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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 001-33251

 

 

UNIVERSAL INSURANCE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   65-0231984

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1110 W. Commercial Blvd., Fort Lauderdale, Florida 33309

(Address of principal executive offices)

(954) 958-1200

(Registrant’s telephone number, including area code)

 

 

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 (or for such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See the definitions of “large accelerated filer” and “accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer    x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company    ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 39,992,769 shares of common stock, par value $0.01 per share, outstanding on November 2, 2011.

 

 

 


Table of Contents

UNIVERSAL INSURANCE HOLDINGS, INC.

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

 

          Page
No.
 
Item 1.    Financial Statements:   
   Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010 (unaudited)      4   
   Consolidated Statements of Income for the three and nine-month periods ended September 30, 2011 and 2010 (unaudited)      5   
   Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2011 and 2010 (unaudited)      6   
   Notes to Consolidated Financial Statements (unaudited)      7   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      27   
Item 3.    Quantitative and Qualitative Disclosure about Market Risk      43   
Item 4.    Controls and Procedures      45   
PART II – OTHER INFORMATION   
Item 1.    Legal Proceedings      46   
Item 1A.    Risk Factors      46   
Item 5.    Other Information      46   
Item 6.    Exhibits      46   
Signatures         48   

 

2


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To The Board of Directors and Stockholders of

Universal Insurance Holdings, Inc. and Subsidiaries

Fort Lauderdale, Florida

We have reviewed the accompanying condensed consolidated balance sheet of Universal Insurance Holdings, Inc. and Subsidiaries as of September 30, 2011 and the related condensed consolidated statements of income for the three and nine-month periods ended September 30, 2011 and 2010 and cash flows for the nine-month periods ended September 30, 2011 and 2010. These interim financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

/s/ Blackman Kallick, LLP

Chicago, Illinois

November 8, 2011

 

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Table of Contents

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except per share data)

 

     As of
September 30,
2011
    As of
December 31,
2010
 

ASSETS:

    

Cash and cash equivalents

   $ 328,838      $ 147,585   

Investment securities, at fair value

     153,476        224,532   

Prepaid reinsurance premiums

     251,342        221,086   

Reinsurance recoverables

     77,545        79,552   

Reinsurance receivable, net

     49,816        37,607   

Premiums receivable, net

     50,580        43,622   

Receivable from securities

     5,585        17,556   

Other receivables

     2,910        2,864   

Property and equipment, net

     6,597        5,407   

Deferred policy acquisition costs, net

     13,013        9,446   

Deferred income taxes

     24,120        13,448   

Other assets

     3,126        1,132   
  

 

 

   

 

 

 

Total assets

   $ 966,948      $ 803,837   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

LIABILITIES:

    

Unpaid losses and loss adjustment expenses

   $ 162,954      $ 158,929   

Unearned premiums

     375,779        328,334   

Advance premium

     21,639        19,840   

Accounts payable

     4,287        3,767   

Bank overdraft

     34,914        23,030   

Payable for securities

     17,667        —     

Reinsurance payable, net

     128,804        75,553   

Income taxes payable

     16,378        8,282   

Dividends payable to shareholders

     3,199        —     

Other accrued expenses

     22,322        23,150   

Long-term debt

     22,059        23,162   
  

 

 

   

 

 

 

Total liabilities

     810,002        664,047   
  

 

 

   

 

 

 

Commitments and Contingencies (Note 12)

    

STOCKHOLDERS’ EQUITY:

    

Cumulative convertible preferred stock, $.01 par value

     1        1   

Authorized shares - 1,000

    

Issued shares - 108

    

Outstanding shares - 108

    

Minimum liquidation preference, $2.66 per share

    

Common stock, $.01 par value

     410        404   

Authorized shares - 55,000

    

Issued shares - 41,010 and 40,407

    

Outstanding shares - 39,993 and 39,388

    

Treasury shares, at cost - 1,018 and 1,019

     (3,102     (3,109

Additional paid-in capital

     35,549        33,675   

Retained earnings

     124,088        108,819   
  

 

 

   

 

 

 

Total stockholders’ equity

     156,946        139,790   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 966,948      $ 803,837   
  

 

 

   

 

 

 

The accompanying notes to condensed consolidated financial statements are an integral part of these statements.

 

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Table of Contents

UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)

(in thousands, except per share data)

 

0000000 0000000 0000000 0000000
     For the Three
Months Ended September 30,
    For the Nine
Months Ended September 30,
 
     2011     2010     2011     2010  

PREMIUMS EARNED AND OTHER REVENUES

        

Direct premiums written

   $ 171,370      $ 152,662      $ 558,024      $ 520,782   

Ceded premiums written

     (123,984     (108,539     (393,673     (357,411
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

     47,386        44,123        164,351        163,371   

Decrease (increase) in net unearned premium

     2,248        4,708        (17,189     (39,865
  

 

 

   

 

 

   

 

 

   

 

 

 

Premiums earned, net

     49,634        48,831        147,162        123,506   

Net investment income

     122        66        358        377   

Net realized gains on investments

     5,884        6,149        12,496        11,893   

Net unrealized (losses) gains on investments

     (15,985     6,281        (23,037     6,281   

Net foreign currency (losses) gains on investments

     (455     (8     (384     801   

Commission revenue

     5,192        4,423        14,313        13,469   

Policy fees

     3,535        3,525        12,110        12,000   

Other revenue

     1,486        1,468        4,400        3,489   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total premiums earned and other revenues

     49,413        70,735        167,418        171,816   
  

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING COSTS AND EXPENSES

        

Losses and loss adjustment expenses

     29,343        29,370        81,380        77,857   

General and administrative expenses

     18,827        20,053        48,598        43,631   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

     48,170        49,423        129,978        121,488   
  

 

 

   

 

 

   

 

 

   

 

 

 

INCOME BEFORE INCOME TAXES

     1,243        21,312        37,440        50,328   

Income taxes, current

     7,331        7,359        25,690        19,016   

Income taxes, deferred

     (7,063     876        (10,672     524   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income taxes, net

     268        8,235        15,018        19,540   
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 975      $ 13,077      $ 22,422      $ 30,788   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.02      $ 0.33      $ 0.57      $ 0.78   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average of common shares outstanding - Basic

     39,190        39,167        39,177        39,076   
  

 

 

   

 

 

   

 

 

   

 

 

 

Fully diluted earnings per common share

   $ 0.02      $ 0.32      $ 0.55      $ 0.76   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average of common shares outstanding - Diluted

     40,330        40,276        40,536        40,386   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividend declared per common share

   $ 0.08      $ —        $ 0.18      $ 0.22   
  

 

 

   

 

 

   

 

 

   

 

 

 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
00000000 00000000 00000000 00000000
     For the Three
Months Ended September 30,
     For the Nine
Months Ended September 30,
 
     2011      2010      2011      2010  

Comprehensive Income:

           

Net income

   $        975       $      13,077       $    22,422       $   30,788   

Change in net unrealized gains (losses) on investments, net of tax

     —           409         —           (558
  

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive Income

   $ 975       $ 13,486       $ 22,422       $ 30,230   
  

 

 

    

 

 

    

 

 

    

 

 

 

The accompanying notes to condensed consolidated financial statements are an integral part of these statements.

 

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Table of Contents

UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

 

     Nine Months Ended
September 30,
 
     2011     2010  

Cash flows from operating activities:

    

Net Income

   $ 22,422      $ 30,788   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Bad debt expense

     622        1,666   

Depreciation

     379        732   

Amortization of cost of stock options

     957        1,766   

Amortization of non-vested shares

     931        690   

Net realized gains on investments

     (12,496     (11,893

Net unrealized losses (gains) on investments

     23,037        (6,281

Net foreign currency losses (gains) on investments

     384        (835

Amortization of premium / accretion of discount, net

     185        405   

Deferred income taxes

     (10,672     885   

Other

     (21     (21

Net change in assets and liabilities relating to operating activities:

    

Prepaid reinsurance premiums

     (30,256     (28,069

Reinsurance recoverables

     2,007        24,480   

Reinsurance receivable, net

     (12,209     (9,608

Premiums receivable, net

     (7,578     (12,819

Accrued investment income

     580        —     

Other receivables

     (629     2,035   

Income taxes recoverable

     —          3,212   

Deferred policy acquisition costs, net

     (3,567     (3,388

Proceeds from sale of trading securities

     661,809        395,288   

Purchases of trading securities

     (572,790     (348,111

Other assets

     (1,428     (150

Unpaid losses and loss adjustment expenses

     4,025        9,660   

Unearned premiums

     47,445        67,934   

Accounts payable

     519        323   

Reinsurance payable, net

     53,251        4,436   

Income taxes payable

     8,096        3,130   

Other accrued expenses

     (828     1,732   

Advance premium

     1,799        3,879   
  

 

 

   

 

 

 

Net cash provided by operating activities

     175,974        131,866   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Proceeds from sale of property, plant and equipment

     63        33   

Purchases of property, plant and equipment

     (1,611     (1,589

Purchases of fixed maturities, available for sale

     —          (129,141

Proceeds from sales of fixed maturities, available for sale

     —          116,238   

Purchases of equity securities, available for sale

     —          (80,730

Proceeds from sales of equity securities, available for sale

     —          70,681   
  

 

 

   

 

 

 

Net cash used in investing activities

     (1,548     (24,508
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Bank overdraft

     11,884        4,482   

Preferred stock dividend

     (15     (15

Common stock dividend

     (3,939     (8,617

Issuance of common stock

     —          7   

Purchase of treasury shares

     —          (3,724

Excess tax benefits from stock-based compensation

     —          3,660   

Repayment of debt

     (1,103     (1,103
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     6,827        (5,310
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     181,253        102,048   

Cash and cash equivalents at beginning of period

     147,585        192,924   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 328,838      $ 294,972   
  

 

 

   

 

 

 

Supplemental cash flow disclosure

    

Dividends accrued

   $ 3,199      $ —     

Interest

   $ 744      $ 711   

Income taxes

   $ 13,513      $ 7,923   

The accompanying notes to condensed consolidated financial statements are an integral part of these statements.

 

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Table of Contents

UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Nature of Operations and Basis of Presentation

Nature of Operations

Universal Insurance Holdings, Inc. (“UIH”) is a Delaware corporation originally incorporated as Universal Heights, Inc. in November 1990. UIH and its wholly-owned subsidiaries (the “Company”) is a vertically integrated insurance company performing all aspects of insurance underwriting, distribution and claims. Through its wholly-owned subsidiaries, including Universal Property & Casualty Insurance Company (“UPCIC”), the Company is principally engaged in the property and casualty insurance business offered primarily through a network of independent agents. Risk from catastrophic losses is managed through the use of reinsurance agreements. The Company’s primary product is homeowners’ insurance currently offered in four states, including Florida, where a majority of the Company’s policies are in force. See Note 5, Insurance Operations, for more information regarding the Company’s insurance operations.

The Company generates revenues primarily from the collection of premiums and the investment of those premiums. Other significant sources of revenue include commissions collected from reinsurers and policy fees.

Basis of Presentation

The Company has prepared the accompanying unaudited Condensed Consolidated Financial Statements (“Financial Statements”) in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by United States Generally Accepted Accounting Principles (“GAAP”) for complete financial statements. Therefore, the Financial Statements should be read in conjunction with the audited Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, filed with the SEC on March 31, 2011. The condensed consolidated balance sheet at December 31, 2010, was derived from audited financial statements, but does not include all disclosures required by GAAP. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation have been included in the Financial Statements. The results for interim periods do not necessarily indicate the results that may be expected for any other interim period or for the full year.

The Financial Statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

Management must make estimates and assumptions that affect amounts reported in the Company’s Financial Statements and in disclosures of contingent assets and liabilities. Actual results could differ from those estimates.

To conform to the current period presentation, certain amounts in the prior periods’ consolidated financial statements and notes have been reclassified. Such reclassifications were of an immaterial amount and had no effect on net income or stockholders’ equity. The Company reclassified $37.6 million of its reinsurance payable, net as of December 31, 2010, to reinsurance receivable, net upon discovery that the Company was offsetting receivables and payables with separate reinsurers. This correction represents a change in the presentation only of the Company’s Condensed Consolidated Balance Sheet as of December 31, 2010 and Condensed Consolidated Statement of Cash Flows for the Nine Months ended September 30, 2010, and had no impact on earnings, equity or cash flows from operating, investing and financing activities. The following line items were adjusted (in thousands):

 

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Table of Contents

Condensed Consolidated Balance Sheet as of December 31, 2010

 

     As Reported      Reclassification      Adjusted  

Receivable from reinsurers, net

   $ —         $ 37,607       $ 37,607   

Total assets

   $ 766,230       $ 37,607       $ 803,837   

Payable to reinsurers, net

   $ 37,946       $ 37,607       $ 75,553   

Total liabilities

   $ 626,440       $ 37,607       $ 664,047   

Condensed Consolidated Statement of Cash Flows for the Nine Months

Ended September 30, 2010

 

Net change in assets and liabilities relating to operating activities:    As Reported     Reclassification     Adjusted  

Reinsurance receivable, net

   $ —        $ (9,608   $ (9,608

Reinsurance payable, net

   $ (5,172   $ 9,608      $ 4,436   

 

2. Significant Accounting Policies

The Company reported Significant Accounting Policies in its Annual Report on Form 10-K for the year ended December 31, 2010. The following are new or revised disclosures or disclosures required on a quarterly basis.

