-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TvmWPN+qE0DmxwC7wc50fRlQi82u+wuGvx3DYeY7/Mk13688aMdOM/bHHGPDdbla YLDZWDRtmcnQKT1Zo0O+uw== 0000950144-01-004636.txt : 20010409 0000950144-01-004636.hdr.sgml : 20010409 ACCESSION NUMBER: 0000950144-01-004636 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: 21ST CENTURY HOLDING CO CENTRAL INDEX KEY: 0001069996 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 650248866 STATE OF INCORPORATION: FL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: SEC FILE NUMBER: 000-25001 FILM NUMBER: 1591108 BUSINESS ADDRESS: STREET 1: 4161 N W 5TH STREET CITY: PLANTATION STATE: FL ZIP: 33317 BUSINESS PHONE: 9545819993 MAIL ADDRESS: STREET 1: 4161 N W 5TH STREET CITY: PLANTATION STATE: FL ZIP: 33317 10KSB40 1 g68106e10ksb40.txt 21ST CENTURY HOLDINGS COMPANY 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB (MARK ONE) ( X ) ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES ACT OF 1934 For the fiscal year ended DECEMBER 31, 2000 or ( ) TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period of _____________to_______________ Commission file number 0-2500111 21ST CENTURY HOLDING COMPANY (Name of Small Business Issuer as specified in its Charter) FL 65-0248866 ------------------------------- ----------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No) 4161 N.W. 5TH STREET, PLANTATION, FLORIDA 33317 --------------------------------------------------- (Address of Principal executive offices) (Zip Code) Registrant's telephone number, including area code (954) 581-9993 -------------- Securities registered pursuant to Section 12(b) of the Exchange Act: None Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, par value $0.01 per share (Title of Class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter periods 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 Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ X ] State issuer's revenues for its most recent fiscal year: $37,553,607 ----------- As of March 28, 2001, the aggregate market value of the Issuer's Common Stock held by non-affiliates (based on the last sale of the common stock as reported by the Nasdaq National market) was: $4,367,624. As of March 28, 2001, there were 3,186,567 shares of the common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE 21st Century Holding Company's Definitive Proxy Statement for its 2001 Annual Meeting of Shareholders will be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this report on Form 10-KSB pursuant to General Instruction E (3) of the Form 10-KSB. Information from such Definitive Proxy Statement will be incorporated by reference into Part III, Items 9, 10, 11 and 12 hereof. 1 2 FORWARD-LOOKING STATEMENTS 21st Century Holding Company (the "Company") cautions readers that certain important factors may affect the Company's actual results and could cause such results to differ materially from any forward-looking statements which may be deemed to have been made in this report or which are otherwise made by or on behalf of the Company. For this purpose, any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "would," "estimate," or "continue" or the negative other variations thereof or comparable terminology are intended to identify forward-looking statements. Factors which may affect the Company's results include, but are not limited to, risks discussed elsewhere in this Report and in the Company's other filings with the Securities and Exchange Commission the ("Commission"). See "Glossary of Selected Terms" at the end of Item 1 for definition of insurance terms used in this report. PART I ITEM 1. BUSINESS GENERAL The Company is a vertically integrated insurance holding company, which, through its subsidiaries, controls substantially all aspects of the insurance underwriting, distribution and claims process. The Company underwrites nonstandard and standard personal automobile insurance and homeowners and mobile home property and casualty insurance in the State of Florida through its subsidiary, Federated National Insurance Company ("Federated National"). The Company has underwriting authority for third-party insurance companies, which it represents through a wholly owned managing general agent, Assurance Managing General Agents, Inc. ("Assurance MGA"). The Company internally processes claims made by Federated National's and third-party insureds through a wholly-owned claims adjusting company, Superior Adjusting, Inc. ("Superior"). The Company also offers premium financing to its own and third-party insureds through its wholly-owned subsidiary, Federated Premium Finance, Inc. ("Federated Premium"), and pay advances through Fed First Corp ("Fed First"). The Company markets and distributes Federated National's and third-party insurers' products and its other services primarily in South Florida, through a network of 37 Company-owned agencies and approximately 500 active independent agents. The Company, through its wholly-owned subsidiary, FedUSA, Inc. ("FedUSA"), franchises agencies under the FedUSA name. In December 2000, the Company sold its first franchised agency, which began operations on January 1, 2001. The Company intends to sell approximately 25 of its Company-owned agencies to individual employees/managers and convert them to franchised operations. The Company intends to focus its future expansion efforts on franchised agencies. The Company believes that it can be distinguished from its competitors because it generates revenue from substantially all aspects of the insurance underwriting, distribution and claims process. The Company provides quality service to both its agents and insureds by utilizing an integrated computer system, which links the Company's insurance and service entities. The Company's computer and software systems allow for automated premium quotation, policy issuance, billing and payment and claims processing and enables the Company to continuously monitor substantially all aspects of its business. Using these systems, the Company's agents can access a customer's driving record, quote a premium, offer premium financing and, if requested, generate a policy on-site. The Company believes that these systems have facilitated its ability to market and underwrite insurance products on a cost-efficient basis, and that they will enhance the Company's ability to expand to other regions in Florida and to other states. 2 3 The Company's primary product is nonstandard personal automobile insurance, which is principally provided to insureds who are unable to obtain preferred or standard insurance coverage because of their payment history, driving record, age, vehicle type or other factors, including market conditions for preferred or standard risks. Underwriting standards for preferred or standard insurance coverage have become more restrictive, thereby requiring more drivers to seek coverage in the nonstandard automobile insurance market. These factors have contributed to an increase in the size of the nonstandard personal automobile insurance market. Based on information provided by A.M. Best, a leading rating agency for the insurance industry, from 1994 to 1998, the nonstandard personal automobile insurance market in the United States grew from approximately $15.6 billion to approximately $23.3 billion in annual premium volume and from approximately 15.7% to approximately 19.2% of the total personal automobile insurance market. Also, according to A.M. Best, from 1994 to 1998, annual premium volume in the nonstandard personal automobile insurance market in Florida grew from approximately $1.8 billion to approximately $2.6 billion and from approximately 30.5% to approximately 34.8% of the total personal automobile insurance market in Florida. The Company's executive offices are located at 4161 N.W. 5th Street, Plantation, Florida and its telephone number is (954) 581-9993. RECENT DEVELOPMENTS In January 2000, the Company began writing homeowners insurance in the State of Florida through its Company owned agencies and independent agencies. To accelerate the program the Company purchased policies from the Florida Joint Underwriters' Association. In November 2000, the Company withdrew its application with the Office of Thrift Supervision to organize a federal savings bank in order to concentrate on its core insurance business. In March 2001, the Company repurchased 157,000 shares of its outstanding common stock for $392,500. In March 2001, the Company announced its intention to sell 25 of the Company-owned agencies to individual employees/managers and convert them to franchised operations. The sales of the agencies are expected to be completed in the first half of 2001. In March 2001, the Company entered into an agreement to purchase American Vehicle Insurance Company ("American Vehicle") for $500,000 in cash. In addition, the Company must contribute approximately $800,000 to the surplus of American Vehicle, in order for American Vehicle to meet the $2.75 million minimum surplus requirement of the State of Florida. American Vehicle is licensed to underwrite automobile insurance in Florida and Louisiana, but has not written any policies since June 1997. The Company intends to use American Vehicle to underwrite policies in Florida and other states that will be 100% reinsured. BUSINESS STRATEGY The Company's strategy is to seek continued growth of its business by capitalizing on the efficiencies of its vertical integration and by: o expanding its agency network primarily through the sale of FedUSA franchises; o employing the business practices developed and used in Florida to expand to other selected states; o using American Vehicle to expand the Company's products while taking minimal risk; o maintaining a commitment to provide quality service to its agents and insureds by emphasizing customer service; o encouraging agents to place a high volume of quality business with the Company by providing them with attractive commission structures tied to premium levels and loss ratios; and o identifying and reviewing opportunities to acquire additional insurers. 3 4 INSURANCE OPERATIONS UNDERWRITING GENERAL. The Company underwrites its nonstandard and standard personal automobile insurance, homeowners and mobile home property insurance and casualty insurance through Federated National. Federated National is licensed to conduct business only in Florida. The Company is currently in the process of applying to underwrite insurance in South Carolina. The following tables set forth the amount and percentages of Federated National's gross premiums written and premiums ceded to reinsurers and net premiums written by line of business for the periods indicated.
YEARS ENDED DECEMBER 31, --------------------------------------------------------- 2000 1999 ------------------------- -------------------- PREMIUM PERCENT PREMIUM PERCENT ------- ------- ------- ------- (DOLLARS IN THOUSANDS) Written: Nonstandard Automobile........................ $25,361 79.1% $16,779 87.1% Homeowners.................................... 4,604 14.3 - - Mobile Home................................... 2,109 6.6 2,495 12.9 ------- ----- ------- ----- Total Written................................ 32,074 100.0% 19,274 100.0% Ceded: Nonstandard Automobile........................ (7,625) 100.0% (5,058) 81.3% Homeowners.................................... - - - - Mobile Home................................... - - (1,164) 18.7 ------ ----- Total Ceded................................... (7,625) 100.0% (6,222) 100.0% Net: Nonstandard Automobile........................ 17,736 72.5% 11,721 89.8% Homeowners.................................... 4,604 18.8 - - Mobile Home................................... 2,109 8.7 1,331 10.2 ------- ----- ------- ----- Total Net....................................... $24,449 100.0% $13,052 100.0% ======= ===== ======= =====
NONSTANDARD AUTOMOBILE. Nonstandard personal automobile insurance is principally provided to insureds that are unable to obtain standard insurance coverage because of their payment history, driving record, age, vehicle type or other factors, including market conditions. Underwriting standards for preferred and standard coverage have become more restrictive, thereby requiring more insureds to seek nonstandard coverage and contributing to the increase in the size of the nonstandard automobile market. Nonstandard automobile insurance, however, generally involves the potential for increased loss exposure and higher claims experience. Loss exposure is limited because premiums usually are at higher rates than those charged for standard insurance coverage and because approximately 30% of the policies issued by Federated National provide the minimum coverage required of the policyholder by statute and provide no bodily injury coverage. Federated National currently underwrites nonstandard personal automobile insurance in Florida, where the minimum limits are $10,000 per individual, $20,000 per accident for bodily injury, $10,000 per accident for property damage and comprehensive and $50,000 for collision. The average annual premium on policies currently in force is approximately $600. Federated National underwrites this coverage on an annual and semi-annual basis. Due to the purchasing habits of nonstandard automobile insureds (for example, insureds seeking the least expensive insurance required of the policyholder by statute which satisfies the requirements of state laws to register a vehicle), policy renewal rates tend to be low compared to standard policies. Federated National's experience has been that a significant number of existing policyholders allow their policies to lapse and then reapply for insurance as new policyholders. Federated National's average policy renewal rate is 35 to 40%. The success of Federated National's nonstandard automobile insurance program, therefore, depends in part on its ability to replace non-renewing insureds with new policyholders through marketing efforts. 4 5 The Company markets Federated National's nonstandard personal automobile coverage primarily through its network of Company-owned agencies and independent agents. The Company also markets its insurance on a limited basis directly to insureds through its FedFirst direct advertising program. The Company emphasizes customer service to both its agents and insureds by utilizing an integrated computer system, which links all of the Company's insurance and service entities. The Company's computer and software systems allow for rapid automated premium quotation, policy issuance, billing and payment and claims processing and enables the Company to monitor substantially all aspects of its business. This system enables the Company's agents to rapidly access the customer's driving record, quote a premium and, if requested, generate the policy on-site. The Company is focusing its efforts on further penetrating the Florida nonstandard personal automobile insurance market. Ultimately, the Company intends to expand to other selected states. The Company will select states for expansion based on a number of criteria, including the size of the personal automobile insurance market, statewide loss results, competition and the regulatory climate. The Company's ability to expand into other states will be subject to the prior regulatory approval of each state. Certain states impose seasoning requirements upon licensee applicants, which, due to the Company's relatively limited operating history, may impose burdens on the Company's ability to obtain a license to conduct insurance business in those other states. There can be no assurance that the Company will be able to obtain the required licenses, and the failure to do so would limit the Company's ability to expand geographically. STANDARD AUTOMOBILE. Standard personal automobile insurance is principally provided to insureds that present an average risk profile in terms of payment history, driving record, vehicle type and other factors. As part of its expansion strategy, in August 1998, Federated National commenced underwriting standard personal automobile insurance. Limits on standard personal automobile insurance are generally significantly higher than those for nonstandard coverage, but typically provide for deductibles and other restrictive terms. Federated National is initially underwriting standard personal automobile insurance policies providing coverage no higher than $100,000 per individual, $300,000 per accident for bodily injury, $50,000 per accident for property damage and comprehensive and collision up to $50,000 per accident, with deductibles ranging from $200 to $1,000. The Company is marketing Federated National's standard personal automobile insurance through its network of Company-owned agencies and independent agents and directly to insureds through its FedFirst direct advertising program. MOBILE HOME. In 1997, Federated National commenced underwriting homeowners insurance for mobile homes, principally in Central and Northern Florida, where the Company believes that the risk of catastrophe loss from hurricanes is less than in other areas of the state. Homeowners' insurance generally protects an owner of real or personal property against covered causes of loss to that property. Homeowners' insurance for mobile homes generally involves the potential for above-average loss exposure. In the absence of major catastrophe losses, loss exposure is limited because premiums usually are at higher rates than those charged for non-mobile home property and casualty insurance. Additionally, Federated National's property lines typically provide maximum coverage in the amount of $75,000, with the average policy limit being approximately $31,000. In addition, the Company presently intends to limit its mobile home coverage to no more than 10% of its underwriting exposure. The average annual premium on policies currently in force is approximately $314 and the typical deductible is $500. As the Company-owned agencies are located primarily in South Florida, the Company markets Federated National's mobile home property and casualty insurance through independent agents in Central and Northern Florida. HOMEOWNERS. In January 2000, Federated National commenced underwriting homeowners' insurance principally in Central and Southern Florida. Homeowners' insurance generally protects an owner of real and personal property against covered causes of loss to that property. Limit on homeowners' insurance is generally significantly higher than those for mobile homes, but typically provide for deductibles and other restrictive terms. Federated National's property lines typically provide maximum coverage in the amount of $150,000, with the average policy limit being approximately $100,000. The average annual premium on policies currently in force is approximately $1,260 and the typical deductible is $1,000. The Company markets Federated National's homeowners' insurance through its network of Company-owned agencies and independent agents and directly to insureds through its FedFirst direct advertising program. 5 6 FUTURE PRODUCTS. The Company intends to expand its product offerings by underwriting additional insurance products and programs and marketing them through its distribution network. During 2001, the Company intends to expand its product line to include general liability and flood insurance. Expansion of the Company's product offerings will result in a slight increase in expenses due to additional costs incurred in additional actuarial rate justifications, software and personnel. Future products may require regulatory approval. Additionally, the Company intends use American Vehicle to act as a front company for the sale of automobile insurance in several states including Florida. ASSURANCE MGA Assurance MGA acts as Federated National's exclusive managing general agent. Assurance MGA currently provides all underwriting policy administration, marketing, accounting and financial services to Federated National and the Company's agencies and participates in the negotiation of reinsurance contracts. Assurance MGA has established a relationship with and has underwriting authority for Lloyds of London for insurance products and State National Specialty Insurance Company ("State National") for automobile insurance. Assurance MGA also generates revenue through policy fee income and other administrative fees from the marketing of these companies' products through the Company's distribution network. Assurance MGA plans to establish relationships with additional carriers and add additional insurance products. SUPERIOR The Company internally processes claims made by Federated National's insureds through Superior. The Company-owned agencies and independent agents have no authority to settle claims or otherwise exercise control over the claims process. Management believes that the employment of salaried claims personnel, as opposed to independent adjusters, results in reduced ultimate loss payments, lower LAE and improved customer service. The Company only retains independent appraisers and adjusters on an as needed basis. Additionally, Superior currently handles claims for State National and American Vehicle. Claims settlement authority levels are established for each adjuster or manager based on the employee's ability and level of experience. Upon receipt, each claim is reviewed and assigned to an adjuster based on the type and severity of the claim. In 2000, the Company hired in-house counsel to monitor claims-related litigation and to advise staff of changes in law. The claims policy of the Company emphasizes prompt and fair settlement of meritorious claims and the establishment of appropriate liability for claims. The Company believes that the internal processing of claims enables it to provide quality customer service while controlling claims adjustment expenses. FEDERATED PREMIUM Federated Premium provides premium financing to both Federated National's insureds and to third-party insureds. Premium financing is marketed through the Company's distribution network of Company-owned agencies and independent agents. Lending operations are supported by Federated Premium's own capital base and are currently leveraged through the Company's credit facility with Flatiron Funding Company LLC. Premiums for property and casualty insurance are typically payable at the time a policy is placed in force or renewed. Federated Premium's services allow the insured to pay a portion of the premium when the policy is placed in force and the balance in monthly installments over the life of the policy. As security, Federated Premium retains a contractual right, if a premium installment is not paid when due, to cancel the insurance policy and to receive the unearned premium from the insurer, or in the event of insolvency of an insurer, from the Florida Guarantee Association, subject to a $100 per policy deductible. In the event of cancellation, Federated Premium applies the unearned premium towards the payment obligation of the insured. As part of its premium financing offered to third-party insureds, Federated Premium may advance funds for financed premiums to independent insurance agencies that represent third-party insurers. If remittance is not made by the agency to the third-party insurer, advances made by Federated Premium may only be recoverable to the extent that the agency's receipt of such advances is received by the third-party insurer. Premium financing which the Company offers to its own insureds involves limited credit risk. 6 7 The following table sets forth the amount and percentages of premiums financed for Federated National and other insurers for the periods indicated:
YEARS ENDED DECEMBER 31, --------------------------------------------------- 2000 1999 --------------------- ---------------------- PREMIUMS PERCENT PREMIUMS PERCENT -------- ------- -------- ------- (DOLLARS IN THOUSANDS) Federated National......................... $17,006 38.4% $12,338 46.8% Other insurers............................. 27,293 61.6 14,035 53.2 ------- ----- ------- ----- Total................................... $44,299 100.0% $26,373 100.0% ======= ===== ======= =====
