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UNAM > SEC Filings for UNAM > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for UNICO AMERICAN CORP

Form 10-Q for UNICO AMERICAN CORP


14-Nov-2012

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

General

Unico American Corporation is an insurance holding company that underwrites property and casualty insurance through its subsidiary Crusader Insurance Company (Crusader); provides property, casualty, and health insurance through its agency subsidiaries; and provides insurance premium financing and membership association services through its other subsidiaries.

Total revenue for the three months ended September 30, 2012, was $8,228,464 compared to $9,077,819 for the three months ended September 30, 2011, a decrease of $849,355 (9%). Total revenue for the nine months ended September 30, 2012, was $24,830,485 compared to $26,264,663 for the nine months ended September 30, 2011, a decrease of $1,434,178 (5%). The Company had net income of $745,595 for the three months ended September 30, 2012, compared to $1,274,652 for the three months ended September 30, 2011, a decrease of $529,057 (42%). For the nine months ended September 30, 2012, the Company had net income of $1,402,740, compared to $3,095,686 for the nine months ended September 30, 2011, a decrease of $1,692,946 (55%). The decrease in net income in the three and nine months ended September 30, 2012 compared to the prior year periods is primarily due to a decrease in investment income of $430,194 and $914,023 for the three and nine months ended September 30, 2012, respectively, an increase in losses and loss adjustment expenses of $214,169 and $1,003,782 for the three and nine months ended September 30, 2012, respectively, and an increase in salaries and employee benefits of $104,796 and $646,983 (primarily due to the adoption of ASU 2010-26 and an adjustment made in the three months ended March 31, 2011, to the Company's profit sharing plan contribution).

This overview discusses some of the relevant factors that management considers in evaluating the Company's performance, prospects, and risks. It is not all inclusive and is meant to be read in conjunction with the entirety of the management discussion and analysis, the Company's consolidated financial statements and notes thereto, and all other items contained within the report on this Form 10-Q.

Revenue and Income Generation

The Company receives its revenue primarily from earned premium derived from the insurance company operations, commission and fee income generated from the insurance agency operations, finance charges and fee income from the premium finance operations, and investment income from cash generated primarily from the insurance company operation. The insurance company operation generated approximately 90% of consolidated revenues for the three and nine months ended September 30, 2012, compared to 90% and 89% of consolidated revenues for the three and nine months ended September 30, 2011, respectively. The Company's remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually not material to consolidated revenues.

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Insurance Company Operation

The property and casualty insurance industry is highly competitive and includes many insurers, ranging from large companies offering a wide variety of products worldwide to smaller, specialized companies in a single state or region offering only a single product. Many of the Company's existing or potential competitors have considerably greater financial and other resources, have a higher rating assigned by independent rating organizations such as A.M. Best Company, have greater experience in the insurance industry and offer a broader line of insurance products than the Company. As of September 30, 2012, Crusader was licensed as an admitted insurance carrier in the states of Arizona, California, Nevada, Oregon, and Washington. Since 2004, all of Crusader's business has been written in the state of California. In December of 2011, A.M. Best Company reaffirmed Crusader's financial strength rating of A- (Excellent) and a rating outlook of "stable." In addition, Crusader was assigned an Issuer Credit Rating of a- (Excellent).

Premium written (before reinsurance) is a non-GAAP financial measure which is defined, under statutory accounting, as the contractually determined amount charged by the company to the policyholder for the effective period of the contract based on the expectation of risk, policy benefits, and expenses associated with the coverage provided by the terms of the policies. Premiums written is a required statutory measure designed to determine written premium production levels. Premium earned, the most directly comparable GAAP measure, represents the portion of premiums written that is recognized as income in the financial statements for the period presented and earned on a pro-rata basis over the terms of the policies.

Premium written before reinsurance increased $471,432 (6%) and $755,359 (3%) to $8,176,524 and $24,914,049 for the three and nine months ended September 30, 2012, respectively, compared to $7,705,092 and $24,158,690 for the three and nine months ended September 30, 2011, respectively.