Concentrations of Credit Risk. The Company is exposed to concentrations of credit risk, consisting principally of cash and cash equivalents, debt securities, premiums receivable, reinsurance receivable and reinsurance recoverables.

Concentrations of credit risk with respect to cash on deposit are limited by the Company’s policy of investing excess cash with custodial institutions who invest primarily in money market accounts backed by the United States Government and United States Government agency securities with major national banks. These accounts are held by the Institutional Trust & Custody division of U.S. Bank, the Trust Department of SunTrust Bank and Bank of New York Trust Fund.

The Company maintains depository relationships with SunTrust Bank and Wells Fargo Bank N.A. It is the Company’s policy not to have a balance of more than $250 thousand for any of its affiliates at either institution on any given day to minimize exposure to a bank failure. Cash balances in excess of $250 thousand are transferred daily into custodial accounts with SunTrust Bank where cash is immediately invested into shares of Money Market Funds.

Cash and cash equivalents consist of checking, repurchase and money market accounts with carrying values as follows (in thousands):

 

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Table of Contents
     As of September 30, 2011  

Institution

   Cash      Money Market
Funds
     State Deposits      Total      %  

U. S. Bank IT&C

   $ —         $ 41,275       $ —         $ 41,275         12.6

SunTrust Bank

     580         —           —           580         0.2

SunTrust Bank Institutional Asset Services

     —           219,525         —           219,525         66.8

Wells Fargo Bank N.A.

     772         —           —           772         0.2

Bank of New York Trust Fund (1)

     —           62,873         —           62,873         19.1

All Other Banking Institutions

     1,210         3         2,600         3,813         1.2
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,562       $ 323,676       $ 2,600       $ 328,838         100.0
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     As of December 31, 2010  

Institution

   Cash      Money Market
Funds
     State Deposits      Total      %  

U. S. Bank IT&C

   $ —         $ 41,454       $ —         $ 41,454         28.1

SunTrust Bank

     1,241         —           —           1,241         0.8

SunTrust Bank Institutional Asset Services

     —           89,724         —           89,724         60.8

Wells Fargo Bank N.A.

     780         —           —           780         0.5

Bank of New York Trust Fund (1)

     —           11,340         —           11,340         7.7

All Other Banking Institutions

     443         3         2,600         3,046         2.1
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,464       $ 142,521       $ 2,600       $ 147,585         100.0
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Amounts held in trust include collateral contributed by the Company in connection with reinsurance contracts entered into between a segregated account owned and maintained by the Company and UPCIC.

See Note 4—Reinsurance for information about this arrangement.

All debt securities included in cash and cash equivalents as of September 30, 2011, and December 31, 2010, are direct obligations of the United States Treasury.

Concentrations of credit risk with respect to premiums receivable are limited due to the large number of individuals comprising the Company’s customer base. However, the majority of the Company’s revenues are currently derived from products and services offered to customers in Florida, which could be adversely affected by economic downturns, an increase in competition or other environmental changes.

In order to reduce credit risk for amounts due from reinsurers, UPCIC seeks to do business with financially sound reinsurance companies and regularly evaluate the financial strength of all reinsurers used. Everest Reinsurance Company, the reinsurer to which UPCIC cedes the largest volume of premium, has the following ratings from each of the rating agencies: A+ from A.M. Best Company, A+ from Standard and Poor’s Rating Services and Aa3 from Moody’s Investors Service, Inc. UPCIC’s reinsurance portfolio contained the following authorized reinsurers that had reinsurance receivables, unsecured recoverables for paid and unpaid losses, including incurred but not reported (“IBNR”) reserves, loss adjustment expenses and unearned premiums whose aggregate balance exceeded 3% of UPCIC’s statutory surplus (in thousands):

 

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Table of Contents
     As of September 30,      As of December 31,  

Reinsurer

   2011      2010  

Everest Reinsurance Company

   $ 308,384       $ 265,549   

Florida Hurricane Catastrophe Fund

     —           32,849   
  

 

 

    

 

 

 

Total

   $ 308,384       $ 298,398   
  

 

 

    

 

 

 

Recently Adopted Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB “) issued new accounting guidance which expands disclosure requirements relating to fair value measurements. The guidance adds requirements for disclosing amounts of and reasons for significant transfers into and out of Levels 1 and 2 and requires gross rather than net disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements. The guidance also provides clarification that fair value measurement disclosures are required for each class of assets and liabilities. Disclosures about the valuation techniques and inputs used to measure fair value for measurements that fall in either Level 2 or Level 3 are also required. The Company adopted the provisions of the new guidance as of March 31, 2010, except for disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which were adopted as of January 1, 2011. Disclosures are not required for earlier periods presented for comparative purposes. The new guidance affects disclosures only; therefore, the adoption had no impact on the Company’s results of operations or financial position.

 

3. Investments

The following table provides the Company’s investment holdings by type of instrument as of the periods presented (in thousands):

 

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Table of Contents
     As of September 30, 2011      As of December 31, 2010  
     Cost or
Amortized
Cost
     Fair Value      Carrying
Value
     Cost or
Amortized
Cost
     Fair Value      Carrying
Value
 

Cash equivalents (1) (2)

   $ 326,276       $ 326,276       $ 326,276       $ 145,121       $ 145,121       $ 145,121   

Trading portfolio:

                 

Debt securities:

                 

U.S. government securities obligations and agencies (2)

     3,182         3,711         3,711         138,086         130,116         130,116   

Foreign government bonds

     54,353         54,352         54,352         —           —           —     

Equity securities:

                 

Common stock:

                 

Metals and mining

     42,344         30,829         30,829         22,638         25,752         25,752   

Other

     20,749         16,173         16,173         344         362         362   

Exchange-traded and mutual funds:

                 

Metals and mining

     26,534         23,295         23,295         32,736         42,209         42,209   

Agriculture

     17,699         15,411         15,411         10,961         14,877         14,877   

Energy

     9,206         8,333         8,333         5,798         5,559         5,559   

Indices

     1,483         1,372         1,372         11,047         4,613         4,613   

Other

     —           —           —           1,029         1,044         1,044   

Derivatives: (3)

                 

Non-hedging instruments

     768         1,545         1,545         419         182         182   

Other investments (3) (4)

     413         366         366         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total trading portfolio investments

     176,731         155,387         155,387         223,058         224,714         224,714   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 503,007       $ 481,663       $ 481,663       $ 368,179       $ 369,835       $ 369,835   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Cash equivalents include short-term debt securities consisting of direct obligations of the U.S. Treasury or money-market accounts that invest in direct obligations of the U.S. Treasury.
(2) The Company is required by various state laws and regulations to maintain certain securities on deposit in depositary accounts with the states in which we do business. As of September 30, 2011 and December 31, 2010, securities having fair values of $3.7 million and $3.4 million, respectively were on deposit. These laws and regulations govern not only the amount, but also the type of security that is eligible for deposit.
(3) Derivatives and other investments are in included in other assets in the consolidated balance sheets.
(4) Other investments represent physical metals held by the Company.

The Company has made an assessment of its invested assets for fair value measurement as further described in Note 13 – Fair Value Measurements.

The following table provides investment income comprised primarily of interest and dividends (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Cash and equivalents

   $ 203      $ 58      $ 253      $ 109   

Debt securities

     13        164        481        710   

Equity securities

     76        17        136        37   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     292        239        870        856   

Less: Investment expenses

     (170     (173     (512     (479
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

   $ 122      $ 66      $ 358      $ 377   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Trading Portfolio

The following table provides the effect of trading activities on the Company’s results of operations by type of instrument and by line item in the condensed consolidated statements of income (in thousands):

 

     Three Months Ended     Nine Months Ended  
     September 30,     September 30,  
     2011     2010     2011     2010  

Realized gains(losses) on investments

        

Debt securities

   $ —        $ 2,521      $ (3,616   $ 2,521   

Equity securities

     5,669        3,726        16,535        3,726   

Derivatives (non-hedging instruments)

     215        (98     (423     (98
  

 

 

   

 

 

   

 

 

   

 

 

 

Total realized gains on trading portfolio

     5,884        6,149        12,496        6,149   

Unrealized gains (losses) on investments

        

Debt securities

     112        423        8,372        423   

Equity securities

     (17,504     6,497        (32,398     6,497   

Derivatives (non-hedging instruments)

     1,454        17        1,036        17   

Other

     (47     —          (47     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) on trading portfolio

     (15,985     6,937        (23,037     6,937   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (losses) gains recognized on trading securities

   $ (10,101   $ 13,086      $ (10,541   $ 13,086   
  

 

 

   

 

 

   

 

 

   

 

 

 

The preceding table represents alternative quantitative disclosures permitted for derivatives that are not used as hedging instruments and are included in a trading portfolio.

Securities Available-for-sale

The following table provides information related available-for-sale securities (in thousands):

 

     Three Months
Ended
     Nine Months Ended  
     September 30,      September 30,  
     2011      2010      2011      2010  

Sales proceeds (fair value)

     n/a         n/a         n/a       $ 195,329   

Gross realized gains

     n/a         n/a         n/a       $ 9,090   

Gross realized losses

     n/a         n/a         n/a       $ (938

Other than temporary losses

     n/a         n/a         n/a       $ (2,408

During the three-month period ended September 30, 2010, the Company evaluated the trading activity in its investment portfolio, its investing strategy, and its overall investment program. As a result of this evaluation, the Company reclassified its available-for-sale portfolio as a trading portfolio effective July 1, 2010. Net unrealized losses of $656 thousand were reflected as a transfer as of July 1, 2010, and recognized in earnings and included under the caption “Unrealized Gains on Investments” in the Consolidated Statement of Income. The net unrealized loss of $656 thousand was comprised of $1.2 million in unrealized losses, offset by $573 thousand of unrealized gains.

 

4. Reinsurance

UPCIC seeks to reduce its risk of loss by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers, generally, as of the beginning of the hurricane season on June 1 of each year. UPCIC’s reinsurance program consists of excess of loss, quota share and catastrophe reinsurance, subject to the terms and conditions of the applicable agreements. UPCIC is responsible for insured losses related to catastrophes and other events in excess of coverage provided by its reinsurance program. UPCIC also remains responsible for the settlement of insured losses notwithstanding the failure of any of its reinsurers to make payments otherwise due to UPCIC.

 

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Table of Contents

UPCIC’s in-force policyholder coverage for windstorm exposures as of September 30, 2011, was approximately $129.2 billion.

Amounts recoverable from reinsurers are estimated in a manner consistent with the reinsurance contracts. Reinsurance premiums, losses and loss adjustment expenses (“LAE”) are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Reinsurance ceding commissions received are deferred and netted against policy acquisition costs and amortized over the effective period of the related insurance policies.

The Company’s reinsurance arrangements had the following effect on certain items in the Condensed Consolidated Statements of Income (in thousands):

 

     Three Months Ended September 30, 2011     Three Months Ended September 30, 2010  
     Premiums
Written
    Premiums
Earned
    Loss and Loss
Adjustment
Expenses
    Premiums
Written
    Premiums
Earned
    Loss and Loss
Adjustment
Expenses
 

Direct

   $ 171,370      $ 175,858      $ 59,789      $ 152,662      $ 162,093      $ 59,512   

Ceded

     (123,984     (126,224     (30,446     (108,539     (113,262     (30,142
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net

   $ 47,386      $ 49,634      $ 29,343      $ 44,123      $ 48,831      $ 29,370   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     Nine Months Ended September 30, 2011     Nine Months Ended September 30, 2010  
     Premiums
Written
    Premiums
Earned
    Loss and Loss
Adjustment
Expenses
    Premiums
Written
    Premiums
Earned
    Loss and Loss
Adjustment
Expenses
 

Direct

   $ 558,024      $ 510,579      $ 166,280      $ 520,782      $ 452,848      $ 156,537   

Ceded

     (393,673     (363,417     (84,900     (357,411     (329,342     (78,680
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net

   $ 164,351      $ 147,162      $ 81,380      $ 163,371      $ 123,506      $ 77,857   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The following prepaid reinsurance premiums and reinsurance recoverables are reflected in the Condensed Consolidated Balance Sheets (in thousands):

 

     As of
September 30,
2011
     As of
December 31,
2010
 

Prepaid reinsurance premiums

   $ 251,342       $ 221,086   
  

 

 

    

 

 

 

Reinsurance recoverable on unpaid losses and LAE

   $ 76,659       $ 79,114   

Reinsurance recoverable on paid losses

     886         438   
  

 

 

    

 

 

 

Reinsurance recoverables

   $ 77,545       $ 79,552   
  

 

 

    

 

 

 

Segregated Account T25

The Company owns and maintains a segregated account, Segregated Account T25 - Universal Insurance Holdings of White Rock Insurance (SAC) Ltd. (“T25”) established by a third-party reinsurer in accordance with Bermuda law. T25 enters into underlying excess catastrophe contracts with UPCIC for the purpose of assuming the risk of certain policies issued by UPCIC, covering certain loss occurrences including hurricanes. The Company secures the obligations of T25 to UPCIC under these contracts by contributing the amount of T25’s liability for losses, net of UPCIC’s required premium payments, to a trust account as collateral. The collateral will be used to pay any claims that may arise in the event of the occurrence of covered events. Transactions related to this arrangement are eliminated in consolidation, however, and the amount of collateral is held in trust for the benefit of UPCIC until the occurrence of a covered event, expiration or termination of the agreement between T25 and UPCIC.

