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FAC > SEC Filings for FAC > Form 10-K on 4-Mar-2014All Recent SEC Filings

Show all filings for FIRST ACCEPTANCE CORP /DE/

Form 10-K for FIRST ACCEPTANCE CORP /DE/


4-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes included in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this report, particularly under the caption "Item 1A. Risk Factors."

Forward-Looking Statements

This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements made in this report, other than statements of historical fact, are forward-looking statements. You can identify these statements from our use of the words "may," "should," "could," "potential," "continue," "plan," "forecast," "estimate," "project," "believe," "intent," "anticipate," "expect," "target," "is likely," "will," or the negative of these terms and similar expressions. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may include, among other things statements and assumptions relating to:

our future growth, income (loss), income (loss) per share and other financial performance measures;

the anticipated effects on our results of operations or financial condition from recent and expected developments or events;

the financial condition of, and other issues relating to the strength of and liquidity available to, issuers of securities held in our investment portfolio;

the accuracy and adequacy of our loss reserving methodologies; and

our business and growth strategies.

We believe that our expectations are based on reasonable assumptions. However, these forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results to differ materially from our expectations of future results, performance or achievements expressed or implied by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results. We discuss these and other uncertainties in "Risk Factors" in Item 1A, as well as other sections, of this report.

You should not place undue reliance on any forward-looking statements. These statements speak only as of the date of this report. Except as otherwise required by applicable laws, we undertake no obligation to publicly update or revise any forward-looking statements or the risk factors described in this report, whether as a result of new information, future events, changed circumstances or any other reason after the date of this report.

General

We are principally a retailer, servicer and underwriter of non-standard personal automobile insurance. We also own two tracts of land in San Antonio, Texas that are held for sale. Non-standard personal automobile insurance is made available to individuals because of their inability or unwillingness to obtain standard insurance coverage due to various factors, including payment history, payment preference, and failure in the past to maintain continuous insurance coverage, driving record and/or vehicle type.

At March 4, 2014, we leased and operated 356 retail locations (or "stores") staffed by employee-agents who primarily sell non-standard personal automobile insurance products underwritten by us as well as certain commissionable ancillary products. In most states, our employee-agents also sell a complementary insurance product providing personal property and liability coverage for renters underwritten by us. In addition, during the year ended December 31, 2013, select retail locations in highly competitive markets in Illinois and Texas began offering non-standard personal automobile insurance serviced and underwritten by other third-party insurance carriers. At March 4, 2014, we wrote non-standard personal automobile insurance in 12 states and were licensed in 13 additional states.


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                       FIRST ACCEPTANCE CORPORATION 10-K



The following table shows the number of our retail locations. Retail location
counts are based upon the date that a location commenced or ceased writing
business.



                                                         Year Ended
                                                        December 31,
                                                       2013       2012
             Retail locations - beginning of period      369        382
             Opened                                       -          -
             Closed                                       (9 )      (13 )

             Retail locations - end of period            360        369

The following table shows the number of our retail locations by state.

                                               December 31,
                                         2013      2012      2011
                        Alabama             24        24        24
                        Florida             30        30        30
                        Georgia             60        60        60
                        Illinois            61        63        67
                        Indiana             17        17        17
                        Mississippi          7         7         8
                        Missouri            11        11        12
                        Ohio                27        27        27
                        Pennsylvania        16        16        16
                        South Carolina      25        26        26
                        Tennessee           19        19        20
                        Texas               63        69        75

                        Total              360       369       382

Change in Fiscal Year

On November 15, 2011, our Board of Directors approved a change in fiscal year end from June 30 to December 31, effective December 31, 2011. Unless otherwise noted, all references to "years" or "fiscal" refer to the twelve-month fiscal year, which prior to July 1, 2011 ended on June 30, and beginning with December 31, 2012 ends on December 31 of each year. The comparative financial information provided for the six months ended December 31, 2010 and the year ended December 31, 2011 is unaudited and includes all normal recurring adjustments necessary for a fair statement of the results for the respective period.

Consolidated Results of Operations

Overview

Our primary focus is the selling, servicing and underwriting of non-standard personal automobile insurance. Our real estate and corporate segment consists of activities related to the disposition of real estate held for sale, interest expense associated with debt, and other general corporate overhead expenses.


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                       FIRST ACCEPTANCE CORPORATION 10-K



The following table presents selected financial data for our insurance
operations and real estate and corporate segments (in thousands).



