SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual report pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2006 Commission File No. 0-3978
UNICO AMERICAN CORPORATION
(Exact name of registrant as specified in its charter)
Nevada 95-2583928
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
23251 Mulholland Drive, Woodland Hills, California 91364
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (818) 591-9800
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, No Par Value NASDAQ Stock Market LLC
(Title of each class) Name Of Each Exchange On Which Registered
Securities registered pursuant to section 12(g) of the Act:
None
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes__ No X
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes__ No X
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 shorter 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy of information statements
incorporated by reference as Part III of this Form 10-K or any amendment to this
Form 10-K. X
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer __ Accelerated filer __ Non-accelerated filer X
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes__ No X
The aggregate market value of registrant's voting and non-voting common equity
held by non-affiliates as of June 30, 2006, the last business day of
Registrant's most recently completed second fiscal quarter was $29,700,696.
5,597,119
Number of shares of common stock outstanding as of March 23, 2007
Portions of the definitive proxy statement that Registrant intends to file
pursuant to Regulation 14(A) by a date no later than 120 days after December 31,
2006, to be used in connection with the annual meeting of shareholders, are
incorporated herein by reference into Part III hereof. If such definitive proxy
statement is not filed in the 120-day period, the information called for by Part
III will be filed as an amendment to this Form 10-K not later than the end of
the 120 day period.
1
PART I
------
ITEM 1. Business
--------
Unico American Corporation is an insurance holding company that underwrites
property and casualty insurance through its insurance company subsidiary;
provides property, casualty, health and life insurance through its agency
subsidiaries; and through its other subsidiaries provides insurance premium
financing and membership association services. Unico American Corporation is
referred to herein as the "Company" or "Unico" and such references include both
the corporation and its subsidiaries, all of which are wholly owned, unless
otherwise indicated. Unico was incorporated under the laws of Nevada in 1969.
Descriptions of the Company's operations in the following paragraphs are
categorized between the Company's major segment - its insurance company
operation, and all other revenues from insurance operations. The insurance
company operation is conducted through Crusader Insurance Company (Crusader),
Unico's property and casualty insurance company. Insurance company revenues and
other revenues from insurance operations for the years ended December 31, 2006,
December 31, 2005, and December 31, 2004, are as follows:
Year ended December 31
----------------------
2006 2005 2004
-------------------- -------------------- --------------------
Percent Percent Percent
of Total of Total of Total
Total Company Total Company Total Company
Revenues Revenues Revenues Revenues Revenues Revenues
-------- -------- -------- -------- -------- --------
Insurance company revenues $48,942,568 89.4% $54,833,512 89.6% $54,414,947 87.9%
Other revenues from insurance operations
----------------------------------------
Gross commissions and fees:
Health and life insurance program commission income 1,634,438 3.0% 1,628,061 2.7% 2,156,924 3.5%
Policy fee income 2,638,985 4.8% 3,001,966 4.9% 3,394,783 5.5%
Daily automobile rental insurance program:
Commission 371,317 0.7% 441,066 0.7% 565,452 0.9%
Claim administration fees 4,035 - 70,000 0.1% - -
Association operations membership and fee income 300,527 0.5% 318,349 0.5% 333,470 0.5%
Other commission and fee income 38,030 0.1% 48,589 0.1% 53,251 0.1%
--------- --- --------- --- --------- ----
Total gross commission and fee income 4,987,332 9.1% 5,508,031 9.0% 6,503,880 10.5%
Investment income 100,955 0.2% 68,828 0.1% 38,250 0.1%
Finance charges and fees earned 678,740 1.2% 758,325 1.3% 933,529 1.5%
Other income 7,786 - 13,826 - 12,704 -
--------- ---- --------- ---- --------- ----
Total other revenues from insurance operations 5,774,813 10.5% 6,349,010 10.4% 7,488,363 12.1%
---------- ----- ---------- ----- ---------- -----
Total Revenues $54,717,381 100.0% $61,182,522 100.0% $61,903,310 100.0%
========== ===== ========== ===== ========== =====
INSURANCE COMPANY OPERATION
---------------------------
General
-------
The insurance company operation is conducted through Crusader Insurance Company.
Crusader is a multiple line property and casualty insurance company that began
transacting business on January 1, 1985. Since 2004 all Crusader business was
written in the State of California. During the year ended December 31, 2006, 97%
of Crusader's business was commercial multiple peril policies. Commercial
multiple peril policies provide a combination of property and liability coverage
for businesses. Commercial property coverage insures against loss or damage to
buildings, inventory and equipment from natural disasters, including hurricanes,
windstorms, hail, water, explosions, severe winter weather, and other events
such as theft and vandalism, fires, storms, and financial loss due to business
interruption resulting from covered property damage. Commercial liability
coverages insure against third party liability from accidents occurring on the
insured's premises or arising out of its operation. In addition to commercial
multiple peril policies, Crusader also writes separate policies to insure
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commercial property and commercial liability risk on a mono-line basis. As of
December 31, 2006, Crusader was licensed as an admitted insurance carrier in the
states of Arizona, California, Montana, Nevada, Oregon, and Washington.
Historically, most of Crusader's marketing was aimed at independent insurance
brokers, representatives of the consumer. With the relatively recent advent of
heightened competition and of declining sales, in 2007 Crusader adopted a plan
to supplement its marketing efforts with independent agents, representatives of
the Company. The Company believes that those agents will be particularly
effective and that their efforts will not diminish the business historically
produced by independent brokers. Crusader expects to begin making those agency
appointments during 2007.
All of Crusader's business is produced by Unifax Insurance Systems, Inc.
(Unifax), its sister corporation. Unifax has substantial experience with these
classes of business. The commissions paid by Crusader to Unifax are eliminated
as intercompany transactions and are not reflected in the previous table.
Crusader is licensed in property and casualty and disability lines of insurance
by the California Department of Insurance.
Reinsurance
-----------
A reinsurance transaction occurs when an insurance company transfers (cedes) a
portion of its exposure on policies written by it to a reinsurer that assumes
that risk for a premium (ceded premium). Reinsurance does not legally discharge
the Company from primary liability under its policies. If the reinsurer fails to
meet its obligations, the Company must nonetheless pay its policy obligations.
Crusader's primary excess of loss reinsurance agreements since January 1, 1998,
are as follows:
Loss A.M Best Annual Aggregate
Year Reinsurer(s) Rating Retention Deductible
---- ----------- ------ --------- ----------
2006 Platinum Underwriters Reinsurance, Inc. & A
Hannover Ruckversicherungs AG A $300,000 $500,000
2005 Platinum Underwriters Reinsurance, Inc. & A
Hannover Ruckversicherungs AG A $300,000 $500,000
2004 Platinum Underwriters Reinsurance, Inc. & A
Hannover Ruckversicherungs AG A $250,000 $500,000
2003 Platinum Underwriters Reinsurance, Inc. & A
Hannover Ruckversicherungs AG & A
QBE Reinsurance Corporation A $250,000 $500,000
2002 Partner Reinsurance Company of the U.S. A+ $250,000 $675,000
2001 Partner Reinsurance Company of the U.S. A+ $250,000 $500,000
2000 Partner Reinsurance Company of the U.S. A+ $250,000 $500,000
1999 General Reinsurance Corporation A++ $250,000 $750,000
1998 General Reinsurance Corporation A++ $250,000 $750,000
Prior to January 1, 1998, National Reinsurance Corporation (acquired by General
Reinsurance Corporation in 1996) charged a provisional rate on exposures up to
$500,000 that was subject to adjustment and was based on the amount of losses
ceded, limited by a maximum percentage that could be charged. That provisionally
rated treaty was cancelled on a runoff basis and replaced by a flat rated treaty
on January 1, 1998.
In 2006 and 2005 Crusader retained a participation in its excess of loss
reinsurance treaties of 10% in its 1st layer ($700,000 in excess of $300,000),
10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its
property and casualty clash treaties. In 2004 Crusader retained a participation
in its excess of loss reinsurance treaties of 10% in its 1st layer ($750,000 in
excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000),
and 30% in its property and casualty clash treaties. In 2003 Crusader retained a
participation in its excess of loss reinsurance treaties of 5% in its 1st layer
($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of
$1,000,000), and 30% in its property and casualty clash treaties.
Crusader's 2006 1st layer primary excess of loss treaty provides for a
contingent commission equal to 20% of the net profit, if any, accruing to the
reinsurer. The first accounting period for the contingent commission covers the
period from January 1, 2006, through December 31, 2006. The 2005 1st layer
primary excess of loss treaties do not provide for a contingent commission.
Crusader's 2004 and 2003 1st layer primary excess of loss treaty
3
provides for a contingent commission to the Company equal to 45% of the net
profit, if any, accruing to the reinsurer. The first accounting period for the
contingent commission covers the period from January 1, 2003, through December
31, 2004. The Company will calculate and report to the reinsurer its net profit,
if any, within 90 days after 36 months following the end of the first accounting
period, and within 90 days after the end of each 12 month period thereafter
until all losses subject to the agreement have been finally settled. Based on
losses and loss adjustment expenses ceded (including incurred but not reported
losses) as of December 31, 2006, no contingent commission has been accrued for
each of the periods discussed above.
Crusader also has catastrophe reinsurance from various highly rated California
authorized reinsurance companies. These reinsurance agreements help protect
Crusader against liabilities in excess of certain retentions, including major or
catastrophic losses that may occur from any one or more of the property and/or
casualty risks which Crusader insures. The Company has no reinsurance
recoverable balances in dispute.
The aggregate amount of earned premium ceded to the reinsurers was $13,758,424
for the year ended December 31, 2006, $14,234,844 for the year ended December
31, 2005, and $17,784,240 for the year ended December 31, 2004.
On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays
a commission to Crusader that includes a reimbursement of the cost of acquiring
the portion of the premium that is ceded. Crusader does not currently assume any
reinsurance. The Company intends to continue obtaining reinsurance although the
availability and cost may vary from time to time. The unpaid losses ceded to the
reinsurer are recorded as an asset on the balance sheet.
Unpaid Losses and Loss Adjustment Expenses
------------------------------------------
Crusader maintains reserves for losses and loss adjustment expenses with respect
to both reported and unreported losses. When a claim for loss is reported to the
Company, a reserve is established for the expected cost to settle the claim,
including estimates of any related legal expense and other costs associated with
resolving the claim. These reserves are called "case based" reserves. In
addition, the Company also sets up reserves at the end of each reporting period
for losses that have occurred but have not yet been reported to the Company.
These incurred but not reported losses are referred to as "IBNR" reserves.
Crusader establishes reserves for reported losses based on historical
experience, upon case-by-case evaluation of facts surrounding each known loss,
and the related policy provisions. The amount of reserves for unreported losses
is estimated by analysis of historical and statistical information. The ultimate
liability of Crusader may be greater or less than estimated reserves. Reserves
are monitored and adjusted when appropriate and are reflected in the statement
of operations in the period of adjustment. Reserves for losses and loss
adjustment expenses are estimated to cover the future amounts needed to pay
claims and related expenses with respect to insured events that have occurred.
The process of establishing loss and loss adjustment expense reserves involves
significant judgment. The following table shows the development of the unpaid
losses and loss adjustment expenses for fiscal years 1996 through 2006. The top
line of the table shows the estimated liability for unpaid losses and loss
adjustment expenses recorded at the balance sheet date for each of the indicated
years. This liability represents the estimated amount of losses and loss
adjustment expenses for losses arising in the current and prior years that are
unpaid at the balance sheet date. The table shows the reestimated amount of the
previously recorded liability based on experience as of the end of each
succeeding year. The estimate is increased or decreased, as more information
becomes known. The Company believes that its loss and loss adjustment expense
reserves are properly stated. When subsequent loss and loss adjustment expense
development justifies changes in reserving practices, the Company acts.
The table reflects redundancies and deficiencies in Crusader's net loss and loss
adjustment expense reserves. As of December 31, 2006, all periods stated in the
table prior to 2002 reflected a cumulative deficiency. The 2002 through 2005
periods reflect a cumulative redundancy. See discussion of losses and loss
adjustment expenses in Item 7- "Management's Discussion and Analysis - Results
of Operations - Insurance Company Operation."
4
When evaluating the information in the following table, it should be noted that
each amount includes the effects of all changes in amounts of prior periods;
therefore, the cumulative redundancy or deficiency represents the aggregate
change in the estimates over all prior years. Conditions and trends that have
affected development of liability in the past may not necessarily occur in the
future. Accordingly, it may not be appropriate to extrapolate future
deficiencies or redundancies based on this table.
CRUSADER INSURANCE COMPANY
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
Fiscal Year Ended December 31
-------------------------------------------------------------------------------------------
1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ----
(Nine Months)
Reserve for Unpaid Losses and
Loss Adjustment Expenses $37,111,846 $40,591,248 $40,374,232 $37,628,165 $34,546,026 $49,786,215
Paid Cumulative as of
1 Year Later 10,996,896 12,677,646 15,393,167 18,745,224 20,841,417 23,010,615
2 Years Later 19,488,853 23,740,181 28,570,117 34,905,359 37,976,277 39,463,106
3 Years Later 25,552,756 30,217,031 38,923,545 46,072,688 49,053,708 46,256,431
4 Years Later 29,730,976 35,620,705 45,425,709 53,153,491 52,821,183 49,157,040
5 Years Later 33,893,473 40,639,328 50,526,164 56,021,297 54,919,573 44,116,477
6 Years Later 38,075,656 45,028,598 52,588,830 57,247,843 51,678,787
7 Years Later 41,650,221 46,921,020 53,482,116 56,715,300
8 Years Later 43,129,105 47,807,308 58,801,974
9 Years Later 43,885,258 48,975,696
10 Years Later 44,920,340
Reserves Reestimated as of
1 Year Later 32,838,369 35,730,603 39,132,945 41,898,796 53,872,376 57,577,066
2 Years Later 31,086,210 36,032,215 43,164,627 56,423,375 59,746,880 60,629,814
3 Years Later 32,347,788 38,844,953 52,349,735 59,486,543 62,172,320 60,974,567
4 Years Later 35,513,862 45,907,785 54,291,547 61,791,428 62,369,460 59,745,610
5 Years Later 43,335,778 47,940,955 56,619,057 62,174,813 61,894,587 58,289,479
6 Years Later 44,588,020 50,374,721 57,151,258 61,983,908 61,192,597
7 Years Later 46,146,262 50,993,874 56,935,245 61,875,465
8 Years Later 46,740,535 50,819,391 56,906,786
9 Years Later 46,520,046 50,884,573
10 Years Later 46,604,154
Cumulative Redundancy (Deficiency) $(9,492,308) $(10,293,325) $(16,532,554) $(24,247,300) $(26,646,571) $(8,503,264)
========= ========== ========== ========== ========== =========
Gross Liability for Unpaid Losses
and Loss Adjustment Expenses $39,740,865 $42,004,851 $41,513,945 $41,592,489 $45,217,369 $60,534,295
Ceded Liability for Unpaid Losses
and Loss Adjustment Expenses (2,629,019) (1,413,603) (1,139,713) (3,964,324) (10,671,343) (10,748,080)
--------- --------- --------- --------- ---------- ----------
Net Liability for Unpaid Losses
and Loss Adjustment Expenses $37,111,846 $40,591,248 $40,374,232 $37,628,165 $34,546,026 $49,786,215
========== ========== ========== ========== ========== ==========
Gross Liability Reestimated $75,052,908 $74,324,407 $82,231,714 $90,001,974 $92,841,114 $88,989,237
Ceded Liability Reestimated (28,448,754) (23,439,834) (25,324,928) (28,126,509) (31,648,517) (30,699,758)
---------- ---------- ---------- ---------- ---------- ----------
Net Liability Reestimated $46,604,154 $50,884,573 $56,906,786 $61,875,465 $61,192,597 $58,289,479
========== ========== ========== ========== ========== ==========
Gross Reserve Redundancy (Deficiency) $(35,312,043) $(32,319,556) $(40,717,769) $(48,409,485) $(47,623,745) $(28,454,942)
========== ========== ========== ========== ========== ==========
5
CRUSADER INSURANCE COMPANY
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
Fiscal Year Ended December 31
---------------------------------------------------------------------------
2002 2003 2004 2005 2006
---- ---- ---- ---- ----
Reserve for Unpaid Losses and
Loss Adjustment Expenses $53,596,945 $58,883,861 $67,349,989 $76,235,467 $70,076,430
Paid Cumulative as of
1 Year Later 21,326,688 18,546,279 14,626,446 17,257,218
2 Years Later 35,883,729 28,289,327 26,374,067
3 Years Later 40,808,763 26,374,067
4 Years Later 35,508,898
5 Years Later
6 Years Later
7 Years Later
8 Years Later
9 Years Later
10 Years Later
Reserves Reestimated as of
1 Year Later 56,348,531 58,048,427 63,525,526 64,064,784
2 Years Later 57,237,770 54,623,000 51,981,027
3 Years Later 55,430,550 50,602,947
4 Years Later 53,154,847
5 Years Later
6 Years Later
7 Years Later
8 Years Later
9 Years Later
10 Years Later
Cumulative Redundancy (Deficiency) $442,098 $8,280,914 $15,368,962 $12,170,683
======= ========= ========== ==========
Gross Liability for Unpaid Losses
and Loss Adjustment Expenses $74,905,284 $78,139,090 $87,469,000 $101,914,548 $93,596,117
Ceded Liability for Unpaid Losses
and Loss Adjustment Expenses (21,308,339) (19,255,229) (20,119,011) (25,679,081) (23,519,687)
---------- ---------- ---------- ---------- ----------
Net Liability for Unpaid Losses
and Loss Adjustment Expenses $53,596,945 $58,883,861 $67,349,989 $76,235,467 $70,076,430
========== ========== ========== ========== ==========
Gross Liability Reestimated $76,509,675 $72,127,634 $73,494,183 $93,937,077
Ceded Liability Reestimated (23,354,828) (21,524,687) (21,513,156) (29,872,293)
---------- ---------- ---------- ----------
Net Liability Reestimated $53,154,847 $50,602,947 $51,981,027 $64,064,784
========== ========== ========== ==========
Gross Reserve Redundancy (Deficiency) $(1,604,391) $6,011,456 $13,974,817 $7,977,471
========= ========= ========== =========
5
Net Premium Written to Policyholders' Surplus Ratio
---------------------------------------------------
The following table shows, for the periods indicated, Crusader's statutory
ratios of net premiums written to statutory policyholders' surplus. Since each
property and casualty insurance company has different capital needs, an
"acceptable" ratio of net premium written to policyholders' surplus for one
company may be inapplicable to another. While there is no statutory requirement
applicable to Crusader that establishes a permissible net premium to surplus
ratio, guidelines established by the National Association of Insurance
Commissioners (NAIC) provide that such ratio should generally be no greater than
3 to 1.
Twelve months ended December 31
-------------------------------
Statutory: 2006 2005 2004 2003 2002
---------- ---- ---- ---- ---- ----
Net premiums written $38,166,864 $46,030,707 $51,089,573 $47,420,157 $38,363,201
Policyholders' surplus $50,023,768 $36,586,441 $29,436,343 $26,103,440 $26,258,452
Ratio 0.8 to 1 1.3 to 1 1.7 to 1 1.8 to 1 1.5 to 1
Crusader results are reported in accordance with U.S. generally accepted
accounting principles (GAAP). These results differ from its financial results
reported in accordance with Statutory Accounting Principles (SAP) as prescribed
or permitted by insurance regulatory authorities. Crusader is required to file
financial statements with insurance regulatory authorities prepared on a SAP
basis.
SAP differs in certain respects from GAAP. The more significant of these
differences that apply to Crusader are:
o Under GAAP, policy acquisition costs such as commissions, premium taxes
and other variable costs incurred in connection with writing new and
renewal business are capitalized and amortized on a pro rata basis over
the period in which the related premiums are earned, rather than
expensed as incurred as required by SAP.
o Certain assets included in balance sheets under GAAP are designated as
"non-admitted assets" and are charged directly against statutory
surplus under SAP. Non-admitted assets include primarily premium
receivables that are outstanding over 90 days, federal deferred tax
assets in excess of statutory limitations, furniture, equipment,
leasehold improvements, and prepaid expenses.
o Under GAAP, amounts related to ceded reinsurance are shown gross as
prepaid reinsurance premiums and reinsurance recoverable, rather than
netted against unearned premium reserves and loss and loss adjustment
expense reserves, respectively, as required by SAP.
o Under GAAP, fixed maturity securities, which are classified as
available-for-sale, are reported at estimated fair values, rather than
at amortized cost or the lower of amortized cost or market, depending
on the specific type of security as required by SAP.
o The differing treatment of income and expense items results in a
corresponding difference in federal income tax expense. Under GAAP
reporting, changes in deferred income taxes are reflected as an item of
income tax benefit or expense. As required by SAP, federal income taxes
are recorded when payable and deferred taxes, subject to limitations,
are recognized but only to the extent that they do not exceed 10% of
statutory surplus. Changes in deferred taxes are recorded directly to
statutory surplus.
Regulation
----------
The insurance company operation is subject to regulation by the California
Department of Insurance (the insurance department) and by the department of
insurance of other states in which Crusader is licensed. The insurance
department has broad regulatory, supervisory, and administrative powers. These
powers relate primarily to the standards of solvency which must be met and
maintained; the licensing of insurers and their agents; the nature and
limitation of insurers' investments; the prior approval of rates, rules and
forms; the issuance of securities by insurers; periodic financial and market
conduct examinations of the affairs of insurers; the annual and other reports
required to be filed on the financial condition and results of operations of
such insurers or for other purposes; and the establishment of reserves required
to be maintained for unearned premiums, losses, and other purposes. The
regulations and supervision by the insurance department are designed principally
for the benefit of policyholders and not for the insurance company shareholders.
The insurance department's Market Conduct Division is responsible for conducting
periodic examinations of companies to ensure compliance with California
Insurance Code and California Code of Regulations with respect to rating,
underwriting and claims handling practices. The most recent Market Conduct
Examination of Crusader covered rating and underwriting practices in California
as reflected by policies issued during the three months period from December 15,
2005 through March 15, 2006, and by policies related thereto issued during the
6
preceding two years. No significant issues were reported as a result of that
examination. The insurance department also conducts periodic financial
examinations of Crusader. The insurance department completed its financial
examination of Crusader's December 31, 2004, statutory financial statements. No
significant issues were reported as a result of that examination.
In December 1993, the NAIC adopted a Risk-Based Capital (RBC) Model Law for
property and casualty companies. The RBC Model Law is intended to provide
standards for calculating a variable regulatory capital requirement related to a
company's current operations and its risk exposures (asset risk, underwriting
risk, credit risk and off-balance sheet risk). These standards are intended to
serve as a diagnostic solvency tool for regulators that establishes uniform
capital levels and specific authority levels for regulatory intervention when an
insurer falls below minimum capital levels. The RBC Model Law specifies four
distinct action levels at which a regulator can intervene with increasing
degrees of authority over a domestic insurer if its RBC is equal to or less than
200% of its computed authorized control level RBC. A company's RBC is required
to be disclosed in its statutory annual statement. The RBC is not intended to be
used as a rating or ranking tool nor is it to be used in premium rate making or
approval. Crusader's adjusted capital at December 31, 2006, was 624% of
authorized control level risk-based capital.
The following table sets forth the different levels of risk-based capital that
may trigger regulatory involvement and the corresponding actions that may
result.
LEVEL TRIGGER CORRECTIVE ACTION
----- ------- -----------------
Company Action Level Adjusted Capital less than 200% The insurer must submit a comprehensive plan to the
of Authorized Control Level insurance commissioner
Regulatory Action Level Adjusted Capital less than 150% In addition to above, insurer is subject to examination,
of Authorized Control Level analysis, and specific corrective action.
Authorized Control Level Adjusted Capital less than 100% In addition to both of the above, insurance commissioner
of Authorized Control Level may place insurer under regulatory control.
Mandatory Control Level Adjusted Capital less than 70% of Insurer must be placed under regulatory control.
Authorized Control Level
Insurance Regulatory Information System (IRIS) was developed by a committee of
state insurance regulators primarily to assist state insurance departments in
executing their statutory mandate to oversee the financial condition of
insurance companies. IRIS helps those companies that merit highest priority in
the allocation of the regulators' resources on the basis of 13 financial ratios
that are calculated annually. The analytical phase is a review of annual
statements and the financial ratios. The ratios and trends are valuable in
pointing to companies likely to experience financial difficulties, but are not
themselves indicative of adverse financial condition. The ratio and benchmark
comparisons are mechanically produced and are not intended to replace the state
insurance departments' own in-depth financial analysis or on-site examinations.
An unusual range of ratio results has been established from studies of the
ratios of companies that have become insolvent or have experienced financial
difficulties. In the analytical phase, companies that receive four or more
financial ratio values outside the usual range are analyzed in order to identify
those companies that appear to require immediate regulatory action.
Subsequently, a more comprehensive review of the ratio results and an insurer's
annual statement is performed to confirm that an insurer's situation calls for
increased or close regulatory attention. In 2006, the Company was outside the
usual values on one of the thirteen IRIS ratio tests. The ratio was the "Net
Change in Adjusted Policyholders' Surplus." This ratio compares the Company's
ratio to an established minimum and maximum range of greater than 10% decrease
in adjusted policyholders' surplus and less than 25% increase in adjusted
policyholders' surplus. The Company's net change in adjusted policyholders'
surplus ratio was an increase of 37%.
