Description
Filed with the SEC from June 21 to June 27:
Universal Insurance Holdings (UVE)
CEO Bradley Meier decreased his holdings to 13,513,171 shares (33.6%),by selling 1,500,000 shares on June 22 at $3.15 per share via an underwritten offering.
BUSINESS OVERVIEW
THE COMPANY
Universal Insurance Holdings, Inc. (“UIH”) is a Delaware corporation originally incorporated as Universal Heights, Inc. in November 1990. The name was changed to Universal Insurance Holdings, Inc. in January 2001. UIH and its wholly-owned subsidiaries (“we” or the “Company”) have evolved into a vertically integrated insurance company. Our insurance products are offered to our customers through Universal Property & Casualty Insurance Company (“UPCIC”) and American Platinum Property and Casualty Insurance Company (“APPCIC”), (collectively the “Insurance Entities”). Substantially all aspects of insurance underwriting, distribution and claims processing are covered through our subsidiaries. Our principal executive offices are located at 1110 West Commercial Boulevard, Suite 100, Fort Lauderdale, Florida 33309, and our telephone number is (954) 958-1200.
In 1997, we organized a subsidiary, UPCIC, as part of our strategy to take advantage of what management believed to be profitable business and growth opportunities in the residential property and casualty insurance marketplace. UPCIC was formed to participate in the transfer of homeowners’ insurance policies from the Florida Residential Property and Casualty Joint Underwriting Association (“JUA”). UPCIC’s application to become a Florida licensed property and casualty insurance company was filed with the Florida Office of Insurance Regulation (“OIR”) on May 14, 1997 and approved on October 29, 1997. UPCIC’s proposal to begin operations through the acquisition of homeowners’ insurance policies issued by the JUA was approved by the JUA on May 21, 1997, subject to certain minimum capitalization and other requirements.
In September 2006, we initiated the process of acquiring all of the outstanding common stock of Atlas Florida Financial Corporation, which owned all of the outstanding common stock of Sterling Premium Finance Company, Inc. (“Sterling”), from our Chief Executive Officer and Chief Operating Officer for $50,000, which approximated Sterling’s book value. We received approval of the acquisition from the OIR. Sterling has been renamed Atlas Premium Finance Company and commenced offering premium finance services in November 2007.
Blue Atlantic Reinsurance Corporation (“BARC”) was incorporated in Florida on November 9, 2007 as a wholly owned subsidiary of UIH to be a reinsurance intermediary broker. BARC became licensed by the Florida Department of Financial Services as a reinsurance intermediary broker on January 4, 2008.
We filed an application with the OIR on June 23, 2008 to open a second property and casualty insurance subsidiary, Infinity Property and Casualty Insurance Company (“Infinity”), in Florida. Infinity was renamed APPCIC. On October 1, 2008, we signed a consent order agreeing to the terms and conditions for the issuance of a certificate of authority to APPCIC. The final approval and issuance of the certificate of authority was granted by the OIR on December 2, 2008.
INSURANCE BUSINESS
The Florida Insurance Code currently requires that residential property insurers holding a certificate of authority before July 1, 2011, such as our Insurance Entities, maintain capitalization equivalent to the greater of ten percent of the insurer’s total liabilities or $5 million referred to as “minimum capitalization”. The dollar amount for the minimum capitalization is scheduled to increase to $10 million on July 1, 2016 and then to $16 million on July 1, 2021. Both Insurance Entities’ statutory capital and surplus exceeded the minimum capitalization requirements as of December 31, 2011. The Insurance Entities are also required to adhere to prescribed premium-to-capital surplus ratios which were also met as of December 31, 2011.
Our primary product is homeowners’ insurance offered through the Insurance Entities. Our criteria for selecting insurance policies includes, but is not limited to, the use of specific policy forms, coverage amounts on buildings and contents and required compliance with local building codes. Also, to improve underwriting and manage risk, we utilize standard industry modeling techniques for hurricane and windstorm exposure. Approximately 98% of the Insurance Entities’ in-force policies as of December 31, 2011 were policies with coverage including wind risks in the states of Florida, North Carolina, South Carolina, Hawaii and Georgia.
We may consider underwriting other types of policies in the future, subject to approval by the appropriate regulatory authorities. See “Government Regulation and Initiatives,” “Competition” and “Product Pricing” for a discussion of the material regulatory and market factors that may affect the Insurance Entities’ ability to obtain additional policies.
UPCIC is licensed to transact insurance business in Florida, North Carolina, South Carolina, Hawaii, Georgia, Maryland and Massachusetts. The 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. APPCIC is licensed to transact insurance business only in Florida.
Management of Exposure to Catastrophic Losses
The Insurance Entities are exposed to potentially numerous insured losses arising out of single or multiple occurrences, such as natural catastrophes. The Insurance Entities’ exposure to catastrophic losses arises principally out of hurricanes and windstorms. Through the use of standard industry modeling techniques that are susceptible to change, the Insurance Entities manage their exposure to such losses on an ongoing basis from an underwriting perspective. We also continue to actively explore and analyze credible scientific evidence, including the potential impact of global climate change, that may affect the ability to manage exposure under the Insurance Entities’ policies as well as the potential impact of laws and regulations intended to combat climate change.
The Insurance Entities protect themselves against the risk of catastrophic loss by obtaining annual reinsurance coverage as of the beginning of hurricane season on June 1 of each year.
The Insurance Entities rely on reinsurers to limit the amount of risk retained under their policies and to increase their ability to write additional risks. Our intention is to limit the Insurance Entities’ exposure and therefore protect their capital, even in the event of catastrophic occurrences, through reinsurance agreements. The Insurance Entities obtain a significant portion of their reinsurance coverage from the Florida Hurricane Catastrophe Fund (“FHCF”).
Our reinsurance program consists of excess of loss, quota share and catastrophe reinsurance for multiple hurricanes. Our catastrophe reinsurance program is subject to the terms and limitations of the reinsurance contracts and currently covers certain levels of the Insurance Entities’ projected exposure through three catastrophe events. However, we may not buy enough reinsurance to cover multiple storms going forward or be able to timely or cost-effectively obtain reinsurance. The Insurance Entities are responsible for losses related to catastrophic events with incurred losses in excess of coverage provided by our reinsurance program and for losses that otherwise are not covered by the reinsurance program.
UPCIC has historically purchased reinsurance coverage up to and above the 100-year “Probable Maximum Loss” (“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 such as AIR CLASIC/2 and RMS Risk Link, produce loss estimates that are quantified in terms of dollars and probabilities. The Insurance Entities’ PML amounts are modeled using both the AIR CLASIC/2 and RMS Risk Link versions in effect at the date of the calculation. 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. 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. However, as the Insurance Entities write policies throughout the year, the 100-year PML will change. It is possible that the reinsurance in place may not always surpass the 100-year PML at every point in time in one specific model. In addition, modeling results are merely estimates and are subject to various assumptions. Please see “Item 1A. Risk Factors – As a property and casualty insurer, we may face significant losses from catastrophes and severe weather events.”
Although we use what we believe to be widely recognized and, commercially available models to estimate hurricane loss exposure, discrepancies between the assumptions and scenarios utilized in the models and the characteristics of future hurricane events could result in losses that are not covered by the Insurance Entities’ reinsurance program. See “Item 1A. Risk Factors – As a property and casualty insurer, we may face significant losses from catastrophes and severe weather events.”
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. However, see “Item 1A. Risk Factors – Reinsurance subjects us to the credit risk of our reinsurers and may not be adequate to protect us against losses arising from ceded insurance, which could have a material adverse effect on our operating results and financial condition.” While ceding premiums to reinsurers reduces the Insurance Entities’ risk of exposure in the event of catastrophic losses, it also reduces their potential for greater profits in the event that such catastrophic events do not occur. We believe that the extent of our Insurance Entities’ reinsurance is typical of companies similar in size and geographic exposure in the homeowners’ insurance industry.
