ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
General
Unico American Corporation, referred to herein as the “Company” or “Unico,” is an insurance holding company. The Company’s subsidiary Crusader Insurance Company (“Crusader”) has historically underwritten commercial property and casualty insurance, the Company’s subsidiaries Unifax Insurance Systems, Inc. (“Unifax”) and American Insurance Brokers, Inc. (“AIB”) provided marketing and still provides various underwriting support services related to property, casualty, health and life insurance, the Company’s subsidiary AAC provided insurance premium financing, and the Company’s subsidiary Insurance Club, Inc., dba AAQHC (“AAQHC”), an Administrator provides membership association services.
This overview discusses some of the relevant factors that management considers in evaluating the Company’s performance, prospects, and risks. It is not all-inclusive and is meant to be read in conjunction with the entirety of the management discussion and analysis, the Company’s consolidated financial statements and notes thereto, and all other items contained within the Company’s 2020 Annual Report on Form 10-K as filed with the Securities and Exchange Commission.
Total revenues for the three months ended September 30, 2021, were $8,595,648 compared to $8,259,686 for the three months ended September 30, 2020, an increase of $335,962 (4%). Total revenues for the nine months ended September 30, 2021, were $28,199,908 compared to $24,241,094 for the nine months ended September 30, 2020, an increase of $3,958,814 (16%). The increase in revenues was primarily due to an increase in policies written in the Transportation line of business. The Company had a net loss of $2,510,198 for the three months ended September 30, 2021, compared to a net loss of $17,940,488 for the three months ended September 30, 2020, a decrease in net loss of $15,430,290 (91%). The Company had a net loss of $1,649,305 for the nine months ended September 30, 2021, compared to a net loss of $19,419,128 for the nine months ended September 30, 2020, a decrease in net loss of $17,769,823 (85%). On February 12, 2021, the Company, through Crusader, completed the sale of the Company’s headquarters at 26050 Mureau Road, Calabasas, California 91302, for $12,695,000 which netted $12,028,876 (the “Sale”). The Company recognized a gain of $3,693,858 on the sale of the building in 2021. The large decrease in net loss from 2020 compared to 2021 was due to the substantial increase in IBNR as described in the Form 10-K for the year ended December 31, 2020, which generated a majority of the loss.
In connection with the Company’s previously announced review of strategic alternatives, during the quarter ended September 30, 2021, Unico took actions to cause Crusader to enter into runoff. In connection with its runoff, Crusader began to cease writing new and renewal business and to wind down operations that support the writing of insurance policies. Effective September 30, 2021, Crusader ceased writing any new insurance policies and will no longer renew policies after December 8, 2021. Crusader has issued notices of non-renewal for its existing in-force policies to terminate such policies at the expiration of the current policy periods. Such notices of non-renewal are sent to policyholders in the time frame required by state insurance laws and regulations. Crusader continues to provide services to existing insurance policyholders and claimants during its runoff. Actions to wind down operations that support the writing of new insurance policies and the issuance of renewal insurance policies began immediately, and the servicing operations will be adjusted over time to support business requirements including the retention of the necessary staff. During the quarter ended September 30, 2021, Unico also discontinued its premium financing operations formerly conducted through AAC.
Going Concern
Based on Unico’s current cash and short‑term investments at September 30, 2021, as well as the other factors described herein, there is substantial doubt that Unico will have sufficient cash to meet its operating and other liquidity requirements when they become due during the next twelve months from the date of issuance of the accompanying condensed consolidated financial statements.
During the quarter ended September 30, 2021, Unico’s liquidity position continued to deteriorate. As an insurance holding company, Unico does not independently generate significant revenue, and is dependent on dividends and other cash distributions from Crusader and its other subsidiaries to fund its operations and expenses. Historically, Unico generally received dividends periodically from Crusader, but does not expect to receive any such dividends for the foreseeable future due to prohibitions on dividends imposed by the California Department of Insurance (the “CA DOI”) pursuant to the Supervision Agreement (the “Supervision Agreement”), dated as of September 7, 2021, by and between Crusader and the CA DOI, Crusader’s decreased policyholder surplus caused by additional underwriting losses during 2021, and the need to preserve policyholder surplus at Crusader. Any continued financial support from Crusader will be at the discretion of the Special Examiner appointed pursuant to the Supervision Agreement. If the Special Examiner does not permit Crusader to continue to provide significant financial support to Unico, Unico will be unable to continue to fund its continued operations and expenses. Additionally, many of the potential strategic alternatives that the Unico Board is considering will also depend on continued financial support from Crusader to fund transaction expenses and other costs. If Crusader is not permitted to do so, Unico would be unable to pursue such alternatives, which may otherwise be in the best interests of its stockholders. These circumstances raise substantial doubt about Unico’s ability to continue as a going concern. The accompanying condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and reclassification of assets or the amounts and classifications of liabilities that may result from the outcome of the uncertainty of our ability to remain a going concern.
