XASE:UVE Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 001-33251

 

 

UNIVERSAL INSURANCE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   65-0231984

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1110 W. Commercial Blvd., Fort Lauderdale, Florida 33309

(Address of principal executive offices)

(954) 958-1200

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See the definitions of “large accelerated filer” and “accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 40,171,028 shares of common stock, par value $0.01 per share, outstanding on August 7, 2012.

 

 

 


Table of Contents

UNIVERSAL INSURANCE HOLDINGS, INC.

TABLE OF CONTENTS

 

          Page
No.
 
PART I – FINANCIAL INFORMATION   

Item 1.

  

Financial Statements:

  
  

Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011 (unaudited)

     4   
  

Condensed Consolidated Statements of Comprehensive Income for the three and six-month periods ended June 30, 2012 and 2011 (unaudited)

     5   
  

Condensed Consolidated Statements of Cash Flows for the six-month periods ended June 30, 2012 and 2011 (unaudited)

     6   
  

Notes to Condensed Consolidated Financial Statements (unaudited)

     7   

Item 2.

  

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

     24   

Item 3.

  

Quantitative and Qualitative Disclosure about Market Risk

     39   

Item 4.

  

Controls and Procedures

     41   
   PART II – OTHER INFORMATION   

Item 1.

  

Legal Proceedings

     41   

Item 1A.

  

Risk Factors

     41   

Item 6.

  

Exhibits

     42   

Signatures

     43   

 

2


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To The Board of Directors and Stockholders of

Universal Insurance Holdings, Inc. and Subsidiaries

Fort Lauderdale, Florida

We have reviewed the accompanying condensed consolidated balance sheet of Universal Insurance Holdings, Inc. (the “Company”) and its Subsidiaries as of June 30, 2012 and the related condensed consolidated statements of comprehensive income for the three and six-month periods ended June 30, 2012 and cash flows for the six-month period ended June 30, 2012. These interim financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying interim financial statements as of June 30, 2012 and for the three and six-month periods then ended for them to be in conformity with accounting principles generally accepted in the United States of America.

The condensed consolidated statements of comprehensive income for the three and six-month periods ended June 30, 2011 and statement of cash flows for the six-month period ended June 30, 2011 of Universal Insurance Holdings, Inc. (the “Company”) and its Subsidiaries were reviewed by Blackman Kallick, LLP whose report dated August 5, 2011, stated that based on its procedures, it was not aware of any material modifications that should be made to those financial statements in order for them to be in a conformity with accounting principles generally accepted in the United States of America. Black Kallick, LLP subsequently merged into Plante & Moran, PLLC.

/s/ Plante & Moran, PLLC

Chicago, Illinois

August 8, 2012

 

3


Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except per share data)

 

     As of  
     June 30,
2012
    December 31,
2011
 

ASSETS:

    

Cash and cash equivalents

   $ 356,325      $ 229,685   

Restricted cash and cash equivalents

     74,274        78,312   

Fixed maturities, at fair value

     3,913        3,801   

Equity securities, at fair value

     81,713        95,345   

Prepaid reinsurance premiums

     247,835        243,095   

Reinsurance recoverables

     115,459        85,706   

Reinsurance receivable, net

     125,664        55,205   

Premiums receivable, net

     56,377        45,828   

Receivable from securities sold

     594        9,737   

Other receivables

     3,631        2,732   

Property and equipment, net

     8,915        7,116   

Deferred policy acquisition costs, net

     17,744        12,996   

Income taxes recoverable

     624        —     

Deferred income tax asset, net

     21,280        22,991   

Other assets

     1,825        1,477   
  

 

 

   

 

 

 

Total assets

   $ 1,116,173      $ 894,026   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

LIABILITIES:

    

Unpaid losses and loss adjustment expenses

   $ 164,625      $ 187,215   

Unearned premiums

     406,952        359,842   

Advance premium

     25,606        19,390   

Accounts payable

     5,342        4,314   

Bank overdraft

     27,650        25,485   

Payable for securities purchased

     1,239        1,067   

Reinsurance payable

     273,787        87,497   

Income taxes payable

     1,331        12,740   

Dividends payable to shareholders

     3,214        —     

Other liabilities and accrued expenses

     23,710        24,780   

Long-term debt

     20,956        21,691   
  

 

 

   

 

 

 

Total liabilities

     954,412        744,021   
  

 

 

   

 

 

 

Commitments and Contingencies (Note 11)

    

STOCKHOLDERS’ EQUITY:

    

Cumulative convertible preferred stock, $.01 par value

     1        1   

Authorized shares - 1,000

    

Issued shares - 108

    

Outstanding shares - 108

    

Minimum liquidation preference, $2.66 per share

    

Common stock, $.01 par value

     412        411   

Authorized shares - 55,000

    

Issued shares - 41,189 and 41,100

    

Outstanding shares - 40,171 and 40,082

    

Treasury shares, at cost - 1,018

     (3,101     (3,101

Additional paid-in capital

     38,126        36,536   

Retained earnings

     126,323        116,158   
  

 

 

   

 

 

 

Total stockholders’ equity

     161,761        150,005   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,116,173      $ 894,026   
  

 

 

   

 

 

 

The accompanying notes to condensed consolidated financial statements are an integral part of these statements.

 

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Table of Contents

UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

(in thousands, except per share data)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  

PREMIUMS EARNED AND OTHER REVENUES

        

Direct premiums written

   $ 222,568      $ 213,479      $ 412,571      $ 386,654   

Ceded premiums written

     (102,433     (145,798     (265,867     (269,689
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

     120,135        67,681        146,704        116,965   

Change in net unearned premium

     (64,441     (18,157     (42,370     (19,437
  

 

 

   

 

 

   

 

 

   

 

 

 

Premiums earned, net

     55,694        49,524        104,334        97,528   

Net investment income (expense)

     (16     (21     (52     236   

Net realized gains (losses) on investments

     (1,705     2,960        (9,154     6,612   

Net unrealized gains (losses) on investments

     (5,788     (9,640     3,399        (7,052

Net foreign currency gains (losses) on investments

     —          —          23        71   

Commission revenue

     6,131        4,941        10,672        9,121   

Policy fees

     4,072        4,402        7,973        8,575   

Other revenue

     1,540        1,506        2,980        2,914   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total premiums earned and other revenues

     59,928        53,672        120,175        118,005   
  

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING COSTS AND EXPENSES

        

Losses and loss adjustment expenses

     29,437        25,852        55,611        52,037   

General and administrative expenses

     17,499        14,699        35,343        29,771   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

     46,936        40,551        90,954        81,808   
  

 

 

   

 

 

   

 

 

   

 

 

 

INCOME BEFORE INCOME TAXES

     12,992        13,121        29,221        36,197   

Income taxes, current

     9,086        9,622        9,860        18,359   

Income taxes, deferred

     (3,871     (4,050     1,711        (3,609
  

 

 

   

 

 

   

 

 

   

 

 

 

Income taxes, net

     5,215        5,572        11,571        14,750   
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME AND COMPREHENSIVE INCOME

   $ 7,777      $ 7,549      $ 17,650      $ 21,447   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.20      $ 0.19      $ 0.44      $ 0.55   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average of common shares outstanding - Basic

     39,668        39,187        39,528        39,187   
  

 

 

   

 

 

   

 

 

   

 

 

 

Fully diluted earnings per common share

   $ 0.19      $ 0.19      $ 0.44      $ 0.53   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average of common shares outstanding - Diluted

     40,377        40,645        40,460        40,657   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividend declared per common share

   $ 0.08      $ —        $ 0.18      $ 0.10   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes to condensed consolidated financial statements are an integral part of these statements.

 

5


Table of Contents

UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

 

     Six Months Ended June 30,  
     2012     2011  

Cash flows from operating activities:

    

Net Income

   $ 17,650      $ 21,447   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Bad debt expense (recovery)

     103        394   

Depreciation

     410        299   

Amortization of stock-based compensation

     1,692        919   

Net realized (gains) losses on investments

     9,154        (6,612

Net unrealized (gains) losses on investments

     (3,399     7,052   

Net foreign currency (gains) losses on investments

     (23     (71

Amortization of premium / accretion of discount, net

     21        170   

Deferred income taxes

     1,711        (3,609

Excess tax (benefits) shortfall from stock-based compensation

     71        —     

Other

     —          (21

Net change in assets and liabilities relating to operating activities:

    

Restricted cash and cash equivalents

     4,038        (19,689

Prepaid reinsurance premiums

     (4,740     (32,496

Reinsurance recoverables

     (29,753     2,349   

Reinsurance receivable, net

     (70,459     (10,419

Premiums receivable, net

     (10,628     (8,790

Accrued investment income

     199        981   

Other receivables

     (1,123     (1,682

Income taxes recoverable

     (624     —     

Deferred policy acquisition costs, net

     (4,748     (2,580

Proceeds from sale of trading securities

     217,301        454,266   

Purchases of trading securities

     (200,584     (327,774

Other assets

     17        (1,936

Unpaid losses and loss adjustment expenses

     (22,590     (3,554

Unearned premiums

     47,110        51,934   

Accounts payable

     1,028        1,925   

Reinsurance payable, net

     186,290        64,977   

Income taxes payable

     (11,480     5,198   

Other liabilities and accrued expenses

     (1,070     (3,128

Advance premium

     6,216        5,990   
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     131,790        195,540   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Proceeds from sale of property and equipment

     18        63   

Purchases of property and equipment

     (2,227     (1,021
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (2,209     (958
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Bank overdraft

     2,166        (433

Preferred stock dividend

     (259     (10

Common stock dividend

     (4,012     (3,939

Issuance of common stock

     91        —     

Payments related to tax withholding for share-based compensation

     (121     —     

Excess tax benefits (shortfall) from stock-based compensation

     (71     —     

Repayment of debt

     (735     (735
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (2,941     (5,117
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     126,640        189,465   

Cash and cash equivalents at beginning of period

     229,685        133,645   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 356,325      $ 323,110   
  

 

 

   

 

 

 

Supplemental cash flow disclosures

    

Interest

   $ 241      $ 564   

Income taxes

   $ 21,953      $ 13,083   

The accompanying notes to condensed consolidated financial statements are an integral part of these statements.

 

6


Table of Contents

UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Nature of Operations and Basis of Presentation

 

Nature of Operations

Universal Insurance Holdings, Inc. (“UIH”) is a Delaware corporation originally incorporated as Universal Heights, Inc. in November 1990. UIH, with its wholly-owned subsidiaries (the “Company”) is a vertically integrated insurance company performing all aspects of insurance underwriting, distribution and claims. Through its wholly-owned subsidiaries, including Universal Property & Casualty Insurance Company (“UPCIC”) and American Platinum Property and Casualty Insurance Company (“APPCIC”), collectively referred to as the (“Insurance Entities”), the Company is principally engaged in the property and casualty insurance business offered primarily through a network of independent agents. Risk from catastrophic losses is managed through the use of reinsurance agreements. The Company’s primary product is homeowners’ insurance offered in five states as of June 30, 2012, including Florida which comprises the vast majority of the Company’s in-force policies. See Note 5, Insurance Operations, for more information regarding the Company’s insurance operations.

The Company generates revenues primarily from the collection of premiums and the investment of available funds in excess of those retained for claims-paying obligations and insurance operations. Other significant sources of revenue include commissions collected from reinsurers and policy fees.

 

Basis of Presentation

The Company has prepared the accompanying unaudited Condensed Consolidated Financial Statements (“Financial Statements”) in accordance with the rules and regulations of the United States Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by United States Generally Accepted Accounting Principles (“GAAP”) for complete financial statements. Therefore, the Financial Statements should be read in conjunction with the audited Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011, filed with the SEC on March 26, 2012. The condensed consolidated balance sheet at December 31, 2011, was derived from audited financial statements, but does not include all disclosures required by GAAP. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation have been included in the Financial Statements. The results for interim periods do not necessarily indicate the results that may be expected for any other interim period or for the full year.

The Financial Statements include the accounts of the UIH and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

Management must make estimates and assumptions that affect amounts reported in the Company’s Financial Statements and in disclosures of contingent assets and liabilities. Actual results could differ from those estimates.

To conform to the current period presentation, certain amounts in the prior periods’ consolidated financial statements and notes have been reclassified. Such reclassifications were of an immaterial amount and had no effect on net income or stockholders’ equity. The Company has adjusted its Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2011 to reflect the effect of a reclassification made to its Condensed Consolidated Balance Sheet as of June 30, 2011 related to reinsurance payables. This reclassification was made upon discovery that the Company was offsetting receivables and payables with non-affiliated reinsurers. This correction represents a change in the presentation only of the Company’s Condensed Consolidated Balance Sheet and Condensed Consolidated Statement of Cash Flows and had no impact on earnings, equity or cash flows from operating, investing and financing activities.

