NOTE 5 – INSURANCE OPERATIONS

The Company’s primary product is homeowners insurance currently offered by APPCIC in one state (Florida) and by UPCIC in seven states, including Florida.

The following table provides the percentage of concentrations with respect to the Insurance Entities’ nationwide policies-in-force as of the periods presented:


	December 31, 2013			December 31, 2012
Percentage of Policies-In-Force:
In Florida		93	%		96	%
With wind coverage		98	%		98	%
With wind coverage in South Florida (1)		27	%		28	%

(1)	South Florida is comprised of Miami-Dade, Broward and Palm Beach counties.

Deferred Policy Acquisition Costs, net

The Company defers certain costs in connection with written policies, called Deferred Policy Acquisition Costs (“DPAC”), net of corresponding amounts of ceded reinsurance commissions, called Deferred Reinsurance Ceding Commissions (“DRCC”).

The following table presents the beginning and ending balances and the changes in DPAC, net of DRCC, for the periods presented (in thousands):


	For the years ended December 31,
	2013			2012			2011
DPAC, beginning of year (1)	$	54,431		$	50,200		$	50,127
Capitalized Costs		109,981			107,180			114,358
Amortization of DPAC		(110,313	)		(102,949	)		(107,003	)

DPAC, end of year	$	54,099		$	54,431		$	57,482

DRCC, beginning of year (1)	$	37,149		$	38,845		$	40,682
Ceding Commissions Written		89,679			85,063			89,330
Earned Ceding Commissions		(88,628	)		(86,759	)		(85,526	)

DRCC, end of year	$	38,200		$	37,149		$	44,486

DPAC (DRCC), net, beginning of year (1)	$	17,282		$	11,355		$	9,445
Capitalized Costs, net		20,302			22,117			25,028
Amortization of DPAC (DRCC), net		(21,685	)		(16,190	)		(21,477	)

DPAC (DRCC), net, end of year	$	15,899		$	17,282		$	12,996

(1)	The beginning balances for the twelve months ended December 31, 2012 have been adjusted in connection with the adoption of the FASB’s updated guidance related to deferred acquisition costs as discussed below.

As discussed in Note 2 – SIGNIFICANT ACCOUNTING POLICIES, the Company prospectively adopted new accounting guidance effective January 1, 2012 related to accounting for costs associated with acquiring or renewing insurance contracts. This guidance resulted in a 13% reduction of our net deferred policy acquisition costs as of December 31, 2011, and a corresponding pre-tax charge of $1.6 million against earnings during the first quarter of 2012. This charge represents a charge-off of capitalized costs existing at December 31, 2011, which would have been amortized to earnings within a twelve-month period under the old guidance. In the period of adoption (three months ended March 31, 2012), approximately $9 million of net costs would have been deferred under the old guidance compared to the $5.6 million under the new guidance. Future expenses will be accelerated with the adoption of this guidance, as the amounts being deferred have decreased, partially offset by less amortization. The effect of this change in periods subsequent to March 31, 2012, on income and per share amounts is not determinable as the historical methodology will have been discontinued after adoption.

Liability for Unpaid Losses and Loss Adjustment Expenses

The Insurance Entities establish liabilities for unpaid losses and loss adjustment expenses on reported and unreported claims of insured losses. These liability estimates are based on known facts and interpretation of factors such as claim payment patterns, loss payments, pending levels of unpaid claims, product mix and industry experience. The establishment of appropriate liabilities, including liabilities for catastrophes, is an inherently uncertain process. Management regularly updates its estimates as new facts become known and further events occur which may impact the resolution of unsettled claims.

The level of catastrophe loss experienced in any year cannot be predicted and could be material to results of operations and financial position. The Company’s policyholders are concentrated in South Florida, which is periodically subject to adverse weather conditions, such as hurricanes and tropical storms. During the twelve-month periods ended December 31, 2013, 2012 and 2011, the Company did not experience any significant effects from catastrophic events. Management continuously evaluates alternative business strategies to more effectively manage the Company’s exposure to catastrophe losses, including the maintenance of catastrophic reinsurance coverage as discussed in Note 4.

Management believes that the liabilities for claims and claims expense as of December 31, 2013 are appropriately established in the aggregate and adequate to cover the ultimate cost of reported and unreported claims arising from losses which had occurred by that date. However, if losses exceeded direct loss reserve estimates there could be a material adverse effect on the Company’s financial statements. Also, if there are regulatory initiatives, legislative enactments or case law precedents which change the basis for policy coverage, in any of these events, there could be an effect on direct loss reserve estimates having a material adverse effect on the Company’s financial statements.