CONSUMER LOANS AND PAYDAY ADVANCES In August 1999, the Company began to offer payday advances, in which the Company advances up to $1,000 to a customer for a maximum of ten days. The Company charges the customer 9% of the amount advanced plus a fee of $5 per advance. In April 2000, the Company discontinued its consumer loan program and is allowing the balance of the loans to pay off. TAX PREPARATION SERVICES AND ANCILLARY SERVICES The Company also offers other services at its agencies including tax return preparation and electronic filing and the issuance and renewal of license tags. In August 1999, the Company acquired an 80% interest in Express Tax Service. Express Tax Service licenses tax return preparation software to over 300 agencies throughout the United States and also earns fees on all electronically filed returns. Express Tax Service previously licensed its software to the Company's agencies and will continue to do so in the future. FRANCHISE OPERATIONS In April 2000, the Company formed a wholly-owned subsidiary, FedUSA, for the purpose of franchising insurance and financial service agencies as well as tax preparation centers. FedUSA commenced the offering of franchises in December 2000. FedUSA sold its first franchised insurance agency during December 2000, to begin operations in January 2001. During the first half of 2001, the Company intends to convert up to 25 of its Company-owned agencies to franchises which will be owned by employees/managers. The franchise agreement for each FedUSA franchise grants the franchisee a license for the operation of a FedUSA insurance agency within an exclusive territory to open and operate a center for a seven year period, with two additional seven year options. FedUSA collects a non-refundable initial franchise fee of $14,950, royalty fees, advertising fees, and other fees, pursuant to its Uniform Franchise Offering Circular ("UFOC"). Express Tax is a FedUSA franchise for the tax return preparation and related financial services products business. The franchise agreement grants the franchisee a non-exclusive license to open and operate a center for a seven year period, with two additional seven year options. FedUSA collects a non-refundable initial franchise fee of $7,500, royalty fees, advertising fees, and other fees, as defined in the UFOC. Currently, the initial franchise fee for an Express Tax franchise may be waived if a franchisee acquires both a FedUSA and an Express Tax franchise at the same time. MARKETING AND DISTRIBUTION The Company markets and distributes Federated National's and third-party insurers' products and its other services primarily in South Florida, through a network of 37 Company-owned agencies, one franchised agency and approximately 500 active independent agents. The Company's agencies are located in Miami-Dade, Broward, Palm Beach, Martin, Orange and Polk Counties, Florida, and its network of independent agents are located primarily in South Florida. The Company intends to convert up to 25 of its Company-owned agencies to franchises which will be owned by employees/managers. The Company supports its agency network by advertising in various media. 7 8 Company-employed, franchise-employed and independent agents have the authority to sell and bind insurance coverages in accordance with procedures established by Assurance MGA. Assurance MGA reviews all coverages bound by the agents promptly and generally accepts all coverages, which fall within stated underwriting criteria. Assurance MGA also has the right, within a period of 60 days from a policy's inception, to cancel any policy upon 45 days' notice, even if the risk falls within its underwriting criteria. The Company believes that its integrated computer system, which allows for rapid automated premium quotation and policy issuance by its agents, is a key element in providing quality service to both its agents and insureds. For example, upon entering a customer's basic personal information, the customer's driving record is accessed and a premium rate is quoted. If the customer chooses to purchase the insurance, the system generates the policy on-site. The Company believes that its distribution system will ultimately enable it to lower its expense ratio and operate with more favorable loss experience. A lower expense ratio will, in turn, allow the Company to more effectively compete with larger providers of nonstandard automobile and other forms of insurance. The following table sets forth the amount and percentages of insurance premiums written through Company-owned agencies and independent agents for the periods indicated: YEARS ENDED DECEMBER 31, ---------------------------------------------------------- 2000 1999 ----------------------- ---------------------- PREMIUMS PERCENT PREMIUMS PERCENT -------- ------- -------- ------- (DOLLARS IN THOUSANDS) Through Company-owned agencies......................... $12,990 40.5% $7,929 41.1% Through independent agents............................. 19,084 59.5 11,345 58.9 ------ ---- ------ ---- Total............................................... $32,074 100.0% $19,274 100.0% ======= ====== ======= ======
The Company plans to continue to expand its distribution network and market its products and services in other regions of Florida and other states by franchising additional insurance agencies and establishing relationships with additional independent agents. As the Company expands its insurance operations to other states, the Company will seek to replicate its distribution network in those states. There can be no assurance that the Company will be able to obtain the required regulatory approvals to offer additional insurance products or expand into states other than Florida. REINSURANCE Federated National follows industry practice of reinsuring a portion of its risks and paying for that protection based upon premiums received on all policies subject to such reinsurance. Reinsurance involves an insurance company transferring or "ceding" all or a portion of its exposure on insurance underwritten by it to another insurer, known as a "reinsurer." The reinsurer assumes a portion of the exposure in return for a portion, or quota share, of the premium, and pays the ceding company a commission based upon the amount of insurance ceded. The ceding of insurance does not legally discharge the insurer from its primary liability for the full amount of the policies. If the reinsurer fails to meet its obligations under the reinsurance agreement, the ceding company is still required to pay the loss. Reinsurance is ceded under separate contracts or "treaties" for the separate lines of business underwritten. The Company ceded $8.0 million in premiums written for the year ended December 31, 2000. Federated National's reinsurance for automobile insurance is primarily ceded with Transatlantic Re, an A++ rated reinsurance company. Federated National ceded 30% of automobile premiums written in 2000 to Transatlantic Re and increased that percentage to 50% effective January 1, 2001. The reinsurance program renews annually, although the Company continually reviews the program and may elect to change it more frequently. Reinsurance is placed directly by the Company and through national reinsurance intermediaries. 8 9 The Company is selective in choosing a reinsurer and considers numerous factors, the most important of which is the financial stability of the reinsurer, its history of responding to claims and its overall reputation. In an effort to minimize its exposure to the insolvency of a reinsurer, the Company evaluates the acceptability and reviews the financial condition of the reinsurer at least annually. The Company's current policy is to use only reinsurers that have an A.M. Best rating of "A (Excellent)" or better. In order to minimize the effect of a natural disaster, the Company purchases catastrophic reinsurance from both the state run Florida Hurricane Catastrophe fund and private re-insurers. LIABILITY FOR UNPAID LOSSES AND LAE The Company is directly liable for loss and loss adjustment expenses ("LAE") payments under the terms of the insurance policies that it writes. In many cases, several years may elapse between the occurrence and reporting of an insured loss, the reporting of the loss to the Company and the Company's payment of that loss. As required by insurance regulations and accounting rules, the Company reflects its liability for the ultimate payment of all incurred losses and LAE by establishing a liability for those unpaid losses and LAE for both reported and unreported claims, which represent estimates of future amounts needed to pay claims and related expenses. When a claim involving a probable loss is reported, the Company establishes a liability for the estimated amount of the Company's ultimate loss and LAE payments. The estimate of the amount of the ultimate loss is based upon such factors as the type of loss, jurisdiction of the occurrence, knowledge of the circumstances surrounding the claim, severity of injury or damage, potential for ultimate exposure, estimate of liability on the part of the insured, past experience with similar claims and the applicable policy provisions. All newly reported claims received with respect to nonstandard personal automobile policies are set up with an initial average liability. The average liability for these claims are determined every quarter by dividing the number of closed claims into the total amount paid during the three-month period. If a claim is open more than 30 days, that open case liability is evaluated and the liability is adjusted upward or downward according to the facts and damages of that particular claim. In addition, management provides for a liability on an aggregate basis to provide for losses incurred but not reported ("IBNR"). The Company utilizes independent actuaries to help establish its liability for unpaid losses and LAE. The Company does not discount the liability for unpaid losses and LAE for financial statement purposes. The estimates of the liability for unpaid losses and LAE are subject to the effect of trends in claims severity and frequency and are continually reviewed. As part of this process, the Company reviews historical data and considers various factors, including known and anticipated legal developments, changes in social attitudes, inflation and economic conditions. As experience develops and other data become available, these estimates are revised, as required, resulting in increases or decreases to the existing liability for unpaid losses and LAE. Adjustments are reflected in results of operations in the period in which they are made and the liabilities may deviate substantially from prior estimates. Among the classes of insurance underwritten by the Company, the automobile and homeowners liability claims historically tend to have longer time lapses between the occurrence of the event, the reporting of the claim to the Company and the final settlement than do automobile physical damage and homeowners property claims. Liability claims often involve parties filing suit and therefore may result in litigation. By comparison, property damage claims tend to be reported in a relatively shorter period of time and settle in a shorter time frame with less occurrence of litigation. There can be no assurance that the Company's liability for unpaid losses and LAE will be adequate to cover actual losses. If the Company's liability for unpaid losses and LAE proves to be inadequate, the Company will be required to increase the liability with a corresponding reduction in the Company's net income in the period in which the deficiency is identified. Future loss experience substantially in excess of established liability for unpaid losses and LAE could have a material adverse effect on the Company's business, results of operations and financial condition. 9 10 The following table sets forth a reconciliation of beginning and ending liability for unpaid losses and LAE as shown in the Company's consolidated financial statements for the periods indicated.
YEARS ENDED DECEMBER 31, --------------------- 2000 1999 ------ ------ (DOLLARS IN THOUSANDS) Balance at January 1 $ 6,314 $7,603 Less reinsurance recoverables...................................... (1,886) (2,237) ------- ------ Net balance at January 1.......................................... $ 4,428 $5,366 ======= ====== Incurred related to: Current year....................................................... $13,545 $8,764 Prior years........................................................ 1,445 (670) ------- ------ Total incurred.................................................... $14,990 $8,094 ======= ====== Paid related to: Current year....................................................... $ 8,013 $5,552 Prior years........................................................ 4,429 3,480 ------- ------ Total paid........................................................ $12,442 $9,032 ======= ====== Net balance at end of period......................................... $ 6,976 $4,428 Plus reinsurance recoverables...................................... 2,790 1,886 ------- ------ Balance at end of period.......................................... $9,766 $6,314 ======= ======
As shown above, as a result of the Company's review of its liability for losses and LAE, which includes a re-evaluation of the adequacy of reserve levels for prior year's claims, the Company increased its liability for loss and LAE for claims occurring in prior years by $1,445,000 for the year ended December 31, 2000 and reduced its liability for loss and LAE for claims occurring in prior years by $670,000 in 1999. There can be no assurance concerning future adjustments of reserves, positive or negative, for claims through December 31, 2000. The non standard automobile program experienced an increase in the Loss Ratio, caused mainly by a 10% price reduction in December 1999, which occurred at the same time larger competitors were increasing prices. Consequently, the Company's written policies increased significantly and the quality of the business declined. Since December 1999, the Company has increased prices three times in an effort to improve its Loss Ratio. Based upon consultations with the Company's independent actuarial consultants and their statement of opinion on losses and LAE, the Company believes that the liability for unpaid losses and LAE is adequate to cover all claims and related expenses which may arise from incidents reported and IBNR. The following table presents total unpaid loss and LAE, net and total reinsurance recoverables shown in the Company's consolidated financial statements for the periods indicated.
YEARS ENDED DECEMBER 31, ------------------------ 2000 1999 ------ ------ (DOLLARS IN THOUSANDS) Loss and LAE, net.......................................... $4,662 $3,124 IBNR, net.................................................. 2,314 1,304 ----- ----- Total unpaid loss and LAE, net.......................... $6,976 $4,428 ====== ====== Reinsurance recoverable.................................... $1,861 $1,319 IBNR recoverable........................................... 929 567 ------ ------ Total reinsurance recoverable........................... $2,790 $1,886 ====== ======
10 11 The following table presents the liability for unpaid losses and LAE for the Company for the years ended December 31, 1992 through 2000. The top line of the table shows the estimated net liabilities for unpaid losses and LAE at the balance sheet date for each of the periods indicated. These figures represent the estimated amount of unpaid losses and LAE for claims arising in all prior years that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported. The portion of the table labeled "Cumulative paid as of" shows the net cumulative payments for losses and LAE made in succeeding years for losses incurred prior to the balance sheet date. The lower portion of the table shows the re-estimated amount of the previously recorded liability based on experience as of the end of each succeeding year.
YEARS ENDED DECEMBER 31, (1) ---------------------------------------------------------- 2000 1999 1998 1997 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- ---- ---- ---- ---- (DOLLARS IN THOUSANDS) Balance Sheet Liability $6,976 $4,428 $5,366 $4,635 $4,532 $3,688 $3,355 $2,507 $611 Cumulative paid as of: One year later........................ 3,250 3,480 2,690 2,852 2,638 2,449 1,964 499 Two years later....................... 4,080 3,531 3,539 2,658 2,792 2,426 554 Three years later..................... 3,745 3,884 2,924 3,018 2,449 585 Four years later...................... 4,005 3,061 3,114 2,529 580 Five years later ..................... 3,100 3,172 2,560 583 Six years later....................... 3,179 2,601 583 Seven years later..................... 2,659 583 Eight years later..................... 583 Re-estimated net liability as of: End of year........................... $6,976 $4,428 $5,366 $4,635 $4,532 $3,688 $3,355 $2,507 $611 One year later........................ 5,824 4,696 4,364 4,334 3,750 3,570 2,566 628 Two years later....................... 4,911 4,003 4,204 3,252 3,231 2,780 586 Three years later..................... 4,053 4,048 3,255 3,305 2,596 593 Four years later...................... 4,086 3,129 3,289 2,619 580 Five years later...................... 3,167 3,207 2,638 583 Six years later....................... 3,245 2,628 583 Seven years later..................... 2,697 583 Eight years later..................... 586 Cumulative redundancy (deficiency)...... - $(1,396) $455 $582 $446 $521 $110 $(190) $25
(1) To evaluate the information in the table properly it should be noted that, although the Company recorded its participation in the Florida Joint Underwriting Association ("FJUA"), an assigned risk pool for automobile insurance drivers, from 1992 until 1995 in its 1996 statutory financial statements, this table properly reflects the Company's participation in the FJUA in the corresponding years. The cumulative redundancy or deficiency represents the aggregate change in the estimates over all prior years. A deficiency indicates that the latest estimate of the liability for losses and LAE is higher than the liability that was originally estimated and a redundancy indicates that such estimate is lower. It should be emphasized that the table presents a run-off of balance sheet liability for the periods indicated rather than accident or policy loss development for those periods. Therefore, each amount in the table includes the cumulative effects of changes in liability for all prior periods. Conditions and trends that have affected liabilities in the past may not necessarily occur in the future. Underwriting results of insurance companies are frequently measured by their Combined Ratios. However, investment income, Federal income taxes and other non-underwriting income or expense are not reflected in the Combined Ratio. The profitability of property and casualty insurance companies depends on income from underwriting, investment and service operations. Underwriting results are considered profitable when the Combined Ratio is under 100% and unprofitable when the Combined Ratio is over 100%. 11 12 The following table sets forth Loss Ratios, Expense Ratios and Combined Ratios for the periods indicated for the insurance business of Federated National. The ratios, inclusive of unallocated loss adjustment expenses ("ULAE"), are shown in the table below, and are computed based upon SAP. The expense ratios include management fees paid to the Company in the amount of $300,000 and $1.0 million in 2000 and 1999, respectively.
YEARS ENDED DECEMBER 31, ------------------------ 2000 1999 ---- ---- Loss Ratio........................... 80% 67% Expense Ratio........................ 31 38 --- --- Combined Ratio....................... 111% 105% === ====
INVESTMENTS The Company's investment objective is to maximize total rate of return after Federal income taxes while maintaining liquidity and minimizing risk. The Company's current investment policy limits investment in non-investment grade fixed maturity securities (including high-yield bonds), and limits total investments in equity securities and mortgage notes receivable to approximately 17% and 10%, respectively, of total consolidated investments. The Company also complies with applicable laws and regulations, which further restrict the type, quality and concentration of investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in Federal, state and municipal obligations, corporate bonds, preferred and common equity securities and real estate mortgages. The Company's investment policy is established by its Board of Directors and is reviewed on a regular basis. Pursuant to this investment policy, as of December 31, 2000, approximately 82.7% of the Company's investments were in fixed income securities and short-term investments, which are considered to be available for sale, based upon the Company's intent at the time of purchase. Fixed maturities are considered available for sale and are marked to market. The Company may in the future also consider fixed maturities to be held to maturity and carried at amortized cost. The Company does not use any material swaps, options, futures or forward contracts to hedge or enhance its investment portfolio. The Company's investment portfolio is managed by the Company's Investment Committee consisting of the Company's President, the President of Federated National and one outside advisor, in accordance with guidelines established by the Florida Department of Insurance. The table below sets forth investment results for the periods indicated.
YEARS ENDED DECEMBER 31, ------------------------- 2000 1999 ------- ------ (DOLLARS IN THOUSANDS) Interest on fixed maturities............................... $552 $777 Dividends on equity securities............................. 44 72 Interest on short-term investments......................... 647 23 Other...................................................... 10 5 ------ ---- Total investment income.................................... 1,253 877 Investment expense......................................... (28) (23) ------ ---- Net investment income...................................... $1,225 $854 ====== ==== Net realized gain (loss)................................... $ (109) $952 ====== ====
12 13 The following table summarizes, by type, the investments of the Company as of December 31, 2000.
CARRYING PERCENT AMOUNT OF TOTAL -------- -------- (DOLLARS IN THOUSANDS) Fixed maturities, at market: U.S. government agencies and authorities $3,305 17.5% Obligations of states and political subdivisions 10,403 54.9 Corporate securities 1,773 9.3 Collateralized mortgage obligations 210 1.1 ------ ---- Total fixed maturities 15,691 82.8 ------ ---- Equity securities, at market 2,890 15.2 Mortgage notes receivable 385 2.0 ------ ---- Total investments $18,966 100% ======= ====
Fixed maturities are carried on the Company's balance sheet at market. At December 31, 2000, fixed maturities had the following quality ratings (by Moody's Investors Service, Inc. ("Moody's") and for securities not assigned a rating by Moody's, by Standard and Poor's Corporation):
CARRYING PERCENT OF AMOUNT TOTAL ------ ----- (DOLLARS IN THOUSANDS) AAA................... $4,814 30.7 % AA.................... 2,460 15.7 A..................... 2,603 16.6 BBB................... 1,945 12.4 BB++.................. 355 2.2 Not rated............. 3,514 22.4 ------- ----- $15,691 100.0 % ======= ========
The following table summarizes, by maturity, the fixed maturities of the Company as of December 31, 2000.
