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FNHC > SEC Filings for FNHC > Form 10-Q on 14-Aug-2013All Recent SEC Filings

Show all filings for FEDERATED NATIONAL HOLDING CO

Form 10-Q for FEDERATED NATIONAL HOLDING CO


14-Aug-2013

Quarterly Report

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

You should read the following discussion in conjunction with our condensed consolidated financial statements and related notes and information included under this Item 2 and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on April 1, 2013 ("Form 10-K"). Unless the context requires otherwise, as used in this Form 10-Q, the terms "FNHC" "Company," "we," "us" and "our," refers to Federated National Holding Company and its subsidiaries. We changed our name on September 11, 2012, pursuant to approval received at our annual shareholders' meeting, from 21st Century Holding Company so that our parent company and other subsidiary companies' names are consistent with our primary insurance subsidiary and the name under which we have been writing insurance for more than 20 years.

Forward-Looking Statements

Statements in this Quarterly Report on Form 10-Q for the three months ended June 30, 2013 ("Form 10-Q") or in documents that are incorporated by reference that are not historical fact are forward-looking statements that are subject to certain risks and uncertainties that could cause actual events and results to differ materially from those discussed herein. 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. The risks and uncertainties include, without limitation, uncertainties related to estimates, assumptions and projections relating to unpaid losses and loss adjustment expenses and other accounting policies, losses from the nine hurricanes that occurred in fiscal years 2005 and 2004 and in other estimates, assumptions and projections contained in this Form 10-Q; inflation and other changes in economic conditions (including changes in interest rates and financial markets); the impact of new regulations adopted in Florida which affect the property and casualty insurance market; the costs of reinsurance, assessments charged by various governmental agencies; pricing competition and other initiatives by competitors; our ability to obtain regulatory approval for requested rate changes and the timing thereof; legislative and regulatory developments; the outcome of various litigation matters pending against us, including the terms of any settlements; risks related to the nature of our business; dependence on investment income and the composition of our investment portfolio; the adequacy of our liability for loss and loss adjustment expense; insurance agents; claims experience; ratings by industry services; catastrophe losses; reliance on key personnel; weather conditions (including the severity and frequency of storms, hurricanes, tornadoes and hail); changes in driving patterns and loss trends; acts of war and terrorist activities; court decisions and trends in litigation and health care and auto repair costs; and other matters described from time to time by us in this report, and in our other filings with the SEC, including the Company's Form 10-K.

You are cautioned not to place reliance on these forward-looking statements, which are valid only as of the date they were made. The Company undertakes no obligation to update or revise any forward-looking statements to reflect new information or the occurrence of unanticipated events or otherwise. In addition, readers should be aware that Generally Accepted Accounting Principles ("GAAP") prescribes when a company may reserve for particular risks, including litigation exposures. Accordingly, results for a given reporting period could be significantly affected when a reserve is established for a major contingency. Reported results may therefore appear to be volatile in certain accounting periods.

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Federated National Holding Company

Overview

FNHC is an insurance holding company that controls substantially all steps in the insurance underwriting, distribution and claims processes through our subsidiaries and our contractual relationships with our independent agents and general agents.

We are authorized to underwrite, and/or place through our wholly owned subsidiaries, homeowners' multi-peril ("homeowners"), commercial general liability, federal flood, personal auto and various other lines of insurance in Florida and various other states. We market and distribute our own and third-party insurers' products and our other services through a network of agents.

Our insurance subsidiary is Federated National Insurance Company ("FNIC"). FNIC is licensed as an admitted carrier in Florida. An admitted carrier is an insurance company that has received a license from the state insurance regulator for authority to write specific lines of insurance in that state. Through contractual relationships with a network of approximately 3,300 independent agents, of which approximately 1,200 actively sell and service our products, FNIC is authorized to underwrite homeowners', commercial general liability, fire, allied lines and personal and commercial automobile insurance in Florida. FNIC is also licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas, and underwrites commercial general liability insurance in those states and personal automobile insurance in Georgia and Texas.

FNIC operates as a non-admitted carrier in Arkansas, Kentucky, Missouri, Nevada, Oklahoma, South Carolina and Tennessee, and can underwrite commercial general liability insurance in all of these states. A non-admitted carrier, sometimes referred to as a "excess and surplus lines" carrier, is permitted to do business in a state and, although it is strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud, non-admitted carriers are subject to considerably less regulation with respect to policy rates and forms. Non-admitted carriers are not required to financially contribute to and benefit from the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.

Our executive offices are located at 14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323 and our telephone number is (954) 581-9993.

