UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2008
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission File Number 000-20848
UNIVERSAL INSURANCE HOLDINGS, INC.
(Exact name of small business issuer as specified in its charter)
Delaware 65-0231984
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1110 W. Commercial Blvd., Suite 100, Fort Lauderdale, Florida 33309
(Address of principal executive offices)
(954) 958-1200 (Registrant's telephone
number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No
--- ---
Indicate by check mark whether the registrant 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 x Non-accelerated filer
--- --- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act) Yes No x
--- ----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 39,858,019 shares of common
stock, par value $0.01 per share, outstanding on November 5, 2008 (including
906,000 shares held in trust).
UNIVERSAL INSURANCE HOLDINGS, INC.
TABLE OF CONTENTS
Page No.
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
Report of Independent Registered Public Accounting Firm 3
Condensed Consolidated Balance Sheets as of September 30,
2008 and December 31, 2007 4
Condensed Consolidated Statements of Operations for the
Nine-Month and Three-Month Periods Ended September 30, 5
2008 and 2007
Condensed Consolidated Statements of Stockholders' Equity
for the Nine-Month Periods Ended September 30, 2008 and 2007 6
Condensed Consolidated Statements of Cash Flows for the
Nine-Month Periods Ended September 30, 2008 and 2007 7
Notes to Condensed Consolidated Financial Statements 8
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 21
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 38
ITEM 4. Controls and Procedures 38
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings 38
ITEM 1A. Risk Factors 39
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 39
ITEM 3. Defaults Upon Senior Securities 39
ITEM 4. Submission of Matters to a Vote of Security Holders 40
ITEM 5. Other Information 40
ITEM 6. Exhibits 40
SIGNATURES 42
2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To The Board of Directors and Stockholders of
Universal Insurance Holdings, Inc. and Subsidiaries
Fort Lauderdale, Florida
We have reviewed the accompanying condensed consolidated balance sheet of
UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES as of September 30, 2008 and
the related condensed consolidated statements of operations for the nine-month
and three-month periods ended September 30, 2008 and 2007 and cash flows for
each of the nine-month periods ended September 30, 2008 and 2007. These interim
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying interim financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
/s/ Blackman Kallick LLP
Chicago, Illinois
November 10, 2008
3
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
ASSETS 2008 2007
--------------- ---------------
Cash and cash equivalents $ 274,175,693 $ 214,745,606
Investments - fixed maturities -
held to maturity, at amortized cost 4,348,590 -
Real estate, net 3,419,432 3,392,827
Prepaid reinsurance premiums 179,016,856 172,672,795
Reinsurance recoverables 49,745,278 46,399,265
Premiums receivable, net 43,520,344 36,194,822
Other receivables 9,184,030 2,310,500
Property and equipment, net 938,262 874,430
Deferred income taxes 15,112,947 14,202,956
Other assets 653,388 400,164
--------------- ---------------
Total assets $ 580,114,820 $ 491,193,365
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Unpaid losses and loss adjustment expenses $ 75,191,456 $ 68,815,500
Unearned premiums 270,764,790 254,741,198
Deferred ceding commission, net 2,375,549 2,122,269
Accounts payable 2,141,253 2,972,147
Reinsurance payable, net 65,504,986 33,888,350
Dividends payable 3,724,218 3,241,145
Other accrued expenses 19,621,579 16,799,307
Other liabilities 14,960,561 11,035,444
Loans payable - 2,820
Long-term debt 25,000,000 25,000,000
--------------- ---------------
Total liabilities 479,284,392 418,618,180
--------------- ---------------
STOCKHOLDERS' EQUITY:
Cumulative convertible preferred stock,
$.01 par value 1,387 1,387
Authorized shares - 1,000,000
Issued shares - 138,640
Outstanding shares - 138,640
Minimum liquidation preference -
$1,419,700
Common stock, $.01 par value 398,578 393,072
Authorized shares - 55,000,000
Issued shares - 39,858,019 and
39,307,103
Outstanding shares - 37,242,172 and
36,012,729
Treasury shares, at cost - 1,709,847 and
394,374 shares (7,381,768) (974,746)
Common stock held in trust, at cost -
906,000 and 2,900,000 shares (733,860) (2,349,000)
Additional paid-in capital 32,589,301 24,779,798
Retained earnings 75,956,790 50,724,674
--------------- ---------------
Total stockholders' equity 100,830,428 72,575,185
--------------- ---------------
Total liabilities and stockholders'
equity $ 580,114,820 $ 491,193,365
=============== ===============
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
4
UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Nine For the Three
Months Ended September 30, Months Ended September 30,
2008 2007 2008 2007
---------------- ---------------- ---------------- ----------------
PREMIUMS EARNED AND OTHER REVENUES
Direct premiums written $ 394,304,531 $ 381,318,190 $124,718,631 $ 118,754,920
Ceded premiums written (275,284,862) (271,847,589) (91,295,102) (86,699,581)
---------------- ---------------- ---------------- ----------------
Net premiums written 119,019,669 109,470,601 33,423,529 32,055,339
(Increase) decrease in net unearned premium (9,679,531) 9,492,236 4,659,359 4,264,123
---------------- ---------------- ---------------- ----------------
Premiums earned, net 109,340,138 118,962,837 38,082,888 36,319,462
Net investment income 3,628,472 8,241,833 1,109,770 2,766,754
Commission revenue 20,526,922 15,879,099 6,677,703 6,105,510
Other revenue 3,658,373 618,546 1,304,663 508,313
---------------- ---------------- ---------------- ----------------
Total premiums earned and other revenues 137,153,905 143,702,315 47,175,024 45,700,039
---------------- ---------------- ---------------- ----------------
OPERATING COSTS AND EXPENSES
Losses and loss adjustment expenses 53,861,445 37,939,183 23,619,417 13,072,906
General and administrative expenses 29,316,796 34,227,989 11,832,474 12,923,516
---------------- ---------------- ---------------- ----------------
Total operating costs and expenses 83,178,241 72,167,172 35,451,891 25,996,422
---------------- ---------------- ---------------- ----------------
INCOME BEFORE INCOME TAXES 53,975,664 71,535,143 11,723,133 19,703,617
Income taxes, current 22,006,536 31,708,367 3,968,670 8,602,743
Income taxes, deferred (909,992) (3,912,189) 381,809 (2,709,828)
---------------- ---------------- ---------------- ----------------
Income taxes, net 21,096,544 27,796,178 4,350,479 5,892,915
---------------- ---------------- ---------------- ----------------
NET INCOME $ 32,879,120 $ 43,738,965 $ 7,372,654 $ 13,810,702
================ ================ ================ ================
Basic net income per common share $ 0.88 $ 1.23 0.20 $ 0.39
================ ================ ================ ================
Weighted average of common shares
outstanding - Basic 37,448,000 35,528,000 37,500,000 35,763,000
================ ================ ================ ================
Fully diluted net income per share $ 0.81 $ 1.06 $ 0.19 $ 0.33
================ ================ ================ ================
Weighted average of common shares
outstanding - Diluted 40,530,000 41,250,000 39,926,000 41,550,000
================ ================ ================ ================
Cash dividend declared per common share $ 0.20 $ 0.15 $ 0.10 $ 0.08
================ ================ ================ ================
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.
5
UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
---------------------------------------------------------------------------------------------------------------
Preferred Common Preferred Additional Stock Total
Common Stock Stock Stock Paid-in Retained Held in Treasury Stockholders'
Shares Shares Amount Amount Capital Earnings Trust Stock Equity
---------------------------------------------------------------------------------------------------------------
Balance,
December 31, 2007 39,307,103 138,640 $ 393,072 $ 1,387 $ 24,779,798 $ 50,724,674 $ (2,349,000) $ (974,746) $ 72,575,185
Issuance of common
shares 1,516,000 - 15,157 - 2,505,370 - - (3,407,234) (886,707)
Release of shares
from SGT - - - - 25,330 - 1,615,140 (4,041,705) (2,401,235)
Repurchase of common
shares - - - - - - - (2,999,788) (2,999,788)
Retirement of treasury
shares (965,084) - (9,651) - (4,032,054) - - 4,041,705 -
Stock compensation
plans - - - - 3,372,832 - - - 3,372,832
Net income - - - - - 32,879,120 - - 32,879,120
Tax benefit on exercise
of stock options - - - - 5,706,780 - - - 5,706,780
Amortization of deferred
compensation - - - - 231,245 - - - 231,245
Declaration of dividends - - - - - (7,647,004) - - (7,647,004)
Balance, ---------------------------------------------------------------------------------------------------------------
September 30, 2008 39,858,019 138,640 $ 398,578 $ 1,387 $ 32,589,301 $ 75,956,790 $ (733,860) $(7,381,768) $ 100,830,428
===============================================================================================================
Balance,
December 31, 2006 38,057,103 138,640 $ 380,572 $ 1,387 $ 18,726,387 $ 5,390,392 $(2,349,000) $ (101,820) $ 22,047,918
Issuance of common
shares 1,000,000 - 10,000 - 1,750,500 - - (872,926) 887,574
Stock compensation
plans - - - - 1,660,493 - - - 1,660,493
Net income - - - - - 43,738,965 - - 43,738,965
Tax benefit on exercise
of stock options - - - - 1,414,221 - - - 1,414,221
Deferred compensation - - - - (925,000) - - - (925,000)
Amortization of deferred
compensation - - - - 210,964 - - - 210,964
Declaration of dividends - - - - - (5,414,372) - - (5,414,372)
Balance, ---------------------------------------------------------------------------------------------------------------
September 30, 2007 39,057,103 138,640 $ 390,572 $ 1,387 $ 22,837,565 $ 43,714,985 $ (2,349,000) $ (974,746) $ 63,620,763
===============================================================================================================
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.
6
UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended Nine Months Ended
September 30, 2008 September 30, 2007
------------------ -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 32,879,120 $ 43,738,965
Adjustments to reconcile net income to
cash provided by operating activities
Allowance for doubtful accounts 1,184,144 (40,921)
Amortization and depreciation 352,877 253,979
Amortization of bond premium 20,911 -
Loss on disposal of assets - 27,630
Amortization of FAS 123R cost of stock
options 3,372,831 1,660,489
Amortization of restricted stock grant 231,246 210,964
Deferred taxes (909,991) (3,912,188)
Tax benefit on exercise of stock options (4,677,743) (1,143,325)
Net change in assets and liabilities
relating to operating activities:
Reinsurance recoverables (3,346,013) (40,496,927)
Prepaid reinsurance premiums (6,344,061) (42,550,787)
Premiums receivable (8,509,666) 3,682,718
Other receivables (1,166,752) (5,206,355)
Deferred acquisition costs, net - 2,106,116
Other assets (253,224) 17,368
Reinsurance payable 31,616,636 43,519,855
Deferred ceding commission, net 253,280 1,506,066
Other liabilities 3,925,117 6,283,429
Accounts payable (830,894) 6,734,834
Taxes payable - 13,215,182
Other accrued expenses 2,822,272 1,316,477
Unpaid losses and loss adjustment expenses 6,375,956 3,792,006
Unearned premiums 16,023,592 33,058,551
------------------ -------------------
Net cash provided by operating activities 73,019,638 67,774,126
------------------ -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (322,252) (155,375)
Building improvements (121,062) (19,513)
Purchase of investments (4,369,501) 0
------------------ -------------------
Net cash used in investing activities (4,812,815) (174,888)
------------------ -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Preferred stock dividend (37,462) (37,462)
Issuance of common stock 130,530 835,500
Acquisition of treasury stock (6,418,257) (872,926)
Tax benefit on exercise of stock options 4,677,743 1,143,325
Common stock dividend paid (7,126,470) (4,418,746)
Repayments of loans payable (2,820) (12,375,692)
------------------ -------------------
Net cash used in financing activities (8,776,736) (15,726,001)
------------------ -------------------
Net increase in cash and cash equivalents 59,430,087 51,873,237
CASH AND CASH EQUIVALENTS, Beginning of period 214,745,606 232,890,297
------------------ -------------------
CASH AND CASH EQUIVALENTS, End of period $ 274,175,693 $ 284,763,534
================== ===================
Non cash items
------------------ -------------------
Dividends accrued $ 3,724,217 $ 2,861,018
================== ===================
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
7
UNIVERSAL INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements include
the accounts of Universal Insurance Holdings, Inc. ("Company"), its wholly owned
property and casualty insurance subsidiary, Universal Property & Casualty
Insurance Company ("UPCIC"), and other wholly owned subsidiaries of the Company
including the Universal Insurance Holdings, Inc. Stock Grantor Trust. All
intercompany accounts and transactions have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America ("GAAP") that differ from statutory accounting
practices prescribed or permitted for insurance companies by regulatory
authorities. In addition, the accompanying financial statements have been
prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X of the Securities and Exchange Commission ("SEC"). Accordingly,
they omit or condense certain footnotes and other information normally included
in financial statements prepared in conformity with GAAP and thus should be read
in conjunction with the audited consolidated financial statements and notes
included in the Company's Annual Report on Form 10-KSB, as amended, for the year
ended December 31, 2007.
The condensed consolidated balance sheet of the Company as of September 30,
2008, the related condensed consolidated statements of operations for the
nine-month and three-month periods ended September 30, 2008 and 2007, and
condensed consolidated statements of cash flows for the nine-month periods ended
September 30, 2008 and 2007 are unaudited. There were no items comprising
comprehensive income for the nine-month periods ended September 30, 2008 and
2007. Accordingly, consolidated statements of comprehensive income are not
presented. The significant accounting policies followed for quarterly financial
reporting are the same as those disclosed in the Notes to Consolidated Financial
Statements included in the Company's Annual Report on Form 10-KSB, as amended,
for the year ended December 31, 2007, except for the adoption of a new
accounting pronouncement as noted below.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
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. Actual results could differ from those
estimates. The accompanying financial statements reflect all adjustments
(consisting primarily of normal and recurring accruals and adjustments) which
are, in the opinion of management, necessary for a fair statement of the results
for the interim periods presented.
Results of operations for the nine-month period ended September 30, 2008 are not
necessarily indicative of the results for the year ending December 31, 2008.