CARRYING PERCENT OF AMOUNT TOTAL ------ ---------- (DOLLARS IN THOUSANDS) Matures In: One year or less..................................... $0 0% One year to five years............................... 2,799 17.8 Five years to 10 years............................... 3,818 24.3 More than 10 years................................... 9,074 57.9 ------- ----- Total fixed maturities........................... $15,691 100.0% ======= =====
At December 31, 2000, the average maturity of the fixed maturities portfolio was approximately 15 years. 13 14 COMPETITION The Company operates in a highly competitive market and faces competition from both national and regional insurance companies, many of whom are larger and have greater financial and other resources than the Company, have favorable A.M. Best ratings and offer more diversified insurance coverage. The Company's competitors include other companies, which market their products through agents, as well as companies, which sell insurance directly to their customers. Large national writers may have certain competitive advantages over agency writers, including increased name recognition, increased loyalty of their customer base and reduced policy acquisition costs. The Company may also face competition from new or temporary entrants in its niche markets. In some cases, such entrants may, because of inexperience, desire for new business or other reasons, price their insurance below the pricing structure of the Company. Although the Company's pricing is inevitably influenced to some degree by that of its competitors, management of the Company believes that it is generally not in the Company's best interest to compete solely on price, choosing instead to compete on the basis of underwriting criteria, its distribution network and superior service to its agents and insureds. The Company competes with respect to automobile insurance in Florida with more than 100 companies, which underwrite personal automobile insurance. Companies of comparable or smaller size, which compete with the Company in the nonstandard automobile insurance industry, include Fortune Insurance Company, U.S. Security Insurance Company, United Automobile Insurance Company, Direct General Insurance Company and Security National, as well as major insurers such as Progressive Casualty Insurance Company. Competition could have a material adverse effect on the Company's business, results of operations and financial condition. REGULATION GENERAL The Company is subject to the laws and regulations in Florida and will be subject to the laws and regulations of any other states in which it seeks to conduct business in the future. The regulations cover all aspects of its business and are generally designed to protect the interests of insurance policyholders, as opposed to the interests of shareholders. Such regulations relate to authorized lines of business, capital and surplus requirements, allowable rates and forms (particularly for the nonstandard auto segment), investment parameters, underwriting limitations, transactions with affiliates, dividend limitations, changes in control, market conduct, maximum amount allowable for premium financing service charges and a variety of other financial and non-financial components of the Company's business. The failure of the Company to comply with certain provisions of applicable insurance laws and regulations could have a material adverse effect on the Company's business, results of operations or financial condition. In addition, any changes in such laws and regulations including the adoption of consumer initiatives regarding rates charged for automobile or other insurance coverage, could materially adversely affect the operations of the Company's, ability to expand its operations. The Company, however, is unaware of any consumer initiatives, which could have a material adverse effect on the Company's business, results of operations or financial condition. The State of Florida has recently adopted laws regarding personal injury protection. The Company believes that these recently adopted laws will not have a material adverse effect on the Company's business, results of operations or financial condition. Many states have also enacted laws which restrict an insurer's underwriting discretion, such as the ability to terminate policies, terminate agents or reject insurance coverage applications, and many state regulators have the power to reduce, or to disallow increases in, premium rates. These laws may adversely affect the ability of an insurer to earn a profit on its underwriting operations. 14 15 Most states have insurance laws requiring that rate schedules and other information be filed with the state's insurance regulatory authority, either directly or through a rating organization with which the insurer is affiliated. The regulatory authority may disapprove a rate filing if it finds that the rates are inadequate, excessive or unfairly discriminatory. Rates, which are not necessarily uniform for all insurers, vary by class of business, hazard covered, and size of risk. The Company is permitted to file rates for nonstandard policies which are usually higher than those charged for standard risks, reflecting the higher probability of loss. Florida and several other states have recently adopted laws or are considering proposed legislation which, among other things, limit the ability of insurance companies to effect rate increases or to cancel, reduce or non-renew insurance coverage with respect to existing policies, particularly private passenger automobile insurance. Most states require licensure or regulatory approval prior to the marketing of new insurance products. Typically, licensure review is comprehensive and includes a review of a company's business plan, solvency, reinsurance, character of its officers and directors, rates, forms and other financial and non-financial aspects of a company. The regulatory authorities may not allow entry into a new market by not granting a license or by withholding approval. All insurance companies must file quarterly and annual statements with certain regulatory agencies and are subject to regular and special examinations by those agencies. The last regulatory examination of Federated National covered the three-year period ended on December 31, 1998. No material deficiencies were found during this regulatory examination. In some instances, various states routinely require deposits of assets for the protection of policy holders either in those states or for all policyholders. As of December 31, 2000, investment securities with a carrying value of approximately $535,000 were on deposit with the State of Florida. Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its shareholders except out of that part of its available and accumulated capital surplus funds which is derived from realized net operating profits on its business and net realized capital gains. A Florida domestic insurer may not make dividend payments or distributions to shareholders without prior approval of the Florida Department of Insurance if the dividend or distribution would exceed the larger of (i) the lesser of (a) 10.0% of its capital surplus or (b) net income, not including realized capital gains, plus a two-year carryforward, (ii) 10.0% of capital surplus with dividends payable constrained to unassigned funds minus 25.0% of unrealized capital gains or (iii) the lesser of (a) 10.0% of capital surplus or (b) net investment income plus a three-year carryforward with dividends payable constrained to unassigned funds minus 25.0% of unrealized capital gains. Alternatively, a Florida domestic insurer may pay a dividend or distribution without the prior written approval of the Florida Department of Insurance (i) if the dividend is equal to or less than the greater of (a) 10.0% of the insurer's capital surplus as regards policyholders derived from realized net operating profits on its business and net realized capital gains or (b) the insurer's entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, (ii) the insurer will have policy holder capital surplus equal to or exceeding 115.0% of the minimum required statutory capital surplus after the dividend or distribution, (iii) the insurer files a notice of the dividend or distribution with the department at least ten business days prior to the dividend payment or distribution and (iv) the notice includes a certification by an officer of the insurer attesting that, after the payment of the dividend or distribution, the insurer will have at least 115.0% of required statutory capital surplus as to policyholders. Except as provided above, a Florida domiciled insurer may only pay a dividend or make a distribution (i) subject to prior approval by the Florida Department of Insurance or (ii) 30 days after the Florida Department of Insurance has received notice of such dividend or distribution and has not disapproved it within such time. Under these laws, Federated National is permitted to pay dividends of approximately $619,000 to the Company in 2001 without prior regulatory approval. Although the Company believes that amounts required for it to meet its financial and operating obligations will be available, there can be no assurance in this regard. Further, there can be no assurance that, if requested, the Florida Department of Insurance will allow any dividends in excess of the amount to be paid by Federated National to the Company in the future. No dividends were paid by Federated National in 2000 or 1999. The maximum dividends permitted by state law are not necessarily indicative of an insurer's actual ability to pay dividends or other distributions to a parent company, which also may be constrained by business and regulatory considerations, such as the impact of dividends on capital surplus, which could affect an insurer's competitive position, the amount of premiums that can be written and the ability to pay future dividends. Further, state insurance laws and regulations require that the statutory capital surplus of an insurance company following any dividend or distribution by it be reasonable in relation to its outstanding liabilities and adequate for its financial needs. 15 16 While the non-insurance company subsidiaries are not subject directly to the dividend and other distribution limitations, insurance holding company regulations govern the amount, which any affiliate within the holding company system may charge any of the insurance companies for service (e.g., management fees and commissions). In order to enhance the regulation of insurer solvency, the NAIC enacted a model law (the "Model Law") to implement its risk-based capital requirements for insurance companies. The Model Law became effective with respect to property and casualty insurance companies as of December 31, 1994. The requirements are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policy holders. The Model Law measures three major areas of risk facing property and casualty insurers: (i) underwriting risks, which encompass the risk of adverse loss developments and inadequate pricing; (ii) declines in asset values arising from credit risk; and (iii) other business risks from investments. Insurers having less statutory surplus than required by the Model Law will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The Model Law establishes various levels of regulatory action. Based upon the 2000 statutory financial statements for Federated National, the Company's insurance subsidiary, Federated National's statutory surplus exceeds all regulatory action levels established by the NAIC. The Florida Department of Insurance could require Federated National to cease operations in the event Federated National fails to maintain the required statutory capital. The extent of regulatory intervention and action increases as the ratio of an insurer's statutory surplus to its Authorized Control Level ("ACL"), as calculated under the Model Law, decreases. The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200.0% of the ACL amount. The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150.0% of the ACL amount. The Authorized Control Level, the third action level, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70.0% of the ACL amount. Federated National's ratio of statutory surplus to its ACL, as calculated under the Model Law, was 273.2% at December 31, 2000 and 370.9% at December 31, 1999. Regulatory action is triggered if surplus falls below 200.0% of the ACL amount. The NAIC has also developed Insurance Regulatory Information Systems ("IRIS") ratios to assist state insurance departments in identifying companies, which may be developing performance or solvency problems, as signaled by significant changes in the companies' operations. Such changes may not necessarily result from any problems with an insurance company, but may merely indicate changes in certain ratios outside the ranges defined as normal by the NAIC. When an insurance company has four or more ratios falling outside "usual ranges," state regulators may investigate to determine the reasons for the variance and whether corrective action is warranted. As of December 31, 2000, Federated National was within all NAIC usual ranges with respect to its IRIS tests except for two tests as follows: The percentage of net written premiums to surplus was 402.6% compared to a "normal" value of 300% or less, and the percentage change in net premiums written was 90.9% compared of a "normal" value of +/- 33%. The Company is required to comply with NAIC risk-based capital ("RBC") requirements. RBC is a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC's RBC standards are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2000, based on calculations using the appropriate NAIC formula, the Company's total adjusted capital is in excess of ratios, which would require any form of regulatory action. Effective January 1. 2001, the Company adopted the Codification of Statutory Accounting Principles guidance ("the Codification") issued by the NAIC. The Codification provides guidance for areas where statutory accounting has been silent and changes current accounting in some areas. The adoption of the Codification is not expected to have a material effect on the Company's consolidated financial statements. 16 17 INSURANCE HOLDING COMPANY REGULATION The Company is subject to laws governing insurance holding companies in Florida where Federated National is domiciled. These laws, among other things, (i) require the Company to file periodic information with the Florida Department of Insurance, including information concerning its capital structure, ownership, financial condition and general business operations, (ii) regulate certain transactions between the Company and its affiliates, including the amount of dividends and other distributions and the terms of surplus notes and (iii) restrict the ability of any one person to acquire certain levels of the Company's voting securities without prior regulatory approval. Any purchaser of 5% or more of the outstanding shares of Common Stock of the Company will be presumed to have acquired control of Federated National unless the Florida Insurance Commissioner, upon application, has determined otherwise. FINANCE COMPANY REGULATION The Company's premium financing program is also subject to certain laws governing the operation of premium finance companies. These laws pertain to such matters as books and records that must be kept, forms, licensing, fees and charges. For example, in Florida, the maximum late payment fee Federated Premium may charge is the greater of $10 per month or 5% of the amount of the overdue payment. FRANCHISE COMPANY REGULATION FedUSA is subject to Federal Trade Commission ("FTC") regulation, and state and international laws which regulate the offer and sale of franchises. FedUSA is also subject to a number of state laws which regulate substantive aspects of the franchisor-franchisee relationship. The FTC's Trade Regulation Rule on Franchising (the "FTC Rule") requires FedUSA to furnish to prospective franchisees a franchise offering circular containing information prescribed by the FTC Rule. State laws that regulate the offer and sale of franchises and the franchisor-franchisee relationship presently exist in a substantial number of states. Such laws often require registration of the franchise offering with state authorities and regulate the franchise relationship by, for example, requiring the franchisor to deal with its franchisees in good faith, prohibiting interference with the right of free association among franchisees, limiting the imposition of standards of performance on a franchisee and regulating discrimination among franchisees in charges, royalties or fees. UNDERWRITING AND MARKETING RESTRICTIONS During the past several years, various regulatory and legislative bodies have adopted or proposed new laws or regulations to address the cyclical nature of the insurance industry, catastrophic events and insurance capacity and pricing. These regulations include (i) the creation of "market assistance plans" under which insurers are induced to provide certain coverages, (ii) restrictions on the ability of insurers to rescind or otherwise cancel certain policies in mid-term, (iii) advance notice requirements or limitations imposed for certain policy non-renewals and (iv) limitations upon or decreases in rates permitted to be charged. LEGISLATION From time to time, new regulations and legislation are proposed to limit damage awards, to control plaintiffs' counsel fees, to bring the industry under regulation by the Federal government, to control premiums, policy terminations and other policy terms and to impose new taxes and assessments. It is not possible to predict whether, in what form or in what jurisdictions, any of these proposals might be adopted, or the effect, if any, on the Company. INDUSTRY RATINGS SERVICES Federated National received a B rating from A.M. Best during 2000. A.M. Best's ratings are based upon factors of concern to agents, reinsurers and policyholders and are not primarily directed toward the protection of investors. Federated National is rated "BBB" (Adequate and Secure) by Standard and Poor's Corporation and is rated "A" (Strong) by Demotech, Inc. 17 18 EXECUTIVE OFFICERS Set forth below is certain information concerning the executive officers of the Company that are not also directors of the Company: RICHARD A. WIDDICOMBE assumed the office of President of Federated National and Assurance MGA in November 1999. Mr. Widdicombe has over 20 years of insurance experience. During the past 15 years he has worked for Insurance Servicing and Adjusting Company and its sister company, Jardine MacNeil as Vice President. He holds his adjuster's license and CPCU designation. He is a member of the Florida Department of Insurance Initial Disaster Assessment team. SAMUEL A. MILNE has served as the Company's Chief Financial Officer since July 1999. Prior thereto, Mr. Milne was an employee of Premier Administrative Services, Inc., a financial consulting company from July 1998 to July 1999. From May 1995 to April 1998, Mr. Milne was Senior Vice President and Chief Financial Officer for BankUnited Financial Corporation. From April 1992 to May 1995, Mr. Milne was Senior Vice President and Chief Financial Officer for Consolidated Bank, N.A. From August 1984 to September 1991, Mr. Milne served in a number of executive positions at Southeast Bank, N.A., most recently serving as Senior Vice President-Finance. Prior thereto, Mr. Milne was a Senior Manager with Arthur Andersen LLP, the international public accounting firm. EMPLOYEES As of December 31, 2000, the Company and its subsidiaries had 296 employees, including four executive officers. The Company is not a party to any collective bargaining agreement and has not experienced work stoppages or strikes as a result of labor disputes. The Company considers relations with its employees to be satisfactory. 18 19 GLOSSARY OF SELECTED TERMS CEDE To transfer to an insurer or reinsurer all or part of the insurance written by an insurance entity. CEDING A payment by a reinsurer to the ceding company, generally on a COMMISSION proportional basis, to compensate the ceding company for its policy acquisition costs. COMBINED The total of the Loss Ratio plus the Expense Ratio on either SAP RATIO or GAAP basis. EXPENSE Under SAP, the ratio of underwriting expenses to net written RATIO premiums. Using GAAP basis, the ratio of underwriting expenses to net premiums earned. GENERALLY Accounting practices and principles, as defined principally by ACCEPTED the American Institute of Certified Public Accountants, the ACCOUNTING Financial Accounting Standards Board, and the Commission. GAAP is PRINCIPLES the method of accounting typically used by the Company for ("GAAP") reporting to persons or entities other than insurance regulatory authorities. GROSS The total of premiums received or to be received for insurance PREMIUMS written by an insurer during a specific period of time without WRITTEN any reduction for reinsurance ceded. HARD The portion of the market cycle of the property and casualty MARKET insurance industry characterized by constricted industry capital and underwriting capacity, increasing premium rates and, typically, enhanced underwriting performance. INCURRED The estimated liability of an insurer, at a given point in time, BUT NOT with respect to losses that have been incurred but not yet REPORTED reported to the insurer, and for potential future developments LOSSES on reported claims. ("IBNR") INSURANCE A system of ratio analysis developed by the NAIC primarily REGULATORY intended to assist state insurance departments in executing INFORMATION their statutory mandates to oversee the financial condition of SYSTEM insurance companies. ("IRIS") LOSS The expense of investigating and settling claims, including ADJUSTMENT legal fees, outside adjustment expenses and other general EXPENSE expenses of administering the claims adjustment process. ("LAE") LOSS Under both SAP and GAAP, net losses and LAE incurred, divided by RATIO net premiums earned, expressed as a percentage. LOSS The estimated liability of an insurer, at a given point in time, RESERVES with respect to unpaid incurred losses, including losses, which are IBNR and related LAE. LOSSES The total of all policy losses sustained by an insurance INCURRED company during a period, whether paid or unpaid. Incurred losses include a provision for claims that have occurred but have not yet been reported to the insurer. MODEL LAW A Model Law to implement RBC Requirements for insurance companies. The Model Law became effective with respect to property and casualty insurance companies as of December 31, 1994. 19 20 NATIONAL A voluntary organization of state insurance officials that ASSOCIATION OF promulgates model laws regulating the insurance industry, values INSURANCE securities owned by insurers, develops and modifies insurer COMMISSIONERS financial reporting, statements and insurer performance criteria ("NAIC") and performs other services with respect to the insurance industry. NET PREMIUMS The amount of net premiums written allocable to the expired EARNED period of an insurance policy or policies. NET PREMIUMS The gross premiums written during a specific period of time, WRITTEN less the portion of such premiums ceded to (reinsured by) other insurers. NONSTANDARD Risks that generally have been found unacceptable by standard lines insurers for various underwriting reasons. REINSURANCE A procedure whereby a primary insurer transfers (or "cedes") a portion of its risk to a reinsurer in consideration of a payment of premiums by the primary insurer to the reinsurer for their assumption of such portion of the risk. Reinsurance can be affected by a treaty or individual risk basis. Reinsurance does not legally discharge the primary insurer from its liabilities with respect to its obligations to the insured. REINSURERS Insurers (known as the reinsurer or assuming company) who agree to indemnify another insurer (known as the reinsured or ceding company) against all or part of a loss that the latter may incur under a policy or policies it has issued. RISK-BASED Capital requirements for property and casualty insurance CAPITAL companies adopted by the NAIC to assess minimum capital REQUIREMENTS requirements and to raise the level of protection that statutory ("RBC") surplus provides for policy holder obligations. SOFT The portion of the market cycle of the property and casualty MARKET insurance industry characterized by heightened premium rate competition among insurers, increased underwriting capacity and, typically, depressed underwriting performance. STANDARD Personal automobile insurance written for those individuals AUTOMOBILE presenting an average risk profile in terms of loss history, INSURANCE driving record, type of vehicle driven and other factors. STATUTORY Those accounting principles and practices which provide the ACCOUNTING framework for the preparation of financial statements, and the PRACTICES recording of transactions, in accordance with the rules and ("SAP") procedures adopted by regulatory authorities, generally emphasizing solvency consideration rather than a going concern concept of accounting. The principal differences between SAP and GAAP are as follows: (a) SAP, certain assets (non-admitted assets) are eliminated from the balance sheet; (b) under SAP, policy acquisition costs are expensed upon policy inception, while under GAAP they are deferred and amortized over the term of the policies; (c) under SAP, no provision is made for deferred income taxes; and (d) under SAP, certain reserves are recognized which are not recognized under GAAP. 20 21 UNDERWRITING The process whereby an underwriter reviews applications submitted for insurance coverage and determines whether it will provide all or part of the coverage being requested, and the price of such premiums. Underwriting also includes an ongoing review of existing policies and their pricing. UNDERWRITING The aggregate of policy acquisition costs, including that EXPENSE portion of general and administrative expenses attributable to underwriting operations. UNEARNED The portion of premiums written representing unexpired PREMIUMS policy terms as of a certain date. 21 22 ITEM 2. PROPERTIES The Company's agencies are located in leased locations pursuant to leases expiring at various times through February 2016. The aggregate annual rental for the facilities is approximately $960,000. Federated National owns the Company's current headquarters in Plantation, Florida as well as its prospective headquarters in Lauderdale Lakes, Florida. ITEM 3. LEGAL PROCEEDINGS The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. In June 2000, a lawsuit was filed against the Company and its directors and executive officers seeking compensatory damages on the basis of allegations that the Company's amended registration statement dated November 4, 1998 was inaccurate and misleading concerning the manner in which the Company recognized ceded insurance commission income, in violation of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The lawsuit was filed in the United States District Court for the Southern District of New York and seeks class action status. The plaintiff class purportedly includes purchasers of the Company's common stock between November 5, 1998 and August 13, 1999. The Company believes that the lawsuit is without merit and intends to vigorously defend such action. On November 1, 2000, the Company filed a motion to dismiss this lawsuit and is awaiting a decision from the district court. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (A) MARKET INFORMATION The Company's Common Stock has been listed for trading on the Nasdaq National Market under the symbol "TCHC" since November 5, 1998. For the calendar quarters indicated, the table below sets forth the high and low closing prices per share of the Common Stock based on published financial resources.