Merger of FNIC and American Vehicle

In January 2011, we merged FNIC and our other wholly owned insurance subsidiary, American Vehicle Insurance Company ("American Vehicle"), with FNIC continuing the operations of both entities. As part of its approval of the merger between FNIC and American Vehicle, the Florida Office of Insurance Regulation ("Florida OIR"), the Company, FNIC and American Vehicle entered into a consent order with the Florida OIR dated January 25, 2011 (the "Consent Order"), which was amended in February 2013, due to FNIC's statutory underwriting profit during 2012. See Footnote "(1) Organization and Business". References to the historical activities of American Vehicle are appropriately identified throughout this document.

Our Subsidiaries

During the three months ended June 30, 2013, 89.1%, 3.9%, 2.6% and 4.4% of the premiums we underwrote were for homeowners', commercial general liability, federal flood, and automobile insurance, respectively. During the three months ended June 30, 2012, 85.5%, 7.7%, 4.4% and 2.4% of the premiums we underwrote were for homeowners', commercial general liability, federal flood, and automobile insurance, respectively.

During the six months ended June 30, 2013, 88.0%, 4.7%, 2.7% and 4.6% of the premiums we underwrote were for homeowners', commercial general liability, federal flood, and automobile insurance, respectively. During the six months ended June 30, 2012, 86.1%, 7.7%, 3.9% and 2.3% of the premiums we underwrote were for homeowners', commercial general liability, federal flood, and personal automobile insurance, respectively.

Our 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 us. When our estimated liabilities for unpaid losses and loss adjustment expenses ("LAE") are less than the actuarially determined amounts, we increase the expense in the current period. Conversely, when our estimated liabilities for unpaid losses and LAE are greater than the actuarially determined amounts, we decrease the expense in the current period.

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Federated National Holding Company

We are focusing our marketing efforts on continuing to expand our distribution network while maintaining our commitment to long-term relationships. We market our products and services throughout Florida and in other states by establishing relationships with additional independent agents and general agents. There can be no assurance, however, that we will be able to obtain the required regulatory approvals to offer additional insurance products or expand into other states.

Federated National Underwriters, Inc. ("FNU"), formerly known as Assurance Managing General Agents, Inc., a wholly owned subsidiary of the Company, acts as FNIC's exclusive managing general agent in Florida and is also licensed as a managing general agent in the States of Alabama, Georgia, Louisiana, Mississippi, Missouri, North Carolina, Nevada, South Carolina, Texas and Virginia. FNU has contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation, personal umbrella, inland marine and other various lines of insurance through FNU's existing network of agents.

FNU earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. FNU earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliate, FNIC. During the fourth quarter of 2010, FNU, pursuant to the Consent Order as discussed above, reduced its fee to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date with approval from the Florida OIR. A formal agreement reflecting this fee modification was executed during January 2011.

We internally process claims made by our insureds through our wholly owned claims adjusting company, FNA. Our agents have no authority to settle claims or otherwise exercise control over the claims process. Furthermore, we believe that the retention of independent adjusters, in addition to the employment of salaried claims personnel, results in reduced ultimate loss payments, lower LAE and improved customer service for our claimants and policyholders. We also employ an in-house Litigation Manager to cost effectively manage claims-related litigation and to monitor our claims handling practices for efficiency and regulatory compliance.

Insure-Link, Inc. ("Insure-Link") serves as an independent insurance agency. The insurance agency markets direct to the public to provide a variety of insurance products and services to individual clients, as well as business clients, by offering a full line of insurance products including, but not limited to, homeowners', flood, personal and commercial automobile, commercial general liability and workers' compensation insurance through their agency appointments with over thirty different carriers.

Insurance Markets in Which We Operate

We operate in highly competitive markets and face competition from national, regional and residual market insurance companies in the homeowners', commercial general liability, and automobile markets. Our competitors include companies that market their products through agents, as well as companies that 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. We compete based on underwriting criteria, our distribution network and superior service to our agents and insureds. Although our pricing is inevitably influenced to some degree by that of our competitors, we believe that it is generally not in our best interest to compete solely on price.

In Florida, more than 200 companies are authorized to underwrite homeowners' insurance. Several of our competitors include Citizens Property Insurance Corporation ("Citizens"), Universal Property and Casualty Insurance Company and St. Johns Insurance Company. In Florida, more than one dozen companies compete with us in the commercial general liability insurance market.

Critical Accounting Policies

See Note 3, "Summary of Significant Accounting Policies" in the Notes to the Company's condensed consolidated financial statements for the quarter ended June 30, 2013 included in Item 1 of this Quarterly Report on Form 10-Q for a discussion of the Company's critical accounting policies.