 

7


Table of Contents

The following line items were adjusted (in thousands):

 

     Six Months Ended June 30, 2011  
     As Reported      Reclassification     Adjusted  

Condensed Consolidated Statements of Cash Flows:

       

Net change in assets and liabilities relating to operating activities:

       

Reinsurance receivable, net

   $ —         $ (10,419   $ (10,419

Reinsurance payable, net

   $ 54,558       $ 10,419      $ 64,977   

An adjustment has been made to the Company’s Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2011 to reflect the effect of a reclassification made to the Company’s Condensed Consolidated Balance Sheet as of June 30, 2011 related to restricted cash and cash equivalents. The Company reclassified amounts out of cash and cash equivalents that were restricted in terms of their use and withdrawal and has presented those amounts of restricted cash and cash equivalents as a separate line item on the face of the Condensed Consolidated Balance Sheets. The following line items were adjusted (in thousands):

 

     Six Months Ended June 30, 2011  
     As Reported      Reclassification     Adjusted  

Condensed Consolidated Statements of Cash Flows:

       

Net change in assets and liabilities relating to operating activities:

       

Restricted cash and cash equivalents

   $ —         $ (19,689   $ (19,689

Net cash flows provided by (used in) operating activities

   $ 215,229       $ (19,689   $ 195,540   

Net increase in cash and cash equivalents

   $ 209,154       $ (19,689   $ 189,465   

Cash and cash equivalents at beginning of period

   $ 147,585       $ (13,940   $ 133,645   

Cash and cash equivalents at end of period

   $ 356,739       $ (33,629   $ 323,110   

 

2. Significant Accounting Policies

The Company reported Significant Accounting Policies in its Annual Report on Form 10-K for the year ended December 31, 2011. The following are new or revised disclosures or disclosures required on a quarterly basis.

 

Concentrations of Credit Risk. The Company is exposed to concentrations of credit risk, consisting principally of cash and cash equivalents, restricted cash and cash equivalents, debt securities, premiums receivable, prepaid reinsurance premiums, reinsurance receivable and reinsurance recoverables.

Concentrations of credit risk with respect to cash on deposit are limited by the Company’s policy of investing excess cash with custodial institutions that invest primarily in money market accounts consisting of short-term U.S. Treasury securities. These accounts are held primarily by the Institutional Trust & Custody division of U.S. Bank and SunTrust Bank Escrow Services.

The Company maintains depository relationships with SunTrust Bank and Wells Fargo Bank N.A., and other banking institutions. It is the Company’s policy not to have a balance of more than $250 thousand for any of its affiliates at any institution on any given day to minimize exposure to a bank failure. Cash balances in excess of $250 thousand are transferred daily into custodial accounts with SunTrust Bank Escrow Services where cash is immediately invested into shares of money market funds.

Restricted cash and cash equivalents are maintained in money market accounts consisting of U.S. Treasury and government agency securities.

 

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Table of Contents

 

The following table presents the amount of cash and cash equivalents and restricted cash and cash equivalents as of the periods presented (in thousands):

 

     As of June 30, 2012  
     Cash and cash equivalents     Restricted cash and cash equivalents  

Institution

   Cash      Money
Market Funds
     Total      % by
institution
    Funds
held in
Trust (1)
     State
Deposits (2)
     Total      % by
institution
 

U. S. Bank IT&C

   $ —         $ 40,475       $ 40,475         11.4   $ —         $ 800       $ 800         1.1

SunTrust Bank

     1,106         —           1,106         0.3     —           —           —           —     

SunTrust Bank Escrow Services

     —           311,029         311,029         87.3     —           —           —           —     

Wells Fargo Bank N.A.

     1,520         3         1,523         0.4     —           —           —           —     

Bank of New York Mellon Trust Co. (1)

     —           —           —           —          19,979         —           19,979         26.9

Florida Department of Financial Services

     —           —           —           —          —           53,495         53,495         72.0

All Other Banking Institutions

     2,033         159         2,192         0.6     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,659       $ 351,666       $ 356,325         100.0   $ 19,979       $ 54,295       $ 74,274         100.0
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

     As of December 31, 2011  
     Cash and cash equivalents     Restricted cash and cash equivalents  

Institution

   Cash      Money
Market Funds
     Total      % by
institution
    Funds
held in
Trust (1)
     State
Deposits (2)
     Total      % by
institution
 

U. S. Bank IT&C

   $ —         $ 40,474       $ 40,474         17.6   $ —         $ 800       $ 800         1.0

SunTrust Bank

     1,629         —           1,629         0.7     —           —           —           —     

SunTrust Bank Escrow Services

     —           182,701         182,701         79.5     —           —           —           —     

Wells Fargo Bank N.A.

     1,244         14         1,258         0.5     —           —           —           —     

Bank of New York Mellon Trust Co. (1)

     —           —           —           —          30,220         —           30,220         38.6

Florida Department of Financial Services

     —           —           —           —          —           47,292         47,292         60.4

All Other Banking Institutions

     1,739         1,884         3,623         1.6     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,612       $ 225,073       $ 229,685         100.0   $ 30,220       $ 48,092       $ 78,312         100.0
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Amounts held in trust include collateral contributed by UIH in connection with reinsurance contracts entered into between UPCIC and a segregated account owned and maintained by UIH.
(2) State deposits represent amounts held with regulatory agencies in the various states in which our Insurance Entities do business. Applicable laws and regulations govern not only the amount, but also the type of securities that are eligible for deposit. State deposits also include amounts that UPCIC has voluntarily placed on deposit in connection with the reinsurance contract between UPCIC and UIH.

Concentrations of credit risk with respect to premiums receivable are limited due to the large number of individuals comprising the Company’s customer base. However, the majority of the Company’s revenues are currently derived from products and services offered to customers in Florida, which could be adversely affected by economic downturns, an increase in competition or weather-related events.

In order to reduce credit risk for amounts due from reinsurers, the Insurance Entities seek to do business with financially sound reinsurance companies and regularly evaluate the financial strength of all reinsurers used. Everest Reinsurance Company, the reinsurer to which the Insurance Entities ceded the most risk through May 31, 2012, has the following ratings from each of the rating agencies: A+ from A.M. Best Company; A+ from Standard and Poor’s Rating Services and; Aa3 from Moody’s Investors Service, Inc. Additionally, Odyssey Reinsurance Company, the reinsurer to which the Insurance Entities cede the most risk effective June 1, 2012, has the following ratings from each of the rating agencies: A from A.M. Best Company; A- from Standard and Poor’s Rating Services and; A3 from Moody’s Investors Service, Inc.

 

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The following table presents the unsecured net amounts due from the Company’s reinsurers whose aggregate balance exceeds 3% of the Company’s stockholders’ equity (in thousands):

 

     As of  
     June 30,      December 31,  

Reinsurer

   2012      2011  

Everest Reinsurance Company

   $ 193,250       $ 264,997   

Florida Hurricane Catastrophe Fund

     —           30,422   

Odyssey Reinsurance Company

     42,084         —     
  

 

 

    

 

 

 

Total (1)

   $ 235,334       $ 295,419   
  

 

 

    

 

 

 

 

(1) Amounts represent prepaid reinsurance premiums, reinsurance receivables, and net recoverables for paid and unpaid losses, including incurred but not reported (“IBNR”) reserves, loss adjustment expenses, net of offsetting reinsurance payables.

 

Recently Issued Accounting Pronouncements

In December 2011, the Financial Accounting Standards Board (“FASB”) updated its guidance to the Balance Sheet Topic 210 of the FASB Accounting Standards Codification (“ASC”). This updated guidance requires entities that have financial instruments and derivative instruments that are offset, to disclose information about offsetting and related arrangements to enable users of financial statements to understand the effect of those arrangements on an entity’s financial position. This guidance is to be applied for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. Disclosure is required retrospectively for all comparative periods presented. The additional disclosures required by the updated guidance will not have an impact on the Company’s operating results, cash flows or financial position.

 

In June 2011, the FASB updated its guidance related to the Comprehensive Income Topic 220 of the FASB ASC. This updated guidance increases the prominence of items reported in other comprehensive income by eliminating the option of presenting components of other comprehensive income as part of the statement of changes in stockholders’ equity. The guidance requires that total comprehensive income (including both the net income components and other comprehensive income components) be reported in either a single continuous statement of comprehensive income (the approach currently used in the Company’s financial statements), or two separate but consecutive statements. This guidance is to be applied retrospectively to fiscal years (and interim periods within those years) beginning after December 15, 2011. The Company adopted this guidance effective January 1, 2012. This guidance did not have an impact on the presentation of the Company’s financial statements and notes herein, as the Company did not have any amounts of other comprehensive income during the periods presented.

 

In May 2011, the FASB updated its guidance related to the Fair Value Measurement, Topic 820 of the ASC, to achieve common fair value measurement and disclosure requirements with International Financial Reporting Standards. The amendments change the wording used to describe many of the requirements under GAAP, to clarify the intent of application of existing fair value measurement and disclosure requirements, and to change particular principles or requirements for measuring and disclosing fair value measurements. The amendments are to be applied prospectively to interim and annual reporting periods beginning after December 15, 2011. The Company adopted this guidance effective January 1, 2012. The adoption of this guidance resulted in additional disclosure but did not impact the Company’s results of operations, cash flows or financial position.

 

In September 2010, the FASB issued guidance related to accounting for costs associated with acquiring or renewing insurance contracts. This guidance defines allowable deferred policy acquisition costs as costs incurred by insurance entities for the successful acquisition of new and renewal contracts. Such costs result directly from and are essential to the contract transaction(s) and would not have been incurred by the insurance entity had the contract(s) not occurred. This guidance is effective for periods beginning after December 15, 2011, with early adoption permitted. The Company adopted this guidance prospectively effective January 1, 2012. Under the new guidance, the Company’s net deferred

 

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policy acquisition costs were reduced from $13.0 million to $11.4 million, a difference of 13%. The resulting $1.6 million difference was charged directly to earnings during the three months ended March 31, 2012. This charge represents a charge-off of capitalized costs existing at December 31, 2011, which would have been amortized to earnings within a twelve-month period under the old guidance.

 

3. Investments

 

The following table presents the Company’s investment holdings by type of instrument as of the periods presented (in thousands):

 

     As of June 30, 2012     As of December 31, 2011  
     Cost or
Amortized
Cost
    Fair Value     Carrying
Value
    Cost or
Amortized
Cost
     Fair Value      Carrying
Value
 

Cash and cash equivalents (1)

   $ 356,325      $ 356,325      $ 356,325      $ 229,685       $ 229,685       $ 229,685   

Restricted cash and cash equivalents (1)

     74,274        74,274        74,274        78,312         78,312         78,312   

Trading portfolio:

              

Debt securities:

              

U.S. government obligations and agencies (2)

     3,342        3,913        3,913        3,179         3,801         3,801   

Equity securities:

              

Common stock:

              

Metals and mining

     30,637        23,546        23,546        50,121         38,816         38,816   

Energy

     11,854        8,962        8,962        6,077         4,999         4,999   

Other

     2,904        2,517        2,517        8,044         6,945         6,945   

Exchange-traded and mutual funds:

              

Metals and mining

     24,140        22,437        22,437        28,311         25,997         25,997   

Agriculture

     18,761        18,172        18,172        17,781         16,878         16,878   

Energy

     4,420        4,090        4,090        —           —           —     

Indices

     2,378        1,989        1,989        2,006         1,710         1,710   

Non-hedging derivative asset (3)

     147        31        31        357         123         123   

Non-hedging derivative (liability) (3)

     (174     (174     (174     —           —           —     

Other investments (4)

     517        344        344        517         371         371   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total trading portfolio investments

     98,926        85,827        85,827        116,393         99,640         99,640   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total investments

   $ 529,525      $ 516,426      $ 516,426      $ 424,390       $ 407,637       $ 407,637   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

 

(1) Cash and cash equivalents include short-term debt securities consisting of direct obligations of the U.S. Treasury or money-market accounts that invest in direct obligations of the U.S. Treasury.
(2) The Company is required by various state laws and regulations to maintain certain securities on deposit in depositary accounts with the states in which we do business. As of June 30, 2012 and December 31, 2011, securities having fair values of $3.9 million and $3.8 million, respectively, were on deposit. These laws and regulations govern not only the amount, but also the type of security that is eligible for deposit.
(3) Derivatives are included in Other assets and Other liabilities and accrued expenses in the Condensed Consolidated Balance Sheets.
(4) Other investments represent physical metals held by the Company and are included in Other assets in the Condensed Consolidated Balance Sheets.

The Company has made an assessment of its invested assets for fair value measurement as further described in Note 12 – Fair Value Measurements.