QUARTER ENDED HIGH LOW ------------- ---- --- March 31, 1999 $7.750 $5.500 June 30, 1999 $7.125 $4.500 September 30, 1999 $7.000 $5.188 December 31, 1999 $5.750 $4.125 March 31, 2000 $8.000 $3.938 June 30, 2000 $7.000 $4.500 September 30, 2000 $5.000 $3.063 December 31, 2000 $4.000 $2.813
22 23 (B) SALES OF UNREGISTERED SECURITIES The following unregistered shares of the Company's Common Stock were issued in 2000:
SHARES DATE REASON ------ ---- ------ 20,000 January 2000 Employees bonuses 20,667 June 2000 Payment on note payable
No commissions were paid in connection with the foregoing sales, which were made in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933. (C) HOLDERS As of March 26, 2001, there were approximately 36 holders of record of the Company's Common Stock. The Company believes that the number of beneficial owners of its Common Stock is in excess of 300. (D) DIVIDENDS In the fourth quarter of 2000, the Company began paying a dividend of $0.02 per share on its Common Stock and expects to continue to pay a quarterly dividend. However, the ability of the Company to continue to pay dividends may be restricted by regulatory limits on the amount of dividends, which Federated National is permitted to pay to the Company. See Regulations in Part I, Item I. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company is a vertically integrated insurance holding company, which, through its subsidiaries, controls substantially all aspects of the insurance underwriting, distribution and claims process. The Company underwrites nonstandard and standard personal automobile insurance and homeowners and mobile home property and casualty insurance in the State of Florida through its subsidiary, Federated National Insurance Company ("Federated National"). The Company has underwriting authority for third-party insurance companies, which it represents through a wholly owned managing general agent, Assurance Managing General Agents, Inc. ("Assurance MGA"). The Company internally processes claims made by Federated National's and third-party insureds through a wholly-owned claims adjusting company, Superior Adjusting, Inc. ("Superior). The Company also offers premium financing to its own and third-party insureds through its wholly-owned subsidiary, Federated Premium Finance, Inc. ("Federated Premium"), and pay advances through Fed First Corp ("Fed First"). The Company markets and distributes Federated National's and third-party insurers' products and its other services primarily in South Florida, through a network of 37 Company-owned agencies and approximately 500 active independent agents. The Company, through its wholly-owned subsidiary, FedUSA, Inc. ("FedUSA"), franchises agencies under the FedUSA name. In December 2000, the company sold its first franchised agency, which began operations on January 1, 2001. The Company intends to sell approximately 25 of its Company-owned agencies to individual employees/managers and convert them to franchised operations. The Company intends to focus its future expansion efforts on franchised agencies. The Company's business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on the Company's business, results of operations and financial condition. Also, if Federated National's estimated liabilities for unpaid losses and LAE are less than actual losses and LAE, Federated National will be required to increase reserves with a corresponding reduction in Federated National's net income in the period in which the deficiency is identified. 23 24 The Company operates in a highly competitive market and faces competition from both national and regional insurance companies, many of whom are larger and have greater financial and other resources than the Company, have favorable A.M. Best ratings and offer more diversified insurance coverage. The Company's competitors include other companies, which market their products through agents, as well as companies, which sell insurance directly to their customers. Large national writers may have certain competitive advantages over agency writers, including increased name recognition, increased loyalty of their customer base and reduced policy acquisition costs. The Company may also face competition from new or temporary entrants in its niche markets. In some cases, such entrants may, because of inexperience, desire for new business or other reasons, price their insurance below the pricing structure of the Company. Although the Company's pricing is inevitably influenced to some degree by that of its competitors, management of the Company believes that it is generally not in the Company's best interest to compete solely on price, choosing instead to compete on the basis of underwriting criteria, its distribution network and superior service to its agents and insureds. The Company competes with respect to automobile insurance in Florida with more than 100 companies, which underwrite personal automobile insurance. Companies of comparable or smaller size, which compete with the Company in the nonstandard automobile insurance industry, include Fortune Insurance Company, U.S. Security Insurance Company, United Automobile Insurance Company, Direct General Insurance Company and Security National, as well as major insurers such as Progressive Casualty Insurance Company. Competition could have a material adverse effect on the Company's business, results of operations and financial condition. ANALYSIS OF FINANCIAL CONDITION AS OF DECEMBER 31, 2000 AS COMPARED TO DECEMBER 31, 1999 INVESTMENTS. Investments increased $5.0 million to $19.0 million as of December 31, 2000 as compared to $13.9 million as of December 31, 1999. This increase in investments is due to the investing of cash generated by the increase in gross premiums written. CASH AND CASH EQUIVALENTS. Cash and cash equivalents were $2.6 million as of December 31, 2000, as compared to $923,000 as of December 31, 1999. This increase of $1.7 million is due primarily to an increase in the cash required for day-to-day operations due to the increase in revenues and expenses. FINANCE CONTRACTS, CONSUMER LOANS AND PAY ADVANCE RECEIVABLES. Finance contracts, consumer loans and pay advance receivables increased $4.2 million from $9.6 million at December 31, 1999 to $13.8 million at December 31, 2000. This increase is due to an increase in premium finance receivables, which are the result of the increase in premiums written as well as premiums underwritten for third-party insurers by Assurance MGA. PREPAID REINSURANCE PREMIUMS. Prepaid reinsurance premiums increased $471,000 to $3.1 million as of December 31, 2000 from $2.6 million as of December 31, 1999 due to the increase in premiums ceded in 2000 compared to 1999. PREMIUMS RECEIVABLE. Premiums receivable decreased $1.0 million from $1.3 million as of December 31,1999 to $247,000 as of December 31, 2000 because the Company de-emphasized direct billed premiums in 2000 in favor of premium financing. DUE FROM REINSURERS. Due from Reinsurers increased from $1.7 million as of December 31, 1999 to $2.8 million as of December 31, 2000 due to higher losses in 2000 as compared to 1999. DEFERRED ACQUISITION COSTS, NET. Deferred acquisition costs increased from a credit of $10,000 as of December 31, 1999 to a debit of $1.2 million as of December 31, 2000. Included in the December 31, 1999 balance were deferred commissions of $746,000 offset by unearned ceded commissions of $756,000. As of December 31, 2000, deferred commissions were $2.1 million offset by unearned ceded commissions of $877,000. The increase in deferred commissions is related to the increase in premiums written discussed below and premiums written for third party insurers by Assurance MGA. 24 25 DEFERRED INCOME TAXES. The increase of $1.1 million in the deferred income taxes from $1.8 million as of December 31, 1999 to $2.9 million as of December 31, 2000 is due primarily to the deferred tax asset associated with the increase in unearned premiums, unearned commission and the allowances for credit losses. PROPERTY, PLANT AND EQUIPMENT, NET. Property, plant and equipment increased $2.9 million to $5.4 million as of December 31, 2000, from $2.5 million as of December 31, 1999 primarily as a result of the purchase of a building and approximately five acres of vacant land for $2.6 million. The Company currently is contemplating using a portion of the building as its headquarters and a portion of the vacant land for parking. GOODWILL. The decrease in goodwill of $600,000 from $3.4 million as of December 31, 1999 to $2.8 million as of December 31,2000 is due to current year amortization. UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES. Unpaid loss and loss adjustment expenses increased $3.5 million to $9.8 million as of December 31, 2000, as compared to $6.3 million as of December 31, 1999. This increase is related to the increase in losses and LAE discussed below. UNEARNED PREMIUMS. Unearned premiums increased $5.0 million to $13.0 million as of December 31, 2000 from $8.0 million as of December 31, 1999. This increase is the result of the increase in written premiums discussed below. REVOLVING CREDIT OUTSTANDING. The outstanding borrowings under the Revolving Agreement increased $3.4 million to $8.1 million as of December 31, 2000 from $4.7 million as of December 31, 1999 primarily to fund the increase in finance contracts receivables. BANK OVERDRAFT. Bank overdraft is the result of the cash management techniques employed by the Company. The overdraft was $3.2 million as of December 31, 2000, a $1.7 million increase from $1.5 million as of December 31, 1999. This increase is due to increased business activity driven by the increase in revenues. UNEARNED COMMISSIONS. Unearned commissions increased $1.7 million to $2.5 million as of December 31, 2000 from $803,000 as of December 31, 1999. This increase is the result of the unearned managing general agent fees. Assurance MGA began writing policies for one unaffiliated insurance company in July 1999 and for an additional company in January 2000. ACCOUNTS PAYABLE AND ACCRUED EXPENSES. Accounts payable and accrued expenses increased $1.9 million from $512,000 as of December 31, 1999 to $2.3 million as of December 31, 2000 primarily due to a general overall increase in expenses and $368,000 payable to a third party insurance company by Assurance MGA. DRAFTS PAYABLE TO INSURANCE COMPANIES. Drafts payable to insurance companies increased from $313,000 as of December 31, 1999 to $787,000 as of December 31, 2000, principally due to new finance contracts receivable. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 GROSS PREMIUMS WRITTEN. Gross premiums written increased $12.8 million, or 66.4% to $32.1 million for the year ended December 31, 2000 as compared to $19.3 million in 1999. This increase is attributable to an increase in pricing by the Company's major competitors, as well as a 10% rate reduction by the Company, all effective December 1, 1999. Prior to December 1999, these two competitors' pricing was below the Company's pricing. After the price changes, the Company became more competitive with respect to pricing, resulting in a substantial increase in written premiums. The Company reversed its 10% rate reduction effective June 1, 2000 to slow the growth in premiums written and further increased prices on selected products in October 2000. GROSS PREMIUMS CEDED. Gross premiums ceded increased $1.4 million to $7.6 million for the year ended December 31, 2000 from $6.2 million for the year ended December 31, 1999. The increase in gross premiums ceded is directly related to the increase in gross premiums written. 25 26 NET PREMIUMS EARNED. Net premiums earned increased 51.0% to $20.3 million for the year ended December 31, 2000 from $13.5 million for the year ended December 31, 1999. The increase in net premiums written discussed above was partially offset by the increase in the deferral of premiums over the life of the policies. COMMISSION INCOME. Commission income decreased 37.0% to $2.8 million for the year ended December 31, 2000 from $4.4 million in 1999. Commission income consists of fees earned by Company-owned agencies placing business with third-party insurers and third-party premium finance companies. The decrease is attributable to a higher percentage of commissions from Federated National and Assurance MGA, which are eliminated in consolidation. FINANCE REVENUES. Finance revenues increased 54.5% to $5.7 million for the year ended December 31, 2000 from approximately $3.7 million in 1999. The increase was attributable to an increase in the number of premium contracts financed by Federated Premium, as well as income generated from pay advances, which began operations in the third quarter 1999. NET INVESTMENT INCOME. Net investment income increased 43.6% or $372,000 to $1.2 million for the year ended December 31, 2000 from $854,000 for the year ended December 31,1999 because the Company had additional funds invested from the increase in premiums written by Federated National and third party insurers for which, Assurance MGA is the managing general agent. NET REALIZED INVESTMENT GAINS (LOSSES). In 1999, the Company realized $952,000 in investment gains compared to investment losses of $109,000 in 2000. This change is due to the downturn in the stock market in the last third of 2000. MANAGING GENERAL AGENT FEES. Managing general agent fees increased from $964,000 for the year ended December 31, 1999 to $5.4 million for the year ended December 31, 2000. This increase is because Assurance MGA began writing policies for one unaffiliated insurance company in July 1999 and for an additional company in January 2000. Prior to July 1999, substantially all policies were written for Federated National for which Assurance MGA retained $25 per policy. OTHER INCOME. Other income increased $1.2 million to $2.2 million for the year ended December 31, 2000 from $1.0 million for the same period in 1999. This increase is primarily attributable to increased tax preparation fees of $860,000 and adjusting fee income of $634,000 for the year ended December 31, 2000 compared to $353,000 and $4,000, respectively, in 1999. LOSSES AND LAE. The Company's loss ratio, as determined in accordance with GAAP, for 2000 was 73.8% compared with 60.2 % for the same period in 1999. Losses and LAE incurred increased $6.9 million to $15.0 million for the year ended December 31, 2000 from $8.1 million for 1999. Losses and LAE, the Company's most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of its policyholders, including expenses required to settle claims and losses. The Company believes the increase in its loss ratio is a function of a 10% price reduction on policies written from December 1, 1999 to May 31, 2000 coupled with increased claims on policies issued during that period. OPERATING AND UNDERWRITING EXPENSES. Operating and underwriting expenses increased $4.9 million or 69.1% to $11.9 million for the year ended December 31, 2000 from $7.0 million for the year ended December 31, 1999. The increase is due primarily to the 47.9% increase in revenues and is expected to continue in the near future. Included in operating and underwriting expenses are the provision for credit losses and the provision for uncollectible premiums receivables. The provision for credit losses increased to $1,994,000 for the year ended December 31, 2000 from $838,000 for the year ended December 31, 1999. The provision for uncollectible premiums receivable increased to $432,000 for 2000 from $50,000 in 1999. SALARIES AND WAGES. Salaries and wages increased 25.4% to $9.4 million for 2000 from $7.5 million for 1999. The increase is related to the increase in the volume of business during the period. 26 27 AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS. The amortization of deferred policy acquisition costs increased from a credit of $19,000 for the year ended December 31, 1999 to a debit of $1.7 million for 2000. Policy acquisition costs consists of commission expenses paid to third-party agencies less commissions earned on reinsurance ceded. The increase is primarily due to policy acquisition costs of $1.6 million incurred by Assurance MGA for third party insurers' policies in 2000 compared to zero in 1999. INCOME TAX EXPENSE. The Company recorded a benefit for income taxes of $462,000 in 2000 as compared to a provision of $680,000 in 1999 primarily due to pre-tax income/loss. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of capital are revenues generated from operations, investment income and borrowings under the Revolving Agreement. Because the Company is a holding company, it is largely dependent upon management fees and /or dividends from its subsidiaries for cash flow. Federated Premium is party to the Revolving Agreement, which is used to fund its operations. Under the Revolving Agreement, Federated Premium can borrow up to the maximum credit commitment of $9.8 million, including $800,000 overline availability for collateral not delivered. The amount of an advance is subject to availability under a borrowing base calculation, with maximum advances outstanding not to exceed the maximum credit commitment. The annual interest rate on advances under the Revolving Agreement is the prime rate plus additional interest varying from .75% to prime only based on the prior month's average outstanding balance, and was 9.50% at December 31, 2000. Interest on the overline availability is at the default rate of 17.5%. The Revolving Agreement contains various operating and financial covenants and is collateralized by a first lien and assignment of all of the Company's assigned finance contracts receivable. The Revolving Agreement expires on September 30, 2001. Outstanding borrowings under the Revolving Agreement as of December 31, 2000 and 1999 were approximately $8.1 million and $4.7 million, respectively. At December 31, 2000 and 1999, the Company was in compliance with all covenants under the Revolving Agreement. For the year ended December 31, 2000, operations generated operating cash flow of $11.8 million, which was primarily attributable to increases in unearned premiums and unpaid losses and loss adjustment expenses. Operating cash flow is expected to be negative in the short-term due to an increase in quota-share reinsurance from 30% to 50% effective January 1, 2001 and a slight slow down in premiums written caused by three price increases since June 2000 and is expected to be positive thereafter due to increased business in other states. The Company's investment portfolio is available to offset any cash flow deficits, which is highly liquid as it consists almost entirely of readily marketable securities. Cash deficit from investing activities was $14.6 million in 2000 and $1.6 million in 1999. The Company expects positive cash flow from investing activities in the near term to offset any deficits in cash flow from operations. Cash flow provided by financing activities was $4.4 million in 2000 and $2.3 million in 1999. The Company believes that its current capital resources, together with cash flow from its operations and financing activities will be sufficient to meet its anticipated working capital requirements through at least 2001. There can be no assurances, however, that such will be the case. To retain its certificate of authority, the Florida insurance laws and regulations require that Federated National maintain capital surplus equal to the greater of 10% of its liabilities or the 2000 statutory minimum capital and surplus requirement of $2.75 million as defined in the Florida Insurance Code. The Company is in compliance with this requirement. The Company is also required to adhere to prescribed net premium-to-capital surplus ratios. For the year ended December 31, 2000, the Company was not in compliance with this requirement and is subject to a fine by the Florida Department of Insurance. The Company has taken corrective action in 2001, including increasing reinsurance to 50% of premiums written and increasing pricing which should decrease the amount of premiums written. Because of these corrective actions, the Company does not anticipate any fine by the Florida Department of Insurance. The maximum amount of dividends, which can be paid by Florida insurance companies without prior approval of the Florida Commissioner, is subject to restrictions relating to statutory surplus. The maximum dividend that may be paid in 2001, by the Company without prior approval, is limited to the lesser of statutory net income from operations of the preceding calendar year or 10% of statutory unassigned capital surplus as of the preceding December 31. No dividends were paid during 2000 or 1999. 27 28 The Company is required to comply with the NAIC's risk-based capital requirements. The NAIC's risk-based capital requirements are a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC's risk-based capital standards are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2000, based on calculations using the appropriate NAIC formula, the Company's total adjusted capital is in excess of ratios, which would require any form of regulatory action. GAAP differs in some respects from reporting practices prescribed or permitted by the Florida Department of Insurance. Federated National's statutory capital surplus was approximately $6.2 million as of December 31, 2000 and $7.1 million as of December 31, 1999. Statutory net income was a loss of $1.4 million for the year ended December 31, 2000 and income of $1.1 million for 1999. IMPACT OF INFLATION AND CHANGING PRICES The consolidated financial statements and related data presented herein have been prepared in accordance with GAAP which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the effects of the general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the cost of paying losses and LAE. Insurance premiums are established before the Company knows the amount of loss and LAE and the extent to which inflation may affect such expenses. Consequently, the Company attempts to anticipate the future impact of inflation when establishing rate levels. While the Company attempts to charge adequate rates, the Company may be limited in raising its premium levels for competitive and regulatory reasons. Inflation also affects the market value of the Company's investment portfolio and the investment rate of return. Any future economic changes which result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred loss and LAE and thereby materially adversely affect future liability requirements. 28 29 ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Reports................................................................................. 30 Consolidated Balance Sheets as of December 31, 2000 and 1999............................................................................ 32 Consolidated Statements of Operations For the years ended December 31, 2000 and 1999.............................................................. 33 Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income For the years ended December 31, 2000 and 1999.............................................................. 34 Consolidated Statements of Cash Flows For the years ended December 31, 2000 and 1999.............................................................. 35 Notes to Consolidated Financial Statements.................................................................... 36