On May 31, 2011, T25 and UPCIC mutually agreed to a Commutation and Settlement Agreement related to the underlying Property Catastrophe Excess of Loss Reinsurance Contract that was effective January 1, 2011. A replacement contract was entered into between the parties on June 1, 2011, as part of UPCIC’s reinsurance program in effect for the period June 1, 2011, through May 31, 2012. In conjunction with entering into the replacement contract, the Company contributed additional funds to T25 due to the increased reinsurance coverage and collateral requirements. The amount of collateral in the trust account at September 30, 2011, was $63.0 million.

 

5. Insurance Operations

The Company’s primary product is homeowners’ insurance currently offered by UPCIC in four states, including Florida, which represented 98% of policies-in-force as of September 30, 2011, and December 31, 2010. As of September 30, 2011 and December 31, 2010, 32% of the policies-in-force are in Miami-Dade, Broward and Palm Beach counties.

Deferred Policy Acquisition Costs

The following table provides the beginning and ending balances and the changes in deferred policy acquisition costs (“DPAC”), net of deferred ceding commission (“DCC”), for the periods presented (in thousands):

 

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Table of Contents
     For the Three Months Ended September 30,     For the Nine Months Ended September 30,  
     2011     2010     2011     2010  

DPAC, beginning of period

   $ 59,129      $ 58,151      $ 50,128      $ 43,971   

Capitalized costs during the period

     30,759        27,742        87,551        78,703   

Amortization of DPAC during the period (1)

     (30,332     (30,112     (78,123     (66,893
  

 

 

   

 

 

   

 

 

   

 

 

 

DPAC, end of period

   $ 59,556      $ 55,781      $ 59,556      $ 55,781   
  

 

 

   

 

 

   

 

 

   

 

 

 

DCC, beginning of period

   $ (47,103   $ (44,109   $ (40,682   $ (34,506

Ceding commissions written during the period

     (21,220     (18,912     (69,109     (64,554

Earned Ceding Commissions during the period

     21,780        20,093        63,248        56,132   
  

 

 

   

 

 

   

 

 

   

 

 

 

DCC, end of period

   $ (46,543   $ (42,928   $ (46,543   $ (42,928
  

 

 

   

 

 

   

 

 

   

 

 

 

DPAC (DCC), net, beginning of period

   $ 12,026      $ 14,042      $ 9,446      $ 9,465   

Capitalized costs, net during the period

     9,539        8,830        18,442        14,149   

Amortization of DPAC (DCC), net during the period (1)

     (8,552     (10,019     (14,875     (10,761
  

 

 

   

 

 

   

 

 

   

 

 

 

DPAC (DCC), net, end of period

   $ 13,013      $ 12,853      $ 13,013      $ 12,853   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes amortization of agent commissions of $22.8 million and $23.0 million for the three months ended September 30, 2011 and 2010 and $59.5 million and $53.5 million for the nine months ended September 30, 2011 and 2010, respectively.

Liability for Unpaid Losses and Loss Adjustment Expenses

Set forth in the following table is the change in liability for unpaid losses and LAE for the periods presented (in thousands):

 

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Table of Contents
     For the Three Months Ended September 30,      For the Nine Months Ended September 30,  
     2011      2010      2011      2010  

Balance at beginning of period

   $ 155,375       $ 128,903       $ 158,929       $ 127,198   

Less reinsurance recoverable

     76,307         63,451         79,114         62,901   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net balance at beginning of period

   $ 79,068       $ 65,452       $ 79,815       $ 64,297   
  

 

 

    

 

 

    

 

 

    

 

 

 

Incurred related to:

           

Current year

   $ 24,975       $ 29,063       $ 76,897       $ 77,905   

Prior years

     4,368         307         4,483         (48
  

 

 

    

 

 

    

 

 

    

 

 

 

Total incurred

   $ 29,343       $ 29,370       $ 81,380       $ 77,857   
  

 

 

    

 

 

    

 

 

    

 

 

 

Paid related to:

           

Current year

   $ 15,244       $ 17,091       $ 30,119       $ 34,614   

Prior years

     9,587         8,095         47,496         37,903   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total paid

   $ 24,831       $ 25,186       $ 77,615       $ 72,517   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net balance at end of period

     83,580         69,636         83,580         69,636   

Plus reinsurance recoverable

     79,374         67,221         79,374         67,221   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 162,954       $ 136,857       $ 162,954       $ 136,857   
  

 

 

    

 

 

    

 

 

    

 

 

 

As a result of changes in estimates of insured events in prior years, the provision of losses and LAE, net of related reinsurance recoverables increased principally as a result of actual loss development on prior year non-catastrophe losses. The Company has created a proprietary claims analysis tool (P2P) to analyze and calculate reserves. P2P is a custom built application by UPCIC that aggregates, analyzes and forecasts reserves based on historical data that spans more than a decade. It identifies historical claims data using the same “like kind and quality” variables that exist in present claims and sets forth appropriate, more accurate reserves on current claims. P2P is reviewed by UPCIC management on a weekly basis in reviewing the topography of existing and incoming claims. P2P will be analyzed at each quarter’s end and adjustments to reserves are made at an aggregate level when appropriate.

Regulatory Requirements

The Company’s regulated subsidiaries, UPCIC and American Platinum Property and Casualty Insurance Company (“APPCIC”), are subject to regulations and standards of the Florida Office of Insurance Regulation (“OIR”). These standards require the subsidiaries to maintain specified levels of statutory capital and restrict the timing and amount of dividends and other distributions that may be paid to the parent company. Except in the case of extraordinary dividends, these standards generally permit dividends to be paid from statutory unassigned surplus of the regulated subsidiary and are limited based on the regulated subsidiary’s level of statutory net income and statutory capital and surplus. These dividends are referred to as “ordinary dividends” and generally can be paid without prior regulatory approval. If the dividend, together with other dividends paid within the preceding twelve months, exceeds a specified statutory limit or is paid from sources other than earned surplus, the entire dividend is generally considered an “extraordinary dividend” and must receive prior regulatory approval.

 

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Table of Contents

In 2011, based on the 2010 statutory net income and statutory capital and surplus levels, the maximum amount of ordinary dividends which could be paid is $2.5 million from UPCIC and $1.2 million from APPCIC. For the nine months ended September 30, 2011, no dividends were paid from UPCIC or APPCIC to their parent company.

The Florida Insurance Code requires companies to maintain capitalization equivalent to the greater of ten percent of the insurer’s total liabilities or $5.0 million. Ten percent of UPCIC’s total liabilities were $42.9 million and $32.9 million at September 30, 2011, and December 31, 2010, respectively. Ten percent of APPCIC’s total liabilities were $64 thousand and $83 thousand at September 30, 2011 and December 31, 2010, respectively. UPCIC’s statutory capital and surplus was $95.6 million and $115.9 million at September 30, 2011, and December 31, 2010, respectively. APPCIC’s statutory capital and surplus was $9.4 million and $11.3 million at September 30, 2011, and December 31, 2010, respectively. At such dates, both UPCIC and APPCIC met the Florida capitalization requirement. UPCIC and APPCIC are also required to adhere to prescribed premium-to-capital surplus ratio and have met those requirements at such dates.

Through Universal Insurance Holdings Company of Florida, UPCIC’s parent company, UIH made capital contributions of $5.0 million and $12.0 million to UPCIC in June 2011, and September 2011, respectively.

 

6. Share-Based Compensation

Stock Options

The Company recognized stock-based compensation expense as follows (in thousands):

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2011      2010      2011      2010  

Compensation expense:

           

Stock options

   $ 501       $ 314       $ 957       $ 1,767   

Non-vested shares

     468         234         931         690   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 969       $ 548       $ 1,888       $ 2,457   
  

 

 

    

 

 

    

 

 

    

 

 

 

Deferred tax benefits:

           

Stock options

   $ 193       $ 121       $ 369       $ 682   

Non-vested shares

     —           90         —           266   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 193       $ 211       $ 369       $ 948   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total unrecognized compensation expense related to stock options was $2.1 million at September 30, 2011, to be recognized over a weighted-average period of approximately 1.6 years. Total unrecognized compensation expense related to non-vested shares of Company common stock was $1.4 million at September 30, 2011, to be recognized over a weighted-average period of approximately 1 year.

The following table provides certain information related to stock options and non-vested shares (in thousands, except per share data):

 

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Table of Contents
     Three Months Ended September 30, 2011  
     Stock Options      Non-vested Shares  
     Number of
Shares
     Weighted
Average
Exercise
Price
     Aggregate
Intrinsic
Value
     Weighted
Average
Remaining
Term
     Number of
Shares
    Weighted
Average
Grant Date
Fair Value
 

Outstanding as of June 30, 2011

     6,880       $ 4.68               801      $ 5.67   

Granted

     —           —                 —          —     

Forfeited

     —           —                 —          —     

Exercised

     —           —                 —          —     

Vested

     —           —                 —          —     

Expired

     —           —                 —          —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Outstanding as of September 30, 2011

     6,880       $ 4.68       $ 1,797         3.0         801      $ 5.67   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Exercisable as of September 30, 2011

     5,285       $ 4.66       $ 1,797         2.0        
  

 

 

    

 

 

    

 

 

    

 

 

      
     Nine Months Ended September 30, 2011  
     Stock Options      Non-vested Shares  
     Number of
Shares
     Weighted
Average
Exercise
Price
     Aggregate
Intrinsic
Value
     Weighted
Average
Remaining
Term
     Number of
Shares
    Weighted
Average
Grant Date
Fair Value
 

Outstanding as of December 31, 2010

     5,385       $ 4.68               300      $ 5.84   

Granted

     1,495         4.70               600        5.61   

Forfeited

     —           —                 —          —     

Exercised

     —           —                 —          —     

Vested

     —           —                 (99     5.84   

Expired

     —           —                 —          —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Outstanding as of September 30, 2011

     6,880       $ 4.68       $ 1,797         3.0         801      $ 5.67   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Exercisable as of September 30, 2011

     5,285       $ 4.66       $ 1,797         2.0        
  

 

 

    

 

 

    

 

 

    

 

 

      

On June 23, 2011, the Company granted options to purchase an aggregate of 1,495 thousand shares of common stock to the Company’s directors (225 thousand shares), executive officers (675 thousand shares) and management (595 thousand shares). Options granted to directors vest in full on the earlier of (i) the first anniversary of the date of grant, and (ii) the first annual meeting of the Company’s shareholders, following the date of grant, at which the shareholders elect or reelect any directors to the Board. Options granted to executive officers and management vest as follows: (i) one third on the six (6) month anniversary of the date of grant, (ii) one third on the one (1) year anniversary of the date of grant, and (iii) one third on the two (2) year anniversary of the date of grant. The options have an exercise price of $4.70 per share and expire on June 23, 2016 for directors and June 23, 2018 for executive officers and management.

Effective May 11, 2011, the Company issued 600 thousand shares of performance-based restricted common stock at a price of $5.61 per share to its Senior Vice President and Chief Operating Officer. Shares of 200 thousand vest on each of the first, second and third anniversary of the grant date which is March 28, 2011.

 

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Table of Contents
7. Stockholders’ Equity

Dividends

On January 6, 2011, the Company declared a dividend of $0.10 per share on its outstanding common stock paid on April 7, 2011, to the Company’s shareholders of record at the close of business on March 11, 2011.

On August 15, 2011, the Company declared a dividend of $0.08 per share on its outstanding common stock paid on October 6, 2011, to the Company’s shareholders of record at the close of business on September 16, 2011.

 

8. Related Party Transactions

Downes and Associates, a multi-line insurance adjustment corporation based in Deerfield Beach, Florida, performs certain claims adjusting work for UPCIC. Downes and Associates is owned by Dennis Downes, who is the father of Sean P. Downes, Senior Vice President and Chief Operating Officer of the Company. The Company expensed claims adjusting fees to Downes and Associates, as follows (in thousands):

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2011      2010      2011      2010  

Claims adjusting fees

   $ 91       $ 120       $ 521       $ 360   

9. Income Taxes

Deferred income taxes represent the temporary differences between the GAAP and tax basis of the Company’s assets and liabilities. The tax effects of temporary differences are as follows for the periods presented (in thousands):

 

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     As of September 30,     As of December 31,  
     2011     2010  

Deferred income tax assets:

    

Unearned premiums

   $ 9,600      $ 8,274   

Advanced premiums

     1,620        1,460   

Unpaid losses

     2,379        2,194   

Regulatory assessments

     —          182   

Executive compensation

     1,211        1,312   

Stock option expense

     3,836        3,467   

Accrued wages

     906        357   

Allowance for uncollectible receivables

     60        43   

Additional tax basis of securities

     1,106        172   

Recognition of OTTI

     —          307   

Market value losses on trading securities

     8,422        —     
  

 

 

   

 

 

 

Total deferred income tax assets

     29,140        17,768   
  

 

 

   

 

 

 

Deferred income tax liabilities:

    

Deferred policy acquisition costs, net

     (5,020     (3,644

Market value gains on trading securities

     —          (676
  

 

 

   

 

 

 

Total deferred income tax liabilities

     (5,020     (4,320
  

 

 

   

 

 

 

Net deferred income tax asset

   $ 24,120      $ 13,448   
  

 

 

   

 

 

 

Tax years that remain open for purposes of examination of the Company’s income tax liability due to tax authorities, include the years ended December 31, 2010, 2009 and 2008.