Liabilities for Losses
The liabilities for losses and loss adjustment expenses (“LAE”) periodically established by the Insurance Entities 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 the Insurance Entities’ liabilities estimates. The inherent degree of uncertainty involved in the establishment of liabilities for losses and loss adjustment expenses can be more pronounced during periods of rapid growth in written premiums such as those experienced by UPCIC in previous years. We rely 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 changes and patterns, inflation, claim settlement patterns, legislative activity and litigation trends may have an impact on the Insurance Entities’ future loss experience.
The Insurance Entities are directly liable for loss and LAE payments under the terms of the insurance policies that they write. In many cases, several years may elapse between the occurrence of an insured loss and the Insurance Entities’ payment of that loss. As required by insurance regulations and accounting rules, the Insurance Entities reflect their 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, the Insurance Entities establish a liability for the estimated amount of their 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 (“IBNR”). We utilize independent actuaries to help establish liabilities for unpaid losses and LAE. We do 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, we review historical data and consider various factors, including known and anticipated legal developments, changes in social attitudes, inflation and economic conditions. As experience develops and other data become 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.
Liability claims historically tend to have longer time lapses between the occurrence of the event, the reporting of the claim to the Insurance Entities and the final settlement than do 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.
Based upon consultations with our independent actuarial consultants and their statement of opinion on losses and LAE, we believe that the liability for unpaid losses and LAE is currently adequate to cover all claims and related expenses which may arise from incidents reported and IBNR. However, if our liability for unpaid losses and LAE proves to be inadequate, we will be required to increase the liability with a corresponding reduction in net income in the period in which the deficiency is identified. Future losses in excess of established liabilities for unpaid losses and LAE could have a material adverse effect on our business, results of operations and financial condition. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Capital Resources.”
Investments
We generate income by investing funds in excess of those retained for claims-paying obligations and insurance operations. We conduct these investment activities through each of the Insurance Entities and UIH. We may retain investment advisors to advise us or manage portions of our overall investment portfolio. Management reports overall investment results to our Board of Directors, at least on a quarterly basis.
We have and expect to continue to actively trade investment securities and other investments to supplement income derived from our insurance operations. Our investment strategy seeks:
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primarily to maximize after-tax investment income; and
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to obtain favorable risk-adjusted real after-tax investment returns to achieve long-term growth of the Insurance Entities’ statutory surplus and consolidated stockholders’ equity.
The investment activities of the Insurance Entities are subject to regulation and supervision by the OIR. See “Government Regulation and Initiatives” below. The Insurance Entities may only make investments that are consistent with regulatory guidelines, and our investment policies for the Insurance Entities correspondingly limit the amount of investment in, among other things, non-investment grade fixed maturity securities (including high-yield bonds) and total investments in preferred stock and common stock. While we seek to appropriately limit the size and scope of investments in the UIH portfolio, UIH is not similarly restricted by Florida law. Therefore, the investments made by UIH may significantly differ from those made by the Insurance Entities. We do not purchase securities on margin. As of December 31, 2011, approximately 84% of our trading portfolio is held by our Insurance Entities and 16% is held by UIH.
We monitor the quality of investments, duration, sector mix and actual and expected investment returns. In addition to compliance with Florida law and regulatory guidelines, investment decision-making is guided in part by general economic conditions as well as management’s projections of cash flows, including the nature and timing of our expected claims payouts in the ordinary course of business and the possibility that we may have unexpected cash demands. We expect that our investment portfolio will consist primarily of domestic, and to a lesser degree foreign, debt and equity securities (including exchange traded funds (“ETFs”) and mutual funds) and, to a much lesser degree, non-hedging derivative securities and physically held precious metals. However, we may, subject to Florida regulations, when applicable, invest a portion of our funds in other asset types, including, without limitation, options, hedging strategies and real estate assets.
The composition of our investment portfolio will change due to market conditions, opportunities and other factors. As of December 31, 2011, the fair value of our consolidated investment portfolio was approximately $403.0 million, comprised of (i) cash equivalents of approximately $303.4 million, (ii) debt securities (generally, U.S government securities obligations and agency securities) of approximately $3.8 million, (iii) equity securities (generally, common stock, ETFs and mutual funds in various sectors) of approximately $95.3 million, (iv) non-hedging derivatives of approximately $0.1 million and (iv) physical metals of approximately $0.4 million. See “Note 3 – INVESTMENTS” in the accompanying notes to our consolidated financial statements in Part II, Item 8 below.
Government Regulation and Initiatives
Florida insurance companies, such as the Insurance Entities, 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 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.
Florida created the Citizens Property Insurance Corporation (“Citizens”) to provide insurance to Florida homeowners in high-risk areas and to others without private insurance options. As of January 31, 2012, there were 1,475,677 Citizens’ policies in force compared to 1,308,857 as of February 28, 2011. In May 2007, Florida passed legislation that froze 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 privately-offered insurance policy is 15% more than the Citizens rate, compared to the previous opt-in threshold of 25%. These initiatives, together with any future initiatives that seek to further relax eligibility requirements or reduce premium rates for Citizens customers, could adversely affect our ability and the ability of Insurance Entities to conduct profitable business. 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. State and federal legislation relating to insurance is affected by a number of political and economic factors that are beyond our control. The Florida Legislature and the National Association of Insurance Commissioners (“NAIC”) from time to time consider proposals that may affect, among other things, regulatory assessments and reserve requirements.
In addition, the Insurance Entities are required to offer wind mitigation discounts in accordance with a program mandated by the Florida Legislature and implemented by the OIR. The level of wind mitigation discounts mandated by the Florida Legislature to be effective June 1, 2007 for new business and August 1, 2007 for renewal business have had a significant negative effect on UPCIC’s premium. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of the impact of wind mitigation discounts on our results of operations.
UPCIC has become and will become subject to other states’ laws and regulations as it has obtained and continues to seek authority to transact business in other states.
Product Pricing
The rates charged by the Insurance Entities generally are subject to regulatory review and approval before they may be implemented. The Insurance Entities periodically submit their rate revisions to regulators as required by law or deemed by us to be necessary or appropriate for the Insurance Entities’ business. We prepare these filings for the Insurance Entities based on objective data relating to their business and on judgment exercised by management and by retained professionals.
The premiums charged by the Insurance Entities to policyholders are affected by legislative enactments and administrative rules, including a state-mandated program requiring residential property insurance companies like ours to provide premium discounts when policyholders verify that insured properties have certain construction features or other windstorm loss reduction features. The level of required premium discounts may exceed the expected reduction in losses associated with the construction features for which the discounts are provided. Although the Insurance Entities may submit rate filings to address any premium deficiencies, those rate filings are subject to regulatory oversight and may not be approved.
For information regarding recent rate filing approvals, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – RECENT DEVELOPMENTS.”
Competition
The insurance industry is highly competitive and many companies currently write homeowners’ property and casualty insurance. Additionally, we must compete with companies that have greater capital resources and longer operating histories. Increased competition from other private insurance companies as well as Citizens could adversely affect our ability to conduct profitable business. In addition, our Financial Stability Rating ® is an important factor in establishing our competitive position and may impact our sales. Although our pricing is inevitably influenced to some degree by that of our competitors, we believe that it is generally not in our best interest to compete solely on price, choosing instead to compete on the basis of underwriting criteria, our distribution network and high quality service to our agents and insureds.
Employees
As of February 9, 2012, we had 271 full-time employees. None of our employees are represented by a labor union. We have employment agreements with Bradley I. Meier, our President and Chief Executive Officer, Sean P. Downes, our Senior Vice President and Chief Operating Officer and George R. De Heer, our Chief Financial Officer. We also have employment agreements with certain employees that do not serve in an executive capacity.