Crusader's underwriting profit (before income taxes) is as follows:

                                            Three Months Ended September 30                   Nine Months Ended September 30
                                                                       Increase                                           Increase
                                         2012            2011         (Decrease)          2012             2011          (Decrease)

Net premium earned                   $ 6,941,010     $ 6,700,560     $   240,450     $ 20,436,671     $ 20,047,182     $    389,489

Less:
Losses and loss
adjustment expenses                    3,571,972       3,357,803         214,169       11,620,183       10,616,401        1,003,782
Policy acquisition costs               1,659,945       1,778,105        (118,160 )      5,128,473        5,322,970         (194,497 )
  Total                                5,231,917       5,135,908          96,009       16,748,656       15,939,371          809,285
Underwriting Profit
(Before Income Taxes)                $ 1,709,093     $ 1,564,652     $   144,441     $  3,688,015     $  4,107,811     $   (419,796 )

The following table provides an analysis of the losses and loss adjustment expenses as follows:

                                                Three Months Ended September 30                   Nine Months Ended September 30
                                                                           Increase                                           Increase
                                             2012            2011         (Decrease)          2012             2011          (Decrease)
Losses and loss adjustment expenses
 Current accident year                   $ 4,597,500     $ 5,040,499     $  (442,999 )   $ 15,259,868     $ 14,398,512     $    861,356
Favorable  development of all prior
accident years                             1,025,528       1,682,696        (657,168 )      3,639,685        3,782,111         (142,426 )
  Total                                  $ 3,571,972     $ 3,357,803     $   214,169     $ 11,620,183     $ 10,616,401     $  1,003,782

Losses and loss adjustment expenses were 51% and 57% of net premium earned for the three and nine months ended September 30, 2012, respectively, compared to 50% and 53% of net premium earned for the three and nine months ended September 30, 2011, respectively.

Other Operations

The Company's other revenues from insurance operations consist of commissions, fees, finance charges, and investment and other income. Excluding investment and other income, these operations accounted for approximately 10% of total revenues in the three and nine months ended September 30, 2012, compared to 10% and 11% of total revenues in the three and nine months ended September 30, 2011, respectively.

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Investments and Liquidity

The Company generates revenue from its investment portfolio, which consisted of $124,545,446 of fixed maturities and short-term investments (at amortized cost) at September 30, 2012, compared to $128,042,146 (at amortized cost) at December 31, 2011. Investment income decreased $430,194 (59%) and $914,023 (40%) to $303,541 and $1,360,010 for the three and nine months ended September 30, 2012, respectively, compared to $733,735 and $2,274,033 for the three and nine months ended September 30, 2011, respectively. The decrease in investment income is primarily a result of a decrease in invested assets and a decrease in the Company's annualized weighted average investment yield on its fixed maturity obligations to 1.4% and 1.0% for the three and nine months ended September 30, 2012, respectively, from 2.3% for the three and nine months ended September 30, 2011. Due to the current interest rate environment, management believes it is prudent to purchase fixed maturity investments with maturities of five years or less and with minimal credit risk.

Liquidity and Capital Resources

Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, reserves for loss payments, and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its investments. As of September 30, 2012, the Company had cash and investments of $124,639,965 (at amortized cost) of which $121,536,861 (98%) were cash and investments of Crusader.

As of September 30, 2012, the Company had invested $46,499,034 (at amortized cost) or 37% of its invested assets in fixed maturity obligations. In accordance with ASC 320, the Company is required to classify its investments in debt and equity securities into one of three categories: held-to-maturity, available-for-sale, or trading securities. Although all of the Company's investments are classified as available-for-sale, the Company's investment guidelines place primary emphasis on buying and holding high-quality investments until maturity.

The Company's investments in fixed maturity obligations of $46,499,034 (at amortized cost) include $35,364,034 (76%) of U.S. treasury securities and $11,135,000 (24%) of long-term certificates of deposit. The remaining balance of the Company's investments are in short-term investments that include U.S. treasury bills, U.S. treasury money market fund and bank money market and savings accounts that are all highly rated and redeemable within one year.