                                                   Year Ended December 31,
                                             2013           2012           2011
      Revenues:
      Insurance                            $ 240,460      $ 227,966      $ 204,916
      Real estate and corporate                   52             93            122

      Consolidated total                   $ 240,512      $ 228,059      $ 205,038

      Income (loss) before income taxes:
      Insurance                            $  12,748      $  (4,588 )    $ (78,623 )
      Real estate and corporate               (2,918 )       (4,457 )       (5,791 )

      Consolidated total                   $   9,830      $  (9,045 )    $ (84,414 )

Our insurance operations generate revenues primarily from selling, servicing and underwriting non-standard personal automobile insurance policies and related products in 12 states. We conduct our underwriting operations through three insurance company subsidiaries: First Acceptance Insurance Company, Inc., First Acceptance Insurance Company of Georgia, Inc. and First Acceptance Insurance Company of Tennessee, Inc. Our insurance revenues are primarily generated from:

premiums earned, including policy and renewal fees, from sales of policies written and assumed by our insurance company subsidiaries;

commission and fee income, including installment billing fees on policies written, agency fees and commissions and fees for other ancillary products and policies sold on behalf of third-party insurance carriers; and

investment income earned on the invested assets of the insurance company subsidiaries.

The following table presents gross premiums earned by state (in thousands). Driven by improvements in sales execution, a higher percentage of full coverage policies sold and rate increases taken in most states, net premiums earned for the year ended December 31, 2013 increased 8% compared with the same period in the prior year. The changes in premiums earned in Illinois and Texas for the year ended December 31, 2013 were adversely impacted by the increase in policies sold on behalf of third party carriers which generate commission and fee income rather than premiums earned.

                                                Year Ended December 31,
                                          2013           2012           2011
          Premiums earned:
          Georgia                       $  37,957      $  38,500      $  36,002
          Florida                          30,517         26,744         19,667
          Texas                            24,051         22,481         21,912
          Alabama                          20,978         17,157         16,185
          Illinois                         20,200         21,896         21,784
          Ohio                             18,225         15,788         13,752
          South Carolina                   15,301         12,637          9,811
          Tennessee                        12,334         11,819         10,415
          Pennsylvania                      8,624          8,301          8,409
          Indiana                           5,218          4,703          4,382
          Missouri                          3,778          3,172          2,630
          Mississippi                       2,718          2,638          2,456

          Total gross premiums earned     199,901        185,836        167,405
          Premiums ceded                     (201 )         (192 )         (181 )

          Total net premiums earned     $ 199,700      $ 185,644      $ 167,224


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The following table presents the change in the total number of policies in force ("PIF") for the insurance operations, including policies underwritten on behalf of third party carriers. PIF increase as a result of new policies issued and decrease as a result of policies that are canceled or expire and are not renewed. At December 31, 2013, PIF was 4.5% higher than at the same date in the prior year.

                                                      Year Ended December 31,
                                                 2013          2012          2011
     Policies in force - beginning of period     147,500       141,862       144,582
     Net increase (decrease) during period         6,683         5,638        (2,720 )

     Policies in force - end of period           154,183       147,500       141,862

Insurance companies present a combined ratio as a measure of their overall underwriting profitability. The components of the combined ratio are as follows.

Loss Ratio - Loss ratio is the ratio (expressed as a percentage) of losses and loss adjustment expenses incurred to premiums earned and is a basic element of underwriting profitability. We calculate this ratio based on all direct and assumed premiums earned, net of ceded reinsurance.

Expense Ratio - Expense ratio is the ratio (expressed as a percentage) of insurance operating expenses to net premiums earned. Insurance operating expenses are reduced by commission and fee income from insureds. This is a measurement that illustrates relative management efficiency in administering our operations.

Combined Ratio - Combined ratio is the sum of the loss ratio and the expense ratio. If the combined ratio is at or above 100%, an insurance company cannot be profitable without sufficient investment income.

The following table presents the loss, expense and combined ratios for our insurance operations.

                                      Year Ended December 31,
                                   2013        2012         2011
                       Loss         71.5 %       79.8 %       77.5 %
                       Expense      23.9 %       26.7 %       29.4 %

                       Combined     95.4 %      106.5 %      106.9 %


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FIRST ACCEPTANCE CORPORATION 10-K

Operational Initiatives

Since the beginning of 2012, we renewed our focus on improving the customer experience and value through several initiatives. Through February 2014, our progress has included:

investment in our sales organization to improve the quality and consistency of the customer experience in our retail stores;

continued development and consolidation of our "Acceptance" brand;

investment in rebranding our store fronts and refurbishing our store interiors;

development of electronic signature capabilities, thereby enabling most customers to receive quotes and bind policies over the phone and through our website;

development of a consumer-based website that reflects our branding strategy, improves the customer experience, and allows for full-service capabilities including quoting, binding and receiving payments;

launch of our trial implementation of sales of third party carrier automobile insurance in select Illinois and Texas locations where pricing is highly competitive;

development of an internet-specific sales strategy to drive quote traffic to our website, including the release of a mobile platform that puts the full range of our services into the broad spectrum of handheld devices; including mobile phones and tablets;

expansion of our call center processes and people in order to better support our phone sales efforts; and

launch of the sales of a complementary term life insurance product through select retail stores.