To conform to the 2008 presentation, certain amounts in the prior periods'
consolidated financial statements and notes have been reclassified. Such
reclassifications were of an immaterial amount and had no effect on net income
or stockholders' equity.
8
2. NEW ACCOUNTING PRONOUNCEMENTS
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 157 which redefines
fair value, establishes a framework for measuring fair value in GAAP, and
expands disclosures about fair value measurements. SFAS No. 157 applies where
other accounting pronouncements require or permit fair value measurements. SFAS
No. 157 is partially effective for fiscal years beginning after November 15,
2007. The effects of adoption were determined by the types of instruments
carried at fair value in the Company's financial statements at the time of
adoption as well as the method utilized to determine their fair values prior to
adoption. Based on the Company's current use of fair value measurements, the
adoption of SFAS No. 157 did not have a material effect on the results of
operations or financial position of the Company.
In February 2007, FASB issued SFAS No. 159, "The Fair Value Option for Financial
Assets and Financial Liabilities" ("SFAS 159") which permits entities to choose
to measure many financial instruments and certain other items at fair value that
are not currently required to be measured at fair value. SFAS 159 became
effective for the Company on January 1, 2008. SFAS 159 has not had a material
effect on the Company's financial position, cash flows and results of
operations.
In December 2007, FASB issued SFAS No. 141 (revised 2007), "Business
Combinations" ("SFAS 141R"), and SFAS 160, "Noncontrolling Interests in
Consolidated Financial Statements" ("SFAS 160"), to improve, simplify, and
converge internationally the accounting for business combinations and the
reporting of noncontrolling interests in consolidated financial statements. The
provisions of SFAS 141R and SFAS 160 are effective as of the beginning of the
Company's 2009 fiscal year. The Company is currently evaluating the impact of
adopting SFAS 141R and SFAS 160 on its financial statements.
In March 2008, FASB issued SFAS No. 161, "Disclosures about Derivative
Instruments and Hedging Activities" ("SFAS 161"), which amends and expands the
disclosure requirements of SFAS 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133"), to provide an enhanced understanding of an
entity's use of derivative instruments, how they are accounted for under SFAS
133 and their effect on the entity's financial position, financial performance
and cash flows. The provisions of SFAS 161 are effective as of the beginning of
the Company's 2009 fiscal year. The Company is currently evaluating the impact
of adopting SFAS 161 on its financial statements.
In May 2008, FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted
Accounting Principles" ("SFAS 162"), which identifies the sources of accounting
principles and the framework for selecting the principles to be used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with GAAP in the United States. SFAS 162 was issued to
clarify that the GAAP hierarchy is directed to entities since it is the entity
(not its auditor) that is responsible for selecting accounting principles for
financial statements that are presented in conformity with GAAP. The provisions
of SFAS 162 are effective 60 days following the SEC's approval of the PCAOB
amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with
GAAP." The Company has determined that this statement will not result in a
change in current practice.
Also, in May 2008, FASB issued SFAS No. 163, "Accounting for Financial Guarantee
Insurance Contracts" ("SFAS 163") - an interpretation of FASB No. 60,
"Accounting and Reporting by Insurance Enterprises," which requires an insurance
enterprise to recognize a claim liability prior to an event of default (insured
event) when there is evidence that credit deterioration has occurred in an
insured financial obligation. SFAS 163 also clarifies how FASB No. 60 applies to
financial guarantee insurance contracts, including the recognition and
measurement to be used to account for premium revenue and claim liabilities. The
provisions of SFAS 163 are effective as of the beginning of the Company's 2009
9
fiscal year. The Company is currently evaluating the impact of adopting SFAS 163
on its financial statements.
3. INSURANCE OPERATIONS
UPCIC commenced its insurance activity in February 1998 by assuming policies
from the Florida Residential Property and Casualty Joint Underwriting
Association ("JUA"). UPCIC received the unearned premiums of the assumed
policies and began servicing such policies. Since then, UPCIC has developed its
business by actively soliciting business in the open market through independent
agents.
Unearned premiums represent amounts that UPCIC would be required to refund
policyholders if their policies were canceled. UPCIC determines unearned
premiums by calculating the pro-rata amount that would be due to the
policyholders at a given point in time based upon the premiums due for the full
policy term. At September 30, 2008, UPCIC was servicing approximately 451,000
homeowners' and dwelling fire insurance policies with direct unearned premiums
totaling $270,764,790 and in-force premiums of approximately $519,300,000. At
December 31, 2007, UPCIC was servicing 374,000 homeowners' and dwelling fire
insurance policies with direct unearned premiums totaling $254,741,198 and
in-force premiums of approximately $504,500,000.
Premiums earned are included in earnings on a pro-rata basis over the terms of
the policies. UPCIC does not have policies that provide for retroactive premium
adjustments.
Policy acquisition costs, consisting of commissions and other costs that vary
with and are directly related to the production of business, net of ceding
commissions, are deferred and amortized over the terms of the policies, but only
to the extent that unearned premiums are sufficient to cover all related costs
and expenses. Deferred policy acquisition costs are reviewed to determine if
they are recoverable from unearned premiums and, if not, are charged to expense.
As of September 30, 2008 and September 30, 2007, respectively, no amounts of
deferred policy acquisition costs were charged to expense as a result of the
recoverability testing. As of September 30, 2008 and December 31, 2007, deferred
ceding commissions exceeded deferred policy acquisition costs and were recorded
as net liabilities in the amounts of $2,375,549 and $2,122,269, respectively.
An allowance for doubtful accounts is established when it becomes evident that
collection is doubtful. The Company estimates its allowance for doubtful
accounts by calculating the aggregate amount by which balances due from
policyholders exceed unearned premium on a policy-level basis. As of September
30, 2008 and December 31, 2007, UPCIC had recorded allowances for doubtful
accounts in the amounts of $2,016,804 and $832,660, respectively. The aggregate
increase in the allowance is primarily due to an increase in past due
installment payments from policyholders which the Company believes is
attributable to the general economic downturn. The Company intends to monitor
payment cycles and adjust the allowance for doubtful accounts accordingly.
Loss and loss adjustment expenses ("LAE"), less related reinsurance, are
recorded as claims are incurred. The provision for unpaid loss and LAE includes:
(1) the accumulation of individual case estimates for loss and LAE reported, but
not paid prior to the close of the accounting period; (2) estimates for incurred
but unreported claims based on past experience modified for current trends; and
(3) estimates of expenses for investigating and adjusting claims based on past
experience.
Management has implemented several rate changes to strengthen UPCIC's financial
condition. On UPCIC's Homeowner's Program ("HO"), premium rate increases
averaging 9.9% and 13.2% statewide were approved by the Florida Office of
Insurance Regulation ("OIR") and implemented with effective dates in May 2006
and October 2006, respectively. On UPCIC's Dwelling Fire Program ("DP"), premium
10
rate increases averaging 11.2% and 30.6% statewide were also approved by the OIR
and implemented with effective dates in May 2006 and September 2006,
respectively. However, a rate filing mandated by the Florida Legislature in 2007
due to a new law presumed to reduce insurers' reinsurance costs resulted in rate
decreases averaging 11.1% statewide (HO) and 2.3% statewide (DP) was approved by
the OIR and integrated into UPCIC's rates on June 1, 2007. This had an adverse
effect on UPCIC's premium volume. The effect of these rate decreases on existing
policies and the corresponding premium decreases in direct written premium were
completed on May 31, 2008. In addition, UPCIC implemented premium discounts
resulting from wind mitigation efforts by policyholders. Such discounts were
mandated by the Florida Legislature and became effective June 1, 2007 for new
business, and August 1, 2007 for renewal business. Additionally, a rate decrease
of 4.1% statewide (HO) and a rate decrease of 0.2% statewide (DP) were approved
by the OIR and implemented with effective dates in January 2008 for the HO
program and March 2008 for the DP program. The effect of these rate decreases is
reflected in UPCIC's book of business and the full impact of the premium
decreases on direct premiums written should be realized by January 2009 for the
HO program and March 2009 for the DP program.
UPCIC uses proprietary systems for policy issuance and administration. This has
enhanced UPCIC's operating results through its ability to improve and better
control underwriting and loss adjusting activities. In addition, UPCIC monitors
the geographic and coverage mix of the property insurance it writes, which is a
key determinant in the amount and pricing of reinsurance procured by UPCIC.
Management believes these processes, and results attributable to them, will
continue to allow UPCIC to operate profitably. However, there can be no
assurance of the ultimate success of the Company's plans, or that the Company
will be able to maintain profitability.
4. REINSURANCE
In the normal course of business, UPCIC seeks to reduce the loss that may arise
from catastrophes or other events that cause unfavorable underwriting results by
reinsuring certain levels of risk in various areas of exposure with other
insurance enterprises or reinsurers. Amounts recoverable from reinsurers are
estimated in a manner consistent with the reinsurance contracts. Reinsurance
premiums, losses and LAE are accounted for on bases consistent with those used
in accounting for the original policies issued and the terms of the reinsurance
contracts. Reinsurance ceding commissions received are deferred and netted
against policy acquisition costs and amortized over the effective period of the
related insurance policies.
UPCIC limits the maximum net loss that can arise from large risks or risks in
concentrated areas of exposure by reinsuring (ceding) certain levels of risks
with other insurers or reinsurers, either on an automatic basis under general
reinsurance contracts known as "treaties" or by negotiation on substantial
individual risks. The reinsurance arrangements are intended to provide UPCIC
with the ability to maintain its exposure to loss within its capital resources.
Such reinsurance includes quota share, excess of loss and catastrophe forms of
reinsurance. While ceding premiums to reinsurers reduces UPCIC's risk of
exposure in the event of catastrophic losses, it also reduces UPCIC's potential
for greater profits should such catastrophic events fail to occur. The Company
submits the UPCIC reinsurance program for regulatory review to the OIR.
In light of the four windstorm catastrophes Florida experienced in 2004, and
three windstorm catastrophes Florida experienced in 2005, there was a
significant increase in the cost of catastrophe reinsurance coverage commencing
with the June 1, 2006 renewal which the Company had planned and factored into
its policy pricing. Effective June 1, 2006, UPCIC reduced the rate of cession on
its quota share reinsurance. Quota share reinsurance is used primarily to
increase UPCIC's underwriting capacity and to reduce exposure to losses. Quota
share reinsurance refers to a form of reinsurance under which the reinsurer
participates in a specified percentage of the premiums and losses on all
reinsured policies in a given class of business. As a result of this reduction
of UPCIC's quota share reinsurance from 80% to 50%, UPCIC has retained and
11
earned more premiums it writes, but has also retained more related losses.
UPCIC's increased exposure to potential losses could have a material adverse
effect on the business, financial condition and results of operations of UPCIC
and the Company. UPCIC did not experience any catastrophic events during the
nine-month periods ended September 30, 2008 and 2007.
Effective June 1, 2008, UPCIC entered into a quota share reinsurance treaty and
excess per risk agreements with various reinsurers. Under the quota share
treaty, through May 31, 2009, UPCIC cedes 50% of its gross written premiums,
losses and LAE for policies with coverage for wind risk with a ceding commission
payable to UPCIC equal to 31% of ceded gross written premiums. In addition, the
quota share treaty has a limitation for any one occurrence of 55% of gross
premiums earned, not to exceed $150,000,000 (of which UPCIC's net liability in a
first event scenario is $70,000,000, in a second event scenario is $14,800,000
and in a third event scenario is $15,000,000) and a limitation from losses
arising out of events that are assigned a catastrophe serial number by the
Property Claims Services ("PCS") office of 164% of gross premiums earned, not to
exceed $450,000,000.
Effective June 1, 2008 through May 31, 2009, UPCIC entered into a multiple line
excess per risk agreement with various reinsurers. Under the multiple line
excess per risk agreement, UPCIC obtained coverage of $1,300,000 in excess of
$500,000 ultimate net loss for each risk and each property loss, and $1,000,000
in excess of $300,000 for each casualty loss. A $7,800,000 aggregate limit
applies to the term of this agreement. Additionally under this agreement, no
property claim shall be made until UPCIC has retained the first $1,300,000 of
potential recovery.
Effective June 1, 2008 through May 31, 2009, UPCIC entered into a property per
risk excess agreement covering ex-wind only policies. Under the property per
risk excess agreement, UPCIC obtained coverage of $300,000 in excess of $200,000
for each property loss. A $2,100,000 aggregate limit applies to the term of this
agreement.
Effective June 1, 2008 through May 31, 2009, under an excess catastrophe
contract, UPCIC obtained catastrophe coverage of $399,000,000 in excess of
$150,000,000 covering certain loss occurrences including hurricanes. This
contract contains a provision for one reinstatement in the event coverage is
exhausted; additional premium is calculated pro rata as to amount and 100% as to
time. Effective June 1, 2008 through May 31, 2009, UPCIC purchased a
reinstatement premium protection contract which reimburses UPCIC for its cost to
reinstate the catastrophe coverage of the first $274,000,000 (part of
$399,000,000) in excess of $150,000,000. Effective June 1, 2008, UPCIC also
obtained subsequent catastrophe event excess of loss reinsurance to cover
certain levels of UPCIC's net retention through three catastrophe events
including hurricanes. UPCIC also obtained coverage from the Florida Hurricane
Catastrophe Fund ("FHCF"). The approximate coverage initially was estimated to
be 90% of $1,340,000,000 in excess of $290,000,000. Also at June 1, 2008, the
FHCF made available, and UPCIC obtained, $10,000,000 of additional catastrophe
excess of loss coverage with one free reinstatement of coverage to carriers
qualified as Limited Apportionment Companies or companies that participated in
the Insurance Capital Build-Up Incentive Program offered by the FHCF (the "ICBUI
Program"), such as UPCIC. This particular layer of coverage is $10,000,000 in
excess of $29,600,000. On October 31, 2008, the Florida State Board of
Administration ("SBA") published its most recent estimate of the FHCF's loss
reimbursement capacity. The SBA estimated that the FHCF's total loss
reimbursement capacity over the next six to twelve months is between $11.786
billion and $13.286 billion. This is significantly less than the estimate in
effect when UPCIC made its FHCF coverage selections for the 2008-2009 contract
year. By law, the FHCF's obligation to reimburse insurers is limited to its
actual claims-paying capacity. In addition, the cost of UPCIC's reinsurance
program may increase should UPCIC deem it necessary to purchase additional
private market reinsurance due to reduced estimates of the FHCF's claims-paying
capacity.