The Company's investment guidelines on equity securities limit investments in equity securities to an aggregate maximum of $2,000,000. The Company's investment guidelines on fixed maturities limit those investments to high-grade obligations with a maximum term of eight years. The maximum investment authorized in any one issuer is $2,000,000. This dollar limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues. Investments in municipal securities, when made, are primarily pre-refunded and secured by U.S. treasury securities. The short-term investments are either U.S. government obligations, FDIC insured, or are in an institution with a Moody's rating of P2 and/or a Standard & Poor's rating of A1. All of the Company's fixed maturity investment securities are rated, readily marketable, and could be liquidated without any materially adverse financial impact.

On December 19, 2008, the Board of Directors authorized a stock repurchase program to acquire, from time to time, up to an aggregate of 500,000 shares of the Company's common stock. This program has no expiration date and may be terminated by the Board of Directors at any time. During the three and nine months ended September 30, 2012, the Company repurchased 16,782 shares and 22,068 shares of the Company's common stock, in unsolicited transactions at a cost of $171,815 and $226,172, respectively, of which $8,247 and $10,845 were allocated to capital and $163,568 and $215,327 were allocated to retained earnings, respectively. As of September 30, 2012, the Company had remaining authority under the 2008 program to repurchase up to an aggregate of 224,164 shares of its common stock. The 2008 program is the only program under which there is authority to repurchase shares of the Company's common stock. The Company has or will retire all stock repurchased.

The Company reported $1,996,388 net cash used by operating activities for the nine months ended September 30, 2012, an increase of $1,296,409 (185%) compared to $699,979 net cash used by operating activities for the nine months ended September 30, 2011. The increase in net cash used by operating activities in the nine months ended September 30, 2012, is due primarily to an increase in loss and loss adjustment expense payments in the current year compared to the prior year period. Cash flows can change from period to period depending largely on the amount and the timing of claims payments. The variability of the Company's losses and loss adjustment expenses is primarily due to its small population of claims which may result in greater fluctuations in claim frequency and/or severity. As of September 30, 2012, the Company had only 910 open claims. Although the consolidated statements of cash flows continue to reflect net cash used by operating activities, the Company continues to be profitable, well capitalized, and adequately reserved; and it does not anticipate future liquidity problems. As of September 30, 2012, all of the Company's investments are in U.S. treasury securities; FDIC insured certificates of deposit and money market funds. The Company's investments in U.S treasury securities and money market funds are readily marketable. The weighted average maturity of the Company's investments is approximately 0.7 years.

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Although material capital expenditures may also be funded through borrowings, the Company believes that its cash and short-term investments at September 30, 2012, net of trust restrictions of $659,459, statutory deposits of $700,000, and California insurance company statutory dividend rules applicable to Crusader, should be sufficient to meet its operating requirements during the next twelve months without the necessity of borrowing funds.

Results of Operations

All comparisons made in this discussion are comparing the three and nine months ended September 30, 2012, to the three and nine months ended September 30, 2011, unless otherwise indicated.

The Company had net income of $745,595 for the three months ended September 30, 2012, compared to net income of $1,274,652 for the three months ended September 30, 2011, a decrease in net income of $529,057 (42%). The Company had net income of $1,402,740 for the nine months ended September 30, 2012, compared to net income of $3,095,686 for the nine months ended September 30, 2011, a decrease in net income of $1,692,946 (55%). Total revenues decreased $849,355 (9%) to $8,228,464 for the three months and $1,434,178 (5%) to $24,830,485 for the nine months ended September 30, 2012, compared to total revenues of $9,077,819 and $26,264,663 for the three months and nine months ended September 30, 2011, respectively.

Premium written (before reinsurance) is a required statutory measure designed to determine written premium production levels. Direct written premium reported on the Company's statutory statement increased $471,432 (6%) and $755,359 (3%) to $8,176,524 and $24,914,049 for the three and nine months ended September 30, 2012, respectively, compared to $7,705,092 and $24,158,690 for the three and nine months ended September 30, 2011, respectively. The increase in written premium in 2012 indicates stabilization in the insurance marketplace.

The property and casualty insurance industry is characterized by periods of soft market conditions, in which premium rates are stable or falling and insurance is readily available, and by periods of hard market conditions, in which premium rates rise, coverage may be more difficult to find, and insurers' profits increase. The Company believes that the California property and casualty insurance marketplace is stabilizing. The Company cannot determine how long the existing market conditions will continue nor in which direction they might change. Despite the increased competition in the property and casualty marketplace, the Company believes that rate adequacy is more important than premium growth and that underwriting profit is its primary goal. Nonetheless, Crusader believes that it can grow its sales and profitability by continuing to focus upon three key areas of its operations: (1) product development, (2) improved service to retail brokers and (3) appointment of captive and independent retail agents.