California Insurance Guarantee Association
------------------------------------------
The California Insurance Guarantee Association (CIGA) was created to provide for
payment of claims for which insolvent insurers of most casualty lines are liable
but which cannot be paid out of such insurers' assets. The Company is subject to
assessment by CIGA for its pro-rata share of such claims based on premiums
written in the particular line in the year preceding the assessment by insurers
writing that line of insurance in California. Such assessments are based upon
estimates of losses to be incurred in liquidating an insolvent insurer. In a
particular year, the Company cannot be assessed an amount greater than 2% of its
premiums written in the preceding year. Assessments are recouped through a
mandated surcharge to policyholders the year after the assessment. No assessment
was made by CIGA for the 2005 or the 2006 calendar years.
7
Holding Company Act
-------------------
Crusader is subject to regulation by the insurance department pursuant to the
provisions of the California Insurance Holding Company System Regulatory Act
(the "Holding Company Act"). Pursuant to the Holding Company Act, the insurance
department may examine the affairs of Crusader at any time. Certain transactions
defined to be of an "extraordinary" type may not be effected without the prior
approval of the insurance department. Such transactions include, but are not
limited to, sales, purchases, exchanges, loans and extensions of credit, and
investments made within the immediately preceding 12 months involving the lesser
of 3% of admitted assets or 25% of policyholders' surplus as of the preceding
December 31. An extraordinary transaction also includes a dividend which,
together with other dividends or distributions made within the preceding twelve
months, exceeds the greater of 10% of the insurance company's policyholders'
surplus as of the preceding December 31 or the insurance company's net income
for the preceding calendar year. An insurance company is also required to notify
the insurance department of any dividend after declaration, but prior to
payment.
The Holding Company Act also provides that the acquisition or change of
"control" of a California domiciled insurance company or of any person who
controls such an insurance company cannot be consummated without the prior
approval of the Insurance Commissioner. In general, a presumption of "control"
arises from the ownership of voting securities and securities that are
convertible into voting securities, which in the aggregate constitute 10% or
more of the voting securities of a California insurance company or a person who
controls a California insurance company, such as Crusader. A person seeking to
acquire "control," directly or indirectly, of the Company must generally file
with the Insurance Commissioner an application for change of control containing
certain information required by statute and published regulations and provide a
copy of the application to the Company. The Holding Company Act also effectively
restricts the Company from consummating certain reorganization or mergers
without prior regulatory approval. The Company is in compliance with the Holding
Company Act.
Rating
------
Insurance companies are rated to provide both industry participants and
insurance consumers with meaningful information on specific insurance companies.
Higher ratings generally indicate financial stability and a strong ability to
pay claims. These ratings are based upon factors relevant to policyholders and
are not directed toward protection of investors. Such ratings are neither a
rating of securities nor a recommendation to buy, hold or sell any security and
may be revised or withdrawn at any time. Ratings focus primarily on the
following factors: capital resources, financial strength, demonstrated
management expertise in the insurance business, credit analysis, systems
development, market segment position and growth opportunities, marketing, sales
conduct practices, investment operations, minimum policyholders' surplus
requirements and capital sufficiency to meet projected growth, as well as access
to such traditional capital as may be necessary to continue to meet standards
for capital adequacy.
The claims-paying abilities of insurers are rated to provide both insurance
consumers and industry participants with comparative information on specific
insurance companies. Claims-paying ratings are important for the marketing of
certain insurance products. A higher rating generally indicates greater
financial strength and a stronger ability to pay claims.
A.M. Best Company has upgraded Crusader's financial strength rating from B+
(Good) to B++ (Good), effective January 2, 2007, with a rating outlook of
stable.
Terrorism Risk Insurance Act of 2002
------------------------------------
On November 26, 2002, the Terrorism Risk Insurance Act of 2002 (The Act) was
signed by President Bush. On December 22, 2005, the United States' government
extended the The Act, which was set to expire on December 31, 2005, for two more
years. The Act establishes a program within the Department of the Treasury in
which the Federal Government will share the risk of loss from acts of terrorism
with the insurance industry. Federal participation will be triggered when the
Secretary of the Treasury, in concurrence with the Secretary of State and the
Attorney General of the United States, certifies an act to be an act of
terrorism committed by an individual(s) acting on behalf of any foreign
interest, provided the terrorist act results in aggregate losses in excess of $5
million.
Under The Act, the federal government will pay 90% of covered terrorism losses
exceeding the statutorily established deductible. All property and casualty
insurance companies are required to participate in the program
8
to the extent that they must make available property and casualty insurance
coverage for terrorism that does not differ materially from the terms, amounts,
and other coverage limitations applicable to losses arising from events other
than acts of terrorism.
The Company does not write policies on properties considered to be a target of
terrorist activities such as airports, large hotels, large office structures,
amusement parks, landmark defined structures, or other large scale public
facilities. In addition, there is not a high concentration of policies in any
one area where increased exposure to terrorist threats exist. Consequently, the
Company believes its exposure relating to acts of terrorism is low. In 2006
Crusader received $380,569 in terrorism coverage premium from approximately 11%
of its policyholders. Crusader's 2006 terrorism deductible was $11,324,734.
Crusader's 2007 terrorism deductible is $11,338,443.
OTHER INSURANCE OPERATIONS
--------------------------
General Agency Operations
-------------------------
Unifax primarily sells and services commercial multiple peril business insurance
policies for Crusader in California. In addition, it sells and services
commercial earthquake insurance policies in California for a non-affiliated
insurer. Unifax also sold and serviced policies for Crusader in Arizona, Idaho,
Ohio, Kentucky, Montana, Nevada, Oregon, Pennsylvania, Texas, and Washington.
However, in 2002 the Company began placing moratoriums on non-California
business on a state-by-state basis. By July 2003, the Company had placed
moratoriums on all non-California business.
Bedford Insurance Services, Inc., (Bedford) sells and services daily automobile
rental policies in most states for a non-affiliated insurer.
As general agents, these subsidiaries market, rate, underwrite, inspect and
issue policies, bill and collect insurance premiums, and maintain accounting and
statistical data. Unifax is the exclusive general agent for Crusader. Unifax and
Bedford are non-exclusive general agents for non-affiliated insurance companies.
The Company's marketing is conducted through advertising to independent
insurance agents and brokers. For its services, the general agent receives a
commission (based on the premium written) from the insurance company and, in
some cases, a policy fee from the customer. These subsidiaries all hold licenses
issued by the California Department of Insurance and other states where
applicable.
Insurance Premium Finance Operation
-----------------------------------
The Company's subsidiary, American Acceptance Corporation (AAC) is a licensed
insurance premium finance company that provides insurance purchasers with the
ability to pay their insurance premiums on an installment basis. The premium
finance company pays the insurance premium to the insurance company in return
for a premium finance note from the insured. These notes are paid off by the
insured in nine monthly installments and are secured by the unearned premiums
held by the insurance company. AAC provides premium financing for Crusader
policies that are produced by Unifax in California.
Association Operation
---------------------
The Company's subsidiary, Insurance Club, Inc. dba AAQHC, An Administrator
(AAQHC) (formally American Association of Quality Health Care), is a membership
association and a third party administrator. AAQHC provides various consumer
benefits to its members, including participation in group medical and dental
insurance policies that it negotiates. AAQHC also provides services as a third
party administrator and is licensed by the California Department of Insurance.
For these services, AAQHC receives membership and fee income from its members.
Health and Life Insurance Operations
------------------------------------
The Company's subsidiary, American Insurance Brokers, Inc. (AIB) markets
medical, dental, and life insurance in California through non-affiliated
insurance companies for individuals and groups. The services provided consist of
marketing, billing and collection, accounting, and customer service. For these
services AIB receives commissions from insurance companies. Most of the business
is produced through independent insurance agents and brokers. AIB holds licenses
issued by the California Department of Insurance.
9
INVESTMENTS
-----------
The investments of the Company are made by the Company's Chief Financial Officer
under the supervision of an investment committee appointed by the Company's
Board of Directors. The Company's investment guidelines on equity securities
limit investments in equity securities to an aggregate maximum of $2,000,000.
The Company's investment guidelines on fixed maturities limit those investments
to high-grade obligations with a maximum term of eight years. The maximum
investment authorized in any one issuer is $2,000,000 and the maximum in any one
U.S. government agency or U.S. government sponsored enterprise is $3,000,000.
This dollar limitation excludes bond premiums paid in excess of par value and
U.S. government or U.S. government guaranteed issues. Investments in municipal
securities are primarily pre-refunded and secured by U.S. treasury securities.
The short-term investments are either U.S. government obligations, FDIC insured,
or are in an institution with a Moody's rating of P2 and/or a Standard & Poor's
rating of A1. All of the Company's fixed maturity investment securities are
rated and readily marketable and could be liquidated without any materially
adverse financial impact.
COMPETITION
-----------
General
-------
The property and casualty insurance industry is highly competitive in the areas
of price, coverage, and service. It is highly cyclical, characterized by periods
of high premium rates and shortages of underwriting capacity followed by periods
of severe price competition and excess capacity.
The profitability of insurers is affected by many factors including rate and
coverage competition, the frequency of claims and their average cost, natural
disasters, state regulations, interest rates, crime rates, general business
conditions, and court decisions redefining and expanding the extent of coverage
and granting higher compensation awards. One of the challenging and unique
features of the property and casualty business is the fact that, since premiums
are collected before losses are paid, its products are normally priced before
its costs are known.
Insurance Company and General Agency Operations (Property and Casualty)
----------------------------------------------------------------------
The Company's property and casualty insurance business continues to experience a
competitive marketplace. There are many substantial competitors who have larger
resources, operate in more states, and insure coverages in more lines and in
higher limits than the Company. In addition, Crusader competes not only with
other insurance companies but also with other general agencies. Many of those
general agencies offer more products than the Company. The principal method of
competition among competitors is based on price. While the Company attempts to
meet such competition with competitive prices, its emphasis is on service,
promotion, and distribution. Additional information regarding competition in the
insurance marketplace is discussed in the Item 7 - "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Results of
Operations."
Insurance Premium Financing Operation
-------------------------------------
The insurance premium financing operation currently finances policies written
only through its sister company, Unifax. Consequently, AAC's growth is primarily
dependent on the growth of Crusader and Unifax business. In addition, the
competitive pricing, the quality of its service, and the ease and convenience of
financing with AAC have made its profitability possible.
Health and Life Insurance Operations
------------------------------------
Competition in the health and life insurance business is intense. In 2006 and
2005 approximately 69% and 72%, respectively, of the Company's health and life
insurance business was from the CIGNA HealthCare medical and dental plan
programs. CIGNA's plans consist of small group medical and dental policies and
individual dental policies. CIGNA discontinued its individual and family health
insurance programs to new policyholders in the state of California in April 2003
and terminated existing policyholders beginning November 1, 2003, through
October 1, 2004. CIGNA's termination of its California individual and family
health insurance did not affect CIGNA's individual and family dental plans or
its group medical and dental plans. In May 2006, CIGNA HealthCare began offering
new small group medical insurance policies in the state of California.
Currently, all new CIGNA small group medical insurance policies are written
through AIB and all CIGNA small group medical insurance policyholders are
members of AAQHC. The new programs are competitively priced and are being
actively marketed.
10
EMPLOYEES
---------
On March 9, 2007, the Company employed 121 persons at its facility located in
Woodland Hills, California. The Company has no collective bargaining agreements
and believes its relations with its employees are excellent.
ITEM 1A. Risk Factors.
------------
The Company is subject to numerous risks and uncertainties, the outcome of which
may impact future results of operations and financial condition. These risks are
as follows:
Loss and loss adjustment expense reserves are based on estimates and may not be
sufficient to cover future losses.
---------------------------------
Loss and loss adjustment expense reserves represent an estimate of amounts
needed to pay and administer claims with respect to insured events that have
occurred, including events that have incurred which have not yet been reported
to the Company. There is a high level of uncertainty inherent in the evaluation
of the required losses and loss adjustment expense reserves for the Company. The
long-tailed nature of liability claims and the volatility of jury awards
exacerbate that uncertainty. The Company sets loss and loss adjustment expense
reserves at each balance sheet date at management's best estimate of the
ultimate payments that it anticipates will be made to settle all losses incurred
and related loss adjustment expenses incurred as of that date for both reported
and unreported losses. The ultimate cost of claims is dependent upon future
events, the outcomes of which are affected by many factors. Company claim
reserving procedures and settlement philosophy, current and perceived social and
economic inflation, current and future court rulings and jury attitudes,
improvements in medical technology, and many other economic, scientific, legal,
political, and social factors all can have significant effects on the ultimate
costs of claims. Changes in Company operations and management philosophy also
may cause actual developments to vary from the past. Since the emergence and
disposition of claims are subject to uncertainties, the net amounts that will
ultimately be paid to settle claims may vary significantly from the estimated
amounts provided for in the accompanying consolidated financial statements. Any
adjustments to reserves are reflected in the operating results of the periods in
which they are made.
The Company's success depends on its ability to accurately underwrite risks and
to charge adequate premiums to policyholders.
--------------------------------------------
The Company's financial condition, liquidity and results of operations depend in
large part on the Company's ability to underwrite and set premiums accurately
for the risks it faces. Premium rate adequacy is necessary to generate
sufficient premium to offset losses, loss adjustment expenses, underwriting
expenses, and to earn a profit. In order to price its products accurately, the
Company must collect and properly analyze a substantial volume of data; develop,
test and apply appropriate rating formulae; closely monitor and timely recognize
changes in trends; and project both severity and frequency of losses with
reasonable accuracy. The Company's ability to undertake these efforts
successfully is subject to a number of risks and uncertainties, including,
without limitation:
o Availability of sufficient reliable data.
o Incorrect or incomplete analysis of available data.
o Uncertainties inherent in estimates and assumptions.
o Selection and application of appropriate rating formulae or other pricing
methodologies.
o Adoption of successful pricing strategies.
o Prediction of policyholder retention (e.g., policy life expectancy).
o Unanticipated court decisions, legislation or regulatory action.
o Ongoing changes in the Company's claim settlement practices.
o Unexpected inflation.
o Social changes, particularly those affecting litigious inclinations.
Such risks may result in the Company's pricing being based on outdated,
inadequate, or inaccurate data, or inappropriate analyses, assumptions, or
methodologies, and may cause the Company to estimate incorrectly future changes
in the frequency or severity of claims. As a result, the Company could under
price risks, which would negatively affect the Company's margins, or it could
overprice risks, which could reduce the Company's volume and competitiveness. In
either event, the Company's operating results, financial condition, and cash
flow could be materially adversely affected.
11
Inability to obtain reinsurance or to collect on ceded reinsurance could
adversely affect the Company's ability to write new policies.
------------------------------------------------------------
The availability, amount and cost of reinsurance depend on market conditions and
may vary significantly. Any decrease in the amount of the Company's reinsurance
will increase the risk of loss and could materially adversely affect its
business and financial condition. Ceded reinsurance does not discharge the
Company's direct obligations under the policies it writes. The Company remains
liable to its policyholders even if the Company is unable to make recoveries
that it believes it's entitled to under the reinsurance contracts. Losses may
not be recovered from the reinsurers until claims are paid.
The insurance business is subject to extensive regulation and legislative
changes, which may impact the manner in which the company operates its business.
-------------------------------------------------------------------------------
The insurance business is subject to extensive regulation by the California
Department of Insurance. The California Department of Insurance has broad
regulatory powers implemented to protect policyholders, not stockholders or
other investors. These powers include, among other things, the ability to:
o Place limitations on the Company's investments and dividends.
o Place limitations on the Company's ability to transact business with its
affiliates.
o Establish standards of solvency including minimum reserves
and capital surplus requirements.
o Prescribe the form and content of, and to examine, the Company's financial
statements.
Federal legislation typically does not directly impact the property and casualty
business, but the business can be indirectly affected by changes in federal
regulations.
This extensive regulation may affect the cost or demand for the Company's
products and may limit the ability to obtain rate increases or to take other
actions that the Company might desire to do in order to increase its
profitability.
A downgrade in the financial strength rating of the insurance company could
reduce the amount of business it may be able to write.
-----------------------------------------------------
Rating agencies rate insurance companies based on financial strength as an
indication of an ability to pay claims. Crusader's financial strength rating has
been upgraded by A.M. Best Company from B+ (Good) to B++ (Good), effective
January 2, 2007, with a rating outlook of stable. The financial strength rating
of A.M. Best is subject to periodic review using, among other things,
proprietary capital adequacy models, and is subject to revision or withdrawal at
any time. Insurance financial strength ratings are directed toward the concerns
of policyholders and insurance agents and are not intended for the protection of
investors. Any downgrade in the Company's A.M. Best rating could cause a
reduction in the number of policies it writes and could have a material adverse
effect on its results of operations and financial position.
Intense competition could adversely affect the ability to sell policies at
premium rates the Company deem adequate.
---------------------------------------
The Company faces significant competition which, at times, is intense. If the
Company is unable to compete effectively its business and financial condition
could be materially adversely affected. Competition in the property and casualty
marketplace is based on many factors including premiums charged, services
provided, financial strength ratings assigned by independent rating agencies,
speed of claims payments, reputation, perceived financial strength, and general
experience. The Company competes with regional and national insurance companies.
Some competitors have greater financial, marketing, and management resources
than the Company. Intense competitive pressure on prices can result from the
actions of even a single large competitor. The Company uses its own, proprietary
premium rates to determine the price for its property and casualty policies.
The Company's earnings may be affected by changes in interest rates.
-------------------------------------------------------------------
Investment income is an important component of the Company's revenues and net
income. The ability to achieve investment objectives is affected by factors that
are beyond the Company's control. Interest rates are highly sensitive to many
factors, including governmental monetary policies and domestic and international
economic and political conditions. Any significant decline in investment income
as a result of falling interest rates or general market conditions would have an
adverse effect on net income and, as a result, on the Company's stockholders'
equity and policyholders' surplus.
12
The outlook of the Company's investment income is dependent on the future
direction of interest rates and the amount of cash flows from operations that
are available for investment. The fair values of fixed maturity investments that
are "available-for-sale" fluctuate with changes in interest rates and cause
fluctuations in the stockholders' equity.
The Company's geographic concentration ties its performance to the business,
economic, and regulatory conditions in California.
-------------------------------------------------
The Company's insurance business is concentrated in California (100% of gross
written premium in 2004 through 2006). Accordingly, unfavorable business,
economic or regulatory conditions in the state of California could negatively
impact the Company's performance. In addition, California is exposed to severe
natural perils, such as earthquakes and fires, along with the possibility of
terrorist acts. Accordingly, the Company could suffer losses as a result of
catastrophic events.
The Company relies on independent insurance agents and brokers.
--------------------------------------------------------------
The failure or inability of independent insurance agencies and brokers to market
the Company's insurance programs successfully could have a material adverse
effect on its business, financial condition and results of operations.
Independent brokers are not obligated to promote the Company's insurance
programs and may sell competitors' insurance programs. The Company's business
largely depends on the marketing efforts of independent brokers and on the
Company's ability to offer insurance programs and services that meet the
requirements of those brokers' customers.
Litigation may have an adverse effect on the Company's business.
---------------------------------------------------------------
The insurance industry is the target of an increasing number of class action
lawsuits and other types of litigation, some of which involve claims for
substantial and/or indeterminate amounts and the outcomes of which are
unpredictable. This litigation is based on a variety of issues including
insurance and claim settlement practices. Although the Company has not been the
target of any specific class action lawsuits, it is possible that a suit of this
type could have a negative impact on the Company's business.
The Company relies on its information technology systems to manage many aspects
of its business, and any failure of these systems to function properly or any
interruption in their operation could result in a material adverse effect on the
Company's business, financial condition and results of operations.
-----------------------------------------------------------------
The Company depends on the accuracy, reliability, and proper functioning of its
information technology systems. The Company relies on these information
technology systems to effectively manage many aspects of its business, including
underwriting, policy acquisition, claims processing and handling, accounting,
reserving and actuarial processes and policies, and to maintain its policyholder
data. The failure of hardware or software that supports the Company's
information technology systems or the loss of data contained in the systems
could disrupt its business and could result in decreased premiums, increased
overhead costs, and inaccurate reporting, all of which could have a material
adverse effect on the Company's business, financial condition, and results of
operations. In addition, despite system redundancy, the implementation of
security measures and the existence of a disaster recovery plan for the
Company's information technology systems, these systems are vulnerable to damage
or interruption from events such as:
o Earthquake, fire, flood and other natural disasters.
o Terrorist attacks and attacks by computer viruses or hackers.
o Power loss.
o Unauthorized access.
o Computer systems or data network failure.
It is possible that a system failure, accident, or security breach could result
in a material disruption to the Company's business. In addition, substantial
costs may be incurred to remedy the damages caused by these disruptions. To the
extent that a critical system fails or is not properly implemented and the
failure cannot be corrected in a timely manner, the Company may experience
disruptions to the business that could have a material adverse effect on the
Company's results of operations.
The Company's disclosure controls and procedures may not prevent or detect all
acts of fraud.
-------------
The Company's disclosure controls and procedures are designed to reasonably
ensure that information required to be disclosed in reports filed or submitted
under the Securities Exchange Act is accumulated and
13
communicated to management and is recorded, processed, summarized, and reported
within the time periods specified in the SEC's rules and forms. The Company's
management believes that any disclosure controls and procedures or internal
controls and procedures, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Because of the inherent limitations in all control systems, they
cannot provide absolute assurance that all control issues and instances of
fraud, if any, within the Company have been prevented or detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty and that breakdowns can occur because of a simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by an unauthorized override of
the controls. The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and the Company
cannot ensure that any design will succeed in achieving its stated goals under
all potential future conditions. Accordingly, because of the inherent
limitations in a cost effective control system, misstatements due to error or
fraud may occur and may not be detected.
The ability of the Company to attract, develop and retain talented employees,
managers, and executives, and to maintain appropriate staffing levels, is
critical to the Company's success.
---------------------------------
The Company must hire and train new employees, and retain current employees to
handle its operations. The failure of the Company to successfully hire and
retain a sufficient number of skilled employees could result in the Company
having to slow the growth of its business. In addition, the failure to
adequately staff its claims department could result in decreased quality of the
Company's claims operations. The Company's success also depends heavily upon the
continued contributions of its executive officers, both individually and as a
group. The Company's future performance will be substantially dependent on its
ability to retain and motivate its management team. The loss of the services of
any of the Company's executive officers could prevent the Company from
successfully implementing its business strategy, which could have a material
adverse effect on the Company's business, financial condition, and results of
operations.
ITEM 1B. Unresolved Staff Comments.
-------------------------
Not applicable.
ITEM 2. Properties
----------
The Company presently occupies a 46,000 square foot office building located at
23251 Mulholland Drive, Woodland Hills, California, under a master lease
expiring March 31, 2012. Erwin Cheldin, the Company's president, chairman, and
principal stockholder, is the owner of the building. The Company signed an
extension to the lease with a 4% increase in rent effective April 1, 2007. The
lease provides for an annual gross rent of $1,025,952 through March 31, 2007 and
$1,066,990 from April 1, 2007 through March 31, 2012. In addition, the lease
extension provides for two, five-year options with a rent increase of 5% for
each option period. The Company believes that at the inception of the lease
agreement and at each subsequent extension, the terms of the lease were at least
as favorable to the Company as could have been obtained from non-affiliated
third parties. The Company utilizes for its own operations approximately 100% of
the space it leases.
ITEM 3. Legal Proceedings
-----------------
The Company, by virtue of the nature of the business conducted by it, becomes
involved in numerous legal proceedings in which it may be named as either
plaintiff or defendant. Incidental actions are sometimes brought by customers or
others that relate to disputes concerning the issuance or non-issuance of
individual insurance policies or other matters. In addition, the Company resorts
to legal proceedings from time to time in order to enforce collection of
premiums, commissions, or fees for the services rendered to customers or to
their agents. These routine items of litigation do not materially affect the
Company's operations and are handled on a routine basis through its counsel.
ITEM 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None
14
PART II
-------
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters, and
Issuer Purchases of Equity Securities
-------------------------------------
The Company's common stock is traded on the NASDAQ Stock Market under the symbol
"UNAM." The high and low sales prices (by quarter) during the last two
comparable twelve-month periods are as follows:
High Low
Quarter Ended Price Price
------------- ----- -----
March 31, 2005 $11.50 $8.76
June 30, 2005 $9.15 $8.00
September 30, 2005 $9.58 $8.41
December 31, 2005 $9.38 $8.45
March 31, 2006 $9.74 $8.90
June 30, 2006 $12.03 $9.19
September 30, 2006 $12.14 $9.60
December 31, 2006 $13.59 $10.13
Performance Graph
-----------------
The following graph compares the cumulative total shareholder return on the
Company's Common Stock with the cumulative total return of equity securities
traded on the National Association of Securities Dealers Automated Quotation
System (NASDAQ) and a peer group consisting of all NASDAQ property and casualty
companies. The comparison assumes $100.00 was invested on December 31, 2001, in
the Company's Common Stock and in each of the comparison groups, and assumes
reinvestment of dividends. It should be noted that this graph represents
historical stock price performance and is not necessarily indicative of any
future stock price performance.