The following table reconciles the statutory federal income tax rate to the Company’s effective tax rate:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Statutory federal income tax rate

     35.0     35.0     35.0     35.0

Increases resulting from:

        

Disallowed meals & entertainment

     1.3     0.1     0.1     0.3

Disallowed compensation

     25.4     0.4     2.0     0.5

True-up to prior year tax returns

     -43.2     —          -1.3     —     

State income tax, net of federal tax benefit (1)

     3.6     3.6     3.6     3.6

Other, net

     -0.5     -0.5     0.6     -0.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Effective tax rate

     21.6     38.6     40.0     38.8
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Included in income tax is State of Florida income tax at a statutory tax rate of 5.5%.

 

 

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10. Earnings Per Share

Basic earnings per share (“EPS”) is based on the weighted average number of shares outstanding for the period, excluding any dilutive common share equivalents. Diluted EPS reflects the potential dilution that could occur if securities to issue common stock were exercised.

The following tables reconcile the numerator (i.e., income) and denominator (i.e., shares) of the basic and diluted earnings per share computations for net income for the three and nine-month periods ended September 30, 2011, and 2010 (in thousands, except per share data):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Numerator for EPS:

        

Net income

   $ 975      $ 13,077      $ 22,422      $ 30,788   

Less: Preferred stock dividends

     (5     (5     (15     (15
  

 

 

   

 

 

   

 

 

   

 

 

 

Income available to common stockholders

   $ 970      $ 13,072      $ 22,407      $ 30,773   

Denominator for EPS:

        

Weighted average common shares outstanding

     39,190        39,167        39,177        39,076   

Plus: Assumed conversion of stock-based compensation

     651        949        871        1,150   

Assumed conversion of preferred stock

     489        160        489        160   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average diluted common shares outstanding

     40,330        40,276        40,536        40,386   

Basic earnings per common share

   $ 0.02      $ 0.33      $ 0.57      $ 0.78   

Diluted earnings per common share

   $ 0.02      $ 0.32      $ 0.55      $ 0.76   

 

11. Other Comprehensive Income

The components of other comprehensive income on a pre-tax and after-tax basis are as follows (in thousands):

 

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     For the Three Months
Ended September 30, 2011
    

For the Three Months

Ended September 30, 2010

 
     Pretax      Tax      After-tax      Pretax     Tax     After-tax  

Net unrealized gains on available-for-sale investments arising during the periods

   $ —         $ —         $ —         $ —        $ —        $ —     

Less: realized gains on investments

     —           —           —           —          —          —     

Less: reclassification of unrealized losses relating to the reclassification of investment portfolio to trading from available-for-sale

     —           —           —           (656     253        (403

Less: realized foreign currency gains on investments

     —           —           —           —          —          —     

Less: other

     —           —           —           (9     3        (6
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Change in net unrealized gains on available-for-sale investments

     —           —           —           (665     257        (408
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Other comprehensive (loss) income

   $ —         $ —         $ —         $ (665   $ 257      $ (408
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 
    

For the Nine Months

Ended September 30, 2011

    

For the Nine Months

Ended September 30, 2010

 
     Pretax      Tax      After-tax      Pretax     Tax     After-tax  

Net unrealized gains on available-for-sale investments arising during the periods

   $ —         $ —         $ —         $ 4,979      $ (1,921   $ 3,058   

Less: realized gains on investments

     —           —           —           5,744        (2,216     3,528   

Less: reclassification of unrealized losses relating to the reclassification of investment portfolio to trading from available-for-sale

     —           —           —           (656     253        (403

Less: realized foreign currency gains on investments

     —           —           —           809        (312     497   

Less: other

     —           —           —           (9     3        (6
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Change in net unrealized gains on available-for-sale investments

     —           —           —           (909     351        (558
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Other comprehensive (loss) income

   $ —         $ —         $ —         $ (909   $ 351      $ (558
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

There were no amounts of other comprehensive income for the three and nine month periods ended September 30, 2011.

 

12. Commitments and Contingencies

Employment Agreements

The Company has employment agreements with certain employees which are in effect as of September 30, 2011. The agreements provide for minimum salaries, which may be subject to annual percentage increases, and non-equity incentive compensation for certain executives based on pre-tax or net income levels attained by the Company. The agreements also provide for payments contingent upon the occurrence of certain events. The following table provides the amount of commitments and contingent payments the Company is obligated to pay in the form of salaries and non-equity incentive compensation under these agreements (in thousands):

 

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Table of Contents
     As of September 30, 2011  
     Salaries      Non-equity
incentive
compensation
 

Commitments

   $ 15,282       $ 11,836   

Contingent payments upon certain events:

     

Termination

   $ 6,291       $ 5,302   

Change in control

   $ 14,316       $ 9,354   

Death

   $ 8,046       $ 8,003   

Disability

   $ 4,938       $ 2,582   

Operating Leases

The Company has leases for certain computer equipment, software and office space. The Company reported in its Annual Report on Form 10-K for the year ended December 31, 2010, a schedule of future minimum rental payments required under the non-cancelable operating leases.

Litigation

Certain lawsuits have been filed against the Company. These lawsuits involve matters that are routine litigation incidental to the claims aspect of the Company’s business for which estimated losses are included in Unpaid Losses and Loss Adjustment Expenses in the Company’s Consolidated Financial Statements. In the opinion of management, these lawsuits are not material individually or in the aggregate to the Company’s financial position or results of operations. Accruals made or assessments of materiality of disclosure related to probable or possible losses do not consider any anticipated insurance proceeds.

 

13. Fair Value Measurements

GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. GAAP describes three approaches to measuring the fair value of assets and liabilities: the market approach, the income approach and the cost approach. Each approach includes multiple valuation techniques. GAAP does not prescribe which valuation technique should be used when measuring fair value, but does establish a fair value hierarchy that prioritizes the inputs used in applying the various techniques. Inputs broadly refer to the assumptions that market participants use to make pricing decisions, including assumptions about risk. Level 1inputs are given the highest priority in the hierarchy while Level 3 inputs are given the lowest priority. Assets and liabilities carried at fair value are classified in one of the following three categories based on the nature of the inputs to the valuation technique used:

 

   

Level 1 — Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

   

Level 2 — Observable market-based inputs or unobservable inputs that are corroborated by market data.

 

   

Level 3 — Unobservable inputs that are not corroborated by market data. These inputs reflect management’s best estimate of fair value using its own assumptions about the assumptions a market participant would use in pricing the asset or liability.

 

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Summary of significant valuation techniques for assets measured at fair value on a recurring basis

Level 1

Cash equivalents: Comprise actively traded money market funds that have daily quoted net asset values for identical assets that the Company can access.

U.S. government obligations and agencies: Comprise U.S. Treasury Bills or Notes. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

Foreign government bonds: Comprise actively traded fixed-rate bonds of foreign governments rated AAA. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

Common stock: Comprise actively traded, exchange-listed U.S. and international equity securities. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

Exchange traded and mutual funds: Comprise actively traded funds. Valuation is based on daily quoted net asset values for identical assets in active markets that the Company can access.

Level 2

U.S. government obligations and agencies: Comprise U.S. Treasury Inflation Protected Securities (TIPS). The primary inputs to the valuation include quoted prices for identical assets in inactive markets or similar assets in active or inactive markets, contractual cash flows, benchmark yields and credit spreads.

Derivatives: The primary inputs to the valuation include quoted prices or quoted net asset values for identical or similar assets in markets that are not active or highly active.

As required by GAAP, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect their placement within the fair value hierarchy levels.

The following tables set forth by level within the fair value hierarchy the Company’s assets that were accounted for at fair value on a recurring basis as of September 30, 2011 and December 31, 2010 (in thousands):

 

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Table of Contents
     Fair Value Measurements
As of September 30, 2011
 
     Level 1      Level 2      Level 3      Total  

Cash equivalents

   $ 326,276       $ —         $ —         $ 326,276   

Trading portfolio:

           

Debt securities:

           

U.S. government securities obligations and agencies

     175         3,536         —           3,711   

Foreign government bonds

     54,352         —           —           54,352   

Equity securities:

           

Common stock:

           

Metals and mining

     30,829         —           —           30,829   

Other

     16,173         —           —           16,173   

Exchange-traded and mutual funds:

           

Metals and mining

     23,295         —           —           23,295   

Agriculture

     15,411         —           —           15,411   

Energy

     8,333         —           —           8,333   

Indices

     1,372         —           —           1,372   

Derivatives:

           

Non-hedging instruments

     —           1,545         —           1,545   

Other investments

     366         —           —           366   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total trading portfolio investments

     150,306         5,081         —           155,387   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 476,582       $ 5,081       $ —         $ 481,663   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Fair Value Measurements
As of December 31, 2010
 
     Level 1      Level 2      Level 3      Total  

Cash equivalents

   $ 145,121       $ —         $ —         $ 145,121   

Trading portfolio:

           

Debt securities:

           

U.S. government securities obligations and agencies

     179         129,937         —           130,116   

Equity securities:

           

Common stock:

           

Metals and mining

     25,752         —           —           25,752   

Other

     362         —           —           362   

Exchange-traded and mutual funds:

           

Metals and mining

     42,209         —           —           42,209   

Agriculture

     14,877         —           —           14,877   

Energy

     5,559         —           —           5,559   

Indices

     4,613         —           —           4,613   

Other

     1,044         —           —           1,044   

Derivatives:

           

Non-hedging instruments

     —           182         —           182   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total trading portfolio investments

     94,595         130,119         —           224,714   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 239,716       $ 130,119       $ —         $ 369,835   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The Company did not have any transfers between Level 1 and Level 2 for the nine-month periods ended September 30, 2011, and 2010.

The following table summarizes the carrying value, net unrealized gains (losses) and estimated fair values of the Company’s financial instruments that are not carried at fair value (in thousands):

 

     As of September 30, 2011
Fair Value Measurements
 
     Carrying
value
     Net unrealized
Gains/(Losses)
    Estimated Fair
Value
 

Assets:

       

Cash

   $ 2,562       $ —        $ 2,562   
  

 

 

    

 

 

   

 

 

 
   $ 2,562       $ —        $ 2,562   
  

 

 

    

 

 

   

 

 

 

Liabilities:

       

Long-term debt

   $ 22,059       $ (4,481   $ 17,578   
  

 

 

    

 

 

   

 

 

 
   $ 22,059       $ (4,481   $ 17,578   
  

 

 

    

 

 

   

 

 

 
     As of December 31, 2010
Fair Value Measurements
 
     Carrying
value
     Net unrealized
Gains/(Losses)
    Estimated Fair
Value
 

Assets:

       

Cash

   $ 2,464       $ —        $ 2,464   
  

 

 

    

 

 

   

 

 

 
   $ 2,464       $ —        $ 2,464   
  

 

 

    

 

 

   

 

 

 

Liabilities:

       

Long-term debt

   $ 23,162       $ (4,063   $ 19,099   
  

 

 

    

 

 

   

 

 

 
   $ 23,162       $ (4,063   $ 19,099   
  

 

 

    

 

 

   

 

 

 

The carrying value of cash approximates fair value due to its liquid nature.

The carrying value of long-term debt was determined from the expected cash flows discounted using the interest rate quoted by the issuer of the note, the State Board of Administration of Florida (“SBA”) which is below prevailing rates quoted by private lending institutions. However, as the Company’s use of funds from the surplus note is limited by the terms of the agreement, the Company has determined the interest rate quoted by the SBA to be appropriate for purposes of establishing the fair value of the note.

 

14. Subsequent Events

The Company performed an evaluation of subsequent events through the date the Financial Statements were issued and determined there were no recognized or unrecognized subsequent events that would require an adjustment or additional disclosure in the Financial Statements as of September 30, 2011 except the following.

In consultation with the OIR, UPCIC has offered to segregate from its general operating funds an amount equivalent to its anticipated future reinsurance premiums under the arrangement with T25 and UPCIC described in Note 4 “Reinsurance.” On October 28, 2011, UPCIC remitted $45.5 million as a deposit with the Florida Department of Financial Services. According to the terms of the reinsurance contract, UPCIC will pay approximately half of the deposited amount to T25 on or about January 1, 2012 and the remaining amount on or about April 1, 2012. Alternatively, UPCIC anticipates that it will propose to commute the existing contract in December 2011. The commutation would result in the entire deposit being returned to UPCIC in December or being used to support a replacement contract.