Premium earned before reinsurance increased $211,060 (3%) and $214,337 (1%) to $8,233,042 and $24,235,887 for the three and nine months ended September 30, 2012, respectively, compared to $8,021,982 and $24,021,550 for the three and nine months ended September 30, 2011, respectively. The Company writes annual policies and, therefore, earns written premium ratably over the one-year policy term.

Earned ceded premium decreased $29,390 (2%) and $175,152 (4%) to $1,292,032 and $3,799,216 for the three and nine months ended September 30, 2012, respectively, compared to $1,321,422 and $3,974,368 for the three and nine months ended September 30, 2011, respectively. Total earned ceded premium was 16% of direct earned premium in the three and nine months ended September 30, 2012, compared to 16% and 17% of direct earned premium in the three and nine months ended September 30, 2011, respectively. The decrease in earned ceded premium is primarily a result of a decrease in the rates charged by Crusader's reinsurers. The decrease in the reinsurer's rates is primarily due to changes in both the Company's retention and participation in its reinsurance treaties that the Company made in 2011 and continued in 2012. In calendar years 2012 and 2011 Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($500,000 in excess of $500,000), 5% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 0% in its property and casualty clash treaty. The Company evaluates each of its ceded reinsurance contracts at its inception to determine if there is a sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting literature. As of September 30, 2012, all such ceded contracts are accounted for as risk transfer reinsurance.

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In calendar years 2010 and 2009 Crusader retained a participation in its excess of loss reinsurance treaties of 20% in its 1st layer ($700,000 in excess of $300,000), 15% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 0% in its property and casualty clash treaty.

Direct earned premium and earned ceded premium are as follows:

                                            Three Months Ended September 30                    Nine months Ended September 30
                                                                        Increase                                           Increase
                                         2012            2011          (Decrease)          2012             2011          (Decrease)
Direct earned premium                $ 8,233,042     $ 8,021,982     $    211,060     $ 24,235,887     $ 24,021,550     $    214,337
Earned ceded premium                   1,292,032       1,321,422          (29,390 )      3,799,216        3,974,368         (175,152 )
   Net Earned Premium                $ 6,941,010     $ 6,700,560     $    240,450     $ 20,436,671     $ 20,047,182     $    389,489

The 2007 through 2012 excess of loss treaties do not provide for a contingent commission. Crusader's 2006 1st layer primary excess of loss treaty provides for a contingent commission equal to 20% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2006, through December 31, 2006. The 2005 excess of loss treaties do not provide for a contingent commission. Crusader's 2004 and 2003 1st layer primary excess of loss treaties provide for a contingent commission to the Company equal to 45% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2003, through December 31, 2004. For each accounting period as described above, the Company will calculate and report to the reinsurers its net profit (excluding incurred but not reported losses), if any, within 90 days after 36 months following the end of the first accounting period, and within 90 days after the end of each 12-month period thereafter until all losses subject to the agreement have been finally settled. Any contingent commission received is subject to return based on future development of ceded losses and loss adjustment expenses. As of September 30, 2012, the Company has received a total net contingent commission of $3,651,935 for the years subject to contingent commission. Of this amount, the Company has recognized $3,245,478 of contingent commission income, of which $133,600 and $403,320 was recognized in the three and nine months ended September 30, 2012, respectively. The remaining balance of the net payments received of $406,457 is currently unearned and included in "Accrued Expenses and Other Liabilities" in the consolidated balance sheet at September 30, 2012. The unearned contingent commission may be subsequently earned or returned to the reinsurer depending on the future development of the ceded IBNR for the years subject to contingent commission.