Unico needs to improve its consolidated operating results, continue to receive financial support from Crusader, and/or raise substantial additional capital to continue to fund its operations. Unico has taken actions to cause Crusader to enter into runoff and to wind down operations that support the writing of insurance policies. To address its liquidity concerns and meet its capital obligations, Unico has announced a review of strategic alternatives and, with the assistance of a financial advisor, is considering multiple alternatives, including, but not limited to, strategic financing, further scaling back, or eliminating some or all of its remaining business operations, expense reductions, reorganization, merger with another entity, filing for bankruptcy or cessation of operations. There can be no assurances that capital will be available when needed or that, if available, it will be obtained on terms favorable to the Company and its stockholders, particularly in light of the effects that the coronavirus COVID-19 pandemic has recently had on the capital markets and investor sentiment. In addition, equity or debt financings may have a dilutive effect on the holdings of Unico’s existing stockholders, and debt financings may subject Unico to restrictive covenants, operational restrictions and security interests in Unico’s assets. Many of these potential alternatives will also depend on continued financial support from Crusader to fund transaction expenses and other costs. If Unico becomes unable to continue as a going concern, Unico may have to dispose of or liquidate its assets and might realize significantly less than the values at which they are carried on its condensed consolidated financial statements. Additionally, Unico may have to write down some or all of its capitalized assets or liquidate some or all of its investments in gross unrealized loss position. These actions may cause Unico’s stockholders to lose all or part of their investment in Unico’s common stock. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Work Force Reduction
In connection with the runoff of Crusader, on October 7, 2021, and October 8, 2021, the Company informed thirteen employees of the Company’s determination to terminate their employment, effective as of October 8, 2021 (the “October 2021 Work Force Reduction”). Additionally, on December 16, 2021, and December 17, 2021, the Company informed an additional twelve employees of the Company’s determination to terminate their employment, effective as of December 17, 2021 (the “December 2021 Work Force Reduction”). The terminated employees were primarily employed in the Company’s underwriting and marketing groups. In connection with the October 2021 Work Force Reduction and the December 2021 Work Force Reduction, the Company expects to incur total pre-tax costs of approximately $901,000, consisting of severance payments under the Company’s existing policy. The Company recognized these costs during the fourth quarter of 2021. In addition, the Company has offered retention bonuses to certain of the Company’s employees that were not subject to the October 2021 Work Force Reduction and the December 2021 Work Force Reduction, in connection with which, depending on employee participation, the Company expects to incur total pre-tax costs of approximately $438,000. The Company recognized these costs ratably over the retention service periods during the fourth quarter of 2021 and the first quarter of 2022. The Company implemented another retention bonus plan to certain employees in the amount of $256,000 which will be recognized ratable over the last three quarters of 2022. The Company may incur additional costs in connection with the runoff of Crusader, including additional costs associated with workforce reductions.
Supervision Agreement
On September 10, 2021, Crusader and the CA DOI entered into the “Supervision Agreement”, dated September 7, 2021, at the request of the CA DOI. The Supervision Agreement was requested by the CA DOI because of the CA DOI’s expressed concerns regarding the financial stability of Crusader and the potential effects on Crusader and Crusader’s California policyholders of any potential bankruptcy of Unico. The Supervision Agreement among other things, provides for the appointment by the CA DOI of a Special Examiner to provide supervision and regulatory oversight of Crusader. The Supervision Agreement imposes limitations on Crusader’s ability to take certain actions without the prior written consent of the California Insurance Commissioner (the “Commissioner”), the Special Examiner, or the Special Examiner’s appointed representative. Among the actions that Crusader is prohibited from making without such prior written consent are the following: (i) making payments, engaging in any transaction with or entering into any agreement with, any affiliated or otherwise related person or entity if the cost to Crusader is an individual payment of more than $5,000 or aggregate payments of more than $20,000; (ii) making payments, engaging in any transaction with or entering into any agreement with, any non-affiliated or otherwise unrelated person or entity if the cost to Crusader is an individual payment of more than $5,000 or aggregate payments of more than $20,000; (iii) paying any dividend of any amount; (iv) except as provided in (i) and (ii), making any payments to or on behalf of the Company in connection with any agreement entered into between Crusader and the Company; (v) making any loans to affiliates, officers, directors, stockholders or third parties; (vi) incurring any debt, obligation or liability greater than $5,000; (vii) entering into any new reinsurance contract or treaty or amending any existing reinsurance contract or treaty; (viii) making any material changes in management and essential staffing; (ix) increasing salaries or benefits of officers or directors or making any preferential payment of bonuses or other payments considered legally preferential; and (x) making any other material changes in its normal course of operations, including but not limited to, entering into new lines of business, making major corporate reorganizations, or redomesticating from California. The Supervision Agreement provides that the Special Examiner will meet with Crusader to develop a list of recurring payments under items (i) and (ii) that may not require prior written approval. To date, the Special Examiner has permitted Crusader to provide significant financial support to Unico in the form of reimbursement and/or direct payment of certain operating and other expenses, but there can be no assurance that the Special Examiner will continue to permit Crusader to do so under the Supervision Agreement. If the Special Examiner does not continue to permit Crusader to financially support Unico in the future, Unico will be unable to continue to fund its ongoing operations.