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


	Year Ended December 31,
	2013			2012
Balance at beginning of year	$	193,241		$	187,215
Less reinsurance recoverable		(81,415	)		(88,002	)

Net balance at beginning of period		111,826			99,213

Incurred (recovered) related to:
Current year		111,560			119,458
Prior years		(2,945	)		6,729

Total incurred		108,615			126,187

Paid related to:
Current year		62,529			54,141
Prior years		67,274			59,433

Total paid		129,803			113,574

Net balance at end of period		90,638			111,826
Plus reinsurance recoverable		68,584			81,415

Balance at end of year	$	159,222		$	193,241

The liability for unpaid losses and LAE includes a decrease of $2.9 million and an increase of $6.7 million in 2013 and 2012, respectively, in response to reserve development on prior accident years. The favorable development recorded during the year ended December 31, 2013 was primarily the result of lower than anticipated loss settlements on 2004 and 2005 catastrophe claims which were recognized during the calendar year, and favorable development of accident year 2011 and 2012 non-catastrophe loss estimates which were recognized at year end 2013 after a detailed actuarial analysis. Favorable reserve development in 2013 was somewhat offset by increases in loss adjustment expense estimates on non-catastrophe claims for 2010 through 2012 accident years that were recognized at year end. The reserve development for 2012 was primarily the result of actual loss development on prior accident year non-catastrophe homeowners’ losses and higher than expected adjusting and other expenses.

Regulatory Requirements and Restrictions

The Insurance Entities are subject to regulations and standards of the OIR. These standards require the Insurance Entities to maintain specified levels of statutory capital and restrict the timing and amount of dividends and other distributions that may be paid to the parent company. Except in the case of extraordinary dividends, these standards generally permit dividends to be paid from statutory unassigned surplus of the regulated subsidiary and are limited based on the regulated subsidiary’s level of statutory net income and statutory capital and surplus. The maximum dividend that may be paid by UPCIC and APPCIC to their immediate parent company, Universal Insurance Holding Company of Florida (“UIHCF”), without prior approval is limited to the lesser of statutory net income from operations of the preceding calendar year or 10.0% of statutory unassigned surplus as of the preceding year end. These dividends are referred to as “ordinary dividends” and generally can be paid without prior regulatory approval. If the dividend, together with other dividends paid within the preceding twelve months, exceeds a specified statutory limit or is paid from sources other than earned surplus, the entire dividend is generally considered an “extraordinary dividend” and must receive prior regulatory approval.

Based on the 2012 statutory net income and statutory capital and surplus levels, UPCIC and APPCIC did not have the capacity to pay ordinary dividends during 2013. No dividends were paid from UPCIC or APPCIC to UIHCF during the years ended December 31, 2013, 2012 and 2011. Dividends paid to the shareholders of UIH are paid from the equity of UIH not from the surplus of the Insurance Entities.

The Florida Insurance Code requires companies to maintain capitalization equivalent to the greater of ten percent of the insurer’s total liabilities or $5.0 million. The following table presents the amount of statutory capital and surplus, and an amount representing ten percent of total liabilities for both UPCIC and APPCIC as of the periods presented (in thousands):


	As of December 31,
	2013		2012
Ten percent of total liabilities
UPCIC	$	39,179	$	39,260
APPCIC	$	625	$	694
Statutory capital and surplus
UPCIC	$	161,803	$	134,034
APPCIC	$	13,708	$	14,330

At such dates in the table above, both UPCIC and APPCIC met the Florida capitalization requirement. UPCIC and APPCIC are also required to adhere to prescribed premium-to-capital surplus ratios and have met those requirements at such dates.

Through UIHCF, the Insurance Entities’ parent company, UIH recorded capital contributions for the periods presented (in thousands):


	For the Years Ended December 31,
	2013		2012		2011
Capital Contributions	$	—	$	28,550	$	49,000

UPCIC and APPCIC are required annually to comply with the NAIC RBC requirements. RBC requirements prescribe 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 requirements are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2013, based on calculations using the appropriate NAIC RBC formula, UPCIC’s and APPCIC’s reported total adjusted capital was in excess of the requirements.

The Company is required by various state laws and regulations to maintain certain assets in depository accounts. The following table represents assets held by insurance regulators as of the periods presented (in thousands):


	As of		As of
	December 31,		December 31,
	2013		2012
Restricted cash and cash equivalents	$	2,600	$	33,009
Investments	$	3,707	$	4,009

In November 2012, the Florida Insurance Guaranty Association (“FIGA”) Board of Directors determined the need for an emergency assessment upon its member companies. The assessment was 0.9% of each respective member’s Florida net direct premiums for calendar year 2011. The Insurance Entities’ participation in this assessment totaled $6.3 million based on 2011 net direct premiums generated in Florida of approximately $704.8 million. Pursuant to Florida statutes, insurers are permitted to recoup the assessment by adding a surcharge to policies in an amount not to exceed the amount paid by the insurer to FIGA. As a result, the Insurance Entities recorded this assessment as an expense during the year ended December 31, 2012 and began to recoup the assessment on February 1, 2013. The Company has recouped the majority of this assessment as of December 31, 2013.

UPCIC received an order from the OIR dated May 30, 2013 related to the OIR’s Target Market Conduct Final Examination Report of UPCIC for the period January 2009 through May 2013 (“OIR Order”). The OIR Order alleged certain violations and findings and sought to impose certain requirements and an administrative fine of $1.3 million upon UPCIC. On October 4, 2013, UPCIC and the OIR signed a Consent Order settling the OIR Order. The Consent Order clarified language contained in the OIR Order, imposed certain requirements on UPCIC and required UPCIC to pay the administrative fine of $1.3 million, which it paid on October 18, 2013.