(In accordance with Rule 304 of Regulation S-T, the Performance Graph is not
reproduced in this electronic filing. The Performance Graph data is presented
in tabular form below)
12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06
-------- -------- -------- -------- -------- --------
Unico American Corp. 100.0 59.4 105.2 179.1 176.2 246.5
NASDAQ Market Index 100.0 69.1 103.4 112.5 114.9 126.2
Peer Group Index 100.0 102.4 122.1 153.1 175.9 201.5
15
As of December 31, 2006, the approximate number of shareholders of record of the
Company's common stock was 380. In addition, the Company estimates beneficial
owners of the Company's common stock held in the name of nominees to be
approximately 700.
The Company last declared a cash dividend on its common stock in 2002.
Declaration of future annual cash dividends will be subject to the Company's
profitability and its cash requirements. Because the Company is a holding
company and operates through its subsidiaries, its cash flow and, consequently,
its ability to pay dividends are dependent upon the earnings of its subsidiaries
and the distribution of those earnings to the Company. Also, the ability of
Crusader to pay dividends to the Company is subject to certain regulatory
restrictions under the Holding Company Act (see Item 1 - "Business - Insurance
Company Operation - Holding Company Act"). Presently, without prior approval,
Crusader may pay a dividend in any twelve (12) month period to its parent equal
to the greater of (a) 10% of Crusader's statutory policyholders' surplus or (b)
Crusader's statutory net income for the preceding calendar year. Based on
Crusader's statutory net income for the year ended December 31, 2006, the
maximum dividend that could be made by Crusader to Unico without prior
regulatory approval in 2007 is $13,396,732.
The Company previously announced that its Board of Directors had authorized the
repurchase in the open market from time to time of up to an aggregate of 945,000
shares of the common stock of the Company (see Note 16 of "Notes to Consolidated
Financial Statements"). No shares were repurchased during the year ended
December 31, 2006. As of December 31, 2006, the Company has purchased and
retired under the Board of Directors authorization an aggregate of 868,958
shares of its common stock at a cost of $5,517,465.
ITEM 6. Selected Financial Data
-----------------------
Year ended December 31
----------------------
2006 2005 2004 2003 2002
---- ---- ---- ----- -----
Total revenues $54,717,381 $61,182,522 $61,903,310 $51,130,439 $46,028,642
Total costs and expenses 36,563,395 50,716,092 53,230,852 48,981,068 50,842,701
---------- ---------- ---------- ---------- ----------
Income (loss) before taxes $18,153,986 $10,466,430 $8,672,458 $2,149,371 $(4,814,059)
Net income (loss) $11,794,241 $6,715,004 $5,681,500 $1,068,650 $(3,224,689)
Basic earnings (loss) per share $2.12 $1.22 $1.03 $0.19 $(0.59)
Diluted earnings (loss) per share $2.09 $1.20 $1.02 $0.19 $(0.59)
Cash dividends per share - - - - $0.05
Total assets $187,801,836 $186,297,179 $172,570,276 $161,493,695 $148,686,605
Stockholders' equity $60,871,022 $48,394,373 $42,425,325 $38,470,857 $38,408,990
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
-------------------------
Overview
--------
General
-------
Unico American Corporation is an insurance holding company that underwrites
property and casualty insurance through its insurance company subsidiary;
provides property, casualty, health and life insurance through its agency
subsidiaries, insurance premium financing, and membership association services.
The Company's net income was $11,794,241 in 2006, $6,715,004 in 2005, and
$5,681,500 in 2004.
This overview discusses some of the relevant factors that management considers
in evaluating the Company's performance, prospects and risks. It is not
all-inclusive and is meant to be read in conjunction with the entirety of the
management discussion and analysis, the Company's financial statements and notes
thereto, and all other items contained within the report on this Annual Report
on Form 10-K.
Revenue and Income Generation
-----------------------------
The Company receives its revenue primarily from earned premium derived from the
insurance company operations, commission and fee income generated from the
insurance agency operations, finance charges and
16
fee income from the premium finance operations, and investment income from cash
generated primarily from the insurance company operation. The insurance company
operation generates approximately 89% of the Company's total revenue. The
Company's remaining operations constitute a variety of specialty insurance
services, each with unique characteristics and individually not material to
consolidated revenues.
Insurance Company Operation
---------------------------
The property and casualty insurance industry is highly competitive and includes
many insurers, ranging from large companies offering a wide variety of products
worldwide to smaller, specialized companies in a single state or region offering
only a single product. Many of the Company's existing or potential competitors
have considerably greater financial and other resources, have a higher rating
assigned by independent rating organizations such as A.M. Best Company, have
greater experience in the insurance industry and offer a broader line of
insurance products than the Company. Crusader is writing primarily Commercial
Multiple Peril business only in the state of California. Crusader's financial
strength rating has been upgraded by A.M. Best Company from B+ (Good) to B++
(Good), effective January 2, 2007, with a rating outlook of stable.
A primary challenge of the property and casualty insurance company operation is
contending with the fact that the Company sells its products before the ultimate
costs are actually known. That is, when pricing its products, the Company must
forecast the ultimate claim and loss adjustment costs. In addition, factors such
as changes in regulations and legal environment, among other things, can all
impact the accuracy of such cost forecasts.
The property and casualty insurance industry is characterized by periods of soft
market conditions, in which premium rates are stable or falling and insurance is
readily available, and by periods of hard market conditions, in which premium
rates rise, coverage may be more difficult to find and insurers' profits
increase. The Company believes that the California property and casualty
insurance market has transitioned to a "soft market" in the last few years The
Company cannot determine how long the existing market conditions will continue,
nor in which direction they might change. Despite the increased competition in
the property and casualty marketplace, the Company believes that rate adequacy
is more important than premium growth, and that underwriting profit (net earned
premium less losses and loss adjustment expenses and policy acquisition costs)
is its primary goal. For the year ended December 31, 2006, gross written premium
was $51,913,967, a decrease of $8,354,817 (14%) compared to 2005.
For the twelve months ended December 31, 2006, losses and loss adjustment
expenses for insured events of the current year were $29,997,662, offset by
$12,170,683 of favorable development for events of prior years. For the twelve
months ended December 31, 2005, losses and loss adjustment expenses for insured
events of the current year were $35,338,196, offset by $3,824,464 of favorable
development for events of prior years. The favorable developments resulted from
settling or re-estimating claims for lesser amounts than they were previously
forecast.
Other Operations
----------------
The Company's other operations generate commissions, fees, and finance charges
from various insurance products. The events that have the most significant
economic impact are as follows:
Unifax primarily sells and services insurance policies for Crusader. The
commissions paid by Crusader to Unifax are eliminated as intercompany
transactions and are not reflected as income in the financial statements. Policy
fee income for the twelve months ended December 31, 2006, decreased 12% as
compared to the prior year. The decrease in policy fee income is a result of a
decrease in the number of policies issued during the twelve months ended
December 31, 2006, as compared to 2005, offset in part by an approximate 8%
increase in the policy fee for policies effective on or after June 26, 2005.
AAQHC provides various consumer benefits to its members, including participation
in group health care and life insurance policies. For these services, AAQHC
receives membership and fee income from its members. Membership and fee income
decreased 6% in the year ended December 31, 2006, compared to 2005. The decrease
is a result of the decrease in the number of members. In May 2006, CIGNA
HealthCare began offering new small group medical insurance policies in the
state of California. Currently, all new CIGNA small group medical insurance
policies are written through AIB and all CIGNA small group medical insurance
policyholders are members of AAQHC. The new programs are competitively priced
and are being actively marketed.
17
AIB sells and services health insurance policies for individual/family and small
business groups and receives commissions based on the premiums that it writes.
Commissions remained relatively comparable in the year ended December 31, 2006,
compared to 2005.
AAC provides premium financing for Crusader policies that are produced by Unifax
in California. Finance charges and fees earned by AAC during 2006 decreased 10%
as compared to 2005. The decrease is primarily a result of a 17% decrease in the
number of loans issued in 2006 compared to 2005. Average premium financed
increased 8% to $2,758 in 2006 from $2,557 in 2005.
The daily automobile rental insurance program is produced by Bedford Insurance
Services, Inc. Bedford receives a commission from a non-affiliated insurance
company based on premium written. Commission in the daily automobile rental
insurance program decreased $135,714 (27%) as compared to 2005. The decrease is
due to the continued intense competition in the daily automobile rental
insurance program. Bedford continues to produce business only at rates that it
believes are adequate. Primarily due to declining sales, in April 2006 Bedford
hired a new general manager who has substantial experience in the daily
automobile rental insurance business. Future sales growth of the Bedford program
is also currently dependent upon the non-affiliated insurance company approving
and implementing various product enhancements that Bedford recommends. Bedford
is currently working with the non-affiliated insurance company to obtain their
approval of the recommended program enhancements.
Investments and Liquidity
-------------------------
The Company generates revenue from its investment portfolio, which consisted of
approximately $147.3 million (at amortized cost) at December 31, 2006, compared
to $140.6 million (at amortized cost) at December 31, 2005. Investment income
for the twelve months ended December 31, 2006, increased $1.7 million or 39% in
2006 compared to 2005. The increase was primarily due to both an increase in
invested assets of approximately $6.7 million (5%) and an increase in the
Company's annualized yield on average invested assets from 3.2% in 2005 to 4.2%
in 2006. The increase in the annualized yield on average invested assets is a
result of higher yields in the marketplace on both new and reinvested assets.
Due to the current interest rate environment, management believes it is prudent
to purchase fixed maturity investments with maturities of five years or less and
with minimal credit risk.
As of December 31, 2006, the weighted average maturity of the Company's fixed
maturity investments was 1.3 years compared to 1.2 years and 1.4 years as of
December 31, 2005, and December 31, 2004, respectively.
Liquidity and Capital Resources
-------------------------------
Due to the nature of the Company's business (insurance and insurance services)
and whereas Company growth does not normally require material reinvestments of
profits into property or equipment, the cash flow generated from operations
usually results in improved liquidity for the Company. Because the Company is a
holding company and operates through its subsidiaries, its cash flow is
dependent upon the earnings of its subsidiaries and the distributions of those
earnings to the Company.
The cash flow provided by operations in the year ended December 31, 2006, was
$6,297,894, a decrease in cash flow of $3,500,448 compared to the cash flow for
the year ending December 31, 2005. Cash flow provided by operations for the year
ended December 31, 2005, was $9,798,342, a decrease of $5,025,495 in cash
provided compared to the year ended December 31, 2004. The Company has utilized
the cash provided from operating activities and from the maturity of its fixed
maturity investments primarily to purchase $68.9 million of fixed maturity
securities in 2006.
The most significant liquidity risk faced by the Company is adverse development
of the insurance company's loss and loss adjustment expense reserves. Based on
the Company's current loss and loss expense reserves and expected current and
future payments, the Company believes that there are no current liquidity
issues. However, no assurance can be given that the Company's estimate of
ultimate loss and loss adjustment expense reserves will be sufficient.
Crusader generates a significant amount of cash as a result of its holdings of
unearned premium reserves, its reserves for loss payments, and its capital and
surplus. Crusader's loss and loss adjustment expense payments are the most
significant cash flow requirement of the Company. These payments are continually
monitored and projected to ensure that the Company has the liquidity to cover
these payments without the need to liquidate its
18
investments. Cash and investments (excluding net unrealized gains or losses) at
December 31, 2006, were $147,346,870 compared to $140,617,062 at December 31,
2005, a 5% increase. Crusader's cash and investments at December 31, 2006, was
$144,120,695 or 98% of the total held by the Company, compared to $137,990,174
or 98% of the total held by the Company at December 31, 2005.
The Company's investments are as follows:
December 31, 2006 December 31, 2005 December 31, 2004
----------------- ----------------- -----------------
Amount % Amount % Amount %
------ - ------ - ------ -
Fixed maturities (at amortized cost)
Certificates of deposit $400,000 - $500,000 - $500,000 -
U.S. treasury securities 127,553,801 91 107,290,653 79 77,765,616 60
U.S. government sponsored
enterprise securities - - 6,000,000 4 11,998,772 10
Industrial and miscellaneous (taxable) 12,523,393 9 21,403,239 16 37,754,927 29
State and municipal (tax exempt) 15,134 - 934,536 1 970,343 1
----------- --- ----------- --- ----------- ---
Total fixed maturity investments 140,492,328 100 136,128,428 100 128,989,658 100
----------- === ----------- === ----------- ===
Short-term cash investments (at cost)
Certificates of deposit 200,000 3 100,000 2 400,000 13
Cash deposit in lieu of bond* - - 200,000 5 752,659 24
Commercial paper 1,665,000 25 1,830,000 41 1,005,000 32
Bank money market accounts 210,270 3 182,673 4 803,949 26
U.S. gov't obligation money market fund 411,206 6 2,150,671 48 144,925 5
Short-term U.S. treasury bills 4,322,048 63 - - - -
Bank savings accounts 11,483 - 11,818 - 11,585 -
--------- --- --------- --- --------- ---
Total short-term cash investments 6,820,007 100 4,475,162 100 3,118,118 100
--------- === --------- === --------- ===
Total investments $147,312,335 $140,603,590 $132,107,776
============ =========== ===========
* Deposits with superior courts to stay execution of judgment pending appeal of Crusader claims.
In accordance with Statement of Financial Accounting Standard No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," the Company
is required to classify its investment securities into one of three categories:
held-to-maturity, available-for-sale, or trading securities. Although all of the
Company's investment in fixed maturity securities are classified as
available-for-sale and the Company may sell investment securities from time to
time in response to economic and market conditions, its investment guidelines
place primary emphasis on buying and holding high-quality investments to
maturity.
The Company's investment guidelines on equity securities limit investments in
equity securities to an aggregate maximum of $2,000,000. The Company's
investment guidelines on fixed maturities limit those investments to high-grade
obligations with a maximum term of eight years. The maximum investment
authorized in any one issuer is $2,000,000 and the maximum in any one U.S.
government agency or U.S. government sponsored enterprise is $3,000,000. This
dollar limitation excludes bond premiums paid in excess of par value and U.S.
government or U.S. government guaranteed issues. Investments in municipal
securities are primarily pre-refunded and secured by U.S. treasury securities.
The short-term investments are either U.S. government obligations, FDIC insured,
or are in an institution with a Moody's rating of P2 and/or a Standard & Poor's
rating of A1. All of the Company's fixed maturity securities are rated and
readily marketable and could be liquidated without any materially adverse
financial impact.
During 2005 the Company began its conversion to a "paperless office" including
improvements to its computer network, hardware, and other related computer
infrastructure. These projects were substantially completed in 2006. The Company
is now fine-tuning its paperless office systems and back scanning its previous
paper files and documents. As of December 31, 2006, the Company had incurred
approximately $760,000 of capital expenditures on the paperless office and the
related computer infrastructure projects. During 2006, the Company began
benefiting from these capital expenditures due to productivity improvements,
improved customer service, and lower operating costs. In addition, the Company
is in the process of enhancing its technology related to its underwriting
procedures and electronic communication systems to better accommodate its
customers' needs and to improve operating efficiencies.
19
Crusader's statutory capital and surplus as of December 31, 2006, was
$50,023,768, an increase of $13,437,327 (37%) from December 31, 2005. Crusader's
statutory capital and surplus as of December 31, 2005, was $36,586,441, an
increase of $7,150,098 (24%) from December 31, 2004.
No dividends were declared or paid by Crusader to Unico in 2006, 2005 or 2004.
Based on Crusader's statutory net income for the year ended December 31, 2005,
the maximum dividend that could be made by Crusader to Unico without prior
regulatory approval in 2007 is $13,396,732.
The Company has previously announced that its Board of Directors had authorized
the repurchase in the open market from time to time of up to an aggregate of
945,000 shares of the common stock of the Company (see Note 16 of "Notes to
Consolidated Financial Statements"). During the year ended December 31, 2006,
the Company did not repurchase any shares of the Company's common stock. As of
December 31, 2006, the Company has purchased and retired under the Board of
Directors' authorization an aggregate of 868,958 shares of its common stock at a
cost of $5,517,465.
Although material capital expenditures may also be funded through borrowings,
the Company believes that its cash and short-term investments at year end, net
of trust restriction of $933,053, statutory deposits of $700,000, and California
insurance company statutory dividend restrictions applicable to Crusader plus
the cash to be generated from operations, should be sufficient to meet its
operating requirements during the next twelve months without the necessity of
borrowing funds.
As a California insurance company, Crusader is obligated to pay a premium tax on
gross premiums written in all states that Crusader is admitted. Premium taxes
are deferred and amortized as the related premiums are earned. The premium tax
is in lieu of state franchise taxes and is not included in the provision for
state taxes.
The Company has certain obligations to make future payments under contracts and
credit-related financial instruments and commitments. At December 31, 2006,
certain long-term aggregate contractual obligations and credit-related
commitments are summarized as follows:
Within 1-3 3-5 After
Contractual Obligations Total 1 Year Years Years 5 years
----------------------- ----- ------ ----- ----- -------
Building lease $5,591,438 $1,056,731 $2,133,980 $2,133,980 $266,747
Loss and loss adjustment expense reserves* 93,596,117 35,007,595 36,371,998 12,755,566 9,460,958
---------- ---------- ---------- ---------- ---------
Total $99,187,555 $36,064,326 $38,505,978 $14,889,546 $9,727,705
========== ========== ========== ========== =========
* Unlike many other forms of contractual obligations, loss and loss adjustment
expense reserves do not have definitive due dates and the ultimate payment
dates are subject to a number of variables and uncertainties. As a result,
the total loss and loss adjustment expense reserve payments to be made by
period, as shown above, are estimates.
Results of Operations
---------------------
General
-------
The Company had net income of $11,794,241 for the year ended December 31, 2006,
compared to net income of $6,715,004 for the year ended December 31, 2005, and
net income of $5,681,500 for the year ended December 31, 2004. Total revenue for
the year ended December 31, 2006, was $54,717,381 compared to $61,182,522 for
the year ended December 31, 2005, and $61,903,310 for the year ended December
31, 2004.
For the year ended December 31, 2006, the Company had income before taxes of
$18,153,986 compared to income before taxes of $10,466,430 in the year ended
December 31, 2005, an increase in income before taxes of $7,687,556. The
increase in pre-tax income was primarily due to an increase of $7,404,321 in the
underwriting profit from Crusader.
For the year ended December 31, 2005, the Company had income before taxes of
$10,466,430 compared to income before taxes of $8,672,458 in the year ended
December 31, 2004, an increase in income before taxes of $1,793,972. The
increase in pre-tax income was primarily due to an increase of $3,114,856 in the
underwriting
20
profit (net earned premium less losses and loss adjustment expenses and policy
acquisition costs) from Crusader offset by $995,849 decrease in gross
commissions and fees income.
The effect of inflation on the net income of the Company during the years ended
December 31, 2006, 2005, and 2004 was not significant.
The Company derives revenue from various sources as discussed below.
Insurance Company Operation
---------------------------
Premium and loss information of Crusader are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Gross written premium $51,913,967 $60,268,784 $68,872,021
Net written premium (net of reinsurance ceded) $38,166,864 $46,030,707 $51,089,573
Earned premium before reinsurance ceded $56,692,213 $64,712,764 $67,890,808
Earned premium (net of reinsurance ceded) $42,933,789 $50,477,920 $50,106,568
Losses and loss adjustment expenses $17,826,979 $31,513,732 $34,450,738
Gross unpaid losses and loss adjustment expenses $93,596,117 $101,914,548 $87,469,000
Net unpaid losses and loss adjustment expenses $70,076,430 $76,235,467 $67,349,989
Crusader's primary line of business is commercial multiple peril policies. This
line of business represented approximately 97% of Crusader's total written
premium for the year ended December 31, 2006, 97% for the year ended December
31, 2005, and 98% for the year ended December 31, 2004.
As of December 31, 2006, Crusader was licensed as an admitted insurance company
in the states of Arizona, California, Montana, Nevada, Oregon, and Washington
and is approved as a non-admitted surplus lines writer in other states.
Premiums
--------
For the year ended December 31, 2006, gross written premium decreased by
$8,354,817 (14%) over 2005. For the year ended December 31, 2005, gross written
premium decreased by $8,603,237 (12%) over 2004. The decrease in written premium
in both 2006 and 2005 reflected heightened competition and management's
continued emphasis on rate adequacy and underwriting discipline. The Company
cannot determine how long the existing market condition will continue, nor in
which direction it might change.
The Company's future writings and growth are dependent on market conditions,
competition, and upon the Company's ability to introduce new marketing channels
and profitable products. The Company continues to believe that it can compete
effectively and profitably by offering better service and by focusing its
marketing efforts upon independent agents. Historically, most of Crusader's
marketing was aimed at independent insurance brokers, representatives of the
consumer. With the relatively recent advent of heightened competition and of
declining sales, in 2007 Crusader adopted a plan to supplement its marketing
efforts with independent agents, representatives of the Company. The Company
believes that those agents will be particularly effective and that their efforts
will not diminish the business historically produced by independent brokers.
Crusader expects to begin making those agency appointments during 2007.
The Company writes annual policies and, therefore, earns written premium daily
over the one-year policy term. Premium earned before reinsurance decreased
$8,020.551 (12%) in the year ended December 31, 2006, compared to the year ended
December 31, 2005, and decreased $3,178,044 (5%) in the year ended December 31,
2005, compared to the year ended December 31, 2004. The decrease in earned
premium before reinsurance in 2006 and 2005 is a direct result of the decrease
in written premium in 2006 and 2005, respectively.
Earned ceded premium for the 12 months ended December 31, 2006, decreased
$476,420 (3%) to $13,758,424 compared to $14,234,844 for the 12 months ended
December 31, 2005. Earned ceded premiums as a percentage of direct earned
premiums were 24% and 22% for 2006 and 2005, respectively. Earned ceded premium
for the 12 months ended December 31, 2005, decreased $3,594,396 (20%) to
$14,234,844 compared to $17,784,240 for the 12 months ended December 31, 2004.
Earned ceded premiums as a percentage of direct earned premiums were 22% and 26%
for 2005 and 2004, respectively.
21
In 2006 and 2005 Crusader retained a participation in its excess of loss
reinsurance treaties of 10% in its 1st layer ($700,000 in excess of $300,000),
10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its
property and casualty clash treaties. In 2004 Crusader retained a participation
in its excess of loss reinsurance treaties of 10% in its 1st layer ($750,000 in
excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000),
and 30% in its property and casualty clash treaties. In 2003 Crusader retained a
participation in its excess of loss reinsurance treaties of 5% in its 1st layer
($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of
$1,000,000), and 30% in its property and casualty clash treaties.
Crusader's 2006 1st layer primary excess of loss treaty provides for a
contingent commission equal to 20% of the net profit, if any, accruing to the
reinsurer. The first accounting period for the contingent commission covers the
period from January 1, 2006, through December 31, 2006. The 2005 1st layer
primary excess of loss treaties do not provide for a contingent commission.
Crusader's 2004 and 2003 1st layer primary excess of loss treaty provides for a
contingent commission to the Company equal to 45% of the net profit, if any,
accruing to the reinsurer. The first accounting period for the contingent
commission covers the period from January 1, 2003, through December 31, 2004.
The Company will calculate and report to the reinsurer its net profit, if any,
within 90 days after 36 months following the end of the first accounting period,
and within 90 days after the end of each 12 month period thereafter until all
losses subject to the agreement have been finally settled. Based on losses and
loss adjustment expenses ceded (including incurred but not reported losses) as
of December 31, 2006, no contingent commission has been accrued for each of the
periods discussed above.
Crusader's direct earned premium, earned ceded premium, and ceding com`mission
are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Direct earned premium $56,692,213 $64,712,764 $67,890,808
Earned ceded premium
Excluding provisionally rated ceded premium 13,825,061 14,281,810 17,843,805
Provisionally rated ceded premium (66,637) (46,966) (59,565)
---------- ---------- ----------
Total earned ceded premium 13,758,424 14,234,844 17,784,240
Ceding commission 4,376,474 4,647,748 6,031,987
--------- --------- ----------
Earned ceded premium, net of ceding commission $9,381,950 $9,587,096 $11,752,253
========= ========= ==========
Ratios to direct earned premium
Direct ceded premium 24% 22% 26%
Earned ceded premium, net of ceding commission 17% 15% 17%
Losses and Loss Adjustment Expenses
-----------------------------------
Losses and loss adjustment expenses and loss ratio are as follows:
Year Ended December 31
----------------------
2006 2005 2004
---- ---- ----
Net earned premium $42,933,789 $50,477,920 $50,106,568
Net losses and loss adjustment expenses
Provision for insured events of current year 29,997,662 35,338,196 35,286,172
(Decrease) in provision for events of prior years (12,170,683) (3,824,464) (835,434)
---------- ---------- ----------
Total net losses and loss adjustment expenses $17,826,979 $31,513,732 $34,450,738
========== ========== ==========
Loss ratio 41.5% 62.4% 68.8%
Expected losses and loss adjustment expenses are determined based on earned
premiums. The portion of the premium dollar expected to pay claims costs is
referred to as the expected loss and loss adjustment expense ratio. Accident
years 2004 through 2006 has substantially the same expected loss and loss
adjustment expense ratio. The Company's emerging loss and loss adjustment
expense ratios for each accident year are reviewed in detail at the end of each
quarter as part of the reserve diagnostics testing.