 

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Table of Contents

 

The following table presents net investment income (expense) comprised primarily of interest and dividends (in thousands):

 

     Three Months Ended     Six Months Ended  
     June 30,     June 30,  
     2012     2011     2012     2011  

Cash and cash equivalents (1)

   $ 60      $ 35      $ 239      $ 50   

Debt securities

     1        67        11        468   

Equity securities

     160        34        219        60   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     221        136        469        578   

Less investment expenses

     (237     (157     (521     (342
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment (expense) income

   $ (16   $ (21   $ (52   $ 236   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes interest earned on restricted cash and cash equivalents.

Trading Portfolio

 

The following table presents the effect of trading activities on the Company’s results of operations by type of instrument and by line item in the condensed consolidated statements of income (in thousands):

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  

Realized gains (losses) on investments:

        

Debt securities

   $ —        $ 523      $ —        $ (3,617

Equity securities

     (1,836     2,682        (9,429     10,867   

Derivatives (non-hedging instruments) (1)

     131        (245     275        (638
  

 

 

   

 

 

   

 

 

   

 

 

 

Total realized gains (losses) on trading portfolio

     (1,705     2,960        (9,154     6,612   

Unrealized gains (losses) on investments:

        

Debt securities

     100        2,741        137        8,260   

Equity securities

     (5,817     (11,699     3,172        (14,894

Derivatives (non-hedging instruments) (1)

     (30     (681     117        (418

Other

     (41     —          (27     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) on trading portfolio

     (5,788     (9,639     3,399        (7,052
  

 

 

   

 

 

   

 

 

   

 

 

 

Net gains (losses) recognized on trading securities

   $ (7,493   $ (6,679   $ (5,755   $ (440
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) This table represents the alternative quantitative disclosures permitted for derivatives that are not used as hedging instruments and are included in the trading portfolio.

 

4. Reinsurance

The Company seeks to reduce its risk of loss by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers, generally, as of the beginning of the hurricane season on June 1 of each year. The Company’s reinsurance program consists of excess of loss, quota share and catastrophe reinsurance, subject to the terms and conditions of the applicable agreements. The Company is responsible for insured losses related to catastrophes and other events in excess of coverage provided by its reinsurance program. The Company also remains responsible for the settlement of insured losses notwithstanding the failure of any of its reinsurers to make payments otherwise due to the Company. The Company’s in-force policyholder coverage for windstorm exposures as of June 30, 2012 was approximately $126.2 billion.

 

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The Company has reduced the percentage of premiums ceded by UPCIC to its quota share reinsurer to 45% under the reinsurance program which became effective June 1, 2012, from 50% under the prior year quota share contract effective June 1, 2011 through May 31, 2012. The Company’s intent is to increase its profitability over the contract term by ceding 5% less premium to its quota share reinsurer. This reduction of cession rate also decreases the amount of losses and loss adjustment expenses that may be ceded by UPCIC and effectively increases the amount of risk retained by UPCIC and the Company. The reduction of cession rate also reduces the amount of ceding commissions earned from the Company’s quota share reinsurer during the contract term and decreases the amount of deferred ceding commission, as of June 30, 2012, that is a component of net deferred policy acquisition costs.

Amounts recoverable from reinsurers are estimated in a manner consistent with the reinsurance contracts. Reinsurance premiums, losses and loss adjustment expenses (“LAE”) are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Deferred ceding commissions are netted against policy acquisition costs and amortized over the effective period of the related insurance policies.

 

The Company’s reinsurance arrangements had the following effect on certain items in the Condensed Consolidated Statements of Income (in thousands):

 

     Three Months Ended June 30, 2012     Six Months Ended June 30, 2012  
     Premiums
Written
    Premiums
Earned
    Loss and Loss
Adjustment
Expenses
    Premiums
Written
    Premiums
Earned
    Loss and Loss
Adjustment
Expenses
 

Direct

   $ 222,568      $ 186,656      $ 56,533      $ 412,571      $ 365,460      $ 109,140   

Ceded

     (102,433     (130,962     (27,096     (265,867     (261,126     (53,529
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net

   $ 120,135      $ 55,694      $ 29,437      $ 146,704      $ 104,334      $ 55,611   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Three Months Ended June 30, 2011     Six Months Ended June 30, 2011  
     Premiums
Written
    Premiums
Earned
    Loss and Loss
Adjustment
Expenses
    Premiums
Written
    Premiums
Earned
    Loss and Loss
Adjustment
Expenses
 

Direct

   $ 213,479      $ 170,134      $ 53,360      $ 386,654      $ 334,721      $ 106,491   

Ceded

     (145,798     (120,610     (27,508     (269,689     (237,193     (54,454
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net

   $ 67,681      $ 49,524      $ 25,852      $ 116,965      $ 97,528      $ 52,037   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

The following prepaid reinsurance premiums and reinsurance recoverables and receivables are reflected in the Condensed Consolidated Balance Sheets (in thousands):

 

     As of      As of  
     June 30, 2012      December 31, 2011  

Prepaid reinsurance premiums

   $ 247,835       $ 243,095   
  

 

 

    

 

 

 

Reinsurance recoverable on unpaid losses and LAE

   $ 73,169       $ 88,002   

Reinsurance recoverable on paid losses

     42,290         (2,296

Reinsurance receivables, net

     125,664         55,205   
  

 

 

    

 

 

 

Reinsurance recoverables and receivables

   $ 241,123       $ 140,911   
  

 

 

    

 

 

 

 

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5. Insurance Operations

The Company’s primary product is homeowners insurance currently offered by APPIC in one state (Florida) and by UPCIC in five states, including Florida, which represented 97% and 98% of the Insurance Entities’ policies-in-force as of June 30, 2012 and December 31, 2011, respectively. Approximately 98% of the Insurance Entities’ policies-in-force as of June 30, 2012 and December 31, 2011 included coverage for wind. As of June 30, 2012 and December 31, 2011, 29% and 32%, respectively, of the Insurance Entities’ policies-in-force with wind coverage were for insured properties located in Miami-Dade, Broward and Palm Beach counties.

Deferred Policy Acquisition Costs

The Company defers certain costs in connection with the written policies, called Deferred Policy Acquisition Costs (“DPAC”), net of corresponding amounts of ceded reinsurance commissions, called Deferred Reinsurance Ceding Commissions (“DRCC”). Net DPAC is amortized over the effective period of the related insurance policies. The following table presents the beginning and ending balances and the changes in DPAC, net of DRCC, for the periods presented (in thousands):

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  

DPAC, beginning of period (1)

   $ 51,872      $ 51,860      $ 50,200      $ 50,128   

Capitalized costs

     29,536        30,507        55,680        56,792   

Amortization of DPAC

     (24,486     (23,238     (48,958     (47,791
  

 

 

   

 

 

   

 

 

   

 

 

 

DPAC, end of period

   $ 56,922      $ 59,129      $ 56,922      $ 59,129   
  

 

 

   

 

 

   

 

 

   

 

 

 

DRCC, beginning of period (1)

   $ 40,074      $ 41,721      $ 38,845      $ 40,682   

Ceding commissions written

     21,286        26,457        44,775        47,888   

Earned ceding commissions

     (22,182     (21,075     (44,442     (41,467
  

 

 

   

 

 

   

 

 

   

 

 

 

DRCC, end of period

   $ 39,178      $ 47,103      $ 39,178      $ 47,103   
  

 

 

   

 

 

   

 

 

   

 

 

 

DPAC (DRCC), net, beginning of period (1)

   $ 11,798      $ 10,139      $ 11,355      $ 9,446   

Capitalized costs, net

     8,250        4,050        10,905        8,904   

Amortization of DPAC (DRCC), net

     (2,304     (2,163     (4,516     (6,324
  

 

 

   

 

 

   

 

 

   

 

 

 

DPAC (DRCC), net, end of period

   $ 17,744      $ 12,026      $ 17,744      $ 12,026   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The beginning balances for the six months ended June 30, 2012 have been adjusted in connection with the adoption of the FASB’s updated guidance related to deferred acquisition costs as discussed below.

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

 

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Table of Contents

Liability for Unpaid Losses and Loss Adjustment Expenses

 

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

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012     2011  

Balance at beginning of period

   $ 172,300       $ 158,249       $ 187,215      $ 158,928   

Less reinsurance recoverable

     79,285         78,611         88,002        79,114   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net balance at beginning of period

     93,015         79,638         99,213        79,814   
  

 

 

    

 

 

    

 

 

   

 

 

 

Incurred related to:

          

Current year

     29,362         25,587         55,711        51,923   

Prior years

     75         265         (100     114   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total incurred

     29,437         25,852         55,611        52,037   
  

 

 

    

 

 

    

 

 

   

 

 

 

Paid related to:

          

Current year

     14,382         12,817         15,335        14,875   

Prior years

     16,614         13,606         48,033        37,909   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total paid

     30,996         26,423         63,368        52,784   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net balance at end of period

     91,456         79,068         91,456        79,068   

Plus reinsurance recoverables

     73,169         76,307         73,169        76,307   
  

 

 

    

 

 

    

 

 

   

 

 

 

Balance at end of period

   $ 164,625       $ 155,375       $ 164,625      $ 155,375   
  

 

 

    

 

 

    

 

 

   

 

 

 

Regulatory Requirements

The Insurance Entities are subject to regulations and standards of the Florida Office of Insurance Regulation (“OIR”). UPCIC is also subject to the laws of other states in which it operates. The OIR standards require the Insurance Entities to maintain specified levels of statutory capital and restrict the timing and amount of dividends and other distributions that may be paid to the parent company. Except in the case of extraordinary dividends, these standards generally permit the Insurance Entities to pay dividends from statutory unassigned surplus. The dividends are limited based on the Insurance Entities’ level of statutory net income and statutory capital and surplus. These dividends are referred to as “ordinary dividends” and generally can be paid without prior regulatory approval. If the dividend, together with other dividends paid within the preceding twelve months, exceeds a specified statutory limit or is paid from sources other than earned surplus, the entire dividend is generally considered an “extraordinary dividend” and must receive prior regulatory approval.

Based on the 2011 statutory net income and statutory capital and surplus levels, UPCIC and APPCIC do not have the capacity to pay ordinary dividends during 2012. For the six months ended June 30, 2012, no dividends were paid from UPCIC or APPCIC to the parent company.

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

 

     As of      As of  
     June 30,     

December 31,

 
     2012      2011  

Ten percent of total liabilities

     

UPCIC

   $ 60,300       $ 37,063   

APPCIC

   $ 461       $ 97   

Statutory capital and surplus

     

UPCIC

   $ 135,337       $ 122,956   

APPCIC

   $ 9,331       $ 9,378   

 

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

 

6. Share-Based Compensation

 

The following table presents certain information related to stock options and non-vested shares (“restricted stock”) (in thousands, except per share data):

 

                                                                       
     Three Months Ended June 30, 2012  
     Stock Options      Restricted Stock  
     Number of
Shares
    Weighted
Average
Exercise
Price
     Aggregate
Intrinsic
Value
     Weighted
Average
Remaining
Term
     Number of
Shares
     Weighted
Average
Grant Date
Fair Value
 

Outstanding as of March 31, 2012

     6,685      $ 4.79               502       $ 5.66   

Granted

     —          —                 —           —     

Forfeited

     —          —                 —           —     

Exercised (1)

     (200     2.31               —           n/a   

Vested

     —          —                 —           —     

Expired

     —          —                 —           n/a   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Outstanding as of June 30, 2012 (2)

     6,485      $ 4.87       $ 660         2.3         502       $ 5.66   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Exercisable as of June 30, 2012

     6,062      $ 4.88       $ 660         2.1         
  

 

 

   

 

 

    

 

 

    

 

 

       

 

                                                                       
     Six Months Ended June 30, 2012  
     Stock Options      Restricted Stock  
     Number of
Shares
    Weighted
Average
Exercise
Price
     Aggregate
Intrinsic
Value
     Weighted
Average
Remaining
Term
     Number of
Shares
    Weighted
Average
Grant Date
Fair Value
 

Outstanding as of December 31, 2011

     6,720      $ 4.78               801      $ 5.67   

Granted

     —          —                 —          —     

Forfeited

     —          —                 —          —     

Exercised (1)

     (235     2.35               —          n/a   

Vested

     —          —                 (299     5.69   

Expired

     —          —                 —          n/a   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Outstanding as of June 30, 2012 (2)

     6,485      $ 4.87       $ 660         2.3         502      $ 5.66   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Exercisable as of June 30, 2012

     6,062      $ 4.88       $ 660         2.1        
  

 

 

   

 

 

    

 

 

    

 

 

      

 

