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FNHC > SEC Filings for FNHC > Form 10-Q on 15-May-2012All Recent SEC Filings

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Form 10-Q for 21ST CENTURY HOLDING CO


15-May-2012

Quarterly Report

Management's Discussion and Analysis of Financial Condition and Results of Operations

The availability and costs associated with the acquisition of reinsurance will vary year to year. These fluctuations, which can be significant, are not subject to our control and may limit our ability to purchase adequate coverage. For example, FHCF has restricted its very affordable reinsurance capacity for the 2011-2012 and 2010-2011 hurricane seasons and is expected to continue constricting its claim paying capacity for future seasons. This gradual restriction is requiring us to replace that capacity with more expensive private market reinsurance. The recovery of increased reinsurance costs through rate action is not immediate and cannot be presumed, as it is subject to Florida OIR approval. Our reinsurance program is subject to approval by the Florida OIR and review by Demotech, Inc. ("Demotech").

Our property lines of business include homeowners' and fire. For the 2011-2012 hurricane season, the excess of loss and FHCF treaties will insure the property lines for approximately $298.0 million of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $226.0 million, with the Company retaining the first $7.0 million of losses and LAE for each event. Our reinsurance program includes coverage purchased from the private market, which affords optional reinstatement premium protection that provides coverage beyond the first event, along with any remaining coverage from the FHCF. Coverage afforded by the FHCF totals approximately $154.1 million, or 51.7% of the $298.0 million of aggregate catastrophic losses and LAE. The FHCF affords coverage for the entire season, subject to maximum payouts, without regard to any particular insurable event.

The estimated cost to the Company for the excess of loss reinsurance products for the 2011-2012 hurricane season, inclusive of approximately $11.7 million payable to the FHCF and the prepaid automatic premium reinstatement protection, is approximately $39.7 million.

Annually, the cost and amounts of reinsurance are based on management's analysis of Federated National's exposure to catastrophic risk as of June 30 and estimated to September 30. Our data is then subjected to actual exposure level analysis as of September 30. This analysis of our exposure level in relation to the total exposures to the FHCF and excess of loss treaties may produce changes in limits and reinsurance premiums as a result of the reconciliation of estimated to actual exposure level. The September 30, 2010 change to total limits was an increase of $10.3 million of probable maximum loss or 2.9% and the change to reinsurance premiums was an increase of $3.7 million or 8.7%. The September 30, 2011 change to total limits was an increase of $172.2 million of total insured value or 1.4 % and the change to reinsurance premiums was an increase of $0.5 million or 1.1%. The subsequent change to management's June 30, 2011 exposure analysis, as of September 30, 2011 is being amortized over the underlying policy term.

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                          21st Century Holding Company
              Notes to Condensed Consolidated Financial Statements

The 2011-2012 private reinsurance companies and their respective A.M. Best
Company ("A.M. Best") rating are listed in the table as follows.

Reinsurer                                                     A.M. Best Rating

UNITED STATES
American Agricultural Insurance                                         A-
Everest Reinsurance Company                                             A+        (2)
Houston Casualty Co. (UK Branch)                                        A+        (2)
Munich Reinsurance America, Inc.                                        A+        (2)
Odyssey Reinsurance Company                                             A
QBE Reinsurance Corporation                                             A         (2)

BERMUDA
ACE Tempest Reinsurance Ltd.                                            A+      * (2)
Arch Reinsurance Limited                                                A         (2)
Ariel Reinsurance Company Limited                                       A-      *
DaVinci Reinsurance Limited                                             A       * (2)
D.E. Shaw Re (Bermuda) Ltd.                                             NR        (1)
JC Re Ltd (Juniperus)                                                   NR      * (1)
Montpelier Reinsurance Ltd.                                             A-
Renaissance Reinsurance Limited                                         A+      * (2)
Torus Insurance (Bermuda) Limited                                       A-      *