CEO BACKGROUND
Sean P. Downes has been Senior Vice President, Chief Operating Officer and a director of the Company since January 2005. He has served as Chief Operating Officer and a director of Universal Property & Casualty Insurance Company (“UPCIC”), a wholly owned subsidiary of the Company, since July 2003. Mr. Downes was Chief Operating Officer of Universal Adjusting Corporation from July 1999 to July 2003. During that time Mr. Downes created the Company’s claims operation. Before joining the Company in July 1999, Mr. Downes was Vice President of Downes and Associates, a multi-line insurance adjustment corporation.
Mr. Downes has over 23 years of experience in the insurance industry. As an experienced financial and operational leader within the insurance industry, Mr. Downes brings a broad understanding of the strategic priorities and operational demands facing the Company.
Bradley I. Meier has been President, Chief Executive Officer and a director of the Company since its inception in November 1990. He has served as President of UPCIC since its formation in April 1997. In 1990, Mr. Meier graduated with a B.S. in Economics from the Wharton School of Business at the University of Pennsylvania.
Mr. Meier, as the founder of the Company, has a deep understanding of our business and the Florida insurance market. He has navigated numerous challenges, including the global economic downturn and regulatory challenges in the Florida insurance market. As our Chairman, President and Chief Executive Officer, he is a key member of our Board.
Norman M. Meier has been a director of the Company since July 1992 and Secretary of the Company since January 1, 2008. Presently Mr. Meier serves as Executive Chairman of DermWorx Incorporated, a privately held dermatologic specialty pharmaceutical company. From February 2000 until January 2006, Mr. Meier was President and Chief Executive Officer of PharmaMatrix, Inc., a medical marketing and advertising company. From December 1986 until November 1999, Mr. Meier was President, Chief Executive Officer and a director of Columbia Laboratories, Inc., a publicly traded corporation in the pharmaceuticals business. From 1977 until 1986, Mr. Meier served as a consultant to Key Pharmaceuticals. From 1971 to 1977, Mr. Meier was Vice President of Sales and Marketing for Key Pharmaceuticals.
Mr. Meier is an experienced business leader with a broad understanding of the operational, financial and strategic issues facing public companies. This experience gives him valuable knowledge and perspective as a member of our Board.
Michael A. Pietrangelo has been a director of the Company since March 2010. Mr. Pietrangelo has practiced law at Pietrangelo Cook PLC since 1998 and is admitted to the New York, Tennessee and District of Columbia bars. He currently serves on the board of directors of Medicis Pharmaceutical Corporation, an independent specialty pharmaceutical company listed on the New York Stock Exchange (“NYSE”) and the American Parkinson Disease Association, a not-for-profit organization focused on serving the Parkinson’s community. Mr. Pietrangelo currently serves as the managing partner of Theraplex Company LLC, a privately held company. Mr. Pietrangelo currently serves on the board of directors of Surgivision, Inc., a public company now known as MRI Interventions, Inc. From 1994 until 1998, Mr. Pietrangelo served as President of Johnson Products Company, a subsidiary of IVAX Corporation. From 1990 to 1994, Mr. Pietrangelo was the President and Chief Executive Officer of CLEO, Inc., a subsidiary of Gibson Greetings, Inc. and manufacturer of specialized paper products. From 1967 to 1989, he served in a variety of legal and management roles at the Federal Trade Commission, Pfizer, Inc., Schering-Plough Corporation and Western Publishing Group.
Mr. Pietrangelo has valuable experience in corporate governance, legal and financial matters as a result of his participation as a lawyer, executive and director of privately held and public companies as well as non-profit organizations. This experience gives him perspective and knowledge as a member of our Board.
Ozzie A. Schindler has been a director of the Company since January 2007. Mr. Schindler serves as Chairman of the Company’s Audit Committee. Mr. Schindler is a shareholder with the law firm of Greenberg Traurig and specializes in international tax planning. He has an LL.M. in Taxation from New York University School of Law and graduated with honors from the University of Florida School of Law. Mr. Schindler graduated with high honors from the University of Florida Fisher School of Accounting. He is admitted to both the Florida and New York Bars.
Mr. Schindler provides strong legal, regulatory, accounting, financial, risk analysis, internal audit, compliance, corporate governance and administrative skills and experience to our Board.
Reed J. Slogoff has been a director of the Company since March 1997. Mr. Slogoff is currently a principal with Pearl Properties, LLC, a commercial real estate investment firm based in Philadelphia, Pennsylvania. Mr. Slogoff was formerly with Entercom Communications Corp., a publicly traded radio broadcasting company, and was previously a member of the corporate and real estate group of the law firm of Dilworth, Paxson, LLP. Mr. Slogoff received a B.A. with Honors from the University of Pennsylvania in 1990, and a J.D. from the University of Miami School of Law in 1993.
Mr. Slogoff provides valuable insight to our Board as a licensed attorney formerly engaged in private practice and as an experienced businessman in the commercial real estate industry. While practicing law, Mr. Slogoff advised clients on a variety of corporate, securities and finance matters and was involved in the public offering process, including an initial listing on the NYSE, and with other aspects of public company corporate matters.
Over the past approximately 11 years, Mr. Slogoff has been actively engaged in commercial real estate through his ownership and management of Pearl Properties, LLC. His day-to-day responsibilities include a variety of functions such as financial analysis, arranging, negotiating and obtaining financing, sourcing and negotiating acquisitions and managing portfolio insurance coverage. Mr. Slogoff’s responsibility with respect to insurance matters is particularly relevant to our insurance operations. Mr. Slogoff’s experience in addressing complex issues including corporate, finance and insurance matters translates to valuable insight on matters facing growing companies today.
Joel M. Wilentz, M.D. has been a director of the Company since March 1997. Dr. Wilentz is one of the founding members of Dermatology Associates, founded in 1970, and of the Centers for Cosmetic Enhancement in Florida. He is a former member of the Board of Directors of the Neurological Injury Compensation Association (NICA) for the State of Florida. He is a former member of the Board of Directors of the Broward County, Florida Medical Association. He was the former President of the Broward County Dermatological Society. Dr. Wilentz is at present a member of the Board of Governors of Nova Southeastern University.
Dr. Wilentz’s general business acumen and deep understanding of the Florida business, professional and regulatory environment provides independent guidance to our Board on a wide variety of general corporate and strategic matters.
Officers are elected annually by the Board and serve at the discretion of the Board. All directors hold office until the next annual meeting of shareholders or the election and qualification of their successors. The Company has not received director candidate recommendations from the shareholders in the past and does not have a formal policy regarding consideration of such recommendations.
MANAGEMENT DISCUSSION FROM LATEST 10K
OVERVIEW
UIH is a vertically integrated insurance holding company performing all aspects of insurance underwriting, distribution and claims. Through our wholly-owned subsidiaries, including the Insurance Entities, we are principally engaged in the property and casualty insurance business offered primarily through a network of independent agents. Our underwriting criteria includes, but is not limited to, the use of specific policy forms, coverage amounts on buildings and contents and required compliance with local building codes. Also, to improve underwriting and manage risk, we utilize standard industry modeling techniques for hurricane and windstorm exposure. Our primary product is homeowners’ insurance currently offered in five states, including Florida, which represented 98% of the 593 thousand policies-in-force as of December 31, 2011, and 98% of the 584 thousand policies-in-force as of December 31, 2010. Approximately 98% of our policies in force as of December 31, 2011 and 2010 include wind coverage. With respect to geographic distribution of business within Florida as of December 31, 2011, and December 31, 2010, approximately 32% of the wind coverage policies-in-force are in Miami-Dade, Broward and Palm Beach Counties. Risk from catastrophic losses is managed through the use of reinsurance agreements.
We generate revenues primarily from the collection of premiums and the investment of those premiums. Other significant sources of revenue include commissions collected from reinsurers and policy fees.