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Unless the context otherwise requires, all references to “we,” “us,” “our,” and “Company” refer to Universal Insurance Holdings, Inc. and its subsidiaries. You should read the following discussion together with our unaudited condensed consolidated financial statements and the related notes thereto included in Part I, Item 1 “Financial Statements.” Operating results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for the year.

Forward-Looking Statements

In addition to historical information, the following discussion may contain “forward-looking statements” within the meaning of the Private Securities Reform Litigation Act of 1995. The words “expect,” “estimate,” “anticipate,” “believe,” “intend,” “project,” “plan” and similar expressions and variations thereof-, speak only as of the date the statement was made and are intended to identify forward-looking statements. Forward-looking statements are based on various factors and assumptions that include known and unknown risks and uncertainties. Such statements may include, but not be limited to, projections of revenues, income or loss, expenses, plans, as well as assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future results could differ materially from those in the following discussion and those described in forward-looking statements as a result of the risks set forth in the section below entitled “Cautionary Note Regarding Forward-Looking Statements.”

Overview

Universal Insurance Holdings, Inc. (“UIH”) is a vertically integrated insurance holding company performing all aspects of insurance underwriting, distribution and claims. Through our wholly-owned subsidiaries, including Universal Property & Casualty Insurance Company (“UPCIC”), we are principally engaged in the property and casualty insurance business offered primarily through a network of independent agents. Our primary product is homeowners’ insurance currently offered in four states, including the State of Florida, which represented 98% of the 595 thousand policies-in-force as of September 30, 2011, and 98% of the 584 thousand policies-in-force as of December 31, 2010. As for the geographic distribution of business within Florida as of September 30, 2011, and December 31, 2010, 32% of the policies-in-force are in Miami-Dade, Broward and Palm Beach Counties. Risk from catastrophic losses is managed through the use of reinsurance agreements.

We generate revenues primarily from the collection of premiums and the investment of those premiums. Other significant sources of revenue include commissions collected from reinsurers and policy fees.

2011 Developments

On October 28, 2011, UPCIC remitted $45.5 million as a deposit with the Florida Department of Financial Services. In consultation with the Florida Office of Insurance Regulation (“OIR”), UPCIC has offered to segregate from its general operating funds an amount equivalent to its anticipated future reinsurance premiums under the arrangement with T25 and UPCIC, as described below under 2011-2012 Reinsurance Program. See Liquidity and Capital resources for further discussion regarding this arrangement.

 

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UPCIC filed a premium rate change for its Dwelling Fire insurance program with the OIR on September 23, 2011. The rate increase, which will result in an average rate increase of approximately 8.8% statewide, is still pending approval by OIR. Also included in the filing was a proposal to remove sinkhole coverage from the base policy. The sinkhole coverage and form changes filed for Dwelling Fire are similar in nature to those filed for Homeowners described below. An effective date of December 22, 2011 was requested in the filing.

UPCIC filed a premium rate change for its Homeowners insurance program with the OIR on September 21, 2011. The rate increase, which will result in an average rate increase of approximately 14.8% statewide, is still pending approval by OIR. UPCIC also filed to remove Sinkhole from the standard HO3 & HO8 policy and offer the coverage via endorsement for an additional surcharge, and a mandatory 10% deductible, to those policyholders that meet the proposed eligibility standards. An effective date of December 21, 2011 was requested for new and renewal business, although notification requirements for the sinkhole coverage change will dictate the effective date for renewal business depending on the date of approval. A forms filing was made immediately after the rate filing to segregate the sinkhole coverage and to include updated policy language as a result of the property insurance bill which became law in May, 2011 (Senate Bill 408).

On August 17, 2011, we announced that the Georgia department of insurance approved the homeowners’ rates and forms of its wholly-owned subsidiary, UPCIC. UPCIC expects to begin to write homeowners’ insurance in Georgia in the near future.

On August 15, 2011, we declared a cash dividend of $0.08 per share on our outstanding common stock, payable on October 6, 2011, to shareholders of record at the close of business on September 16, 2011.

During the second quarter, UPCIC completed its 2011-2012 reinsurance program effective June 1, 2011. See 2011-2012 Reinsurance Program below for a description of that program.

During the second quarter, American Platinum Property and Casualty Insurance Company (“APPCIC,”) received approval of its rate filing from the OIR. APPCIC intends to write homeowners’ multi-peril and inland marine insurance on Florida homes valued in excess of $1 million, which are limits and coverages currently not targeted by UPCIC.

On January 6, 2011, we declared a cash dividend of $0.10 per share on our outstanding common stock payable on April 7, 2011, to shareholders of record at the close of business on March 11, 2011.

UPCIC filed a premium rate change for its Homeowners’ insurance programs with the Florida Office of Insurance Regulation (“OIR”) on November 5, 2010. The rate increase, which will result in an average rate increase of approximately 14.9 percent statewide, was approved by the OIR on February 3, 2011. The effective dates for the rate increase are February 7, 2011 for new business and March 28, 2011 for renewal business. We expect the approved premium rate increases to have a positive effect on premiums written and earned in future months as new and renewal policies are written at the higher rates.

2011-2012 Reinsurance Program

Quota Share

Effective June 1, 2011 through May 31, 2012, UPCIC entered into a quota share reinsurance contract with Everest Re. Everest Re has the following ratings from each of the rating agencies: A+ from A.M. Best

 

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Company, A+ from Standard and Poor’s Rating Services and Aa3 from Moody’s Investors Service, Inc. Under the quota share contract, UPCIC cedes 50% of its gross written premiums, losses and loss adjustment expenses (“LAE”) for policies with coverage for wind risk with a ceding commission equal to 25% of ceded gross written premiums. In addition, the quota share contract has a limitation for any one occurrence not to exceed $34.8 million (of which UPCIC’s net liability on the first $34.8 million of losses in a first event scenario is $17.4 million, in a second event scenario is $17.4 million and in a third event scenario is $30 million) and a limitation from losses arising out of events that are assigned a catastrophe serial number by the Property Claims Services (“PCS”) office not to exceed $69.6 million. The contract requires UPCIC to reassume 100% of the attritional loss and LAE activity from 30% to 37.5% of gross written premium and has a limitation for LAE not to exceed 30% of indemnity losses paid during the contract period. Further, the contract limits the amount of premium which can be deducted for inuring reinsurance to $288 million, excluding reinstatement premiums, or $326 million, including reinstatement premiums, if any.

Excess Per Risk

Effective June 1, 2011 through May 31, 2012, UPCIC entered into a multiple line excess per risk contract with various reinsurers. Under the multiple line excess per risk contract, UPCIC obtained coverage of $1.4 million in excess of $600 thousand ultimate net loss for each risk and each property loss, and $1 million in excess of $300 thousand for each casualty loss. A $7 million aggregate limit applies to the term of the contract.

Effective June 1, 2011 through May 31, 2012, UPCIC entered into a property per risk excess contract covering ex-wind only policies. Under the property per risk excess contract, UPCIC obtained coverage of $400 thousand in excess of $200 thousand for each property loss. A $2 million aggregate limit applies to the term of the contract.

The total cost of our multiple line excess reinsurance program effective June 1, 2011 through May 31, 2012 is $4 million of which our cost is 50%, or $2 million and the quota share reinsurers’ cost is the remaining 50%. The total cost of our property per risk reinsurance program effective June 1, 2011 through May 31, 2012 is $575 thousand.

Excess Catastrophe

Effective June 1, 2011 through May 31, 2012, under excess catastrophe contracts, UPCIC obtained catastrophe coverage of $541.3 million in excess of $185 million covering certain loss occurrences including hurricanes. The coverage of $541.3 million in excess of $185 million has a second full limit available to UPCIC. Additional premium is calculated pro rata as to amount and 100% as to time, as applicable.

Effective June 1, 2011 through May 31, 2012, UPCIC purchased reinstatement premium protection which reimburses UPCIC for its cost to reinstate the catastrophe coverage of the first $399.3 million (part of $541.3 million) in excess of $185 million.

Effective June 1, 2011 through May 31, 2012, under an excess catastrophe contract specifically covering risks located in Georgia, North Carolina and South Carolina, UPCIC obtained catastrophe coverage of 50% of $24.8 million in excess of $10 million and 100% of $20 million in excess of $34.8 million covering certain loss occurrences including hurricanes. Both coverages have a second full limit available to UPCIC. Additional premium is calculated pro rata as to amount and 100% as to time, as applicable.

 

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The cost of UPCIC’s excess catastrophe contracts specifically covering risks in Georgia, North Carolina and South Carolina is $3.9 million.

Effective June 1, 2011 through May 31, 2012, UPCIC also obtained subsequent catastrophe event excess of loss reinsurance to cover certain levels of UPCIC’s net retention through three catastrophe events including hurricanes, as follows:

 

     2nd Event     3rd Event  
Coverage     
 
 
 
 
 
$140.2 million in excess of
$44.8 million each loss
occurrence subject to an
otherwise recoverable
amount of $140.2 million
(placed 100%)
  
  
  
  
  
  
   
 
 
 
 
 
$155.0 million in excess of
$30.0 million each loss
occurrence subject to an
otherwise recoverable
amount of $310.0 million
(placed 100%)
  
  
  
  
  
  

Deposit premium (100%)

   $ 27.8 million      $ 11.9 million   

Minimum premium (100%)

   $ 22.2 million      $ 9.5 million   

Premium rate -% of total insured value

     0.021863     0.009400

UPCIC also obtained coverage from the Florida Hurricane Catastrophe Fund (“FHCF”), which is administered by the Florida State Board of Administration (“SBA”). Under the reimbursement agreement, the FHCF would reimburse UPCIC, for each loss occurrence during the contract year, for 90% of the ultimate loss paid by UPCIC in excess of its retention plus 5% of the reimbursed losses to cover loss adjustment expenses, subject to an aggregate contract limit. A covered event means any one storm declared to be a hurricane by the National Hurricane Center for losses incurred in Florida, both while it is a hurricane and through subsequent downgrades. For the contract year June 1, 2011 to May 31, 2012, UPCIC purchased the traditional FHCF coverage and did not purchase the Temporary Increase in Coverage Limit Option offered to insurers by the FHCF. UPCIC’s estimate of its traditional FHCF coverage is based upon UPCIC’s exposure in-force as of June 30, 2011, as reported by UPCIC to the FHCF on September 1, 2011 and is 90% of $1.172 billion in excess of $457 million. The estimated premium for this coverage is $73.3 million.

Also at June 1, 2011, the FHCF made available, and UPCIC obtained, $10.0 million of additional catastrophe excess of loss coverage with one free reinstatement of coverage to carriers qualified as Limited Apportionment Companies or companies that participated in the Insurance Capital Build-Up Incentive (“ICBUI”) Program offered by the FHCF, such as UPCIC. This particular layer of coverage at June 1, 2011 is $10.0 million in excess of $34.8 million. The premium for this coverage is $5.0 million.

On October 28, 2011, the SBA published its most recent estimate of the FHCF’s loss reimbursement capacity in the Florida Administrative Weekly. The SBA estimated that the FHCF’s total loss reimbursement capacity under current market conditions for the 2011—2012 contract year is projected to be $15.17 billion over the 12-month period following the estimate. The SBA also referred to

 

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its report entitled, “October 18, 2011 Estimated Claims Paying Capacity Report” (“Report”) as providing greater detail regarding the FHCF’s loss reimbursement capacity. The Report estimated that the FHCF’s loss reimbursement capacity range is $12.17 billion to $18.17 billion. UPCIC elected to purchase the FHCF Mandatory Layer of Coverage for the 2011—2012 contract year, which corresponds to FHCF loss reimbursement capacity of $17 billion. By law, the FHCF’s obligation to reimburse insurers is limited to its actual claims-paying capacity. The aggregate cost of UPCIC’s reinsurance program may increase should UPCIC deem it necessary to purchase additional private market reinsurance due to reduced estimates of the FHCF’s loss reimbursement capacity.

The total cost of UPCIC’s multiple line excess and property per risk reinsurance program effective June 1, 2011 through May 31, 2012 is $4.575 million, of which UPCIC’s cost is $2.575 million, and the quota share reinsurer’s cost is the remaining $2.0 million. The total cost of UPCIC’s underlying excess catastrophe contract with T25 (see below) is $111.4 million, subject to a potential return premium of $83.4 million, which is eliminated in consolidation. The total cost of UPCIC’s private catastrophe reinsurance program effective June 1, 2011 through May 31, 2012 is $135.8 million, of which UPCIC’s cost is 50%, or $67.9 million, and the quota share reinsurer’s cost is the remaining 50%. In addition, UPCIC purchases reinstatement premium protection as described above, the cost of which is $22.4 million. UPCIC’s cost of the subsequent catastrophe event excess of loss reinsurance is $19.8 million. The estimated premium that UPCIC plans to cede to the FHCF for the 2011 hurricane season is $73.3 million of which UPCIC’s cost is 50%, or $36.7 million, and the quota share reinsurer’s cost is the remaining 50%. UPCIC is also participating in the additional coverage option for Limited Apportionment Companies or companies that participated in the Insurance Capital Build-Up Incentive Program offered by the FHCF, the premium for which is $5.0 million, of which UPCIC’s cost is 50%, or $2.5 million, and the quota share reinsurer’s cost is the remaining 50%.