UNITED KINGDOM
Amlin Syndicate No. 2001 (AML)                                          A       * (2)
Antares Syndicate No. 1274 (AUL)                                        A         (2)
Arrow Syndicate No. 1910 (ARW)                                          A       * (2)
Broadgate Underwriting Limited Syndicate No. 1301 (BGT)                 A         (2)
Liberty Syndicates Paris/Syndicate 4472                                 A         (2)
MAP Underwriting Syndicate No. 2791 (MAP)                               A       * (2)
Novae Syndicate No. 2007 (NVA)                                          A         (2)

EUROPE
Amlin Bermuda Limited                                                   A         (2)
Flagstone Reassurance Suisse SA                                         A-
Lansforsakringar Sak Forsakringsaktiebolag                              NR-5      (2)
Scor Switzerland AG                                                     A         (2)

* Reinstatement Premium Protection Program Participants

(1) Participant will fund a trust agreement for their exposure with cash and U.S. Government obligations of American institutions at fair market value.

(2) Standard & Poor's rated "A" or higher (investment grade - economic situation can affect finance)

For the 2010-2011 hurricane season, the excess of loss and FHCF treaties insured the property lines for approximately $360.7 million of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $285.5 million, with the Company retaining the first $5.0 million of losses and LAE for each event. Our reinsurance program included coverage purchased from the private market, which afforded optional reinstatement premium protection that provided coverage beyond the first event, along with coverage from the FHCF. Coverage afforded by the FHCF totaled approximately $220.4 million, or 61.1% of the $360.7 million of aggregate catastrophic losses and LAE. The FHCF affords coverage for the entire season, subject to maximum payouts, without regard to any particular insurable event.

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                          21st Century Holding Company
              Notes to Condensed Consolidated Financial Statements

The estimated cost to the Company for the excess of loss reinsurance products
for the 2010-2011 hurricane season, inclusive of approximately $19.1 million
payable to the FHCF and the prepaid automatic premium reinstatement protection,
was approximately $46.5 million.

The 2010-2011 private reinsurance companies and their respective A.M. Best
rating are listed in the table as follows.

 Reinsurer                                                     A.M. Best Rating

UNITED STATES
American Agricultural Insurance                                          A             (2)
Everest Reinsurance Company                                              A+            (2)
Munich Reinsurance America, Inc.                                         A+            (2)
QBE Reinsurance Corporation                                              A             (2)

BERMUDA
ACE Tempest Reinsurance Ltd.                                             A+        *   (2)
Actua Re Limited                                                         NR        *   (1)
Amlin Bermuda Limited                                                    A             (2)
Ariel Reinsurance Company Limited                                        A-        *
DaVinci Reinsurance Limited                                              A         *   (2)
Flagstone Reinsurance Limited                                            A-
Montpelier Reinsurance Ltd.                                              A-            (2)
Nephila/ Allianz Risk Trnsfr Zurich (BDA)                                NR-5      *   (2)
Renaissance Reinsurance Limited                                          A+        *   (2)
Torus Insurance (Bermuda) Limited                                        A-        *

UNITED KINGDOM
Antares Syndicate No. 1274 (AUL)                                         A             (2)
Broadgate Underwriting Limited Syndicate No. 1301 (BGT)                  A             (2)
Arrow Syndicate No. 1910 (ARW)                                           A         *   (2)
Amlin Syndicate No. 2001 (AML)                                           A             (2)
Novae Syndicate No. 2007 (NVA)                                           A             (2)
Houson Casualty Co. (UK Branch)                                          A+            (2)

EUROPE
Lansforsakringar Sak Forsakringsaktiebolag                               NR-5          (2)
Liberty Syndicates Paris/Syndicate 4472                                  A             (2)

* Reinstatement Premium Protection Program Participants

(1) Participant has funded a trust agreement for their exposure with approximately $3.8 million of cash and U.S. Government obligations of American institutions at fair market value.