The combined ratio is the sum of (1) the net ratio of losses and loss adjustment
expenses incurred (including a provision for incurred-but-not-reported losses
"IBNR") to net premiums earned (loss ratio) and (2) the ratio of
22
policy acquisition costs to net premiums earned (expense ratio). The following
table shows the loss ratios, expense ratios, and combined ratios of Crusader as
derived from data prepared in accordance with GAAP.
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Loss ratio 41.5% 62.4% 68.8%
Expense ratio 21.5% 20.8% 20.6%
---- ---- ----
Combined ratio 63.0% 83.2% 89.4%
==== ==== ====
As indicated in the above table, the loss ratio for the year ended December 31,
2006, decreased to 41.5% from 62.4% in 2005 and 68.8% in 2004. The continuous
decrease in the loss ratio was primarily due to improvements in the provision
for prior years' incurred losses. Generally, if the combined ratio is below
100%, an insurance company has an underwriting profit; if it is above 100%, a
company has an underwriting loss.
The Company's net losses and loss adjustment expenses for the calendar year
ended December 31, 2006, were $17,826,979. This amount is comprised of accident
year 2006 net losses and loss adjustment expenses of $29,997,662 and favorable
development of prior accident years of $12,170,683. The Company's net losses and
loss adjustment expenses for the calendar year ended December 31, 2005, were
$31,513,732. This amount is comprised of accident year 2005 net losses and loss
adjustment expenses of $35,338,196 and favorable development of prior accident
years of $3,824,464. The Company's net losses and loss adjustment expenses for
the calendar year ended December 31, 2004, were $34,450,738. This amount is
comprised of accident year 2004 net losses and loss adjustment expenses of
$35,286,172 and favorable development of prior accident years of $835,434.
The favorable development by accident year is as follows:
Year Ended Year Ended Year Ended
December 31, 2006 December 31, 2005 December 31, 2004
----------------- ----------------- -----------------
Favorable
Favorable % of Favorable % of (Adverse) % of
Accident Year Development Total Development Total Development Total
------------- ----------- ----- ----------- ----- ----------- -----
Prior to 2001 $701,989 6% $474,872 12% $(197,143) (24%)
2001 754,141 6% 754,085 20% (147,614) (18%)
2002 819,572 7% 578,264 15% (544,484) (65%)
2003 1,744,350 14% 1,618,207 42% 1,724,675 207%
2004 7,524,447 62% 399,036 11% - -
2005 626,184 5% - - -
---------- --- --------- --- ------- ---
Total prior accident years $12,170,683 100% $3,824,464 100% $835,434 100%
========== === ========= === ======= ===
As reflected in the above table, the increase in the favorable development for
the year ended December 31, 2006 is primarily due to a substantial decrease in
the provision for losses and loss adjustment expenses for accident year 2004
during the calendar year 2006. This favorable development arose from the lower
than expected emergence of losses during 2006 relative to expectations used to
establish our loss reserves at the end of 2005 and 2004. The severity of late
reported property and casualty claims that emerged during 2006 was lower than
expected and case development on previously reported claims was better than
expected. During the fourth quarter of 2006 the Company determined that the
favorable development of accident year 2004, which developed during 2006, was
sufficient to warrant a reduction in the ultimate expected losses and loss
adjustment expenses for that accident year. During the first three quarters of
2006, the Company determined that the development during that period was not
sufficient to warrant reducing accident year 2004 reserves further than
previously recorded. Because the incidence of the CMP losses is subject to a
considerable element of fortuity, reserve estimates for this line are based on
an analysis of past loss experience on average over a period of years. As a
result, the favorable development recognized in 2006 had a minimal effect on our
determination of carried CMP loss reserves at December 31, 2006. The adjustment
of prior accident year reserves discussed above is not necessarily indicative of
the results that may be expected in future periods.
Any reduction in losses and loss adjustment expenses from redundancies in the
Company's December 31, 2006, reserves over actual future payments, and/or any
additional losses and loss adjustment expenses from actual
23
future payments that exceed the Company's reserves, will be recognized in the
consolidated statements of operations of future accounting periods. The
Company's current expected loss and loss adjustment expense ratio assumption
closely approximates the Company's historical average loss and loss adjustment
expense ratio. A difference between the Company's current expected loss and loss
adjustment expense ratio assumption and the actual loss and loss adjustment
expense ratio for a given accident year will ultimately result in a dollar
change (either higher or lower) that is a multiple of the earned premium for
that year. The actual loss and loss adjustment expense ratio has been within
five percentage points of the current expected loss and loss adjustment expense
ratio in four of the Company's twenty-two years. Since the Company's net earned
premium in 2006 was $42,933,789, a difference between the accident year 2006
actual and current expected loss and loss adjustment expense ratios of only five
percentage points will ultimately impact losses and loss adjustment expenses by
$2,146,689. The actual loss and loss adjustment expense ratio has been within
ten percentage points of the current expected loss and loss adjustment expense
ratio in nine of the Company's twenty-two years. A difference of ten percentage
points on accident year 2006 will ultimately impact losses and loss adjustment
expenses by $4,293,379. The actual loss and loss adjustment expense ratio has
been within twenty percentage points of the current expected loss and loss
adjustment expense ratio in fifteen of the Company's twenty-two years. A twenty
percentage point difference between the accident year 2006 actual and the
current expected loss and loss adjustment expense ratios will ultimately impact
losses and loss adjustment expenses by $8,586,758. In addition, accident years
2005 and prior are still developing. Future development on those years might
either offset or add to any future development that emerges on accident year
2006.
Reserves for Losses and Loss Adjustment Expenses
------------------------------------------------
The Company's liability for unpaid loss and loss adjustment expense (reserves)
consists of case reserves and reserves for incurred but not reported (IBNR)
claims. Case reserves are established by claims personnel based on a review of
the facts known at the time the claim is reported and are subsequently revised
as more information about a claim becomes known. IBNR is computed using various
actuarial methods and techniques and includes (1) reserves for losses and loss
adjustment expenses on claims that have occurred but for which claims have not
yet been reported to the Company, and (2) a provision for expected future
development on case reserves for information not currently known.
The Company's loss and loss adjustment expense reserves are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Direct reserves
Case reserves $21,796,117 $23,114,548 $19,699,000
IBNR reserves 71,800,000 78,800,000 67,770,000
---------- ----------- ----------
Total direct reserves $93,596,117 $101,914,548 $87,469,000
========== =========== ==========
Reserves net of reinsurance
Case reserves $18,776,430 $19,135,467 $17,879,989
IBNR reserves 51,300,000 57,100,000 49,470,000
---------- ---------- ----------
Total net reserves $70,076,430 $76,235,467 $67,349,989
========== ========== ==========
Reserves for losses and loss adjustment expenses before reinsurance for each of
Crusader's lines of business were as follows:
Year ended December 31
----------------------
Line of Business 2006 2005 2004
---------------- ------------------ ------------------- -----------------
CMP $90,604,178 96.8% $98,758,298 96.9% $83,677,560 95.7%
Other Liability 2,736,790 2.9% 2,967,804 2.9% 3,592,719 4.1%
Other 255,149 0.3% 188,446 0.2% 198,721 0.2%
---------- ----- ----------- ----- ---------- -----
Total $93,596,117 100.0% $101,914,548 100.0% $87,469,000 100.0%
========== ===== =========== ====== ========== =====
The Company`s consolidated financial statements include estimated reserves for
unpaid losses and related loss adjustment expenses of the insurance company
operation. The Company sets loss and loss adjustment expense reserves at each
balance sheet date at management's best estimate of the ultimate payments that
it anticipates will be made to settle all losses incurred and all related loss
adjustment expenses incurred as of that date, for both reported and unreported
claims.
24
Analysis of the roll forward of reserves for losses and loss adjustment expenses
--------------------------------------------------------------------------------
The following table provides an analysis of the roll forward of Crusader's
losses and loss adjustment expenses, including a reconciliation of the ending
balance sheet liability for the periods indicated:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Reserve for unpaid losses and loss adjustment expenses
at beginning of year - net of reinsurance $76,235,467 $67,349,989 $58,883,861
---------- ---------- ----------
Incurred losses and loss adjustment expenses
Provision for insured events of current year 29,997,662 35,338,196 35,286,172
Decrease in provision for events of prior years (12,170,683) (3,824,464) (835,434)
---------- ---------- ----------
Total losses and loss adjustment expenses 17,826,979 31,513,732 34,450,738
---------- ---------- ----------
Payments
Losses and loss adjustment expenses attributable to
insured events of the current year 6,728,798 8,001,808 7,438,331
Losses and loss adjustment expenses attributable to
insured events of prior years 17,257,218 14,626,446 18,546,279
---------- ---------- ----------
Total payments 23,986,016 22,628,254 25,984,610
---------- ---------- ----------
Reserve for unpaid losses and loss adjustment expenses
at end of year - net of reinsurance 70,076,430 76,235,467 67,349,989
Reinsurance recoverable on unpaid losses and loss
adjustment expenses at end of year 23,519,687 25,679,081 20,119,011
---------- ---------- ----------
Reserve for unpaid losses and loss adjustment expenses at
end of year per balance sheet, gross of reinsurance * $93,596,117 $101,914,548 $87,469,000
========== =========== ==========
* In accordance with Financial Accounting Standards Board Statement No. 113,
"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts," reinsurance recoverable on unpaid losses and loss adjustment
expenses are reported for GAAP as assets rather than netted against the
corresponding liability for such items on the balance sheet.
The Company's net loss and loss adjustment expense reserve was $70,076,430 as of
December 31, 2006. Since underwriting profit is a significant part of income, a
small percentage change in reserve estimates may result in a substantial effect
on future reported earnings. Such changes might result from a variety of
factors, including claims costs emerging in a different pattern than the average
historical development patterns. Considering the continuum of possible
development patterns, none of which is necessarily more or less likely than the
next, one must consider the varying probabilities that the development pattern
is off in varying degrees. If future development ultimately ends up being five
percent different than the Company's 2006 reserve, approximately $3.5 million
would be reflected in future periods as an increase or decrease in the provision
for events of prior years and would be recognized in the Company's consolidated
statement of operations in future periods. A variance of five percent of net
loss and loss adjustment expense reserves is not an unlikely scenario.
Similarly, a variance of ten percent of the Company's 2006 reserves would be
reflected in approximately $7.1 million in future periods as an increase or
decrease in the provision for events of prior years and would be recognized in
the Company's consolidated statements of operations in future periods. This is
also not an unlikely scenario. Differences of more than ten percent are also
possible, though not quite as likely as differences of ten percent or less.
Other Insurance Operations
--------------------------
Association Operation
---------------------
Membership and fee income from the association program of AAQHC is as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Membership and fee income $300,527 $318,349 $333,470
25
Membership and fee income for the year ended December 31, 2006, decreased
$17,822 (6%), compared to the year ended December 31, 2005. Membership and fee
income for the year ended December 31, 2004, decreased $15,121 (5%), compared to
the year ended December 31, 2004. In May 2006, CIGNA HealthCare began offering
new small group medical insurance policies in the state of California.
Currently, all new CIGNA small group medical insurance policies are written
through AIB and all CIGNA small group medical insurance policyholders are
members of AAQHC. The new programs are competitively priced and are being
actively marketed.
Health and Life Insurance Program
---------------------------------
Commission income from the health and life insurance sales is as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Commission income $1,634,438 $1,628,061 $2,156,924
AIB markets health and life insurance in California through non-affiliated
insurance companies for individuals and groups. For these services, AIB receives
commission based on the premiums that it writes. Commission income remained
relatively comparable in the year ended December 31, 2006, compared to 2005.
Commission income decreased $528,863 (25%) in the year ended December 31, 2005,
compared to 2004. The decrease in commission in 2005 was primarily due to the
discontinuance of CIGNA's individual and family health insurance program in the
state of California. Commissions from carriers other than CIGNA for the year
ended December 31, 2006, remained relatively comparable to 2005 and 2004.
Policy Fee Income
-----------------
Unifax sells and services insurance policies for Crusader. The policy fee
charged to the policyholder by Unifax is recognized as income in the
consolidated financial statements. Policy fee income of Unifax is as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Policy fee income $2,638,985 $3,001,966 $3,394,783
Policies issued 15,186 17,927 20,885
Policy fee income for the year ended December 31, 2006, decreased $362,981 (12%)
as compared to the year ended December 31, 2005. The 12% decrease in policy fee
income is primarily a result of a 2,741 (15%) decrease in the number of policies
issued during 2006 as compared to 2005, offset by the increase in policy fee
from $165 per policy to $178 per policy effective on and after August 2005.
Policy fee income for the year ended December 31, 2005, decreased $392,817 (12%)
as compared to the year ended December 31, 2004. The 12% decrease in policy fee
income is primarily a result of a 2,958 (14%) decrease in the number of policies
issued during 2005 as compared to 2004 offset, by the increase in policy fee
from $165 per policy to $178 per policy effective on and after August 2005.
Daily Automobile Rental Insurance Program
-----------------------------------------
The daily automobile rental insurance program is produced by Bedford. Bedford
receives a commission from a non-affiliated insurance company based on premium
written. Prior to December 31, 2003, Bedford also received a claim
administration fee from the non-affiliated insurance company.
Commission and fee income from the daily automobile rental insurance program are
as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Rental program commission $317,679 $411,189 $555,964
Contingent commission 53,638 29,877 9,488
------- ------- -------
Total commission 371,317 441,066 565,452
Claim administration fee 4,035 70,000 -
------- ------- -------
Total commission and fee income $375,352 $511,066 $565,452
======= ======= =======
26
The daily automobile rental insurance program commission and fee income
decreased $135,714 (27%) from $511,066 in 2005 to $375,352 in 2006. Commission
and fee income decreased $54,386 (10%) from $565,452 in 2004 to $511,066 in
2005. The daily automobile rental insurance program commission and fee income
excluding claim administration fee and contingent commission decreased $93,510
(23%) from $411,189 in 2005 to $317,679 in 2006. Commission and fee income
excluding claim administration fee and contingent commission decreased $144,775
(26%) from $555,964 in 2004 to $411,189 in 2005. Premium written in 2006
decreased 25% compared to premium written in 2005, and premium written in 2005
decreased 24% compared to premium written in 2004. The decrease in written
premium in 2006 and 2005 is primarily due to the continued intense price
competition in the daily automobile rental insurance program, which is causing
these reductions in the Company's written premium and related commission income.
The Company cannot determine how long the existing market conditions will
continue, nor in which direction they might change. To avoid underwriting losses
for the non-affiliated insurance Company that it represents, Bedford continues
to produce business only at rates that it believes to be adequate.
Primarily due to declining sales, in April 2006 Bedford hired a new general
manager who has substantial experience in the daily automobile rental insurance
business. Future sales growth of the Bedford program is also currently dependent
on the non-affiliated insurance company approving and implementing various
product enhancements that Bedford recommends. Bedford is currently working with
the non-affiliated insurance company to obtain their approval of the recommended
program enhancements.
The Company's subsidiary U.S. Risk Managers, Inc., (U.S. Risk) ceased providing
insurance claim administration services to the non-affiliated daily automobile
insurer as of December 31, 2003; and it is currently inactive. As of December
31, 2003, the non-affiliated insurer assumed the claim administration
responsibility for all outstanding and IBNR claims. During 2003, the Company
recognized $200,000 of claim administration fees that were unearned as of
December 31, 2002. Although U.S. Risk is inactive, the Company is still
responsible for all claim administration cost arising from losses covered by
premiums for which it received a claim administration fee. During 2004 and 2005,
the Company did not receive any claim administration fees and did not incur any
future internal claim administration costs. During 2005, the Company recognized
an additional amount of $70,000 of the $100,000 claim administration fees that
were unearned as of December 31, 2004. As of December 31, 2006, the
non-affiliated insurer had billed the Company for the final claim administration
costs due and the Company recognized the remaining balance in the amount of
$4,035 as a claim administration fee income.
Other Commission and Fee Income
-------------------------------
Other commission and fee income are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Earthquake program commission income $37,914 $48,519 $53,140
Miscellaneous commission and fee income 116 70 111
------ ------ ------
Total other commission and fee income $38,030 $48,589 $53,251
====== ====== ======
Unifax began producing commercial earthquake insurance policies in California
for non-affiliated insurance companies in 1999. Unifax receives a commission
from these insurance companies based on premium written. Commission income on
the earthquake program for the year ended December 31, 2006, decreased $10,605
(22%) compared to 2005. Commission income on the earthquake program for the year
ended December 31, 2005, decreased $4,621 (9%) compared to 2004.
The commissions paid by Crusader to Unifax are eliminated as intercompany
transactions and are not reflected in commission income or commission expense.
Premium Finance Program
-----------------------
Premium finance charges and late fees earned from financing policies are as
follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Premium finance charges and fees earned $678,740 $758,325 $933,529
New loans 3,596 4,200 5,156
27
AAC provides premium financing for Crusader policies produced by Unifax in
California. The growth of this program is dependent and directly related to the
growth of Crusader's written premium and AAC's ability to market its competitive
rates and service. Premium finance charges and fees earned decreased $79,585
(10%) in the year ended December 31, 2006, compared to 2005 due primarily to the
fact that there were 604 (14%) fewer loans financed in the current year. Premium
finance charges and fees earned decreased $175,204 (19%) in the year ended
December 31, 2005, compared to 2004 due primarily to the fact that there were
956 (19%) fewer loans financed in the current year. During 2006, 32% of all
Unifax policies were financed and 75% of those policies were financed by AAC.
During 2005, 32% of all Unifax policies were financed and 75% of those policies
were financed by AAC.
Investment Income and Net Realized Gains
----------------------------------------
Investment income and net realized gains are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Average Invested Assets
at amortized cost $143,957,963 $136,355,683 $125,331,342
Interest income
Insurance company operations $5,906,079 $4,248,399 $4,204,573
Other operations 100,955 68,828 38,250
--------- --------- ---------
Total investment income
and realized gains $6,007,034 $4,317,227 $4,242,823
========= ========= =========
Yield on Average Invested Assets 4.17% 3.17% 3.39%
In the year ended December 31, 2006, while the Company's average invested assets
(at amortized value) increased $7,602,280 (6%) compared to the year ended
December 31, 2005, investment income earned increased $1,689,807 (39%) compared
to the year ended December 31, 2005. The yield on average invested assets
increased to 4.17% in 2006 from 3.17% in 2005. The increase in the yield on
average invested assets is primarily the result of an increase in the average
return on new and reinvested assets in the Company's investment portfolio. Due
to the current interest rate environment, management believes it prudent to
purchase fixed maturity investments with relatively short maturity duration.
Thus, the weighted average maturity of the Company's fixed maturity investments
as of December 31, 2006 was 1.3 years compared to 1.2 years as of December 31,
2005. The Company's average invested assets increased in the year ending
December 31, 2006, primarily as a result of increased cash flows from
operations. The mix of taxable and tax-exempt securities in the portfolio
affects the investment income return percentage. Tax-exempt securities generally
carry a lower yield than taxable securities. These securities (at amortized
value) decreased to $15,134 (0% of total investments) at December 31, 2006,
compared to $934,536 (1% of total investments) at December 31, 2005.
In the year ended December 31, 2005, while the Company's average invested assets
(at amortized value) increased $11,024,341 (9%) compared to the year ended
December 31, 2004, investment income earned increased $74,404 (2%) compared to
the year ended December 31, 2004. The yield on average invested assets decreased
to 3.17% in 2005 from 3.39% in 2004. The decrease in the yield on average
invested assets is primarily the result of a decline in the average return on
new and reinvested assets in the Company's investment portfolio. Also
contributing to the decline in the yield on average invested assets is a shorter
weighted average maturity of new and reinvested assets. Due to the 2005 interest
rate environment, management believes it prudent to purchase fixed maturity
investments with shorter maturities, and therefore, the weighted average
maturity of the Company's fixed maturity investments has decreased to 1.2 years
as of December 31, 2005, from 1.4 years as of December 31, 2004. The Company's
average invested assets increased in the year ending December 31, 2005,
primarily as a result of increased cash flows from operations. The mix of
taxable and tax-exempt securities in the portfolio affects the investment income
return percentage. These securities (at amortized value) decreased to $934,536
(1% of total investments) at December 31, 2005, compared to $970,343 (1% of
total investments) at December 31, 2004.
The par value, amortized cost, estimated market value and weighted average yield
of fixed maturity investments at December 31, 2006, by contractual maturity are
as follows. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
penalties.
28
Weighted
Maturities by Calendar Year Par Value Amortized Cost Fair Value Average Yield
--------------------------- --------- -------------- ---------- -------------
December 31, 2007 $70,275,000 $70,219,895 $69,923,874 4.16%
December 31, 2008 49,360,000 49,348,028 49,294,401 4.85%
December 31, 2009 13,500,000 13,593,098 13,646,589 5.07%
December 31, 2010 100,000 100,000 100,000 4.11%
December 31, 2011 7,250,000 7,231,307 7,200,078 4.61%
----------- ----------- -----------
Total $140,485,000 $140,492,328 $140,164,942 4.52%
=========== =========== ===========
The following table sets forth the composition of the investment portfolio of
the Company at the dates indicated:
(Amounts in Thousands)
As of December 31
-----------------
2006 2005 2004
--------------------- -------------------- --------------------
Amortized Fair Amortized Fair Amortized Fair
Type of Security Cost Value Cost Value Cost Value
---------------- ---- ----- ---- ----- ---- -----
Certificates of deposit $400 $400 $500 $500 $500 $500
U.S. treasury securities 127,554 127,192 107,291 106,563 77,766 77,299
U.S. government sponsored enterprise securities - - 6,000 5,933 11,999 11,853
Industrial and miscellaneous taxable bonds 12,523 12,558 21,403 21,631 37,755 38,950
State and municipal tax-exempt bonds 15 15 934 922 970 958
------- ------- ------- ------- ------- -------
Total fixed maturity investments 140,492 140,165 136,128 135,549 128,990 129,560
Short-term cash investments 6,820 6,820 4,475 4,475 3,118 3,118
------- ------- ------- ------- ------- -------
Total investments $147,312 $146,985 $140,603 $140,024 $132,108 $132,678
======= ======= ======= ======= ======= =======
The following table summarizes, for all fixed maturities in an unrealized loss
position at December 31, 2006, the aggregate fair value and gross unrealized
loss by length of time those fixed maturities have been continuously in an
unrealized loss. No securities were sold at a loss during 2006, 2005, or 2004.
Amortized Gross
Cost Fair Value Unrealized Loss
---- ---------- ---------------
0-6 months $17,464,974 $17,406,777 $58,197
7-12 months 27,040,360 26,931,181 109,179
Over 12 months 57,120,330 56,813,213 307,117
----------- ---------- -------
Total $101,625,664 $101,151,171 $474,493
=========== =========== =======
At December 31, 2006, the fixed maturity investments with a gross unrealized
loss for continuous periods of 0 to 6 months consisted of U.S. treasury
securities. The fixed maturity investments with a gross unrealized loss position
for continuous periods of 7 to 12 months consisted both U.S. treasury securities
and investment grade industrial securities. The fixed maturity investments with
a gross unrealized loss position for a continuous period over 12 months
consisted of U.S. treasury securities, investment grade industrial securities
and pre-refunded municipal bonds. The unrealized loss is primarily due to rising
interest rates.
The Company monitors its investments closely. If an unrealized loss is
determined to be other than temporary, it is written off as a realized loss
through the Consolidated Statements of Operations. The Company's methodology of
assessing other-than-temporary impairments is based on security-specific
analysis as of the balance sheet date and considers various factors including
the length of time to maturity and the extent to which the fair value has been
less than the cost, the financial condition and the near term prospects of the
issuer, whether the debtor is current on its contractually obligated interest
and principal payments, and the Company's intent to hold the investment for a
period of time sufficient to allow the Company to recover its costs. The Company
has concluded that the gross unrealized losses of $474,493 at December 31, 2006,
were temporary in nature. However, facts and circumstances may change which
could result in a decline in market value considered to be other than temporary.
The Company sold one fixed maturity investment in the year ended December 31,
2006, with net
29
realized gain in the amount of $2,617. The Company did not sell any fixed
maturity investment in the year ended December 31, 2005.
Operating Expenses
------------------
POLICY ACQUISITION COSTS are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Policy acquisition costs $9,250,989 $10,512,688 $10,319,186
Ratio to net earned premium (GAAP ratio) 22% 21% 21%
Policy acquisition costs consist of commissions, premium taxes, inspection fees,
and certain other underwriting costs that are directly related to and vary with
the production of Crusader insurance policies. These costs include both Crusader
expenses and allocated expenses of other Unico subsidiaries. On certain
reinsurance treaties, Crusader receives a ceding commission from its reinsurer
that represents a reimbursement of the acquisition costs related to the premium
ceded. No ceding commission is received on facultative, catastrophe, or
provisionally rated ceded premium. Policy acquisition costs, net of ceding
commission, are deferred and amortized as the related premiums are earned. No
significant change in the ratio of policy acquisition cost to net earned premium
was noted for the years ended December 31, 2006, 2005 and 2004.
SALARIES AND EMPLOYEE BENEFITS are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Total salaries and employee benefits incurred $9,913,740 $9,401,757 $9,126,929
Less: charged to losses and loss adjustment expenses (1,320,508) (1,387,198) (1,335,778)
Less: capitalized to policy acquisition costs (2,731,683) (2,873,586) (2,921,985)
--------- --------- ---------
Net amount charged to operating expenses $5,861,549 $5,140,973 $4,869,166
========= ========= =========
Total salaries and employee benefits incurred for the year ended December 31,
2006, increased $511,983 (5%) compared to the year ended December 31, 2005.