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Federated National Holding Company

New Accounting Pronouncements

See Note 3, "Summary of Significant Accounting Policies" in the Notes to the Company's condensed consolidated financial statements for the quarter ended June 30, 2013 included in Item 1 of this Quarterly Report on Form 10-Q for a discussion of recent accounting pronouncements and their effect, if any, on the Company.

Analysis of Financial Condition
As of June 30, 2013 Compared with December 31, 2012

Total Investments

Financial Accounting Standards Board ("FASB") issued guidance addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. The guidance requires that these securities be classified into one of three categories: Held-to-maturity, Trading, or Available-for-sale securities.

Investments classified as held-to-maturity include debt securities wherein the Company's intent and ability are to hold the investment until maturity. The accounting treatment for held-to-maturity investments is to carry them at amortized cost without consideration to unrealized gains or losses. Investments classified as trading securities include debt and equity securities bought and held primarily for the sale in the near term. The accounting treatment for trading securities is to carry them at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments. The accounting treatment for available-for-sale securities is to carry them at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders' equity, namely "Other Comprehensive Income".

Total investments increased $13.9 million, or 10.7%, to $144.0 million as of June 30, 2013, compared with $130.1 million as of December 31, 2012.

The debt and equity securities that are available for sale and carried at fair value represent 95% of total investments as of June 30, 2013, compared with 94% as of December 31, 2012.

We did not hold any trading investment securities during the six months ended June 30, 2013.

The FASB issued guidance also addresses the determination as to when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. The Company's policy for the valuation of temporarily impaired securities is to determine impairment based on the analysis of the following factors.

rating downgrade or other credit event (eg., failure to pay interest when due);

length of time and the extent to which the fair value has been less than amortized cost;

financial condition and near term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology or discontinuance of a business segment;

prospects for the issuer's industry segment;

intent and ability of the Company to retain the investment for a period of time sufficient to allow for anticipated recovery in market value;

historical volatility of the fair value of the security.

Pursuant to FASB issued guidance, the Company records the unrealized losses, net of estimated income taxes that are associated with that part of our portfolio classified as available-for-sale through the shareholders' equity account titled "Other Comprehensive Income". Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. Factors used in such consideration include, but are not limited to, the extent and length of time over which the market value has been less than cost, the financial condition and near-term prospects of the issuer and our ability and intent to keep the investment for a period sufficient to allow for an anticipated recovery in market value.

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Federated National Holding Company

In reaching a conclusion that a security is either other-than-temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor's ("S&P") and Moody's Investors Service, Inc. ("Moody's"), as well as information released via the general media channels. In connection with this process, we have not charged net realized losses to operations during the three months ended June 30, 2013, whereas we charged $44,000 of net realized investment losses to operations during the three and six months ended June 30, 2012.

As of June 30, 2013 and December 31, 2012, respectively, all of our securities are in good standing and not impaired as defined by FASB issued guidance.

As of June 30, 2013 and December 31, 2012, our investments consisted primarily of corporate bonds held in various industries, municipal bonds and United States government bonds. As of June 30, 2013, 72% of our debt portfolio was in diverse industries and 28% was in United States government bonds. As of June 30, 2013, approximately 87% of our equity holdings were in equities related to diverse industries and 13% were in mutual funds. As of December 31, 2012, 69% of our debt portfolio was in diverse industries and 31% is in United States government bonds. As of December 31, 2012, approximately 87% of our equity holdings were in equities related to diverse industries and 13% were in mutual funds.

As of June 30, 2013 and December 31, 2012, we have classified $7.3 million and $7.4 million, respectively, of our bond portfolio as held-to-maturity. We classify bonds as held-to-maturity to support securitization of credit requirements.

During the three and six months ended June 30, 2013 and 2012, respectively, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity.

During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic Underwriters Insurance Company ("Republic") which was terminated in April 2007. During 2010, the letter of credit in favor of Republic was replaced by a fully funded trust agreement. As of June 30, 2013 and December 31, 2012 respectively, the amount held in trust was $1.0 million.

Below is a summary of net unrealized gains and losses as of June 30, 2013 and December 31, 2012, by category.

                                                                  Unrealized Gains and (Losses)
                                                                                       December 31,
                                                                June 30, 2013              2012
                                                                      (Dollars in Thousands)
Debt securities:
United States government obligations and authorities           $          (123 )       $        567
Obligations of states and political subdivisions                            14                  201
Corporate                                                                  438                3,760
International                                                              (52 )                106
                                                                           277                4,634

Equity securities:
Common stocks                                                            3,917                1,887

Total debt and equity securities                               $         4,194         $      6,521

The net unrealized gain of $4.2 million is inclusive of $2.1 million of unrealized losses. The $2.1 million of unrealized losses is inclusive of unrealized losses of $1.3 million and $0.8 million from debt and equity securities, respectively.