(2) Standard & Poor's rated "A" or higher (investment grade - economic situation can affect finance)

For the 2012-2013 hurricane season, Federated National entered into a Reimbursement Contract and Addendum No. 1 thereto with SBA on February 28, 2012. This Reimbursement Contract will reimburse Federated National for covered property losses under its homeowners' insurance policies resulting from hurricanes that cause damage in the State of Florida through May 31, 2013. Under this Reimbursement Contract, the FHCF will provide approximately $135.0 million of aggregate seasonal coverage for covered losses in excess of approximately $53.0 million, subject to a 10.0% Company participation. Federated National's premium for the FHCF reinsurance coverage will be approximately $8.2 million payable in three installments between August 2012 and December 2012. The actual attachment point, total coverage and cost will not be finalized until December 31, 2012.

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21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

Pursuant to commutation provisions contained in the original 2005 FHCF agreement, on July 21, 2011 Federated National and the FHCF negotiated such a commutation agreement for the 2005 contract year. The terms of the agreement provide that Federated National release the FHCF from all its obligations under the original reinsurance agreement for a negotiated consideration as a final payment for all unpaid claims subject to the treaty. This negotiation resulted in a final commutation payment received by us for a total of $4.1 million, which is the maximum available under the treaty to pay loss and LAE including incurred but not yet reported ("IBNR") for the subject losses. The benefit of the FHCF treaty inures to the benefit of the private reinsurers participating in the treaty.

The FHCF reimbursement contract and addendums were all effective June 1, 2011, and the private excess of loss type treaties were all effective July 1, 2011; all treaties have a term of one year. Our reinsurance treaty with the FHCF has a significant credit risk, including the fact that the FHCF may not be able to raise sufficient money to pay its claims or be able to pay its claims in a timely manner. This could result in significant financial, legal and operational challenges to all companies, including ours. Additionally, the FHCF treaty contains an exclusion for "Losses in excess of the sum of the Balance of the Fund as of December 31 of the Contract Year and the amount the SBA is able to raise through the issuance of revenue bonds or by the use of other financing mechanisms, up to the limit pursuant to Section 215.555(4) (c), Florida Statutes." This credit risk is mitigated by a fund cash buildup due to the absence of covered events in recent years.

To date, we have made no claims asserted against our reinsurers in connection with the 2011-2012 and 2010-2011 excess of loss and FHCF treaties.

As regards to the commercial multi-peril property program that began recording premium on August 28, 2009, we have secured an automatic facultative reinsurance agreement with Munich Reinsurance America, Inc. ("Munich Re") and Ascot Underwriting Limited ("Ascot") for bound risks with total insured values not to exceed $10.0 million, with additional coverage in excess of $10.0 million available upon submission and subjected to underwriting guidelines. This coverage excludes catastrophic wind-storm risk. A.M. Best ratings for Munich Re and Ascot are A+ and A, respectively.

During 2010, the Company secured casualty reinsurance affording coverage totaling $4.0 million in excess of $1.0 million. This reinsurance also protects the Company against extra contractual obligations and losses in excess of policy limits. Any loss occurrence that involves liability exposure written by either Federated National or American Vehicle or a combination of both will be covered. The cost of this coverage totaled approximately $0.5 million.

In order to expand our commercial business, American Vehicle entered into various quota share reinsurance agreements whereby American Vehicle is the assuming reinsurer. On March 26, 2009, we announced that American Vehicle received approval from the Florida OIR to enter into a reinsurance relationship allowing the opportunity to market and underwrite commercial insurance through a company that has an "A" rating with A.M. Best. This agreement was designed to enable the deployment of commercial general liability and other commercial insurance products in most of the contiguous 48 states to policyholders who require their commercial insurance policy to come from an insurance company with an A- or better A.M. Best rating. Operations began during the quarter ended June 30, 2009. During 2011, the companies mutually agreed to suspend this treaty effective May 15, 2011.

The quota share retrocessionaire reinsurance agreements require American Vehicle to securitize credit, regulatory and business risk. As of December 31, 2010, irrevocable letters of credit fully collateralized by American Vehicle and further guaranteed by the parent company, 21st Century, were replaced by fully funded trust agreements. Fully funded trust agreements totaled $4.8 million and $4.7 million as of March 31, 2012 and December 31, 2011, respectively.