Factors that affected the 5% increase were primarily general salary increases
and increases in employee benefits costs. Total salaries and employee benefits
incurred for the year ended December 31, 2005, increased $274,828 (3%) compared
to the year ended December 31, 2004. Factors that affected the 3% increase were
general salary increases and increases in employee benefits costs, offset by
reduction in the number of employees.
COMMISSIONS TO AGENTS/BROKERS are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Commission to agents/brokers $611,200 $674,674 $934,452
Commissions to agents/brokers (not including commissions on Crusader policies
that are reflected in policy acquisition costs) are generally related to gross
commission income from the health and life insurance program, the daily
automobile rental insurance program, and the earthquake program. Commissions to
agents and brokers decreased $63,474 (9%) for the year ended December 31, 2006,
as compared to the year ended December 31, 2005. Commissions to agents and
brokers decreased $259,778 (28%) for the year ended December 31, 2005, as
compared to the year ended December 31, 2004. The decreases in both years are
primarily the result of a decrease in premiums written and the related decrease
in the commission expense in the health and life insurance program and the daily
automobile rental insurance program.
OTHER OPERATING EXPENSES are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Other operating expenses $3,012,678 $2,874,025 $2,657,310
30
Other operating expenses generally do not change significantly with changes in
production. This is true for both increases and decreases in production. Other
operating expenses increased $138,653 (5%) for the year ended December 31, 2006,
compared to the year ended December 31, 2005. Operating expenses increased
$216,715 (8%) for the year ended December 31, 2005, compared to the year ended
December 31, 2004.
Income Taxes
------------
Income tax expense for the year ended December 31, 2006, was $6,359,745 compared
to an income tax expense of $3,751,426 for the year ended December 31, 2005. The
effective combined income tax rates for 2006 and 2005 were 35% and 36%,
respectively. The pre-tax income increased $7,687,556 for the year ended
December 31, 2006, compared to the year ended December 31, 2005, which resulted
in an increased income tax expense in 2006. The income tax expense for the year
ended December 31, 2005, was $3,751,426 compared to an income tax expense of
$2,990,958 for the year ended December 31, 2004. The effective combined income
tax rates for 2005 and 2004 were 36% and 34%, respectively.
In the year ended December 31, 2003, the Company recognized an income tax
expense of $287,000 resulting from an assessment for the years 1999 and 2000
from the California Franchise Tax Board. The assessment resulted from a court
ruling in Ceridian vs. Franchise Tax Board that held that the California statute
permitting the tax deductibility of dividends received from a wholly owned
insurance subsidiary was unconstitutional because it discriminated against
out-of-state holding companies and thus was in violation of the interstate
commerce clause of the United States Constitution. The ruling concluded that the
discriminatory sections of the statute are not severable and the entire statute
was invalid and unenforceable. California law provides that the proper remedy in
such circumstances is to disallow the deduction to those taxpayers that
benefited from the deduction. As a result of the court ruling, in February 2003,
the Franchise Tax Board (FTB) notified the Company that it would issue a Notice
of Proposed Assessment (NPA) for tax years 1999 and 2000 of approximately
$287,000 representing California state franchise taxes plus related interest of
approximately $80,000. In September 2004, California enacted legislation (AB
263) that addresses many aspects of the tax treatment of insurance company
owners, including holding companies such as Unico. The legislation provides for
an election, applicable if made to all tax years ending after December 1, 1997,
and before January 1, 2005, under which a dividend-received deduction of up to
80% of dividends paid by an insurer to a non-insurer parent is allowed. In 2004,
the Company made the election authorized by AB 263 and, therefore, has reversed
80% of the $287,000 income tax expense and 80% of the interest accrued thereon.
In addition, as a result of AB 263, the Company is obligated to establish a
state deferred tax liability which represents the Company's future state tax
liability for all undistributed earnings of Crusader since January 1, 1993, in
accordance with FASB 109.
Recently Issued Accounting Standards
------------------------------------
In June 2006, the Financial Accounting Standards Board (FASB) issued an
interpretation of FASB Statement No. 109, "Accounting for Uncertainty in Income
Taxes" (FIN 48). This interpretation clarifies the accounting for uncertainty in
income taxes recognized in an enterprise's financial statements in accordance
with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. This interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. This interpretation will be effective January 1,
2007. The Company is currently assessing the effect of implementing FIN 48, and
does not expect any material impact from the implementation of FIN 48.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measures" (SFAS
157). SFAS 157 provides guidance for using fair value to measure assets and
liabilities and applies whenever other standards require (or permit) assets or
liabilities to be measured at fair value but does not expand the use of fair
value in any new circumstances. SFAS 157 is effective for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal years. The
Company is currently reviewing the provisions of SFAS 157 to determine the
impact on our financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 ("SAB 108").
SAB 108 requires registrants to quantify misstatements by using both the
balance-sheet and income-statement approaches and to determine whether financial
statement restatement is necessary. SAB 108 is effective for annual financial
statements covering the first fiscal year ending after November 15, 2006. The
Company's adoption of SAB 108 did not have an effect on its results of
operations or financial positions.
31
In September 2006, the FASB issued Statement No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans - an Amendment of FASB
Statement No. 87, 88, 106 and 132(R)" ("SFAS 158"). SFAS 158 requires a business
entity that sponsors an employer defined benefit plan to measure plan assets and
obligations as of the date of the employer's fiscal year-end statement of
financial position and recognize funded status as a component of other
comprehensive income. SFAS 158 is effective for fiscal years ending after
December 15, 2006. There is no impact on the Company's consolidated financial
statements from adoption of this standard since the Company does not provide a
defined benefit plan to its employees.
In October 2005, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 05-1, "Accounting by Insurance
Enterprises for Deferred Acquisition Costs in Connection with Modifications or
Exchanges of Insurance Contracts" ("SOP 05-1"). SOP 05-1 provides accounting
guidance for deferred policy acquisition costs associated with internal
replacements of insurance and investment contracts other than those already
described in SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for
Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale
of Investments." SOP 05-1 defines an internal replacement as a modification in
product benefits, features, rights or coverages that occurs by the exchange of a
contract for a new contract, or by amendment, endorsement or rider to a
contract, or by the election of a feature or coverage within a contract. The
provisions of SOP 05-1 are effective for internal replacements occurring in
fiscal years beginning after December 15, 2006. The Company is currently
assessing the impact of SOP 05-1 on its results of operations and financial
position. The Company does not expect the impact of the adoption to have a
material effect on its results of operations or financial position.
There were no other accounting standards issued during 2006 that are expected to
have a material impact on the Company's consolidated financial statements.
Significant Accounting Policies
-------------------------------
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
certain assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. While every effort is made to
ensure the integrity of such estimates, actual results could differ.
Management believes the Company's current critical accounting policies comprise
the following:
Losses and Loss Adjustment Expenses
-----------------------------------
The preparation of the Company's financial statements requires judgments and
estimates. The most significant is the estimate of loss reserves as required by
Statement of Financial Accounting Standards No. 60 (SFAS No. 60), "Accounting
and Reporting by Insurance Enterprises" and Statement of Financial Accounting
Standards No. 5 (SFAS No. 5), "Accounting for Contingencies."
Management makes its best estimate of the liability for unpaid claims costs as
of the end of each fiscal quarter. Due to the inherent uncertainties in
estimating the Company's unpaid claims costs, actual loss and loss adjustment
expense payments should be expected to vary, perhaps significantly, from any
estimate made prior to the settling of all claims. Variability is inherent in
establishing loss and loss adjustment expense reserves, especially for a small
insurer like the Company. For any given line of insurance, accident year, or
other group of claims, there is a continuum of possible reserve estimates, each
having its own unique degree of propriety or reasonableness. Due to the
complexity and nature of the insurance claims process, there are potentially an
infinite number of reasonably likely scenarios. The Company does not
specifically identify reasonably likely scenarios other than utilizing
management's best estimate. In addition to applying the various standard methods
to the data, an extensive series of diagnostic tests of the resultant reserve
estimates are applied to determine management's best estimate of the unpaid
claims liability. Among the statistics reviewed for each accident year are loss
and loss adjustment expense development patterns, frequencies (expected claim
counts), severities (average cost per claim), loss and loss adjustment expense
ratios to premium, and loss adjustment expense ratios to loss. When there is
clear evidence that the actual claims costs emerged are different than expected
for any prior accident year, the claims cost estimates for that year are revised
accordingly.
Some lines of insurance are commonly referred to as "long-tail" lines because of
the extended time required before claims are ultimately settled. Lines of
insurance in which claims are settled relatively quickly are called "short-tail"
lines. It is generally more difficult to estimate loss reserves for long-tail
lines because of the long
32
period that elapses between the occurrence of a claim and its final disposition
and the difficulty of estimating the settlement value of the claim. The
Company's short-tail lines consist of its property coverages and its long-tail
lines consist of its liability coverages. However, compared to other long-tail
liability lines that are not underwritten by the Company, such as workers'
compensation, professional liability, umbrella liability, and medical
malpractice, the Company's liability claims tend to be settled relatively
quicker.
The Company underwrites four statutory annual statement lines of business: (1)
commercial multiple peril, (2) liability other than automobile and products, (3)
fire, and (4) allied lines. Commercial multiple peril policies comprised 97% of
the Company's 2006 and 2005 premium volume. Commercial multiple peril policies
include both property and liability coverages. For all of the Company's
coverages and lines of business, the Company's actuarial loss and loss
adjustment expense reserving methods require assumptions that can be grouped
into two key categories: (1) expected loss and loss adjustment expense, required
by the expected loss ratio and Bornhuetter-Ferguson methods, and (2) expected
development patterns, required by the loss development and Bornhuetter-Ferguson
methods.
The Company also segregates most of its business into smaller homogeneous
categories primarily for management's internal detailed business review and
analysis. These homogeneous categories used by the Company include various
combinations and special groupings of its lines of business, programs types,
states, and coverages. Some categories exclude certain items and/or others
include certain items. Not all categories are defined in the same way. This
analysis includes the tracking of historical claims costs and development
patterns separately for each of these uniquely designed categories. Generally,
neither the liability development patterns nor the property development patterns
vary significantly by category.
The accurate establishment of loss and loss adjustment expense reserves is a
difficult process, as there are many factors that can ultimately affect the
final settlement of a claim and, therefore, the reserve that is needed.
Estimates are based on a variety of industry data and on the Company's current
and historical accident year claims data, including but not limited to reported
claim counts, open claim counts, closed claim counts, closed claim counts with
payments, paid losses, paid loss adjustment expenses, case loss reserves, case
loss adjustment expense reserves, earned premiums and policy exposures, salvage
and subrogation, and unallocated loss adjustment expenses paid. Many other
factors, including changes in reinsurance, changes in pricing, changes in policy
forms and coverage, changes in underwriting and risk selection, legislative
changes, results of litigation and inflation are also taken into account.
At the end of each fiscal quarter, the Company's reserves are re-evaluated for
each accident year (i.e., for all claims incurred within each year) by a
committee consisting of the Company's executive vice president, the Company's
chief financial officer, and an independent consulting actuary. The Company uses
the loss ratio method to estimate ultimate claims costs on the current accident
year. The current accident year IBNR reserves are initially determined by
multiplying earned premiums for the year by the expected loss and loss
adjustment expense ratio, then subtracting the current accident year's
cumulative incurred (paid plus case reserves) to date. This method is subject to
adjustment based upon actual results incurred during the reporting period. This
initial IBNR reserve is adjusted as subsequent development of that accident year
takes place.
The Company also applies several additional standard actuarial methods to the
historical claims costs data to estimate its unpaid claims liability for each
accident year. The additional standard methods include loss development methods
and Bornhuetter-Ferguson methods, both of which can be applied to paid loss and
loss adjustment expense (claims costs), reported incurred (paid plus case
reserve) claims costs, and/or claim counts. These methodologies do not vary by
tail length; however, certain parameters do vary. In particular, loss
development factors for short-tail property claims are different than for
long-tail liability claims.
Development patterns generally do not tend to change materially over time.
Generally, the Company has very little property claim development subsequent to
the end of an accident year. Although liability claims may take 10 or more years
to fully develop, most of the development occurs in the first five to six years
subsequent to the end of the accident year. However, liability claims are
substantially developed by two years subsequent to the end of the accident year.
Other than the change in the expected loss and loss adjustment expense ratio
assumption discussed above, the Company's reserving methodology assumptions have
not changed in the years presented and the only significant effect on the
Company's financial statements has resulted from estimated costs being adjusted
as actual costs emerge.
33
The Company's actuarially based loss and loss adjustment expense reserve
methodology does not include an implicit or explicit provision for uncertainty.
Insurance claims costs are inherently uncertain. There is not a precise means of
quantifying a provision for uncertainty when determining an appropriate
liability for unpaid claims costs. Rather, the potential for claims costs being
less than estimated and the potential for claims costs being more than estimated
are considered when selecting the parameters to be used in the application of
the actuarial methods and when testing the estimates for reasonableness.
Management believes that its recorded loss and loss adjustment expense reserve
makes reasonable provision for its liability for unpaid claims costs.
The information that management uses to arrive at its best reserve estimate
comes from many sources within the Company, including its accounting, legal,
claims, and underwriting departments. Informed managerial judgment is applied
throughout the reserving process. In addition, time can be a critical part of
reserving determinations since the longer the span between the incidence of a
loss and the payment or settlement of the claim, the more variable the ultimate
settlement amount can be. Accordingly, short-tail claims, such as property
damage claims, tend to be more reasonably predictable than long-tail liability
claims. The liability for unpaid losses and loss adjustment expenses is based
upon the accumulation of individual case estimates for losses reported prior to
the close of the accounting period plus estimates based on experience and
industry data for development of case estimates and for unreported losses and
loss adjustment expenses. Since the emergence and disposition of claims are
subject to uncertainties, the net amounts that will ultimately be paid to settle
claims may vary significantly from the estimated amounts provided for in the
accompanying consolidated financial statements. Any adjustments to reserves are
reflected in the operating results of the periods in which they are made.
Management believes that the aggregate reserves for losses and loss adjustment
expenses are reasonable and adequate to cover the cost of claims, both reported
and unreported.
The Company must estimate its ultimate losses and loss adjustment expenses using
a very small claim population size. At the beginning of 2006, the Company had
771 open claim files. During 2006, 1,230 new claim files were opened and 1,284
claim files were closed, leaving 717 open claim files at the end of 2006. Due to
the small size of the Company and the related small population of claims, the
Company's losses and loss adjustment expenses for any accident year can vary
significantly from the initial expectations. Due to the small number of claims,
changes in claim frequency and/or severity can materially affect the Company's
reserve estimate. The potential variability from management's best estimate
cannot be measured from any meaningful statistical basis due to the numerous
uncertainties in the claims reserving process and the small population of
claims.
At each quarterly review, actual claims costs that emerge are compared with the
claims costs that were expected to emerge during that development period.
Sometimes the previous claims costs estimates prove to have been too high;
sometimes they prove to have been too low. In the case of the Company, the
estimates proved to be too high in each of the past three years. The favorable
development in 2004 through 2006 underscores the inherent uncertainty in
insurance claims costs, especially for a very small insurer.
Calendar Year Ended December 31
-------------------------------
2006 2005 2004
---- ---- ----
Net reserves for unpaid losses and loss adjustment expenses at beginning of year $76,235,467 $67,349,989 $58,883,861
Net (decrease) in provision for events of prior years $(12,170,683) $(3,824,464) $(835,424)
Percent of development to beginning reserves (16.0%) (5.7%) (1.4%)
The differences between actual and expected claims costs are typically not due
to one specific factor, but a combination of many factors such as the period of
time between the initial occurrence and the final settlement of the claim,
current and perceived social and economic inflation, and many other economic,
legal, political, and social factors. Because of these and other factors, actual
loss and loss adjustment expense payments should be expected to vary, perhaps
significantly, from any estimate made prior to the settling of all claims. Any
adjustments to reserves are reflected in the operating results of the periods in
which they are made. Management believes that the aggregate reserves for losses
and loss adjustment expenses are reasonable and adequate to cover the cost of
claims, both reported and unreported.
Reinsurance
-----------
The Company's receivable from reinsurers represents an estimate of the amount of
future loss and loss adjustment expense payments that will be recoverable from
the Company's reinsurers. These estimates are
34
based upon estimates of the ultimate losses and loss adjustment expenses that
the Company expects to incur and the portion of those losses that are expected
to be allocable to reinsurers based upon the terms of the reinsurance
agreements. Given the uncertainty of the ultimate amounts of losses and loss
adjustment expenses, the estimates may vary significantly from the eventual
outcome. The Company's estimate of the amounts receivable from reinsurers is
regularly reviewed and updated by management as new data becomes available. The
Company's assessment of the collectibility of the recorded amounts receivable
from reinsurers is based primarily upon public financial statements and rating
agency data. Any adjustments necessary are reflected in then current operations.
We evaluate each of our ceded reinsurance contracts at their inception to
determine if there is sufficient risk transfer to allow the contract to be
accounted for as reinsurance under current accounting literature. At December
31, 2006, all such ceded contracts are accounted for as risk transfer
reinsurance.
The following tables provide the effect of reinsurance on the Company's
financial statements:
The effect of ceded reinsurance on financial position is as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Ceded losses and loss adjustment expenses incurred on excess of loss treaties*
-----------------------------------------------------------------------------
Ceded paid losses and loss adjustment expenses $5,148,736 $6,828,051 $5,121,775
Change in ceded case loss reserves (959,394) 2,160,070 (1,336,218)
Change in ceded IBNR reserves (1,200,000) 3,400,000 2,200,000
--------- ---------- ---------
Total ceded losses incurred $2,989,342 $12,388,121 $5,985,557
========= ========== =========
Ceded loss and loss adjusting expense recoverable on excess of loss treaties
----------------------------------------------------------------------------
Ceded case loss and loss adjusting expense reserves recoverable $3,019,687 $3,979,081 $1,819,011
Ceded IBNR reserves recoverable 20,500,000 21,700,000 18,300,000
---------- ---------- ----------
Total ceded loss and loss adjusting expense reserves recoverable $23,519,687 $25,679,081 $20,119,011
========== ========== ==========
*There were no catastrophe losses incurred during the period covered by this table.
The effect of ceded reinsurance on results of operations is as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Direct earned premium $56,692,213 $64,712,764 $67,890,808
========== ========== ==========
Earned ceded premium
Excess of loss treaty premium 12,668,766 13,448,281 17,210,476
Catastrophe treaty premium 1,156,295 833,529 633,329
Other (66,637) (46,966) (59,565)
---------- ---------- ----------
Total earned ceded premium 13,758,424 14,234,844 17,784,240
Ceding commission 4,376,474 4,647,748 6,031,987
--------- --------- ----------
Earned ceded premium, net of ceding commission $9,381,950 $9,587,096 $11,752,253
========= ========= ==========
The effect of ceded reinsurance on cash flow is as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Changes in reinsurance recoverable from statements of cash flows $3,602,749 $(7,253,268) $(259,330)
The Company's reinsurance strategy is to reduce volatility in its expected loss
and loss adjustment expense results by protecting the Company against
liabilities in excess of certain retentions, including major or
35
catastrophic losses that may occur from any one or more of the property and/or
casualty risks which it insures. On an annual basis, or sooner if warranted, the
Company evaluates whether any changes to its retention, participation, or
retained limits are necessary. The most significant change to the Company's
reinsurance program during the three years ended December 31, 2006, was
increasing its catastrophic reinsurance in 2005 from $15 million to $35 million.
The Company currently only writes business in the state of California. The types
of businesses and the coverage limits written by the Company are not considered
difficult lines for obtaining reinsurance. In addition, because the major
catastrophe exposure is primarily from riots and fire following earthquakes, the
Company does not anticipate significant limitations on its ability to cede
future losses on a basis consistent with its historical results.
Investments
-----------
In accordance with Statement of Financial Accounting Standard No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," the Company
is required to classify its investments in debt and equity securities into one
of three categories: held-to-maturity, available-for-sale or trading securities.
The Company's fixed maturity investments are classified as available-for-sale
and are stated at market value. Although all of the Company's investments are
classified as available-for-sale and the Company may sell investment securities
from time to time in response to economic and market conditions, its investment
guidelines place primary emphasis on buying and holding high-quality investments
to maturity. Short-term investments are carried at cost, which approximates
market value. Investments in equity securities are carried at market value. The
unrealized gains or losses from fixed maturities and equity securities are
reported as "accumulated other comprehensive income (loss)," which is a separate
component of stockholders' equity, net of any deferred tax effect. When a
decline in value of a fixed maturity or equity security is considered other than
temporary, a loss is recognized in the consolidated statements of operations.
Realized gains and losses are included in the Consolidated Statements of
Operations based on the specific identification method.
Related Party Transactions
--------------------------
The Company presently occupies a 46,000 square foot office building located at
23251 Mulholland Drive, Woodland Hills, California, under a master lease
expiring March 31, 2012. Erwin Cheldin, the Company's president, chairman, and
principal stockholder, is the owner of the building. The Company signed an
extension to the lease with a 4% increase in rent effective April 1, 2007. The
lease provides for an annual gross rent of $1,025,952 through March 31, 2007 and
$1,066,990 from April 1, 2007 through March 31, 2012. In addition, the lease
extension provides for two five year options with a rent increase of 5% for each
option period. The Company believes that at the inception of the lease agreement
and at each subsequent extension, the terms of the lease were at least as
favorable to the Company as could have been obtained from non-affiliated third
parties. The Company utilizes for its own operations approximately 100% of the
space it leases.
Forward Looking Statements
--------------------------
Certain statements contained herein, including the sections entitled "Business,"
"Legal Proceedings" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations," that are not historical facts are forward
looking. These statements, which may be identified by forward looking words or
phrases such as "anticipate," "appears," "believe," "estimates," "expect,"
"intend," "may," "should," and "would," involve risks and uncertainties, many of
which are beyond the control of the Company. Such risks and uncertainties could
cause actual results to differ materially from these forward looking statements.
Factors which could cause actual results to differ materially include those
described under Item 1 - "Business - Competition" and Item 1A - "Risk Factors";
premium rate adequacy relating to competition or regulation; actual versus
estimated claim experience; the outcome of rate change filings with regulatory
authorities; acceptance by insureds of rate changes; adequacy of rate changes;
changes in Crusader's A.M. Best rating; regulatory changes or developments; the
outcome of regulatory proceedings; unforeseen calamities; general market
conditions; and the Company's ability to introduce new profitable products.
36
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
The Company's consolidated balance sheet includes a substantial amount of
invested assets whose fair values are subject to various market risk exposures
including interest rate risk and equity price risk.
The Company's invested assets at December 31, 2006 and 2005 consisted of the
following:
2006 2005
---- ----
Fixed maturity bonds (at amortized cost) $140,092,328 $135,628,428
Short-term cash investments (at cost) 6,820,007 4,475,162
Certificates of deposit - over 1 year (at cost) 400,000 500,000
----------- -----------
Total invested assets $147,312,335 $140,603,590
=========== ===========
The Company's interest rate risk is primarily in its fixed maturity bond
portfolio. As market interest rates decrease, the value of the portfolio
increases with the opposite holding true in rising interest rate environments.
In addition, the longer the maturity, the more sensitive the asset is to market
interest rate fluctuations. The Company limits this risk by investing in
securities with maturities no greater than eight years. In addition, although
fixed maturity bonds are classified as available-for-sale, the Company's
investment guidelines place primary emphasis on buying and holding high-quality
bonds to maturity. Because fixed maturity bonds are primarily held to maturity,
the change in the market value of these bonds resulting from interest rate
movements is unrealized and no gains or losses are recognized in the
consolidated statements of operations. Unrealized gains and losses are reported
as separate components of stockholders' equity, net of any deferred tax effect.
As of December 31, 2006, the Company's unrealized losses (net of unrealized
gains) before income taxes on its fixed maturity bond portfolio were $327,386
compared to unrealized losses (net of unrealized gains) before income taxes of
$579,128 as of December 31, 2005. Given a hypothetical parallel increase of 100
basis points in interest rates, the fair value of the fixed maturity bond
portfolio as of December 31, 2006, would decrease by approximately $1,694,000.
This decrease would not be reflected in the statements of operations except to
the extent that the securities were sold.
The Company's short-term investments and certificates of deposit have only
minimal interest rate risk.
37
ITEM 8. Financial Statements and Supplementary Data
-------------------------------------------
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
Page
Number
------
Report of Independent Registered Public Accounting Firm 39
Consolidated Balance Sheets as of December 31, 2006, and 2005 40
Consolidated Statements of Operations for the years ended
December 31, 2006, 2005, and 2004 41
Consolidated Statements of Comprehensive Income for the years
ended December 31, 2006, 2005, and 2004 42
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 2006, 2005, and 2004 43
Consolidated Statements of Cash Flows for the years ended
December 31, 2006, 2005, and 2004 44
Notes to Consolidated Financial Statements 45
38
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
The Board of Directors and Stockholders
Unico American Corporation:
We have audited the accompanying consolidated balance sheets of Unico American
Corporation and subsidiaries as of December 31, 2006 and 2005, and the related
consolidated statements of operations, comprehensive income, changes in
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2006. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Unico American
Corporation and subsidiaries as of December 31, 2006 and 2005, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles.