UPCIC is responsible for losses related to catastrophic events with incurred losses in excess of coverage provided by UPCIC’s reinsurance program and for losses that otherwise are not covered by the reinsurance program, which could have a material adverse effect on UPCIC’s and our business, financial condition and results of operations.

UPCIC estimates, based upon its in-force exposures as of September 30, 2011, it had coverage to approximately the 123-year Probable Maximum Loss (PML), modeled using AIR CLASIC/2 v.11.0, long term, without demand surge. Recently, AIR updated its catastrophe model and outlook of risk with the release of its new version, AIR CLASIC/2 v12.04. UPCIC estimates, based on its in-force exposures as of September 30, 2011, that it had coverage to approximately the 89-year PML, modeled using AIR CLASIC/2 v.12.04, long term, without demand surge. Additionally, from time to time, UPCIC uses estimates from other catastrophe modeling vendors to estimate its PML. UPCIC estimates based upon its in-force exposures as of June 1, 2011, that it had coverage to approximately the 126-year PML, modeled using RMS’s new release of its RiskLink model, v11, long term, without loss amplification. PML is a general concept applied in the insurance industry for defining high loss scenarios that should be considered when underwriting insurance risk. Catastrophe models produce loss estimates that are qualified in terms of dollars and probabilities. Probability of exceedance or the probability that the actual loss level will exceed a particular threshold is a standard catastrophe model output. For example, the 100-year PML represents a 1.00% Annual Probability of Exceedance (the 123-year, 89-year and 126-year PML represents a 0.81%, 1.12% and 0.79% Annual Probability of Exceedance, respectively, for AIR v11.0, AIR v12.04 and RMS v11). It is estimated that the 100-year PML is likely to be equaled or exceeded in one year out of 100 on average, or 1 percent of the time. It is the 99th percentile of the annual loss distribution.

UPCIC limits the maximum net loss that can arise from large risks or risks in concentrated areas of exposure by reinsuring (ceding) certain levels of risks with other insurers or reinsurers on an automatic basis under reinsurance contracts. The reinsurance arrangements are intended to provide UPCIC with the ability to limit its exposure to losses within its capital resources. Such reinsurance includes quota share, excess of loss and catastrophe forms of reinsurance. UPCIC submits the reinsurance program annually for regulatory review to the OIR.

 

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In the event of catastrophic losses in the future, there could be a material adverse impact on our Financial Statements. With the implementation of our 2011-2012 reinsurance program, we retained a maximum, pre-tax net liability of $157.6 million for the first catastrophic event up to $1.781 billion of losses. Refer to the preceding table for information with respect to subsequent catastrophic events coverage. If catastrophic losses result in a net operating loss for the 2011 tax year, we can carry back the net operating loss to the 2010 and 2009 tax years and recover all, or a portion of, income taxes paid in those years.

In addition to coverage obtained by UPCIC under the reinsurance programs, the ultimate parent of UPCIC obtained $60.0 million of coverage via a catastrophe risk-linked transaction contract, effective June 1, 2011 through December 31, 2011, in the event UPCIC’s catastrophe coverage is exhausted. The total cost of the risk-linked transaction contract is $8.7 million.

Segregated Account T25

UIH owns and maintains a segregated account, Segregated Account T25—Universal Insurance Holdings of White Rock Insurance (SAC) Ltd. (“T25”) established by a third-party reinsurer in accordance with Bermuda law. T25 enters into underlying excess catastrophe contracts with UPCIC for the purpose of assuming the risk of certain policies issued by UPCIC, covering certain loss occurrences including hurricanes. UIH secures the obligations of T25 to UPCIC under these contracts by contributing the amount of T25’s liability for losses, net of UPCIC’s required premium payments, to a trust account as collateral. The collateral will be used to pay any claims that may arise in the event of the occurrence of covered events. Transactions related to this arrangement are eliminated in consolidation; however, the amount of collateral is held in trust for the benefit of UPCIC until the occurrence of a covered event, expiration or termination of the agreement between T25 and UPCIC.

UPCIC and T25 mutually agreed to a Commutation and Settlement Agreement on May 31, 2011, related to the underlying Property Catastrophe Excess of Loss Reinsurance Contract that was effective January 1, 2011. A replacement contract was entered into between the parties on June 1, 2011 as part of UPCIC’s reinsurance program in effect for the period June 1, 2011, through May 31, 2012. In conjunction with entering into the replacement contract, UIH contributed additional funds to T25 due to the increased reinsurance coverage and collateral requirements. The amount of collateral in the trust account at September 30, 2011 was $63.0 million.

Results of Operations - Three Months Ended September 30, 2011, Compared to Three Months Ended September 30, 2010

The following table summarizes changes in each component of our Statement of Income for the three months ended September 30, 2011, compared to the same period in 2010 (in thousands):

 

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     Three Months Ended September 30,     Change  
     2011     2010     $     %  

PREMIUMS EARNED AND OTHER REVENUES

        

Direct premiums written

   $ 171,370      $ 152,662      $ 18,708        12.3

Ceded premiums written

     (123,984     (108,539     (15,445     14.2
  

 

 

   

 

 

   

 

 

   

Net premiums written

     47,386        44,123        3,263        7.4

Decrease in net unearned premium

     2,248        4,708        (2,460     NM   
  

 

 

   

 

 

   

 

 

   

Premiums earned, net

     49,634        48,831        803        1.6

Net investment income

     122        66        56        84.8

Net realized gains on investments

     5,884        6,149        (265     -4.3

Net unrealized (losses) gains on investments

     (15,985     6,281        (22,266     NM   

Net foreign currency losses on investments

     (455     (8     (447     NM   

Commission revenue

     5,192        4,423        769        17.4

Policy fees

     3,535        3,525        10        0.3

Other revenue

     1,486        1,468        18        1.2
  

 

 

   

 

 

   

 

 

   

Total premiums earned and other revenues

     49,413        70,735        (21,322     -30.1
  

 

 

   

 

 

   

 

 

   

OPERATING COSTS AND EXPENSES

        

Losses and loss adjustment expenses

     29,343        29,370        (27     -0.1

General and administrative expenses

     18,827        20,053        (1,226     -6.1
  

 

 

   

 

 

   

 

 

   

Total operating costs and expenses

     48,170        49,423        (1,253     -2.5
  

 

 

   

 

 

   

 

 

   

INCOME BEFORE INCOME TAXES

     1,243        21,312        (20,069     -94.2

Income taxes, current

     7,331        7,359        (28     -0.4

Income taxes, deferred

     (7,063     876        (7,939     NM   
  

 

 

   

 

 

   

 

 

   

Income taxes, net

     268        8,235        (7,967     -96.7
  

 

 

   

 

 

   

 

 

   

NET INCOME

   $ 975      $ 13,077      $ (12,102     -92.5
  

 

 

   

 

 

   

 

 

   

Net income decreased by $12.1 million, or 92.5% primarily as a result of unrealized trading losses in our investment portfolio. These losses reflect a particularly steep decline in the equity markets as a whole during the quarter ended September 2011.

The increase in net earned premiums of $803 thousand, or 1.6%, was due to an increase in the number of policies written generated by our agent network and the rate increases which became effective in February 2011, as well as those that became effective in the latter part of 2009. These rate increases have had a positive effect on premium generated by renewal policies. The benefit from these factors was partially offset by an increase in the number of policies-in-force eligible for wind mitigation credits.

The following table reflects the effect of wind mitigation credits received by UPCIC policyholders (in thousands):

 

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     Reduction of in-force premium (only policies including wind coverage)

Date

  

Percentage of UPCIC
policyholders

receiving credits

  

Total credits

  

In-force

premium

  

Percentage reduction of

in-force premium

6/1/2007

   1.9%    $        6,285    $    487,866    1.3%

12/31/2007

   11.8%    $      31,952    $    500,136    6.0%

3/31/2008

   16.9%    $      52,398    $    501,523    9.5%

6/30/2008

   21.3%    $      74,186    $    508,412    12.7%

9/30/2008

   27.3%    $      97,802    $    515,560    16.0%

12/31/2008

   31.1%    $    123,525    $    514,011    19.4%

3/31/2009

   36.3%    $    158,230    $    530,030    23.0%

6/30/2009

   40.4%    $    188,053    $    544,646    25.7%

9/30/2009

   43.0%    $    210,292    $    554,379    27.5%

12/31/2009

   45.2%    $    219,974    $    556,557    28.3%

3/31/2010

   47.8%    $    235,718    $    569,870    29.3%

6/30/2010

   50.9%    $    281,386    $    620,277    31.2%

9/30/2010

   52.4%    $    291,306    $    634,285    31.5%

12/31/2010

   54.2%    $    309,858    $    648,408    32.3%

3/31/2011

   55.8%    $    325,511    $    660,303    33.0%

6/30/2011

   56.4%    $    322,640    $    673,951    32.4%

9/30/2011

   57.1%    $    324,313    $    691,031    31.9%

Net unrealized losses on investments of $16.0 million, recorded during the three months ended September 30, 2011, reflect the net decrease in value of investments held in our trading portfolio as of September 30, 2011. These unrealized losses in the trading portfolio during the three months ended September 30, 2011, were partially offset by realized gains of $5.9 million recorded during the same period. The unrealized losses reflect a particularly steep decline in the equity markets as a whole during the quarter ended September 2011. We will continue to record future changes in the market value of our trading portfolio directly to earnings as unrealized gains and losses on investments. All investment securities held at June 30, 2010, were classified as available-for-sale with net unrealized losses reflected in Accumulated Other Comprehensive Income in the Condensed Consolidated Statement of Financial Condition. During 2010, management evaluated the trading activity of our investment portfolio, investing strategy and overall investment program. As a result of this evaluation, we reclassified the available-for-sale portfolio as a trading portfolio effective July 1, 2010. Since July 1, 2010, changes in the market value of our trading portfolio are recorded directly to revenues as unrealized gains or losses on investments. In previous periods, the changes in unrealized gains and losses on the available-for-sale portfolio were appropriately included in Other Comprehensive Income rather than current period income.

Commission revenue is comprised principally of reinsurance commission sharing agreements. The increase in commission revenue of $769 thousand is due to an increase in the amount of ceded premiums.

The net loss and LAE ratios, or net losses and LAE as a percentage of net earned premiums, were 59.1% and 60.1% during the three-month periods ended September 30, 2011, and 2010, respectively, and were comprised of the following components (in thousands):

 

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     Three months ended September 30, 2011  
     Direct     Ceded     Net  

Loss and loss adjustment expenses

   $ 59,789      $ 30,446      $ 29,343   

Premiums earned

   $ 175,858      $ 126,224      $ 49,634   

Loss & LAE ratios

     34.0     24.1     59.1
     Three months ended September 30, 2010  
     Direct     Ceded     Net  

Loss and loss adjustment expenses

   $ 59,512      $ 30,142      $ 29,370   

Premiums earned

   $ 162,093      $ 113,262      $ 48,831   

Loss & LAE ratios

     36.7     26.6     60.1

The reduction in the direct loss and LAE ratio reflects an increase in earned premiums and favorable loss experience in the current year net of adverse development related to prior years.

General and administrative expenses decreased by $1.2 million due primarily to a decrease in performance-based bonus accruals of $1.9 million and a decrease in bad debt expense of $807 thousand. Performance-based bonuses are based on either net income before taxes or net income. These decreases were partially offset by an increase in stock-based compensation of $422 thousand for the three months ended September 30, 2011 compared to 2010, and non-recurring credits in the amount of $975 thousand from the recovery of Florida Insurance Guaranty Association (“FIGA”) assessments recorded during the three months ended September 30, 2010. FIGA assessments are ultimately passed down to policyholders. Amounts charged or credited to our earnings represent timing differences between the time assessments are made by FIGA to us, and the collection of those assessments from policyholders.

The decrease in income tax expense was the result of a significant reduction in taxable income due to unrealized losses in the trading portfolio. In addition, we recorded adjustments in connection with the filing of federal and state income tax returns for prior periods reducing the effective tax rate to 21.6% for the three months ended September 30, 2011.