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Federated National Holding Company

The $1.3 million of unrealized losses from debt securities are made up of $0.9 million losses from corporate bonds, $0.3 million from United State government obligations and $0.1 million from municipal and international bonds. The Company does not expect to settle at prices less than the amortized cost basis. The Company does not consider these investments to be other-than-temporarily impaired at June 30, 2013 because we neither currently intend to sell these investments nor consider it likely that we will be required to sell these investments before recovery of the amortized cost basis.

The $0.8 million of unrealized losses from equity securities are from common stocks and mutual funds held in diverse industries as of June 30, 2013. The Company evaluated the near-term prospects in relation to the severity and duration of the impairment. Based on this evaluation and the Company's ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2013.

The following table summarizes, by type, our investments as of June 30, 2013 and December 31, 2012.

                                                June 30, 2013              December 31, 2012
                                           Carrying       Percent       Carrying       Percent
                                            Amount        of Total       Amount        of Total
                                                          (Dollars in Thousands)
Debt securities, at market:
United States government obligations and
authorities                                $  26,094          18.12 %   $  27,392          21.06 %
Obligations of states and political
subdivisions                                   3,434           2.38 %       3,939           3.03 %
Corporate                                     73,570          51.11 %      67,313          51.74 %
International                                  3,114           2.16 %       3,111           2.39 %
                                             106,212          73.77 %     101,755          78.22 %
Debt securities, at amortized cost:
United States government obligations and
authorities                                    5,183           3.60 %       6,016           4.62 %
Corporate                                      2,002           1.39 %       1,203           0.92 %
International                                     80           0.06 %         140           0.11 %
                                               7,265           5.05 %       7,359           5.65 %
Total debt securities                        113,477          78.82 %     109,114          83.87 %

Equity securities, at market:                 30,507          21.18 %      20,982          16.13 %
Total investments                          $ 143,984         100.00 %   $ 130,096         100.00 %

Cash and Short-Term Investments

Cash and short-term investments, which include cash, certificates of deposits, and money market accounts, increased $28.2 million, or 133.2%, to $49.3 million as of June 30, 2013, compared with $21.1 million as of December 31, 2012. The increase in cash and short-term investments is for a planned reinsurance payment.

Prepaid Reinsurance Premiums

Prepaid reinsurance premiums decreased $6.5 million, or 92.3%, to $0.5 million as of June 30, 2013, compared with $7.0 million as of December 31, 2012 due to the amortization of our payment patterns. We believe concentrations of credit risk associated with our prepaid reinsurance premiums are not significant.

Premiums Receivable, Net of Allowance for Credit Losses

Premiums receivable, net of allowance for credit losses, increased $11.6 million, or 144.8%, to $19.6 million as of June 30, 2013, compared with $8.0 million as of December 31, 2012.

Our homeowners' insurance premiums receivable increased $9.9 million, or 165.5%, to $15.8 million as of June 30, 2013, compared with $6.0 million as of December 31, 2012.

Our commercial general liability insurance premiums receivable increased $0.2 million, or 43.2%, to $0.7 million as of June 30, 2013, compared with $0.5 million as of December 31, 2012.

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Federated National Holding Company

Premiums receivable in connection with our automobile line of business increased $1.6 million, or 95.5%, to $3.2 million as of June 30, 2013, compared with $1.6 million as of December 31, 2012.

Our allowance for credit losses remained unchanged at less than $0.1 million as of June 30, 2013, compared with $0.1 million as of December 31, 2012.

Reinsurance Recoverable, Net

Reinsurance recoverable, net, remained unchanged at $3.5 million as of June 30, 2013 compared with December 31, 2012. The lack of change is due to the payment patterns by our reinsurers, as influenced by catastrophe related claims. All amounts are current and deemed collectable. We believe concentrations of credit risk associated with our reinsurance recoverables, net, are not significant.

Deferred Policy Acquisition Costs ("DPAC")

DPAC increased $4.7 million, or 55.7%, to $13.2 million as of June 30, 2013, compared with $8.5 million as of December 31, 2012. The change is due to the deferral of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned associated with our increased unearned premium.

Deferred Income Taxes, Net

Deferred income taxes, net, decreased $0.3 million, or 8.0%, to $4.0 million as of June 30, 2013, compared with $4.3 million as of December 31, 2012. Deferred income taxes, net, is comprised of approximately $7.4 million and $6.5 million of deferred tax assets, net of approximately $3.4 million and $2.2 million of deferred tax liabilities as of June 30, 2013 and December 31, 2012. The change to our deferred tax assets includes a decrease related to our available-for-sale portfolio. The change to our deferred tax liabilities includes an increase . . .

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