29 30 INDEPENDENT AUDITORS' REPORT To the Shareholders and Board of Directors of 21st Century Holding Company: We have audited the accompanying consolidated balance sheet of 21st Century Holding Company and Subsidiaries ("the Company" and a Florida Corporation) as of December 31, 2000, and the related consolidated statements of operations, changes in shareholders' equity and comprehensive income and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of 21st Century Holding Company and Subsidiaries as of December 31, 2000, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. MCKEAN, PAUL, CHRYCY, FLETCHER & CO. Plantation, Florida March 31, 2001 30 31 INDEPENDENT AUDITORS' REPORT The Board of Directors 21st Century Holding Company: We have audited the accompanying consolidated balance sheet of 21st Century Holding Company and subsidiaries (the "Company") as of December 31, 1999, and the related consolidated statements of operations, changes in shareholders' equity and comprehensive income, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of 21st Century Holding Company and subsidiaries as of December 31, 1999, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Miami, Florida March 30, 2000 31 32 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2000 AND 1999
2000 1999 ----------- ----------- ASSETS Investments Fixed maturities, available for sale, at fair value............................. $15,691,147 $11,170,035 Equity securities............................................................... 2,889,627 2,627,232 Mortgage loans.................................................................. 385,024 119,304 ----------- ---------- Total investments........................................................... 18,965,798 13,916,571 ----------- ---------- Cash and cash equivalents......................................................... 2,627,041 923,175 Finance contracts, consumer loans and pay advances receivable, net of allowance for credit losses of $832,231 and $272,192, respectively........................................... 13,792,791 9,642,163 Prepaid reinsurance premiums...................................................... 3,076,017 2,604,607 Premiums receivable, net of allowance for credit losses of $325,000 and $50,000, respectively........................... 246,787 1,256,485 Due from reinsurers, net.......................................................... 2,797,648 1,670,849 Deferred acquisition costs, net................................................... 1,192,260 (10,243) Deferred income taxes............................................................. 2,915,894 1,785,514 Property, plant and equipment, net................................................ 5,381,780 2,514,505 Other assets...................................................................... 1,275,701 980,375 Goodwill, net..................................................................... 2,795,750 3,402,403 ----------- ----------- Total assets................................................................ $55,067,467 $38,686,404 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Unpaid losses and loss adjustment expenses........................................ $9,765,848 $6,314,307 Unearned premiums................................................................. 13,038,417 8,037,083 Premium deposits.................................................................. 382,058 357,186 Revolving credit outstanding...................................................... 8,091,034 4,650,026 Bank overdraft.................................................................... 3,212,962 1,528,736 Unearned commissions.............................................................. 2,505,690 802,757 Accounts payable and accrued expenses............................................. 2,328,586 511,997 Notes payable..................................................................... - 417,773 Drafts payable to insurance companies............................................. 786,875 312,651 ----------- ----------- Total liabilities........................................................... 40,111,470 22,932,516 ----------- ----------- Commitments and contingencies Shareholders' equity: Common stock of $0.01 par value. Authorized 25,000,000 shares, issued 3,410,667 and 3,370,000 shares, outstanding 3,330,367 and 3,365,000 shares respectively........................................................... 34,107 33,700 Additional paid-in capital...................................................... 12,894,630 12,690,087 Accumulated other comprehensive deficit......................................... (1,300,404) (1,244,830) Retained earnings............................................................... 3,642,066 4,297,994 Treasury stock, 80,300 and 5,000 shares, respectively, at cost.................. (314,402) (23,063) ----------- ----------- Total shareholders' equity.................................................. 14,955,997 15,753,888 ----------- ----------- Total liabilities and shareholders' equity.................................. $55,067,467 $38,686,404 =========== ===========
See accompanying notes to consolidated financial statements. 32 33 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2000 AND 1999
2000 1999 ----------- ----------- Revenue: Gross premiums written................................................. $32,073,768 $19,273,561 Gross premiums ceded................................................... (7,625,095) (6,221,853) ----------- ----------- Net premiums written.......................................... 24,448,673 13,051,708 Decrease (increase) in unearned premiums, net of prepaid reinsurance premiums..................................... (4,127,334) 404,640 ----------- ----------- Net premiums earned........................................... 20,321,339 13,456,348 Commission income...................................................... 2,780,869 4,410,856 Finance revenue........................................................ 5,709,848 3,696,843 Managing general agent fees............................................ 5,410,500 963,797 Net investment income.................................................. 1,225,413 853,659 Net realized investment gains (losses)................................. (109,256) 952,153 Other income........................................................... 2,214,894 1,043,798 ----------- ----------- Total revenue................................................. 37,553,607 25,377,454 ----------- ----------- Expenses: Losses and loss adjustment expenses.................................... 14,990,118 8,094,677 Operating and underwriting expenses.................................... 11,892,577 7,032,428 Salaries and wages..................................................... 9,375,775 7,474,572 Amortization of deferred acquisition costs, net........................ 1,673,754 (18,563) Amortization of goodwill............................................... 606,653 547,548 ----------- ----------- Total expenses................................................ 38,538,877 23,130,662 ----------- ----------- Income (loss) before provision for income tax expense.................... (985,270) 2,246,792 (Provision) benefit for income tax expense............................... 462,396 (680,061) ----------- ----------- Net income (loss)............................................. $ (522,874) $ 1,566,731 =========== =========== Basic net income (loss) per share........................................ $ (0.15) $ 0.46 =========== ===========
See accompanying notes to consolidated financial statements. 33 34 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME LOSS YEARS ENDED DECEMBER 31, 2000 AND 1999
Accumulated Additional Other Total Comprehensive Common Paid-In Comprehensive Retained Treasury Shareholders' DESCRIPTION Income Stock Capital Deficit Earnings Stock Equity - ----------- ------------- ------- ----------- ---------- ---------- --------- ----------- Balance as of December 31, 1998.... $33,500 $12,460,287 $(257,227) $2,731,263 $ - $14,967,823 Net income $1,566,731 1,566,731 1,566,731 Stock issued for acquisitions..... 600 429,400 430,000 Acquisition of common shares...... (223,063) (223,063) Cancellation of common shares..... (400) (199,600) 200,000 - Net unrealized change in investments, net of tax effect of $595,855..... (987,603) (987,603) (987,603) --------- Comprehensive income................ $ 579,128 ========== ------ ---------- ---------- --------- ------- ---------- Balance as of December 31, 1999... 33,700 12,690,087 (1,244,830) 4,297,994 (23,063) 15,753,888 Net loss $ (522,874) (522,874) (522,874) Cash dividends ................... (133,054) (133,054) Acquisition of common shares...... (291,339) (291,339) Stock issued ...................... 407 204,543 204,950 Net unrealized change in investments, net of tax effect of $33,530...... (55,574) (55,574) (55,574) ---------- Comprehensive loss.................... $ (578,448) ========== ------- ----------- ----------- ---------- --------- ----------- Balance as of December 31, 2000...... $34,107 $12,894,630 $(1,300,404) $3,642,066 $(314,402) $14,955,997 ======= =========== =========== ========== ========= ===========
See accompanying notes to consolidated financial statements. 34 35 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2000 AND 1999
2000 1999 ------------ ------------- Cash flow from operating activities: Net income (loss)................................................................ $(522,874) $1,566,731 Adjustments to reconcile net income to net cash flow (used in) provided by operating activities: Amortization (accretion) of investment premium (discount), net................. (10,592) 3,232 Depreciation and amortization of property plant and equipment.................. 323,743 199,537 Amortization of goodwill....................................................... 606,653 547,548 Deferred income tax expense.................................................... (1,096,850) (106,337) Net realized investment (gains) losses......................................... 109,256 (952,153) Amortization of deferred acquisition costs, net................................ 1,673,754 (18,563) Provision for credit losses, net............................................... 1,994,274 838,335 Provision for uncollectible premiums receivable................................ 432,052 50,000 Stock issued to employees...................................................... 100,000 - Changes in operating assets and liabilities: Premiums receivable......................................................... 577,646 (1,306,485) Prepaid reinsurance premiums................................................ (471,410) 92,597 Due from reinsurers, net.................................................... (1,126,799) 255,887 Deferred acquisition costs, net............................................. (2,876,257) 118,330 Other assets................................................................ (295,326) (163,146) Unpaid losses and loss adjustment expenses.................................. 3,451,541 (1,289,153) Unearned premiums........................................................... 5,001,334 (497,237) Premium deposits............................................................ 24,872 (135,236) Unearned commissions........................................................ 1,702,933 216,165 Drafts payable to insurance companies....................................... 474,224 16,704 Accounts payable and accrued expenses....................................... 1,750,795 (1,420,953) ------------ ------------- Net cash flow (used in) provided by operating activities..................... 11,822,969 (1,984,197) ------------ ------------- Cash flow from investing activities: Proceeds from sale of investment securities available for sale................... 49,110,449 37,826,024 Purchases of investment securities available for sale............................ (54,081,724) (34,715,726) Finance contracts receivables, consumer loans and pay advances receivable........ (6,144,902) (3,386,905) Mortgage loans................................................................... (272,773) (120,000) Sale of and collection of mortgage loans......................................... 7,053 163,860 Purchases of property and equipment.............................................. (3,191,018) (910,561) Acquisitions..................................................................... - (491,697) ------------ ------------- Net cash used in investing activities....................................... (14,572,915) (1,635,005) ------------ ------------- Cash flow from financing activities: Bank overdraft................................................................... 1,684,226 328,795 Loans from Shareholders.......................................................... - (400,494) Dividends paid................................................................... (67,260) - Purchases of treasury stock...................................................... (291,339) (223,063) Repayment of indebtedness........................................................ (312,823) - Revolving credit outstanding..................................................... 3,441,008 2,587,078 ------------ ------------- Net cash flow provided by financing activities............................... 4,453,812 2,292,316 ------------ ------------- Net (decrease) increase in cash and cash equivalents......................... 1,703,866 (1,326,886) Cash and cash equivalents at beginning of year..................................... 923,175 2,250,061 ------------ ------------- Cash and cash equivalents at end of year........................................... $2,627,041 $923,175 ============ ============= Supplemental disclosure of cash flow information: Cash paid (received) during the year for: Interest...................................................................... $662,809 $374,496 ============ ============= Income taxes................................................................ $1,529,690 $1,788,500 ============ ============= Non-cash investing and financing activities: Shares issued for settlement of note payable.................................. $104,950 - ============ Shares issued for acquisition of agency and majority owned subsidiary......... - $430,000 ============= Notes payable issued for agency acquisition................................... - $300,000 ============= Accrued dividend payable...................................................... $65,794 - ============
See accompanying notes to consolidated financial statements 35 36 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (1) ORGANIZATION AND BUSINESS The accompanying consolidated financial statements include the accounts of 21st Century Holding Company and its subsidiaries (collectively referred to as the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. The Company is a vertically integrated insurance holding company, which, through its subsidiaries, controls substantially all aspects of the insurance underwriting, distribution and claims process. The Company's Federated National Insurance Company ("Federated National") subsidiary underwrites nonstandard and standard personal automobile insurance and mobile home property and casualty insurance in the State of Florida. Through its wholly owned subsidiaries, Assurance Managing General Agents, Inc. ("Assurance MGA") and Superior Adjusting, Inc., the Company has underwriting and claims authority, respectively, for third-party insurance companies. The Company also offers premium financing, pay advances, tax preparation and other ancillary services to its customers. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (A) CASH AND CASH EQUIVALENTS The Company considers all short-term highly liquid investments with original maturities of three months or less to be cash equivalents. (B) INVESTMENTS All of the Company's investment securities have been classified as available-for-sale because all of the Company's securities are available to be sold in response to the Company's liquidity needs, changes in market interest rates and asset-liability management strategies, among other reasons. Investments available-for-sale are stated at fair value on the balance sheet. Unrealized gains and losses are excluded from earnings and are reported as a component of other comprehensive income within shareholders' equity, net of related deferred income taxes. A decline in the fair value of an available-for-sale security below cost that is deemed other than temporary results in a charge to income, resulting in the establishment of a new cost basis for the security. For the years ended December 31, 2000 and 1999, the realized losses for declines in fair value deemed to be other than temporary were zero and approximately $100,000, respectively, and are reported as a component of net realized investment gains on the consolidated statements of operations. Premiums and discounts are amortized or accreted, respectively, over the life of the related fixed maturity security as an adjustment to yield using a method that approximates the effective interest method. Dividends and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific-identification method for determining the cost of securities sold. (C) PREMIUM REVENUE Premium revenue on property and casualty insurance is earned on a pro rata basis over the life of the policies. Unearned premiums represent the portion of the premium related to the unexpired policy terms. 36 37 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (D) DEFERRED ACQUISITION COSTS Deferred acquisition costs represent primarily commissions paid to the Company's outside agents at the time of policy issuance (to the extent they are recoverable from future premium income) net of ceding premium commission earned from reinsurers, and are amortized over the life of the related policy in relation to the amount of premiums earned. The method followed in computing deferred acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, unpaid losses and loss adjustment expenses and certain other costs expected to be incurred as the premium is earned. There is no indication that these costs will not be fully recoverable in the near term. An analysis of deferred acquisition costs follows:
DECEMBER 31, ------------------------------- 2000 1999 ---------- --------- Balance, beginning of period $(10,243) $89,524 Acquisition costs deferred 2,876,257 (118,330) Amortized to expense during period (1,673,754) 18,563 ---------- ------ Balance, end of period $1,192,260 $(10,243) ========== =========