Results of Operations—Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010

The following table summarizes changes in each component of our Statement of Income for the nine months ended September 30, 2011, compared to the same period in 2010 (in thousands):

 

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     Nine Months Ended September 30,     Change  
     2011     2010     $     %  

PREMIUMS EARNED AND OTHER REVENUES

        

Direct premiums written

   $ 558,024      $ 520,782      $ 37,242        7.2

Ceded premiums written

     (393,673     (357,411     (36,262     10.1
  

 

 

   

 

 

   

 

 

   

Net premiums written

     164,351        163,371        980        0.6

Increase in net unearned premium

     (17,189     (39,865     22,676        -56.9
  

 

 

   

 

 

   

 

 

   

Premiums earned, net

     147,162        123,506        23,656        19.2

Net investment income

     358        377        (19     -5.0

Net realized gains on investments

     12,496        11,893        603        5.1

Net unrealized (losses) gains on investments

     (23,037     6,281        (29,318     NM   

Net foreign currency (losses) gains on investments

     (384     801        (1,185     NM   

Commission revenue

     14,313        13,469        844        6.3

Policy fees

     12,110        12,000        110        0.9

Other revenue

     4,400        3,489        911        26.1
  

 

 

   

 

 

   

 

 

   

Total premiums earned and other revenues

     167,418        171,816        (4,398     -2.6
  

 

 

   

 

 

   

 

 

   

OPERATING COSTS AND EXPENSES

        

Losses and loss adjustment expenses

     81,380        77,857        3,523        4.5

General and administrative expenses

     48,598        43,631        4,967        11.4
  

 

 

   

 

 

   

 

 

   

Total operating costs and expenses

     129,978        121,488        8,490        7.0
  

 

 

   

 

 

   

 

 

   

INCOME BEFORE INCOME TAXES

     37,440        50,328        (12,888     -25.6

Income taxes, current

     25,690        19,016        6,674        35.1

Income taxes, deferred

     (10,672     524        (11,196     NM   
  

 

 

   

 

 

   

 

 

   

Income taxes, net

     15,018        19,540        (4,522     -23.1
  

 

 

   

 

 

   

 

 

   

NET INCOME

   $ 22,422      $ 30,788      $ (8,366     -27.2
  

 

 

   

 

 

   

 

 

   

Net income decreased by $8.4 million, or 27.2%, primarily as a result of unrealized trading losses in our investment portfolio. These losses reflect a particularly steep decline in the equity markets as a whole during the quarter ended September 2011.

The increase in net earned premiums of $23.7 million, or 19.2%, was due to an increase in the number of policies written generated by our agent network and the rate increases which became effective in the second quarter of 2011, as well as those that became effective in the latter part of 2009. These rate increases have had a positive effect on premiums generated by renewal policies. This benefit was partially offset by an increase in the number of policies-in-force eligible for and receiving wind mitigation credits. See “Results of Operations – Three Months Ended September 30, 2011 Compared to Three Months Ended September 30, 2010” for a table reflecting the effect of wind mitigation credits received by UPCIC policyholders.

Net unrealized losses on investments of $23.0 million recorded during the nine months ended September 30, 2011, reflect the net decrease in value of investments held in our trading portfolio as of September 30, 2011. These unrealized losses in the trading portfolio during the three months ended September 30, 2011, were partially offset by realized gains of $12.5 million recorded during the same period. The unrealized losses reflect a particularly steep decline in the equity markets as a whole during the quarter ended September 2011. We will continue to record future changes in the market value of investments held in our trading portfolio directly to earnings as unrealized gains and losses on investments. All investment securities held at June 30, 2010, were classified as available-for-sale with net unrealized losses reflected in Accumulated Other Comprehensive Income in the Condensed Consolidated Statement of Financial Condition. As discussed in the Results of Operations for the Three Months Ended September 30, 2011, compared to 2010, management evaluated the trading activity of our investment portfolio, investing strategy, and overall investment program during 2010. As a result of this evaluation, we reclassified the available-for-sale portfolio as a trading portfolio effective July 1, 2010. Since July 1, 2010, changes in the market value of our trading portfolio are recorded directly to revenues as unrealized gains or losses on investments. In previous periods, the changes in unrealized gains and losses on the available-for-sale portfolio were appropriately included in Other Comprehensive Income rather than current period income.

 

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During the nine months ended September 30, 2010, we recorded $2.4 million of other than temporary losses for certain securities that were available-for-sale. Effective July 1, 2010, we transferred all securities classified as available-for-sale to the trading portfolio and recognized all unrealized gains and losses in earnings thereafter.

Foreign currency losses and gains reflect changes in exchange rates for investments denominated in currencies other than U.S dollars.

The increase in other revenues of $911 thousand is due primarily to a higher volume of policyholders participating in our installment payment plan program offered by UPCIC.

The increase in net losses and LAE of $3.5 million, or 4.5%, was primarily related to the servicing of additional policies due to the growth in policy count on a year-over-year basis.

The net loss and LAE ratios, or net losses and LAE as a percentage of net earned premiums, were 55.3% and 63.0% during the nine-month periods ended September 30, 2011, and 2010, respectively, and were comprised of the following components (in thousands):

 

     Nine months ended September 30, 2011  
     Direct     Ceded     Net  

Loss and loss adjustment expenses

   $ 166,280      $ 84,900      $ 81,380   

Premiums earned

   $ 510,579      $ 363,417      $ 147,162   

Loss & LAE ratios

     32.6     23.4     55.3
     Nine months ended September 30, 2010  
     Direct     Ceded     Net  

Loss and loss adjustment expenses

   $ 156,537      $ 78,680      $ 77,857   

Premiums earned

   $ 452,848      $ 329,342      $ 123,506   

Loss & LAE ratios

     34.6     23.9     63.0

The improvement in the direct loss and LAE ratio for the nine-month period ended September 30, 2011, compared to the same period in the prior year, was the result of an increase in earned premiums and favorable loss experience in the current year net of adverse development related to prior years.

General and administrative expenses increased by $5.0 million due primarily to an increase in the amortization of deferred acquisition costs of $4.1 million. The increase in amortization of deferred acquisition costs is primarily in response to an increase in commissions paid on direct premium and the associated premium taxes thereon, partially offset by an increase in ceding commissions. Commissions and premium taxes are directly related to the volume of direct premium. Direct written premium has increased in response to an increase in the number of policies-in-force and the increase in average premium per policy. Other factors giving rise to the increase in general and administrative expenses include non-recurring credits in the amount of $2.3 million from the recovery of FIGA assessments recorded during the nine months ended September 30, 2010, an increase in legal fees of $678 thousand

 

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related to corporate matters, and an increase in insurance expense of $364 thousand. FIGA assessments are ultimately passed down to policyholders. Amounts charged or credited to our earnings represent timing differences between the time assessments are made by FIGA to us, and the collection of those assessments from policyholders. These increases were partially offset by a decrease of $1.5 million in performance-based bonus accruals, a decrease in bad debt expense of $1.0 million, and a decrease in stock-based compensation of $569 thousand.

The decrease in income tax expense was the result of a significant reduction in taxable income due to unrealized losses in the trading portfolio.

Analysis of Financial Condition - As of September 30, 2011, Compared to December 31, 2010

We believe that premiums will be sufficient to meet our working capital requirements for at least the next twelve months.

Our policy is to invest amounts considered to be in excess of current working capital requirements. We reduced our aggregate investment securities to $153.5 million as of September 30, 2011, from $224.5 million as of December 31, 2010, in response to market conditions. We have a receivable of $5.6 million at September 30, 2011, for securities sold that had not yet settled compared to $17.6 million at December 31, 2010, and a payable for securities purchased that had not yet settled of $17.7 million as of September 30, 2011.

The following table summarizes, by type, the carrying values of investments (in thousands):

 

      As of
September 30,
     As of
December 31,
 

Type of Investment

   2011      2010  

Cash and cash equivalents

   $ 328,838       $ 147,585   

Debt securities

     58,063         130,116   

Equity securities

     95,413         94,416   

Non-hedge derivatives

     1,545         182   

Other investments

     366         —     
  

 

 

    

 

 

 

Total Investments

   $ 484,225       $ 372,299   
  

 

 

    

 

 

 

Prepaid reinsurance premiums represent ceded unearned premiums related to our catastrophe and quota share reinsurance programs. The increase of $30.3 million to $251.3 million during the nine months ended September 30, 2011, was primarily due to an increase in premiums for catastrophe reinsurance coverage, as previously described in Recent Developments, 2011-2012 Reinsurance Program, and an increase in quota share reinsurance premiums commensurate with the increase in direct written premium. Premiums for catastrophe reinsurance coverage are earned over the respective contract periods which are generally effective from June 1, 2011, through May 31, 2012.

Reinsurance receivable, net, represents inuring premiums receivable, net of ceded premiums payable with our quota share reinsurer. The increase of $12.2 million to $49.8 million during the nine months ended September 30, 2011, was due to greater ceded premiums on our catastrophe reinsurance program and timing of the settlement with the quota share reinsurer. In prior periods, we netted this receivable against reinsurance payables. See Note 1 “Nature of Operations and Basis of Presentation” for more information about this reclassification in the Basis of Presentation section.

 

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Premiums receivable represent amounts due from policyholders. The increase of $7.0 million to $50.6 million during the nine months ended September 30, 2011 was due to the growth in direct written premiums and an increase in the number of policyholders participating in the installment payment plan program offered by UPCIC.

See Note 5 “Insurance Operations” in our Notes to Condensed Consolidated Financial Statements for a roll-forward in the balance of our deferred policy acquisition costs.

The increase in deferred income taxes of $10.7 million during the nine months ended September 30, 2011 is due primarily to unrealized losses in the trading portfolio.

See Note 5 “Insurance Operations” in our Notes to Condensed Consolidated Financial Statements for a roll-forward in the balance of our unpaid losses and loss adjustment expenses.

Unearned premiums represent the portion of written premiums that will be earned pro rata in the future. The increase of $47.4 million to $375.8 million during the nine months ended September 30, 2011 was due to growth in, and timing of, direct written premiums.

Reinsurance payable, net, represents our liability to reinsurers for ceded written premiums, net of ceding commissions receivable. The increase of $53.3 million to $128.8 million during the nine months ended September 30, 2011 was primarily due to the timing of settlements with reinsurers and amounts not yet due to reinsurers for catastrophe reinsurance coverage, as previously described in Recent Developments, 2011-2012 Reinsurance Program. In prior periods, we netted reinsurance receivable, net against reinsurance payables. See Note 1 “Nature of Operations and Basis of Presentation” for more information about this reclassification in the Basis of Presentation section.

Liquidity and Capital Resources

Liquidity

Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet its short and long-term obligations.

The balance of cash and cash equivalents as of September 30, 2011, was $328.8 million compared to $147.6 million at December 31, 2010. See our Condensed Consolidated Statements of Cash Flows for a reconciliation of the balance of cash and cash equivalent between September 30, 2011 and December 31, 2010. Most of this amount is available to pay claims in the event of a catastrophic event pending reimbursement amounts recoverable under reinsurance agreements. The source of liquidity for possible claim payments consists of the collection of net premiums after deductions for expenses, reinsurance recoverables and short-term loans.

As a means by which T25 can secure its potential obligation under its reinsurance contract with UPCIC, UIH holds collateral in a trust account for the benefit of UPCIC until the occurrence of a covered event or the expiration or termination of the agreement between T25 and UPCIC. The amount of collateral in the trust account at September 30, 2011 was $63.0 million and is placed with a major U.S. financial institution as provided by the Florida Insurance Code. These funds are segregated from the general operating funds of UIH. See Note 4 “Reinsurance” in our Notes to Condensed Consolidated Financial Statements for information about the arrangement between T25 and UPCIC.

In consultation with the OIR, UPCIC has offered to segregate from its general operating funds an amount equivalent to its anticipated future reinsurance premiums under the arrangement with T25 and UPCIC.

 

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On October 28, 2011, UPCIC remitted $45.5 million as a deposit with the Florida Department of Financial Services. According to the terms of the reinsurance contract, UPCIC will pay approximately half of the deposited amount to T25 on or about January 1, 2012 and the remaining amount on or about April 1, 2012. Alternatively, UPCIC anticipates that it will propose to commute the existing contract in December 2011. The commutation would result in the entire deposit being returned to UPCIC in December or being used to support a replacement contract.

The Company’s liquidity requirements primarily include potential payments of catastrophe losses, the payment of dividends to shareholders, and interest and principal payments on debt obligations. The declaration and payment of future dividends to shareholders will be at the discretion of our Board of Directors and will depend upon many factors, including our operating results, financial condition, capital requirements and any regulatory constraints.

Our insurance operations provide liquidity in that premiums are generally received months or even years before losses are paid under the policies sold. Historically, cash receipts from operations, consisting of insurance premiums, commissions, policy fees and investment income, have provided more than sufficient funds to pay loss claims and operating expenses. We maintain substantial investments in highly liquid, marketable securities. Liquidity can also be generated by funds received upon the sale of marketable securities in our investment portfolio.

Effective July 1, 2010, we elected to classify our securities investment portfolio as trading. Accordingly, purchases and sales of investment securities are included in cash flows from operations beginning July 1, 2010. We generated $176.0 million in cash from operations during the nine months ended September 30, 2011, compared to $ 131.9 million of cash generated by operating activities for the nine months ended September 30, 2010. The generation of cash during the nine months ended September 30, 2011 reflects proceeds from sales of investment securities, net of purchases of $89.0 million.

UPCIC is responsible for losses related to catastrophic events with incurred losses in excess of coverage provided by UPCIC’s reinsurance programs and for losses that otherwise are not covered by the reinsurance programs, which could have a material adverse effect on either UPCIC’s or our business, financial condition, results of operations and liquidity (see Note 4 for a discussion of the 2011-2012 reinsurance program and Note 3 to our Consolidated Financial Statements in Part II, Item 8 of Form 10-K for the Year Ended December 31, 2010 for a discussion of the 2008-2009, 2009-2010 and 2010-2011 reinsurance programs).

Funds generated from operations have generally been sufficient to meet liquidity requirements and we expect that in the future funds from operations will continue to meet such requirements. There can be no assurances, however, that this will be the case.