On September 13, 2021, the Special Examiner advised Crusader, through its counsel, that a deficiency existed in certain funds that Unifax is required to maintain, in a fiduciary capacity, for Crusader’s benefit. Pursuant to the provisions of California Insurance Code Sections 1733 and 1734, Unifax is required to hold premium payment funds received from policyholders as fiduciary funds in trust maintained for the benefit of Crusader. The Special Examiner informed Crusader that the CA DOI believed that the deficiency in such fiduciary funds was approximately $3,100,000 as of September 13, 2021. The Company believes that as of September 30, 2021, the amount of such deficiency was approximately $2,452,835. In January 2022 Unico, Crusader, and Unifax agreed, with the pre-approval of the Special Examiner, to transfer a computer system, owned by Unico, to Crusader. Unico contributed the computer system at its book value of $1,779,140 to Unifax, and Unifax in turn contributed the computer system to Crusader at its book value of $1,779,140 as a direct reduction in the amount due to Crusader which resulted in a dollar-for-dollar reduction in the premium trust deficiency. As of March 1, 2022, the premium trust deficiency was $390,567.
Independent Investigation
The Audit Committee of Unico’s Board of Directors retained independent outside counsel, who in turn engaged forensic accountants to work at their direction, to conduct an independent investigation and provide legal advice to the Audit Committee (the “Independent Investigation”), regarding the facts and circumstances relating to, and resulting in, the observed fiduciary funds deficiency. As a result of the Independent Investigation, the Company has determined that, over a period of multiple years, (i) Unifax did not comply with the requirements of the CIC to hold premium trust funds in separate accounts or segregate such funds in accordance with the CIC; (ii) the funds in question were improperly transferred to an operating account of Unifax and were subsequently transferred to a Unico operating account, and (iii) the funds in question were utilized by Unico and its consolidated subsidiaries for general corporate purposes. The independent investigation did not find any evidence that any of such funds had been stolen or used for non-corporate purposes.
COVID-19
As a result, of the ongoing COVID-19 pandemic, economic uncertainties have arisen which can impact the fair value of investments, day-to-day administration of the business and premium volume. While the Company does not believe it is exposed to substantial risk from coronavirus-related claims under the insurance policies written by Crusader, it is possible that the Company’s results of operations, financial condition and the fair value of its investment portfolio may be adversely affected by the general economic conditions as a result of the pandemic.
The effects of the ongoing COVID-19 pandemic were a major contributor to the variability in fair value of the Company’s fixed income and equity investments during the first half of 2020, however, the investment portfolio recovered in value in subsequent quarters. The overall response to the pandemic contributed to the recent decline in investment yields, compared to the previous years, which will cap the Company’s investment portfolio’s ability to generate higher levels of investment income, absent a larger invested asset base or a change in investment philosophy.
Crusader has received a number of coronavirus-related business interruption claims. With the exception of one claim for which investigation is still ongoing, all such claims were denied after the individual circumstances of each claim were reviewed to determine whether insurance coverage applied. Like many companies in the property casualty insurance industry, Crusader was named as defendant in lawsuits seeking insurance coverage under the policies issued by Crusader for alleged economic losses resulting from the shutdown or suspension of their businesses due to the COVID-19 pandemic. Although the allegations vary, the plaintiffs generally seek a declaration of insurance coverage, damages for breach of contract in unspecified amounts for claim denials, interest and attorney fees. Some of the lawsuits also allege that the insurance claims were denied in bad faith or otherwise in violation of state laws and seek extra-contractual or punitive damages.
Crusader denies the allegations in these lawsuits and intends to continue to vigorously defend them. Although the policy terms vary in general, the claims at issue in these lawsuits were denied because the policyholder identified no direct physical loss, such as fire or water damage, to property at the insured premises, and the governmental orders that led to the complete or partial shutdown of the business were not due to the existence of any direct physical loss or damage to property in the immediate vicinity of the insured premises and did not prohibit access to the insured premises, as required by the terms of the insurance policies. Depending on the individual policy, additional policy terms and conditions may also prohibit coverage, such as exclusions for pollutants, ordinance or law, loss of use, and acts or decisions. Most of Crusader’s policies also contain an exclusion for losses caused directly or indirectly by “virus or bacteria.”