Investment Portfolio
As discussed under “Item 1. Business – Investments”, we seek to generate income through the investment activities conducted by each of the Insurance Entities and UIH. Our investment strategy is intended to support our overall business strategy and supplement income derived from our insurance underwriting activities. Thus, our operating results are significantly dependent upon the results of our investment portfolio.
For the year ended December 31, 2011, we recorded $14.5 million of net losses on our trading portfolio, compared to $30.6 million of net gains for the year ended December 31, 2010. The losses in our trading portfolio in 2011 reflect a particularly steep decline in the value of our equity securities holdings occurring mostly during the second half of the year. Excluding cash and cash equivalents, at December 31, 2011, $95.3 million, or 96%, of our total trading portfolio was invested in equity securities as compared to $94.4 million, or 42%, at December 31, 2010. The composition of our trading portfolio will change due to market conditions, opportunities, and other factors.
Our results of operations in 2012 will significantly be impacted by our ability to manage our investment portfolio as well as the conditions in the securities and financial markets, particularly as it relates to our investments in equity securities. We expect that our investment portfolio will consist primarily of domestic, and to a lesser degree foreign, debt and equity securities and, to a much lesser degree, non-hedging derivative securities and physically held precious metals. However, we may, subject to Florida regulations applicable to our Insurance Entities, invest a portion of our funds in other asset types.
RECENT DEVELOPMENTS
On January 6, 2011, we declared a cash dividend of $0.10 per share on our outstanding common stock payable on April 7, 2011, to shareholders of record at the close of business on March 11, 2011.
On February 3, 2011, UPCIC received approval for a premium rate increase for its Homeowner’s program within the State of Florida. The premium rate increase averaged approximately 14.9 percent statewide. The effective dates for the rate increase were February 7, 2011 for new business and March 28, 2011 for renewal business.
During the second quarter of 2011, UPCIC completed its 2011-2012 reinsurance program effective June 1, 2011. See “- 2011-2012 Reinsurance Program” below for a description of that program.
On August 15, 2011, we declared a cash dividend of $0.08 per share on our outstanding common stock, payable on October 6, 2011, to shareholders of record at the close of business on September 16, 2011.
On August 17, 2011, we announced that the Georgia Department of Insurance approved the homeowners’ rates and forms of its wholly-owned subsidiary, UPCIC.
On October 28, 2011, UPCIC remitted $45.5 million as a deposit with the Florida Department of Financial Services. In consultation with the OIR, UPCIC has offered to segregate from its general operating funds an amount equivalent to its anticipated future reinsurance premiums under the arrangement with T25 and UPCIC. See “-2011-2012 Reinsurance Program” for further discussion regarding this arrangement.
On November 11, 2011, we announced that APPCIC had written its first homeowners’ insurance policy in Florida. APPCIC received approval of its rate filing from the OIR during the second quarter of 2011. APPCIC currently writes homeowners’ multi-peril and inland marine insurance on Florida homes valued in excess of $1 million, which are limits and coverages currently not targeted through its affiliate, UPCIC.
On November 22, 2011, we announced that UPCIC had written its first homeowners’ insurance policies in Georgia making it the fifth state in which UPCIC conducts business.
On December 5, 2011, we declared a cash dividend of $0.14 per share on our outstanding common stock payable on December 28, 2011, to shareholders of record at the close of business on December 21, 2011.
On January 11, 2012, we announced that UPCIC received approval from the OIR for premium rate increases for its homeowners and Dwelling Fire programs within Florida. The premium rate increases will average approximately 14.9% statewide for its homeowners program and 8.8% for its dwelling fire (“Dwelling Fire”) program. The effective dates for both of the premium rate increases are January 9, 2012 for new business and February 28, 2012 for renewal business.
A forms filing was made immediately after the rate filing to segregate the Sinkhole coverage and to include updated policy language as a result of the property insurance bill which became law in May 2011 (Senate Bill 408). This forms filing is currently pending with the OIR with an expected approval and implementation month of March 2012. With the approval of this forms filing, sinkhole coverage will be removed from certain base homeowners policies and the coverage will be offered via endorsement for an additional surcharge, and a mandatory 10% deductible, to those policyholders that meet the proposed eligibility standards. Revised inspection and eligibility requirements will not be imposed upon existing policyholders who elect to continue sinkhole coverage at their policy renewal.
Sinkhole coverage and form changes for Dwelling Fire were filed at the same time and are similar in nature to those filed for homeowners. Notification requirements for Sinkhole coverage changes, once approved, will dictate the actual effective date for renewal business depending on the date of approval from the OIR. Coverage for catastrophic ground cover collapse will remain a covered peril under all standard policy forms.
On February 22, 2012, we declared a dividend of $0.10 per share on our outstanding common stock payable on April 6, 2012, to shareholders of record at the close of business on March 28, 2012.
Impact of new accounting pronouncement
As discussed below in New Accounting Pronouncements Issued But Not Yet Adopted, we intend to prospectively adopt new accounting guidance in the first quarter of 2012 related to accounting for costs associated with acquiring or renewing insurance contracts. This guidance will result in a reduction of our net deferred policy acquisition costs by approximately 20% to 30%, which will cause us to recognize a material charge against earnings during the first quarter of 2012. This charge represents an acceleration of deferred charges in the period of adoption, which would have ultimately been recognized within a twelve-month period. Thus, our adoption of this new accounting guidance will likely have a material impact on our results of operations in the first quarter of 2012.
Prior year rate increases impacting current results
On October 19, 2009, UPCIC received approval for a premium rate increase for its Homeowner’s program within Florida. The premium rate increase averaged approximately 14.6 percent statewide. The effective dates for the premium rate increase were October 22, 2009 for new business and December 11, 2009 for renewal business. On November 3, 2009, UPCIC received approval for a premium rate increase for its dwelling fire program within Florida. The premium rate increase averaged approximately 14.8 percent statewide. The effective dates for the premium rate increase were November 5, 2009 for new business and December 29, 2009 for renewal business.
2011-2012 Reinsurance Program
In the normal course of business, we limit the maximum net loss that can arise from large risks, risks in concentrated areas of exposure and catastrophes, such as hurricanes or other similar loss occurrences, by reinsuring certain levels of risk in various areas of exposure with other insurers or reinsurers under our reinsurance agreements. See “Item 1 – Management of Exposure to Catastrophic Losses.” Our intention is to limit our exposure and the Insurance Entities’ exposure thereby protecting stockholders’ equity and the Insurance Entities’ capital and surplus, even in the event of catastrophic occurrences, through reinsurance agreements. Without these reinsurance agreements, the Insurance Entities would be more substantially exposed to catastrophic losses with a greater likelihood that those losses could exceed their statutory capital and surplus. Any such catastrophic event, or multiple catastrophes, could have a material adverse effect on the Insurance Entities’ solvency and our results of operations, financial condition and liquidity.
Quota Share
Effective June 1, 2011 through May 31, 2012, UPCIC entered into a quota share reinsurance contract with Everest Re. Everest Re has the following ratings from each of the rating agencies: A+ from A.M. Best Company, A+ from Standard and Poor’s Rating Services and Aa3 from Moody’s Investors Service, Inc. Under the quota share contract, UPCIC cedes 50% of its gross written premiums, losses and LAE for policies with coverage for wind risk with a ceding commission equal to 25% of ceded gross written premiums. In addition, the quota share contract has a limitation for any one occurrence not to exceed $34.8 million (of which UPCIC’s net liability on the first $34.8 million of losses in a first event scenario is $17.4 million, in a second event scenario is $17.4 million and in a third event scenario is $30 million) and a limitation from losses arising out of events that are assigned a catastrophe serial number by the Property Claims Services (“PCS”) office not to exceed $69.6 million. The contract requires UPCIC to reassume 100% of the attritional loss and LAE activity from 30% to 37.5% of gross written premium and has a limitation for LAE not to exceed 30% of indemnity losses paid during the contract period. Further, the contract limits the amount of premium which can be deducted for inuring reinsurance to $288 million, excluding reinstatement premiums, or $326 million, including reinstatement premiums, if any.
Excess Per Risk
Effective June 1, 2011 through May 31, 2012, UPCIC entered into a multiple line excess per risk contract with various reinsurers. Under the multiple line excess per risk contract, UPCIC obtained coverage of $1.4 million in excess of $600 thousand ultimate net loss for each risk and each property loss, and $1 million in excess of $300 thousand for each casualty loss. A $7 million aggregate limit applies to the term of the contract.
Effective June 1, 2011 through May 31, 2012, UPCIC entered into a property per risk excess contract covering ex-wind only policies. Under the property per risk excess contract, UPCIC obtained coverage of $400 thousand in excess of $200 thousand for each property loss. A $2 million aggregate limit applies to the term of the contract.
The total cost of our multiple line excess reinsurance program effective June 1, 2011 through May 31, 2012 is $4 million of which our cost is 50%, or $2 million and the quota share reinsurers’ cost is the remaining 50%. The total cost of our property per risk reinsurance program effective June 1, 2011 through May 31, 2012 is $575 thousand.
Effective October 1, 2011 through May 31, 2012, APPCIC entered into a multiple line excess per risk contract with various reinsurers. Under the multiple line excess per risk contract, APPCIC obtained coverage of $8.4 million in excess of $600 thousand ultimate net loss for each risk and each property loss, and $1 million in excess of $300 thousand for each casualty loss. A $21 million aggregate limit applies to the term of the contract.
The total cost of the APPCIC multiple line excess reinsurance program effective October 1, 2011 through May 31, 2012 is a minimum premium of $31,475, of which our cost is 50% or $15,737 and the quota share reinsurers’ cost is the remaining 50%, which is equated as follows: $25,000 minimum premium on 87.5% of the contract, $75,000 minimum premium on 10% of the contract and $84,000 minimum premium on 2.5% of the contract. The final premium will be determined by applying how much business APPCIC writes during this timeframe based on a predetermined pricing algorithm within the reinsurance contract.
Excess Catastrophe
Effective June 1, 2011 through May 31, 2012, under excess catastrophe contracts, UPCIC obtained catastrophe coverage of $541.3 million in excess of $185 million covering certain loss occurrences including hurricanes. The coverage of $541.3 million in excess of $185 million has a second full limit available to UPCIC. Additional premium is calculated pro rata as to amount and 100% as to time, as applicable.
Effective June 1, 2011 through May 31, 2012, UPCIC purchased reinstatement premium protection which reimburses UPCIC for its cost to reinstate the catastrophe coverage of the first $399.3 million (part of $541.3 million) in excess of $185 million.
Effective June 1, 2011 through May 31, 2012, under an excess catastrophe contract specifically covering risks located in Georgia, North Carolina and South Carolina, UPCIC obtained catastrophe coverage of 50% of $24.8 million in excess of $10 million and 100% of $20 million in excess of $34.8 million covering certain loss occurrences including hurricanes. Both coverages have a second full limit available to UPCIC. Additional premium is calculated pro rata as to amount and 100% as to time, as applicable. The cost of UPCIC’s excess catastrophe contracts specifically covering risks in Georgia, North Carolina and South Carolina is $3.9 million.
The total cost of UPCIC’s multiple line excess and property per risk reinsurance program effective June 1, 2011 through May 31, 2012 is $4.575 million, of which UPCIC’s cost is $2.575 million, and the quota share reinsurer’s cost is the remaining $2.0 million. The total costs of APPCIC’s multiple line excess is at a minimum $31,475, of which APPCIC’s cost is at a minimum $15, 737 and the quota share reinsurer’s cost is the remaining 50%. The total cost of UPCIC’s underlying excess catastrophe contract with T25 (see below) is $111.4 million, subject to a potential return premium of $83.4 million, which is eliminated in consolidation. The total cost of UPCIC’s private catastrophe reinsurance program effective June 1, 2011 through May 31, 2012 is $135.8 million, of which UPCIC’s cost is 50%, or $67.9 million, and the quota share reinsurer’s cost is the remaining 50%. In addition, UPCIC purchases reinstatement premium protection as described above, the cost of which is $22.4 million. UPCIC’s cost of the subsequent catastrophe event excess of loss reinsurance is $19.8 million. The estimated premium that UPCIC plans to cede to the FHCF for the 2011 hurricane season is $73.3 million of which UPCIC’s cost is 50%, or $36.7 million, and the quota share reinsurer’s cost is the remaining 50%. UPCIC is also participating in the additional coverage option for Limited Apportionment Companies or companies that participated in the Insurance Capital Build-Up Incentive Program offered by the FHCF, the premium for which is $5.0 million, of which UPCIC’s cost is 50%, or $2.5 million, and the quota share reinsurer’s cost is the remaining 50%.
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.
UPCIC estimates, based upon its in-force exposures as of December 31, 2011, it had coverage to approximately the 137-year Probable Maximum Loss (PML), modeled using AIR CLASIC/2 v.11.0, long term, without demand surge. Recently, AIR updated its catastrophe model and outlook of risk with the release of its new version, AIR CLASIC/2 v12.04. UPCIC estimates, based on its in-force exposures as of December 31, 2011, that it had coverage to approximately the 94-year PML, modeled using AIR CLASIC/2 v.12.04, long term, without demand surge. Additionally, from time to time, UPCIC uses estimates from other catastrophe modeling vendors to estimate its PML. UPCIC estimates based upon its in-force exposures as of September 30, 2011, that it had coverage to approximately the 131-year PML, modeled using RMS’s new release of its RiskLink model, v11, long term, without loss amplification. PML is a general concept applied in the insurance industry for defining high loss scenarios that should be considered when underwriting insurance risk. Both “loss amplification” and “demand surge” refer to the potential impact of secondary contributors to insured losses arising from catastrophic events. Examples of loss amplification or demand surge include increases in the cost of labor or materials, incremental losses associated with time elapsing between the initial date of loss and the date of repair, claim inflation, and potential coverage ambiguities due to concurrent causes of loss. Catastrophe models produce loss estimates that are quantified 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 137-year, 94-year and 131-year PML represents a 0.80%, 1.06% and 0.76% Annual Probability of Exceedance, respectively, for AIR v11.0, AIR v12.04 and RMS v11). 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.
With the implementation of our 2011-2012 reinsurance program at June 1, 2011, we retained a maximum, pre-tax net liability of $157.6 million as of December 31, 2011 for the first catastrophic event up to $1.781 billion of losses. Refer to the preceding table for information with respect to subsequent catastrophic events coverage. If catastrophic losses result in a net operating loss for the 2011 tax year, we can carry back the net operating loss to the 2010 and 2009 tax years and recover all, or a portion of, income taxes paid in those years.
Separately from the Insurance Entities’ reinsurance programs, UIH protected its own interests against diminution in value due to catastrophe events by purchasing $60 million in coverage via a catastrophe risk- linked transaction contract, effective June 1, 2011 through December 31, 2011. The contract provided for a recovery by UIH in the event of the exhaustion of UPCIC’s catastrophe coverage. The total cost to UIH of the risk-linked transaction contract is $8.7 million.
Segregated Account T25
UIH owns and maintains a segregated account, Segregated Account T25 – Universal Insurance Holdings of White Rock Insurance (SAC) Ltd. (“T25”), established in accordance with Bermuda law. As part of our overall reinsurance program, T25 at times enters into underlying excess catastrophe contracts with the Insurance Entities for the purpose of assuming certain risk for specified loss occurrences, including hurricanes. The agreements between T25 and the Insurance Entities are a cost-effective alternative to reinsurance that the Insurance Entities would otherwise purchase from third-party reinsurers. While we retain the risk that otherwise would be transferred to third party reinsurers, these agreements provide benefits to the Insurance Entities in “no-loss” years that cannot be replicated in the open reinsurance market. These benefits include the return to the Insurance Entities of a substantial portion of the earned reinsurance premiums under the contract. All the related intercompany transactions with respect to these agreements are eliminated in consolidation.
Under the T25 agreement effective June 1, 2011 through May 31, 2012, T25 retained a maximum, pre-tax liability of $140.2 million, in excess of $44.8 million, for the first catastrophic event up to $1.781 billion of losses. The Insurance Entities were required to make premium installment payments aggregating $111.4 million to T25, subject to the terms of the agreement. Through capital contributions made to T25 by UIH, T25 contributes an amount equal to its liability for losses, net of the Insurance Entities’ required premium payments and expenses thereon, to a trust account as collateral. The trust account was funded with the amount of required collateral at the inception of the agreement and invested in a cash reserve fund. The amounts held in the cash reserve fund are included in restricted cash and cash equivalents in our Consolidated Balance Sheets. The collateral held in trust was available to be used to pay any claims that may have arisen from the occurrence of covered events. The collateral was required to be held in trust for the benefit of the Insurance Entities until the occurrence of a covered event or expiration or termination of the agreement between T25 and the Insurance Entities. UIH has no requirement to fund T25 in the event losses exceed the amount of collateral held in trust.
Reinsurance agreements between T25 and the Insurance Entities are generally terminated on or about May 31 and December 31 each year and replaced with similarly structured agreements or with agreements with third party reinsurers effective June 1 and January 1, respectively. The terminations effective May 31 are intended to coordinate and integrate the replacement contracts into the Insurance Entities’ overall reinsurance program and the related changes to limits and retention levels for the subsequent contract year (i.e., June 1 through May 31). The terminations effective December 31 are intended to provide the aforementioned benefit of return premium to the Insurance Entities.
The T25 agreement effective June 1, 2011 through May 31, 2012 was terminated effective December 31, 2011, pursuant to the terms of the agreement. In anticipation of the termination of the agreement, the affiliates agreed to release funds held in trust due to the beneficiary (i.e., the Insurance Entities) during December 2011 and the balance to the grantor (i.e., UIH) in December 2011 and January 2012.
We continually evaluate strategies to more effectively manage our exposure to catastrophe losses, including the maintenance of catastrophic reinsurance coverage. Effective January 1, 2012, the T25 contract was subsequently replaced, at identical limits and retentions as the prior agreement, with an unaffiliated third-party reinsurer as an open market purchase. Effective January 1, 2012 through May 31, 2012, under an excess catastrophe contract, the Insurance Entities obtained catastrophe coverage of $140.2 million, in excess of $44.8 million, covering certain loss occurrences including hurricanes. The total cost of this reinsurance coverage is $4.4 million. In the event of a non-hurricane loss subject to this contract, the Insurance Entities will pay to the reinsurer 20.0% of the ultimate net loss ceded to the reinsurer arising out of such non-hurricane loss. For further discussion of risks associated with our reinsurance programs, see “Item 1A. RISK FACTORS – Reinsurance may be unavailable at current levels and prices, which may limit our ability to write new business.”
Wind Mitigation Discounts
The insurance premiums charged by the Insurance Entities are subject to various statutory and regulatory requirements. Among these, the Insurance Entities must offer wind mitigation discounts in accordance with a program mandated by the Florida Legislature and implemented by the OIR. The level of wind mitigation discounts mandated by the Florida Legislature to be effective June 1, 2007 for new business and August 1, 2007 for renewal business have had a significant negative effect on UPCIC’s premium.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
Universal Insurance Holdings, Inc. (“UIH”) is a vertically integrated insurance holding company performing all aspects of insurance underwriting, distribution and claims. Through our wholly-owned subsidiaries, including Universal Property & Casualty Insurance Company (“UPCIC”) and American Platinum Property and Casualty Insurance Company (“APPCIC”), collectively referred to as the (“Insurance Entities”), we are principally engaged in the property and casualty insurance business offered primarily through a network of independent agents. Our primary product is homeowners’ insurance currently offered in five states, including Florida, which represented 98% of the 584 thousand policies-in-force as of March 31, 2012, and 98% of the 593 thousand policies-in-force as of December 31, 2011. As for the geographic distribution of business within Florida as of March 31, 2012, and December 31, 2011, 30% and 32%, respectively, of the policies-in-force are in Miami-Dade, Broward and Palm Beach Counties. Risk from catastrophic losses is managed through the use of reinsurance agreements.
We generate revenues primarily from the collection of premiums and the investment of funds in excess of those retained for claims-paying obligations and insurance operations. Other significant sources of revenue include commissions collected from reinsurers and policy fees.
2012 Developments
On January 11, 2012, we announced that UPCIC received OIR approval for premium rate increases for its homeowners and Dwelling Fire programs within Florida. The premium rate increases will average approximately 14.9% statewide for its homeowners program and 8.8% statewide for its dwelling fire program. The effective dates for both of the premium rate increases are January 9, 2012 for new business and February 28, 2012 for renewal business.
UPCIC made a forms filing immediately after the rate filing to segregate sinkhole coverage and to include updated policy language as a result of the property insurance bill which became law in May 2011 (Senate Bill 408). The OIR approved the forms filing with effective dates of April 1, 2012 for new business and May 21, 2012 for renewals. With the approval of this forms filing, sinkhole coverage will be removed from certain base homeowners policies and the coverage will be offered via endorsement for an additional surcharge, and a mandatory 10% deductible, to those policyholders that meet the proposed eligibility standards. Revised inspection and eligibility requirements will not be imposed upon existing policyholders who elect to continue sinkhole coverage at their policy renewal. Form changes for sinkhole coverage on dwelling fire policies, which are similar in nature to those filed for homeowners policies, were approved by the OIR with effective dates of May 1, 2012 for new business and June 8, 2012 for renewal business. Coverage for catastrophic ground cover collapse will remain a covered peril under all standard policy forms.
On February 22, 2012, we declared a dividend of $0.10 per share on our outstanding common stock payable on April 6, 2012, to shareholders of record at the close of business on March 28, 2012.
On April 17, 2012, Demotech, Inc. affirmed UPCIC’s Financial Stability Rating ® of A. A Financial Stability Rating ® of A is the third highest of six possible rating levels. According to Demotech, Inc., A ratings are assigned to insurers that have “…exceptional ability to maintain liquidity of invested assets, quality reinsurance, acceptable financial leverage and realistic pricing while simultaneously establishing loss and loss adjustment expense reserves at reasonable levels.” The rating of UPCIC is subject to at least annual review by, and may be revised upward or downward or revoked at the sole discretion of Demotech, Inc.
On April 23, 2012, we declared a dividend of $0.08 per share on our outstanding common stock payable on July 9, 2012, to shareholders of record at the close of business on June 26, 2012. We expect to declare additional quarterly dividends in the same amount to shareholders of record in the third and fourth quarters of 2012. Declaration and payment of future dividends is subject to the discretion of UIH’s board of directors and will be dependent on future earnings, cash flows, financial requirements and other factors.
Impact of new accounting pronouncement
We prospectively adopted new accounting guidance related to accounting for costs associated with acquiring or renewing insurance contracts effective January 1, 2012. The overall impact under the new guidance, which was adopted on January 1, 2012, was a reduction in earnings of $2.7 million ($1.7 million after tax or $0.04 per diluted share). The $2.7 million pre-tax reduction in earnings during the three months ended March 31, 2012, includes an acceleration of capitalized costs existing as of December 31, 2011, which would have been amortized to earnings within a twelve-month period, and the immediate recognition of costs which otherwise would have been deferred, partially offset by a lesser amount of amortization expense due to the reduction in capitalized costs. The new guidance does not result in incremental charges to earnings, but rather affects the timing of the recognition of those charges in the income statement.