KPMG LLP
Los Angeles, California
March 23, 2007
39
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31 December 31
2006 2005
---- ----
ASSETS
------
Investments
Available for sale:
Fixed maturities, at fair value (amortized cost: December 31,
2006 $140,492,328; December 31, 2005 $136,128,428) $140,164,942 $135,549,300
Short-term investments, at cost 6,820,007 4,475,162
----------- -----------
Total Investments 146,984,949 140,024,462
Cash 34,535 13,472
Accrued investment income 1,762,586 1,207,278
Premiums and notes receivable, net 5,841,749 6,740,793
Reinsurance recoverable:
Paid losses and loss adjustment expenses 268,355 1,711,710
Unpaid losses and loss adjustment expenses 23,519,687 25,679,081
Deferred policy acquisition costs 6,430,265 7,356,179
Property and equipment (net of accumulated depreciation) 739,080 824,504
Deferred income taxes 1,473,024 1,769,286
Other assets 747,606 970,414
----------- -----------
Total Assets $187,801,836 $186,297,179
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
LIABILITIES
-----------
Unpaid losses and loss adjustment expenses $93,596,117 $101,914,548
Unearned premiums 26,434,187 30,619,047
Advance premium and premium deposits 1,802,243 1,460,790
Income taxes payable 1,605,385 -
Accrued expenses and other liabilities 3,492,882 3,908,421
----------- -----------
Total Liabilities $126,930,814 $137,902,806
----------- -----------
STOCKHOLDERS' EQUITY
--------------------
Common stock, no par - authorized 10,000,000 shares, issued and outstanding
shares 5,592,119 at December 31, 2006, and 5,496,315
at December 31, 2005 $3,236,745 $2,720,487
Accumulated other comprehensive (loss) (216,074) (382,224)
Retained earnings 57,850,351 46,056,110
---------- ----------
Total Stockholders' Equity $60,871,022 $48,394,373
---------- ----------
Total Liabilities and Stockholders' Equity $187,801,836 $186,297,179
=========== ===========
See accompanying notes to consolidated financial statements.
40
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
2006 2005 2004
---- ---- ----
REVENUES
--------
Insurance Company Revenues
Premium earned $56,692,213 $64,712,764 $67,890,808
Premium ceded 13,758,424 14,234,844 17,784,240
---------- ---------- ----------
Net premium earned 42,933,789 50,477,920 50,106,568
Investment income 5,903,462 4,248,399 4,204,573
Realized investment gains 2,617 - -
Other income 102,700 107,193 103,806
---------- ---------- ----------
Total Insurance Company Revenues 48,942,568 54,833,512 54,414,947
Other Revenues from Insurance Operations
Gross commissions and fees 4,987,332 5,508,031 6,503,880
Investment income 100,955 68,828 38,250
Finance charges and fees earned 678,740 758,325 933,529
Other income 7,786 13,826 12,704
---------- ---------- ----------
Total Revenues 54,717,381 61,182,522 61,903,310
---------- ---------- ----------
EXPENSES
--------
Losses and loss adjustment expenses 17,826,979 31,513,732 34,450,738
Policy acquisition costs 9,250,989 10,512,688 10,319,186
Salaries and employee benefits 5,861,549 5,140,973 4,869,166
Commissions to agents/brokers 611,200 674,674 934,452
Other operating expenses 3,012,678 2,874,025 2,657,310
---------- ---------- ----------
Total Expenses 36,563,395 50,716,092 53,230,852
---------- ---------- ----------
Income Before Taxes 18,153,986 10,466,430 8,672,458
Income Tax Expense 6,359,745 3,751,426 2,990,958
--------- --------- ---------
Net Income $11,794,241 $6,715,004 $5,681,500
========== ========= =========
PER SHARE DATA:
--------------
Basic
Earnings Per Share $2.12 $1.22 $1.03
Weighted Average Shares 5,567,883 5,495,948 5,490,346
Diluted Earnings Per Share
Earnings Per Share $2.09 $1.20 $1.02
Weighted Average Shares 5,652,901 5,612,426 5,581,295
See accompanying notes to consolidated financial statements.
41
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31,
2006 2005 2004
---- ---- ----
Net income $11,794,241 $6,715,004 $5,681,500
Other changes in comprehensive income, net of tax:
Unrealized gains (losses) on securities classified as
available-for-sale arising during the period 166,150 (758,396) (1,734,807)
---------- --------- ---------
Comprehensive Income $11,960,391 $5,956,608 $3,946,693
========== ========= =========
See accompanying notes to consolidated financial statements.
42
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
Accumulated
Common Shares Other
------------------------- Comprehensive
Issued and Income Retained
Outstanding Amount (Losses) Earnings Total
----------- ------ ------ -------- -----
Balance - December 31, 2003 5,489,815 $2,700,272 $2,110,979 $33,659,606 $38,470,857
Net shares issued for exercise of
stock options 2,500 7,775 - - 7,775
Change in comprehensive income,
net of deferred income tax - - (1,734,807) - (1,734,807)
Net income - - - 5,681,500 5,681,500
--------- --------- ------- ---------- ----------
Balance - December 31, 2004 5,492,315 $2,708,047 $376,172 $39,341,106 $42,425,325
Net shares issued for exercise of
stock options 4,000 12,440 - - 12,440
Change in comprehensive income,
net of deferred income tax - - (758,396) - (758,396)
Net income - - - 6,715,004 6,715,004
--------- --------- ------- ---------- ----------
Balance - December 31, 2005 5,496,315 $2,720,487 $(382,224) $46,056,110 $48,394,373
Net shares issued for exercise of
stock options 95,750 313,132 - - 313,132
Tax benefit from disqualified incentive
stock options - 203,126 203,126
Shares canceled or adjusted 54 - - - -
Change in comprehensive income,
net of deferred income tax - - 166,150 - 166,150
Net income - - - 11,794,241 11,794,241
--------- --------- ------- ---------- ----------
Balance - December 31, 2006 5,592,119 $3,236,745 $(216,074) $57,850,351 $60,871,022
========= ========= ======= ========== ==========
See accompanying notes to consolidated financial statements.
43
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
2006 2005 2004
---- ---- ----
Cash flows from operating activities:
Net income $11,794,241 $6,715,004 $5,681,500
Adjustments to reconcile net income to net cash from operations
Depreciation and amortization 238,834 160,571 95,084
Bond amortization, net (66,447) 109,840 251,318
Net realized gain on sale of fixed maturities (2,617) - -
Changes in assets and liabilities
Premium, notes and investment income receivable 343,736 869,767 723,457
Reinsurance recoverable 3,602,749 (7,253,268) (259,330)
Deferred policy acquisition costs 925,914 847,059 (148,875)
Other assets (53,261) (197,085) 156,375
Reserve for unpaid losses and loss adjustment expenses (8,318,431) 14,445,548 9,329,910
Unearned premium reserve (4,184,860) (5,037,346) 981,213
Advance premium and premium deposits 341,453 393,566 (51,394)
Accrued expenses and other liabilities (415,539) (1,316,362) (1,750,505)
Tax benefit from disqualified incentive stock options (203,126) - -
Income taxes current/deferred 2,295,248 61,048 (184,916)
--------- --------- ----------
Net Cash Provided from Operations 6,297,894 9,798,342 14,823,837
--------- --------- ----------
Cash flows from investing activities:
Purchase of fixed maturity investments (68,914,691) (59,444,701) (51,447,350)
Proceeds from maturity of fixed maturity investments 63,589,500 52,196,090 33,530,817
Proceeds from sale of fixed maturity investments 1,004,000 - -
Net (increase) decrease in short-term investments (2,318,488) (1,357,044) 4,112,347
Additions to property and equipment (153,410) (706,671) (50,398)
--------- --------- ----------
Net Cash (Used) by Investing Activities (6,793,089) (9,312,326) (13,854,584)
--------- --------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock 313,132 12,440 7,775
Tax benefit from disqualified incentive stock options 203,126 - -
Repayment of notes payable - related parties - (500,000) (1,000,000)
------- ------- ---------
Net Cash Provided (Used) by Financing Activities 516,258 (487,560) (992,225)
------- ------- -------
Net increase (decrease) in cash 21,063 (1,544) (22,972)
Cash at beginning of year 13,472 15,016 37,988
------ ------ ------
Cash at End of Year $34,535 $13,472 $15,016
====== ====== ======
Supplemental cash flow information Cash paid during the period for:
Interest - $6,330 $13,666
Income taxes $4,325,651 $3,740,922 $3,383,876
See accompanying notes to consolidated financial statements.
44
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Nature of Business
------------------
Unico American Corporation is an insurance holding company that underwrites
property and casualty insurance through its insurance company subsidiary;
provides property, casualty, health and life insurance through its agency
subsidiaries; and provides insurance premium financing and membership
association services through its other subsidiaries. Unico American Corporation
is referred to herein as the "Company" or "Unico" and such references include
both the corporation and its subsidiaries, all of which are wholly owned, unless
otherwise indicated. Unico was incorporated under the laws of Nevada in 1969.
Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of Unico American
Corporation and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Basis of Presentation
---------------------
The consolidated financial statements have been prepared in conformity with U.S.
generally accepted accounting principles (GAAP). As described in Note 13, the
Company's insurance subsidiary also files financial statements with regulatory
agencies prepared on a statutory basis of accounting that differs from GAAP.
Use of Estimates
----------------
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
certain assets, liabilities, and disclosure of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. While every effort is made to ensure
the integrity of such estimates, actual results may differ.
Reclassifications
-----------------
Certain reclassifications have been made to prior year balances to conform to
the current year presentation.
Investments
-----------
All of the Company's fixed maturity investments are classified as
available-for-sale and are stated at fair value. Although all of the Company's
investments are classified as available-for-sale and the Company may sell
investment securities from time to time in response to economic and market
conditions, its investment guidelines place primary emphasis on buying and
holding high-quality investments to maturity. Short-term investments are carried
at cost, which approximates fair value. The unrealized gains or losses from
fixed maturities are reported as "accumulated other comprehensive income
(loss)," which is a separate component of stockholders' equity, net of any
deferred tax effect. When a decline in value of a fixed maturity or equity
security is considered other than temporary, a loss is recognized in the
consolidated statements of operations. Realized gains and losses, if any, are
included in the Consolidated Statements of Operations based on the specific
identification method.
The Company had unrealized investment losses, net of deferred taxes, of $216,074
as of December 31, 2006, and unrealized investment losses, net of deferred
taxes, of $382,224 as of December 31, 2005.
Property and Equipment
----------------------
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using straight line methods over the estimated useful
lives of the related assets.
Income Taxes
------------
The provision for federal income taxes is computed on the basis of income as
reported for financial reporting purposes. Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes, and are measured using the enacted tax rates and laws expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. Income tax expense provisions increase or
decrease in the same period in which a change in tax rates is enacted.
45
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value of Financial Instruments
-----------------------------------
The Company has used the following methods and assumptions in estimating its
fair value disclosures:
o Investment Securities - Fair values for fixed maturity securities are
obtained from a national quotation service. The fair values for equity
securities are based on quoted market prices.
o Cash and Short-Term Investments - The carrying amounts reported in the
balance sheet for these instruments approximate their fair values.
o Premiums and Notes Receivable - The carrying amounts reported in the
balance sheet for these instruments approximate their fair values.
Earnings Per Share
------------------
Basic earnings per share exclude the impact of common share equivalents and are
based upon the weighted average common shares outstanding. Diluted earnings per
share utilize the average market price per share when applying the treasury
stock method in determining common share dilution. When dilutive, outstanding
stock options are treated as common share equivalents for purposes of computing
diluted earnings per share and represent the difference between basic and
diluted weighted average shares outstanding. In loss periods, options are
excluded from the calculation of diluted earnings per share, as the inclusion of
such options would have an anti-dilutive effect.
Revenue Recognition
--------------------
a. General Agency Operations
-----------------------------
Commissions and policy fees due the Company are recognized as income on the
effective date of the insurance policies.
b. Insurance Company Operations
--------------------------------
Premiums are earned on a pro-rata basis over the terms of the policies.
Premiums applicable to the unexpired terms of policies in force are
recorded as unearned premiums. The Company earns a commission on policies
that are ceded to its reinsurers. This commission is considered earned on a
pro-rata basis over the terms of the policies.
c. Insurance Premium Financing Operations
------------------------------------------
Premium finance interest is charged to policyholders who choose to finance
insurance premiums. Interest is charged at rates that vary with the amount
of premium financed. Premium finance interest is recognized using a method
that approximates the interest (actuarial) method.
Losses and Loss Adjustment Expenses
-----------------------------------
The liability for unpaid losses and loss adjustment expenses is based upon the
accumulation of individual case estimates for losses reported prior to the close
of the accounting period plus estimates based on experience and industry data
for development of case estimates and for unreported losses and loss adjustment
expenses.
There is a high level of uncertainty inherent in the evaluation of the required
loss and loss adjustment expense reserves for the Company. The long-tailed
nature of liability claims and the volatility of jury awards exacerbate that
uncertainty. The Company sets loss and loss adjustment expense reserves at each
balance sheet date at management's best estimate of the ultimate payments that
it anticipates will be made to settle all losses incurred and related expenses
incurred as of that date for both reported and unreported losses. The ultimate
cost of claims is dependent upon future events, the outcomes of which are
affected by many factors. Company claim reserving procedures and settlement
philosophy, current and perceived social and economic inflation, current and
future court rulings and jury attitudes, improvements in medical technology, and
many other economic, scientific, legal, political, and social factors all can
have significant effects on the ultimate costs of claims. Changes in Company
operations and management philosophy also may cause actual developments to vary
from the past. Since the emergence and disposition of claims are subject to
uncertainties, the net amounts that will ultimately be paid to settle claims may
vary significantly from the estimated amounts provided for in the accompanying
consolidated financial statements. Any adjustments to reserves are reflected in
the operating results of the periods in which they are made.
46
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Management believes that the aggregate reserves for losses and loss adjustment
expenses are reasonable and adequate to cover the cost of claims, both reported
and unreported.
Restricted Funds
----------------
Restricted funds are as follows:
Year ended December 31
----------------------
2006 2005
---- ----
Premium trust funds (1) $933,053 $265,668
Cash deposited in lieu of bond (2) - 200,000
Assigned to state agencies (3) 700,000 700,000
--------- ---------
Total restricted funds $1,633,053 $1,165,668
========= =========
(1) As required by law, the Company segregates from its operating
accounts the premiums collected from insurers which are payable to
insurance companies into separate trust accounts. These amounts are
included in cash and short-term investments.
(2) Included in short-term investments for the year ended December 31,
2005 is a deposit assigned and held by Travis County. The deposit was
filed with the superior courts in lieu of a bond in order to stay
execution of judgments and to allow the Company to appeal the
judgment in these matters.
(3) Included in fixed maturity investments are statutory deposits
assigned to and held by the California State Treasurer and the
Insurance Commissioner of the State of Nevada. These deposits are
required for writing certain lines of business in California and for
admission in states other than California.
Deferred Policy Acquisition Costs
---------------------------------
Policy acquisition costs consist of costs associated with the production of
insurance policies such as commissions, premium taxes, and certain other
underwriting expenses that vary with and are primarily related to the production
of the insurance policy. Policy acquisition costs are deferred and amortized as
the related premiums are earned and are limited to their estimated realizable
value based on the related unearned premiums plus investment income less
anticipated losses and loss adjustment expenses. Ceding commission applicable to
the unexpired terms of policies in force is recorded as unearned ceding
commission, which is included in deferred policy acquisition costs.
Reinsurance
-----------
The Company cedes reinsurance to provide for greater diversification of business
to allow management to control exposure to potential losses arising from large
risks by reinsuring certain levels of risk in various areas of exposure, to
reduce the loss that may arise from catastrophes, and to provide additional
capacity for growth. Prepaid reinsurance premiums and reinsurance receivables
are reported as assets and represent ceded unearned premiums and reinsurance
recoverable on both paid and unpaid losses, respectively. Amounts recoverable
from reinsurers are estimated in a manner consistent with the claim liability
associated with the reinsured policies.
Segment Reporting
-----------------
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" establishes standards for the way
information about operating segments is reported in financial statements. The
Company has identified its insurance company operation as its primary reporting
segment. Revenues from this segment comprised 89% of consolidated revenues for
the year ended December 31, 2006, 90% of consolidated revenues for the year
ended December 31, 2005, and 88% for the year ended December 31, 2004. The
Company's remaining operations constitute a variety of specialty insurance
services, each with unique characteristics and individually insignificant to
consolidated revenues.
47
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The insurance company operation is conducted through the Company's wholly owned
subsidiary Crusader Insurance Company (Crusader), which as of December 31, 2006,
was licensed as an admitted insurance carrier in the states of Arizona,
California, Montana, Nevada, Oregon, and Washington. Crusader is a multiple-line
property and casualty insurance company, which began transacting business on
January 1, 1985. As of December 31, 2006, 97% of Crusader's business was
commercial multiple peril insurance policies. Commercial multiple peril policies
provide a combination of property and liability coverage for businesses.
Commercial property coverages insure against loss or damage to buildings,
inventory and equipment from natural disasters, including hurricanes,
windstorms, hail, water, explosions, severe winter weather and other events such
as theft and vandalism, fires and storms and financial loss due to business
interruption resulting from covered property damage. Commercial liability
coverages insure against third party liability from accidents occurring on the
insured's premises or arising out of its operations, such as injuries sustained
from products sold or operation of the insured premises. In addition to
commercial multiple peril policies, Crusader also writes separate policies to
insure commercial property and commercial liability risks on a mono-line basis.
Revenues, income before income taxes and assets by segment are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Revenues
--------
Insurance company operation $48,942,568 $54,833,512 $54,414,947
---------- ---------- ----------
Other insurance operations 20,095,648 22,847,069 26,380,789
Intersegment elimination (1) (14,320,835) (16,498,059) (18,892,426)
---------- ---------- ----------
Total other insurance operations 5,774,813 6,349,010 7,488,363
--------- --------- ---------
Total revenues $54,717,381 $61,182,522 $61,903,310
========== ========== ==========
Income (loss) before income taxes
---------------------------------
Insurance company operation $19,589,474 $9,615,682 $5,333,273
Other insurance operations (1,435,488) 850,748 3,339,185
---------- ---------- ---------
Total income before income taxes $18,153,986 $10,466,430 $8,672,458
========== ========== =========
Assets
------
Insurance company operation $167,475,047 $166,911,366 $151,963,707
Intersegment eliminations (2) (1,711,026) (2,180,548) (2,285,589)
----------- ----------- -----------
Total insurance company operation 165,764,021 164,730,818 149,678,118
Other insurance operations 22,037,815 21,566,361 22,892,158
----------- ----------- -----------
Total assets $187,801,836 $186,297,179 $172,570,276
=========== =========== ===========
(1) Intersegment revenue eliminations reflect commissions paid by Crusader to Unifax.
(2) Intersegment asset eliminations reflect the elimination of Crusader receivables and Unifax payables.
Concentration of Risks
----------------------
In 2006 100% of Crusader's gross premium written was derived from California. In
2006 approximately 69% of the $1,136,306 commission and fee income from the
Company's health and life insurance program was from CIGNA HealthCare medical
and dental plan programs.
At December 31, 2006, the Company's reinsurance recoverable on paid and unpaid
losses and loss adjustment expenses of $23,788,042 were as follows:
48
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A.M. Best Amount
Name of Reinsurer Rating Recoverable
----------------- ------ -----------
Platinum Reinsurance A $12,899,390
Partners Reinsurance of the U.S. A+ 2,812,356
Hannover Ruckversicherungs AG A 6,670,345
General Reinsurance Corporation A++ 744,005
QBE Reinsurance Corporation A 661,946
----------
Total $23,788,042
==========
Stock-Based Compensation
------------------------
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"), using
the modified prospective transition method and therefore has not restated
results from prior periods. Under this transition method, share-based
compensation expense for 2006 includes compensation expense for all share-based
compensation awards granted prior to, but not yet vested as of January 1, 2006,
based on the grant-date fair value estimated in accordance with the original
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation." Share-based compensation expense for all
share-based payment awards granted or modified on or after January 1, 2006 is
based on the grant-date fair value estimated in accordance with the provisions
of SFAS No. 123R.
Prior to January 1, 2006, the Company applied the intrinsic-value based method
of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations
including FASB Interpretation No. 44, "Accounting for Certain Transactions
Involving Stock Compensation," an interpretation of APB Opinion No. 25, to
account for its fixed-plan stock options. Under this method, compensation
expense was recorded on the date of grant only if the current market price of
the underlying stock exceeded the exercise price. FASB Statement No. 123 (SFAS
123), "Accounting for Stock-Based Compensation," and FASB Statement No. 148,
"Accounting for Stock Based Compensation - Transition and Disclosure," an
amendment of SFAS 123, established accounting and disclosure requirements using
a fair-value based method of accounting for stock-based employee compensation
plans. As permitted by existing accounting standards, the Company elected to
continue to apply the intrinsic-value based method of accounting described above
and has adopted only the disclosure requirements of SFAS 123, as amended for
applicable periods prior to 2006. In December 2004, FASB Statement No. 123R
(SFAS 123R) which revised SFAS 123 was issued and was adopted by the Company in
2006 (see Note 14).
On December 30, 2005, the Company accelerated the vesting of all of its
outstanding stock-based compensation awards granted under the Company's 1999
Omnibus Stock Plan. All accelerated options were "in the money." The number of
shares covered by the options accelerated totaled 67,500 of which 37,500 were
originally scheduled to vest on January 1, 2006 and 30,000 were originally
scheduled to vest on January 1, 2007. The Company accelerated vesting of the
options in order to minimize the compensation costs associated with the adoption
of SFAS 123R. All accelerated options were granted to long-term management
employees who were not expected to leave the Company prior to the originally
scheduled vesting date. The estimated compensation cost which will be excluded
from future periods as a result of the acceleration of the vesting of the
options is approximately $89,100. There were no options granted during 2006 and
there were no unvested options as of January 1, 2006 on adoption of SFAS 123R,
as a result, there is no compensation expenses recorded for the year ended
December 31, 2006.
Had compensation cost for the Company's stock-based compensation plan been
reflected in the accompanying consolidated financial statements based on the
fair value at the grant dates for option awards consistent with the method of
SFAS 123, the Company's net income for the years ended December 31, 2005, and
December 31, 2004, would have been reduced to the pro forma amounts indicated in
the following table:
49
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year ended December 31
----------------------
2005 2004
---- ----
Net income
As reported $6,715,004 $5,681,500
Deduct:
Total stock-based employee compensation expense determined under fair value
based method for all awards, net of related tax effects - 43,604
Estimated stock-based employee compensation expense due to the acceleration of
future stock options net of related tax effects 89,100 -
--------- ---------
Pro forma $6,625,904 $5,637,896
========= =========
Income per share
As reported $1.22 $1.03
Pro forma $1.21 $1.03
Income per share - assuming dilution:
As reported $1.20 $1.02
Pro forma $1.18 $1.01
Calculations of the fair value under the method prescribed by SFAS No. 123 were
made using the Black-Scholes Option-Price Model with the following weighted
average assumptions used for the 1999 and 2002 grants:
2002 1999
---- ----
Dividend yield 1.40% 2.46%
Expected volatility 34% 43%
Expected lives 10 Years 10 Years
Risk-free interest rates 4.05% 6.09%
Fair value of options granted $1.32 $4.30
Reinsurance
-----------
The Company cedes reinsurance to provide for greater diversification of
business, to allow management to control exposure to potential losses arising
from large risks by reinsuring certain levels of risk in various areas of
exposure, to reduce the loss that may arise from catastrophes, and to provide
additional capacity for growth. Prepaid reinsurance premiums and reinsurance
receivables are reported as assets and represent ceded unearned premiums and
reinsurance recoverable on both paid and unpaid losses, respectively. Amounts
recoverable from reinsurers are estimated in a manner consistent with the claim
liability associated with the reinsured policies.
Recently Issued Accounting Standards
------------------------------------
In June 2006, the Financial Accounting Standards Board (FASB) issued
interpretation of FASB Statement No. 109, "Accounting for Uncertainty in Income
Taxes" (FIN 48). This interpretation clarifies the accounting for uncertainty in
income taxes recognized in an enterprise's financial statements in accordance
with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. This interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. This interpretation will be effective January 1,
2007. The Company is currently assessing the effect of implementing FIN 48, and
does not expect any material impact from the implementation of FIN 48.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measures" (SFAS
157). SFAS 157 provides guidance for using fair value to measure assets and
liabilities and applies whenever other standards require (or permit) assets or
liabilities to be measured at fair value but does not expand the use of fair
value in any new circumstances. SFAS 157 is effective for fiscal years beginning
after November 15, 2007, and interim periods
50
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
within those fiscal years. The Company is currently reviewing the provisions of
SFAS 157 to determine the impact on our financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 ("SAB 108").
SAB 108 requires registrants to quantify misstatements by using both the
balance-sheet and income-statement approaches and to determine whether financial
statement restatement is necessary. SAB 108 is effective for annual financial
statements covering the first fiscal year ending after November 15, 2006. The
Company's adoption of SAB 108 did not have an effect on its results of
operations or financial position.