(1) Unless otherwise specified, such as in the case of the exercise of stock options, the per share prices were determined using the closing price of the Company’s Common Stock as quoted on the NYSE MKT LLC. Shares issued upon exercise of options represent original issuances in private transactions pursuant to Section 4(2) of the Securities Act of 1933, as amended.
(2) All shares outstanding as of June 30, 2012 are expected to vest.

n/a – Not applicable

 

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The following table presents certain information regarding the Company’s stock-based compensation for the periods presented (in thousands):

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012     2011  

Compensation expense:

          

Stock options

   $ 309       $ 202       $ 646      $ 456   

Restricted stock

     371         319         1,046        463   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 680       $ 521       $ 1,692      $ 919   
  

 

 

    

 

 

    

 

 

   

 

 

 

Deferred tax benefits:

          

Stock options

   $ 119       $ 78       $ 249      $ 176   

Restricted stock

     87         —         $ 291        —     
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 206       $ 78       $ 540      $ 176   
  

 

 

    

 

 

    

 

 

   

 

 

 

Realized tax benefits:

          

Stock options

   $ 128       $ —         $ 141      $ —     

Restricted stock

     —           —           291        —     
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 128       $ —         $ 432      $ —     
  

 

 

    

 

 

    

 

 

   

 

 

 

Excess tax benefits(shortfall):

          

Stock options

   $ 71       $ —         $ 71      $ —     

Restricted stock

     —           —           (142     —     
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 71       $ —         $ (71   $ —     
  

 

 

    

 

 

    

 

 

   

 

 

 

Weighted average fair value:

          

Stock option grants

   $ —         $ 2,497       $ —        $ 2,497   

Restricted stock grants

   $ —         $ 3,366       $ —        $ 3,366   

Intrinsic value of options exercised

   $ 332       $ —         $ 367      $ —     

Fair value of restricted stock vested

   $ —         $ —         $ 1,164      $ 540   

Cash received for strike price and tax withholdings

   $ —         $ —         $ 518      $ 199   

Shares acquired through cashless exercise (1)

     147         —           147        —     

Value of shares acquired

   $ 583       $ —         $ 583      $ —     

 

(1) All shares acquired represent shares tendered to cover the exercise price for options and tax withholdings on the intrinsic value of options exercised or restricted stock vested. These shares have been cancelled by the Company.

 

The following table presents the amount of unrecognized compensation expense as of the most recent balance sheet date and the weighted average period over which those expenses will be recorded for both stock options and restricted stock (dollars in thousands):

 

     As of June 30, 2012  
     Stock
Options
     Restricted
Stock
 

Unrecognized expense

   $ 965       $ 2,142   

Weighted average remaining years

     0.98         1.24   

 

7. Stockholders’ Equity

Dividends

On February 23, 2012, the Company declared a dividend of $0.10 per share on our outstanding common stock paid on April 6, 2012, to the shareholders of record at the close of business on March 28, 2012.

 

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On April 23, 2012, the Company declared a dividend of $0.08 per share on our outstanding common stock paid on July 9, 2012, to the shareholders of record at the close of business on June 26, 2012.

 

8. Related Party Transactions

Downes and Associates, a multi-line insurance adjustment corporation based in Deerfield Beach, Florida, performs certain claims adjusting work for UPCIC. Downes and Associates is owned by Dennis Downes, who is the father of Sean P. Downes, Senior Vice President and Chief Operating Officer of the Company.

 

The following table presents payments made by the Company to Downes and Associates for the periods presented (in thousands):

 

     Three Months Ended
June  30,
     Six Months Ended
June  30,
 
     2012      2011      2012      2011  

Claims adjusting fees

   $ 130       $ 170       $ 260       $ 430   

There were no amounts due to Downes and Associates as of June 30, 2012 and December 31, 2011.

 

9. Income Taxes

 

Deferred income taxes represent the temporary differences between the GAAP and tax basis of the Company’s assets and liabilities. The tax effects of temporary differences are as follows for the periods presented (in thousands):

 

     As of June 30,     As of December 31,  
     2012     2011  

Deferred income tax assets:

    

Unearned premiums

   $ 12,276      $ 9,007   

Advanced premiums

     1,918        1,451   

Unpaid losses and LAE

     2,935        3,139   

Stock-based compensation

     4,377        4,341   

Accrued wages

     833        958   

Allowance for uncollectible receivables

     190        276   

Additional tax basis of securities

     482        2,407   

Unrealized losses on investments

     5,114        6,425   
  

 

 

   

 

 

 

Total deferred income tax assets

     28,125        28,004   
  

 

 

   

 

 

 

Deferred income tax liabilities:

    

Deferred policy acquisition costs, net

     (6,845     (5,013
  

 

 

   

 

 

 

Total deferred income tax liabilities

     (6,845     (5,013
  

 

 

   

 

 

 
    
  

 

 

   

 

 

 

Net deferred income tax asset

   $ 21,280      $ 22,991   
  

 

 

   

 

 

 

A valuation allowance is deemed unnecessary as of June 30, 2012 and December 31, 2011, because management believes it is probable that the Company will generate taxable income sufficient to realize the tax benefits associated with the net deferred income tax asset shown above in the near future.

 

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Tax years that remain open for purposes of examination of the Company’s income tax liability by taxing authorities include the years ended December 31, 2010, 2009 and 2008. The Company’s 2009 consolidated federal income tax return is currently under examination by the Internal Revenue Service.

 

The following table reconciles the statutory federal income tax rate to the Company’s effective tax rate for the periods presented:

 

     Three Months Ended
June  30,
    Six Months Ended
June  30,
 
     2012     2011     2012     2011  

Statutory federal income tax rate

     35.0     35.0     35.0     35.0

Increases resulting from:

        

Disallowed meals & entertainment

     0.2     0.1     0.2     0.1

Disallowed compensation

     1.0     2.0     0.7     1.2

State income tax, net of federal tax benefit (1)

     3.6     3.6     3.6     3.6

Other, net (2)

     0.3     1.8     0.1     0.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Effective tax rate

     40.1     42.5     39.6     40.7
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Included in income tax is State of Florida income tax at a statutory tax rate of 5.5%.
(2) Other, net, includes estimated penalties and interest of 1.8% and 0.7% for the three and six months ended June 30, 2011, respectively, regarding an underpayment of estimated taxes in 2011.

 

10. Earnings Per Share

Basic earnings per share (“EPS”) is based on the weighted average number of common shares outstanding for the period, excluding any dilutive common share equivalents. Diluted EPS reflects the potential dilution resulting from exercises of stock options, vesting of restricted stock and conversion of preferred stock.

 

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The following table reconciles the numerator (i.e., income) and denominator (i.e., shares) of the basic and diluted earnings per share computations for the periods presented (in thousands, except per share data):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Numerator for EPS:

        

Net income

   $ 7,777      $ 7,549      $ 17,650      $ 21,447   

Less: Preferred stock dividends

     (5     (5     (259     (10
  

 

 

   

 

 

   

 

 

   

 

 

 

Income available to common stockholders

   $ 7,772      $ 7,544      $ 17,391      $ 21,437   

Denominator for EPS:

        

Weighted average common shares outstanding

     39,668        39,187        39,528        39,187   

Plus: Assumed conversion of stock-based compensation (1)

     221        970        444        981   

Assumed conversion of preferred stock

     488        488        488        489   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average diluted common shares outstanding

     40,377        40,645        40,460        40,657   

Basic earnings per common share

   $ 0.20      $ 0.19      $ 0.44      $ 0.55   

Diluted earnings per common share

   $ 0.19      $ 0.19      $ 0.44      $ 0.53   

 

(1) Represents the dilutive effect of unvested restricted stock and unexercised stock options.

 

11. Commitments and Contingencies

Employment Agreements

The Company has employment agreements with certain employees which are in effect as of June 30, 2012. The agreements provide for minimum salaries, which may be subject to annual percentage increases, and non-equity incentive compensation for certain executives based on pre-tax income or net income levels attained by the Company. The agreements also provide for payments contingent upon the occurrence of certain events.

 

The following table presents the amount of commitments and estimated contingent payments the Company is obligated to pay in the form of salaries and non-equity incentive compensation under the agreements with named executive officers (in thousands):

 

     As of June 30, 2012  
     Salaries      Non-equity
incentive
compensation
     Equity
compensation
 

Commitments

   $ 7,328       $ 3,772         —     

Contingent payments upon certain events:

        

Termination

   $ 4,374       $ 2,823         —     

Change in control

   $ 13,634       $ 5,016       $ 260   

Death

   $ 4,924       $ 2,671         —     

Disability

   $ 3,278       $ 1,760         —     

 

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Litigation

Certain lawsuits have been filed against the Company. These lawsuits involve matters that are routine litigation incidental to the claims aspect of the Company’s business for which estimated losses are included in Unpaid Losses and Loss Adjustment Expenses in the Company’s Condensed Consolidated Financial Statements. In the opinion of management, these lawsuits are not material individually or in the aggregate to the Company’s financial position or results of operations. Accruals made or assessments of materiality of disclosure related to probable or possible losses do not consider any anticipated insurance proceeds.

Loss Contingencies

In July 2012, a dispute arose between the Insurance Entities and one of their reinsurers over certain provisions of a reinsurance contract that expired May 31, 2012. While the Company believes it has meritorious claims in the dispute, the ultimate resolution of the matter, the date of which is not yet determinable, could result in a pre-tax loss ranging from zero to $5.4 million.

 

12. Fair Value Measurements

GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. GAAP describes three approaches to measuring the fair value of assets and liabilities: the market approach, the income approach and the cost approach. Each approach includes multiple valuation techniques. GAAP does not prescribe which valuation technique should be used when measuring fair value, but does establish a fair value hierarchy that prioritizes the inputs used in applying the various techniques. Inputs broadly refer to the assumptions that market participants use to make pricing decisions, including assumptions about risk. Level 1 inputs are given the highest priority in the hierarchy while Level 3 inputs are given the lowest priority. Assets and liabilities carried at fair value are classified in one of the following three categories based on the nature of the inputs to the valuation technique used:

 

 

Level 1 – Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

 

Level 2 – Observable market-based inputs or unobservable inputs that are corroborated by market data.

 

 

Level 3 – Unobservable inputs that are not corroborated by market data. These inputs reflect management’s best estimate of fair value using its own assumptions about the assumptions a market participant would use in pricing the asset or liability.

Summary of significant valuation techniques for assets measured at fair value on a recurring basis

Level 1

Cash and cash equivalents and restricted cash and cash equivalents: Cash equivalents and restricted cash equivalents comprise actively traded money market funds that have daily quoted net asset values for identical assets that the Company can access. The carrying value of cash and cash equivalents and restricted cash and cash equivalents approximates fair value due to its liquid nature.

Common stock: Comprise actively traded, exchange-listed U.S. and international equity securities. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

Exchange-traded and mutual funds: Comprise actively traded funds. Valuation is based on daily quoted net asset values for identical assets in active markets that the Company can access.

 

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Other investments: Currently comprise physical metal positions held by the Company. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

Level 2

U.S. government obligations and agencies: Comprise U.S. Treasury Bills or Notes or U.S. Treasury Inflation Protected Securities (TIPS). The primary inputs to the valuation include quoted prices for identical assets in inactive markets or similar assets in active or inactive markets, contractual cash flows, benchmark yields and credit spreads.

Derivatives: The primary inputs to the valuation include quoted prices or quoted net asset values for identical or similar assets in markets that are not active or highly active.

As required by GAAP, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect their placement within the fair value hierarchy levels.

 

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The following tables set forth by level within the fair value hierarchy the Company’s assets and liabilities that were accounted for at fair value on a recurring basis as of the periods presented (in thousands):

 

     Fair Value Measurements
As of June 30, 2012
 
     Level 1      Level 2     Level 3      Total  

Cash and cash equivalents

   $ 356,325       $ —        $ —         $ 356,325   

Restricted cash and cash equivalents

     74,274         —          —           74,274   

Trading portfolio:

          

Debt securities:

          

U.S. government obligations and agencies

     —           3,913        —           3,913   

Equity securities:

          

Common stock:

          

Metals and mining

     23,546         —          —           23,546   

Energy

     8,962         —          —           8,962   

Other

     2,517         —          —           2,517   

Exchange-traded and mutual funds:

          

Metals and mining

     22,437         —          —           22,437   

Agriculture

     18,172         —          —           18,172   

Energy

     4,090         —          —           4,090   

Indices

     1,989         —          —           1,989   

Non-hedging derivative asset

     —           31        —           31   

Non-hedging derivative (liability)

     —           (174     —           (174

Other investments

     344         —          —           344   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total trading portfolio investments

     82,057         3,770        —           85,827   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total investments

   $ 512,656       $ 3,770      $ —         $ 516,426   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

     Fair Value Measurements
As of December 31, 2011
 
     Level 1      Level 2      Level 3      Total  

Cash and cash equivalents

   $ 229,685       $ —         $ —         $ 229,685   

Restricted cash and cash equivalents

     78,312         —           —           78,312   

Trading portfolio:

           

Debt securities:

           

U.S. government obligations and agencies

     174         3,627         —           3,801   

Equity securities:

           

Common stock:

           

Metals and mining

     38,816         —           —           38,816   

Energy

     4,999         —           —           4,999   

Other

     6,927         18         —           6,945   

Exchange-traded and mutual funds:

           

Metals and mining

     25,997         —           —           25,997   

Agriculture

     16,878         —           —           16,878   

Indices

     1,710         —           —           1,710   

Non-hedging derivative asset

     —           123         —           123   

Other investments

     371         —           —           371   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total trading portfolio investments

     95,872         3,768         —           99,640   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 403,869       $ 3,768       $ —         $ 407,637   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The Company utilizes third-party independent pricing services that provide a price quote for each debt security, equity security and derivative. Management reviews the methodology used by the pricing services. If management believes that the price used by the pricing service does not reflect an orderly transaction between participants, management will use an alternative valuation methodology. There were no adjustments made by the Company to the prices obtained from the independent pricing source for any debt securities, equity securities or derivatives included in the tables above.