2011-2012 Reinsurance Program
In the normal course of business, we limit the maximum net loss that can arise from large risks, risks in concentrated areas of exposure and catastrophes, such as hurricanes or other similar loss occurrences, by reinsuring certain levels of risk in various areas of exposure with other insurers or reinsurers under our reinsurance agreements. Our intention is to limit our exposure and the Insurance Entities’ exposure thereby protecting stockholders’ equity and the Insurance Entities’ capital and surplus, even in the event of catastrophic occurrences, through reinsurance agreements. Without these reinsurance agreements, the Insurance Entities would be more substantially exposed to catastrophic losses with a greater likelihood that those losses could exceed their statutory capital and surplus. Any such catastrophic event, or multiple catastrophes, could have a material adverse effect on the Insurance Entities’ solvency and our results of operations, financial condition and liquidity.
Quota Share
Effective June 1, 2011 through May 31, 2012, UPCIC entered into a quota share reinsurance contract with Everest Re. Everest Re has the following ratings from each of the rating agencies: A+ from A.M. Best Company, A+ from Standard and Poor’s Rating Services and Aa3 from Moody’s Investors Service, Inc. Under the quota share contract, UPCIC cedes 50% of its gross written premiums, losses and LAE for policies with coverage for wind risk with a ceding commission equal to 25% of ceded gross written premiums. In addition, the quota share contract has a limitation for any one occurrence not to exceed $34.8 million (of which UPCIC’s net liability on the first $34.8 million of losses in a first event scenario is $17.4 million, in a second event scenario is $17.4 million and in a third event scenario is $30 million) and a limitation from losses arising out of events that are assigned a catastrophe serial number by the Property Claims Services (“PCS”) office not to exceed $69.6 million. The contract requires UPCIC to reassume 100% of the attritional loss and LAE activity from 30% to 37.5% of gross written premium and has a limitation for LAE not to exceed 30% of indemnity losses paid during the contract period. Further, the contract requires UPCIC to purchase and maintain certain inuring reinsurance agreements. The contract limits the amount of reinsurance premiums inuring to the contract to $288 million excluding reinstatement premiums, and limits the total reinsurance premiums inuring to the contract to $326 million including any reinstatement premiums and all ancillary payments under the inuring reinsurance agreements.
Excess Per Risk
Effective June 1, 2011 through May 31, 2012, UPCIC entered into a multiple line excess per risk contract with various reinsurers. Under the multiple line excess per risk contract, UPCIC obtained coverage of $1.4 million in excess of $600 thousand ultimate net loss for each risk and each property loss, and $1 million in excess of $300 thousand for each casualty loss. A $7 million aggregate limit applies to the term of the contract.
Effective June 1, 2011 through May 31, 2012, UPCIC entered into a property per risk excess contract covering ex-wind only policies. Under the property per risk excess contract, UPCIC obtained coverage of $400 thousand in excess of $200 thousand for each property loss. A $2 million aggregate limit applies to the term of the contract.
The total cost of our multiple line excess reinsurance program effective June 1, 2011 through May 31, 2012 is $4 million of which our cost is 50%, or $2 million and the quota share reinsurers’ cost is the remaining 50%. The total cost of our property per risk reinsurance program effective June 1, 2011 through May 31, 2012 is $575 thousand.
Effective October 1, 2011 through May 31, 2012, APPCIC entered into a multiple line excess per risk contract with various reinsurers. Under the multiple line excess per risk contract, APPCIC obtained coverage of $8.4 million in excess of $600 thousand ultimate net loss for each risk and each property loss, and $1 million in excess of $300 thousand for each casualty loss. A $21 million aggregate limit applies to the term of the contract.
The total cost of the APPCIC multiple line excess reinsurance program effective October 1, 2011 through May 31, 2012 is a minimum premium of $31,475, of which our cost is 50% or $15,737 and the quota share reinsurers’ cost is the remaining 50%, which is equated as follows: $25,000 minimum premium on 87.5% of the contract, $75,000 minimum premium on 10% of the contract and $84,000 minimum premium on 2.5% of the contract. The final premium will be determined based upon APPCIC’s volume of business during the contract term and a predetermined pricing algorithm.
Excess Catastrophe
Effective June 1, 2011 through May 31, 2012, under excess catastrophe contracts, UPCIC obtained catastrophe coverage of $541.3 million in excess of $185 million covering certain loss occurrences including hurricanes. The coverage of $541.3 million in excess of $185 million has a second full limit available to UPCIC. Additional premium is calculated pro rata as to amount and 100% as to time, as applicable.
Effective June 1, 2011 through May 31, 2012, UPCIC purchased reinstatement premium protection which reimburses UPCIC for its cost to reinstate the catastrophe coverage of the first $399.3 million (part of $541.3 million) in excess of $185 million.
Effective June 1, 2011 through May 31, 2012, under an excess catastrophe contract specifically covering risks located in Georgia, North Carolina and South Carolina, UPCIC obtained catastrophe coverage of 50% of $24.8 million in excess of $10 million and 100% of $20 million in excess of $34.8 million covering certain loss occurrences including hurricanes. Both coverages have a second full limit available to UPCIC. Additional premium is calculated pro rata as to amount and 100% as to time, as applicable. The cost of UPCIC’s excess catastrophe contracts specifically covering risks in Georgia, North Carolina and South Carolina is $3.9 million.
Also at June 1, 2011, the FHCF made available, and UPCIC obtained, $10.0 million 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, such as UPCIC. This particular layer of coverage at June 1, 2011 is $10.0 million in excess of $34.8 million. The premium for this coverage is $5.0 million.
On October 28, 2011, the SBA published its most recent estimate of the FHCF’s loss reimbursement capacity in the Florida Administrative Weekly . The SBA estimated that the FHCF’s total loss reimbursement capacity under current market conditions for the 2011 – 2012 contract year is projected to be $15.17 billion over the 12-month period following the estimate. The SBA also referred to its report entitled, “October 18, 2011 Estimated Claims Paying Capacity Report” (“Report”) as providing greater detail regarding the FHCF’s loss reimbursement capacity. The Report estimated that the FHCF’s loss reimbursement capacity range is $12.17 billion to $18.17 billion. UPCIC elected to purchase the FHCF Mandatory Layer of Coverage for the 2011 – 2012 contract year, which corresponds to FHCF loss reimbursement capacity of $17 billion. By law, the FHCF’s obligation to reimburse insurers is limited to its actual claims-paying capacity. The aggregate 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 loss reimbursement capacity. Fortunately, no hurricanes made landfall in Florida during the 2011-2012 contract year and no reimbursement payments for the 2011-2012 contract year were required from the FHCF to participating companies. Accordingly, the effect of the change in the FHCF’s reimbursement capacity estimate as compared to prior estimates had no effect on our financial position, results of operations and liquidity. In the 2012 Florida legislative session, the FHCF advocated a statutory change that would have reduced the amount of reimbursement capacity made available to the insurance industry in future years. However, the proposal did not pass.
The total cost of UPCIC’s multiple line excess and property per risk reinsurance program effective June 1, 2011 through May 31, 2012 is $4.575 million, of which UPCIC’s cost is $2.575 million, and the quota share reinsurer’s cost is the remaining $2.0 million. The total costs of APPCIC’s multiple line excess is at a minimum $31,475, of which APPCIC’s cost is at a minimum $15,737 and the quota share reinsurer’s cost is the remaining 50%. The total cost of UPCIC’s underlying excess catastrophe contract with T25 (see below) is $111.4 million, subject to a potential return premium of $83.4 million, which is eliminated in consolidation. The total cost of UPCIC’s private catastrophe reinsurance program effective June 1, 2011 through May 31, 2012 is $135.8 million, of which UPCIC’s cost is 50%, or $67.9 million, and the quota share reinsurer’s cost is the remaining 50%. In addition, UPCIC purchases reinstatement premium protection as described above, the cost of which is $22.4 million. UPCIC’s cost of the subsequent catastrophe event excess of loss reinsurance is $19.8 million. The estimated premium that UPCIC plans to cede to the FHCF for the 2011 hurricane season is $73.3 million of which UPCIC’s cost is 50%, or $36.7 million, and the quota share reinsurer’s cost is the remaining 50%. UPCIC is also participating in the additional coverage option for Limited Apportionment Companies or companies that participated in the Insurance Capital Build-Up Incentive Program offered by the FHCF, the premium for which is $5.0 million, of which UPCIC’s cost is 50%, or $2.5 million, and the quota share reinsurer’s cost is the remaining 50%.