In addition to the inherent difficulty in predicting litigation outcomes, the COVID-19 pandemic business income coverage lawsuits present a number of uncertainties and contingencies that are not yet known, including how many policyholders will ultimately file claims, the number of lawsuits that will be filed, the extent to which any class may be certified, and the size and scope of any such classes. The legal theories advanced by plaintiffs vary by case. These lawsuits are in the early stages of litigation; many complaints continue to be amended; several have been dismissed voluntarily and may be refiled; and others have been dismissed by trial courts. Some early decisions on motion filings have been appealed.
On March 23, 2021, ten policyholders sued Crusader in a putative class action entitled Anchors & Whales LLC et al. v. Crusader Insurance Company, Superior Court of the State of California for the County of San Francisco (CGC-21-590999). The action alleges that Crusader wrongly denied claims for business interruption coverage made by bars and restaurants related to the COVID-19 pandemic and related government orders that limited or halted operations of bars and restaurants. The action further alleges that Crusader acted unreasonably in denying the claims, and it seeks as damages the amounts allegedly due as contract benefits under the insurance policies, attorneys’ fees and costs, punitive damages, and other unspecified damages. The lawsuit alleges a putative class of all bars and restaurants in California that were insured by Crusader for loss of business income, who made such a claim as a result of “one or more Governmental Orders and the presence of the COVID-19 virus on the property,” and whose claim was denied by Crusader. On October 1, 2021, Crusader was granted its motions on the pleadings without leave to amend and the lawsuit was dismissed. Plaintiffs have appealed this ruling.
While the coronavirus pandemic is also affecting the Company’s internal operations, the Company implemented a plan at the onset of the COVID-19 pandemic to help its operations continue effectively during the ongoing pandemic, including processes to limit the spread of COVID-19 among employees. For example, the Company modified its business practices in accordance with social distancing and safety guidelines, allowing many work-from-home arrangements, flexible work schedules, and restricted business travel. The Company’s employees are following the guidelines and approximately 75% are working from their homes. The Company will follow governmental safety guidelines in determining on when to remove the coronavirus-related business restrictions and on when to request the employees working from their homes to return to their workplaces for several days per week; the Company estimates this will occur in the fourth quarter of 2021. While the pandemic has created new challenges for the Company, the Company’s ability to maintain its operations, internal controls and relationships has not been adversely affected.
Termination of Reinsurance Arrangement
On August 31, 2021, Crusader and United Specialty Insurance Company (“USIC”), terminated the Quota Share Reinsurance Agreement (the “Reinsurance Agreement”), effective April 1, 2020, by and between Crusader and USIC. Pursuant to the Reinsurance Agreement, Crusader agreed to reinsure all of USIC’s liability for policies issued by USIC and produced by Unifax, for property, general liability, CMP, CMP liability and other miscellaneous coverages, subject to certain maximum policy limits. Crusader’s obligations under the Reinsurance Agreement continue after termination for business in force at the time of termination, for policies with effective dates prior to the termination but issued after the termination date, and for policies that must be issued or renewed as a matter of law until the expiration of the policies.
On August 31, 2021, as a result of the termination of the Reinsurance Agreement, the Surplus Line Broker Agreement (the “Broker Agreement”), effective April 1, 2020, by and between Unifax and USIC, automatically terminated. Pursuant to the Broker Agreement, USIC authorized Unifax to act as its broker for the purpose of producing and administering certain specified classes of insurance policies, which are the subject of the Reinsurance Agreement. Unifax’s obligations under the Broker Agreement continue after termination for insurance business reinsured under the Broker Agreement. Unifax’s obligations include handling and servicing of all policies until their expiration.
On August 31, 2021, as a result of the termination of the Broker Agreement, the Claims Administration Agreement (the “Claims Administration Agreement”), effective April 1, 2020, by and between U.S. Risk Managers, Inc. and USIC, automatically terminated. Pursuant to the Claims Administration Agreement, USIC appointed U.S. Risk to adjust and settle claims on its behalf in connection with the surplus lines policies issued by USIC in connection with the Reinsurance Agreement. Upon termination of the Claims Administration Agreement, U.S. Risk is obligated (unless revoked by USIC) to continue to manage claims during the run-off of the business reinsured.
The parties agreed to mutually terminate the Reinsurance Agreement. There are no early termination penalties incurred as a result of the termination. The Reinsurance Agreement provides for a minimum ceding fee, and, upon termination of the Reinsurance Agreement, the minimum ceding fee shall be pro-rated to the date of termination unless there are policies issued after the termination of the Reinsurance Agreement. In such case, the minimum ceding fee shall continue past the termination of the Reinsurance Agreement until such time as no further policies are issued. Accordingly, the Company estimates that Crusader may pay an additional $276,000 to USIC for the minimum ceding fee in addition to the $120,000 previously paid.