The Company did not have any transfers between Level 1 and Level 2 for the three and six-month periods ended June 30, 2012 and 2011.

 

The following table summarizes the carrying value and estimated fair values of the Company’s financial instruments that are not carried at fair value (in thousands):

 

     As of June 30, 2012  
     Carrying value      (Level 3)
Estimated Fair
Value
 

Liabilities:

     

Long-term debt

   $ 20,956       $ 17,990   

 

     As of December 31, 2011  
     Carrying value      (Level 3)
Estimated Fair
Value
 

Liabilities:

     

Long-term debt

   $ 21,691       $ 18,775   

Level 3

Long-term debt: The fair value of long-term debt was determined by management from the expected cash flows discounted using the interest rate quoted by the issuer of the note, the State Board of Administration of Florida (“SBA”) which is below prevailing rates quoted by private lending institutions. However, as the Company’s use of funds from the surplus note is limited by the terms of the agreement, the Company has determined the interest rate quoted by the SBA to be appropriate for purposes of establishing the fair value of the note.

 

13. Subsequent Events

The Company performed an evaluation of subsequent events through the date the Financial Statements were issued and determined there were no recognized or unrecognized subsequent events that would require an adjustment or additional disclosure in the Financial Statements as of June 30, 2012.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Unless the context otherwise requires, all references to “we,” “us,” “our,” and “Company” refer to Universal Insurance Holdings, Inc. and its subsidiaries. You should read the following discussion together with our unaudited condensed consolidated financial statements and the related notes thereto included in Part I, Item 1 “Financial Statements.” Operating results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for the year.

Forward-Looking Statements

In addition to historical information, the following discussion may contain “forward-looking statements” within the meaning of the Private Securities Reform Litigation Act of 1995. The words “expect,” “estimate,” “anticipate,” “believe,”

 

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“intend,” “project,” “plan” and similar expressions and variations thereof, speak only as of the date the statement was made and are intended to identify forward-looking statements. Forward-looking statements are based on various factors and assumptions that include known and unknown risks and uncertainties. Such statements may include, but not be limited to, projections of revenues, income or loss, expenses, plans, as well as assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future results could differ materially from those in the following discussion and those described in forward-looking statements as a result of the risks set forth below.

Risk Factors Summary

We operate in a rapidly changing environment that involves a number of uncertainties, some of which are beyond our control. Certain statements made in this report that reflect management’s expectations regarding future events are forward-looking in nature and, accordingly are subject to risks and uncertainties. These forward-looking statements are only current expectations about future events. Actual results could differ materially from those set forth in or implied by any forward-looking statement. Factors that could cause or contribute to such differences include, but are not limited to, risk factors set forth in filings with the Securities and Exchange Commission, including our annual and quarterly reports. The following is a summary of uncertainties which were disclosed in greater detail in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011:

Risks Relating to the Property-Casualty Business

 

   

As a property and casualty insurer, we may face significant losses from catastrophes and severe weather events

 

   

Unanticipated increases in the severity or frequency of claims may adversely affect our profitability and financial condition

 

   

Actual claims incurred may exceed current reserves established for claims and may adversely affect our operating results and financial condition

 

   

Predicting claim expense relating to environmental liabilities is inherently uncertain and may have a material adverse effect on our operating results and financial condition

 

   

The failure of the risk mitigation strategies we utilize could have a material adverse effect on our financial condition or results of operations

 

   

Reinsurance may be unavailable at current levels and prices, which may limit our ability to write new business

 

   

Regulation limiting rate increases and requiring us to participate in loss sharing may decrease our profitability

 

   

The potential benefits of implementing our profitability model may not be fully realized

 

   

Our financial condition and operating results and the financial condition and operating results of the Insurance Entities may be adversely affected by the cyclical nature of the property and casualty business

 

   

Continued weakness in the Florida real estate market could adversely affect our loss results

Risks Relating to Investments

 

   

We have periodically experienced, and may experience further reductions in returns or losses on our investments especially during periods of heightened volatility, which could have a material adverse effect on our results of operations or financial condition

 

   

We are subject to market risk which may adversely impact investment income

 

   

Concentration of our investment portfolios in any particular segment of the economy may have adverse effects on our operating results and financial condition

 

   

Our overall financial performance is significantly dependent on the returns on our investment portfolio, which may have a material adverse effect on our results of operations or cause such results to be volatile

Risks Relating to the Insurance Industry and Other Factors

 

   

Our future results are dependent in part on our ability to successfully operate in an insurance industry that is highly competitive

 

   

Difficult conditions in the economy generally could adversely affect our business and operating results

 

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There can be no assurance that actions of the U.S. federal government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets and stimulating the economy will achieve the intended effect

 

   

We are subject to extensive regulation and potential further restrictive regulation may increase our operating costs and limit our growth

 

   

Reinsurance subjects us to the credit risk of our reinsurers and may not be adequate to protect us against losses arising from ceded risks, which could have a material adverse effect on our operating results and financial condition

 

   

The continued threat of terrorism and ongoing military actions may adversely affect the level of claim losses we incur and the value of our investment portfolio

 

   

A downgrade in our Financial Stability Rating® may have an adverse effect on our competitive position, the marketability of our product offerings, and our liquidity, operating results and financial condition

 

   

Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs or our ability to obtain credit on acceptable terms

 

   

Changing climate conditions may adversely affect our financial condition, profitability or cash flows

 

   

Loss of key executives could affect our operations

Overview

Universal Insurance Holdings, Inc. (“UIH”) with its wholly-owned subsidiaries is a vertically integrated insurance company performing all aspects of insurance underwriting, distribution and claims. Through our wholly-owned subsidiaries, including Universal Property & Casualty Insurance Company (“UPCIC”) and American Platinum Property and Casualty Insurance Company (“APPCIC”), collectively referred to as the (“Insurance Entities”), we are principally engaged in the property and casualty insurance business offered primarily through a network of independent agents. Our primary product is homeowners insurance currently offered in five states, including Florida, which represented 97% of the 574 thousand policies-in-force as of June 30, 2012, and 98% of the 593 thousand policies-in-force as of December 31, 2011. As for the geographic distribution of business within Florida as of June 30, 2012, and December 31, 2011, 29% and 32%, respectively, of the policies-in-force are in Miami-Dade, Broward and Palm Beach Counties. Risk from catastrophic losses is managed through the use of reinsurance agreements.

We generate revenues primarily from the collection of premiums and the investment of funds in excess of those retained for claims-paying obligations and insurance operations. Other significant sources of revenue include commissions collected from reinsurers and policy fees.

2012 Developments

On January 11, 2012, we announced that UPCIC received OIR approval for premium rate increases for its homeowners and Dwelling Fire programs within Florida. The premium rate increases are expected to average approximately 14.9% statewide for its homeowners program and 8.8% statewide for its dwelling fire program. The effective dates for both of the premium rate increases are January 9, 2012 for new business and February 28, 2012 for renewal business.

UPCIC made a forms filing immediately after the rate filing to segregate sinkhole coverage and to include updated policy language as a result of the property insurance bill which became law in May 2011 (Senate Bill 408). The OIR approved the forms filing with effective dates of April 1, 2012 for new business and May 21, 2012 for renewals. With the approval of this forms filing, sinkhole coverage will be removed from certain base homeowners policies and the coverage will be offered via endorsement for an additional surcharge, and a mandatory 10% deductible, to those policyholders that meet the proposed eligibility standards. Revised inspection and eligibility requirements will not be imposed upon existing policyholders who elect to continue sinkhole coverage at their policy renewal. Form changes for sinkhole coverage on dwelling fire policies, which are similar in nature to those filed for homeowners policies, were approved by the OIR with effective dates of May 1, 2012 for new business and June 8, 2012 for renewal business. Coverage for catastrophic ground cover collapse will remain a covered peril under all standard policy forms.

 

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On February 22, 2012, we declared a dividend of $0.10 per share on our outstanding common stock paid on April 6, 2012, to shareholders of record at the close of business on March 28, 2012.

On April 23, 2012, we declared a dividend of $0.08 per share on our outstanding common stock paid on July 9, 2012, to shareholders of record at the close of business on June 26, 2012. We expect to declare additional quarterly dividends in the same amount to shareholders of record in the third and fourth quarters of 2012. Declaration and payment of future dividends is subject to the discretion of UIH’s board of directors and will be dependent on future earnings, cash flows, financial requirements and other factors.

On June 26, 2012, Demotech, Inc. affirmed UPCIC’s Financial Stability Rating® of A. A Financial Stability Rating® of A is the third highest of six possible rating levels. According to Demotech, Inc., A ratings are assigned to insurers that have “…exceptional ability to maintain liquidity of invested assets, quality reinsurance, acceptable financial leverage and realistic pricing while simultaneously establishing loss and loss adjustment expense reserves at reasonable levels.” The rating of UPCIC is subject to at least annual review by, and may be revised upward or downward or revoked at the sole discretion of Demotech, Inc.

On July 11, 2012, we announced that UPCIC received approval from the Massachusetts Division of Insurance for homeowners policies rates and forms.

On August 1, 2012, we announced that UPCIC bound its first homeowners insurance policy in Massachusetts. The expansion marks the sixth state where UPCIC writes homeowners insurance.

Impact of new accounting pronouncement

We prospectively adopted new accounting guidance related to accounting for costs associated with acquiring or renewing insurance contracts effective January 1, 2012. The overall impact under the new guidance, which was adopted on January 1, 2012, was a reduction in earnings of $2.7 million ($1.7 million after tax or $0.04 per diluted share). The $2.7 million pre-tax reduction in earnings during the three months ended March 31, 2012, includes an acceleration of capitalized costs existing as of December 31, 2011, which would have been amortized to earnings within a twelve-month period, and the immediate recognition of costs which otherwise would have been deferred, partially offset by a lesser amount of amortization expense due to the reduction in capitalized costs. The new guidance does not result in incremental charges to earnings, but rather affects the timing of the recognition of those charges in the income statement.

2012-2013 Reinsurance Program

Effective June 1, 2012, we entered into multiple reinsurance agreements comprising our 2012-2013 reinsurance program.

REINSURANCE GENERALLY

In the normal course of business, we limit the maximum net loss that can arise from large risks, risks in concentrated areas of exposure and catastrophes, such as hurricanes or other similar loss occurrences, by reinsuring certain levels of risk in various areas of exposure with other insurers or reinsurers through our reinsurance agreements. Our intention is to limit our exposure and the exposure of the Insurance Entities, thereby protecting stockholders’ equity and the Insurance Entities’ capital and surplus, even in the event of catastrophic occurrences, through reinsurance agreements. Without these reinsurance agreements, the Insurance Entities would be more substantially exposed to catastrophic losses with a greater likelihood that those losses could exceed their statutory capital and surplus. Any such catastrophic event, or multiple catastrophes, could have a material adverse effect on the Insurance Entities’ solvency and our results of operations, financial condition and liquidity.

Below is a description of our 2012-2013 reinsurance program. Although the terms of the individual contracts vary, we believe the overall terms of the 2012-2013 reinsurance program are more favorable than the 2011-2012 reinsurance program as reinsurance pricing remained largely the same as the prior year contracts while direct earned premium is expected to increase as a result of the previously approved and expected future rate increases. We also reduced the percentage of premiums ceded by UPCIC to its quota share reinsurer to 45% under the reinsurance program which

 

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became effective June 1, 2012, from 50% under the prior year quota share contract effective June 1, 2011 through May 31, 2012. Our intent is to increase profitability over the contract term by ceding 5% less premium to our quota share reinsurer. This reduction of cession rate also decreases the amount of losses and loss adjustment expenses that may be ceded by UPCIC and effectively increases the amount of risk we retain. The reduction of cession rate also reduces the amount of ceding commissions earned from our quota share reinsurer during the contract term. We also eliminated the loss corridor and the cap on losses and loss adjustment expenses in the quota share contract effective June 1, 2012.