Investment income decreased $430,194 (59%) and $914,023 (40%) to $303,541 and $1,360,010 for the three and nine months ended September 30, 2012, respectively, compared to $733,735 and $2,274,033 for the three and nine months ended September 30, 2011, respectively. The Company had no realized gains or losses for the three and nine months ended September 30, 2012 and 2011. The decrease in investment income in the current period as compared to the prior year period is primarily a result of a decrease in invested assets and a decrease in the Company's annualized weighted average yield to 1.4% and 1.0% for the three and nine months ended September 30, 2012, respectively, compared to 2.3% for the three and nine months ended September 30, 2011. The decrease in the annualized yield on average invested assets is a result of lower yields in the marketplace on both new and reinvested assets.

The average annualized yields on the Company's average invested assets are as follows:

                                      Three Months Ended September 30           Nine months Ended September 30
                                          2012                 2011                 2012                2011
Average invested assets*           $    124,323,946       $ 128,573,754      $    126,293,796      $ 129,313,758
Total investment income            $        303,541       $     733,735      $      1,360,010      $   2,274,033
Annualized yield on average
invested assets                                 1.0 %               2.3 %                 1.4 %              2.3 %

*The average is based on the beginning and ending balance of the amortized cost of the invested assets.

The par value, amortized cost, estimated market value and weighted average yield of fixed maturity investments at September 30, 2012, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.

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                                         Par                                                      Weighted
Maturities by Calendar Year             Value           Amortized Cost        Fair Value        Average Yield
December 31, 2012                   $ 13,445,000      $     13,444,432      $ 13,477,423                  3.7 %
December 31, 2013                     30,890,000            30,904,602        31,169,062                  1.3 %
December 31, 2014                      1,600,000             1,600,000         1,600,000                  0.5 %
December 31, 2015                        450,000               450,000           450,000                  0.9 %
December 31, 2016                        100,000               100,000           100,000                  1.9 %
 Total                              $ 46,485,000      $     46,499,034      $ 46,796,485                  2.0 %

The weighted average maturity of the Company's fixed maturity investments was 0.7 years as of September 30, 2012, and less than 1 year as of September 30, 2011. Due to the current interest rate environment, management believes it is prudent to purchase fixed maturity investments with maturities of five years or less and with minimal credit risk.

As of September 30, 2012, the Company held fixed maturity investments with unrealized appreciation of $297,451 and held no fixed maturity investment with unrealized depreciation. As of September 30, 2011, the Company held fixed maturity investments with unrealized appreciation of $1,991,448 and held no fixed maturity investments with unrealized depreciation. The Company monitors its investments closely. If an unrealized loss is determined to be other-than-temporary, it is written off as a realized loss through the Consolidated Statements of Operations. The Company's methodology of assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near-term prospects of the issuer, and whether the debtor is current on its contractually obligated interest and principal payments. The Company does not have the intent to sell its fixed maturity investments; and it is not likely that the Company would be required to sell any of its fixed maturity investments prior to recovery of its amortized costs. The Company did not sell any fixed maturity investments in the three and nine months ended September 30, 2012 and 2011.

Other Income included in insurance company revenues decreased $605,176 (81%) and $647,522 (60%) to $141,146 and $437,888 for the three and nine months ended September 30, 2012, respectively, compared to $746,322 and $1,085,410 for the three and nine months ended September 30, 2011, respectively. The decrease in other income included in insurance company revenues during the three and nine months ended September 30, 2012, when compared to the prior year period are primarily related to the closing of provisionally rated reinsurance treaties during the three months ended September 30, 2011. These provisionally rated reinsurance treaties covered the periods 1985 through 1997. Generally, fluctuations in other income included in insurance company revenues in any given period are primarily related to the change in the amount of contingent commission recognized during any given period. The Company recognized $133,600 and $403,320 of contingent commission during the three and nine months ended September 30, 2012, respectively, compared to $108,614 and $418,641 recognized during the three and nine months ended September 30, 2011, respectively.

Gross commissions and fees decreased $55,230 (6%) and $255,282 (9%) to $820,729 and $2,535,962 for the three and nine months ended September 30, 2012, respectively, compared to $875,959 and $2,791,244 for the three and nine months ended September 30, 2011, respectively.

The decreases in gross commission and fee income for the three and nine months ended September 30, 2012, as compared to the three and nine months ended September 30, 2011, are as follows:

                                        Three Months Ended September 30                 Nine Months Ended September 30
. . .
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