Moving forward, we continue to believe that our retail stores are the foundation of our business, providing an opportunity for us to directly interact with our customers on a regular basis. We also recognize that customer preferences have changed and that we need to adapt to meet those needs. For that reason, we will continue to invest in our people, retail stores, website and call center initiatives, and our customer interaction efforts in order to improve the customer experience. Our current initiatives include:

expansion of our potential customer base through enhancements to our insurance products;

continued investment and refinement of our internet-specific sales strategy;

continued investment and development of our website's full-service capabilities; and

continued assessment and possible expansion of sales of third party carrier auto insurance and use of alternative insurance products in select locations where pricing is highly competitive.

Investments

We use the services of an independent investment manager to manage our investment portfolio. The investment manager conducts, in accordance with our investment policy, all of the investment purchases and sales for our insurance company subsidiaries. Our investment policy has been established by the Investment Committee of our Board of Directors and specifically addresses overall investment goals and objectives, authorized investments, prohibited securities, restrictions on sales by the investment manager and guidelines as to asset allocation, duration and credit quality. Management and the Investment Committee meet regularly with our investment manager to review the performance of the portfolio and compliance with our investment guidelines.

The invested assets of the insurance company subsidiaries consist substantially of marketable, investment grade debt securities, and include U.S. government securities, municipal bonds, corporate bonds, mutual funds and collateralized mortgage obligations ("CMOs"), in addition to some recent investments made into limited partnership interests. Investment income is comprised primarily of interest earned on these securities, net of related investment expenses. Realized gains and losses may occur from time to time as changes are made to our holdings based upon changes in interest rates or the credit quality of specific securities.

The value of our consolidated available-for-sale investment portfolio was $130.2 million at December 31, 2013 and consisted of fixed maturity securities and investments in mutual funds, all carried at fair value with unrealized gains and losses reported as a separate component of stockholders' equity. At December 31, 2013, we had gross unrealized gains of $5.7 million and gross unrealized losses of $2.3 million in our consolidated investments available-for-sale portfolio.

At December 31, 2013, 93% of the fair value of our fixed maturity portfolio was rated "investment grade" (a credit rating of AAA to BBB-) by nationally recognized statistical rating organizations. Investment grade


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securities generally bear lower yields and have lower degrees of risk than those that are unrated or non-investment grade. We believe that a high quality investment portfolio is more likely to generate a stable and predictable investment return.

Investments in CMOs had a fair value of $16.1 million at December 31, 2013 and represented 13% of our fixed maturity portfolio. At December 31, 2013, 67% of our CMOs were considered investment grade by nationally recognized statistical rating agencies and 47% were backed by agencies of the United States government.

The following table summarizes our investment securities at December 31, 2013 (in thousands).

                                                                 Gross             Gross
                                              Amortized        Unrealized        Unrealized          Fair
                                                 Cost            Gains             Losses            Value
U.S. government and agencies                  $   12,006      $        495      $        (16 )     $  12,485
State                                                697                39                -              736
Political subdivisions                               601                11                -              612
Revenue and assessment                            14,050               619               (11 )        14,658
Corporate bonds                                   73,461             2,127            (2,263 )        73,325
Collateralized mortgage obligations:
Agency backed                                      7,113               401                -            7,514
Non-agency backed - residential                    4,181               480                (1 )         4,660
Non-agency backed - commercial                     3,363               580                -            3,943
Redeemable preferred stock                         1,500                78                -            1,578

Total fixed maturities, available-for-sale       116,972             4,830            (2,291 )       119,511
Mutual fund, available-for-sale                    9,901               836                -           10,737

                                              $  126,873      $      5,666      $     (2,291 )     $ 130,248


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FIRST ACCEPTANCE CORPORATION 10-K

Year Ended December 31, 2013 Compared with the Year Ended December 31, 2012

Consolidated Results

Revenues for the year ended December 31, 2013 increased 5% to $240.5 million from $228.1 million in the prior year. Income before income taxes for the year ended December 31, 2013 was $9.8 million, compared with loss before income taxes of $9.0 million for the year ended December 31, 2012. The income before income taxes for the year ended December 31, 2013 included favorable development of $3.0 million for losses occurring in prior fiscal years, while the loss before income taxes for the same period in the prior year included the recognition of a net realized gain on investments of $3.2 million, or $0.08 per share on a diluted basis, and unfavorable development of $4.0 million for losses occurring in prior fiscal years. Net income for the year ended December 31, 2013 was $9.2 million, compared with net loss of $9.0 million for the year ended December 31, 2012. Basic and diluted net income per share were $0.22, for the year ended December 31, 2013, compared with basic and diluted net loss per share of $0.22 for the same period in the prior year.