The Insurance Entities are responsible for insured losses related to catastrophic events in excess of coverage provided by their reinsurance programs. The Insurance Entities also remain responsible for insured losses notwithstanding the failure of any reinsurer to make payments otherwise due to the Insurance Entities. The Insurance Entities’ inability to satisfy valid insurance claims resulting from catastrophic events could have a material adverse effect on our results of operations, financial condition and liquidity.

UPCIC REINSURANCE PROGRAM

Effective June 1, 2012, UPCIC entered into a quota share reinsurance contract with Odyssey Reinsurance Company. Under the quota share contract, through May 31, 2013, UPCIC cedes 45% of its gross written premiums, losses and loss adjustment expenses for policies with coverage for wind risk with a ceding commission equal to 25% of ceded gross written premiums. In addition, the quota share contract has a limitation for any one occurrence not to exceed $75 million (of which UPCIC’s net liability on the first $75 million of losses in a first event scenario is $24.75 million, in a second event scenario is $27.5 million and in a third event scenario is $16.5 million) and a limitation from losses arising out of events that are assigned a catastrophe serial number by the Property Claims Services (“PCS”) office not to exceed $180 million. The contract limits the amount of premium which can be deducted for inuring reinsurance to the lesser of actual costs or 32% of gross earned premium, excluding reinstatement premiums, or the lesser of actual costs or 32% of gross earned premium plus a maximum additional of $135.978 million including reinstatement premiums, if any.

Effective June 1, 2012 through May 31, 2013, UPCIC entered into a multiple line excess per risk contract with various reinsurers. Under the multiple line excess per risk contract, UPCIC obtained coverage of $1.4 million in excess of $600 thousand ultimate net loss for each risk and each property loss, and $1 million in excess of $300 thousand for each casualty loss. The contract has a limitation for any one occurrence not to exceed $1.4 million and a $7 million aggregate limit that applies to the term of the contract. Effective June 1, 2012 through May 31, 2013, UPCIC entered into a property per risk excess contract covering ex-wind only policies. Under the property per risk excess contract, UPCIC obtained coverage of $350 thousand in excess of $250 thousand for each property loss. The contract has a limitation for any one occurrence not to exceed $1.05 million and a $1.75 million aggregate limit that applies to the term of the contract.

Effective June 1, 2012 through May 31, 2013, under an underlying excess catastrophe contract, UPCIC obtained catastrophe coverage of 45% of $75 million in excess of $75 million and 55% of $105 million in excess of $45 million covering certain loss occurrences including hurricanes. UPCIC entered into this contract with a segregated account, Segregated Account T25 – Universal Insurance Holdings of White Rock Insurance (SAC) Ltd. (“T25”), which is owned by UIH and was established by a third-party reinsurer under Bermuda law. Under this T25 agreement, T25 retains a maximum, pre-tax liability of $91.5 million for the first catastrophic event up to $1.683 billion of losses. UPCIC is required to make premium installment payments aggregating $72.981 million to T25, subject to the terms of the agreement. Through capital contributions made to T25 by UIH, T25 contributes an amount equal to its liability for losses, net of UPCIC’s required premium payments and expenses thereon, to a trust account as collateral. The trust account is funded with the required collateral and invested in a cash reserve fund. The amounts held in the cash reserve fund are included in restricted cash and cash equivalents in our Condensed Consolidated Balance Sheets. The collateral is available to be used to pay any claims that may arise from the occurrence of covered events. The collateral is required to be held in trust for the benefit of UPCIC until the occurrence of a covered event or expiration or termination of the agreement between T25 and UPCIC. UIH has no requirement to fund T25 in the event losses exceed the amount of collateral held in trust.

UIH has secured the obligations of the segregated account by contributing the amount of the segregated account’s liability for losses net of UPCIC’s required premium payments, to a trust account for the current June 1, 2012 to May 31, 2013 contract period. In the event of a loss under the terms of this contract, the capital contributed by UIH would be used to pay claims and would have an adverse effect on stockholders’ equity and cash resources.

 

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The agreements between T25 and the Insurance Entities are a cost-effective alternative to reinsurance that the Insurance Entities would otherwise purchase from third-party reinsurers. While we retain the risk that otherwise would be transferred to third party reinsurers, these agreements provide benefits to the Insurance Entities in “no-loss” years that cannot be replicated in the open reinsurance market. These benefits include the return to the Insurance Entities of a substantial portion of the earned reinsurance premiums under the contract. All the related intercompany transactions with respect to these agreements are eliminated in consolidation.

Effective June 1, 2012 through May 31, 2013, under excess catastrophe contracts, UPCIC obtained catastrophe coverage of $541.2 million in excess of $150 million covering certain loss occurrences including hurricanes. The coverage of $541.2 million in excess of $150 million has a second full limit available to UPCIC; additional premium is calculated pro rata as to amount and 100% as to time, as applicable. Effective June 1, 2012 through May 31, 2013, UPCIC purchased reinstatement premium protection which reimburses UPCIC for its cost to reinstate the catastrophe coverage of the first $371.2 million (part of $541.2 million) in excess of $150 million.

Effective June 1, 2012 through May 31, 2013, UPCIC also obtained subsequent catastrophe event excess of loss reinsurance to cover certain levels of UPCIC’s net retention through three catastrophe events including hurricanes. Specifically, UPCIC obtained catastrophe coverage for a second event of 45% of $75 million excess of $75 million in excess of $75 million otherwise recoverable and 55% of $100 million excess of $50 million in excess of $100 million otherwise recoverable. UPCIC also obtained catastrophe coverage for a third event of $120 million excess of $30 million in excess of $240 million otherwise recoverable.

Effective June 1, 2012 through June 1, 2013, under an excess catastrophe contract specifically covering risks located in Georgia, North Carolina and South Carolina, UPCIC obtained catastrophe coverage of 55% of $20 million in excess of $30 million and 55% of $25 million in excess of $50 million covering certain loss occurrences including hurricanes. Both layers of coverage have a second full limit available to UPCIC; additional premium is calculated pro rata as to amount and 100% as to time, as applicable. The cost of UPCIC’s excess catastrophe contracts specifically covering risks in Georgia, North Carolina and South Carolina is $2.296 million.

UPCIC also obtained coverage from the Florida Hurricane Catastrophe Fund (“FHCF”). The approximate coverage is estimated to be for 90% of $1.102 billion in excess of $431 million.

The total cost of UPCIC’s multiple line excess and property per risk reinsurance program, effective June 1, 2012 through May 31, 2013, is $4.35 million, of which UPCIC’s cost is $2.618 million, and the quota share reinsurer’s cost is the remaining $1.733 million. The total cost of UPCIC’s underlying excess catastrophe contract is $72.981 million. The total cost of UPCIC’s private catastrophe reinsurance program, effective June 1, 2012 through May 31, 2013, is $135.978 million, of which UPCIC’s cost is 55%, or $74.788 million, and the quota share reinsurer’s cost is the remaining 45%. In addition, UPCIC purchases reinstatement premium protection as described above, the cost of which is $24.042 million. The total cost of the subsequent catastrophe event excess of loss reinsurance is $26.306 million, of which UPCIC’s cost is $16.418 million, and the quota share reinsurer’s cost is the remaining $9.889 million. The estimated premium that UPCIC plans to cede to the FHCF for the 2012 hurricane season is $76.706 million of which UPCIC’s cost is 55%, or $40.636, and the quota share reinsurer’s cost is the remaining 45%.

The largest private participants in UPCIC’s reinsurance program include leading reinsurance companies such as Odyssey Re, Everest Re, Renaissance Re and Lloyd’s of London syndicates.

With the implementation of our 2012-2013 reinsurance program at June 1, 2012, we retain a maximum pre-tax net liability of $127.47 million for the first catastrophic event up to $1.683 billion of losses relating to the UPCIC Florida program, and a maximum pre-tax net liability of $18.796 million for the first catastrophic event up to $75 million of losses relating to the UPCIC other states’ program.

Separately from the Insurance Entities’ reinsurance programs, UIH protected its own interests against diminution in value due to catastrophe events by purchasing $80 million in coverage via a catastrophe risk-linked transaction contract, effective June 1, 2012 through December 31, 2012. The contract provides for recovery by UIH in the event of the exhaustion of UPCIC’s catastrophe coverage. The total cost to UIH of the risk-linked transaction contract is $10.960 million.

 

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APPCIC REINSURANCE PROGRAM

Effective June 1, 2012 through May 31, 2013, under an excess catastrophe contract, APPCIC obtained catastrophe coverage of $5 million in excess of $1 million covering certain loss occurrences including hurricanes. The coverage of $5 million in excess of $1 million has a second full limit available to APPCIC; additional premium is calculated pro rata as to amount and 100% as to time, as applicable. The total cost of APPCIC’s private catastrophe reinsurance program effective June 1, 2012 through May 31, 2013 is $1.063 million.

APPCIC also obtained coverage from the FHCF. The approximate coverage is estimated to be for 90% of $12.1 million in excess of $4.7 million. The estimated premium that APPCIC plans to cede to the FHCF for the 2012 hurricane season is $844 thousand.

Effective October 1, 2011 through May 31, 2012, APPCIC had entered into a multiple line excess per risk contract with various reinsurers. Effective June 1, 2012, APPCIC elected to extend the multiple line excess per risk contract through June 30, 2012. Under this multiple line excess per risk contract, APPCIC had coverage of $8.4 million in excess of $600 thousand ultimate net loss for each risk and each property loss, and $1 million in excess of $300 thousand for each casualty loss. A $21 million aggregate limit applied to the term of the contract.

Effective July 1, 2012 through May 31, 2013, APPCIC entered into a multiple line excess per risk contract with various reinsurers. Under the multiple line excess per risk contract, UPCIC obtained three layers of coverage. The first layer provides coverage of $700 thousand in excess of $300 thousand ultimate net loss for each risk and each property loss, and $1 million in excess of $300 thousand for each casualty loss. The first layer has a limitation for any one property loss occurrence not to exceed $1.4 million and a $3.5 million aggregate limit that applies to the term of the contract. The first layer also has a limitation for any one liability loss occurrence not to exceed $1 million and a $2 million aggregate limit that applies to the term of the contract. The second layer provides coverage of $2 million in excess of $1 million ultimate net loss for each risk and each property loss. The second layer has a limitation for any one property loss occurrence not to exceed $2 million and a $6 million aggregate limit that applies to the term of the contract. The third layer provides coverage of $6 million in excess of $3 million ultimate net loss for each risk and each property loss. The third layer has a limitation for any one property loss occurrence not to exceed $6 million and a $12 million aggregate limit that applies to the term of the contract.

The total cost of the APPCIC multiple line excess reinsurance program effective July 1, 2012 through May 31, 2013 is $1.760 million.

The largest private participants in APPCIC’s reinsurance program include leading reinsurance companies such as Odyssey Re, Hannover Ruck, Amlin Bermuda and Lloyd’s of London syndicates.

With the implementation of our 2012-2013 reinsurance program at July 1, 2012, we retain a maximum pre-tax net liability of $2.063 million for the first catastrophic event up to $16.9 million of losses relating to the APPCIC program.

Wind Mitigation Discounts

The insurance premiums charged by the Insurance Entities are subject to various statutory and regulatory requirements. Among these, the Insurance Entities must offer wind mitigation discounts in accordance with a program mandated by the Florida Legislature and implemented by the OIR. The level of wind mitigation discounts mandated by the Florida Legislature to be effective June 1, 2007 for new business and August 1, 2007 for renewal business have had a significant negative effect on our premium.