12
The total cost of UPCIC's underlying catastrophe private reinsurance program
effective June 1, 2008 through May 31, 2009 is $86,795,000 of which UPCIC's cost
is 50%, or $43,397,500, and the quota share reinsurers' cost is the remaining
50%. In addition, UPCIC purchases reinstatement premium protection as described
above which amounts to $12,266,483. The cost of subsequent event catastrophe
reinsurance is $12,180,000. The estimated premium UPCIC plans to cede to the
FHCF for the 2008 hurricane season is $57,870,530 of which UPCIC's cost is 50%,
or $28,935,265, and the quota share reinsurers' cost is the remaining 50%. UPCIC
is also participating in the additional coverage option for Limited
Apportionment Companies or companies that participated in the ICBUI Program, the
premium for which is $5,000,000, of which UPCIC's cost is 50%, or $2,500,000,
and the quota share reinsurers' cost is the remaining 50%.
Effective July 1, 2008 through May 31, 2009, under an excess catastrophe
contract, UPCIC obtained an additional $90,000,000 of catastrophe coverage via a
new top layer of 90% of $100,000,000 in excess of $549,000,000 covering certain
loss occurrences including hurricanes. The contract contains a provision for one
reinstatement in the event coverage is exhausted; additional premium is
calculated pro rata as to amount and 100% as to time. The total cost of this new
top layer is $7,200,000 of which UPCIC's cost is 50%, or $3,600,000, and the
quota share reinsurers' cost is the remaining 50%.
Also effective July 1, 2008 through May 31, 2009, UPCIC secured an additional
$80,000,000 of third event catastrophe coverage via a new layer of 80% of
$100,000,000. The total cost of this new layer is $4,000,000 of which UPCIC's
cost is 50%, or $2,000,000, and the quota share reinsurers' cost is the
remaining 50%.
Effective June 1, 2008 through December 31, 2008, the Company obtained
$60,000,000 of coverage via a catastrophe risk-linked transaction product in the
event UPCIC's catastrophe coverage is exhausted or UPCIC is unable to
successfully collect from the FHCF for losses involving the Temporary Increase
in Coverage Limits. The total cost of the Company's risk-linked transaction
product is $10,260,000.
UPCIC is responsible for losses related to catastrophic events with incurred
losses in excess of coverage provided by UPCIC's reinsurance program and for
losses that otherwise are not covered by the reinsurance program, which could
have a material adverse effect on UPCIC's and the Company's business, financial
condition and results of operations. At the start of the hurricane season on
June 1, 2008, UPCIC has coverage to approximately the 133-year Probable Maximum
Loss (PML). With the additional catastrophic coverage via the new top layer
effective July 1, 2008, UPCIC would have had coverage to approximately the
145-year PML. For the 2007 hurricane season, UPCIC had coverage to approximately
the 150-year PML. PML is a general concept applied in the insurance industry for
defining high loss scenarios that should be considered when underwriting
insurance risk. Catastrophe models produce loss estimates that are qualified in
terms of dollars and probabilities. Probability of exceedance or the probability
that the actual loss level will exceed a particular threshold is a standard
catastrophe model output. For example, the 100-year PML represents a 1.00%
Annual Probability of Exceedance (the 133-year PML represents a 0.752% Annual
Probability of Exceedance and the 145-year PML represents a 0.690% Annual
Probability of Exceedance). It is estimated that the 100-year PML is likely to
be equaled or exceeded in one year out of 100 on average, or 1 percent of the
time. It is the 99th percentile of the annual loss distribution.
13
The reinsurance arrangements had the following effect on certain items in the
accompanying consolidated financial statements:
Nine Months Ended Nine Months Ended
September 30, 2008 September 30, 2007
-------------------------------------------- ----------------------------------------------
Loss and Loss Loss and Loss
Premiums Premiums Adjustment Premiums Premiums Adjustment
Written Earned Expenses Written Earned Expenses
------- ------ -------- ------- ------ --------
Direct $394,304,531 $378,280,937 $107,105,622 $381,318,190 $348,259,639 $73,524,183
Ceded (275,284,862) (268,940,799) (53,244,177) (271,847,589) (229,296,802) (35,585,000)
------------- ------------- ------------ ------------ ------------ ------------
Net $119,019,669 $109,340,138 $ 53,861,445 $109,470,601 $118,962,837 $37,939,183
============= ============= ============ ============ ============ ============
Three Months Ended Three Months Ended
September 30, 2008 September 30, 2007
-------------------------------------------- ----------------------------------------------
Loss and Loss Loss and Loss
Premiums Premiums Adjustment Premiums Premiums Adjustment
Written Earned Expenses Written Earned Expenses
------- ------ -------- ------- ------ --------
Direct $124,718,631 $128,626,371 $46,907,087 $118,754,920 $127,235,717 $24,824,146
Ceded (91,295,102) (90,543,483) (23,287,670) (86,699,581) (90,916,255) (11,751,240)
------------- ------------- ------------ ------------ ------------ ------------
Net $ 33,423,529 $ 38,082,888 $23,619,417 $ 32,055,339 $ 36,319,462 $13,072,906
============= ============= ============ ============ ============ ============
OTHER AMOUNTS:
September 30, 2008
------------------
Prepaid reinsurance premiums $179,016,856
============
Reinsurance recoverable on unpaid losses and loss $38,819,548
adjustment expenses
Reinsurance recoverable on paid losses 10,925,730
-----------
Reinsurance recoverables $49,745,278
===========
Reinsurance payable, net
$65,504,986
===========
Reinsurance payable, as of September 30, 2008, has been reduced by $5,591,765,
which represents ceding commissions due from reinsurers and $42,618,923 which
represents inuring premiums receivable. The Company has determined that a right
of offset, as defined in FASB Interpretation No. 39, "Offsetting of Amounts
Related to Certain Contracts," exists between the Company and its reinsurers,
under its quota share reinsurance treaties.
UPCIC's reinsurance contracts do not relieve UPCIC from its obligations to
policyholders. Failure of reinsurers to honor their obligations could result in
losses to UPCIC; consequently, allowances are established for amounts deemed
uncollectible. No allowance is deemed necessary at September 30, 2008. UPCIC
evaluates the financial condition of its reinsurers and monitors concentrations
of credit risk arising from similar geographic regions, activities, or economic
characteristics of the reinsurers to minimize its exposure to significant losses
from reinsurer insolvencies. UPCIC currently has reinsurance contracts with
various reinsurers located throughout the United States and internationally.
UPCIC believes that ceding risks to reinsurers whom it considers to be
financially sound combined with the distribution of reinsurance contracts to an
array of reinsurers adequately minimizes UPCIC's risk from any potential
operating difficulties of its reinsurers. However, UPCIC is required by law to
purchase certain reimbursement coverage from the FHCF and has purchased other
14
optional FHCF reimbursement coverage.
UPCIC may also be subject to assessments by Citizens Property Insurance
Corporation ("Citizens"), Florida's state-run insurer of last resort, and the
FHCF as a result of operating deficiencies related to windstorm catastrophes. In
addition, UPCIC is subject to assessments by the Florida Insurance Guaranty
Association ("FIGA"). FIGA services pending claims by Florida policyholders of
member insurance companies which become insolvent and are ordered liquidated.
FIGA's membership is composed of all Florida licensed direct writers of property
or casualty insurance. Under Florida's current statutes and regulations,
insurers may recoup the amount of their assessments from policyholders, or in
some cases collect the amount of the assessments from policyholders as
surcharges for the benefit of the assessing entity.
On June 12, 2006, the OIR ordered an emergency FHCF assessment of 1% of direct
premiums written for policies with effective dates beginning January 1, 2007,
which UPCIC is currently collecting from policyholders, as the assessment is to
policyholders, not UPCIC. This assessment was a result of catastrophe losses
Florida experienced in 2004 and 2005. The assessments collected from
policyholders are remitted to FHCF quarterly.
On September 14, 2006, the Board of Governors of Citizens authorized the levying
of a regular assessment on assessable insurers to recoup the 2005 Plan Year
Deficit incurred in the High Risk Account. The assessment is based upon UPCIC's
share of direct written premium for the subject lines of business in the State
of Florida for the calendar year preceding the plan year in which the deficit
occurred. UPCIC's participation in this assessment totaled $263,650. Pursuant to
Florida law, insurers are permitted to recoup the assessment by adding a
surcharge to policies in an amount not to exceed the amount paid by the insurer
to Citizens. As a result, UPCIC recorded this assessment as an expense during
the year ended December 31, 2006 and began implementing the recoupment in
connection with this assessment in 2007. The Company expects that recoupment of
this assessment will be completed in 2009.
During its meeting on December 14, 2006, the FIGA Board determined the need for
an emergency assessment upon its member companies. The FIGA Board decided on an
emergency assessment on member companies of 2% of the Florida net direct
premiums for the calendar year 2005. Based on the 2005 net direct premiums of
$11.2 billion, this assessment would generate approximately $225 million.
UPCIC's participation in this assessment totaled $1,772,861. Pursuant to Florida
law, insurers are permitted to recoup the assessment by adding a surcharge to
policies in an amount not to exceed the amount paid by the insurer to FIGA. As a
result, UPCIC recorded this assessment as an expense during the year ended
December 31, 2006 and began implementing the recoupment in connection with this
assessment in 2007. The Company expects that recoupment of this assessment will
be completed in 2009.
On January 11, 2007, the OIR ordered an emergency Citizens assessment of 1.4% of
certain direct written premiums for policies with effective dates beginning July
1, 2007. This assessment was a result of catastrophic losses the State of
Florida experienced in 2005. This assessment will be in effect for 10 years.
UPCIC assesses this surcharge to policyholders at the policy effective date and
remits to Citizens the assessments collected on a monthly basis.
During its meeting on October 11, 2007, the FIGA Board determined the need for
an assessment upon its member companies, which the OIR approved on October 29,
2007. The FIGA Board decided on an assessment on member companies of 2% of the
Florida net direct premiums for the calendar year 2006. Based on the 2006 net
direct premiums of $15.8 billion, this assessment would generate approximately
$315 million. UPCIC's participation in this assessment totaled $7,435,090.
Pursuant to Florida law, insurers are permitted to recoup the assessment by
adding a surcharge to policies in an amount not to exceed the amount paid by the
insurer to FIGA. As a result, UPCIC recorded this assessment as an expense
during the year ended December 31, 2007 and has begun implementing the
recoupment in connection with this assessment in 2008.
15
5. EARNINGS PER SHARE
Earnings per share ("EPS") amounts are calculated in accordance with SFAS No.
128, "Earnings per Share." Basic EPS is based on the weighted average number of
shares outstanding for the period, excluding any dilutive common share
equivalents. Diluted EPS reflects the potential dilution that could occur if
securities to issue common stock were exercised.
A reconciliation of shares used in calculating basic and diluted EPS for the
nine-month and three-month periods ended September 30, 2008 and 2007,
respectively, follows:
Nine Months Ended
-----------------
September 30, 2008 September 30, 2007
------------------ ------------------
Number of shares used in calculating basic EPS 37,448,000 35,528,000
Effect of assumed conversion of common stock
equivalents 3,082,000 5,722,000
------------------- ------------------
Number of shares used in calculating diluted EPS 40,530,000 41,250,000
Three Months Ended
------------------
September 30, 2008 September 30, 2007
------------------ ------------------
Number of shares used in calculating basic EPS 37,500,000 35,763,000
Effect of assumed conversion of common stock
equivalents 2,426,000 5,787,000
------------------- ------------------
Number of shares used in calculating diluted EPS 39,926,000 41,550,000
Options to purchase 2,314,304 and 530,376 shares of common stock for the
nine-month periods ended September 30, 2008 and 2007, respectively, and options
to purchase 3,040,000 and 1,386,685 shares of common stock for the three-month
periods ended September 30, 2008 and 2007, respectively, were not included in
the computation of diluted earnings per share because the exercise price of the
options was greater than the average market prices during the relevant periods.
6. STOCK-BASED COMPENSATION PLANS AND WARRANTS
Effective January, 2006, the Company adopted SFAS No. 123 (R), "Share-Based
Payments," and began recognizing compensation expense in its Consolidated
Statements of Operations for its stock option grants based on the fair value of
the awards. Under SFAS No.123 (R), the compensation expense for the stock
compensation plans that has been charged against income before income taxes was
$3,372,832 and $1,660,493 for the nine-month periods ended September 30, 2008
and 2007, respectively, with a corresponding deferred income tax benefit of
$1,301,070 and $640,536, respectively. As of September 30, 2008 the total
unrecognized compensation cost related to nonvested share-based compensation
granted under the stock compensation plans was $1,758,597. The cost is expected
to be recognized over a weighted average period of 0.67 year.
On May 16, 2008, the Company granted options to purchase an aggregate of
1,440,000 shares of common stock to the Company's directors, executive officers
and management. All of the options granted on May 16, 2008 vest on May 16, 2009,
have an exercise price of $3.90 per share, and expire on May 16, 2013. The
options granted to Bradley I. Meier, the Company's President and Chief Executive
Officer, and to Sean P. Downes, the Company's Chief Operating Officer and Senior
Vice President, are only exercisable on such date or dates as the fair market
value (as defined in their respective option agreements) of the Company's common
16
stock is and has been at least one hundred fifty percent (150%) of the exercise
price for the previous twenty (20) consecutive trading days.
Cash received from option exercises under all stock compensation plans for the
nine-month periods ended September 30, 2008 and 2007 was $130,530 and $0,
respectively. The actual tax benefit realized for tax deductions from option
exercises of share-based compensation was $5,706,780 and $1,414,223 for the
nine-month periods ended September 30, 2008 and 2007, respectively.
At September 30, 2008 and 2007, there were options outstanding to purchase
5,600,000 and 7,105,000 shares of common stock, respectively, with intrinsic
values of $6,357,300 and $34,253,700, respectively, weighted average remaining
contract terms of 3.00 and 3.47 years, respectively, and weighted average
exercise prices of $3.30 and $2.32, respectively. Of the total options
outstanding, options to purchase 2,410,000 and 3,780,000 shares of common stock,
respectively, were currently exercisable with intrinsic values of $2,122,300 and
$22,605,700, respectively, weighted average remaining contract terms of 3.26 and
3.46 years, respectively, and weighted average exercise prices of $4.58 and
$1.16, respectively.