The negative deferred acquisition cost balance as of December 31, 1999 is the result of unearned reinsurance commissions exceeding policy acquisition costs. (E) PREMIUM DEPOSITS Premium deposits represent premiums received on policies not yet written. The Company takes approximately 30 working days to write the policy from the date the cash and policy application are received. (F) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES Unpaid losses and loss adjustment expenses are provided for through the establishment of liabilities in amounts estimated to cover incurred losses and loss adjustment expenses. Such liabilities are determined based upon the Company's assessment of claims pending and the development of prior years' loss liability. These amounts include liabilities based upon individual case estimates for reported losses and loss adjustment expenses and estimates of such amounts that are incurred but not reported. Changes in the estimated liability are charged or credited to operations as the estimates are revised. Unpaid losses and loss adjustment expenses are reported net of estimates for salvage and subrogation recoveries, which totaled approximately $559,000 and $342,000, net of reinsurance, at December 31, 2000 and 1999, respectively. The estimates of unpaid losses and loss adjustment expenses are subject to the effect of trends in claims severity and frequency and are continually reviewed. As part of the process, the Company reviews historical data and considers various factors, including known and anticipated legal developments, changes in social attitudes, inflation and economic conditions. As experience develops and other data becomes available, these estimates are revised, as required, resulting in increases or decreases to the existing unpaid losses and loss adjustment expenses. Adjustments are reflected in results of operations in the period in which they are made and the liabilities may deviate substantially from prior estimates. There can be no assurance that the Company's unpaid losses and loss adjustment expenses will be adequate to cover actual losses. If the Company's unpaid losses and loss adjustment expenses prove to be inadequate, the Company will be required to increase the liability with a corresponding reduction in the Company's net income in the period in which the deficiency is identified. Future loss experience substantially in excess of the established unpaid losses and loss adjustment expenses could have a material adverse effect on the Company's business, results of operations and financial condition. The Company does not discount unpaid losses and loss adjustment expenses for financial statement purposes. 37 38 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (G) COMMISSION INCOME Commission income consists of fees earned by the Company-owned agencies placing business with third party insurers and third party premium finance companies. Commission income is earned on a pro rata basis over the life of the policies. Unearned commissions represent the portion of the commissions related to unexpired policy terms. (H) FINANCE REVENUE Interest and service income, resulting from the financing of insurance premiums and pay advances, is recognized using a method that approximates the effective interest method. Late charges are recognized as income when chargeable. (I) CREDIT LOSSES Provisions for credit losses are charged to operations in amounts sufficient to maintain the allowance for credit losses at a level considered adequate to cover anticipated losses in the existing finance contracts, consumer loans and pay advances receivable (J) MANAGING GENERAL AGENT FEES If substantially all the costs associated with the managing general agent ("MGA") contract are incurred during the underwriting process, then the MGA fees and the related acquisition costs are recognized at the time the policy is underwritten, net of estimated cancellations. If the MGA contract requires significant involvement subsequent to the completion of the underwriting process, then the MGA fees and related acquisition costs are deferred and recognized over the life of the policy. (K) POLICY FEES Policy fees represent a $25 non-refundable application fee for insurance coverage, which is intended to reimburse the Company for the costs incurred to underwrite the policy. The fees and related costs are recognized when the policy is underwritten. These underwriting costs are not included as a component of deferred acquisition costs. (L) REINSURANCE The Company recognizes the income and expense on reinsurance contracts principally on a pro-rata basis over the life of the policies covered under the reinsurance agreements. The Company is reinsured under separate reinsurance agreements for the different lines of business underwritten. Reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company continually monitors its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company only cedes risks to reinsurers whom the Company believes to be financially sound. The Company's reinsurance is ceded to Transatlantic Re, an A++ rated reinsurance company, on a quota share basis. At December 31, 2000, all reinsurance recoverables are considered collectible. (M) INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax-credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 38 39 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (N) CONTINGENT REINSURANCE COMMISSION The Company's reinsurance contracts provide ceding commissions for premiums written which are subject to adjustment. The amount of ceding commissions is determined by the loss experience for the reinsurance agreement term. The reinsurer provides commissions on a sliding scale with maximum and minimum achievable levels. The reinsurer provides the Company with the provisional commissions. The Company has recognized the commissions based on the current loss experience for the policy year premiums. This results in establishing a liability, included in due from reinsurers, for the excess of provisional commissions retained compared to amounts recognized, which is subject to variation until the ultimate loss experience is determinable. Approximately $78,000 of contingent ceding commissions were recognized as an expense for the year ended December 31, 2000 and approximately $89,000 of contingent ceding commissions were recognized in income in 1999. (O) CONCENTRATION OF CREDIT RISK Financial instruments, which potentially expose the Company to concentrations of credit risk consist primarily of investments, premiums receivable, amounts due from reinsurers on paid and unpaid losses, and finance contracts, consumer loans and pay advances receivable. The Company has not experienced significant losses related to premiums receivable from individual policyholders or groups of policyholders in a particular industry or geographic area. The Company has not experienced significant losses related to consumer loans or pay advances receivable. Management believes no credit risk beyond the amounts provided for collection losses is inherent in the Company's premiums receivable or finance contracts, consumer loans and pay advances receivable. In order to reduce credit risk for amounts due from reinsurers, the Company seeks to do business with financially sound reinsurance companies and regularly reviews the financial strength of all reinsurers used. (P) DUE FROM FLORIDA JOINT UNDERWRITING ASSOCIATION (THE "ASSOCIATION") PARTICIPATION An amount recorded as a component of other assets represents the Company's proportionate share of the net assets of the Association. The Company's proportionate share of premiums, losses, loss expenses, and other related items is recorded and presented in their respective accounts in the accompanying consolidated financial statements. (Q) ACCOUNTING CHANGES Effective January 1, 1999, the Company adopted Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance Related Assessments", which requires entities to recognize liabilities for insurance related assessments when such assessments are probable and the amount of the assessments can be reasonably estimated. Adoption of this statement did not materially impact the Company's results of operations or financial position. (R) ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires all derivatives to be recognized at fair value as either assets or liabilities on the balance sheet. Any gain or loss resulting from changes in such fair value is required to be recognized in earnings to the extent the derivatives are not effective as hedges. SFAS No. 137. "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of SFAS No. 133" issued in June 1999 defers the effective date of SFAS No. 133 to all fiscal quarters of all fiscal years beginning after June 15 of 2000. Adoption of this statement is not expected to have a material impact on the Company's results of operations or financial position. 39 40 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 In June 2001, the FASB expects to finalize its exposure draft, Business, Combinations and Intangible Assets - Accounting for Goodwill, which will become effective almost immediately. The key elements of the exposure draft are (1) the elimination of the pooling-of-interest method for business combinations, (2) the elimination of amortization of goodwill for both new and previous acquisitions, (3) intangible assets must be recognized separately from goodwill, (4) the impairment of goodwill must be tested whenever events or circumstances warrant, and (5) pro forma disclosures for all past periods presented to reflect the amount of amortization which would have been reversed had the standard been applied retroactively. Upon adoption of the new standard, the Company will cease to amortize goodwill and the remaining unamortized balance will be periodically tested for impairment. Amortization of goodwill for the year ended December 31, 2000 was $606,653. Effective January 1. 2001, the Company adopted the Codification of Statutory Accounting Principles guidance ("the Codification") issued by the NAIC. The Codification provides guidance for areas where statutory accounting has been silent and changes current accounting in some areas. The adoption of the Codification is not expected to have a material effect on the Company's consolidated financial statements. (S) USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with general accepted accounting principles requires management to make estimates and assumptions that affect the reported financial statement balances as well as the disclosure of contingent assets and liabilities. Actual results could differ materially from those estimates used. Similar to other property and casualty insurers, the Company's liability for unpaid losses and loss adjustment expenses, although supported by actuarial projections and other data is ultimately based on management's reasoned expectations of future events. Although considerable variability is inherent in these estimates, management believes that this liability is adequate. Estimates are reviewed regularly and adjusted as necessary. Such adjustments are reflected in current operations. In addition, the realization of the Company's deferred income tax assets is dependent on generating sufficient future taxable income. It is reasonably possible that the expectations associated with these accounts could change in the near term and that the effect of such changes could be material to the consolidated financial statements. (T) NATURE OF OPERATIONS The following is a description of the most significant risks facing the Company and how it mitigates those risks: (I) LEGAL/REGULATORY RISKS - the risk that changes in the regulatory environment in which an insurer operates will create additional expenses not anticipated by the insurer in pricing its products. That is, regulatory initiatives designed to reduce insurer profits, restrict underwriting practices and risk classifications, mandate rate reductions and refunds, and new legal theories or insurance company insolvencies through guaranty fund assessments may create costs for the insurer beyond those recorded in the financial statements. The Company attempts to mitigate this risk by monitoring proposed regulatory legislation and by assessing the impact of new laws. As the Company writes business only in the state of Florida, it is more exposed to this risk than some of its more geographically balanced competitors. (II) CREDIT RISK - the risk that issuers of securities owned by the Company will default or that other parties, including reinsurers to whom business is ceded, which owe the Company money, will not pay. The Company attempts to minimize this risk by adhering to a conservative investment strategy, maintaining reinsurance agreements with financially sound reinsurers, and by providing for any amounts deemed uncollectible. (III) INTEREST RATE RISK - the risk that interest rates will change and cause a decrease in the value of an insurer's investments. To the extent that liabilities come due more quickly than assets mature, an insurer might have to sell assets prior to maturity and potentially recognize a gain or a loss. 40 41 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (U) FAIR VALUE The fair value of the Company's investments are estimated based on bid prices published by financial services or quotations received from securities dealers and is reflective of the interest rate environment that existed as of the close of business on December 31, 2000 and 1999. Changes in interest rates subsequent to December 31, 2000 may affect the fair value of the Company's investments. Refer to note 3(a) for details. The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2000 and 1999 because of their short-term nature: cash and cash equivalents, premiums receivable, finance contracts, consumer loans and pay advance receivable, due from reinsurers, drafts payable to insurance companies, notes payable, revolving credit outstanding, bank overdraft, and accounts payable and accrued expenses. The fair value of mortgage loans is estimated using the present value of future cash flows based on the market rate for similar types of loans. Carrying value approximates market value as rates used are commensurate with market rate. (V) GOODWILL Goodwill, representing the excess of cost over the fair value of assets acquired, is amortized on a straight-line basis over seven years. The carrying value of goodwill is periodically reviewed by the Company based on the expected future undiscounted operating cash flows of the related item. Based upon its most recent analysis, the Company believes that no impairment of goodwill exists at December 31, 2000. (W) STOCK OPTION PLAN The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Compensation cost for stock options, if any, is measured as the excess of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. SFAS No. 123, "Accounting for Stock-Based Compensation", establishes accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. ( See Note 16.) (X) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation on property, plant and equipment is calculated on a straight-line basis over the following estimated useful lives: building and improvements - 30 years and furniture and fixtures 7 years. The carrying value of property, plant and equipment is periodically reviewed by the Company based on the expected future undiscounted operating cash flows of the related item. Based upon its most recent analysis, the Company believes that no impairment of property, plant and equipment exists at December 31, 2000. (Y) RECLASSIFICATIONS Certain 1999 financial statement amounts have been reclassified to conform with 2000 presentation. 41 42 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (3) INVESTMENTS (A) FIXED MATURITIES AND EQUITY SECURITIES A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of fixed maturities and equity securities at December 31, 2000 and 1999 is as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE ----------- ---------- ---------- ----------- DECEMBER 31, 2000 Fixed Maturities: Mortgage-backed securities..................... $223,277 $ - $13,544 $209,733 U. S. Government obligations................... 3,212,927 92,353 - 3,305,280 Obligations of states and political subdivisions................................ 10,568,822 - 165,685 10,403,137 Corporate securities........................... 2,044,485 - 271,488 1,772,997 ----------- ------- -------- ----------- $16,049,511 $92,353 $450,717 $15,691,147 =========== ======= ======== =========== Equity Securities: Preferred stocks............................... $218,396 $ - $63,179 $155,217 Common stocks.................................. 4,397,351 - 1,662,941 2,734,410 ----------- -------- ---------- ---------- $4,615,747 $ - $1,726,120 $2,889,627 =========== ======== ========== ========== DECEMBER 31,1999 Fixed Maturities: Mortgage-backed securities..................... $265,513 $ - $17,478 $248,035 Obligations of states and political subdivisions................................ 10,347,412 - 1,193,007 9,154,405 Corporate securities........................... 2,028,004 - 260,409 1,767,595 ----------- -------- ---------- ----------- $12,640,929 $ - $1,470,894 $11,170,035 =========== ======== ========== =========== Equity Securities: Preferred stocks............................... $218,396 $ - $46,334 $172,062 Common stocks.................................. 2,933,322 105,059 583,211 2,455,170 ----------- -------- ---------- ----------- $3,151,718 $105,059 $629,545 $2,627,232 =========== ======== ========== ===========
Below is a summary of fixed maturities at December 31, 2000 and 1999 by contractual or expected maturity periods. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
DECEMBER 31, 2000 DECEMBER 31, 1999 ----------------------------- ---------------------------- AMORTIZED ESTIMATED AMORTIZED ESTIMATED COST FAIR VALUE COST FAIR VALUE ----------- ----------- ----------- ----------- Due in one year or less......................... $0 $0 $0 $0 Due after one year through five years..................................... 2,712,927 2,799,345 0 0 Due after five years through ten years.......................................... 3,975,492 3,817,916 1,691,811 1,547,528 Due after ten years............................. 9,361,092 9,073,886 10,949,118 9,622,507 ----------- ----------- ----------- ----------- $16,049,511 $15,691,147 $12,640,929 $11,170,035 =========== =========== =========== ===========
Political subdivision bonds with an amortized cost of approximately $527,000 and a fair market value of approximately $535,000 were on deposit with the Florida Department of Insurance as of December 31, 2000, as required by law. 42 43 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 A summary of the sources of net investment income follows:
YEARS ENDED DECEMBER 31, -------------------------- 2000 1999 ---- ---- Fixed maturities................................ $551,973 $776,948 Equity securities............................... 44,343 71,744 Cash and cash equivalents....................... 646,780 23,363 Other........................................... 10,459 5,162 ------ ----- Total investment income...................... 1,253,555 877,217 Less investment expenses........................ (28,142) (23,558) -------- --------- Net investment income........................ $1,225,413 $853,659 ========== ========
Proceeds from sales of fixed maturities and equity securities for the years ending December 31, 2000 and 1999 were $49,110,449 and $37,826,024, respectively. A summary of realized investment gains (losses) and (increases) decreases in net unrealized losses follows:
YEARS ENDED DECEMBER 31, -------------------------- 2000 1999 ---- ---- Net realized gains (losses): Fixed maturities................................. $(14,937) $(66,048) Equity securities................................ (94,319) 1,018,201 Total......................................... $(109,256) $952,153 ========== ======== Change in net unrealized losses: Fixed maturities................................. $1,112,530 $(1,506,800) Equity securities................................ (1,201,634) (71,022) ----------- -------- Total......................................... $(89,104) $(1,577,822) ========= ============
(B) MORTGAGE LOANS A portion of these amounts represents outstanding balances from related party transactions. Refer to Note 15 for details. 43 44 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (4) FINANCE CONTRACTS, CONSUMER LOANS AND PAY ADVANCES RECEIVABLE Below is a summary of the components of the finance contracts, consumer loans and pay advances receivable balance:
December 31, ---------------------------- 2000 1999 ----------- ---------- Finance contracts receivable $14,580,589 $8,520,503 Consumer loans receivable 118,693 1,307,143 Pay advances receivable 493,707 416,499 ----------- ------- 15,192,989 10,244,145 Less: Unearned income (567,967) (329,790) Allowance for credit losses (832,231) (272,192) ----------- ---------- Finance contracts, consumer loans and pay advances receivable, net $13,792,791 $9,642,163 =========== ==========
The activity in the allowance for credit losses was as follows for the years ended December 31, 2000 and 1999:
2000 1999 ---------- -------- Allowance for credit losses at beginning of year $272,192 $195,883 Additions charged to bad debt expense 1,994,274 838,335 Write-downs charged against the allowance (1,434,235) (762,026) ---------- -------- Allowance for credit losses at end of year $832,231 $272,192 ========== ========
As security, Federated Premium retains a contractual right, if a premium installment is not paid when due, to cancel the insurance policy and to receive the unearned premium from the insurer. (5) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at December 31, 2000 and 1999 consist of the following:
2000 1999 --------- --------- Land $907,369 $155,000 Building and Improvements 3,572,483 1,820,143 Furniture and Fixtures 1,698,335 1,012,276 --------- ---------- 6,178,187 2,987,419 Accumulated Depreciation (796,407) (472,914) --------- ---------- $5,381,780 $2,514,505
Depreciation of property, plant, and equipment was $323,743 and $199,537 during 2000 and 1999 respectively. 44 45 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (6) REINSURANCE The Company reinsures (cedes) a portion of its written premiums on a quota-share basis to nonaffiliated insurance companies in order to limit its loss exposure. The Company also maintains coverages to limit losses from large exposures, which the Company believes are adequate for its current volume. To the extent that reinsuring companies are unable to meet their obligations assumed under the reinsurance agreements, the Company remains primarily liable to its policyholders. The impact of reinsurance on the financial statements is as follows:
YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 ----------- ----------- Premiums written: Direct............................... $32,073,768 $19,273,561 Ceded................................ (7,625,095) (6,221,853) ----------- ----------- $24,448,673 $13,051,708 =========== =========== Premiums earned: Direct............................... $27,072,339 $19,770,797 Ceded................................ (6,751,000) (6,314,449) ----------- ----------- $20,321,339 $13,456,348 =========== =========== Losses and loss adjustment expenses incurred: Direct............................... $21,003,683 $11,698,046 Ceded................................ (6,013,565) (3,603,369) ----------- ----------- $14,990,118 $8,094,677 =========== ==========
AS OF DECEMBER 31, ------------------------------ 2000 1999 ---------- ----------- Unpaid losses and loss adjustment expenses, net: Direct.............................. $9,765,848 $6,314,307 Ceded .............................. (2,789,619) (1,886,226) ----------- ----------- $6,976,229 $4,428,081 ========== ========== Unearned premiums: Direct.............................. $13,038,417 $8,037,083 Ceded .............................. (2,924,082) (2,604,607) ----------- ----------- $10,114,335 $5,432,476 =========== ==========
The Company received approximately $2.3 million and $1.8 million in commissions on premiums ceded during the years ended December 31, 2000 and 1999, respectively. Had all of the Company's reinsurance agreements been canceled at December 31, 2000, the Company would have returned a total of approximately $877,000 in reinsurance commissions to its reinsurers; in turn, its reinsurers would have returned approximately $3.0 million in unearned premiums to the Company. Effective January 1, 2001, the Company increased its quota share on automobile policies from 30% to 50%. As a result the Company had to pay its reinsurer $1,949,388 in unearned premiums and received $584,816 in ceded commissions. 45 46 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 At December 31, 2000 and 1999, the Company had an unsecured aggregate recoverable for paid and unpaid losses and loss adjustment expenses and unearned premiums with the following reinsurers:
DECEMBER 31, --------------------------------- 2000 1999 ---------- ---------- Transatlantic Reinsurance Company (A++ A.M. Best Rated): Unearned premiums........................................................ $2,924,082 $2,167,937 Reinsurance recoverable on paid losses and loss adjustment expenses...... 1,059,793 495,426 Unpaid losses and loss adjustment expenses............................... 2,789,619 1,793,623 --------- --------- $6,773,494 $4,456,986 ========== ========= Other: Unearned premium......................................................... $151,935 $436,670 Reinsurance recoverable on paid losses and loss adjustment expenses...... - 37,036 Unpaid losses and loss adjustment expenses............................... - 92,603 --- ------ $151,935 $566,309 ======== ======= Amounts due from reinsurers consisted of amounts related to: Unpaid losses and loss adjustment expenses............................... $2,789,619 $1,886,226 Reinsurance recoverable on paid losses and loss adjustment expenses...... 1,059,793 532,462 Reinsurance payable...................................................... (707,173) (481,023) Contingent ceded commissions payable..................................... (344,591) (266,816) --------- --------- $2,797,648 $1,670,849 ========== ==========