In September 2006, the FASB issued Statement No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans - an Amendment of FASB
Statement No. 87, 88, 106 and 132(R)" ("SFAS 158"). SFAS 158 requires a business
entity that sponsors an employer defined benefit plan to measure plan assets and
obligations as of the date of the employer's fiscal year-end statement of
financial position and recognize funded status as a component of other
comprehensive income. SFAS 158 is effective for fiscal years ending after
December 15, 2006. There is no impact on the Company's consolidated financial
statements from adoption of this standard since the Company does not provide a
defined benefit plan to its employees.
In October 2005, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 05-1, "Accounting by Insurance
Enterprises for Deferred Acquisition Costs in Connection with Modifications or
Exchanges of Insurance Contracts" ("SOP 05-1"). SOP 05-1 provides accounting
guidance for deferred policy acquisition costs associated with internal
replacements of insurance and investment contracts other than those already
described in SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for
Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale
of Investments." SOP 05-1 defines an internal replacement as a modification in
product benefits, features, rights, or coverages that occurs by the exchange of
a contract for a new contract, or by amendment, endorsement or rider to a
contract, or by the election of a feature or coverage within a contract. The
provisions of SOP 05-1 are effective for internal replacements occurring in
fiscal years beginning after December 15, 2006. The Company is currently
assessing the impact of SOP 05-1 on its results of operations and financial
position. The Company does not expect the impact of the adoption to have a
material effect on its results of operations or financial position.
There were no other accounting standards issued during 2006 that are expected to
have a material impact on the Company's consolidated financial statements.
NOTE 2 - ADVANCE PREMIUM AND PREMIUM DEPOSITS
------------------------------------
The insurance company operation records a liability for advance premium that
represents the written premium on policies that have been submitted to the
Company and are bound, billed, and recorded prior to their effective date of
coverage. These advance premiums are not included in written premium or the
liability for unearned premium.
Some of the Company's health and life programs require payments of premium prior
to the effective date of coverage; and, accordingly, invoices are sent out as
early as two months prior to the coverage effective date. Insurance premiums
received for coverage months effective after the balance sheet date are recorded
as advance premiums. The Company received deposits to guarantee the payment of
premiums for past coverage months on its daily automobile rental program. These
deposits are required when information such as gross receipts or number of
rental cars is required to compute the actual premium due but is not available
until after the coverage month.
51
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - INVESTMENTS
--------------------
The amortized cost and estimated fair values of investments in fixed maturities
by categories are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
December 31, 2006
-----------------
Available for sale:
Fixed maturities
----------------
Certificates of deposit $400,000 - - $400,000
U.S. treasury securities 127,553,801 $65,513 $427,668 127,191,646
State and municipal tax-exempt bonds 15,134 - 104 15,030
Industrial and miscellaneous taxable bonds 12,523,393 81,594 46,721 12,558,266
----------- ------- ------- -----------
Total fixed maturities $140,492,328 $147,107 $474,493 $140,164,942
=========== ======= ======= ===========
December 31, 2005
-----------------
Available for sale:
Fixed maturities
----------------
Certificates of deposit $500,000 - - $500,000
U.S. treasury securities 107,290,653 - $727,741 106,562,912
U.S. government sponsored enterprise securities 6,000,000 - 66,570 5,933,430
State and municipal tax-exempt bonds 934,536 - 12,551 921,985
Industrial and miscellaneous taxable bonds 21,403,239 $262,912 35,178 21,630,973
----------- ------- ------- -----------
Total fixed maturities $136,128,428 $262,912 $842,040 $135,549,300
=========== ======= ======= ===========
A summary of the unrealized appreciation (depreciation) on investments carried
at fair value and the applicable deferred federal income taxes are shown below:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Gross unrealized appreciation of fixed maturities: $147,107 $262,912 $1,242,024
Gross unrealized (depreciation) of fixed maturities: (474,493) (842,040) (672,067)
------- ------- -------
Net unrealized appreciation (depreciation) on investments (327,386) (579,128) 569,957
Deferred federal tax income (expense) 111,312 196,904 (193,785)
------- ------- -------
Net unrealized appreciation (depreciation), net of deferred income taxes $(216,074) $(382,224) $376,172
======= ======= =======
The amortized cost and estimated fair value of fixed maturity investments at
December 31, 2006, by contractual maturity are as follows. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without penalties.
Amortized Estimated
Cost Fair Value
---- ----------
Due in one year or less $70,219,895 $69,923,874
Due after one year through five years 70,272,433 70,241,068
Due after five years through ten years - -
----------- -----------
Total fixed maturities $140,492,328 $140,164,942
=========== ===========
The following table illustrates the gross unrealized losses included in the
Company's investment portfolio and the fair value of those securities,
aggregated by investment category. The table also illustrates the length of time
that they have been in a continuous unrealized loss position as of December 31,
2006 and December 31, 2005.
52
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year Ended Amortized Gross
December 31 Cost Fair Value Unrealized Loss
----------- ---- ---------- ---------------
2006
----
0-6 months $17,464,974 $17,406,777 $58,197
7-12 months 27,040,360 26,931,181 109,179
Over 12 months 57,120,330 56,813,213 307,117
----------- ----------- -------
Total $101,625,664 $101,151,171 $474,493
=========== =========== =======
2005
----
0-6 months $46,834,903 $46,585,392 $249,511
7-12 months 14,327,095 14,166,247 160,848
Over 12 months 50,421,376 49,989,695 431,681
---------- ----------- -------
Total $111,583,374 $110,741,334 $842,040
=========== =========== =======
At December 31, 2006, the fixed maturity investments with a gross unrealized
loss for continuous periods of 0 to 6 months consisted of U.S. treasury
securities. The fixed maturity investments with a gross unrealized loss position
for continuous periods of 7 to 12 months consisted both U.S. treasury securities
and investment grade industrial securities. The fixed maturity investments with
a gross unrealized loss position for a continuous period over 12 months
consisted of U.S. treasury securities, investment grade industrial securities,
and pre-refunded municipal bonds. The unrealized loss is primarily due to rising
interest rates.
At December 31, 2005, the fixed maturity investments with a gross unrealized
loss for continuous periods of 0 to 6 months and 7 to 12 months both consisted
of U.S. treasury securities and investment grade industrial securities. The
fixed maturity investments with a gross unrealized loss position for a
continuous period over 12 months consisted of U.S. treasury securities,
U.S. government sponsored enterprise securities, and pre-refunded municipal
bonds. The unrealized loss is primarily due to rising interest rates.
The Company monitors its investments closely. If an unrealized loss is
determined to be other than temporary, it is written off as a realized loss
through the Consolidated Statements of Operations. The Company's methodology of
assessing other-than-temporary impairments is based on security-specific
analysis as of the balance sheet date and considers various factors including
the length of time to maturity and the extent to which the fair value has been
less than the cost, the financial condition and the near term prospects of the
issuer, whether the debtor is current on its contractually obligated interest
and principal payments, and the Company's intent to hold the investment for a
period of time sufficient to allow the Company to recover its costs. The Company
has concluded that the gross unrealized losses of $474,493 at December 31, 2006,
were temporary in nature. However, facts and circumstances may change which
could result in a decline in fair value considered to be other than temporary.
The Company sold one fixed maturity investment in the year ended December 31,
2006, with net realized gain in the amount of $2,617. The Company did not sell
any fixed maturity investment in the year ended December 31, 2005.
Short-term investments have an initial maturity of one year or less and consist
of the following:
Year ended December 31
----------------------
2006 2005
---- ----
Short-term U.S. treasury bill $4,322,048 -
Certificates of deposit 200,000 $100,000
Cash deposited in lieu of bond* - 200,000
Commercial paper 1,665,000 1,830,000
Bank money market accounts 210,270 182,673
U.S. government obligation money market fund 411,206 2,150,671
Bank savings accounts 11,483 11,818
--------- ---------
Total short-term investments $6,820,007 $4,475,162
========= =========
*Deposit with superior court to stay execution of judgment pending appeal of
Crusader claim.
53
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company manages its own investment portfolio. A summary of net investment
and related income is as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Fixed maturities $5,824,510 $4,218,302 $4,200,190
Realized gains on fixed maturities 2,617 - -
Short-term investments 179,907 98,925 42,633
--------- --------- ---------
Total investment income $6,007,034 $4,317,227 $4,242,823
========= ========= =========
NOTE 4 - PROPERTY AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION)
--------------------------------------------------------
Property and equipment consist of the following:
Year ended December 31
----------------------
2006 2005
---- ----
Furniture, fixtures, computer, office, and transportation equipment $2,350,451 $2,197,041
Accumulated depreciation 1,611,371 1,372,537
--------- ---------
Net property and equipment $739,080 $824,504
======= =======
NOTE 5 - PREMIUMS, COMMISSIONS AND NOTES RECEIVABLE, NET
-----------------------------------------------
Premiums, commissions and notes receivable, net are as follows:
Year ended December 31
----------------------
2006 2005
---- ----
Premiums and commission receivable $2,177,694 $2,690,402
Premium finance notes receivable 3,669,606 4,057,137
--------- ---------
Total premiums and notes receivable 5,847,300 6,747,539
Less allowance for doubtful accounts 5,551 6,746
--------- ---------
Net premiums and notes receivable $5,841,749 $6,740,793
========= =========
Premiums and notes receivable are substantially secured by unearned premiums and
funds held as security for performance.
Bad debt expense for the year ended December 31, 2006, and the year ended
December 31, 2005, were $10,023 and $8,927, respectively. Premium finance notes
receivable represent the balance due to the Company's premium finance subsidiary
from policyholders who elect to finance their premiums over the policy term.
These notes are net of unearned finance charges.
NOTE 6 - UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
------------------------------------------
The Company's loss and loss adjustment expense reserves are as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Direct reserves
Case reserves $21,796,117 $23,114,548 $19,699,000
IBNR reserves 71,800,000 78,800,000 67,770,000
---------- ---------- ----------
Total direct reserves $93,596,117 $101,914,548 $87,469,000
========== =========== ==========
Reserves net of reinsurance
Case reserves $18,776,430 $19,135,467 $17,879,989
IBNR reserves 51,300,000 57,100,000 49,470,000
---------- ---------- ----------
Total net reserves $70,076,430 $76,235,467 $67,349,989
========== ========== ==========
54
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reserves for losses and loss adjustment expenses before reinsurance for each of
Crusader's lines of business were as follows:
Year ended December 31
----------------------
Line of Business 2006 2005 2004
---------------- ------------------ ------------------ ------------------
CMP $90,604,178 96.8% $98,758,298 96.9% $83,677,560 95.7%
Other Liability 2,736,790 2.9% 2,967,804 2.9% 3,592,719 4.1%
Other 255,149 0.3% 188,446 0.2% 198,721 0.2%
---------- ----- ----------- ----- ---------- -----
Total $93,596,117 100.0% $101,914,548 100.0% $87,469,000 100.0%
========== ===== =========== ===== ========== =====
The Company`s consolidated financial statements include estimated reserves for
unpaid losses and related loss adjustment expenses of the insurance company
operation. The Company sets loss and loss adjustment expense reserves at each
balance sheet date at management's best estimate of the ultimate payments that
it anticipates will be made to settle all losses incurred and all related loss
adjustment expenses incurred as of that date, for both reported and unreported
claims.
The following table provides an analysis of the roll-forward of Crusader's
losses and loss adjustment expenses, including a reconciliation of the ending
balance sheet liability for the periods indicated:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Reserve for unpaid losses and loss adjustment expenses
at beginning of year - net of reinsurance $76,235,467 $67,349,989 $58,883,861
---------- ---------- ----------
Incurred losses and loss adjustment expenses
Provision for insured events of current year 29,997,662 35,338,196 35,286,172
Decrease in provision for events of prior years (12,170,683) (3,824,464) (835,434)
---------- ---------- ----------
Total losses and loss adjustment expenses 17,826,979 31,513,732 34,450,738
---------- ---------- ----------
Payments
Losses and loss adjustment expenses attributable to
insured events of the current year 6,728,798 8,001,808 7,438,331
Losses and loss adjustment expenses attributable to
insured events of prior years 17,257,218 14,626,446 18,546,279
---------- ---------- ----------
Total payments 23,986,016 22,628,254 25,984,610
---------- ---------- ----------
Reserve for unpaid losses and loss adjustment expenses
at end of year - net of reinsurance 70,076,430 76,235,467 67,349,989
Reinsurance recoverable on unpaid losses and loss
adjustment expenses at end of year 23,519,687 25,679,081 20,119,011
---------- ---------- ----------
Reserve for unpaid losses and loss adjustment expenses at
end of year per balance sheet, gross of reinsurance * $93,596,117 $101,914,548 $87,469,000
========== =========== ==========
* In accordance with Financial Accounting Standards Board Statement No. 113,
"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts," reinsurance recoverable on unpaid losses and loss adjustment
expenses are reported for GAAP as assets rather than netted against the
corresponding liability for such items on the balance sheet.
The Company's net losses and loss adjustment expenses for the calendar year
ended December 31, 2006, were $17,826,979. This amount is comprised of accident
year 2006 net losses and loss adjustment expenses of $29,997,662 and favorable
development of prior accident years of $12,170,683. The Company's net losses and
loss adjustment expenses for the calendar year ended December 31, 2005, were
$31,513,732. This amount is comprised of accident year 2005 net losses and loss
adjustment expenses of $35,338,196 and favorable development of prior accident
years of $3,824,464. The Company's net losses and loss adjustment expenses for
the calendar year ended December 31, 2004, were $34,450,738. This amount is
comprised of accident year
55
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2004 net losses and loss adjustment expenses of $35,286,172 and favorable
development of prior accident years of $835,434.
NOTE 7 - DEFERRED POLICY ACQUISITION COSTS
---------------------------------
The following table provides an analysis of the roll forward of Crusader's
deferred policy acquisition costs:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Deferred policy acquisition costs at beginning of year $7,356,179 $8,203,238 $8,054,363
Policy acquisition costs incurred during year 8,325,075 9,665,629 10,468,061
Policy acquisition costs amortized during year (9,250,989) (10,512,688) (10,319,186)
--------- --------- ----------
Deferred policy acquisition costs at end of year $6,430,265 $7,356,179 $8,203,238
========= ========= =========
Deferred policy acquisition costs consist of commissions (net of ceding
commission), premium taxes, inspection fees, and certain other underwriting
costs, which are related to and vary with the production of Crusader policies.
Policy acquisition costs are deferred and amortized as the related premiums are
earned. Deferred acquisition costs are reviewed to determine if they are
recoverable from future income, including investment income.
NOTE 8 - LEASE COMMITMENT TO RELATED PARTY
---------------------------------
The lease commitment provides for the following minimum annual rental
commitments:
Year ending
-----------
December 31, 2007 1,056,731
December 31, 2008 1,066,990
December 31, 2009 1,066,990
December 31, 2010 1,066,990
December 31, 2011 1,066,990
December 31, 2012 (through March 31, 2012) 266,747
---------
Total minimum payments $5,591,438
=========
The Company presently occupies a 46,000 square foot office building located at
23251 Mulholland Drive, Woodland Hills, California, under a master lease
expiring March 31, 2012. Erwin Cheldin, the Company's president, chairman, and
principal stockholder, is the owner of the building. The Company signed an
extension to the lease with a 4% increase in rent effective April 1, 2007. The
lease provides for an annual gross rent of $1,025,952 through March 31, 2007 and
$1,066,990 from April 1, 2007 through March 31, 2012. In addition, the lease
extension provides for two, five-year options with a rent increase of 5% for
each option period. The Company believes that at the inception of the lease
agreement and at each subsequent extension, the terms of the lease were at least
as favorable to the Company as could have been obtained from non-affiliated
third parties. The Company utilizes for its own operations approximately 100% of
the space it leases. The total rent expense under this lease agreement was
$1,025,952 for the year ended December 31, 2006; $1,025,952 for the year ended
December 31, 2005; and $1,025,952 for the year ended December 31, 2004.
NOTE 9 - ACCRUED EXPENSES AND OTHER LIABILITIES
--------------------------------------
Accrued expenses and other liabilities consist of the following:
56
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year ended December 31
----------------------
2006 2005
---- ----
Premium payable $2,221,559 $2,494,285
Unearned claim administration income - 30,000
Profit sharing contributions 650,000 645,000
Accrued salaries 345,560 333,354
Commission payable 214,766 210,451
Other 60,997 195,331
--------- ---------
Total accrued expenses and other liabilities $3,492,882 $3,908,421
========= =========
NOTE 10 - COMMITMENT AND CONTINGENCIES
----------------------------
The Company, by virtue of the nature of the business conducted by it, becomes
involved in numerous legal proceedings as either plaintiff or defendant. The
Company is also required to resort to legal proceedings from time to time in
order to enforce collection of premiums, commissions, or fees for the services
rendered to customers or to their agents. These routine items of litigation do
not materially affect the Company and are handled on a routine basis by the
Company through its general counsel.
Likewise, the Company is sometimes named as a cross-defendant in litigation,
which is principally directed against an insurer who was issued a policy of
insurance directly or indirectly through the Company. Incidental actions are
sometimes brought by customers or others, which relate to disputes concerning
the issuance or non-issuance of individual policies. These items are also
handled on a routine basis by the Company's general counsel, and they do not
materially affect the operations of the Company. Management is confident that
the ultimate outcome of pending litigation should not have an adverse effect on
the Company's consolidated operation or financial position.
NOTE 11 - REINSURANCE
-----------
A reinsurance transaction occurs when an insurance company transfers (cedes) a
portion of its exposure on policies written by it to a reinsurer that assumes
that risk for a premium (ceded premium). Reinsurance does not legally discharge
the Company from primary liability under its policies. If the reinsurer fails to
meet its obligations, the Company must nonetheless pay its policy obligations.
Crusader's primary excess of loss reinsurance agreements since January 1, 1998,
are as follows:
Loss A.M Best Annual Aggregate
Year Reinsurer(s) Rating Retention Deductible
---- ----------- ------ --------- ----------
2006 Platinum Underwriters Reinsurance, Inc. & A
Hannover Ruckversicherungs AG A $300,000 $500,000
2005 Platinum Underwriters Reinsurance, Inc. & A
Hannover Ruckversicherungs AG A $300,000 $500,000
2004 Platinum Underwriters Reinsurance, Inc. & A
Hannover Ruckversicherungs AG A $250,000 $500,000
2003 Platinum Underwriters Reinsurance, Inc. & A
Hannover Ruckversicherungs AG & A
QBE Reinsurance Corporation A $250,000 $500,000
2002 Partner Reinsurance Company of the U.S. A+ $250,000 $675,000
2001 Partner Reinsurance Company of the U.S. A+ $250,000 $500,000
2000 Partner Reinsurance Company of the U.S. A+ $250,000 $500,000
1999 General Reinsurance Corporation A++ $250,000 $750,000
1998 General Reinsurance Corporation A++ $250,000 $750,000
57
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Prior to January 1, 1998, National Reinsurance Corporation (acquired by General
Reinsurance Corporation in 1996) charged a provisional rate on exposures up to
$500,000 that was subject to adjustment and was based on the amount of losses
ceded, limited by a maximum percentage that could be charged. That provisionally
rated treaty was cancelled on a runoff basis and replaced by a flat rated treaty
on January 1, 1998.
In 2006 and 2005 Crusader retained a participation in its excess of loss
reinsurance treaties of 10% in its 1st layer ($700,000 in excess of $300,000),
10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its
property and casualty clash treaties. In 2004 Crusader retained a participation
in its excess of loss reinsurance treaties of 10% in its 1st layer ($750,000 in
excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000),
and 30% in its property and casualty clash treaties. In 2003 Crusader retained a
participation in its excess of loss reinsurance treaties of 5% in its 1st layer
($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of
$1,000,000), and 30% in its property and casualty clash treaties.
Crusader's 2006 1st layer primary excess of loss treaty provides for a
contingent commission equal to 20% of the net profit, if any, accruing to the
reinsurer. The first accounting period for the contingent commission covers the
period from January 1, 2006, through December 31, 2006. The Company will
calculate and report to the reinsurer its net profit, if any, within 90 days
after 36 months following the end of the first accounting period, and within 90
days after the end of each 12 month period thereafter until all losses subject
to the agreement have been finally settled. Based on losses and loss adjustment
expenses ceded (including incurred but not reported losses) as of December 31,
2006, no contingent commission has been accrued. The 2005 1st layer primary
excess of loss treaties do not provide for a contingent commission. Crusader's
2004 and 2003 1st layer primary excess of loss treaty provides for a contingent
commission to the Company equal to 45% of the net profit, if any, accruing to
the reinsurer. The first accounting period for the contingent commission covers
the period from January 1, 2003, through December 31, 2004. The Company will
calculate and report to the reinsurer its net profit, if any, within 90 days
after 36 months following the end of the first accounting period, and within 90
days after the end of each 12 month period thereafter until all losses subject
to the agreement have been finally settled. Based on losses and loss adjustment
expenses ceded (including incurred but not reported losses) as of December 31,
2006, no contingent commission has been accrued.
Crusader also has catastrophe reinsurance from various highly rated California
authorized reinsurance companies. These reinsurance agreements help protect
Crusader against liabilities in excess of certain retentions, including major or
catastrophic losses that may occur from any one or more of the property and/or
casualty risks which Crusader insures. The Company has no reinsurance
recoverable balances in dispute.
The aggregate amount of earned premium ceded to the reinsurers was $13,758,424
for the year ended December 31, 2006, $14,234,844 for the year ended December
31, 2005, and $17,784,240 for the year ended December 31, 2004.
On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays
a commission to Crusader that includes a reimbursement of the cost of acquiring
the portion of the premium that is ceded. Crusader does not currently assume any
reinsurance. Ceding commission was $4,376,474 in 2006, $4,647,748 in 2005, and
$6,031,987 in 2004. The Company intends to continue obtaining reinsurance
although the availability and cost may vary from time to time. The unpaid losses
ceded to the reinsurer are recorded as an asset on the balance sheet.
58
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The effect of reinsurance on premiums written, premiums earned, and incurred
losses is as follows:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Premiums written:
Direct business $51,913,967 $60,268,784 $68,872,021
Reinsurance assumed - - -
Reinsurance ceded (13,747,103) (14,238,077) (17,782,448)
---------- ---------- ----------
Net premiums written $38,166,864 $46,030,707 $51,089,573
========== ========== ==========
Premiums earned:
Direct business $56,692,213 $64,712,764 $67,890,808
Reinsurance assumed - - -
Reinsurance ceded (13,758,424) (14,234,844) (17,784,240)
---------- ---------- ----------
Net premiums earned $42,933,789 $50,477,920 $50,106,568
========== ========== ==========
Incurred losses and loss adjustment expenses:
Direct $20,816,321 $43,901,853 $40,436,295
Assumed - - -
Ceded (2,989,342) (12,388,121) (5,985,557)
---------- ---------- ----------
Net incurred losses and loss adjustment expenses $17,826,979 $31,513,732 $34,450,738
========== ========== ==========
Reinsurance ceded premium as a percentage of direct earned premium was 24% in
2006, 22% in 2005 and 26% in 2004. The decrease in the ratio is primarily the
result of rate decreases by the Company's reinsurers due to the Company's
improving ceded loss experience.
NOTE 12 - RETIREMENT PLANS
----------------
Profit Sharing Plan
-------------------
During the fiscal year ended March 31, 1986, the Company adopted the Unico
American Corporation Profit Sharing Plan. Company employees who are at least 21
years of age and have been employed by the Company for at least two years are
participants in such Plan. Pursuant to the terms of such Plan, the Company
annually contributes for the account of each participant an amount equal to a
percentage of the participant's eligible compensation as determined by the Board
of Directors. Participants must be employed by the Company on the last day of
the plan year to be eligible for contribution. Participants are entitled to
receive distribution of benefits under the Plan upon retirement, termination of
employment, death or disability.
Money Purchase Plan
-------------------
During the year ended December 31, 1999, the Company adopted the Unico American
Corporation Money Purchase Plan. This plan covers the present executive officers
of the Company. Pursuant to the terms of such Plan, the Company annually
contributes to the account of each participant an amount equal to a percentage
of the participant's eligible compensation as determined by the Board of
Directors. However, amounts contributed to the Unico American Corporation Profit
Sharing Plan will be considered first in determining the actual amount available
under the Internal Revenue Service maximum contribution limits. Participants
must be employed by the Company on the last day of the plan year to be eligible
for contribution. Participants are entitled to receive distribution of benefits
under the Plan upon retirement, termination of employment, death or disability.
Retirement plans expense was as follows:
Year ended December 31, 2006 $896,063
Year ended December 31, 2005 $867,532
Year ended December 31, 2004 $759,482
59
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - STATUTORY CAPITAL AND SURPLUS
-----------------------------
Crusader is required to file an annual statement with insurance regulatory
authorities prepared on an accounting basis prescribed or permitted by such
authorities (statutory). Statutory accounting practices differ in certain
respects from GAAP. The more significant of these differences for statutory
accounting are (a) premium income is taken into earnings over the periods
covered by the policies, whereas the related acquisition and commission costs
are expensed when incurred; (b) fixed maturity securities are reported at
amortized cost, or the lower of amortized cost or fair value, depending on the
quality of the security as specified by the NAIC; (c) equity securities are
valued by the NAIC as required by Statutory Accounting Principles; d)
non-admitted assets are charged directly against surplus; (e) loss reserves and
unearned premium reserves are stated net of reinsurance; and (f) federal income
taxes are recorded when payable and deferred taxes, subject to limitations, are
recognized but only to the extent that they do not exceed 10% of statutory
surplus; changes in deferred taxes are recorded directly to surplus as regards
policyholders. Additionally, the cash flow presentation is not consistent with
U.S. generally accepted accounting principles and reconciliation from net income
to cash provided by operations is not presented. Comprehensive income is not
presented under statutory accounting.