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.
UPCIC estimates, based upon its in-force exposures as of December 31, 2011, it had coverage to approximately the 137-year Probable Maximum Loss (PML), modeled using AIR CLASIC/2 v.11.0, long term, without demand surge. Recently, AIR updated its catastrophe model and outlook of risk with the release of its new version, AIR CLASIC/2 v12.04. UPCIC estimates, based on its in-force exposures as of December 31, 2011, that it had coverage to approximately the 94-year PML, modeled using AIR CLASIC/2 v.12.04, long term, without demand surge. Additionally, from time to time, UPCIC uses estimates from other catastrophe modeling vendors to estimate its PML. UPCIC estimates based upon its in-force exposures as of September 30, 2011, that it had coverage to approximately the 131-year PML, modeled using RMS’s new release of its RiskLink model, v11, long term, without loss amplification. PML is a general concept applied in the insurance industry for defining high loss scenarios that should be considered when underwriting insurance risk. Both “loss amplification” and “demand surge” refer to the potential impact of secondary contributors to insured losses arising from catastrophic events. Examples of loss amplification or demand surge include increases in the cost of labor or materials, incremental losses associated with time elapsing between the initial date of loss and the date of repair, claim inflation, and potential coverage ambiguities due to concurrent causes of loss. Catastrophe models produce loss estimates that are quantified 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 137-year, 94-year and 131-year PML represents a 0.80%, 1.06% and 0.76% Annual Probability of Exceedance, respectively, for AIR v11.0, AIR v12.04 and RMS v11). 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.
With the implementation of our 2011-2012 reinsurance program at June 1, 2011, we retained a maximum, pre-tax net liability of $157.6 million as of December 31, 2011 for the first catastrophic event up to $1.781 billion of losses. Refer to the preceding table for information with respect to subsequent catastrophic events coverage. If catastrophic losses result in a net operating loss for the 2011 tax year, we can carry back the net operating loss to the 2010 and 2009 tax years and recover all, or a portion of, income taxes paid in those years.
Separately from the Insurance Entities’ reinsurance programs, UIH protected its own interests against diminution in value due to catastrophe events by purchasing $60 million in coverage via a catastrophe risk-linked transaction contract, effective June 1, 2011 through December 31, 2011. The contract provided for a recovery by UIH in the event of the exhaustion of UPCIC’s catastrophe coverage. The total cost to UIH of the risk-linked transaction contract is $8.7 million.
We continually evaluate strategies to more effectively manage our exposure to catastrophe losses, including the maintenance of catastrophic reinsurance coverage. The Company is currently in the process of renegotiating its 2012-2013 reinsurance program. Based on current discussions, the Company does not expect that the terms of the 2012-2013 reinsurance program will differ materially from the 2011-2012 reinsurance program, but there can be no assurance that the Company will be able to obtain reinsurance at the same levels, terms or price as the 2011-2012 program.
Termination of Agreements with Segregated Account T25
Effective January 1, 2012, the agreement between the Insurance Entities and UIH’s Segregated Account T25 – Universal Insurance Holdings of White Rock Insurance (SAC) Ltd. (“T25”) was replaced at identical limits and retentions as the prior agreement with an unaffiliated third-party reinsurer as an open market purchase. Effective January 1, 2012 through May 31, 2012, under an excess catastrophe contract, the Insurance Entities obtained catastrophe coverage of $140.2 million in excess of $44.8 million covering certain loss occurrences including hurricanes. The total cost of this reinsurance coverage is $4.4 million. In the event of a non-hurricane loss subject to this contract, the Insurance Entities will pay to the reinsurer 20.0% of the ultimate net loss ceded to the reinsurer arising out of such non-hurricane loss.
Wind Mitigation Discounts
The insurance premiums charged by the Insurance Entities are subject to various statutory and regulatory requirements. Among these, the Insurance Entities must offer wind mitigation discounts in accordance with a program mandated by the Florida Legislature and implemented by the OIR. The level of wind mitigation discounts mandated by the Florida Legislature to be effective June 1, 2007 for new business and August 1, 2007 for renewal business have had a significant negative effect on our premium.
Liquidity and Capital Resources
Liquidity
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet its short and long-term obligations. Funds generated from operations have generally been sufficient to meet our liquidity requirements and we expect that in the future funds from operations will continue to meet such requirements.
The balance of cash and cash equivalents as of March 31, 2012 was $326 million compared to $229.7 million at December 31, 2011. See our Condensed Consolidated Statements of Cash Flows for a reconciliation of the balance of cash and cash equivalent between March 31, 2012 and December 31, 2011. Most of this amount is available to pay claims in the event of a catastrophic event pending reimbursement amounts recoverable under reinsurance agreements. The source of liquidity for possible claim payments consists of the collection of net premiums after deductions for expenses, reinsurance recoverables and short-term loans.
The balance of restricted cash and cash equivalents as of March 31, 2012 was $48.2 million. Restricted cash as of March 31, 2012 is mostly comprised of cash equivalents on deposit with regulatory agencies in the various states in which our Insurance Entities do business.
The Company’s liquidity requirements primarily include potential payments of catastrophe losses, the payment of dividends to shareholders, and interest and principal payments on debt obligations. The declaration and payment of future dividends to shareholders will be at the discretion of our Board of Directors and will depend upon many factors, including our operating results, financial condition, capital requirements and any regulatory constraints.
Our insurance operations provide liquidity in that premiums are generally received months or even years before losses are paid under the policies sold. Historically, cash receipts from operations, consisting of insurance premiums, commissions, policy fees and investment income, have provided more than sufficient funds to pay loss claims and operating expenses. We maintain substantial investments in highly liquid, marketable securities. Liquidity can also be generated by funds received upon the sale of marketable securities in our investment portfolio.
Effective July 1, 2010, we elected to classify our securities investment portfolio as trading. Accordingly, purchases and sales of investment securities are included in cash flows from operations beginning July 1, 2010. We generated $95.3 million in cash from operations during the three months ended March 31, 2012, compared to $ 119.8 million of cash generated by operating activities for the three months ended March 31, 2011. The generation of cash during the three months ended March 31, 2012 reflects proceeds from sales of investment securities, net of purchases, of $12.4 million, compared to $71.2 million during the three months ended March 31, 2011.
The Insurance Entities are responsible for losses related to catastrophic events with incurred losses in excess of coverage provided by the Insurance Entities’ reinsurance programs and for losses that otherwise are not covered by the reinsurance programs, which could have a material adverse effect on either the Insurance Entities’ or our business, financial condition, results of operations and liquidity (see 2011-2012 Reinsurance Program above for a discussion of the 2011-2012 reinsurance program).
Capital Resources
Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks and facilitate continued business growth. At March 31, 2012, we had total capital of $177.9 million, comprised of stockholders’ equity of $156.6 million and total debt of $21.3 million. Our debt-to-total-capital ratio and debt-to-equity ratio were 12% and 13.6%, respectively, at March 31, 2012. At December 31, 2011, we had total capital of $171.7 million, comprised of stockholders’ equity of $150 million and total debt of $21.7 million. Our debt-to-total-capital ratio and debt-to-equity ratio were 12.6% and 14.5%, respectively, at December 31, 2011.
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Fund Letters
