same number of the 2000 Annual
Report on Form 10-KSB.
(10) Previously filed as an exhibit of the same number of the 2001 Annual
Report on Form 10-K.
(11) Previously filed as an exhibit of the same number of the 2002 Annual
Report on Form 10-K.
(12) Previously filed as an exhibit of the same number of Amendment No. 1
to the 2002 Annual Report on Form 10K.
(13) Filed herewith.
(14) Previously filed as an exhibit of the same number of Form 8-K dated
December 4, 2002.
(B) REPORTS ON FORM 8-K
On October 31, 2003, the Company furnished information consisting
of its reported results of operations and financial condition for it
third fiscal quarter of 2003 pursuant to Regulation FD and Item 12 of
Form 8-K.
-80-
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
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/ Richard A. Widdicombe
----------------------------------------------
Richard A. Widdicombe, Chief Executive Officer
/s/ James G. Jennings III
----------------------------------------------
James G. Jennings III, Chief Financial Officer
Dated: March 30, 2004
Pursuant to the requirements of the Exchange Act of 1934, this Report
has been signed by the following persons on behalf of the registrant and in the
capacities and on the date indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Richard A. Widdicombe Chief Executive Officer March 30, 2004
- ------------------------- (Principal Executive Officer)
Richard A. Widdicombe
/s/ Edward J. Lawson Chairman of the Board and March 30, 2004
- ------------------------- President
Edward J. Lawson
/s/ James G. Jennings III Chief Financial Officer (Principal March 30, 2004
- ------------------------- Financial and Accounting Officer)
James G. Jennings III
/s/ Carl Dorf Director March 30, 2004
- -------------------------
Carl Dorf
/s/ Bruce Simberg Director March 30, 2004
- -------------------------
Bruce Simberg
/s/ Charles B. Hart, Jr. Director March 30, 2004
- -------------------------
Charles B. Hart, Jr.
/s/ Richard W. Wilcox, Jr. Director March 30, 2004
- -------------------------
Richard W. Wilcox, Jr.
/s/ Peter Prygelski Director March 30, 2004
- -------------------------
Peter Prygelski
-81-