During the nine-month period ended September 30, 2008, options to purchase
1,440,000 shares of common stock were granted, and during the same period in
2007, options to purchase 2,010,000 shares of common stock were granted. Options
to purchase 2,910,000 and 750,000 shares of common stock were exercised during
the nine-month periods ended September 30, 2008 and 2007, respectively. Options
to purchase 35,000 shares of common stock expired during the nine-month period
ended September 30, 2008.
At September 30, 2008, there were no warrants outstanding to purchase shares of
common stock. At September 30, 2007, there were warrants outstanding and
exercisable to purchase 850,000 shares of common stock. Warrants to purchase
600,000 shares of common stock were exercised during the nine-month period ended
September 30, 2008, while none were exercised during the same period in 2007.
The Company estimated the fair value of all stock options awards as of the grant
date by applying the Black-Scholes-Merton option pricing model. The use of this
valuation model involves assumptions that are judgmental and highly sensitive in
the determination of compensation expense and include the expected life of the
option, stock price volatility, risk-free interest rate, dividend yield,
exercise price, and forfeiture rate. Under SFAS 123(R), forfeitures are
estimated at the time of valuation and reduce expense ratably over the vesting
period. The forfeiture rate is adjusted periodically based on the extent to
which actual forfeitures differ, or are expected to differ, from the previous
estimate. Under SFAS 123 and APB 25, the Company elected to account for
forfeitures when awards were actually forfeited and reflect the forfeitures as a
cumulative adjustment to the pro forma expense.
In accordance with SFAS 123(R), fair values of options granted prior to adoption
and determined for purposes of disclosure under SFAS 123 have not been changed.
The fair value of options granted prior to adoption of SFAS 123(R) was estimated
assuming the following: weighted average expected life of five years, dividend
yield of 0.0 percent, risk-free interest rate of 6.5 percent, and expected
volatility as calculated at the date of grant. There were 1,440,000 options
granted during the nine-month period ended September 30, 2008. The fair value of
options granted during the nine-month period ended September 30, 2008 was
estimated assuming the following: weighted average expected life of 2.59 years,
dividend yield of 4.0 percent, risk-free interest rate of 2.55 percent, and
expected volatility of 80.7 percent. There were 2,010,000 options granted during
the nine-month period ended September 30, 2007. The fair value of options during
the nine-month period ended September 30, 2007 was estimated assuming the
following: weighted average expected life of 2.45 years, dividend yield of 4.0
percent, risk-free interest rate of 4.86 percent, and expected volatility of
70.0 percent.
17
7. RELATED PARTY TRANSACTIONS
All underwriting, rating, policy issuance, reinsurance negotiations and
administration functions for UPCIC are performed by UPCIC, Universal Risk
Advisors, Inc., a wholly owned subsidiary of the Company, Blue Atlantic
Reinsurance Corporation, a wholly-owned subsidiary of the Company ("Blue
Atlantic"), and unaffiliated third parties. Claims adjusting functions are
performed by Universal Adjusting Corporation (a wholly owned subsidiary of the
Company), Blue Atlantic, and affiliated and unaffiliated third parties.
Downes and Associates, a multi-line insurance adjustment corporation based in
Deerfield Beach, Florida, performs certain claims adjusting work for UPCIC.
Downes and Associates is owned by Dennis Downes, who is the father of Sean P.
Downes, Chief Operating Officer and Senior Vice President of UPCIC. During the
nine-month periods ended September 30, 2008 and 2007, the Company expensed
claims adjusting fees of $200,000 and $615,237, respectively, to Downes and
Associates.
The Company acquired all of the outstanding common stock of Atlas Florida
Financial Corporation ("Atlas"), which owned all of the outstanding common stock
of Sterling Premium Finance Company, Inc. ("Sterling"), from the Company's Chief
Executive Officer and Chief Operating Officer for $50,000, which approximated
Sterling's book value. On March 6, 2008, the Company received approval of this
acquisition from the OIR. Sterling has been renamed Atlas Premium Finance
Company and commenced offering premium finance services in November 2007.
8. STOCK AND WARRANTS ISSUANCES
On January 2, 2008, the Company issued 518,919 shares of common stock at a price
of $1.00 per share, to a private investor, pursuant to the exercise, on a
"cashless" basis, of warrants to purchase common stock.
During the nine-month period ended September 30, 2008, the Company issued shares
of restricted common stock pursuant to the exercise of stock options as follows:
Number of Shares Price per
---------------- ---------
Date Issued Share Name Relation to Company
---- ------ ----- ---- -------------------
01/02/2008 15,000 $0.90 Harris Siskind Former Director
01/07/2008 9,254 $0.50 Irwin Kellner Former Director
01/07/2008 16,716 $1.10 Irwin Kellner Former Director
01/07/2008 8,955 $0.70 Irwin Kellner Former Director
01/07/2008 75,672 $1.63 Irwin Kellner Former Director
01/11/2008 10,445 $1.10 Sean P. Downes SVP and COO
01/11/2008 66,316 $0.50 Sean P. Downes SVP and COO
01/11/2008 93,208 $3.80 Sean P. Downes SVP and COO
01/11/2008 14,359 $1.10 James M. Lynch EVP and CFO
01/11/2008 9,861 $0.70 James M. Lynch EVP and CFO
01/11/2008 67,970 $0.50 James M. Lynch EVP and CFO
01/11/2008 7,785 $3.80 James M. Lynch EVP and CFO
01/11/2008 23,135 $0.50 Employee Employee
01/11/2008 6,574 $0.70 Employee Employee
01/11/2008 31,195 $1.00 Employee Employee
01/11/2008 3,064 $1.10 Employee Employee
03/18/2008 31,000 $1.63 Reed J. Slogoff Director
-------------
Total Shares 490,509
18
On April 3, 2000, the Company established the Universal Insurance Holdings, Inc.
Stock Grantor Trust ("SGT") to fund its obligations arising from its various
stock option agreements. The Company funded the SGT with 2,900,000 shares of the
Company's common stock. On both April 11, 2008 and May 7, 2008, the Company's
Board of Directors' Compensation Committee, by unanimous written consent,
released shares from the SGT to satisfy Company obligations to issue stock
options.
During the nine-month period ended September 30, 2008, the Company released from
the SGT shares of restricted common stock pursuant to the exercise of stock
options as follows:
Number of Shares Price per
---------------- ---------
Date Issued Share Name Relation to Company
---- ------ ----- ---- -------------------
04/08/2008 627,422 $0.06 Bradley I. Meier President and CEO
04/08/2008 104,009 $1.63 Bradley I. Meier President and CEO
05/01/2008 54,342 $1.63 Joel M. Wilentz Director
05/01/2008 37,495 $1.63 Reed J. Slogoff Director
05/01/2008 32,977 $1.10 Norman M. Meier Director
05/01/2008 172,671 $1.63 Norman M. Meier Director
------------------
Total Shares 1,028,916
The aggregate number of shares of the Company's common stock released from the
SGT was 1,994,000. Of that total, 1,028,916 shares of common stock were issued
to those individuals exercising stock options and 965,084 shares of common stock
were retained by the Company as treasury shares. The shares retained by the
Company were in payment for the exercise price of certain options and the
satisfaction of statutory tax liability associated with such exercise.
Unless otherwise specified, such as in the case of the exercise of stock options
or warrants, the per share prices were determined using the closing price of the
Company's common stock as quoted on the NYSE Alternext ("Alternext"), formerly
known as the American Stock Exchange, and the shares were issued in private
transactions pursuant to Section 4(2) of the Securities Act of 1933, as amended.
During the nine-month period ended September 30, 2008, the aggregate number of
stock options and warrants exercised was 3,510,000 (1,516,000 newly issued and
1,994,000 released from the SGT). Of that total, 2,038,342 shares of common
stock were issued to those individuals exercising stock options and warrants and
1,471,658 shares of common stock were retained by the Company as treasury
shares. The shares retained by the Company were in payment for the exercise
price of certain options and the satisfaction of statutory tax liability
associated with such exercise.
During the nine-month period ended September 30, 2008, the Company retired
965,084 shares of its common stock held as treasury stock at a cost of
$4,041,705.
9. PROVISION FOR INCOME TAX EXPENSE
Federal and state income taxes decreased 24.1% to $21,096,544 for the nine-month
period ended September 30, 2008 from $27,796,178 for the nine-month period ended
September 30, 2007. Federal and state income taxes were 39.1% of pretax income
for the nine-month period ended September 30, 2008, and 38.9% for the nine-month
period ended September 30, 2007. The decrease in income tax expense is primarily
due to lower income before income taxes.
10. LOANS PAYABLE
On November 9, 2006, UPCIC entered into a $25.0 million surplus note with the
Florida State Board of Administration ("SBA") under the ICBUI Program. Under the
ICBUI Program, which was implemented by the Florida Legislature to encourage
19
insurance companies to write additional residential insurance coverage in
Florida, the SBA matched UPCIC's funds of $25.0 million that were earmarked for
participation in the program. The surplus note brings the current capital and
surplus of UPCIC to approximately $89.2 million. The $25.0 million is invested
in a U.S. treasury money market account.
The surplus note has a twenty-year term and accrues interest at a rate
equivalent to the 10-year U.S. Treasury Bond rate, adjusted quarterly based on
the 10-year Constant Maturity Treasury rate. For the first three years of the
term of the surplus note, UPCIC is required to pay interest only, although
principal payments can be made during this period. Any payment of principal or
interest by UPCIC on the surplus note must be approved by the Commissioner of
the OIR.
In May 2008, the Florida Legislature passed a law providing participants in the
Program an opportunity to amend the terms of their surplus notes based on law
changes. The new law contains methods for calculating compliance with the
writing ratio requirements that might be more favorable to UPCIC than current
law and the terms of the existing surplus note. On November 6, 2008, UPCIC and
the SBA executed an addendum to the surplus note ("the addendum") that reflects
these law changes. The terms of the addendum are effective July 1, 2008. In
addition to other less significant changes, the addendum modifies the
definitions of Minimum Required Surplus, Minimum Writing Ratio, Surplus, and
Gross Written Premium, respectively, as defined in the original surplus note.
Prior to the execution of the addendum, UPCIC was in compliance with each of the
loan's covenants as implemented by rules promulgated by the SBA. UPCIC currently
remains in compliance with each of the loan's covenants as implemented by rules
promulgated by the SBA. An event of default will occur under the surplus note,
as amended, if UPCIC: (i) defaults in the payment of the surplus note; (ii)
drops below a net written premium to surplus of 1:1 for three consecutive
quarters beginning January 1, 2010 and drops below a gross written premium to
surplus ratio of 3:1 for three consecutive quarters beginning January 1, 2010;
(iii) fails to submit quarterly filings to the OIR; (iv) fails to maintain at
least $50 million of surplus during the term of the surplus note, except for
certain situations; (v) misuses proceeds of the surplus note; (vi) makes any
misrepresentations in the application for the program; (vii) pays any dividend
when principal or interest payments are past due under the surplus note; or
(viii) fails to maintain a level of surplus sufficient to cover in excess of
UPCIC's 1-in-100 year probable maximum loss as determined by a hurricane loss
model accepted by the Florida Commission on Hurricane Loss Projection
Methodology as certified by the OIR annually.
The original surplus note provided for increases in interest rates for failure
to meet the Minimum Writing Ratio. Under the terms of the surplus note
agreement, at December 31, 2007, the interest rate on the note was increased by
450 basis points. As of March 31, 2008 and June 30, 2008, respectively, the
additional interest rate on the note was decreased from 450 basis points to 25
basis points. Under the terms of the surplus note, as amended, the net written
premium to surplus requirement and gross written premium to surplus requirement
have been modified. As of September 30, 2008, UPCIC's net written premium to
surplus ratio and gross written premium to surplus ratio were in excess of the
required minimums and, therefore, UPCIC was not subject to increases in interest
rates.
To meet its matching obligation under the ICBUI Program, on November 3, 2006,
the Company entered into a Secured Promissory Note with Benfield Greig
(Holdings), Inc. in the aggregate principal amount of $12 million. Interest on
the note accrued at the rate of 12.75% per annum. The outstanding principal was
due in six monthly installments of $1.5 million and a final seventh monthly
installment of the remaining balance plus all accrued interest under the terms
of the note starting on January 31, 2007 and ending on July 31, 2007. In
connection with the loan, the Company and its subsidiaries appointed Benfield
Inc. as their reinsurance intermediary for all of their reinsurance placements
for the contract year beginning on June 1, 2007. The Company made all payments
in a timely manner and paid the final installment on July 18, 2007. Under the
terms of the Secured Promissory Note, Benfield Greig (Holdings), Inc. agreed to
20
refund a portion of the interest paid on the note if the Company fulfilled all
its material obligations under the related broker agreements. On July 27, 2007,
the Company received a refund of interest from Benfield Greig (Holdings), Inc.
in the amount of $280,500 that reduced the effective interest rate on the note
to 8.25% per annum.
11. COMPANY STOCK REPURCHASE
On June 25, 2008, the Company's Board of Directors authorized the Company to
repurchase up to $3,000,000 of its shares of outstanding common stock. Under the
repurchase program, management was authorized to repurchase shares through
December 31, 2008, with block trades permitted, in open market purchases or in
privately negotiated transactions at prevailing market prices in compliance with
applicable securities laws and other legal requirements. To facilitate
repurchases, the Company made purchases pursuant to a Rule 10b5-1 plan, which
allowed the Company to repurchase its shares during periods when it otherwise
might have been prevented from doing so under insider trading laws. In total,
the Company repurchased 808,900 shares under its repurchase plan at an aggregate
cost of $2,999,788. On August 26, 2008, the Company announced the completion of
the repurchase program.
12. SUBSEQUENT EVENT
On November 5, 2008, the Company's Board of Directors declared a dividend of
$0.20 per share on its outstanding common stock. The dividend is to be paid on
December 17, 2008 to the shareholders of record of the Company at the close of
business on December 2, 2008. The Company expects to pay an aggregate dividend
of approximately $7.4 million.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis by management of the Company's
consolidated financial condition and results of operations should be read in
conjunction with the Company's Condensed Consolidated Financial Statements and
Notes thereto.