Insurance Operations

Revenues from insurance operations were $240.5 million for the year ended December 31, 2013, compared with $228.0 million for the year ended December 31, 2013. Income before income taxes from insurance operations for the year ended December 31, 2013 was $12.7 million, compared with loss before income taxes from insurance operations of $4.6 million for the year ended December 31, 2012. Income before income taxes from insurance operations for the year ended December 31, 2012 included the recognition of a net realized gain on investments of $3.2 million.

Premiums Earned

Premiums earned increased by $14.1 million, or 8%, to $199.7 million for the year ended December 31, 2013, from $185.6 million for the year ended December 31, 2012. This improvement was primarily due to our recent pricing actions. Excluding closed retail locations, premiums earned increased by 9% for the year ended December 31, 2013.

Commission and Fee Income

Commission and fee income increased 8% to $35.1 million for the year ended December 31, 2013, from $32.6 million for the year ended December 31, 2012. This increase in commission and fee income was a result of an increase in sales of ancillary products and policies on behalf of third-party insurance carriers.

Investment Income

Investment income decreased to $5.7 million during the year ended December 31, 2013 from $6.6 million during the year ended December 31, 2012. This decrease in investment income was primarily a result of the low-yielding reinvestment opportunities for both portfolio maturities and the proceeds from the sale in September 2012 of $29.6 million of corporate bonds in order to increase the statutory surplus of the insurance company subsidiaries. Such decreases were offset however by investment income earned from the recent investments in limited partnership interests. At December 31, 2013 and 2012, the tax-equivalent book yields for our fixed maturities portfolio were 3.2% and 3.3%, respectively, with effective durations of 3.59 and 3.19 years, respectively.


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Net Realized Losses on Investments, Available-for-Sale

Net realized losses on investments, available-for-sale during the year ended December 31, 2013 primarily included $61 thousand of charges related to OTTI on certain non-agency backed CMOs. Net realized gains on investments, available-for-sale during the year ended December 31, 2012 primarily included $3.2 million in net realized gain from the sales of $29.6 million of corporate bonds which were sold in September 2012 in order to increase the statutory capital and surplus of the insurance company subsidiaries. For additional information with respect to the determination of OTTI losses on investment securities, see "Critical Accounting Estimates - Investments" below and Note 3 to our consolidated financial statements.

Loss and Loss Adjustment Expenses

The loss ratio was 71.5% for the year ended December 31, 2013, compared with 79.8% for the year ended December 31, 2012. We experienced favorable development related to prior fiscal years of $3.0 million for the year ended December 31, 2013, compared with unfavorable development of $4.0 million for the year ended December 31, 2012. The favorable loss development for the year ending December 31, 2013 was primarily related to bodily injury claims occurring in accident years 2010 through 2012, partially offset by unfavorable loss and loss adjustment expense development on Florida personal injury protection claims. The unfavorable development for the year ended December 31, 2012 was primarily due to higher than expected severity with Florida personal injury protection claims and with Georgia bodily injury claims in older accident periods, and unfavorable loss adjustment expense development that was primarily related to higher than expected legal expenses for bodily injury claims for accident years 2010 and prior.

Excluding the development related to prior fiscal years, the loss ratios for the years ended December 31, 2013 and 2012 were 73.0% and 77.7%, respectively. The year-over-year decrease in the loss ratio was primarily due to the impact of pricing actions taken throughout 2012.

Operating Expenses

Insurance operating expenses increased 1% to $82.8 million for the year ended December 31, 2013 from $82.1 million for the year ended December 31, 2012. The increase was primarily a result of additional advertising costs and management performance bonuses incurred.

The expense ratio was 23.9% for the year ended December 31, 2013, compared with 26.7% for the year ended December 31, 2012. The year-over-year decrease in the expense ratio was primarily due to the increase in premiums earned which resulted in a lower percentage of fixed expenses in our retail operations (such as rent and base salary).

Overall, the combined ratio decreased to 95.4% for the year ended December 31, 2013 from 106.5% for the year ended December 31, 2012.

Provision (Benefit) for Income Taxes

. . .

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