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Index

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

We are selective in choosing reinsurers and consider numerous factors, the most important of which are the financial stability of the reinsurer, their history of responding to claims and their overall reputation. In an effort to minimize our exposure to the insolvency of a reinsurer, we evaluate the acceptability and review the financial condition of the reinsurer at least annually.

(8) Stock Compensation Plans

We implemented a stock option plan in September 1998, which expired in September 2008, and provided for the granting of stock options to officers, key employees and consultants. The objectives of this plan included attracting and retaining the best personnel, providing for additional performance incentives, and promoting our success by providing employees the opportunity to acquire common stock. Options outstanding under this plan were granted at prices either equal to or above the market value of the stock on the date of grant, typically vest over a four-year or five-year period and expire six or ten years after the grant date. Under this plan, we were authorized to grant options to purchase up to 900,000 common shares, and, as of March 31, 2012 and December 31, 2011, we had outstanding exercisable options to purchase 88,500 and 89,750 shares, respectively.

In 2001, we implemented a franchisee stock option plan that was terminated during September 2008, and provided for the granting of stock options to individuals purchasing Company owned agencies that were then converted to franchised agencies. The purpose of the plan was to advance our interests by providing an additional incentive to encourage managers of Company owned agencies to purchase the agencies and convert them to franchises. Options outstanding under the plan were granted at prices, which were above the market value of the stock on the date of grant, vested over a ten-year period, and expired ten years after the grant date. Under this plan, we were authorized to grant options to purchase up to 988,500 common shares, and, as of March 31, 2012 and December 31, 2011, we had no outstanding exercisable options to purchase shares.

In 2002, we implemented the 2002 Stock Option Plan. The purpose of this plan is to advance our interests by providing an additional incentive to attract, retain and motivate highly qualified and competent persons who are key to the Company, including employees, consultants, independent contractors, officers and directors. Our success is largely dependent upon their efforts and judgment; therefore, by authorizing the grant of options to purchase common stock, we encourage stock ownership. Options outstanding under the plan were granted at prices either equal to or above the market value of the stock on the date of grant, expire six or ten years after the grant date and have vesting periods determined by the Compensation Committee of our Board of Directors. Under this plan, we are authorized to grant options to purchase up to 1,800,000 common shares, and, as of March 31, 2012 and December 31, 2011, we had outstanding exercisable options to purchase 623,500 and 624,700 shares, respectively.

FASB issued guidance requires that when valuing an employee stock option under the Black-Scholes option pricing model, the fair value be based on the option's expected term and expected volatility rather than the contractual term. The estimate of the fair value on the grant date should reflect the assumptions marketplace participants now use on the date of the measurement (i.e. grant date). During 2011, management changed the expected term in the Black -Scholes option pricing model from four years to two years for new options granted. Management believes that share price volatility over the last two years is more indicative of future share price volatility. The change has had an immaterial impact on the financial statements.

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Index

                          21st Century Holding Company
              Notes to Condensed Consolidated Financial Statements

Activity in our stock option plans for the period from January 1, 2010 to March
31, 2012 is summarized below.

                                            1998 Plan                           2002 Plan
                                                    Weighted                            Weighted
                                                    Average                             Average
                                 Number of           Option          Number of           Option
                                   Shares        Exercise Price        Shares        Exercise Price
Outstanding at January 1, 2010      124,599     $          15.88        736,951     $          12.03
Granted                                   -     $              -        109,500     $           3.59
Exercised                                 -     $              -              -     $              -
Cancelled                           (34,849 )   $          23.74       (271,651 )   $          14.78
Outstanding at January 1, 2011       89,750     $          12.83        574,800     $           9.12
Granted                                   -     $              -        179,000     $           2.45
Exercised                                 -     $              -              -     $              -
Cancelled                                 -     $              -       (129,100 )   $          14.29
Outstanding at January 1, 2012       89,750     $          12.83        624,700     $           6.15
Granted                                   -     $              -              -     $              -
Exercised                                 -     $              -              -     $              -
Cancelled                            (1,250 )   $           6.67         (1,200 )   $           2.59
Outstanding at March 31, 2012        88,500     $          12.92        623,500     $           6.15

Options outstanding as of March 31, 2012 are exercisable as follows.