FORWARD-LOOKING STATEMENTS
Certain statements made by the Company's management may be considered to be
"forward-looking statements" within the meaning of the Private Securities Reform
Litigation Act of 1995. Forward-looking statements are based on various factors
and assumptions that include known and unknown risks and uncertainties. The
words "believe," "expect," "anticipate," and "project," and similar expressions,
identify forward-looking statements, which speak only as of the date the
statement was made. Such statements may include, but not be limited to,
projections of revenues, income or loss, expenses, plans, as well as assumptions
relating to the foregoing. Forward-looking statements are inherently subject to
risks and uncertainties, some of which cannot be predicted or quantified. Future
results could differ materially from those described in forward-looking
statements as a result of the risks set forth in the following discussion and in
21
the section below entitled "Factors Affecting Operation Results and Market Price
of Stock," among others.
OVERVIEW
The Company is a vertically integrated insurance holding company. The Company,
through its subsidiaries, is currently engaged in insurance underwriting,
distribution and claims. UPCIC generates revenue from the collection and
investment of premiums. The Company's agency operations, which include Universal
Florida Insurance Agency and Coastal Homeowners Insurance Specialists, Inc.,
generate income from commissions. Universal Risk Advisors, Inc., the Company's
managing general agent, generates revenue through policy fee income and other
administrative fees from the marketing of UPCIC's and third-party insurance
products through the Company's distribution network and UPCIC. In addition, the
Company has formed an independent claims adjusting company, Universal Adjusting
Corporation, which adjusts UPCIC claims, and an inspection company, Universal
Inspection Corporation, which performs property inspections for homeowners'
policies underwritten by UPCIC.
Blue Atlantic was incorporated in Florida on November 9, 2007 as a wholly owned
subsidiary of the Company to be a reinsurance intermediary broker. Blue Atlantic
became licensed by the Florida Department of Financial Services as a reinsurance
intermediary broker on January 4, 2008.
The Company acquired all of the outstanding common stock of Atlas, which owned
all of the outstanding common stock of Sterling, from the Company's Chief
Executive Officer and Chief Operating Officer for $50,000, which approximated
Sterling's book value. On March 6, 2008 the Company received approval of this
acquisition from the OIR. Sterling was renamed Atlas Premium Finance Company and
commenced offering premium finance services in November 2007.
UPCIC has applied to write homeowners' insurance policies in five additional
states besides the State of Florida. Those states are Texas, Hawaii, Georgia,
South Carolina and North Carolina. On July 16, 2008, August 18, 2008, and
September 30, 2008, UPCIC was licensed to transact insurance business within the
States of South Carolina, Hawaii, and North Carolina, respectively. The State of
North Carolina Department of Insurance has restricted UPCIC to writing no more
than $12.0 million of direct premiums in each of the first two full calendar
years after which such restriction may be lifted.
UPCIC filed a request with the National Flood Insurance Program ("NFIP") to
become authorized to write and service NFIP's Write Your Own Program ("WYO
Program") flood insurance policies. The WYO Program began in 1983 and is a
cooperative undertaking of the insurance industry and the Federal Emergency
Management Agency (FEMA). The WYO Program allows participating property and
casualty insurance companies to write and service NFIP's Standard Flood
Insurance Policy in their own names. The companies receive an expense allowance
for policies written and claims processed while the federal government retains
responsibility for underwriting losses. The WYO Program operates as part of
NFIP. The Company will not be able to begin writing WYO Program policies until
NFIP initiates its new policy administration and reporting system, which is
currently under development and testing, and the Company demonstrates that it
complies with the new requirements.
The Company filed an application with OIR on June 23, 2008 to open a second
property and casualty subsidiary, Infinity Property and Casualty Insurance
Company ("Infinity"), in the State of Florida. The Company intends for this new
subsidiary to write homeowners, multi peril and inland marine coverage on homes
valued in excess of $1.0 million. UPCIC does not offer limits and coverage to
those risks. Additionally, the Company intends for the new subsidiary to write
excess flood insurance on homes valued in excess of $250,000. On October 1,
2008, the Company signed a consent order agreeing to the terms and conditions
for the issuance of a certificate of authority to Infinity. Final approval and
issuance of the certificate of authority will be granted at such time as the OIR
22
is satisfied Infinity has complied with all provisions of the consent order and
has received related documentation.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management has reassessed the critical accounting policies as disclosed in the
Company's 2007 Annual Report on Form 10-KSB, as amended, and determined that no
changes, additions or deletions are needed to the policies as disclosed. Also
there were no significant changes in the Company's estimates associated with
those policies.
The Company's financial statements are combined with those of its subsidiaries
and are presented on a consolidated basis in accordance with GAAP. UPCIC makes
estimates and assumptions that can have a significant effect on amounts and
disclosures reported in the Company's financial statements. The most significant
estimate relates to the reserves for property and casualty insurance unpaid
losses and loss adjustment expenses. While the Company believes the estimates
are appropriate, the ultimate amounts may differ from the estimates provided.
The Company reviews these estimates on, at least, a quarterly basis and reflects
any adjustment considered necessary in its current results of operations.
ANALYSIS OF FINANCIAL CONDITION - AS OF SEPTEMBER 30, 2008 COMPARED TO DECEMBER
31, 2007
The source of liquidity for possible claim payments consists of the collection
of net premiums after deductions for expenses, reinsurance recoverables and
short-term loans. The Company held cash and cash equivalents at September 30,
2008 and December 31, 2007 of $274,175,693 and $214,745,606, respectively. As of
September 30, 2008, the Company held US Treasury bonds at a book value of
$4,348,590 and a market value of $4,364,794. The US Treasury bonds have gross
unrealized gains of $16,204 and no gross unrealized losses. It is the Company's
intent to hold the bonds to maturity, which will occur at various dates in a one
to five year period. As of December 31, 2007, the Company held no bonds. The
Company has not had, nor does it currently have, any exposure to sub-prime
related holdings.
The Company believes that premiums will be sufficient to meet the Company's
working capital requirements for at least the next twelve months. The Company's
policy is to invest amounts considered to be in excess of current working
capital requirements. At September 30, 2008 and December 31, 2007, the Company's
investments were comprised of $16,542,142 and $176,350,298, respectively, in
cash, $257,633,551 and $38,395,308, respectively, in short-term investments,
$4,348,590 and $0, respectively, in bonds, and $3,419,432 and $3,392,827,
respectively, in real estate consisting of a building purchased by UPCIC that
the Company is currently using as its home office. The Company has transferred
excess funds to U.S. Treasury money market funds from cash accounts to more
conservatively limit its exposure to the volatility in the current banking
environment.
The Company's Property and Equipment, net of accumulated depreciation, increased
to $938,262 as of September 30, 2008 from $874,430 as of December 31, 2007. The
increase was primarily due to the acquisition of automobiles and furniture and
fixtures.
As of September 30, 2008, the Company had a liability for Accounts Payable of
$2,141,253 as compared to $2,972,147 as of year-end 2007. The net decrease in
Accounts Payable is primarily due to a lower liability to vendors as of
September 30, 2008.
23
The Company's liability for Reinsurance Payable increased $31,616,636 to
$65,504,986 during the nine-month period ended September 30, 2008 from
$33,888,350 as of year-end 2007, primarily due to the timing of settlements with
reinsurers.
As of September 30, 2008 and December 31, 2007, respectively, the Company had
overpayments of $5,325,406 and $460,225, which are included in Other
Receivables, due to estimated income tax installment payments exceeding the
Company's provision for Federal and state income taxes. The net increase in the
recoverable balance consisted primarily of the current year provision for income
taxes in the amount of $22,006,536, the tax benefit on the exercise of stock
options in the amount of $5,706,780 and estimated income tax installment
payments of $20,474,740.
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO NINE
MONTHS ENDED SEPTEMBER 30, 2007
Net income decreased 24.8% to $32,879,120 for the nine-month period ended
September 30, 2008 from $43,738,965 for the nine-month period ended September
30, 2007. The Company's earnings per diluted share were $0.81 for the 2008
period versus $1.06 in the same period last year. Even though there was an
increase in the number of homeowners' and dwelling fire insurance policies
serviced by the Company and increases in gross premiums written and earned
during the nine-month period ending September 30, 2008, the Company experienced
a decrease in net income during this period due primarily to increases in ceded
premiums earned and losses and loss adjustment expenses incurred as described
below.
In January 2007, the Florida Legislature passed a law designed to reduce
residential catastrophe reinsurance costs and requiring insurance companies to
offer corresponding rate reductions to policyholders. The new law expanded the
amount of reinsurance available from the FHCF, which is a state-run entity
providing hurricane reinsurance to residential insurers at premiums less than
the private reinsurance market. The Legislature intended for the new law to
reduce residential insurers' reinsurance costs by allowing them to directly
replace some of their private market reinsurance with less costly FHCF
reinsurance. In addition, prices in the private reinsurance market have fallen
as reinsurers have had capital displaced by the expanded FHCF.
UPCIC purchased the maximum additional coverage available to the Company under
the expanded FHCF, allowing UPCIC to maximize its cost savings from the new law.
UPCIC's mid-2007 rate reductions therefore reflected actual reductions in
UPCIC's operating costs. In addition, UPCIC's private reinsurance costs in 2007
and its costs in 2008 are lower than were included in its rates prior to the
2007 legislation.
Florida's Legislature also has implemented strategies to improve the ability of
residential structures to withstand hurricanes. 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. An increasing number of insureds are likely to qualify
for insurance premium discounts as new homes are built and existing homes are
retrofitted. These premium discounts result from homes' reduced vulnerability to
hurricane losses due to the mitigation efforts, which UPCIC takes into account
in its underwriting and profitability models.
Gross premiums written increased 3.4% to $394,304,531 during the nine-month
period ending September 30, 2008 from $381,318,190 in the same period of 2007.
As of September 30, 2008 and December 31, 2007, UPCIC was servicing
approximately 451,000 and 374,000, respectively, homeowners' and dwelling fire
insurance policies with in-force premiums of approximately $519,300,000 and
$504,500,000, respectively.
24
Net premiums earned decreased 8.1% to $109,340,138 for the nine-month period
ended September 30, 2008 from $118,962,837 for the nine-month period ended
September 30, 2007. The decrease is due to an increase in direct premiums earned
(net of previously discussed rate decreases and implementation of wind
mitigation credits) and a proportionally higher increase in ceded premiums
earned related to changes in the reinsurance program as described in Note 4 -
Reinsurance to the Company's unaudited condensed consolidated financial
statements in Part I, Item 1 above.
Net investment income decreased 56.0% to $3,628,472 for the nine-month period
ended September 30, 2008 from $8,241,833 for the nine-month period ended
September 30, 2007. The decrease is primarily due to a lower interest rate
environment during the nine-month period ended September 30, 2008.
Commission revenue increased 29.3% to $20,526,922 for the nine-month period
ended September 30, 2008 from $15,879,099 for the nine-month period ended
September 30, 2007. Commission revenue is comprised principally of the managing
general agent's policy fee income and service fee income on all new and renewal
insurance policies, reinsurance commission sharing agreements, and commissions
generated from agency operations. The increase is primarily attributable to an
increase in reinsurance commission sharing of approximately $2.5 million, and an
increase in managing general agent's policy fee income of approximately $2.1
million.
Other revenue increased 491.4% to $3,658,373 for the nine-month period ended
September 30, 2008 from $618,546 for the nine-month period ended September 30,
2007. The increase is primarily due to fees earned on new payment plans offered
to policyholders by UPCIC. UPCIC was not offering such payment plans during the
2007 period.
Net losses and LAE increased 42.0% to $53,861,445 for the nine-month period
ended September 30, 2008 from $37,939,183 for the nine-month period ended
September 30, 2007. The net loss and LAE ratios, or net losses and LAE as a
percentage of net earned premiums, were 49.3% and 31.9% during the nine-month
periods ended September 30, 2008 and 2007, respectively, and were comprised of
the following components:
Nine months ended September 30, 2008
------------------------------------
Direct Ceded Net
------ ----- ---
Loss and loss adjustment expenses $107,105,622 $53,244,177 $53,861,445
Premiums earned $378,280,937 $268,940,799 $109,340,138
Loss & LAE ratios 28.3% 19.8% 49.3%
Nine months ended September 30, 2007
------------------------------------
Direct Ceded Net
------ ----- ---
Loss and loss adjustment expenses $73,524,183 $35,585,000 $37,939,183
Premiums earned $348,259,639 $229,296,802 $118,962,837
Loss & LAE ratios 21.1% 15.5% 31.9%
The direct loss and LAE ratio for the nine-month period ended September 30, 2008
was 28.3% compared to 21.1% for the nine-month period ended September 30, 2007.
The increase in the direct loss and LAE ratio is attributable to the increase in
direct loss and LAE incurred outpacing the increase in direct earned premium in
the 2008 period.
25
Although total direct premiums earned increased 8.6% in the nine-month 2008
period compared to the same period in 2007, the average premium per policy
decreased significantly due to the previously described rate decreases and wind
mitigation credits. As of September 30, 2008, UPCIC was servicing approximately
451,000 homeowners' and dwelling fire insurance policies with in-force premiums
of approximately $519,300,000, or an average of $1,151 per policy. The
comparable average in-force premium per policy as of September 30, 2007 was
$1,441. Consequently, the direct loss and LAE ratio increased for the 2008
period. However, except for incurred losses and LAE of approximately $5.3
million, or 1.4% of direct earned premium, related to Tropical Storm Fay in the
third quarter of 2008, the Company's loss experience did not vary significantly
during the 2008 period compared to the 2007 period.
The ceded loss and LAE ratio for the nine-month period ended September 30, 2008
was 19.8% compared to 15.5% for the nine-month period ended September 30, 2007.
The ceded loss and LAE ratio was influenced by greater direct incurred loss and
LAE ceded under the Company's quota share reinsurance treaty and higher total
reinsurance costs in the 2008 period compared to the 2007 period. Although
reinsurance costs have decreased, total reinsurance costs are higher as UPCIC
purchased additional coverage in 2008.