Crusader Insurance Company statutory capital and surplus are as follows:
As of December 31, 2006 $50,023,768
As of December 31, 2005 $36,586,441
Crusader Insurance Company statutory net income is as follows:
Year ended December 31, 2006 $13,396,732
Year ended December 31, 2005 $6,817,451
Year ended December 31, 2004 $3,343,859
The insurance department also conducts periodic financial examinations of
Crusader. The insurance department has completed its financial examination of
Crusader's December 31, 2004, statutory financial statements. A final
report on the examination was issued by the department of insurance on May 10,
2006. No significant issues were reported in the final report.
The Company believes that Crusader's statutory capital and surplus were
sufficient to support the insurance premiums written based on guidelines
established by the NAIC.
Crusader is restricted in the amount of dividends it may pay to its parent in
any twelve (12) month period without prior approval of the California Department
of Insurance. Presently, without prior approval, Crusader may pay a dividend in
any twelve (12) month period to its parent equal to the greater of (a) 10% of
Crusader's statutory policyholders' surplus or (b) Crusader's statutory net
income for the preceding calendar year. Based on Crusader's statutory net income
for the year ended December 31, 2006, the maximum dividend that could be made by
Crusader to Unico without prior regulatory approval in 2007 is $13,396,732.
There were no dividends paid by Crusader to Unico in 2006, 2005, or in 2004.
In December 1993, the National Association of Insurance Commissioners (NAIC)
adopted a Risk-Based Capital (RBC) Model Law for property and casualty
companies. The RBC Model Law is intended to provide standards for calculating a
variable regulatory capital requirement related to a company's current
operations and its risk exposures (asset risk, underwriting risk, credit risk,
and off-balance sheet risk). These standards are intended to serve as a
diagnostic solvency tool for regulators that establishes uniform capital levels
and specific authority levels for regulatory intervention when an insurer falls
below minimum capital levels. The RBC Model Law specifies four distinct action
levels at which a regulator can intervene with increasing degrees of authority
over a domestic insurer if its RBC is equal to or less than 200% of its computed
authorized control level RBC. A company's RBC is required to be disclosed in its
statutory annual statement. The RBC is not intended to be used as a rating or
ranking tool nor is it to be used in premium rate making or approval. Crusader's
adjusted capital at December 31, 2006, was 624% of authorized control level
risk-based capital.
Insurance Regulatory Information System (IRIS) was developed by a committee of
state insurance regulators primarily to assist state insurance departments in
executing their statutory mandate to oversee the financial
60
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
condition of insurance companies. IRIS helps those companies that merit highest
priority in the allocation of the regulators' resources on the basis of 13
financial ratios that are calculated annually. The analytical phase is a review
of annual statements and the financial ratios. The ratios and trends are
valuable in pointing to companies likely to experience financial difficulties
but are not themselves indicative of adverse financial condition. The ratio and
benchmark comparisons are mechanically produced and are not intended to replace
the state insurance department's own in-depth financial analysis or on-site
examinations.
An unusual range of ratio results has been established from studies of the
ratios of companies that have become insolvent or have experienced financial
difficulties. In the analytical phase, companies that receive four or more
financial ratio values outside the usual range are analyzed in order to identify
those companies that appear to require immediate regulatory action.
Subsequently, a more comprehensive review of the ratio results and an insurer's
annual statement is performed to confirm that an insurer's situation calls for
increased or close regulatory attention. In 2006, the Company was outside the
usual values on one of the thirteen IRIS ratio tests. The ratio was the Net
Change in Adjusted Policyholders' Surplus. This ratio compares the Company's
ratio to an established minimum and maximum range of greater than 10% decrease
in adjusted policyholders' surplus and less than 25% increase in adjusted
policyholders' surplus. The Company's net change in adjusted policyholders'
surplus ratio was an increase of 37%.
NOTE 14 - STOCK PLANS
-----------
The Company's 1999 Omnibus Stock Plan that covers 500,000 shares of the
Company's common stock (subject to adjustment in the case of stock splits,
reverse stock splits, stock dividends, etc.) was approved by shareholders on
June 4, 1999. On August 26, 1999, the Company granted 135,000 incentive stock
options. As of December 31, 2006, 92,500 of those options were outstanding and
exercisable, 2,500 options had been exercised, and 40,000 options had been
terminated. These options expire 10 years from the date of the grant.
On December 18, 2002, the Company granted 182,000 incentive stock options under
the Company's 1999 Omnibus Stock Plan. On December 30, 2005, the Company
accelerated the vesting of 37,500 options that were originally schedule to vest
on January 1, 2006, and 30,000 options that were originally schedule to vest on
January 1, 2007 (see Note 1). As of December 31, 2006, 79,750 of those options
were outstanding and exercisable, 99,750 options had been exercised and 2,500
options had been terminated. These options expire 10 years from the date of the
grant.
The changes in the number of common shares under option are summarized as
follows:
Weighted Average
Options Exercise Price
------- --------------
Outstanding at December 31, 2003 277,000 $5.216
Options granted - -
Options exercised (2,500) 3.110
Options terminated (2,500) 3.110
-------
Outstanding at December 31, 2004 272,000 5.254
Options granted - -
Options exercised (4,000) 3.110
Options terminated - -
-------
Outstanding at December 31, 2005 268,000 5.286
Options granted - -
Options exercised (95,750) 3.270
Options terminated - -
-------
Outstanding at December 31, 2006 172,250 $6.407
=======
Options exercisable were 172,250 at December 31, 2006, at a weighted average
exercise price of $6.407; 268,000 at December 31, 2005, at a weighted average
exercise price of $5.286; 149,500 at December 31, 2004, at a weighted average
exercise price of $7.01. Aggregate intrinsic value of outstanding and currently
exercisable options at December 31, 2006 was $1,149,383.
61
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information regarding the stock options
outstanding at December 31, 2006:
Weighted Weighted Weighted
Average Average Average
Number of Remaining Exercise Price Number of Exercise Price
Exercise Options Contractual Life of Outstanding Options of Exercisable
Price Outstanding (Years) Options Exercisable Options
----- ----------- ----- ------- ----------- -------
$9.25 92,500 2.65 $9.25 92,500 $9.25
$3.11 79,750 5.96 $3.11 79,750 $3.11
NOTE 15 - TAXES ON INCOME
---------------
The provision for taxes on income consists of the following:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Current provision:
Federal $6,137,538 $3,319,904 $2,947,668
State 11,537 142,923 64,400
--------- --------- ---------
Total federal and state 6,149,075 3,462,827 3,012,068
Deferred 210,670 288,599 (21,110)
--------- --------- ---------
Provision for taxes $6,359,745 $3,751,426 $2,990,958
========= ========= =========
The income tax provision reflected in the consolidated statements of operations
is different than the expected federal income tax on income as shown in the
table below:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Computed income tax expense $6,172,355 $3,558,586 $2,948,636
Tax effect of:
State tax, net of federal tax benefit 90,623 272,789 65,237
Federal tax in excess of 34% 173,196 - -
Tax exempt income (3,184) (4,166) (10,612)
Other (73,245) (75,783) (12,303)
--------- -------- ---------
Income tax per financial statements $6,359,745 $3,751,426 $2,990,958
========= ========= =========
62
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of the net federal income tax asset included in the financial
statements as required by the assets and liability method are as follows:
Year ended December 31
-----------------------
2006 2005
---- ----
Deferred tax assets:
Discount on loss reserves $2,361,583 $2,270,225
Unearned premiums 2,002,863 2,116,186
Unrealized loss on investments 111,312 196,904
State income tax deductible in future periods 181,007 145,270
Other 176,154 112,072
--------- ---------
Total deferred tax assets $4,832,919 $4,840,657
--------- ---------
Deferred tax liabilities:
Deferred acquisition costs $2,447,275 $2,501,101
State tax on undistributed insurance company earnings 521,235 283,663
Tax depreciation in excess of book depreciation 150,138 112,758
Other 241,247 173,849
--------- ---------
Total deferred tax liabilities $3,359,895 $3,071,371
--------- ---------
Net deferred tax assets $1,473,024 $1,769,286
========= =========
Although realization is not assured, management believes it is more likely than
not that all of the deferred tax assets will be realized. The amount of the
deferred tax assets considered realizable could be reduced in the near term if
estimates of future taxable income during the carryforward period are reduced.
The Company and its wholly owned subsidiaries file consolidated federal and
combined California income tax returns. Pursuant to the tax allocation
agreement, Crusader and American Acceptance Corporation are allocated taxes or
(in the case of losses) tax credits at current corporate rates based on their
own taxable income or loss.
As a California insurance company, Crusader is obligated to pay a premium tax on
gross premiums written in all states that Crusader is admitted. Premium taxes
are deferred and amortized as the related premiums are earned. The premium tax
is in lieu of state franchise taxes and is not included in the provision for
state taxes.
NOTE 16 - REPURCHASE OF COMMON STOCK - EFFECT ON STOCKHOLDERS' EQUITY
-----------------------------------------------------------
The Company has previously announced that its Board of Directors had authorized
the repurchase in the open market from time to time of up to an aggregate of
945,000 shares of the common stock of the Company. During the year ended
December 31, 2006, the Company did not purchase any shares of the Company's
common stock. As of December 31, 2006, the Company had purchased and retired
under the Board of Directors' authorization an aggregate of 868,958 shares of
its common stock at a cost of $5,517,465.
63
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - EARNINGS PER SHARE
-------------------
A reconciliation of the numerator and denominator used in the basic and diluted
earnings per share calculation is presented below:
Year ended December 31
----------------------
2006 2005 2004
---- ---- ----
Basic Earnings Per Share
Net income numerator $11,794,241 $6,715,004 $5,681,500
========== ========= =========
Weighted average shares outstanding denominator 5,567,883 5,495,948 5,490,346
========= ========= =========
Per share amount $2.12 $1.22 $1.03
Diluted Earnings Per Share
Net income numerator $11,794,241 $6,715,004 $5,681,500
========== ========= =========
Weighted average shares outstanding 5,567,883 5,495,948 5,490,346
Effect of diluted securities 85,018 116,478 90,949
--------- --------- ---------
Diluted shares outstanding denominator 5,652,901 5,612,426 5,581,295
========= ========= =========
Per share amount $2.09 $1.20 $1.02
NOTE 18 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
--------------------------------------------
Summarized unaudited quarterly financial data for each of the calendar years
2006 and 2005 is set forth below:
Comparable Period by Quarter Ended
----------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
Calendar Year 2006
------------------
Total revenues $14,073,675 $13,667,146 $13,659,332 $13,317,228
Income before taxes 2,914,143 3,013,171 3,404,647 8,822,025
Net income 1,887,550 1,956,720 2,214,146 5,735,825
Earnings per share: Basic $0.34 $0.35 $0.40 $1.03
Diluted $0.34 $0.35 $0.39 $1.01
Calendar Year 2005
------------------
Total revenues $15,481,114 $15,662,323 $15,204,435 $14,834,650
Income before taxes 2,356,327 2,643,991 2,585,017 2,881,095
Net income 1,505,180 1,693,313 1,661,458 1,855,053
Earnings per share: Basic $0.27 $0.31 $0.30 $0.34
Diluted $0.27 $0.30 $0.30 $0.33
64
ITEM 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure
------------------------
None
ITEM 9A. Controls and Procedures
-----------------------
An evaluation was carried out by the Company's management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of
December 31, 2006, (as defined in Rule 13a-15(e) or 15d-15(e) under the
Securities Exchange Act of 1934). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the design and
operation of these disclosure controls and procedures were effective.
During the period covered by this report, there have been no changes in the
Company's internal control over financial reporting that have materially
affected or are reasonably likely to materially affect the Company's internal
control over financial reporting.
ITEM 9b. Other Information
-----------------
None
PART III
--------
ITEM 10. Directors, Executive Officers and Corporate Governance.
------------------------------------------------------
Information in response to Item 10 is incorporated by reference from the
Company's definitive proxy statement to be used in connection with the Company's
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 11. Executive Compensation.
----------------------
Information in response to Item 11 is incorporated by reference from the
Company's definitive proxy statement to be used in connection with the Company's
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
-------------------------------
Information in response to Item 12 is incorporated by reference from the
Company's definitive proxy statement to be used in connection with the Company's
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 13. Certain Relationships and Related Transactions,
and Director Indenpendence
--------------------------
Information in response to Item 13 is incorporated by reference from the
Company's definitive proxy statement to be used in connection with the Company's
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
ITEM 14. Principal Accountant Fees and Services
--------------------------------------
Information in response to Item 14 is incorporated by reference from the
Company's definitive proxy statement to be used in connection with the Company's
Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
65
PART IV
-------
ITEM 15. Exhibits and Financial Statement Schedules
------------------------------------------
(a) Financial Statements, Schedules and Exhibits:
1. Financial statements:
The consolidated financial statements for the fiscal year ended December
31, 2006, are contained herein as listed in the index to consolidated
financial statements on page 38.
2. Financial schedules:
Index to Consolidated Financial Statements
------------------------------------------
Independent Registered Public Accounting Firms' Report on Financial
Statement Schedules
Schedule II - Condensed Financial Information of Registrant
Schedule III - Supplemental Insurance Information
Schedules other than those listed above are omitted, since they are not
applicable, not required, or the information required being set forth is
included in the consolidated financial statements or notes.
3. Exhibits:
3.1 Articles of Incorporation of Registrant, as amended. (Incorporated
herein by reference to Exhibit 3.1 to the Registrant's Annual Report
on Form 10-K for the fiscal year ended March 31, 1984.)
3.2 By-Laws of Registrant, as amended. (Incorporated herein by
reference to Exhibit 3.2 to Registrant's Annual Report on Form 10-K
for the fiscal year ended March 31, 1991.)
10.1 Unico American Corporation Profit Sharing Plan & Trust. (Incorporated
herein by reference to Exhibit 10.1 to the Registrant's Annual Report
on Form 10-K for the fiscal year ended March 31, 1985.)*
10.2 The Lease dated July 31, 1986, between Unico American Corporation and
Cheldin Management Company. (Incorporated herein by reference to
Exhibit 10.5 to Registrant's Annual Report on Form 10-K for the
fiscal year ended March 31, 1987.)
10.3 The Lease Amendment #1 dated February 22, 1995, between Unico
American Corporation and Cheldin Management amending the lease dated
July 31, 1986. (Incorporated herein by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year ended
March 31, 1995.)
10.4 1999 Omnibus Stock Plan of Unico American Corporation (Incorporated
herein by reference to Exhibit A to Registrant's Proxy Statement for
its Annual Meeting of Shareholders held June 4, 2000.)*
10.5 Employment Agreement effective May 15, 2006, by and between the
Registrant and Cary L. Cheldin. (Incorporated herein by reference to
Exhibit 10.1 to Registrant's Current Report on Form 8-K filed on May
31, 2006.)*
10.6 Employment Agreement effective May 15, 2006, by and between the
Registrant and George C. Gilpatrick. (Incorporated herein by
reference to Exhibit 10.2 to Registrant's Current Report on Form 8-K
filed on May 31, 2006.)*
10.7 Employment Agreement effective May 15, 2006, by and between the
Registrant and Lester A. Aaron. (Incorporated herein by reference to
Exhibit 10.3 to Registrant's Current Report on Form 8-K filed on May
31, 2006.)*
21 Subsidiaries of Registrant. (Incorporated herein by reference to
Exhibit 22 to Registrant's Annual Report on Form 10-K for the fiscal
year ended March 31, 1984.)
23 Consent of Independent Registered Public Accounting Firm - KPMG LLP.
31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* Indicates management contract or compensatory plan or arrangement.
66
SIGNATURES
-----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: March 28, 2007
UNICO AMERICAN CORPORATION
By: /s/ Erwin Cheldin
-----------------
Erwin Cheldin
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Erwin Cheldin Chairman of the Board, March 28, 2007
------------- President and Chief
Erwin Cheldin Executive Officer,
(Principal Executive Officer)
/s/ Lester A. Aaron Treasurer, Chief Financial March 28, 2007
--------------- Officer and Director
Lester A. Aaron (Principal Accounting and
Principal Financial Officer)
/s/ Cary L. Cheldin Executive Vice President March 28, 2007
--------------- and Director
Cary L. Cheldin
/s/ George C. Gilpatrick Vice President, Secretary March 28, 2007
-------------------- and Director
George C. Gilpatrick
/s/ David A. Lewis Director March 28, 2007
--------------
David A. Lewis
/s/ Warren D. Orloff Director March 28, 2007
----------------
Warren D. Orloff
/s/ Donald B. Urfrig Director March 28, 2007
----------------
Donald B. Urfrig
67
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
The Board of Directors and Stockholders
Unico American Corporation:
Under date of March 23, 2007, we reported on the consolidated balance sheets of
Unico American Corporation and subsidiaries as of December 31, 2006 and 2005,
and the related consolidated statements of operations, comprehensive income,
changes in stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 2006, as contained in the 2006 annual
report to stockholders. These consolidated financial statements and our report
thereon are incorporated by reference in the annual report on Form 10-K for the
year 2006. In connection with our audits of the aforementioned consolidated
financial statements, we also audited the related financial statement schedules
as listed under Item 15(a)2. These financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
KPMG LLP
Los Angeles, California
March 23, 2007
68
SCHEDULE II
-----------
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS - PARENT COMPANY ONLY
December 31 December 31
2006 2005
---- ----
ASSETS
------
Investments
Short-term investments $9,741 $9,358
----- -----
Total Investments 9,741 9,358
Cash 5,815 7,017
Accrued investment and other income 5,000 12,902
Investments in subsidiaries 79,694,821 67,740,804
Property and equipment (net of accumulated depreciation) 739,080 824,504
Other assets 189,344 470,442
---------- ----------
Total Assets $80,643,801 $69,065,027
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
LIABILITIES
-----------
Accrued expenses and other liabilities $165,620 $156,352
Payables to subsidiaries (net of receivables) (1) 18,001,774 20,514,302
Income taxes payable 1,605,385 -
---------- ----------
Total Liabilities $19,772,779 $20,670,654
---------- ----------
STOCKHOLDERS' EQUITY
--------------------
Common stock $3,236,745 $2,720,487
Accumulated other comprehensive (loss) (216,074) (382,224)
Retained earnings 57,850,351 46,056,110
---------- ----------
Total Stockholders' Equity $60,871,022 $48,394,373
---------- ----------
Total Liabilities and Stockholders' Equity $80,643,801 $69,065,027
========== ==========
(1) The Company and its wholly owned subsidiaries file consolidated federal and
combined California income tax returns. Pursuant to a tax allocation
agreement, Crusader Insurance Company and American Acceptance Corporation
are allocated taxes or (in the case of losses) tax credits at current
corporate rates based on their own taxable income or loss. The payable to
subsidiaries includes their income tax receivable or liability included in
the consolidated return.
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes.
69
SCHEDULE II (continued)
----------------------
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS - PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31
2006 2005 2004
---- ---- ----
REVENUES
--------
Net investment income $529 $6,120 $9,293
Other income 7,663 13,820 11,981
----- ------ ------
Total Revenue 8,192 19,940 21,274
EXPENSES
--------
General and administrative expenses 1,818 6,930 9,257
----- ----- -----
Income before equity in net income of subsidiaries 6,374 13,010 12,017
Equity in net income of subsidiaries 11,787,867 6,701,994 5,669,483
---------- --------- ---------
Net Income $11,794,241 $6,715,004 $5,681,500
========== ========= =========
The Company and its subsidiaries file a consolidated federal income tax return.
Unico received cash dividends from American Acceptance Corporation of $500,000
in the year ended December 31, 2005, and $200,000 in the year ended December 31,
2004.
Unico was reimbursed certain expenses by its ubsidiaries. These expenses
included depreciation and amortization of $238,833, $160,571, and $95,084
for the years ended December 31, 2006, 2005, and 2004 respectively.
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes.
70
SCHEDULE II (continued)
----------------------
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS - PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31
2006 2005 2004
---- ---- ----
Cash flows from operating activities: Cash flows from operating activities:
Net income $11,794,241 $6,715,004 $5,681,500
Adjustments to reconcile net income to net cash
from operations
Undistributed equity in net (income) of subsidiaries (11,787,867) (6,701,994) (5,669,483)
Depreciation and amortization 238,833 160,571 95,084
Accrued expenses and other liabilities 9,268 6,555 (138,543)
Accrued investment and other income 7,902 (6,902) 6,000
Income taxes receivable (payable) - (227,550) -
Tax benefit from disqualified incentive stock options (203,126) - -
Other assets 281,098 (13,655) (298,227)
------- ------ --------
Net cash provided (used) from operations 340,349 (67,971) (323,669)
------- ------ -------
Cash flows from investing activities
(Increase) in short-term investments (383) (211) (50)
Additions to property and equipment (153,409) (706,671) (50,398)
------- ------- ------
Net cash (used) by investing activities (153,792) (706,882) (50,448)
------- ------- ------
Cash flows from financing activities
Proceeds from issuance of common stock 313,132 12,440 7,775
Tax benefit from disqualified incentive stock options 203,126 - -
Repayment of notes payable - related parties - (500,000) (1,000,000)
Net change in payables and receivables from subsidiaries (704,017) 1,261,113 1,357,540
------- --------- ---------
Net cash provided (used) by financing activities (187,759) 773,553 365,315
------- ------- -------
Net (decrease) in cash (1,202) (1,300) (8,802)
Cash at beginning of year 7,017 8,317 17,119
----- ----- ------
Cash at end of year $5,815 $7,017 $8,317
===== ===== =====
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes.
71
SCHEDULE III
------------
UNICO AMERICAN CORPORATION
AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
Future
Benefits, Benefits, Amortization
Deferred Losses, Claims, of Deferred
Policy and Loss Net Losses and Policy Other Net
Acquisition Adjustment Unearned Premium Investment Settlement Acquisition Operating Premium
Cost Expenses Premiums Revenue Income Expenses Costs Costs Written
---- -------- -------- ------- ------ -------- ------ ----- -------
Year Ended
December 31, 2006
Property &
Casualty $6,430,265 $93,596,117 $26,434,187 $42,933,789 $5,906,079 $17,826,979 $9,250,989 $1,691,629 $38,166,864
Year Ended
December 31, 2005
Property &
Casualty $7,356,179 $101,914,548 $30,619,047 $50,477,920 $4,248,399 $31,513,732 $10,512,688 $2,402,397 $46,030,707
Year Ended
December 31, 2004
Property &
Casualty $8,203,238 $87,469,000 $35,656,393 $50,106,568 $4,204,573 $34,450,738 $10,319,186 $1,746,815 $51,089,573
72
EXHIBIT INDEX
-------------
Exhibit
No. Description
-- -----------
3.1 Articles of Incorporation of Registrant, as amended. (Incorporated
herein by reference to Exhibit 3.1 to the Registrant's Annual Report
on Form 10-K for the fiscal year ended March 31, 1984.)
3.2 By-Laws of Registrant, as amended. (Incorporated herein by
reference to Exhibit 3.2 to Registrant's Annual Report on Form 10-K
for the fiscal year ended March 31, 1991.)
10.1 Unico American Corporation Profit Sharing Plan & Trust. (Incorporated
herein by reference to Exhibit 10.1 to the Registrant's Annual Report
on Form 10-K for the fiscal year ended March 31, 1985.)*
10.2 The Lease dated July 31, 1986, between Unico American Corporation and
Cheldin Management Company. (Incorporated herein by reference to
Exhibit 10.5 to Registrant's Annual Report on Form 10-K for the
fiscal year ended March 31, 1987.)
10.3 The Lease Amendment #1 dated February 22, 1995, between Unico
American Corporation and Cheldin Management amending the lease dated
July 31, 1986. (Incorporated herein by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year ended
March 31, 1995.)
10.4 1999 Omnibus Stock Plan of Unico American Corporation (Incorporated
herein by reference to Exhibit A to Registrant's Proxy Statement for
its Annual Meeting of Shareholders held June 4, 2000.)*
10.5 Employment Agreement effective May 15, 2006, by and between the
Registrant and Cary L. Cheldin. (Incorporated herein by reference to
Exhibit 10.1 to Registrant's Current Report on Form 8-K filed on May
31, 2006.)*
10.6 Employment Agreement effective May 15, 2006, by and between the
Registrant and George C. Gilpatrick. (Incorporated herein by
reference to Exhibit 10.2 to Registrant's Current Report on Form 8-K
filed on May 31, 2006.)*
10.7 Employment Agreement effective May 15, 2006, by and between the
Registrant and Lester A. Aaron. (Incorporated herein by reference to
Exhibit 10.3 to Registrant's Current Report on Form 8-K filed on May
31, 2006.)*
21 Subsidiaries of Registrant. (Incorporated herein by reference to
Exhibit 22 to Registrant's Annual Report on Form 10-K for the fiscal
year ended March 31, 1984.)
23 Consent of Independent Registered Public Accounting Firm - KPMG LLP.
31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* Indicates management contract or compensatory plan or arrangement.