 

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The following table reflects the effect of wind mitigation credits received by our policy holders (in thousands):

 

     Reduction of in-force premium (only policies including wind coverage)  

Date

   Percentage of
Insurance Entities
policyholders
receiving credits
    Total credits      In-force
premium
     Percentage reduction of
in-force premium
 

6/1/2007

     1.9   $ 6,285       $ 487,866         1.3

12/31/2007

     11.8   $ 31,952       $ 500,136         6.0

3/31/2008

     16.9   $ 52,398       $ 501,523         9.5

6/30/2008

     21.3   $ 74,186       $ 508,412         12.7

9/30/2008

     27.3   $ 97,802       $ 515,560         16.0

12/31/2008

     31.1   $ 123,525       $ 514,011         19.4

3/31/2009

     36.3   $ 158,230       $ 530,030         23.0

6/30/2009

     40.4   $ 188,053       $ 544,646         25.7

9/30/2009

     43.0   $ 210,292       $ 554,379         27.5

12/31/2009

     45.2   $ 219,974       $ 556,557         28.3

3/31/2010

     47.8   $ 235,718       $ 569,870         29.3

6/30/2010

     50.9   $ 281,386       $ 620,277         31.2

9/30/2010

     52.4   $ 291,306       $ 634,285         31.5

12/31/2010

     54.2   $ 309,858       $ 648,408         32.3

3/31/2011

     55.8   $ 325,511       $ 660,303         33.0

6/30/2011

     56.4   $ 322,640       $ 673,951         32.4

9/30/2011

     57.1   $ 324,313       $ 691,031         31.9

12/31/2011

     57.7   $ 325,315       $ 703,459         31.6

3/31/2012

     57.9   $ 323,286       $ 718,164         31.0

6/30/2012

     58.0   $ 325,806       $ 728,056         30.9

The Insurance Entities fully experience the impact of rate or discount changes more than 12 months after implementation because insurance policies renew throughout the year. Although the Insurance Entities may seek to offset the impact of wind mitigation credits through subsequent rate increase filings with the OIR, there is no assurance that the OIR and the Insurance Entities will agree on the amount of rate change that is needed. In addition, any adjustments to the Insurance Entities’ rates similarly take more than 12 months to be fully integrated into its business.

 

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Results of Operations - Three Months Ended June 30, 2012, Compared to Three Months Ended June 30, 2011

The following table summarizes changes in each component of our Statement of Income for the three months ended June 30, 2012, compared to the same period in 2011 (in thousands):

 

     Three Months Ended June 30,     Change  
     2012     2011     $     %  

PREMIUMS EARNED AND OTHER REVENUES

        

Direct premiums written

   $ 222,568      $ 213,479      $ 9,089        4.3

Ceded premiums written

     (102,433     (145,798     43,365        -29.7
  

 

 

   

 

 

   

 

 

   

Net premiums written

     120,135        67,681        52,454        77.5

Change in net unearned premium

     (64,441     (18,157     (46,284     254.9
  

 

 

   

 

 

   

 

 

   

Premiums earned, net

     55,694        49,524        6,170        12.5

Net investment income (expense)

     (16     (21     5        -23.8

Net realized gains (losses) on investments

     (1,705     2,960        (4,665     NM   

Net unrealized gains (losses) on investments

     (5,788     (9,640     3,852        -40.0

Commission revenue

     6,131        4,941        1,190        24.1

Policy fees

     4,072        4,402        (330     -7.5

Other revenue

     1,540        1,506        34        2.3
  

 

 

   

 

 

   

 

 

   

Total premiums earned and other revenues

     59,928        53,672        6,256        11.7
  

 

 

   

 

 

   

 

 

   

OPERATING COSTS AND EXPENSES

        

Losses and loss adjustment expenses

     29,437        25,852        3,585        13.9

General and administrative expenses

     17,499        14,699        2,800        19.0
  

 

 

   

 

 

   

 

 

   

Total operating costs and expenses

     46,936        40,551        6,385        15.7
  

 

 

   

 

 

   

 

 

   

INCOME BEFORE INCOME TAXES

     12,992        13,121        (129     -1.0

Income taxes, current

     9,086        9,622        (536     -5.6

Income taxes, deferred

     (3,871     (4,050     179        -4.4
  

 

 

   

 

 

   

 

 

   

Income taxes, net

     5,215        5,572        (357     -6.4
  

 

 

   

 

 

   

 

 

   

NET INCOME

   $ 7,777      $ 7,549      $ 228        3.0
  

 

 

   

 

 

   

 

 

   

NM - Not meaningful.

Net income remained relatively flat increasing by $228 thousand, or 3%. Increases in earned premium and commission revenue were largely offset by weaker performance in the investment trading portfolio and increases in operating costs and expenses.

The increase in net earned premiums of $6.2 million, or 12.5%, reflects an increase in direct earned premium of $16.5 million partially offset by an increase in ceded earned premium of $10.3 million. The increase in direct earned premium is due primarily to rate increases over the past 24 months, the most recent of which were in January and February of 2012. These rate increases, along with strategic initiatives we have undertaken to manage our exposure such as the decision not to renew certain policies, have resulted in a moderate reduction in the number of policies in force even as direct written premiums have increased. The benefit from the rate increases continued to be partially offset by wind mitigation credits within the state of Florida. The increase in ceded earned premium of $10.3 million is also attributable to rate increases over the past 24 months and also includes $1.8 million in the 2012 period relating to an underlying property catastrophe excess of loss reinsurance contract with an unaffiliated third-party reinsurer that did not exist during the 2011 period.

 

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Net realized losses on investments of $1.7 million recorded during the three months ended June 30, 2012 reflect loss in value of investments sold during the period. The majority of net realized losses recorded during the three months ended June 30, 2012 were in the metals and mining sector.

We hold debt and equity securities, derivatives and other investments in our trading portfolio. All unrealized gains and losses on investments in our trading portfolio are reflected in earnings. Unrealized gains and losses reflect the change in value during the period for investments held in our trading portfolio, including the reversal of unrealized gains and losses recorded when investments are sold. We recorded $5.8 million of net unrealized losses during the three months ended June 30, 2012.

The majority of the unrealized losses in the trading portfolio as of June 30, 2012 are in the metals and mining sector. Equity securities in the metals and mining sector represent approximately 54% of the fair value of investments held in the trading portfolio as of June 30, 2012.

Commission revenue is comprised principally of brokerage commission we earn from reinsurers based upon premiums earned by the reinsurers at agreed upon brokerage rates. The increase in commission revenue of $1.2 million reflects an increase in ceded earned premium and a change in terms for the reinsurance contract periods that were in effect during the three months ended June 30, 2012 as compared to the same period in 2011.

Policy fees are comprised primarily of the managing general agent’s policy fee income from insurance policies. The decrease of $330 thousand reflects a reduction in the number of policies written and renewed primarily due to the rate increases that have taken effect, which has caused some attrition.

The increase in net losses and loss adjustment expenses of $3.6 million was due primarily to an increase in direct losses incurred per exposure.

The net loss and LAE ratios, or net losses and loss adjustment expenses as a percentage of net earned premiums, were 52.9% and 52.2% during the three-month periods ended June 30, 2012 and 2011, respectively, and were comprised of the following components (in thousands):

 

     Three months ended June 30, 2012  
     Direct     Ceded     Net  

Loss and loss adjustment expenses

   $ 56,533        27,096      $ 29,437   

Premiums earned

   $ 186,656         130,962      $ 55,694   

Loss & LAE ratios

     30.3     20.7     52.9

 

     Three months ended June 30, 2011  
     Direct     Ceded     Net  

Loss and loss adjustment expenses

   $ 53,360      $ 27,508      $ 25,852   

Premiums earned

   $ 170,134      $ 120,610      $ 49,524   

Loss & LAE ratios

     31.4     22.8     52.2

The increase in net loss and LAE ratio reflects an increase in net losses and loss adjustment expenses proportionately larger than the increase in premiums earned.

The increase in general and administrative expenses of $2.8 million was due primarily to factors related to net deferred policy acquisition costs. The reduction in the amount of ceding commissions received from quota share reinsurers under the 2012-2013 Reinsurance Program effectively increased the amount of net deferred policy acquisition costs and related amortization. In addition, the company is charging certain costs directly to earnings that were previously capitalized under the superseded FASB guidance which governed how we accounted for deferred policy acquisition costs until January 1, 2012.

 

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Income taxes decreased by $357 thousand, or 6.4% primarily as a result of a decrease in pre-tax income. The effective tax rate decreased to 40.1% for the three months ended June 30, 2012 from 42.5 % for the same period in the prior year primarily as a result of estimated penalties and interest recorded in the second quarter of 2011 from the underpayment of federal and state income taxes. We limited our payments of estimated income taxes during 2011 due to the uncertainty of potential losses during the current hurricane season and the effect of those potential losses on pre-tax earnings and our ultimate income tax liability for the year.

Results of Operations - Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011

The following table summarizes changes in each component of our Statement of Income for the six months ended June 30, 2012 compared to the same period in 2011 (in thousands):

 

     Six Months Ended June 30,     Change  
     2012     2011     $     %  

PREMIUMS EARNED AND OTHER REVENUES

        

Direct premiums written

   $ 412,571      $ 386,654      $ 25,917        6.7

Ceded premiums written

     (265,867     (269,689     3,822        -1.4
  

 

 

   

 

 

   

 

 

   

Net premiums written

     146,704        116,965        29,739        25.4

Change in net unearned premium

     (42,370     (19,437     (22,933     118.0
  

 

 

   

 

 

   

 

 

   

Premiums earned, net

     104,334        97,528        6,806        7.0

Net investment income (expense)

     (52     236        (288     NM   

Net realized gains (losses) on investments

     (9,154     6,612        (15,766     NM   

Net unrealized gains (losses) on investments

     3,399        (7,052     10,451        NM   

Net foreign currency gains (losses) on investments

     23        71        (48     -67.6

Commission revenue

     10,672        9,121        1,551        17.0

Policy fees

     7,973        8,575        (602     -7.0

Other revenue

     2,980        2,914        66        2.3
  

 

 

   

 

 

   

 

 

   

Total premiums earned and other revenues

     120,175        118,005        2,170        1.8
  

 

 

   

 

 

   

 

 

   

OPERATING COSTS AND EXPENSES

        

Losses and loss adjustment expenses

     55,611        52,037        3,574        6.9

General and administrative expenses

     35,343        29,771        5,572        18.7
  

 

 

   

 

 

   

 

 

   

Total operating costs and expenses

     90,954        81,808        9,146        11.2
  

 

 

   

 

 

   

 

 

   

INCOME BEFORE INCOME TAXES

     29,221        36,197        (6,976     -19.3

Income taxes, current

     9,860        18,359        (8,499     -46.3

Income taxes, deferred

     1,711        (3,609     5,320        NM   
  

 

 

   

 

 

   

 

 

   

Income taxes, net

     11,571        14,750        (3,179     -21.6
  

 

 

   

 

 

   

 

 

   

NET INCOME

   $ 17,650      $ 21,447      $ (3,797     -17.7
  

 

 

   

 

 

   

 

 

   

NM - Not meaningful.

Net income decreased by $3.8 million, or 17.7%, primarily as a result of weaker performance in the investment trading portfolio and increases in operating costs and expenses, partially offset by increases in earned premium and commission revenue.

 

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The increase in net earned premiums of $6.8 million, or 7.0%, reflects an increase in direct earned premium of $30.7 million partially offset by an increase in ceded earned premium of $23.9 million. The increase in direct earned premium is due primarily to rate increases over the past 24 months, the most recent of which were in January and February of 2012. These rate increases, along with strategic initiatives we have undertaken to manage our exposure such as the decision not to renew certain policies, have resulted in a moderate reduction in the number of policies in force even as direct written premiums have increased. The benefit from the rate increases continued to be partially offset by wind mitigation credits within the state of Florida. The increase in ceded earned premium of $23.9 million is also attributable to rate increases over the past 24 months and also includes $4.4 million in the 2012 period relating to an underlying property catastrophe excess of loss reinsurance contract with an unaffiliated third-party reinsurer that did not exist during the 2011 period.

Net investment expenses for the six months ended June 30, 2012, compared to net investment income for the same period in the prior year, reflects a reduction in the amount of interest earning securities held in the investment portfolio and non-recurring charges for investment accounting services as we convert to a new investment accounting service provider.

Net realized losses on investments of $9.2 million recorded during the six months ended June 30, 2012 reflect loss in value of investments sold during the period. The majority of realized losses recorded during the six months ended June 30, 2012 were in the metals and mining sector.

We hold debt and equity securities, derivatives and other investments in our trading portfolio. All unrealized gains and losses on investments in our trading portfolio are reflected in earnings. Unrealized gains and losses reflect the change in value during the period for investments held in our trading portfolio, including the reversal of unrealized gains and losses recorded when investments are sold. We recorded $3.4 million of net unrealized gains during the six months ended June 30, 2012.

The majority of the unrealized losses in the trading portfolio as of June 30, 2012 are in the metals and mining sector. Equity securities in the metals and mining sector represent approximately 54% of the fair value of investments held in the trading portfolio as of June 30, 2012.

Commission revenue is comprised principally of brokerage commission we earn from reinsurers. The increase in commission revenue of $1.6 million is due to an increase in ceded earned premium for the reinsurance contract periods that were in effect during the six months ended June 30, 2012 as compared to the same period in 2011.

Policy fees are comprised primarily of the managing general agent’s policy fee income from insurance policies. The decrease of $602 thousand reflects a reduction in the number of policies written and renewed primarily due to the rate increases that have taken effect, which has caused some attrition.