Capital Resources

Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks and facilitate continued business growth. At September 30, 2011, we had total capital of $179.0 million, comprised of stockholders’ equity of $156.9 million and total debt of $22.1 million. Our debt-to-total-capital ratio and debt-to-equity ratio were 12.3% and 14.1%, respectively, at September 30, 2011.

At September 30, 2011, UPCIC was in compliance with all of the covenants under its surplus note and its total adjusted capital was in excess of regulatory requirements.

Cash Dividends

 

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On January 6, 2011, we declared a dividend of $0.10 per share on our outstanding common stock to be paid on April 7, 2011, to the shareholders of record at the close of business on March 11, 2011. On August 8, 2011, we declared a dividend of $0.08 per share on our outstanding common stock to be paid on October 6, 2011, to the shareholders of record at the close of business on September 16, 2011.

Contractual Obligations

There have been no material changes during the period covered by this Quarterly Report on Form 10-Q, outside of the ordinary course of business, to the contractual obligations specified in the table of contractual obligations included in Part 1, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2010.

Critical Accounting Policies and Estimates

There have been no material changes during the period covered by this Quarterly Report on Form 10-Q to Critical Accounting Policies and Estimates previously disclosed in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2010.

Accounting Pronouncements Issued and Not Yet Adopted

In September 2010, the Financial Accounting Standards Board (“FASB”) issued guidance related to accounting for costs associated with acquiring or renewing insurance contracts. This guidance defines allowable deferred acquisition costs as costs incurred by insurance entities for the successful acquisition of new and renewal contracts. Such costs result directly from and are essential to the contract transaction(s) and would not have been incurred by the insurance entity had the contract(s) not occurred. This guidance will be effective for periods beginning after December 15, 2011, with early adoption permitted. We plan to prospectively adopt this guidance on January 1, 2012. Although we have not yet completed our evaluation of the impact to our financial statements, this guidance represents a significant departure from current industry practice upon adoption and will result in a reduction in our net deferred policy acquisition costs of as much as 20% to 30%, with a corresponding charge to earnings, and a reduction of deferrals and amortization of policy acquisition costs in future periods. This adjustment represents an acceleration of the amortization of costs that ultimately are charged to earnings.

In June 2011, the FASB updated its guidance related to the Comprehensive Income Topic 220 of the FASB Accounting Standards Codification (ASC). The objective of this updated guidance is to increase the prominence of items reported in other comprehensive income by eliminating the option of presenting components of other comprehensive income as part of the statement of changes in stockholders’ equity. The guidance requires total comprehensive income (including both the net income components and other comprehensive income components) be reported in either a single continuous statement of comprehensive income, or two separate but consecutive statements (the approach currently used in the Company’s consolidated financial statements). This guidance is to be applied retrospectively to fiscal years (and interim periods within those years) beginning after December 15, 2011. Early adoption is permitted. Since we already use the two-statement approach for reporting comprehensive income, this guidance will not have an impact on the presentation of our financial statements and notes.

 

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In May 2011, the FASB updated its guidance related to the Fair Value Measurement, Topic 820 of the ASC, to achieve common fair value measurement and disclosure requirements with International Financial Reporting Standards. The amendments change the wording used to describe many of the requirements in United States generally accepted accounting principles, to clarify the intent of application of existing fair value measurement and disclosure requirements, and to change particular principles or requirements for measuring and disclosing fair value measurements. The amendments are to be applied prospectively to interim and annual reporting periods beginning after December 15, 2011. The amendments are to be applied prospectively. The Company is currently evaluating the requirements of the guidance and its impact on the Company’s financial statements.

Related Parties

See Note 8 “Related Party Transactions” in our Notes to Condensed Consolidated Financial Statements for information about related parties.

Cautionary Note Regarding Forward-Looking Statements

We operate in a rapidly changing environment that involves a number of uncertainties, some of which are beyond our control. Certain statements made in this report that reflect management’s expectations regarding future events are forward-looking in nature and, accordingly are subject to risks and uncertainties. These forward-looking statements are only current expectations about future events. Actual results could differ materially from those set forth in or implied by any forward-looking statement. Factors that could cause or contribute to such differences include, but are not limited to, risk factors set forth in filings with the Securities and Exchange Commission, including our annual and quarterly reports. The following is a summary of uncertainties which were disclosed in greater detail in “Factors Affecting Operating Results and Market Price of Stock” in our Annual Report on Form 10-K for the year ended December 31, 2010:

 

   

Industry risks relating to fluctuating operating results caused by competition, catastrophe losses, general economic conditions including interest rate changes and market conditions, legislative initiatives, the regulatory environment, the frequency of litigation, the size of judgments, severe weather conditions, climate changes or cycles, the role of federal or state government in the insurance market, judicial or other authoritative interpretations of laws and policies, and the availability and cost of reinsurance.

 

   

Our ability to manage our exposure to catastrophic losses.

 

   

Risks related to our dependence upon third party developers of models to estimate hurricane losses and the reasonableness of assumptions or scenarios incorporated into the models which may be provided by third parties or management.

 

   

Risks related to our dependence upon third parties to perform certain functions including, but not limited to, the purchase of reinsurance and risk management analysis. We also rely on reinsurers to limit the amount of risk retained under our policies and to increase our ability to write additional risks.

 

   

Our ability to obtain reinsurance to the same extent and at the same cost as currently in place and minimize the loss of potential profits by ceding premiums to reinsurers.

 

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Credit risk, including certain concentrations with respect to our reinsurers, in light of our primary liability for the full amount of the risk underlying the reinsurance agreements.

 

   

Risks related to the ability of the Florida Hurricane Catastrophe Fund (FHCF) to provide reimbursements at levels requested and relied upon by us or as timely as required by our claims payments to policyholders. In addition, the cost of our reinsurance program may increase should we deem it necessary to purchase additional private market reinsurance due to reduced estimates of the FHCF’s claims-paying capacity.

 

   

Risks that laws, contracts or requirements relating to the FHCF may not be interpreted in a manner consistent with UPCIC’s understandings or will change in the future.

 

   

Our ability to estimate and maintain adequate liabilities to pay claims for losses and loss adjustment expenses.

 

   

Adverse regulation or legislation.

 

   

Our ability to implement sufficient and timely rate adjustments to provide aggregate premiums commensurate with expected losses.

 

   

Risks related to our dependence upon the efforts of key individuals.

 

   

Our ability to compete in a highly competitive industry.

 

   

Our ability to maintain our financial stability rating provided by Demotech, Inc.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the potential for economic losses due to adverse changes in fair value of financial instruments. Our primary market risk exposures are related to our investment portfolio and include interest rates, equity prices and commodity prices. We also have exposure to foreign currency exchange rates for investments denominated in foreign currencies, and to a lesser extent, our debt obligation in the form of a surplus note. The surplus note, as previously described in “Liquidity and Capital Resources,” accrues interest at an adjustable rate based on the 10-year Constant Maturity Treasury rate. Investments held in trading are carried on the balance sheet at fair value. Our investment trading portfolio is comprised primarily of debt and equity securities and also includes non-hedging derivatives and physical positions in precious metals. See Note 5 “Investments” for a schedule of investment holdings as of September 30, 2011 and December 31, 2010.

Our investment objective is to maximize total rate of return after federal income taxes while maintaining liquidity and minimizing risk. Our investment portfolio is managed by an investment committee consisting of all current directors in accordance with guidelines established by the OIR. The committee reviews management’s investment policies on a regular basis. The current investment policy limits investment in non-investment grade fixed maturity securities (including high-yield bonds), and limits total investments in preferred stock and common stock. We 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.

Interest Rate Risk

 

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Interest rate risk is the sensitivity of a fixed-rate instrument to changes in interest rates. When interest rates rise, the fair value of our fixed-rate instruments decline.

The following table provides information about our fixed income investments, which are sensitive to changes in interest rates. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates for investments held in trading at September 30, 2011, and December 31, 2010 (in thousands):

 

     As of September 30, 2011  
     Amortized Cost        
     2011     2012     2013      2014      2015      Thereafter     Total     Fair Value  

U.S. government securities obligations and agencies

   $ —        $ 172      $ —         $ —         $ —         $ 3,153      $ 3,325      $ 3,711   

Average interest rate

       4.09              1.85     1.97     1.97

Foreign government bonds

   $ 1,894      $ 52,459      $ —         $ —         $ —         $ —        $ 54,353      $ 54,352   

Average interest rate

     6.00     0.79                0.97     0.97
     As of December 31, 2010  
     Amortized Cost        
     2011     2012     2013      2014      2015      Thereafter     Total     Fair Value  

U.S. government securities obligations and agencies

   $ —        $ 174      $ —         $ —         $ —         $ 137,792      $ 137,966      $ 130,116   

Average interest rate

       2.60              1.30     1.30     1.30

United States government and agency securities are rated from AAA to Aaa by Moody’s Investors Service, Inc., and AA+ by Standard and Poor’s Company.

Equity and Commodity Price Risk

Equity and commodity price risk is the potential for loss in fair value of investments in common stock, exchange-traded funds (ETF), and mutual funds from adverse changes in the prices of those instruments.

 

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The following table provides information about the composition of equity securities, non-hedging derivatives and other investments held in the Company’s investment portfolio (in thousands):

 

     As of September 30, 2011     As of December 31, 2010  
     Fair Value      Percent     Fair Value      Percent  

Equity securities:

          

Common stock:

          

Metals and mining

   $ 30,829         31.7   $ 25,752         27.2

Other

     16,173         16.6     362         0.4

Exchange-traded and mutual funds:

          

Metals and mining

     23,295         23.9     42,209         44.6

Agriculture

     15,411         15.8     14,877         15.7

Energy

     8,333         8.6     5,559         5.9

Indices

     1,372         1.4     4,613         4.9

Other

     —           0.0     1,044         1.1

Derivatives:

          

Non-risk management instruments

     1,545         1.6     182         0.2

Other investments (4)

     366         0.4     —           0.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 97,324         100.0   $ 94,598         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

A hypothetical decrease of 10% in the market prices of each of the equity securities, non-hedging derivatives, and other investments held at September 30, 2011, and December 31, 2010, would have resulted in decreases of $9.7 million and $9.6 million, respectively, in the fair value of the equity securities, non-hedging derivatives and other investment portfolio.

Foreign Currency Exchange Risk

A hypothetical change of 10% in the exchange rates of our foreign denominated investments held at September 30, 2011, would have resulted in a charge or credit to earnings of $5.4 million.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of the period covered by this report. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that disclosure controls and procedures were effective as of September 30, 2011, to ensure that information required to be disclosed by the Company in its reports that it files or submits 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.

Changes in Internal Control Over Financial Reporting

 

 

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There was no change in the Company’s internal controls over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

The Company is involved in certain lawsuits. In the opinion of management, none of these lawsuits: (1) involve claims for damages exceeding 10% of the Company’s cash and invested assets, (2) involve matters that are not routine litigation incidental to the claims aspect of its business, (3) involve bankruptcy, receivership or similar proceedings, (4) involve material Federal, state, or local environmental laws; (5) potentially involve more than $100 thousand in sanctions and a governmental authority is a party, or (6) are material proceedings to which any director, officer, affiliate of the Company, beneficial owner of more than 5% of any class of voting securities of the Company, or security holder is a party adverse to the Company or has a material interest adverse to the Company.

Item 1A. Risk Factors

Due to the implementation of our 2011-2012 reinsurance program, we retained a maximum, pre-tax net liability of $157.6 million for the first catastrophic event up to $1.781 billion of losses. Refer to the table in the 2011-2012 Reinsurance Program under 2011 Developments in Management’s Discussion and Analysis of Financial Condition and Results of Operations for information with respect to subsequent catastrophic events coverage. If catastrophic losses result in a net operating loss for the 2011 tax year, we can carry back the net operating loss to the 2010 and 2009 tax years and recover all, or a portion of, income taxes paid in those years.

In the opinion of management, there have been no other material changes during the period covered by this Quarterly Report on Form 10-Q to the risk factors previously disclosed in Part I, Item 1A, “Risk Factors”, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Item 5. Other Information

At the Company’s 2011 Annual Meeting of Shareholders held on May 11, 2011, the Company’s shareholders voted on an advisory proposal regarding the frequency of future advisory votes on executive compensation. As reported in the Company’s Current Report on Form 8-K, consistent with the recommendation of the Company’s Board of Directors, shareholders voted in favor of conducting future advisory votes on executive compensation once every three years and, subject to annual re-evaluation by the Board, the Company will follow this advisory vote and conduct future advisory votes on executive compensation every three years.

Item 6. Exhibits

 

Exhibit No.

  

Exhibit

3.1    Registrant’s Restated Amended and Restated Certificate of Incorporation (1)
3.2    Certificate of Designation for Series A Convertible Preferred Stock dated October 11, 1994 (2)
3.3    Certificate of Designations, Preferences, and Rights of Series M Convertible Preferred Stock dated August 13, 1997 (3)
3.4    Certificate of Amendment of Amended and Restated Certificate of Incorporation dated October 19, 1998 (2)
3.5    Certificate of Amendment of Amended and Restated Certificate of Incorporation dated December 18, 2000 (2)

 

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