Catastrophes are an inherent risk of the property-liability insurance business
which may contribute to material year-to-year fluctuations in UPCIC's and the
Company's results of operations and financial position. During the nine-month
periods ended September 30, 2008 and 2007, respectively, neither UPCIC nor the
Company experienced any catastrophic events. The level of catastrophe loss
experienced in any year cannot be predicted and could be material to the results
of operations and financial position of UPCIC and the Company. While management
believes UPCIC's and the Company's catastrophe management strategies will reduce
the severity of future losses, UPCIC and the Company continue to be exposed to
catastrophic losses, including catastrophic losses that may exceed the limits of
the Company's reinsurance program.
General and administrative expenses decreased 14.3% to $29,316,796 for the
nine-month period ended September 30, 2008 from $34,227,989 for the nine-month
period ended September 30, 2007. The decrease in general and administrative
expenses was due to several factors, including an increase in ceding commissions
due to greater ceded earned premiums, an increase in insurance expense, a
decrease in assessment expense due to increased collections of assessments from
policyholders, and a decrease in executive incentive compensation.
Federal and state income taxes decreased 24.1% to $21,096,544 for the nine-month
period ended September 30, 2008 from $27,796,178 for the nine-month period ended
September 30, 2007. Federal and state income taxes were 39.1% of pretax income
for the nine-month period ended September 30, 2008, and 38.9% for the nine-month
period ended September 30, 2007. The decrease is primarily due to lower income
before income taxes.
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO THREE
MONTHS ENDED SEPTEMBER 30, 2007
Net income decreased 46.6% to $7,372,654 for the three-month period ended
September 30, 2008 from $13,810,702 for the three-month period ended September
30, 2007. The Company's earnings per diluted share were $0.19 for the 2008
period versus $0.33 in the same period last year. Even though there was an
increase in the number of homeowners' and dwelling fire insurance policies
serviced by the Company and gross premiums written and earned during the
three-month period ending September 30, 2008, the Company experienced a decrease
in net income during this period due primarily to increases in ceded premiums
earned and losses and loss adjustment expenses incurred as described below.
26
In January 2007, the Florida Legislature passed a law designed to reduce
residential catastrophe reinsurance costs and requiring insurance companies to
offer corresponding rate reductions to policyholders. The new law expanded the
amount of reinsurance available from the FHCF, which is a state-run entity
providing hurricane reinsurance to residential insurers at premiums less than
the private reinsurance market. The Legislature intended for the new law to
reduce residential insurers' reinsurance costs by allowing them to directly
replace some of their private market reinsurance with less costly FHCF
reinsurance. In addition, prices in the private reinsurance market have fallen
as reinsurers have had capital displaced by the expanded FHCF.
UPCIC purchased the maximum additional coverage available to the Company under
the expanded FHCF, allowing UPCIC to maximize its cost savings from the new law.
UPCIC's mid-2007 rate reductions therefore reflected actual reductions in
UPCIC's operating costs. In addition, UPCIC's private reinsurance costs in 2007
and its costs in 2008 are lower than were included in its rates prior to the
2007 legislation.
Florida's Legislature also has implemented strategies to improve the ability of
residential structures to withstand hurricanes. 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. An increasing number of insureds are likely to qualify
for insurance premium discounts as new homes are built and existing homes are
retrofitted. These premium discounts result from homes' reduced vulnerability to
hurricane losses due to the mitigation efforts, which UPCIC takes into account
in its underwriting and profitability models.
Gross premiums written increased 5.0% to $124,718,631 in the third quarter of
2008 from $118,754,920 in the same period of 2007. As of September 30, 2008 and
December 31, 2007, UPCIC was servicing approximately 451,000 and 374,000,
respectively, homeowners' and dwelling fire insurance policies with in-force
premiums of approximately $519,300,000 and $504,500,000, respectively.
Net premiums earned increased 4.9% to $38,082,888 for the three-month period
ended September 30, 2008 from $36,319,462 for the three-month period ended
September 30, 2007. The increase is due to an increase in direct premiums earned
(net of previously discussed rate decreases and implementation of wind
mitigation credits).
Net investment income decreased 59.9% to $1,109,770 for the three-month period
ended September 30, 2008 from $2,766,754 for the three-month period ended
September 30, 2007. The decrease is primarily due to a lower interest rate
environment during the three-month period ended September 30, 2008.
Commission revenue increased 9.4% to $6,677,703 for the three-month period ended
September 30, 2008 from $6,105,510 for the three-month period ended September
30, 2007. Commission revenue is comprised principally of the managing general
agent's policy fee income and service fee income on all new and renewal
insurance policies, reinsurance commission sharing agreements, and commissions
generated from agency operations. For the three-month period ended September 30,
2008, reinsurance commission sharing was approximately $3.7 million and managing
general agent's policy fee income was approximately $3.0 million.
Other revenue increased 156.7% to $1,304,663 for the three-month period ended
September 30, 2008 from $508,313 for the three-month period ended September 30,
2007. The increase is primarily due to fees earned on new payment plans offered
to policyholders by UPCIC. UPCIC was not offering such payment plans during the
2007 period.
Net losses and LAE increased 80.7% to $23,619,417 for the three-month period
ended September 30, 2008 from $13,072,906 for the three-month period ended
September 30, 2007. The net loss and LAE ratios, or net losses and LAE as a
27
percentage of net earned premiums, were 62.0% and 36.0% during the three-month
periods ended September 30, 2008 and 2007, respectively, and were comprised of
the following components:
Three months ended September 30, 2008
-------------------------------------
Direct Ceded Net
------ ----- ---
Loss and loss adjustment expenses $46,907,087 $23,287,670 $23,619,417
Premiums earned $128,626,371 $90,543,483 $38,082,888
Loss & LAE ratios 36.5% 25.7% 62.0%
Three months ended September 30, 2007
-------------------------------------
Direct Ceded Net
------ ----- ---
Loss and loss adjustment expenses $24,824,146 $11,751,240 $13,072,906
Premiums earned $127,235,717 $90,916,255 $36,319,462
Loss & LAE ratios 19.5% 12.9% 36.0%
The direct loss and LAE ratio for the three-month period ended September 30,
2008 was 36.5% compared to 19.5% for the three-month period ended September 30,
2007. The increase in the direct loss and LAE ratio is attributable to the
increase in direct loss and LAE incurred outpacing the increase in direct earned
premium in the 2008 period.
Total direct premiums earned increased 1.1% in the three-month 2008 period
compared to the same period in 2007. However, the average premium per policy
decreased significantly due to the previously described rate decreases and wind
mitigation credits. As of September 30, 2008, UPCIC was servicing approximately
451,000 homeowners' and dwelling fire insurance policies with in-force premiums
of approximately $519,300,000, or an average of $1,151 per policy. The
comparable average in-force premium per policy as of September 30, 2007 was
$1,441. Consequently, the direct loss and LAE ratio increased significantly for
the 2008 period. However, except for incurred losses and LAE of approximately
$5.3 million, or 4.1% of direct earned premium, related to Tropical Storm Fay in
the third quarter of 2008, the Company's loss experience did not vary
significantly during the 2008 period compared to the 2007 period.
The ceded loss and LAE ratio for the three-month period ended September 30, 2008
was 25.7% compared to 12.9% for the three-month period ended September 30, 2007.
The ceded loss and LAE ratio was influenced by greater direct incurred loss and
LAE ceded under the Company's quota share reinsurance treaty and higher total
reinsurance costs in the 2008 period compared to the 2007 period. Although
reinsurance costs have decreased, total reinsurance costs are higher as UPCIC
purchased additional coverage in 2008.
Catastrophes are an inherent risk of the property-liability insurance business
which may contribute to material year-to-year fluctuations in UPCIC's and the
Company's results of operations and financial position. During the three-month
periods ended September 30, 2008 and 2007, respectively, neither UPCIC nor the
Company experienced any catastrophic events. The level of catastrophe loss
experienced in any year cannot be predicted and could be material to the results
of operations and financial position of UPCIC and the Company. While management
believes UPCIC's and the Company's catastrophe management strategies will reduce
the severity of future losses, UPCIC and the Company continue to be exposed to
catastrophic losses, including catastrophic losses that may exceed the limits of
the Company's reinsurance program.
28
General and administrative expenses decreased 8.4% to $11,832,474 for the
three-month period ended September 30, 2008 from $12,923,516 for the three-month
period ended September 30, 2007. The decrease in general and administrative
expenses was due to several factors, including an increase in ceding commissions
due to greater ceded earned premiums, an increase in insurance expense, and a
decrease in assessment expense due to increased collections of assessments from
policyholders.
Federal and state income taxes decreased 26.2% to $4,350,479 for the three-month
period ended September 30, 2008 from $5,892,915 for the three-month period ended
September 30, 2007. Federal and state income taxes were 37.1% of pre-tax income
for the three-month period ended September 30, 2008, and 29.9% for the
three-month period ended September 30, 2007. The decrease is primarily due to
lower pre-tax income for the three-month period ended September 30, 2008 than
for the same period in 2007, and certain expenses that were not allowed as a tax
deductible expense for the three-month period ended September 30, 2007. The
disallowance had the effect of increasing taxable income and, therefore, income
taxes, during the 2007 period. There were no similar expenses disallowed for
income tax purposes for the three-month period ended September 30, 2008.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
The Company's primary sources of cash flow are the receipt of premiums,
commissions, policy fees, investment income, reinsurance recoverables and short-
term loans.
For the nine-month periods ended September 30, 2008 and 2007, cash flows
provided by operating activities were $73,019,638 and $67,774,126, respectively.
Cash flows from operating activities are expected to be positive in both the
short term and reasonably foreseeable future. In addition, the Company's
investment portfolio is highly liquid as it consists entirely of cash, bonds and
money market accounts.
The Company believes that its current capital resources are sufficient to
support current operations and expected growth for at least twelve months.
On June 25, 2008, the Company's Board of Directors authorized the Company to
repurchase up to $3,000,000 of its shares of outstanding common stock. Under the
repurchase program, management was authorized to repurchase shares through
December 31, 2008, with block trades permitted, in open market purchases or in
privately negotiated transactions at prevailing market prices in compliance with
applicable securities laws and other legal requirements. To facilitate
repurchases, the Company made purchases pursuant to a Rule 10b5-1 plan, which
allowed the Company to repurchase its shares during periods when it otherwise
might have been prevented from doing so under insider trading laws. In total,
the Company repurchased 808,900 shares under its repurchase plan at an aggregate
cost of $2,999,788. On August 26, 2008, the Company announced the completion of
the repurchase program.
COMPANY BORROWINGS
On November 9, 2006, UPCIC entered into a $25.0 million surplus note with the
Florida State Board of Administration ("SBA") under the ICBUI Program. Under the
ICBUI Program, which was implemented by the Florida Legislature to encourage
insurance companies to write additional residential insurance coverage in
Florida, the SBA matched UPCIC's funds of $25.0 million that were earmarked for
participation in the program. The surplus note brings the current capital and
surplus of UPCIC to approximately $89.2 million. The $25.0 million is invested
in a U.S. treasury money market account.
29
The surplus note has a twenty-year term and accrues interest at a rate
equivalent to the 10-year U.S. Treasury Bond rate, adjusted quarterly based on
the 10-year Constant Maturity Treasury rate. For the first three years of the
term of the surplus note, UPCIC is required to pay interest only, although
principal payments can be made during this period. Any payment of principal or
interest by UPCIC on the surplus note must be approved by the Commissioner of
the OIR.
In May 2008, the Florida Legislature passed a law providing participants in the
Program an opportunity to amend the terms of their surplus notes based on law
changes. The new law contains methods for calculating compliance with the
writing ratio requirements that might be more favorable to UPCIC than current
law and the terms of the existing surplus note. On November 6, 2008, UPCIC and
the SBA executed an addendum to the surplus note ("the addendum") that reflects
these law changes. The terms of the addendum are effective July 1, 2008. In
addition to other less significant changes, the addendum modifies the
definitions of Minimum Required Surplus, Minimum Writing Ratio, Surplus, and
Gross Written Premium, respectively, as defined in the original surplus note.
Prior to the execution of the addendum, UPCIC was in compliance with each of the
loan's covenants as implemented by rules promulgated by the SBA. UPCIC currently
remains in compliance with each of the loan's covenants as implemented by rules
promulgated by the SBA. An event of default will occur under the surplus note,
as amended, if UPCIC: (i) defaults in the payment of the surplus note; (ii)
drops below a net written premium to surplus of 1:1 for three consecutive
quarters beginning January 1, 2010 and drops below a gross written premium to
surplus ratio of 3:1 for three consecutive quarters beginning January 1, 2010;
(iii) fails to submit quarterly filings to the OIR; (iv) fails to maintain at
least $50 million of surplus during the term of the surplus note, except for
certain situations; (v) misuses proceeds of the surplus note; (vi) makes any
misrepresentations in the application for the program; (vii) pays any dividend
when principal or interest payments are past due under the surplus note; or
(viii) fails to maintain a level of surplus sufficient to cover in excess of
UPCIC's 1-in-100 year probable maximum loss as determined by a hurricane loss
model accepted by the Florida Commission on Hurricane Loss Projection
Methodology as certified by the OIR annually.
The original surplus note provided for increases in interest rates for failure
to meet the Minimum Writing Ratio. Under the terms of the surplus note
agreement, at December 31, 2007, the interest rate on the note was increased by
450 basis points. As of March 31, 2008 and June 30, 2008, respectively, the
additional interest rate on the note was decreased from 450 basis points to 25
basis points. Under the terms of the surplus note, as amended, the net written
premium to surplus requirement and gross written premium to surplus requirement
have been modified. As of September 30, 2008, UPCIC's net written premium to
surplus ratio and gross written premium to surplus ratio were in excess of the
required minimums and, therefore, UPCIC was not subject to increases in interest
rates.
To meet its matching obligation under the ICBUI Program, on November 3, 2006,
the Company entered into a Secured Promissory Note with Benfield Greig
(Holdings), Inc. in the aggregate principal amount of $12 million. Interest on
the note accrued at the rate of 12.75% per annum. The outstanding principal was
due in six monthly installments of $1.5 million and a final seventh monthly
installment of the remaining balance plus all accrued interest under the terms
of the note starting on January 31, 2007 and ending on July 31, 2007. In
connection with the loan, the Company and its subsidiaries appointed Benfield
Inc. as their reinsurance intermediary for all of their reinsurance placements
for the contract year beginning on June 1, 2007. The Company made all payments
in a timely manner and paid the final installment on July 18, 2007. Under the
terms of the Secured Promissory Note, Benfield Greig (Holdings), Inc. agreed to
refund a portion of the interest paid on the note if the Company fulfilled all
its material obligations under the related broker agreements. On July 27, 2007,
the Company received a refund of interest from Benfield Greig (Holdings), Inc.
in the amount of $280,500 that reduced the effective interest rate on the note
to 8.25% per annum.
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There can be no assurance that the above described transactions will be
sufficient to ensure UPCIC's future compliance with Florida insurance laws and
regulations, or that the Company will be able to maintain profitability. Failure
by UPCIC to maintain the required level of statutory capital and surplus could
result in the suspension of UPCIC's authority to write new or renewal business,
other regulatory actions or ultimately, in the revocation of UPCIC's certificate
of authority by the OIR.
AVAILABLE CASH
The Company held cash and cash equivalents at September 30, 2008 of
$274,175,693. Of that amount, $251,330,244 was held by UPCIC, most of which is
available to pay claims or relates to policyholder surplus. Accordingly, cash
and cash equivalents in UPCIC are not available to buy back Company stock or pay
Company dividends. A portion of those claims paid by the Company would be
recoverable through the Company's catastrophic reinsurance upon presentation to
the reinsurer of evidence of claim payment. As of December 31, 2007, the Company
held cash and cash equivalents of $214,745,606.
GAAP differs in some respects from reporting practices prescribed or permitted
by the OIR. To retain its certificate of authority, the Florida insurance laws
and regulations require that UPCIC maintain capital and surplus equal to the
statutory minimum capital and surplus requirement defined in the Florida
Insurance Code as the greater of 10% of the insurer's total liabilities or
$4,000,000. UPCIC's statutory capital and surplus was $89,171,907 at September
30, 2008 and exceeded the minimum capital and surplus requirements. UPCIC is
also required to adhere to prescribed premium-to-capital surplus ratios.
The maximum amount of dividends, which can be paid by Florida insurance
companies without prior approval of the Commissioner of the OIR, is subject to
restrictions relating to statutory surplus. The maximum dividend that may be
paid by UPCIC to the Company without prior approval is limited to the lesser of
statutory net income from operations of the preceding calendar year or statutory
unassigned surplus as of the preceding year end. Statutory unassigned surplus at
December 31, 2007 was $35,580,159. During the nine-month period ended September
30, 2008, UPCIC declared and paid aggregate dividends to the Company of
$23,000,000.
UPCIC is required annually to comply with the National Association of Insurance
Commissioners' ("NAIC") Risk-Based Capital ("RBC") requirements. RBC
requirements prescribe a method of measuring the amount of capital appropriate
for an insurance company to support its overall business operations in light of
its size and risk profile. NAIC's RBC requirements are used by regulators to
determine appropriate regulatory actions relating to insurers who show signs of
weak or deteriorating condition. As of December 31, 2007, based on calculations
using the appropriate NAIC RBC formula, UPCIC's reported total adjusted capital
was in excess of the requirements.
CASH DIVIDENDS
On April 8, 2008, the Company paid a dividend that was accrued at December 31,
2007, of $0.09 per share on its outstanding common stock. The aggregate amount
of the dividend was $3,329,204. On January 23, 2008, the Company's Board of
Directors declared a dividend of $0.10 per share on its outstanding common
stock. The dividend was paid on August 7, 2008 to stockholders of record as of
July 9, 2008 in the aggregate amount of $3,791,617. On August 15, 2008, the
Company's Board of Directors declared a dividend of $0.10 per share on its
outstanding common stock. The dividend was paid on October 30, 2008 to
stockholders of record as of October 2, 2008 in the aggregate amount of
$3,724,217.
On November 5, 2008, the Company's Board of Directors declared a dividend of
$0.20 per share on its outstanding common stock. The dividend is to be paid on
December 17, 2008 to the shareholders of record of the Company at the close of
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business on December 2, 2008. The Company expects to pay an aggregate dividend
of approximately $7.4 million.
IMPACT OF INFLATION
Property and casualty insurance premiums are established before the Company
knows the amount of loss and LAE and the extent to which inflation may affect
such expenses. Consequently, the Company attempts to anticipate the future
impact of inflation when establishing rate levels. While the Company attempts to
charge adequate rates, the Company may be limited in raising its premium levels
for competitive and regulatory reasons. Inflation also affects the market value
of the Company's investment portfolio and the investment rate of return. Any
future economic changes which result in prolonged and increasing levels of
inflation could cause increases in the dollar amount of incurred loss and LAE
and thereby materially adversely affect future liability requirements.
OFF-BALANCE SHEET ARRANGEMENTS
There were no off-balance sheet arrangements during the nine-month periods ended
September 30, 2008 and 2007, respectively.
CONTRACTUAL OBLIGATIONS
There have been no material changes during the period covered by this Report,
outside of the ordinary course of the Company's business, to the contractual
obligations specified in the table of contractual obligations included in the
section "Management's Discussion and Analysis of Financial Condition and Results
of Operations" included in the Company's Form 10-KSB, as amended for the fiscal
year ended December 31, 2007.
FACTORS AFFECTING OPERATION RESULTS AND MARKET PRICE OF STOCK
The Company and its subsidiaries operate in a rapidly changing environment that
involves a number of uncertainties, some of which are beyond the Company's
control. This report contains, in addition to historical information, forward
looking statements that involve risks and uncertainties. The words "expect,"
"estimate," "anticipate," "believe," "intend," "plan" and similar expressions
and variations thereof are intended to identify forward-looking statements. The
Company's actual results could differ materially from those set forth in or
implied by any forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those
uncertainties discussed below as well as those discussed elsewhere in this
report.
NATURE OF THE COMPANY'S BUSINESS
Factors affecting the sectors of the insurance industry in which the Company
operates may subject the Company to significant fluctuations in operating
results. These factors include competition, catastrophe losses and general
economic conditions including interest rate changes, as well as legislative
initiatives, the regulatory environment, the frequency of litigation, the size
of judgments, severe weather conditions, climate changes or cycles, the role of
federal or state government in the insurance market, judicial or other
authoritative interpretations of laws and policies, and the availability and
cost of reinsurance. Specifically, the homeowners' insurance market, which
comprises the bulk of the Company's current operations, is influenced by many
factors, including state and federal laws, market conditions for homeowners'
insurance and residential plans. Additionally, an economic downturn could result
in fewer home sales and less demand for new homeowners seeking insurance.
32
Historically, the financial performance of the property and casualty insurance
industry has tended to fluctuate in cyclical patterns of soft markets followed
by hard markets. Although an individual insurance company's financial
performance is dependent on its own specific business characteristics, the
profitability of most property and casualty insurance companies tends to follow
this cyclical market pattern.
The Company believes that a substantial portion of its future growth will depend
on its ability, among other things, to successfully implement its business
strategy, including expanding the Company's product offering by underwriting and
marketing additional insurance products and programs through its distribution
network, further penetrating the Florida market by establishing relationships
with additional independent agents in order to expand its distribution network
and to further disperse its geographic risk and expanding into other
geographical areas outside the State of Florida. Any future growth is contingent
on various factors, including the availability of adequate capital, the
Company's ability to hire and train additional personnel, regulatory
requirements, the competitive environment, and rating agency considerations.
There is no assurance that the Company will be successful in expanding its
business, that the existing infrastructure will be able to support additional
expansion or that any new business will be profitable. Moreover, as the Company
expands its insurance products and programs and the Company's mix of business
changes, there can be no assurance that the Company will be able to maintain or
improve its profit margins or other operating results. There can also be no
assurance that the Company will be able to obtain the required regulatory
approvals to offer additional insurance products. UPCIC also is required to
maintain minimum surplus to support its underwriting program. The surplus
requirement affects UPCIC's potential growth.
MANAGEMENT OF EXPOSURE TO CATASTROPHIC LOSSES
UPCIC is exposed to potentially numerous insured losses arising out of single or
multiple occurrences, such as natural catastrophes. As with all property and
casualty insurers, UPCIC expects to and will incur some losses related to
catastrophes and will price its policies accordingly. UPCIC's exposure to
catastrophic losses arises principally out of hurricanes and windstorms. Through
the use of standard industry modeling techniques that are susceptible to change,
UPCIC manages its exposure to such losses on an ongoing basis from an
underwriting perspective. UPCIC also protects itself against the risk of
catastrophic loss by obtaining reinsurance coverage as of the beginning of
hurricane season on June 1 of each year. UPCIC's reinsurance program consists of
excess of loss, quota share and catastrophe reinsurance for multiple hurricanes.
UPCIC's catastrophe reinsurance program currently covers three events, subject
to the terms and limitations of the reinsurance contracts. However, UPCIC may
not buy enough reinsurance to cover multiple storms going forward or be able to
timely obtain reinsurance. In addition, UPCIC is responsible for losses related
to catastrophic events with incurred losses in excess of coverage provided by
UPCIC's reinsurance program and for losses that otherwise are not covered by the
reinsurance program, and such losses could have a material adverse effect on the
business, financial condition and results of operations of UPCIC and the
Company.
RELIANCE ON THIRD PARTIES AND REINSURERS
UPCIC is dependent upon third parties to perform certain functions including,
but not limited to the purchase of reinsurance and risk management analysis.
UPCIC also relies on reinsurers to limit the amount of risk retained under its
policies and to increase its ability to write additional risks. UPCIC's
intention is to limit its exposure and therefore protect its capital, even in
the event of catastrophic occurrences, through reinsurance agreements. For the
2007 hurricane season, UPCIC's reinsurance agreements transferred the risk of
loss in excess of $45,000,000 for the first event and $9,300,000 for the second
and third events up to approximately the 150-year PML as of the beginning of
hurricane season on June 1. These amounts may change in the future. At the start
of hurricane season on June 1, 2008, UPCIC has coverage to approximately the
33
133-year PML. With the additional catastrophe coverage via the new top layer
effective July 1, 2008, UPCIC would have had coverage to approximately the
145-year PML. UPCIC is responsible for losses related to catastrophic events
with incurred losses in excess of coverage provided by UPCIC's reinsurance
program and for losses that otherwise are not covered by the reinsurance
program, which could have a material adverse effect on the Company's business,
financial condition and results of operations should catastrophe losses exceed
these amounts.
REINSURANCE
The property and casualty reinsurance industry is subject to the same market
conditions as the direct property and casualty insurance market, and there can
be no assurance that reinsurance will be available to UPCIC to the same extent
and at the same cost as currently in place for UPCIC. Future increases in
catastrophe reinsurance costs are possible and could adversely affect UPCIC's
results. Reinsurance does not legally discharge an insurer from its primary
liability for the full amount of the risks it insures, although it does make the
reinsurer liable to the primary insurer. Therefore, UPCIC is subject to credit
risk with respect to its reinsurers. In addition, UPCIC obtains a significant
portion of its reinsurance coverage from the FHCF. There is no guaranty the FHCF
will be able to honor its obligations. On October 31, 2008, the Florida State
Board of Administration ("SBA") published its most recent estimate of the FHCF's
loss reimbursement capacity. The SBA estimated that the FHCF's total loss
reimbursement capacity over the next six to twelve months is between $11.786
billion and $13.286 billion. This is significantly less than the estimate in
effect when UPCIC made its FHCF coverage selections for the 2008-2009 contract
year. By law, the FHCF's obligation to reimburse insurers is limited to its
actual claims-paying capacity. In addition, the cost of UPCIC's reinsurance
program may increase should UPCIC deem it necessary to purchase additional
private market reinsurance due to reduced estimates of the FHCF's claims-paying
capacity.
Management evaluates the financial condition of its reinsurers and monitors
concentrations of credit risk arising from similar geographic regions,
activities, or economic characteristics of the reinsurers to minimize its
exposure to significant losses from reinsurer insolvencies. A reinsurer's
insolvency or inability to make payments under a reinsurance treaty could have a
material adverse effect on the financial condition and profitability of UPCIC
and the Company. While ceding premiums to reinsurers reduces UPCIC's risk of
exposure in the event of catastrophic losses, it also reduces UPCIC's potential
for greater profits should such catastrophic events fail to occur. The Company
believes that the extent of UPCIC's reinsurance is typical of a company of its
size in the homeowners' insurance industry.
ADEQUACY OF LIABILITIES FOR LOSSES
The liabilities for losses and loss adjustment expenses periodically established
by UPCIC are estimates of amounts needed to pay reported and unreported claims
and related loss adjustment expenses. The estimates necessarily will be based on
certain assumptions related to the ultimate cost to settle such claims. There is
an inherent degree of uncertainty involved in the establishment of liabilities
for losses and loss adjustment expenses and there may be substantial differences
between actual losses and UPCIC's liabilities estimates. UPCIC relies on
industry data, as well as the expertise and experience of independent actuaries
in an effort to establish accurate estimates and adequate liabilities.
Furthermore, factors such as storms and weather conditions, climate change and
patterns, inflation, claim settlement patterns, legislative activity and
litigation trends may have an impact on UPCIC's future loss experience.
Accordingly, there can be no assurance that UPCIC's liabilities will be adequate
to cover ultimate loss developments. The profitability and financial condition
of UPCIC and the Company could be adversely affected to the extent that its
liabilities are inadequate.
34
UPCIC is directly liable for loss and LAE payments under the terms of the
insurance policies that it writes. In many cases, several years may elapse
between the occurrence of an insured loss and UPCIC's payment of that loss. As
required by insurance regulations and accounting rules, UPCIC reflects its
liability for the ultimate payment of all incurred losses and LAE by
establishing a liability for those unpaid losses and LAE for both reported and
unreported claims, which represent estimates of future amounts needed to pay
claims and related expenses.
When a claim involving a probable loss is reported, UPCIC establishes a
liability for the estimated amount of UPCIC's ultimate loss and LAE payments.