IT System Upgrade
In 2018 the Company determined it need to upgrade or replace its legacy IT system, which it opted to upgrade because the cost was substantially less. The upgrade was completed in first quarter of 2021 for a total cost of $2,326,811, which included the capitalization of its employees involved in the upgrade. The Company started depreciating the associated capitalized costs, including the costs of Unico’s employees involved in the upgrade, during the second quarter of 2021.
Revenue and Income Generation
The Company historically received its revenues primarily from earned premium derived from the insurance company operations, commission and fee income generated from the insurance agency operations, finance charges and fee income from the premium finance operations, and investment income from cash generated primarily from the insurance company operation. However, in light of the runoff of Crusader, and the cessation of the premium finance operations provided by AAC, the Company’s revenues from these sources will decline significantly in the future. The insurance company operation, excluding the realized gain on real estate sale, generated approximately 95% and 82% of consolidated revenues for the three and nine months ended September 30, 2021, respectively, compared to 94% and 93% of consolidated revenues for the three and nine months ended September 30, 2020, respectively. None of the Company’s other operations is individually material to consolidated revenues.
Insurance Company Operation
As of September 30, 2021, the Company’s subsidiary Crusader was licensed as an admitted insurance carrier in the states of Arizona, California, Nevada, Oregon, and Washington. From 2004 until September 2014, all of Crusader’s business was written in the state of California. Crusader’s business remains concentrated in California (100% of gross written premium during the three and nine months ended September 30, 2021, and 99.9% of gross written premium during the three and nine months ended September 30, 2020, originated in California). During the three and nine months ended September 30, 2021, approximately 99.9% and 99.7%, respectively of Crusader’s business was Commercial Multiple Peril (“CMP”) policies. During the three and nine months ended September 30, 2020, approximately 99.6% and 99.8%, respectively of Crusader’s business was comprised of CMP policies.
Crusader’s total gross written premium (direct and assumed written premium before cessions to reinsurers under reinsurance treaties), as reported on Crusader’s statutory financial statements, was produced geographically as follows:
| Three Months Ended | | | Nine Months Ended |
| September 30 | | | September 30 |
| | 2021 | | | 2020 | | | Change | | | 2021 | | | 2020 | | | Change | |
| | | | | | | | | | | | | | | | | | |
California | | $ | 12,680,108 | | | $ | 9,653,326 | | | $ | 3,026,782 | | | $ | 34,729,771 | | | $ | 27,619,957 | | | $ | 7,109,814 | |
Arizona | | | - | | | | 3,435 | | | | (3,435 | ) | | | - | | | | 24,817 | | | | (24,817 | ) |
Total gross written premium | | $ | 12,680,108 | | | $ | 9,656,761 | | | $ | 3,023,347 | | | $ | 34,729,771 | | | $ | 27,644,774 | | | $ | 7,084,997 | |
Crusader previously focused its business in three underwriting businesses: (1) Transportation, (2) Mainstreet, and (3) Buildings. The Company reorganized its underwriting businesses for proper staffing and business focus during the first quarter of 2021. The former Food, Beverage and Entertainment and Garage and Mercantile businesses became Mainstreet, and the former Apartments & Commercial Buildings business was renamed Buildings.
Written premium is a non-GAAP financial measure that is defined, under statutory accounting principles (“SAP”) as the contractually determined amount charged by the insurance company to the policyholder for the effective period of the contract based on the expectation of risk, policy benefits, and expenses associated with the coverage provided by the terms of the policies. Written premium is a required statutory measure. Written premium is defined under GAAP in Accounting Standards Codification Topic 405, “Liabilities,” as “premiums on all policies an entity has issued in a period.” Earned premium, the most directly comparable GAAP measure to written premium, represents the portion of written premium that is recognized as income in the financial statements for the period presented and earned on a pro-rata basis over the terms of the policies. Written premium is intended to reflect production levels and is meant as supplemental information and not intended to replace earned premium. Such information should be read in connection with the Company’s GAAP financial results.