The increase in net losses and loss adjustment expenses of $3.6 million was due primarily to an increase in direct losses incurred per exposure.

 

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The net loss and LAE ratios, or net losses and loss adjustment expenses as a percentage of net earned premiums, were 53.3% and 53.4% during the six-month periods ended June 30, 2012 and 2011, respectively, and were comprised of the following components (in thousands):

 

     Six months ended June 30, 2012  
     Direct     Ceded     Net  

Loss and loss adjustment expenses

   $ 109,140      $ 53,529      $ 55,611   

Premiums earned

   $ 365,460      $ 261,126      $ 104,334   

Loss & LAE ratios

     29.9     20.5     53.3

 

     Six months ended June 30, 2011  
     Direct     Ceded     Net  

Loss and loss adjustment expenses

   $ 106,491      $ 54,454      $ 52,037   

Premiums earned

   $ 334,721      $ 237,193      $   97,528   

Loss & LAE ratios

     31.8     23.0     53.4

The net loss and LAE ratio remained relatively flat reflecting a proportionate increase in both net earned premiums and net losses and loss adjustment expenses.

The increase in general and administrative expenses of $5.6 million was due primarily to factors related to net deferred policy acquisition costs. The reduction in the amount of ceding commissions received from quota share reinsurers under the 2012-2013 Reinsurance Program effectively increased the amount of net deferred policy acquisition costs and related amortization. In addition, the company is charging certain costs directly to earnings that were previously capitalized under the superseded FASB guidance which governed how we accounted for deferred policy acquisition costs until January 1, 2012.

Income taxes decreased by $3.2 million, or 21.6% primarily as a result of a decrease in pre-tax income. The effective tax rate decreased to 39.6% for the six months ended June 30, 2012 from 40.7% for the same period in the prior year primarily as a result of estimated penalties and interest recorded in the second quarter of 2011 from the underpayment of federal and state income taxes. We limited our payments of estimated income taxes during 2011 due to the uncertainty of potential losses during the current hurricane season and the effect of those potential losses on pre-tax earnings and our ultimate income tax liability for the year.

Analysis of Financial Condition - As of June 30, 2012 Compared to December 31, 2011

We believe that premiums will be sufficient to meet our working capital requirements for at least the next twelve months.

Our policy is to invest amounts considered to be in excess of current working capital requirements. We have a receivable of $594 thousand at June 30, 2012 for securities sold that had not yet settled compared to $9.7 million at December 31, 2011, and a payable for securities purchased that had not yet settled of $1.2 million as of June 30, 2012 compared to $1.1 million at December 31, 2011.

 

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The following table summarizes, by type, the carrying values of investments (in thousands):

 

Type of Investment

   As of June 30, 2012     As of December 31, 2011  

Cash and cash equivalents

   $ 356,325      $ 229,685   

Restricted cash and cash equivalents

     74,274        78,312   

Debt securities

     3,913        3,801   

Equity securities

     81,713        95,345   

Non-hedging derivative asset

     31        123   

Non-hedging derivative (liability)

     (174     —     

Other investments

     344        371   
  

 

 

   

 

 

 

Total Investments

   $ 516,426      $ 407,637   
  

 

 

   

 

 

 

Reinsurance recoverables represent amounts due from reinsurers for ceded loss and LAE. The increase in reinsurance recoverables of $29.8 million to $115.5 million reflects unsettled recoverables subsequent to the change in third party quota-share reinsurers as described in the 2012-2013 Reinsurance Program discussion.

Reinsurance receivable, net, represents inuring premiums receivable, net of ceded premiums payable with our quota share reinsurer. The increase of $70.5 million to $125.7 million during the six months ended June 30, 2012 was due to the absence of reinsurance payables available for offset given the change in third party quota-share reinsurers.

Premiums receivable represent amounts due from policyholders. The increase of $10.5 million to $56.4 million during the six months ended June 30, 2012 was due to growth in, and timing of, direct written premiums.

The increase in Property and Equipment of $1.8 million to $8.9 million reflects the cost of constructing a new office building which was placed into service at the end of March 2012.

See Note 5, Insurance Operations, in our Notes to Condensed Consolidated Financial Statements for a roll-forward in the balance of our deferred policy acquisition costs.

See Note 9, Income Taxes, in our Notes to Condensed Consolidated Financial Statements for a schedule of deferred income taxes as of June 30, 2012 and December 31, 2012 which shows the components of deferred tax assets and liabilities as of both balance dates.

See Note 5, Insurance Operations, in our Notes to Condensed Consolidated Financial Statements, for a roll-forward in the balance of our unpaid losses and LAE.

Unearned premiums represent the portion of written premiums that will be earned pro rata in the future. The increase of $47.1 million to $407 million during the six months ended June 30, 2012 was due to growth in, and timing of, direct written premiums.

Advance premium represents premium payments made by policyholders ahead of the effective date of the policies. The increase of $6.2 million to $25.6 million reflects a trend for an increase in the volume of policies with advance payments in June, relative to December.

Reinsurance payable, net, represents our liability to reinsurers for ceded written premiums, net of ceding commissions receivable. The increase of $186.3 million to $273.8 million during the six months ended June 30, 2012 was primarily due to unsettled payables subsequent to the change in third party quota-share reinsurers as described in the 2012-2013 Reinsurance Program discussion.

 

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Liquidity and Capital Resources

Liquidity

Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet its short and long-term obligations. Funds generated from operations have generally been sufficient to meet our liquidity requirements and we expect that in the future funds from operations will continue to meet such requirements.

The balance of cash and cash equivalents as of June 30, 2012 was $356.3 million compared to $229.7 million at December 31, 2011. See our Condensed Consolidated Statements of Cash Flows for a reconciliation of the balance of cash and cash equivalents between June 30, 2012 and December 31, 2011. Most of this amount is available to pay claims in the event of a catastrophic event pending reimbursement amounts recoverable under reinsurance agreements. The source of liquidity for possible claim payments consists of the collection of net premiums, after deductions for expenses, reinsurance recoverables and short-term loans.

The balance of restricted cash and cash equivalents as of June 30, 2012 was $74.3 million. Restricted cash as of June 30, 2012 is mostly comprised of cash equivalents on deposit with regulatory agencies in the various states in which our Insurance Entities do business.

The Company’s liquidity requirements primarily include potential payments of catastrophe losses, the payment of dividends to shareholders, and interest and principal payments on debt obligations. The declaration and payment of future dividends to shareholders will be at the discretion of our Board of Directors and will depend upon many factors, including our operating results, financial condition, capital requirements and any regulatory constraints.

Our insurance operations provide liquidity in that premiums are generally received months or even years before losses are paid under the policies sold. Historically, cash receipts from operations, consisting of insurance premiums, commissions, policy fees and investment income, have provided more than sufficient funds to pay loss claims and operating expenses. We maintain substantial investments in highly liquid, marketable securities. Liquidity can also be generated by funds received upon the sale of marketable securities in our investment portfolio.

The Insurance Entities are responsible for losses related to catastrophic events with incurred losses in excess of coverage provided by the Insurance Entities’ reinsurance programs and for losses that otherwise are not covered by the reinsurance programs, which could have a material adverse effect on either the Insurance Entities’ or our business, financial condition, results of operations and liquidity (see 2012-2013 Reinsurance Program above for a discussion of the 2012-2013 reinsurance program).

Capital Resources

Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks and facilitate continued business growth. At June 30, 2012, we had total capital of $182.7 million, comprised of stockholders’ equity of $161.7 million and total debt of $21 million. Our debt-to-total-capital ratio and debt-to-equity ratio were 11.5% and 13%, respectively, at June 30, 2012. At December 31, 2011, we had total capital of $171.7 million, comprised of stockholders’ equity of $150 million and total debt of $21.7 million. Our debt-to-total-capital ratio and debt-to-equity ratio were 12.6% and 14.5%, respectively, at December 31, 2011.

At June 30, 2012, UPCIC was in compliance with all of the covenants under its surplus note and its total adjusted capital was in excess of regulatory requirements.

Cash Dividends

On February 23, 2012, we declared a dividend of $0.10 per share on our outstanding common stock paid on April 6, 2012, to the shareholders of record at the close of business on March 28, 2012.

On April 23, 2012, we declared a dividend of $0.08 per share on our outstanding common stock paid on July 9, 2012, to the shareholders of record at the close of business on June 26, 2012. We expect to declare additional quarterly dividends in the same amount to shareholders of record in the third and fourth quarters of 2012. Declaration and payment of future dividends is subject to the discretion of UIH’s board of directors and will be dependent on future earnings, cash flows, financial requirements and other factors.

 

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Contractual Obligations

There have been no material changes during the period covered by this Quarterly Report on Form 10-Q, outside of the ordinary course of business, to the contractual obligations specified in the table of contractual obligations included in Part 1, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2011.

Critical Accounting Policies and Estimates

There have been no material changes during the period covered by this Quarterly Report on Form 10-Q to Critical Accounting Policies and Estimates previously disclosed in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2011.

Accounting Pronouncements Issued and Not Yet Adopted

In December 2011, the Financial Accounting Standards Board updated its guidance to the Balance Sheet Topic 210 of the FASB Accounting Standards Codification. The objective of this updated guidance requires entities that have financial and derivative instruments that are offset to disclose information about offsetting and related arrangements to enable users of financial statements to understand the effect of those arrangements on an entity’s financial position. This guidance is to be applied for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. Disclosure is required retrospectively for all comparative periods presented. The additional disclosures required by the updated guidance will not have an impact on our operating results, cash flows or financial position.

Related Parties

See Note 8, Related Party Transactions, in our Notes to Condensed Consolidated Financial Statements for information about related parties.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the potential for economic losses due to adverse changes in fair value of financial instruments. Our primary market risk exposures are related to our investment portfolio and include interest rates, equity prices and commodity prices. We also have exposure to foreign currency exchange rates for investments denominated in foreign currencies, and to a lesser extent, our debt obligation in the form of a surplus note. The surplus note, as previously described in “Liquidity and Capital Resources,” accrues interest at an adjustable rate based on the 10-year Constant Maturity Treasury rate. Investments held in trading are carried on the balance sheet at fair value. Our investment trading portfolio is comprised primarily of debt and equity securities and also includes non-hedging derivatives and physical positions in precious metals. See Note 5, Investments, for a schedule of investment holdings as of June 30, 2012 and December 31, 2011.

Our investments have been, and may in the future be, subject to significant volatility. Our investment objective is to maximize total rate of return after federal income taxes while maintaining liquidity and minimizing risk. Our investment strategy includes maintaining investments to support unpaid losses and loss adjustment expenses for the Insurance Entities in accordance with guidelines established by insurance regulators. In addition to investment securities, we invest in derivative financial instruments to try to increase investment returns and for income-generation purposes. The most commonly used instruments are call and put equity options and written call options on common stock (i.e., covered calls). These derivatives are held in our trading portfolio and do not meet the criteria for hedge accounting.

Interest Rate Risk

Interest rate risk is the sensitivity of a fixed-rate instrument to changes in interest rates. When interest rates rise, the fair value of our fixed-rate investment securities declines.

 

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The following table provides information about our fixed income investments, which are sensitive to changes in interest rates. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates for investments held in trading as of the periods presented (in thousands):

 

     As of June 30, 2012  
     Amortized Cost        
     2012     2013      2014     2015      2016      Thereafter     Total     Fair Value  

U.S. government obligations and agencies

   $ 135      $ —         $ 35      $ —         $ —         $ 3,172      $ 3,342      $ 3,913   

Average interest rate

     4.63     —           0.25     —           —           1.85     1.95     1.93

 

     As of December 31, 2011  
     Amortized Cost        
     2012     2013      2014      2015      2016      Thereafter     Total     Fair Value  

U.S. government obligations and agencies

   $ 171      $ —         $ —         $ —         $ —         $ 3,157      $ 3,328      $ 3,801   

Average interest rate

     4.09                 1.85     1.97     1.97

United States government and agency securities are rated Aaa by Moody’s Investors Service, Inc., and AA+ by Standard and Poor’s Company.

Equity and Commodity Price Risk

Equity and commodity price risk is the potential for loss in fair value of investments in common stock, exchange-traded funds (ETF), and mutual funds from adverse changes in the prices of those instruments.

The following table provides information about the composition of equity securities, non-hedging derivatives and other investments held in the Company’s investment portfolio (in thousands):

 

     As of June 30, 2012     As of December 31, 2011  
     Fair Value     Percent     Fair Value      Percent  

Equity securities:

         

Common stock:

         

Metals and mining

   $ 23,546        28.7   $ 38,816         40.5

Energy

   $ 8,962        10.9     4,999         5.3

Other

     2,517        3.1     6,945         7.2

Exchange-traded and mutual funds: