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| UIHC.OB > SEC Filings for UIHC.OB > Form 10-Q on 13-Aug-2009 | All Recent SEC Filings |
13-Aug-2009
Quarterly Report
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Statements in this quarterly report on Form 10-Q for the three and six months ended June 30, 2009 ("Form 10-Q") or in documents that are incorporated by reference that are not historical fact are "forward-looking statements" within the meaning of the Private Securities Reform Litigation Act of 1995. These forward-looking statements include statements about anticipated growth in revenues, earnings per share, estimated unpaid losses on insurance policies, investment returns and expectations about our liquidity. These statements are based on current expectations, estimates and projections about the industry and market in which we operate, and management's beliefs and assumptions. Without limiting the generality of the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "would," "estimate," or "continue" or the negative other variations thereof or comparable terminology are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. The risks and uncertainties include, without limitation, uncertainties related to estimates, assumptions and projections relating to unpaid losses and loss adjustment expenses and other accounting policies, losses from the hurricanes that occurred in 2005 and 2004 and in other estimates, assumptions and projections contained in this Form 10-Q; inflation and other changes in economic conditions (including changes in interest rates and financial markets); the impact of new regulations adopted in Florida which affect the property and casualty insurance market; the costs of reinsurance; assessments charged by various governmental agencies; pricing competition and other initiatives by competitors; our ability to obtain regulatory approval for requested rate changes and the timing thereof; legislative and regulatory developments; the outcome of litigation pending against us, including the terms of any settlements; risks related to the nature of our business; dependence on investment income and the composition of our investment portfolio; the adequacy of our liability for loss and loss adjustment expense; insurance agents; claims experience; ratings by industry services; catastrophe losses; reliance on key personnel; weather conditions (including the severity and frequency of storms, hurricanes, tornadoes and hail); and acts of war and terrorist activities. For additional information, see "Risk Factors" in our annual report on Form 10-K/A for the year ended December 31, 2008.
You are cautioned not to place reliance on these forward-looking statements, which are valid only as of the date they were made. We undertake no obligation to update or revise any forward-looking statements to reflect new information or the occurrence of unanticipated events or otherwise. In addition, readers should be aware that U.S. generally accepted accounting principles ("GAAP") prescribe when a company may reserve for particular risks, including litigation exposures. Accordingly, results for a given reporting period could be significantly affected if and when a reserve is established for a major contingency. Reported results may therefore appear to be volatile in certain accounting periods.
COMPANY OVERVIEW
United Insurance Holdings Corp. (which is referred to herein as "UIHC", "United", "we", or "us"), formerly known as FMG Acquisition Corp., acquired United Insurance Holdings, L.C., a Florida limited liability company ("UIH"), via merger on September 30, 2008 (the "Merger"). Through UIH and its three wholly-owned subsidiaries, UIHC is engaged in the property and casualty insurance business in the State of Florida. Our insurance subsidiary United Property & Casualty Insurance Company ("UPCIC") was initially formed in 1999 to capitalize on legislation designed to attract capital to the Florida homeowner insurance market and our primary products are homeowner and dwelling property and casualty insurance policies. We offer standardized policies and price these policies in accordance with the rates approved by the Florida Office of Insurance Regulation ("OIR"). Our homeowner policy, which provides both structure and content coverage for a broad range of exposures, is a policy that includes coverage options for standard single-family homeowners, tenants (renters), and condominium unit owners. Our dwelling policy allows policyholders to select from a range of standardized policies with differing types and levels of coverage.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Another homeowner insurance coverage we offer is flood insurance ("Flood"), which is provided through the National Flood Insurance Program ("NFIP"). We retain no risk of loss with our Flood program, but earn commissions for the issuance of Flood policies based upon a fixed percentage of net written premiums and the processing of Flood claims based upon a fixed percentage of incurred losses and we can earn additional commissions by meeting certain growth targets for the number of policies-in-force.
All of our policies are written in the State of Florida, which is an area that is exposed to damage from hurricanes and severe storms. We attempt to mitigate our exposure to losses from major catastrophes by purchasing catastrophe reinsurance coverage. Effective June 1, 2009, we entered into our 2009-2010 catastrophe reinsurance contracts, which provide us protection to our estimated one hundred-year probable maximum loss. However, a catastrophe, depending on its path and severity, could result in losses to us exceeding our reinsurance protection. The premium for these contracts totaled $83.6 million, which was $33.8 million higher than the cost of the 2008-2009 catastrophe reinsurance contracts. During the six months ended June 30, 2009, there were no catastrophes that occurred in Florida. Please see the Reinsurance Payable section below for a detailed discussion of these contracts.
In order to reach a broad range of prospective policyholders, we use numerous independent agents who write policies for us (which we refer to as "direct" policies) and we also assume policies from Citizens Property Insurance Corporation ("Citizens") (which we refer to as "assumed" policies). During August of 2008, we entered into an agreement with Citizens ("2008 Citizens Agreement") to assume up to 75,000 additional policies. In February 2009, we assumed approximately 2,200 policies from Citizens. Policyholders may choose to "opt out" of our assumption and keep their policy with Citizens; therefore, the number of policies that are actually assumed from Citizens may be reduced.
At June 30, 2009, approximately 82% of our homeowner policies-in-force were direct policies written by agents and approximately 18% were assumed from Citizens. At June 30, 2009, we had approximately 96,500 homeowner policyholders, an increase of 44% over June 30, 2008, and an increase of 20% over December 31, 2008. During the six months ended June 30, 2009, compared to the same period in 2008, our gross premiums written increased 35% primarily due to an increase in the number of net new policies, endorsements and coverage increases. We evaluate and manage our risk exposures on a continuous basis. As a result of that evaluation, we have taken measures which we anticipate will result in slower growth during the remainder of 2009 than we experienced during the first half of 2009.
As an insurance company, we are highly regulated. Effective September 15, 2009, our Protector homeowner program rate will increase an average of 12.7% for new and renewal business. Effective October 15, 2009, our Guardian dwelling fire program rate will increase 15% for new and renewal business. These rate increases were approved by the OIR.
Our insurance subsidiary is subject to assessments by Citizens, the Florida Hurricane Catastrophe Fund ("FHCF") and the Florida Insurance Guaranty Association ("FIGA"). Citizens and the FHCF may levy assessments against all assessable insurers that write premiums in the State of Florida to cover operating deficiencies related to windstorm catastrophes. FIGA may levy assessments against all assessable insurers that write premiums in the State of Florida to cover the claims of policyholders of insurance companies in the State of Florida that have become insolvent. During the six months ended June 30, 2009, we did not have any new or additional assessments from the FHCF, FIGA or Citizens.
In the fourth quarter of 2007, the Florida legislature implemented a program designed to encourage homeowners to improve the ability of their insured residential structures to withstand hurricanes. Under this program, new construction must meet stronger building codes, and existing homes are eligible for an inspection program that allows homeowners to determine how their homes may be upgraded to mitigate storm damage. Homeowners will qualify for insurance premium discounts if their insured home meets the
Management's Discussion and Analysis of Financial Condition and Results of Operations
required standards. We implemented this program in the fourth quarter of 2007. Our underwriting and profitability models take into account the required premium credits, called "wind mitigation credits," which ultimately reduce our average premium per policy when compared to prior years. The full effect of the wind mitigation credits as a decrease to gross premiums written was reflected in all of our policies-in-force at November 30, 2008. When we compare our average premium per policy during 2009 to the same period(s) during 2008, our average premium-in-force per policy is expected to be lower during 2009 as a result of these wind mitigation credits that were not reflected in our policyholder's premium through November 2008.
We have decided to discontinue offering our commercial product, called e-Z Pak Insurance, which was designed for auto-service professionals. The e-Z Pak Insurance product, which we refer to as our "Garage" line of business, represented approximately 4%, 3% and 2% of our gross premiums written for the fiscal years ended December 31, 2008, 2007 and 2006, respectively. We have entered into an agreement, effective April 1, 2009, granting the renewal rights on the Garage policies to another insurer ("Acquiring Insurer") for a one-year period from June 1, 2009 to May 31, 2010. After May 31, 2009, we will not renew any of our Garage policies. As consideration for these renewal rights, we will receive a percentage of the gross net written premium (adjusted for certain items) for any of the Garage policies that are underwritten by the Acquiring Insurer or its affiliates for the one-year renewal period. There is no assurance that we will receive any amounts pursuant to the foregoing agreement, as our Garage policyholders may choose not to renew their Garage insurance with the Acquiring Insurer.
OPERATIONAL RISKS
The following is a description of the most significant risks facing us and how we attempt to mitigate those risks:
i) LEGAL/REGULATORY RISK - the risk that changes in the regulatory environment in which we operate could create additional expenses not anticipated by us in pricing our products. That is, regulatory initiatives designed to reduce our profits, restrict underwriting practices and risk classifications, or mandate rate reductions and refunds could create costs for us beyond those recorded in our consolidated financial statements, as could new legal theories or insurance company insolvencies (through guaranty fund assessments). We attempt to mitigate this risk by monitoring proposed regulatory legislation and by assessing the impact of new laws. As we write business only in the State of Florida, we are more exposed to this risk than more geographically-balanced companies. At June 30, 2009, we were in compliance with all regulatory requirements.
ii) CREDIT RISK - the risk that financial instruments, which potentially subject us to concentrations of credit risk, may decline in value or default, or the risk that reinsurers, to which we cede some of our business and from which receivables are recorded on the balance sheet, may not pay. We attempt to minimize this risk by adhering to a conservative investment strategy and entering into reinsurance agreements with financially sound reinsurers and obtaining letters of credit from reinsurers, if necessary.
iii) INTEREST RATE RISK - the risk that interest rates will change and cause a decrease in the value of our investments. To the extent liabilities come due more quickly than assets mature, we might have to sell assets prior to maturity and potentially recognize a gain or a loss. Our management team, investment committee and outside investment manager monitor our investment portfolio in an effort to manage this risk.
iv) GEOGRAPHIC, CATASTROPHIC AND/OR SEVERE EVENT RISK - the risk associated with writing insurance policies that cover losses resulting from catastrophes and/or severe events, including hurricanes, tropical storms, tornadoes or other weather-related events in the State of Florida only. We attempt to mitigate our risk of these events through the use of reinsurance, forecast-modeling techniques and the monitoring of concentrations of risk, all of which are designed to protect our statutory surplus. We also attempt to mitigate our risk of these events through our underwriting, which diversifies our concentration of policies throughout the State of Florida.
Management's Discussion and Analysis of Financial Condition and Results of Operations
CRITICAL ACCOUNTING POLICIES
Loss and Loss Adjustment Expenses Reserve
The most significant accounting estimate inherent in the preparation of our financial statements is our evaluation and determination of the liability for unpaid losses and loss adjustment expenses ("LAE").
We establish reserves for unpaid losses and LAE which are comprised of reserves on known claims ("case reserves") and reserves for incurred but not reported ("IBNR") claims. These reserves represent our best estimate of our liability for losses and LAE and are based on the application of various actuarial reserve estimation techniques as well as the consideration of other material facts and circumstances known at the balance sheet date. The process of establishing our reserves is complex and necessarily imprecise, as it involves using judgment that is affected by many variables. Due to the uncertain nature of any projection of the future, including the estimation of loss and LAE reserves, the ultimate loss and LAE payments made by us may be different from the recorded reserves. Please see our Form 10-K/A for the year ended December 31, 2008 for a more complete discussion of our critical accounting policy for determining our loss and LAE reserves.
Reinsurance Recoverables
We cede a portion of our business to reinsurance companies. This allows us to be reimbursed for the portion of claims we pay that are ceded to reinsurance companies. We record reinsurance recoverable for the estimated paid and unpaid portion of losses and LAE we have ceded or will cede. We use the same estimation techniques to estimate the reinsurance recoverable for unpaid ceded claims as we use in establishing our loss and LAE reserves.
Reinsurance recoverable represents our best estimate of the amount of losses and LAE we will ultimately be able to recover from our reinsurers. The process of establishing our unpaid losses and LAE is complex and necessarily imprecise, as it involves using judgment that is affected by many variables in determining our loss and LAE estimates. Due to the uncertain nature of any projection of the future, including the estimation of loss and LAE reserves, the ultimate loss and LAE amounts we recover from our reinsurers may be different from the recorded reinsurance recoverable.
Fair Value of Investments
As discussed in Note 6 to our unaudited interim consolidated financial statements, certain of our investments are valued at fair value using a Level 2 input. A Level 2 input is a valuation based on observable inputs that are not quoted prices in an active market, but are, for example, quoted prices in an inactive market or quoted prices in active markets for similar, but not identical instruments. The fair value for our fixed maturities is largely determined by one of two primary pricing methods: third-party pricing service market prices or independent broker quotations. Prices from third-party pricing services are often unavailable for securities that are rarely traded or are traded only in privately-negotiated transactions and as a result, certain of our securities are priced via broker quotations. The fair value prices and/or quotations could vary from one third-party pricing service/broker to another. Any change in the estimated fair value of our securities could impact the amount of unrealized gains or losses we have recorded, which could change the amount we have recorded for our investments and comprehensive income on our unaudited interim Condensed Consolidated Balance Sheets.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Deferred Policy Acquisition Costs
We defer commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of insurance contracts. The policy acquisition costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, anticipated losses and settlement expenses and certain other costs expected to be incurred as the premium is earned.
Investment Portfolio Impairments
Quarterly, we perform an assessment of our investments to determine if any are other-than-temporarily impaired. An investment is impaired when the fair value of the investment declines to an amount that is lower than the cost or amortized cost of that investment. As part of our assessment process, we determine whether the impairment is temporary or other-than-temporary. We base our assessment on both quantitative criteria and qualitative information, considering a number of factors including, but not limited to: how long the security has been impaired; the amount of the impairment; whether, in the case of equity securities, we intend to hold the security for a period sufficient for us to recover our cost basis, or whether, in the case of debt securities, we intend to sell the security or it is more likely than not that we will have to sell the security before we recover the cost or amortized cost; the financial condition and near-term prospects of the issuer; whether the issuer is current on contractually-obligated interest and principal payments; key corporate events pertaining to the issuer and whether the market decline was affected by macroeconomic conditions. The assessment of whether an OTTI exists involves a high degree of subjectivity and judgment, and we base such assessment on the information available to us at a given point in time. Significant changes in the factors we consider when evaluating investments for impairment losses could result in a significant change in impairment losses reported in our consolidated financial statements if future events, information and the passage of time cause us to determine that a decline in value is other-than-temporary. Any change in the determination of whether the impairment is temporary or other-than-temporary would affect our financial statements.
If we determine that an impairment of a security is temporary, then we record the impairment as an unrealized loss in comprehensive income. If we determine that an impairment of equity securities is other-than-temporary, we permanently reduce the cost of the security to fair value and recognize an OTTI charge in operations. If a debt security is impaired and we either intend to sell the security or it is more likely than not that we will have to sell the security before we are able to recover its cost or amortized cost, we record the full amount of the impairment as an OTTI charge in operations. If we determine that an impairment of a debt security is other-than-temporary and we neither intend to sell the security nor it is more likely than not that we will have to sell the security before we are able to recover its cost or amortized cost, then we separate the impairment into (a) the amount of impairment related to the credit loss and (b) the amount of impairment related to all other factors. We recognize the amount of the impairment related to the credit loss as an OTTI charge in operations, and we recognize the amount of the OTTI related to all other factors in other comprehensive income.
Management's Discussion and Analysis of Financial Condition and Results of Operations
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 3 to our unaudited interim condensed consolidated financial statements for a discussion of recent accounting pronouncements.
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our accompanying unaudited interim condensed consolidated financial statements and related notes appearing elsewhere herein, and in conjunction with the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" included within our Form 10-K/A for the year ended December 31, 2008.
ANALYSIS OF FINANCIAL CONDITION (June 30, 2009 versus December 31, 2008)
Total Investments
All of our investments are held as available-for-sale. Our investments at June 30, 2009 and at December 31, 2008, consist mainly of high-quality money market instruments, securities of the United States government and its agencies and securities of high-quality corporate issuers. The corporate bonds we hold are mostly in the energy, consumer products, healthcare, technology and telecommunications industries. At June 30, 2009, approximately 79% of our fixed-maturity securities are U.S. Treasuries or corporate bonds rated "A" or better; the remaining 21% are corporate bonds rated "BBB". Our equity holdings reflect a similar diversification, with most of our holdings being in the energy, healthcare, industrial and technology sectors.
As noted in the Critical Accounting Policies section above, we perform quarterly assessments of our investments to determine if any have incurred an OTTI. During the first quarter of 2009, we recorded an OTTI charge of $1.9 million, after determining that impairments related to certain of our equity securities were other-than-temporary. During 2008, we did not record an OTTI charge.
At June 30, 2009, we have recorded $0.1 million of net unrealized gains compared to $2.4 million of net unrealized losses at December 31, 2008. The change of $2.5 million of net unrealized losses to net unrealized gains is primarily due to the $1.9 million OTTI charge we recorded during the six months ended June 30, 2009 and a $0.6 million increase in net unrealized gains during the same period. The $0.1 million of net unrealized gains at June 30, 2009 is comprised of net unrealized gains of $1.0 million related to our fixed-maturity investment portfolio and $0.9 million of net unrealized losses related to our equities portfolio. Based upon our assessment of our investment portfolio using the criteria discussed above and given our current level of liquidity, for our fixed maturities, we neither intend to sell the investments nor is it more likely than not that we will be required to sell our fixed maturities that are impaired before recovery of our cost or amortized cost basis, and for our equity securities, we have the intent and the ability to hold these equity securities for a reasonable period of time sufficient for a forecasted recovery of fair value. Therefore, these decreases in fair values compared to carrying cost are currently viewed as being temporary.
Our fixed maturities and equity securities that are available-for-sale and carried at fair value represent 99.7% and 99.8% of our total investments at June 30, 2009 and December 31, 2008, respectively. Our other long-term investments of $0.3 million at June 30, 2009 and December 31, 2008, are invested in a certificate of deposit to secure the payment of our claims as required by the State of Florida. This certificate of deposit automatically renews every twelve months.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Reinsurance Payable
Effective June 1, 2009, we entered into the following reinsurance agreements:
• Property Catastrophe Excess of Loss Reinsurance Agreement ("Private Agreement") between United Property & Casualty Insurance Company and Various Reinsurance Companies
• Florida Hurricane Catastrophe Fund Reimbursement Contract ("FHCF Agreement") between United Property & Casualty Insurance Company and the State Board of Administration of Florida
• Reinstatement Premium Protection Reinsurance Agreement ("RPP Agreement") between United Property & Casualty Insurance Company and Various Reinsurance Companies and
• Multi-Line Per Risk Excess of Loss Reinsurance Agreement ("Multi-Line Agreement") between United Property & Casualty Insurance Company and Various Reinsurance Companies.
Our catastrophe reinsurance contracts provide us coverage against severe weather events. For our catastrophe reinsurance program, we entered into an excess-of-loss Private Agreement for a cost of $38.4 million, and we entered into the FHCF Agreement for an estimated cost of $29.5 million. The Private Agreement provides coverage against severe weather events such as hurricanes, tropical storms and tornadoes. The FHCF Agreement provides coverage only against storms that are designated as hurricanes by the National Hurricane Center.
The Private Agreement has four schedules; these schedules divide the coverage into layers. The coverage provided by one schedule picks up, or "attaches", at the point where coverage under the previous schedule ends. The FHCF Agreement divides our coverage into three layers: the Limited-Apportionment Company ("LAC") layer, the Mandatory layer and the Temporary-Increase-in-Coverage-Limit ("TICL") layer.
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