The following is a reconciliation of gross written premium (direct and assumed written premium before cessions to reinsurers under reinsurance treaties) to net earned premium (after premium ceded to reinsurers under reinsurance treaties):
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | 2021 | | | 2020 | |
| | | | | | | | | | | | |
Direct written premium | | $ | 10,321,267 | | | $ | 9,551,749 | | | $ | 31,279,667 | | | $ | 27,355,064 | |
Assumed written premium | | | 2,358,840 | | | | 105,012 | | | | 3,450,104 | | | | 289,710 | |
Less: written premium ceded to reinsurers | | | (3,111,266 | ) | | | (2,021,261 | ) | | | (8,748,322 | ) | | | (6,003,698 | ) |
Net written premium | | | 9,568,841 | | | | 7,635,500 | | | | 25,981,449 | | | | 21,641,076 | |
Change in direct unearned premium | | | (136,817 | ) | | | (460,746 | ) | | | (2,129,893 | ) | | | (610,418 | ) |
Change in assumed unearned premium | | | (1,657,746 | ) | | | (44,023 | ) | | | (2,452,217 | ) | | | (211,675 | ) |
Change in ceded unearned premiums | | | (36,656 | ) | | | (6,459 | ) | | | (90,209 | ) | | | (13,466 | ) |
Net earned premium | | $ | 7,737,622 | | | $ | 7,124,272 | | | $ | 21,309,130 | | | $ | 20,805,517 | |
The Company’s insurance operational underwriting profitability is defined by pre-tax underwriting gain, which is calculated as net earned premium less losses and loss adjustment expenses and policy acquisition costs.
Crusader’s underwriting loss before income taxes is as follows:
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | Change | | | 2021 | | | 2020 | | | Change | |
| | | | | | | | | | | | | | | | | | |
Net written premium | | $ | 9,568,841 | | | $ | 7,635,500 | | | $ | 1,933,341 | | | $ | 25,981,449 | | | $ | 21,641,076 | | | $ | 4,340,373 | |
Change in net unearned premium | | | (1,831,219 | ) | | | (511,228 | ) | | | (1,319,991 | ) | | | (4,672,319 | ) | | | (835,559 | ) | | | (3,836,760 | ) |
Net earned premium | | | 7,737,622 | | | | 7,124,272 | | | | 613,350 | | | | 21,309,130 | | | | 20,805,517 | | | | 503,613 | |
Less: | | | | | | | | | | | | | | | | | | | | | | | | |
Losses and loss adjustment expenses | | | 6,851,898 | | | | 17,320,051 | | | | (10,468,153 | ) | | | 18,521,818 | | | | 28,086,342 | | | | (9,564,524 | ) |
Policy acquisition costs | | | 1,951,053 | | | | 1,279,703 | | | | (671,350 | ) | | | 4,078,563 | | | | 3,626,154 | | | | (452,409 | ) |
Total underwriting expenses | | | 8,802,951 | | | | 18,599,754 | | | | (9,796,803 | ) | | | 22,600,381 | | | | 31,712,496 | | | | (10,016,933 | ) |
Underwriting gain (loss) before income taxes | | $ | (1,065,329 | ) | | $ | (11,475,482 | ) | | $ | 10,410,153 | | | $ | (1,291,251 | ) | | $ | (10,906,979 | ) | | $ | 10,520,546 | |
Underwriting gain or loss before income taxes is a non-GAAP financial measure. Underwriting gain or loss before income taxes represents one measure of the pretax profitability of the insurance company operation and is derived by subtracting losses and loss adjustment expenses, and policy acquisition costs from net earned premium, which are all GAAP financial measures. Management believes disclosure of underwriting income or loss before income taxes is useful supplemental information that helps align the reader’s understanding with management’s view of Crusader’s operations profitability. Each of these captions is presented in the Condensed Consolidated Statements of Operations but is not subtotaled.
The following is a reconciliation of Crusader’s underwriting loss before income taxes to the Company’s income (loss) before taxes:
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | 2021 | | | 2020 | |
| | | | | | | | | | | | |
Underwriting gain (loss) before income taxes | | $ | (1,065,329 | ) | | $ | (11,475,482 | ) | | $ | (1,291,251 | ) | | $ | (10,906,979 | ) |
Insurance company operation revenues: | | | | | | | | | | | | | | | | |
Net investment income | | | 427,244 | | | | 477,145 | | | | 1,470,846 | | | | 1,487,335 | |
Net realized investment gains | | | 57,173 | | | | 38,214 | | | | 218,982 | | | | 39,789 | |
Net realized gains on real estate sale | | | - | | | | - | | | | 3,693,858 | | | | - | |
Net unrealized investment gains (losses) on equity securities | | | (147,722 | ) | | | 19,670 | | | | 18,559 | | | | 42,629 | |
Other income | | | 95,330 | | | | 74,784 | | | | 123,044 | | | | 278,544 | |
Other insurance operations revenues: | | | | | | | | | | | | | | | | |
Gross commissions and fees | | | 385,548 | | | | 461,540 | | | | 1,234,720 | | | | 1,388,494 | |
Finance charges and fees earned | | | 40,458 | | | | 56,985 | | | | 130,228 | | | | 191,690 | |
Other income (loss) | | | (5 | ) | | | 7,076 | | | | 541 | | | | 7,096 | |
Less expenses: | | | | | | | | | | | | | | | | |
Salaries and employee benefits | | | 1,171,944 | | | | 2,584,478 | | | | 3,505,665 | | | | 4,958,900 | |
Commissions to agents/brokers | | | 20,022 | | | | 23,235 | | | | 61,024 | | | | 73,190 | |
Other operating expenses | | | 1,051,350 | | | | 1,398,135 | | | | 3,371,952 | | | | 3,372,483 | |
Loss before income taxes | | $ | (2,450,619 | ) | | $ | (14,345,916 | ) | | $ | (1,339,114 | ) | | $ | (15,875,975 | ) |
Unearned premiums represent premium applicable to the unexpired terms of policies in force. The Company evaluates its unearned premiums periodically for premium deficiencies by comparing the sum of expected claim costs, unamortized deferred policy acquisition costs, and maintenance costs partially offset by net investment income to related unearned premiums. To the extent that any of the Company’s programs become unprofitable, a premium deficiency reserve may be required. The Company did not carry a premium deficiency reserve as of September 30, 2020 and did book an a allowance against deferred acquisition costs of $848,711 as of September 30, 2021.