(7) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES The liability for unpaid losses and loss adjustment expenses is determined on an individual-case basis for all incidents reported. The liability also includes amounts for unallocated expenses, anticipated future claim development and IBNR. Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:
DECEMBER 31, ------------------------------ 2000 1999 ----------- ---------- Balance at January 1....................... $6,314,307 $7,603,460 Less reinsurance recoverables............. (1,886,226) (2,237,688) ----------- ----------- Net balance at January 1................ $4,428,081 $5,365,772 ========== ========== Incurred related to: Current year.............................. $13,545,562 $8,764,334 Prior years............................... 1,444,556 (669,657) --------- --------- Total incurred.......................... $14,990,118 $8,094,677 =========== ========== Paid related to: Current year.............................. $8,012,742 $5,551,789 Prior years............................... 4,429,228 3,480,579 --------- --------- Total paid.............................. $12,441,970 $9,032,368 =========== ========== Net balance at year end.................... $6,976,229 $4,428,081 Plus reinsurance recoverables............. 2,789,619 1,886,226 --------- --------- Balance at year end..................... $9,765,848 $6,314,307 ========== ==========
Based upon consultations with the Company's independent actuarial consultants and their statement of opinion on losses and loss adjustment expenses, the Company believes that the liability for unpaid losses and loss adjustment expenses is adequate to cover all claims and related expenses which may arise from incidents reported. 46 47 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 As a result of the Company's review of its liability for losses and LAE, which includes a re-evaluation of the adequacy of reserve levels for prior year's claims, the Company increased its liability for loss and LAE for claims occurring in prior years by $1,445,000 for the year ended December 31, 2000 and reduced its liability for loss and LAE for claims occurring in prior years by $670,000 in 1999. The adjustments in the liability were primarily attributable to loss development with respect to the Company's automobile insurance program. There can be no assurance concerning future adjustments of reserves, positive or negative, for claims through December 31, 2000. (8) NOTES PAYABLE The following is a summary of outstanding notes payable at December 31, 2000 and 1999:
DECEMBER 31, -------------------- 2000 1999 ---- ------- Notes payable: Unsecured note payable in the amount of $500,000 at 6% interest, unpaid principal and interest payable on January 1, 2000 $ - $125,000 Unsecured note payable in the amount of $300,000 at 6% interest, unpaid principal and interest payable on June 1, 2000. The principal and interest is payable in cash or Company stock at the option of the Company - 276,950 Other - 15,823 --- ------ $ - $417,773 ==== ========
(9) REVOLVING CREDIT OUTSTANDING The Company, through its wholly owned subsidiary, Federated Premium Finance, Inc. ("Federated Premium") is a party to a revolving loan agreement ("Revolving Agreement") with Flatiron Funding Company LLC ("Flatiron"). The Revolving Agreement is structured as a sale of contracts receivable under a sale and assignment agreement with FPF, Inc. (a wholly-owned subsidiary of Flatiron), which gives FPF Inc. the right to sell or assign these contracts receivable. Federated Premium, which services these contracts, has recorded transactions under the Revolving Agreement as secured borrowings. The Revolving Agreement expires September 30, 2001 and allows for a maximum credit commitment of $9.8 million, including $800,000 overline availability for collateral not delivered. The amount of an advance is subject to availability under a borrowing base calculation, with maximum advances outstanding not to exceed the maximum credit commitment. The annual interest rate on advances under the Revolving Agreement is the prime rate plus additional interest varying from .75% to prime only based on the prior month's average outstanding balance, and was 9.50% at December 31, 2000. Interest on the overline availability is at the default rate of 17.5%. The Revolving Agreement contains various operating and financial covenants, which the Company was in compliance with at December 31, 2000 and 1999. Outstanding borrowings under the Revolving Agreement as of December 31, 2000 and 1999 were $8,091,034 and $4,650,026, respectively, including $211,522 on the overline availability as of December 31, 2000. Interest expense for the years ended December 31, 2000 and 1999 totaled approximately $643,000 and $341,000, respectively. 47 48 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (10) INCOME TAXES A summary of the provision for income tax expense (benefit) for the years ended December 31, 2000 and 1999 is as follows:
2000 1999 ---------- -------- Federal: Current................................. $583,772 $640,525 Deferred................................ (1,001,203) (92,635) ---------- -------- (417,431) 547,890 ---------- -------- State: Current................................. 126,421 145,873 Deferred................................ (171,386) (13,702) ---------- -------- (44,965) 132,171 ---------- -------- $(462,396) $680,061 ========== ========
The actual income tax expense (benefit) differs from the "expected" income tax expense (benefit) for the years ended December 31, 2000 and 1999 (computed by applying the U.S. federal tax rate of 34 percent to income (loss) before provision for income tax expense (benefit) ) as follows:
2000 1999 --------- --------- Computed "expected" tax (benefit), at federal rate........ $(334,992) $763,909 State tax, net of federal deduction benefit............... (29,676) 87,233 Tax-exempt interest....................................... (156,459) (179,812) Amortization of goodwill.................................. 60,747 55,677 Dividend received deduction............................... (14,257) (26,997) Other, net................................................ 12,241 (19,949) --------- -------- Income tax expense (benefit), as reported................. $(462,396) $680,061 ========= ========
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's net deferred tax asset as of December 31, 2000 and 1999 are as follows:
DECEMBER 31, ----------------------------- 2000 1999 ---------- --------- Deferred tax assets: Unpaid losses and loss adjustment expenses .................................. $347,120 $173,776 Unearned premiums............................................................. 756,025 408,848 Unrealized loss on investments available for sale............................. 784,580 751,049 Allowance for credit losses................................................... 436,602 122,377 Unearned Commissions......................................................... 942,892 302,078 Goodwill ..................................................................... 171,468 70,170 Deferred acquisition costs, net............................................... - 13,193 Other......................................................................... 8,905 55,357 ---------- ---------- Total gross deferred tax assets............................................. 3,447,592 1,896,848 Deferred tax liabilities: Deferred acquisition costs, net............................................... (514,393) - Depreciation.................................................................. (17,305) (28,043) Other......................................................................... - (83,291) ---------- ---------- Total gross deferred tax liabilities........................................ (531,698) (111,334) ---------- ---------- Net deferred tax asset...................................................... $2,915,894 $1,785,514 ========== ==========
48 49 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2000 and 1999, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. (11) REGULATORY REQUIREMENTS AND RESTRICTIONS To retain its certificate of authority, the Florida Insurance Code (the "Code") requires that Federated National maintain capital and surplus equal to the greater of 10 percent of its liabilities or the statutory minimum capital and surplus requirement of $2.75 million as defined in the Code. In 2000 and 1999, Federated National was required to have capital surplus of $2.75 million and $5.9 million, respectively. At December 31, 2000 and 1999, Federated National's capital surplus was $6.2 million and $7.1 million, respectively. Further, the Company is also required to adhere to a prescribed net premium-to-surplus ratio. For the year ended December 31, 2000, the Company was not in compliance with this requirement and is subject to a fine by the Florida Department of Insurance. The Company has taken corrective action in 2001, including increasing reinsurance to 50% of premiums written and increasing pricing which should decrease the amount of premiums written. Because of these corrective actions, the Company does not anticipate any fine by the Florida Department of Insurance. As of December 31, 2000, to meet regulatory requirements, the Company had bonds with a carrying value of approximately $535,000 pledged to the Insurance Commissioner of the State of Florida. Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its shareholders except out of that part of its available and accumulated capital surplus funds which is derived from realized net operating profits on its business and net realized capital gains. A Florida domestic insurer may not make dividend payments or distributions to shareholders without prior approval of the Florida Department of Insurance if the dividend or distribution would exceed the larger of (i) the lesser of (a) 10 percent of capital surplus (b) net income, not including realized capital gains, plus a two-year carryforward, (ii) 10 percent of capital surplus with dividends payable constrained to unassigned funds minus 25 percent of unrealized capital gains of (iii) the lesser of (a) 10 percent of capital surplus or (b) net investment income plus a three-year carryfoward with dividends payable constrained to unassigned funds minus 25 percent of unrealized capital gains. Alternatively, a Florida domestic insurer may pay a dividend or distribution without the prior written approval of the Florida Department of Insurance (i) if the dividend is equal to or less than the greater of (a) 10 percent of the insurer's capital surplus as regards policyholders derived from realized net operating profits on its business and net realized capital gains or (b) the insurer's entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, (ii) the insurer will have policyholder capital surplus equal to or exceeding 115 percent of the minimum required statutory capital surplus after the dividend or distribution, (iii) the insurer files a notice of the dividend or distribution with the department at least ten business days prior to the dividend payment or distribution and (iv) the notice includes a certification by an officer of the insurer attesting that, after the payment of the dividend or distribution, the insurer will have at least 115 percent of required statutory capital surplus as to policyholders. Except as provided above, a Florida domiciled insurer may only pay a dividend or make a distribution (i) subject to prior approval by the Florida Department of Insurance or (ii) 30 days after the Florida Department of Insurance has received notice of such dividend or distribution and has not disapproved it within such time. No dividends were declared or paid in 2000 or 1999. Under these laws, Federated National is permitted to pay dividends of approximately $619,000 to the Company in 2001. Dividends in excess of this amount require approval by the Florida Department of Insurance. There can be no assurance that, if requested, that the Florida Department of Insurance will allow any dividends in excess of this amount to be paid by Federated National. 49 50 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 The Company is required to comply with NAIC risk-based capital ("RBC") requirements. RBC is a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC's RBC standards are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2000, based on calculations using the appropriate NAIC formula, the Company's total adjusted capital is in excess of ratios, which would require any form of regulatory action. Generally accepted accounting principles differ in some respects from reporting practices prescribed or permitted by the Florida Department of Insurance. Federated National's statutory capital and surplus was $6.2 million and $7.1 million as of December 31, 2000 and 1999, respectively. Federated National's statutory net loss was $1.4 million for the year ended December 31, 2000. In 1999, Federated National's statutory net income was approximately $1.1 million. Statutory not admitted assets were approximately $1.2 million and $1.6 million as of December 31, 2000 and 1999, respectively. (12) LEASES The Company leases office space under various lease agreements with expiration dates through September 2016. Rental expense associated with operating leases is charged to expense in the period incurred. Rental expenses for 2000 and 1999 were approximately $962,000 and $821,000, respectively, and are included in operating and underwriting expenses in the accompanying consolidated statements of operations. At December 31, 2000, the minimum aggregate rental commitments are as follows:
FISCAL YEAR LEASES ----------- ------ 2001 $820,754 2002 685,125 2003 563,615 2004 309,615 Thereafter 508,961 ------- Total $2,888,070 ==========
(13) SEGMENT INFORMATION The Company and its subsidiaries operate principally in two business segments consisting of insurance and financing. The insurance segment consists of underwriting through Federated National, managing general agent operations through Assurance MGA, claims processing through Superior Adjusting and marketing and distribution through Federated Agency Group. The insurance segment sells primarily nonstandard personal automobile insurance and includes substantially all aspects of the insurance, distribution and claims process. The financing segment consists of premium financing through Federated Premium Finance, consumer loans through RPA Financial Corporation, and pay advances through FedFirst Corporation. The financing segment provides premium financing to both Federated National's insureds and to third-party insureds, consumer loans and pay advances, and is marketed through the Company's distribution network of Company-owned agencies (Federated Agency Group) and independent agents. The accounting policies of the segments are the same as those described in the summary of significant accounting policies and practices. The Company evaluates its business segments based on GAAP pretax operating earnings. Corporate overhead expenses are not allocated to business segments. Transactions between reportable segments are accounted for at fair value. 50 51 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 Operating segments that are not individually reportable are included in the "All Other" category, which includes the operations of 21st Century Holding Company. Information regarding components of operations for the years ended December 31, 2000 and 1999 follows:
2000 1999 ----------- ----------- TOTAL REVENUES Insurance Segment Earned Premiums $20,321,339 $13,456,348 Investment Income 499,331 1,718,382 Adjusting Income 1,858,326 895,485 MGA Fee Income 5,410,500 963,797 Commission Income 6,355,081 6,053,118 Other Income 142,439 841,791 ----------- ----------- Total Insurance Revenue $34,587,016 $23,928,921 =========== =========== Financing Segment: Premium finance income $4,575,674 $2,810,357 Consumer loan interest 334,963 716,352 Pay advance interest 783,843 170,134 Investment Income - - Miscellaneous Income 15,368 - ----------- ----------- Total Financing Revenues $5,709,848 $3,696,843 =========== =========== All Other Total All Other $2,140,538 $2,442,927 =========== =========== Total Operating Segments 42,437,402 30,068,691 Intercompany Eliminations (4,883,795) (4,691,237) ----------- ----------- Total Revenues $37,553,607 $25,377,454 =========== =========== EARNINGS (LOSS) BEFORE INCOME TAXES Insurance Segment $(2,495,974) $1,970,279 Financing Segment 1,165,769 1,400,931 All Other 344,935 (876,369) ----------- ----------- Total Operating Segments (985,270) 2,494,841 Intercompany Eliminations - (248,049) ----------- ----------- Total Earnings before Income Taxes $(985,270) $2,246,792 =========== =========== TOTAL ASSETS Insurance Segment $35,503,710 $24,895,860 Finance Segment 14,570,175 10,779,524 All Others 7,072,230 4,972,955 ----------- ----------- Total Operating Segments 57,146,115 40,648,339 Intercompany Eliminations (2,078,648) (1,961,935) ----------- ----------- Total Assets $55,067,467 $38,686,404 =========== ===========
51 52 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (14) COMMITMENTS AND CONTINGENCIES The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. In June 2000, a lawsuit was filed against the Company and its directors and executive officers seeking compensatory damages on the basis of allegations that the Company's amended registration statement dated November 4, 1998 was inaccurate and misleading concerning the manner in which the Company recognized ceded insurance commission income, in violation of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The lawsuit was filed in the United States District Court for the Southern District of New York and seeks class action status. The plaintiff class purportedly includes purchasers of the Company's common stock between November 5, 1998 and August 13, 1999. The Company believes that the lawsuit is without merit and intends to vigorously defend such action. On November 1, 2000, the Company filed a motion to dismiss this lawsuit and is awaiting a decision from the district court. The Company, as a direct premium writer in the State of Florida, is required to participate in certain risk pools. Participation in these pools is based on the Company's written premium by line of business to total premiums written statewide by all insurers. Participation may result in assessments against the Company. For the years ended December 31, 2000 and 1999, no amounts were assessed against the Company. (15) RELATED PARTY TRANSACTIONS One of the Company's directors is a partner at Conroy, Simberg, and Ganon, a law firm that handles the Company's claims litigation. Fees paid to this law firm amounted to approximately $533,000 and $281,000 for the years ended December 31, 2000 and 1999, respectively. In June 1999, the Company purchased the assets of three insurance agencies from a director for $130,000 in cash and a note payable for $300,000. The note was subsequently paid with 20,667 shares of the Company's common stock in April 2000 and $195,050 cash. Mortgage loan receivables in the amount of $227,391 and $119,304 as of December 31, 2000 and 1999, respectively, represent secured loans to relatives of an officer of the Company. (16) STOCK COMPENSATION PLANS On December 1998, the Company issued warrants to two employees to purchase 62,500 shares of common stock of the Company at $9 per share. The warrants vested immediately and are exercisable between December 1999 and December 2004, at which time if they have not been exercised, they will be canceled. The estimated fair value of these warrants at the date issued was approximately $226,000 using a Black-Scholes option pricing model and assumptions similar to those used for valuing the Company's stock options as described below. As of December 31, 2000 and 1999, no warrants have been exercised. The Company initiated a stock option plan in November 1998 that provides for the granting of stock options to officers, key employees and consultants. The objectives of the plan includes attracting and retaining the best personnel, providing for additional performance incentives, and promoting the success of the Company by providing employees the opportunity to acquire common stock. Options outstanding under the plan have been granted at prices, which are either equal to or above the market value of the stock on the date of grant, vest over a four-year period, and expire ten years after the grant date. 52 53 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 Under the Company's stock option plan, the Company is authorized to grant options to purchase up to 600,000 common shares. As of December 31, 2000, the Company had granted options to purchase 487,971 shares. The status of the Company's stock option plans for the period from January 1, 1999 to December 31, 2000 is summarized below:
Weighted Average Number of Shares Option Exercise Price ---------------- --------------------- Outstanding at January 1, 1999 310,800 $10 Granted 198,300 $10 Exercised - Canceled (36,590) -------- Outstanding at December 31, 1999 472,510 $10 Granted 136,500 $10 Exercised - Canceled (121,039) -------- Outstanding at December 31, 2000 487,971 $10 ======== ===
Weighted Average Options exercisable at: Number of Shares Option Exercise Price ---------------- --------------------- 2000 154,341 $10 2001 121,742 $10 2002 118,750 $10 2003 65,063 $10 2004 28,075 $10 ------- 487,971 =======
The Company continues to account for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, under which no compensation cost for stock options is recognized for stock option awards granted at or above fair market value. Had compensation expense for the Company's stock compensation plan been determined based upon fair values at the grant dates for awards under the plan in accordance with SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been reduced (increased) to the pro forma amounts indicated below. Additional stock option awards are anticipated in future years.