                                       1998 Plan                            2002 Plan
                                                Weighted                            Weighted
                                                Average                             Average
                             Number of           Option          Number of           Option
Options Exercisable at:       Shares         Exercise Price        Shares        Exercise Price

March 31, 2012                   70,100     $          12.92        307,700     $           6.15
December 31, 2012                17,700     $          12.92         94,564     $           6.15
December 31, 2013                   700     $          12.92        110,380     $           6.15
December 31, 2014                     -     $              -         91,056     $           6.15
December 31, 2015                     -     $              -         19,800     $           6.15
December 31, 2016                     -     $              -              -     $              -
Thereafter                            -     $              -              -     $              -
Total options exercisable        88,500                             623,500

Prior to January 1, 2006, we accounted for the plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by the APB and related Interpretation, as permitted by FASB issued guidance. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.

Upon the exercise of options, the Company issues authorized shares.

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Index

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB issued guidance using the modified-prospective-transition method. Under that transition method, compensation costs recognized during 2012 and 2011 include the following.

Compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FASB issued guidance, and

Compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair-value estimated in accordance with the provisions of FASB issued guidance. Results for prior periods have not been restated, as they are not required to be by the pronouncement.

As a result of adopting FASB issued guidance on January 1, 2006, the Company's income from continuing operations before provision for income tax expense and net income for the three months ended March 31, 2012 are lower by approximately $58,000 and $36,000, respectively, than if it had continued to account for share-based compensation under APB guidance.

As a result of adopting FASB issued guidance on January 1, 2006, the Company's income from continuing operations before provision for income taxes and net income for the three months ended March 31, 2011 are lower by approximately $62,000 and $39,000, respectively, than if it had continued to account for share-based compensation under APB guidance.

Basic and diluted earnings per share for the three months ended March 31, 2012 would have remained unchanged at $0.13, if the Company had not adopted FASB issued guidance, compared with reported basic and diluted earnings per share of $0.13.

Basic and diluted earnings per share for the three months ended March 31, 2011 would have been ($0.25), if the Company had not adopted FASB issued guidance, compared with the unchanged reported basic and diluted earnings per share of ($0.25).

Because the change in income taxes receivable includes the effect of excess tax benefits, those excess tax benefits also must be shown as a separate operating cash outflow so that operating cash flows exclude the effect of excess tax benefits. FASB issued guidance requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.

There were no options granted during the three months ended March 31, 2012 or 2011, respectively.

The fair value of options granted is estimated on the date of grant using the following assumptions.

                           March 31, 2012   March 31, 2011
Dividend yield                  N/A              N/A
Expected volatility             N/A              N/A
Risk-free interest rate         N/A              N/A
Expected life (in years)        N/A              N/A

Summary information about the Company's stock options outstanding at March 31, 2012 as follows.

                                                                          Weighted Average          Weighted
                                  Range of          Outstanding at          Contractual             Average           Exercisable at
                               Exercise Price       March 31, 2012        Periods in Years       Exercise Price       March 31, 2012
1998 Plan                     $  6.67 - $16.59                88,500                   1.47     $          12.92                70,100
2002 Plan                     $  2.45 - $18.21               623,500                   5.18     $           6.15               307,700

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21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

(9) Stockholders' Equity

Capital Stock

The Company's authorized capital consists of 1,000,000 shares of preferred stock, par value $0.01 per share, and 25,000,000 shares of common stock, par value $0.01 per share. As of March 31, 2012, there were no preferred shares issued or outstanding and there were 7,946,384 shares of common stock outstanding.

. . .

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