The estimate of the amount of the ultimate loss is based upon such factors as
the type of loss, jurisdiction of the occurrence, knowledge of the circumstances
surrounding the claim, severity of injury or damage, potential for ultimate
exposure, estimate of liability on the part of the insured, past experience with
similar claims and the applicable policy provisions.
All newly reported claims received are set up with an initial average liability.
That claim is then evaluated and the liability is adjusted upward or downward
according to the facts and damages of that particular claim.
In addition, management provides for a liability on an aggregate basis to
provide for losses incurred but not reported. UPCIC utilizes independent
actuaries to help establish its liability for unpaid losses and LAE. UPCIC does
not discount the liability for unpaid losses and LAE for financial statement
purposes.
The estimates of the liability for unpaid losses and LAE are subject to the
effect of trends in claims severity and frequency and are continually reviewed.
As part of this process, UPCIC reviews historical data and considers various
factors, including known and anticipated legal developments, changes in social
attitudes, inflation and economic conditions. As experience develops and other
data becomes available, these estimates are revised, as required, resulting in
increases or decreases to the existing liability for unpaid losses and LAE.
Adjustments are reflected in results of operations in the period in which they
are made and the liabilities may deviate substantially from prior estimates.
Among the classes of insurance underwritten by UPCIC, the homeowners' liability
claims historically tend to have longer time lapses between the occurrence of
the event, the reporting of the claim to UPCIC and the final settlement than do
homeowners' property claims. Liability claims often involve third parties filing
suit and the ensuing litigation. By comparison, property damage claims tend to
be reported in a relatively shorter period of time with the vast majority of
these claims resulting in an adjustment without litigation.
There can be no assurance that UPCIC's liability for unpaid losses and LAE will
be adequate to cover actual losses. If UPCIC's liability for unpaid losses and
LAE proves to be inadequate, UPCIC will be required to increase the liability
with a corresponding reduction in UPCIC's net income in the period in which the
deficiency is identified. Future loss experience substantially in excess of
established liability for unpaid losses and LAE could have a material adverse
effect on UPCIC's and the Company's business, results of operations and
financial condition.
GOVERNMENT REGULATION
Florida insurance companies, such as UPCIC, are subject to regulation and
supervision by the OIR. The OIR has broad regulatory, supervisory and
administrative powers. Such powers relate, among other things, to the granting
and revocation of licenses to transact business; the licensing of agents
(through the Florida Department of Financial Services); the standards of
solvency to be met and maintained; the nature of, and limitations on,
investments; approval of policy forms and rates; review of reinsurance
contracts; periodic examination of the affairs of insurance companies; and the
35
form and content of required financial statements. Such regulation and
supervision are primarily for the benefit and protection of policyholders and
not for the benefit of investors.
In addition, the Florida Legislature and the NAIC from time to time consider
proposals that may affect, among other things, regulatory assessments and
reserve requirements. The Company cannot predict the effect that any proposed or
future legislation or regulatory or administrative initiatives may have on the
financial condition or operations of UPCIC or the Company.
UPCIC will become subject to other states' laws and regulations as it seeks
authority to transact business in states other than Florida. In addition, UPCIC
may be affected by proposals for increased regulatory involvement by the federal
government.
LEGISLATIVE INITIATIVES
The State of Florida operates Citizens to provide insurance to Florida
homeowners in high-risk areas and others without private insurance options. As
of September 30, 2008, there were 1,192,122 Citizens policies in force. In May
2007, the State of Florida passed legislation that freezes property insurance
rates for Citizens customers at December 2006 levels through December 31, 2008
and permits insurance customers to opt into Citizens when the price of a private
policy is 15% more than the Citizens rate, compared to the previous opt-in
threshold of 25%. In May 2008, the Florida Legislature extended a freeze on
Citizens rates through January 2010. These initiatives, together with any future
initiatives that seek to further relax eligibility requirements or reduce
premium rates for Citizens customers, could adversely affect the ability of
UPCIC and the Company to do business profitably. In addition, the Florida
Legislature in 2007 expanded the capacity of the FHCF, with the intent of
reducing the cost of reinsurance otherwise purchased by residential property
insurers. If the expanded FHCF coverage expires or if the law providing for the
expanded coverage is otherwise modified, or if UPCIC purchases additional
private market reinsurance due to reduced estimates of the FHCF's claims-paying
capacity, the cost of UPCIC's reinsurance program may increase, which could
affect UPCIC's profitability until such time as UPCIC can obtain approval of
appropriate rate changes. State and federal legislation relating to insurance is
affected by a number of political and economic factors that are beyond the
control of UPCIC and the Company, and the Florida Legislature and the NAIC from
time to time consider proposals that may affect, among other things, regulatory
assessments and reserve requirements. The Company cannot predict the effect that
any proposed or future legislation or regulatory or administrative initiatives
may have on the financial condition or operations of UPCIC or the Company.
36
PRODUCT PRICING
The rates charged by UPCIC generally are subject to regulatory review and
approval before they may be implemented. UPCIC periodically submits its rate
revisions to regulators as required by law or deemed by the Company and UPCIC to
be necessary or appropriate for UPCIC's business. UPCIC prepares these filings
based on objective data relating to its business and on judgment exercised by
its management or employees and by retained professionals. There is no assurance
that the objective data incorporated in UPCIC's filings based on its past
experience will be reflective of UPCIC's future business. In addition, there is
no assurance that UPCIC's business will develop consistently with the judgments
reflected in its filings. The Company and UPCIC likewise cannot be assured that
regulatory authorities will evaluate UPCIC's data and judgments in the same
manner as UPCIC. UPCIC's filings also might be affected by political or
regulatory factors outside of UPCIC's control, which might result in disapproval
of UPCIC's filings or in negotiated compromises resulting in approved rates that
differ from rates initial filed by UPCIC or that the Company and UPCIC otherwise
would consider more appropriate for its business.
DEPENDENCE ON KEY INDIVIDUALS
UPCIC's operations depend in large part on the efforts of Bradley I. Meier, who
serves as President of UPCIC. Mr. Meier has also served as President, Chief
Executive Officer and Director of the Company since its inception in November
1990. In addition, UPCIC's operations have become materially dependent on the
efforts of Sean P. Downes, who serves as Chief Operating Officer of UPCIC. Mr.
Downes has also served as Chief Operating Officer, Senior Vice President and
Director of the Company since January 2005 and as a Director of UPCIC since May
2003. The loss of the services provided by Mr. Meier or Mr. Downes could have a
material adverse effect on UPCIC's and the Company's financial condition and
results of operations.
COMPETITION
The insurance industry is highly competitive and many companies currently write
homeowners' property and casualty insurance. Additionally, the Company and its
subsidiaries must compete with companies that have greater capital resources and
longer operating histories as well as start-up companies. Increased competition
from other private insurance companies as well as Citizens could adversely
affect the Company's ability to do business profitably. Although the Company's
pricing is inevitably influenced to some degree by that of its competitors,
management of the Company believes that it is generally not in the Company's
best interest to compete solely on price, choosing instead to compete on the
basis of underwriting criteria, its distribution network and high quality
service to its agents and insureds.
FINANCIAL STABILITY RATING
Financial stability ratings are an important factor in establishing the
competitive position of insurance companies and may impact an insurance
company's sales. Demotech, Inc. maintains a letter scale financial stability
rating system ranging from A** (A double prime) to L (licensed by state
regulatory authorities). Demotech, Inc. has assigned UPCIC a financial stability
rating of A, which is two rating levels below the highest level assigned by
Demotech, Inc. According to Demotech, Inc., A ratings are assigned to insurers
that have "exceptional ability to maintain liquidity of invested assets, quality
reinsurance, acceptable financial leverage and realistic pricing while
simultaneously establishing loss and loss adjustment expense reserves at
reasonable levels." With a financial stability rating of A, the Company expects
that UPCIC's property insurance policies will be acceptable to the secondary
mortgage marketplace and mortgage lenders. The rating of UPCIC is subject to at
least annual review by, and may be revised downward by, or revoked at, the sole
discretion of, Demotech, Inc.
37
UPCIC's failure to maintain a commercially acceptable financial stability rating
could have a material adverse effect on the Company's ability to retain and
attract policyholders and agents. Many of the Company's competitors have ratings
higher than that of UPCIC. A downgrade in the financial stability rating of
UPCIC could have an adverse impact on its ability to effectively compete with
other insurers with higher ratings. Additionally, a withdrawal of the rating
could cause UPCIC's insurance policies to no longer be acceptable to the
secondary marketplace and mortgage lenders, which could cause a material adverse
effect of the Company's results of operations and financial position.
Demotech, Inc. bases its ratings on factors that concern policyholders and not
upon factors concerning investor protection. Such ratings are subject to change
and are not recommendations to buy, sell or hold securities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risk generally represents the risk of gain or loss that may
result from the potential change in the fair value of the Company's investment
portfolio as a result of fluctuations in prices, interest rates and, to a lesser
extent, the Company's debt obligations. Other than the Company's purchase of
several US Treasury bonds during the nine-month period ended September 30, 2008,
the Company has maintained approximately the same investment mix from December
31, 2007 to September 30, 2008. As previously described in "Company Borrowings,"
the Company's surplus note accrues interest at an adjustable rate based on the
10-year Constant Maturity Treasury rate.
There have been no material changes to the Company's quantitative and
qualitative market risk exposures from December 31, 2007, as described in the
Company's Form 10-KSB, as amended, through September 30, 2008.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of the
period covered by this report. Based on that evaluation, the Company's Chief
Executive Officer and Chief Financial Officer have concluded that disclosure
controls and procedures were effective as of September 30, 2008 to ensure that
information required to be disclosed by the Company in its reports that it files
or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms. There was no change in the Company's internal controls over financial
reporting that occurred during the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries had any reportable legal
proceedings during the nine-months ended September 30, 2008. Certain claims and
complaints have been filed or are pending against the Company or one or more of
its subsidiaries with respect to various matters. In the opinion of management,
none of these lawsuits is material, and they are adequately provided for or
covered by insurance or, if not so covered, are without any or have little merit
or involve such amounts that if disposed of unfavorably would not have a
38
material adverse effect on the Company or any of its subsidiaries.
ITEM 1A. RISK FACTORS
None.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the nine-month period ended September 30, 2008, the aggregate number of
stock options and warrants exercised was 3,510,000. Of that total, 2,038,342
shares of common stock were issued to those individuals exercising stock options
and warrants and 1,471,658 shares of common stock were retained by the Company
as treasury stock, respectively. The shares retained by the Company were in
payment for the exercise price of certain options and the satisfaction of
statutory tax liability associated with such exercise. Unless otherwise
specified, such as in the case of the exercise of stock options or warrants, the
per share prices were determined using the closing price of the Company's common
stock as quoted on Alternext and the shares were issued in private transactions
pursuant to Section 4(2) of the Securities Act of 1933, as amended.
On June 25, 2008, the Company's Board of Directors authorized the Company to
repurchase up to $3,000,000 of its shares of outstanding common stock. Under the
repurchase program, management is authorized to repurchase shares through
December 31, 2008, with block trades permitted, in open market purchases or in
privately negotiated transactions at prevailing market prices in compliance with
applicable securities laws and other legal requirements. To facilitate
repurchases, the Company made purchases pursuant to a Rule 10b5-1 plan, which
allowed the Company to repurchase its shares during periods when it otherwise
might have been prevented from doing so under insider trading laws. In total,
the Company repurchased 808,900 shares under its repurchase plan at an aggregate
cost of $2,999,788. On August 26, 2008, the Company announced the completion of
the repurchase program. During the three-month period ended September 30, 2008,
the Company repurchased 789,300 shares at a cost of $2,928,671 as follows:
(d) Maximum
Number of
Approximate
(a) Total (c) Total Number of (Dollar Value) of
Number of Shares (or Units) Shares that may
Shares (or (b) Average Purchased as Part of Yet Be Purchased
Units) Price Paid Per Publicly Announced Under the Plans or
Period Purchased Share (or Unit) Plans or Programs Programs
------ --------- --------------- ----------------- --------
July 1-31, 2008 375,900 $3.70 375,900 $ 1,537,870
August 1-31, 2008 413,400 $3.72 413,400 212
September 1-30, 2008 - - - 212
============ ============
Total 789,300 $3.71 789,300 $ 212
============ ===== ============ ============
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
39
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the three-month period ended September 30, 2008, the Company's
stockholders did not vote on any matters.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
Exhibit No. Exhibit
----------- -------
3.1 Registrant's Restated Amended and Restated Certificate of
Incorporation (1)
3.2 Certificate of Designation for Series A Convertible Preferred
Stock dated October 11, 1994 (2)
3.3 Certificate of Designations, Preferences, and Rights of Series M
Convertible Preferred Stock dated August 13, 1997 (3)
3.4 Certificate of Amendment of Amended and Restated Certificate of
Incorporation dated October 19, 1998 (2)
3.5 Certificate of Amendment of Amended and Restated Certificate of
Incorporation dated December 18, 2000 (2)
3.6 Certificate of Amendment of Certificate of Designations of the
Series A Convertible Preferred Stock dated October 29, 2001 (2)
3.7 Certificate of Amendment of Amended and Restated Certificate of
Incorporation dated December 7, 2005 (4)
3.8 Certificate of Amendment of Amended and Restated Certificate of
Incorporation dated May 18, 2007 (4)
3.9 Amended and Restated Bylaws (5)
11.1 Statement Regarding Computation of Per Share Income
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
40
31.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Title 18, United States Code, Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (File No. 33-51546) declared effective on December 14, 1992
(2) Incorporated by reference to the Registrant's Annual Report on Form
10-KSB for the year ended December 31, 2002
(3) Incorporated by reference to the Registrant's Annual Report on Form
10-KSB/A for the year ended April 30, 1997
(4) Incorporated by reference to the Registrant's Quarterly Report on Form
10-QSB for period ended June 30, 2007
(5) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated January 8, 2007
41
SIGNATURES
In accordance with the requirements 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.
UNIVERSAL INSURANCE HOLDINGS, INC.
Date: November 10, 2008 /s/ Bradley I. Meier
----------------------------------------
Bradley I. Meier, President and Chief
Executive Officer
/s/ James M. Lynch
----------------------------------------
James M. Lynch, Chief Financial Officer
42