2000 1999 ---------- ---------- Net income (loss) As reported $(522,874) $1,566,731 Pro forma $(741,191) $1,409,408 Net income (loss) per share As reported $(0.15) $0.46 Pro forma $(0.22) $0.42
The weighted average fair value of options granted during 2000 and 1999 estimated on the date of grant using the Black-Scholes option-pricing model was $2.79 to $6.23 in 2000 and $1.86 in 1999. The fair value of 2000 options granted is estimated on the date of grant using the following assumptions: dividend yield of 0%; expected volatility of 73% to 93%; risk free interest rate of 5.75% and an expected life of 10 years. The fair value of 1999 options granted is estimated on the date of grant using the following assumptions: dividend yield of 0%; expected volatility of 45%, risk-free interest rate of 5.7% and an expected life of 10 years. 53 54 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 Summary information about the Company's stock options outstanding at December 31, 2000:
Weighted Average Weighted Range of Outstanding Contractual Average Exercisable Exercise Price at 12/31/00 Periods in Years Exercise Price at 12/31/00 - -------------- ----------- ---------------- -------------- ----------- $10 487,971 8.2 $10 154,341
(17) NET INCOME (LOSS) PER SHARE Net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents outstanding during the periods presented. Options granted in accordance with the Company's stock option plan are anti-dilutive and are not taken into account in the computation. At December 31, 2000 and 1999, warrants issued to two employees to purchase 62,500 shares of common stock at $9 per share were outstanding. At December 31, 2000 and 1999, warrants sold as part of an underwriting agreement at a price of $0.0001 per warrant, entitling the holder to purchase 125,000 shares of common stock at $10.86 per share, were outstanding. All of these potential common shares were excluded from the computation of net income (loss) per share for 2000 and 1999 because their inclusion would have an anti-dilutive effect. A summary of the numerator and denominator of the basic net income (loss) per share is presented below:
INCOME (LOSS) SHARE PER-SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ---------- ------------ -------- For the year ended December 31, 2000: Basic net (loss) per share.................................... $(522,874) 3,375,498 $(0.15) ========== ========= ====== For the year ended December 31, 1999: Basic net income per share................................... $1,566,731 3,382,188 $0.46 ========== ========= =====
(18) COMPREHENSIVE INCOME (LOSS) Reclassification adjustments related to the investment securities included in comprehensive income (loss) for the years ended December 31, 2000 and 1999 are as follows:
2000 1999 --------- ---------- Unrealized holdings net gains (losses) arising during the year $(665,931) $(1,412,094) Reclassification adjustment for (gains) losses included in net income 576,827 (171,364) --------- ----------- (89,104) (1,583,458) Tax effect 33,530 595,855 --------- ----------- Net depreciation on investment securities $(55,574) $(987,603) ========= ===========
(19) AUTHORIZATION OF PREFERRED STOCK The Company's Amended and Restated Articles of Incorporation authorize the issuance of one million shares of preferred stock with designations, rights and preferences determined from time to time by its board of directors. Accordingly, the Company's board of directors is empowered, without shareholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. The Company has not issued preferred shares as of December 31, 2000. 54 55 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (20) ACQUISITIONS In December 1998, the Company consummated an asset acquisition of 18 insurance agencies in exchange for $1.1 million in cash and a $500,000 note payable. The aggregate acquisition price was allocated to the net identifiable assets based on their fair value. The allocation of acquisition price to net identifiable assets had an excess of fair value over the new adjusted book basis creating goodwill of approximately $1.4 million. In January 1999, the Company consummated an asset acquisition of two insurance agencies in exchange for $212,000 in cash and 40,000 shares of common stock valued at $300,000. The aggregate acquisition price was allocated to the net identifiable assets based on their fair value. The allocation of acquisition price to net identifiable assets had an excess of fair value over the new adjusted book basis creating goodwill of approximately $512,000. In June 1999, the Company consummated an asset acquisition of three insurance agencies in exchange for $130,000 in cash and a note payable in the amount of $300,000. The aggregate acquisition price was allocated to the net identifiable assets based on their fair value. The allocation of acquisition price to net identifiable assets had an excess of fair value over the new adjusted book basis creating goodwill of approximately $430,000. In August 1999, the Company acquired 80% of the outstanding stock of Express Tax and Insurance Services Inc., a licensor of tax return preparation software, for $100,000 cash and 20,000 shares of common stock valued at $130,000. The aggregate acquisition price was allocated to the net identifiable assets based on their fair value. The allocation of the acquisition price to the net identifiable assets had an excess of fair value over the new adjusted book basis creating goodwill of approximately $215,000. Revenues of approximately $3.6 million and expenses of approximately $3.4 million, relating to acquisitions consummated in December 1998 and throughout 1999, are included in the accompanying consolidated statement of operations for the year ended December 31, 1999. (21) EMPLOYEE BENEFIT PLAN The Company has established a profit sharing plan under Section 401(k) of the Internal Revenue Code. This plan allows eligible employees to contribute up to 15 percent of their compensation on a pre-tax basis, not to exceed $10,400 and $10,000 for 2000 and 1999, respectively. For the year ended December 31, 2000, the Company declared a discretionary match of 50 percent of the first 6 percent of the employees' contribution. For the year ended December 31, 1999, the Company declared a discretionary match of 100 percent of the first 3 percent of the employees' contribution. Such matching Company contributions are vested incrementally over five years. The charge to operations for the Company's matching contribution was approximately $143,000 and $59,000 in 2000 and 1999, respectively. 55 56 21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 (22) SUBSEQUENT EVENTS In March 2001, the Company announced its intention to sell 25 of its 37 Company owned agencies to individual employees/managers. The sales of the agencies are expected to be completed in the first half of 2001 and each agency will become, at the time of sale, a franchise of FedUSA Inc. The Company will finance the sale of each individual agency to the employee/buyer over a ten-year period and will require no down payment. Consequently, the sale will be accounted for using the cost recovery method with no income recorded from the sale until the book value of the agency is recovered. In connection with the sale of the agencies, the Company's board of directors has authorized the Company to establish a new stock option plan. Under the new plan, stock options will be granted to employees/buyers in connection with the purchase of the agencies from the Company. The former employee/buyer will receive one option for each $100 in purchase price paid for the agency each year he owns the agency for ten years. It is anticipated that the option price will be $10 and expire in 5 years from date of grant. Options will be cancelled upon the subsequent sale of the agency by the employee/buyer. The board of directors' resolution is subject to shareholder approval and management believes that such approval will be obtained. Also, in March 2001, the Company agreed to purchase all of the outstanding stock and all of the outstanding surplus notes of American Vehicle Insurance Company ("American Vehicle") for $500,000 in cash. Upon consummation of the transaction the surplus notes will become payable to the Company, creating negative goodwill. In addition, the Company has agreed to pay two executives of American Vehicle a finders' fee of $400,000 over a period of three years. The purchase is subject to approval by the Florida Department of Insurance, and the Company anticipates that as part of that approval, the Company will have to contribute approximately $800,000 to American Vehicle to bring statutory surplus to $2.75 million. For statutory purposes, the surplus notes are considered surplus. The acquisition will be accounted for under the purchase method of accounting. A summary of the GAAP balance sheet and income statement for American Vehicle as of and for the year ending December 31, 2000 is as follows (unaudited):
Marketable Securities $2,463,384 Cash 380,660 Other assets 41,621 ---------- Total Assets $2,885,665 ========== Unpaid losses and loss adjustment expense $494,568 Surplus notes 4,800,000 Other Liabilities 331,513 ---------- Total Liabilities 5,626,081 Deficit (2,740,416) ---------- $2,885,665 Investment income $294,909 Losses and loss adjustment expense (1,151,186) ---------- Net loss ($856,277) ==========
56 57 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE As reported in the Company's 10-QSB for the quarterly period ended June 30, 2000, the Company changed its Independent Certifying Accountants from KPMG LLP to McKean, Paul, Chrycy, Fletcher and Co. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT The information contained under the caption "Election of Directors" to appear in the Company's definitive proxy statement relating to the Company's Annual Meeting of Shareholders, which definitive proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year covered by this report on Form 10-KSB (herein referred to as the "Annual Meeting Proxy Statement") is incorporated herein by reference. Information regarding executive officers is included in Part I of this form 10-KSB as permitted by General Instruction E (3). ITEM 10. EXECUTIVE COMPENSATION The information contained under the caption "Executive Compensation" to appear in the Annual Meeting Proxy Statement is incorporated by reference. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information contained under the caption "Beneficial Security Ownership" to appear in the Annual Meeting Proxy Statement is incorporated by reference. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information contained under the caption "Certain Transactions" to appear in the Annual Meeting Proxy Statement is incorporated by reference. 57 58 PART IV ITEM 13. EXHIBITS AND REPORTS ON FORM 8K (A) EXHIBITS
EXHIBIT DESCRIPTION - ------- ----------- 3.1 Amended and Restated Articles of Incorporation (1) 3.2 Form of Registrant's Amended and Restated Bylaws (1) 4.1 Specimen of Common Stock Certificate (1) 4.2 Revised Representative's Warrant Agreement including form of Representative's Warrant (2) 10.1 Form of Stock Option Plan, as amended (3)* 10.2 Employment Agreement between the Registrant and Edward J. Lawson (1)* 10.3 Employment Agreement between the Registrant and Michele V. Lawson (1)* 10.4 Form of Indemnification Agreement between the Registrant and its directors and executive officers (1)* 10.5 Revolving Credit and Term Loan Agreement between FlatIron Funding Company, LLC and FPF, Inc., as amended (1) 10.6 Sale and Assignment Agreement between Federated Premium and FPF, Inc., as amended (1) 10.7 Reinsurance Agreement between Federated National and Transatlantic Re (1) 10.8 Amended Employment Agreement between Registrant and Samuel Milne (4)* 10.9 Employment Agreement between Registrant and Richard A. Widdicombe (4)* 10.10 Addendum No. 1 to Reinsurance Agreement between Federated National and Transatlantic Re (5) 10.11 Addendum No. 2 to Reinsurance Agreement between Federated National and Transatlantic Re (5) 10.12 Third Modification Agreement to Revolving Credit and Term Loan Agreement between FlatIron Funding Company, LLC and FPF, Inc., and Sale and Assignment Agreement between Federated Premium and FPF, Inc. (5) 21.1 Subsidiaries of the Registrant (5) 23.1 Consent of Independent Certified Public Accountants (5) 23.2 Consent of Independent Certified Public Accountants (5) - ----------------------------------------------------- * Management Compensation Plan or Arrangement (1) Previously filed exhibit of the same number to the Registrant's Registration Statement on Form SB-2 (File No. 333-63623) and incorporated herein by reference. (2) Previously filed exhibit of the same number of the 1998 Annual Report on Form 10-KSB. (3) Previously exhibit on the Company's 2000 Annual Meeting Proxy Statement. (4) Previously filed exhibit of the same number of the 1999 Annual Report on Form 10-KSB. (5) Filed herewith.
(B) REPORTS ON FORM 8-K None. 58 59 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized. 21ST CENTURY HOLDING COMPANY By: /s/ Edward J. Lawson ---------------------------------------- Edward J. Lawson, Chairman of the Board, President and Chief Executive Officer /s/ Samuel A. Milne ---------------------------------------- Samuel A. Milne, Chief Financial Officer Dated: March 30, 2001 Pursuant to the requirements of the Exchange Act of 1934, this Report has been signed by the following persons on behalf of he registrant and in the capacities and on the date indicated.
SIGNATURE TITLE DATE - -------------------------- -------------------------- -------------- /s/ Edward J. Lawson March 30, 2001 - -------------------------- Chairman of the Board Edward J. Lawson President, Chief Executive Officer /s/ Samuel A. Milne Chief Financial Officer March 30, 2001 - -------------------------- Samuel A. Milne /s/ Michele V. Lawson March 30, 2001 - -------------------------- Vice President-Agency Operations, Michele V. Lawson Treasurer and Director /s/ Richard A. Widdicombe President, Federated National Ins March 30, 2001 - -------------------------- Richard A. Widdicombe /s/ Joseph A. Epstein Director March 30, 2001 - -------------------------- Joseph A. Epstein /s/ Wallace J. Hilliard Director March 30, 2001 - -------------------------- Wallace J. Hilliard /s/ Robert E. McNally Director March 30, 2001 - -------------------------- Robert E. McNally /s/ Bruce Simberg Director March 30, 2001 - -------------------------- Bruce Simberg
59 EX-10.10 2 g68106ex10-10.txt ADDENDUM NO.1 TO REINSURANCE AGREEMENT 1 EXHIBIT 10.10 ADDENDUM NO. 1 Attaching to and forming part of the COMMERCIAL AND PRIVATE PASSENGER AUTOMOBILE QUOTA SHARE TREATY (hereinafter referred to as the "Agreement") issued to FEDERATED NATIONAL INSURANCE COMPANY Plantation, Florida (hereinafter referred to as the "Company") by The Subscribing Reinsurer executing the Interests and Liabilities Contract attaching to And forming a part of this Agreement (hereinafter referred to as the "Reinsurer") IT IS HEREBY MUTUALLY AGREED by the parties that that effective 12:01 a.m., Eastern Standard Time, December 31, 1999, Article 2- Cover of this Agreement, paragraph A will be deleted and replaced in its entirety with: The Company will cede, and the Reinsurer will accept as reinsurance, a 30% share of all business reinsured (Sections A and B) hereunder subject to the maximum Policy limits stated below: IT IS ALSO MUTUALLY AGREED by the parties that that effective 12:01 a.m., Eastern Standard Time, January 1, 2000, Article 7- Reports and Remittances, will be revised by the addition of the following sentence: Effective December 31, 1999 the reinsurer's share of the incoming unearned premium reserve shall be 30%. ALL OTHER TERMS AND CONDITIONS SHALL REMAIN UNCHANGED. 2 IN WITNESS WHEREOF, the parties hereto by their duly authorized representatives have executed this ADDENDUM NO. 1 in duplicate, as of the dates undermentioned. Signed in Plantation, Florida on this 15 day of November 2000. FEDERATED NATIONAL INSURANCE COMPANY /s/ Richard A. Widdicombe -------------------------------------- and in New York, New York on this 8th day of November 2000. TRANSATLANTIC REINSURANCE COMPANY /s/ Suzanne A. Spantidos -------------------------------------- 2 EX-10.11 3 g68106ex10-11.txt ADDENDUM #2 TO REINSURANCE AGREEMENT 1 EXHIBIT 10.11 ADDENDUM NO. 2 Attaching to and forming part of the COMMERCIAL AND PRIVATE PASSENGER AUTOMOBILE QUOTA SHARE TREATY (hereinafter referred to as the "Agreement") issued to FEDERATED NATIONAL INSURANCE COMPANY Plantation, Florida (hereinafter referred to as the "Company") by TRANSATLANTIC REINSURANCE COMPANY New York, New York (hereinafter referred to as the "Reinsurer") IT IS HEREBY MUTUALLY AGREED by the parties that effective 12:01 a.m., Eastern Standard Time, December 31, 2000, Article 2- Cover of this Agreement, paragraph A, as amended by Addendum No. 1, will be deleted and replaced in its entirety with: A. The Company will cede, and the Reinsurer will accept as reinsurance, a 50% share of all business reinsured (Sections A and B) hereunder subject to the maximum Policy limits stated below: IT IS ALSO MUTUALLY AGREED by the parties that effective 12:01 a.m., Eastern Standard Time, January 1, 2001, Article 2- Cover of this Agreement, will be amended by the addition of paragraph E: E. The maximum limit of liability of the Reinsurer in any one Agreement Year as respects Excess of Policy Limits or Extra Contractual Obligations only, shall be $1,500,000. IT IS ALSO MUTUALLY AGREED by the parties that effective 12:01 a.m., Eastern Standard Time, January 1, 2001, Article 7- Reports and Remittances, the concluding sentence as added by Addendum No. 1, will be deleted and replaced in its entirety with: Effective December 31, 2000 the Reinsurer's share of the incoming unearned premium reserve shall be 50%. ALL OTHER TERMS AND CONDITIONS SHALL REMAIN UNCHANGED. 2 IN WITNESS WHEREOF, the parties hereto by their duly authorized representatives have executed this ADDENDUM NO. 2 in duplicate, as of the dates undermentioned. Signed in Plantation, Florida on this 15 day of January 2001. FEDERATED NATIONAL INSURANCE COMPANY /s/ Richard A. Widdicombe ------------------------------------ and in New York, New York on this 9th day of January 2001. TRANSATLANTIC REINSURANCE COMPANY /s/ Suzanne A. Spantidos ------------------------------------ 2 EX-10.12 4 g68106ex10-12.txt THIRD MODIFICATION AGREEMENT 1 EXHIBIT 10.12 THIRD MODIFICATION AGREEMENT This MODIFICATION AGREEMENT ("Modification") is entered into as of October 31, 2000 by and among FPF, Inc., a Colorado corporation ("FPF"), FEDERATED PREMIUM FINANCE, INC., a Florida corporation, as originator (the "Originator"), FLATIRON FUNDING COMPANY, LLC, a Delaware limited liability company (the Lender"), FEDERATED FUNDING CORPORATION, a Florida corporation (the "Residual Interest Holder") and FLATIRON CREDIT COMPANY, INC. ("Flatiron"). WITNESSETH; WHEREAS, pursuant to that certain Revolving Credit and Term Loan Agreement dated as of September 24, 1997 by and among the Lender and FPF (the "Loan Agreement"), the Lender has loaned and will loan to FPF, subject to the conditions thereof, funds for the acquisition by FPF of certain Premium Loans originated by the Originator pursuant to that certain Sale and Assignment Agreement dated as of September 24, 1997 by and between FPF, as purchaser and the Originator, as seller (the "Sale and Assignment Agreement") and contingent upon certain advances by the Residual Interest Holder under the Residual Purchase and Funding Agreement dated September 24, 1997 (the "Residual Agreement"), each as modifed by those certain Modification Agreements, the first dated May 1, 1998, and the second dated January 25, 1999; and WHEREAS, the Agreement has definitions contained therein to which reference is made to that certain Agreement of Definitions by and among the parties to this Modification dated as of September 24, 1997 (the "Agreement of Definitions"); and WHEREAS, the Loan Agreement, Sale and Assignment Agreement, the Residual Agreement and the Agreement of Definitions and all exhibits to said documents are collectively referred to herein as the "Documents"; and WHEREAS, all capitalized terms used herein and not otherwise defined in the Documents shall have the meaning set forth herein; and WHEREAS, the parties desire to modify and amend the Documents as hereinafter set forth. NOW THEREFORE, in consideration of the covenants, conditions and agreements contained in the Documents, and for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby amend the Agreement of Definitions and all other Documents as follows: 1. AMENDED AND RESTATED PROMISSORY NOTE. All recitations and references to the Note in the Agreement of Definitions and in Section 1.05 of the 2 Loan Agreement shall refer to that certain Third Amended and Restated Promissory Note in the face principal amount of $9,000,000 dated as of the date hereof, executed by FPF in favor of Lender (the "Second Amended Note"). The Third Amended Note constitutes an amendment and restatement of the Promissory Note dated September 24, 1997 in the face principal amount of $5,000,000 executed by the FPF in favor of the Lender pursuant to the Loan Agreement (the "Amended Note") and supersedes and replaces the prior Amended Note. 2. MAXIMUM CREDIT COMMITMENT as described in the Agreement of Definitions shall mean $9,000,000. 3. DOCUMENT RATIFICATION. All terms, conditions and covenants of the Documents, not otherwise modified hereby, are hereby ratified and confirmed and this Agreement, when executed by the parties hereto, shall become a part of the Documents and shall have the same force and effect as if the terms and conditions hereof were originally incorporated in the Documents prior to the execution thereof. IN WITNESS WHEREOF, the parties hereto have caused this Modification Agreement to be executed by their respective officers thereunder duly authorized as of the date and year first above written. FLATIRON FUNDING COMPANY, LLC By: /s/ Bruce Lundy Name: Bruce Lundy Title: FPF, INC. FLATIRON CREDIT COMPANY, INC. By: /s/ Bruce Lundy By: /s/ Bruce Lundy Name: Name: Title: Title: FEDERATED FUNDING CORPORATION FEDERATED PREMIUM FINANC, INC. By: /s/ Edward J. Lawson By: /s/ Stephen Young Name: Edward Lawson Name: Stephen Young Title: President Title: President 2 EX-21.1 5 g68106ex21-1.txt SUBSIDIARIES 1 EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT Assurance Managing General Agents, Inc., a Florida corporation Attorney on Call, Inc., a Florida corporation Express Insurance and Tax Service, Inc., a Florida corporation Express Tax Service, Inc., a Florida corporation Federated Agency Group, Inc., a Florida corporation Federated Funding Corporation, a Florida corporation Federated National Insurance Company, a Florida corporation Federated Premium Finance, Inc., a Florida corporation FedFirst Corp., a Florida corporation Fed USA, Inc., a Florida corporation Reliable Towing & Rental, Inc., a Florida corporation RPA Financial Corporation, a Florida corporation Superior Adjusting, Inc., a Florida corporation EX-23.1 6 g68106ex23-1.txt CONSENT OF MCKEAN, PAUL, CHRYCY, FLETCHER & CO 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS As independent certified public accountants, we hereby consent to the incorporation of our report dated March 31, 2001 included in this Form 10-KSB, into the Company's previously filed Registration Statement on Form S-8 File No. 333-94879. McKEAN, PAUL, CHRYCY, FLETCHER & CO. Plantation, Florida, March 31, 2001 EX-23.2 7 g68106ex23-2.txt CONSENT OF KPMG LLP 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors 21st Century Holding Company We consent to the incorporation by reference in the registration statement on Form S-8 (No. 333-94879) of 21st Century Holding Company of our report dated March 30, 2000, relating to the consolidated balance sheet as of December 31, 1999, and the related consolidated statements of operations, changes in shareholders' equity and comprehensive income, and cash flows for the year then ended, which report appears in the December 31, 2000 annual report on Form 10-KSB. KPMG LLP Miami, Florida March 31, 2001 -----END PRIVACY-ENHANCED MESSAGE-----