The following table shows the loss ratios, expense ratios, and combined ratios of Crusader:
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | 2021 | | | 2020 | |
| | | | | | | | | | | | |
Loss ratio (1) | | | 89 | % | | | 243 | % | | | 87 | % | | | 135 | % |
Expense ratio (2) | | | 36 | % | | | 36 | % | | | 33 | % | | | 38 | % |
Combined ratio (3) | | | 125 | % | | | 279 | % | | | 120 | % | | | 173 | % |
(1) | Loss ratio is defined as losses and loss adjustment expenses divided by net earned premium. |
| |
(2) | Expense ratio is defined as a sum of policy acquisition costs and portions of indirect salaries and employee benefits and other operating expenses allocation to the insurance company operations, reduced by allocation of gross commissions and fees and other income, divided by net earned premium. The calculation of this expense ratio is different from the one used for computing the statutory accounting basis combined ratio. |
| |
(3) | Combined ratio is defined as a sum of loss ratio and expense ratio. This combined ratio is different from the statutory accounting basis combined ratio. |
The following table provides an analysis of losses and loss adjustment expenses:
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | Change | | | 2021 | | | 2020 | | | Change | |
| | | | | | | | | | | | | | | | | | |
Losses and loss adjustment expenses: | | | | | | | | | | | | | | | | | | |
Provision for insured events of current year | | $ | 8,017,701 | | | $ | 9,385,389 | | | $ | (1,367,688 | ) | | $ | 20,529,747 | | | $ | 19,925,024 | | | $ | 604,723 | |
Development of insured events of prior years | | | (1,165,803 | ) | | | 7,934,662 | | | | (9,100,465 | ) | | | (2,007,929 | ) | | | 8,161,318 | | | | (10,169,247 | ) |
Total losses and loss adjustment expenses | | $ | 6,851,898 | | | $ | 17,320,051 | | | $ | (10,468,153 | ) | | $ | 18,521,818 | | | $ | 28,086,342 | | | $ | (9,564,524 | ) |
For further analysis of losses and loss adjustment expenses, refer to “Results of Operations”.
On September 24, 2021, A.M. Best Company (“A.M. Best”) downgraded Crusader’s Financial Strength Rating to C++ (Marginal) from B (Fair) and its Long-Term Issuer Credit Rating (Long-Term ICR) to “b” (Marginal) from “bb+” (Fair). A.M. Best also downgraded Unico’s Long-Term ICR to “ccc-” (Weak) from “b” (Marginal). In addition, A.M. Best maintained the “under review with negative implications” status for these Credit Ratings. On September 24, 2021, A.M. Best’s ratings reflected concerns regarding Crusader’s balance sheet strength, which A.M. Best assessed as weak, as well as its weak operating performance, limited business profile and marginal enterprise risk management. A.M. Best stated that, while Crusader maintains sufficient liquidity, and its risk-adjusted capital levels remain at the strongest level, as measured by A.M. Best’s Capital Adequacy Ratio, the downgrades reflect the lowered assessment of the balance sheet strength given the enterprise’s diminished financial flexibility and the constraints imposed on Crusader by the CA DOI under the Supervision Agreement. The A.M Best rating was withdrawn on September 24, 2021.
Some of Crusader’s policyholders, or the lenders, landlords or clients of Crusader’s policyholders, require insurance from a company that has an A.M. Best FSR of “A-” or higher, and the A.M. Best’s changed ratings of Crusader may also have a negative impact on Crusader’s reputation. Therefore, Crusader’s and Unico’s changed ratings and the ultimate withdrawal of these ratings would have a negative impact on the Company’s revenue and results of operations if Crusader’s operations were not in runoff. In addition, certain policyholders of Crusader may have cancelled their policies because of the change in the rating and ultimate withdrawal of these ratings. The Company cannot quantify the impact that the rating changes or the withdrawal of the ratings have had or will have on its revenue and results of operations.
Revenues from Other Insurance Operations
The Company’s revenues from other insurance operations consist of commissions, fees and other income. These operations accounted for approximately 5% and 6% of total revenues, excluding the realized gain on real estate sale, in the three and nine months ended September 30, 2021, respectively, compared to approximately 7% of total revenues in both the three and nine months ended September 30, 2020.
Investments
The Company generated revenues from its total invested assets of $85,602,034 and $87,154,400 as of September 30, 2021, and 2020, respectively. Investment income (net of investment expenses) decreased $49,901 (10%) and $16,489 (1%) to $427,244 and $1,470,846 for the three and nine months ended September 30, 2021, respectively, compared to $477,145 and $1,487,335 for the three and nine months ended September 30, 2020, respectively. This decrease is the result of having less investments than in the past, as Crusader is in runoff and will be using the investments to satisfy future claims.
Due to the current interest rate environment, the current target effective duration for the Company’s investment portfolio is between 2.0 and 4.0 years. As of September 30, 2021, all of the Company’s investments are in U.S. Treasury securities, corporate fixed maturity securities, agency mortgage-backed securities, common stock, Federal Deposit Insurance Corporation (“FDIC”) insured certificates of deposit, money market funds, and a savings account. The Company’s investments in U.S. treasury securities, corporate fixed maturity securities, agency mortgage-backed securities, common stock and money market funds are readily marketable. As of September 30, 2021, the weighted average maturity of the Company’s investments was approximately 6.9 years, and the effective duration for available-for-sale investments (investments managed under the investment guidelines) was 2.4 years.
LIQUIDITY AND CAPITAL RESOURCES
The Company prepared the accompanying condensed consolidated financial statements on a going concern basis, which assumes that it will realize its assets and satisfy its liabilities in the normal course of business. Unico has a history of recurring losses from operations, negative cash flows from its operating activities which may continue in the future, and, as a holding company, does not independently generate significant revenue and is dependent on dividends and other cash distributions from Crusader and its other subsidiaries to fund its operations and expenses. Historically, Unico generally received dividends periodically from Crusader, but does not expect to receive any such dividends for the foreseeable future due to prohibitions on dividends imposed by the CA DOI pursuant to the Supervision Agreement, Crusader’s decreased policyholder surplus caused by additional underwriting losses during 2021, and the need to preserve policyholder surplus at Crusader. Any continued financial support from Crusader will be at the discretion of the Special Examiner appointed pursuant to the Supervision Agreement. If the Special Examiner does not permit Crusader to continue to provide significant financial support to Unico, Unico will be unable to continue to fund its continued operations and expenses. Additionally, many of the potential strategic alternatives that the Board of Directors of Unico is considering will also depend on continued financial support from Crusader to fund transaction expenses and other costs. If Crusader is not permitted to do so, Unico would be unable to pursue such alternatives, which may otherwise be in the best interests of its stockholders. These circumstances raise substantial doubt about Unico’s ability to continue as a going concern. The accompanying condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and reclassification of assets or the amounts and classifications of liabilities that may result from the outcome of the uncertainty of our ability to remain a going concern.
No assurance can be given that the Company’s estimate of ultimate loss and loss adjustment expense reserves will be sufficient but based on the Company’s current loss and loss expense reserves and expected current and future payments, the Company believes that there are no current liquidity constraints for Crusader. However, as an insurance holding company, the Company does not independently generate significant revenue and is dependent on dividends and other cash distributions from Crusader and its other subsidiaries to fund its operations and expenses. As discussed below, the Company does not expect to receive any dividends from Crusader for the foreseeable future, and accordingly, its financial position and ability to pay operating expenses will be adversely impacted.
Crusader has a significant amount of cash and investments as a result of its holdings of unearned premium reserves, its reserves for loss and loss adjustment expense payments, and its capital and surplus. Crusader’s loss and loss adjustment expense payments are the most significant cash flow requirement of Crusader. Cash and investments (at amortized cost) of Crusader at September 30, 2021, were $99,314,669 compared to $87,575,700 at December 31, 2020.
As a result of Crusader being placed into runoff, Crusader is no longer able to generate any significant amounts of premium and the holdings of unearned premium reserves will be depleted over time. As a result, Crusader will need to liquidate some of its investment holdings to support its operations. Accordingly, the size of Crusader’s investment portfolio and investment income are expected to decrease.
On December 31, 2020, and December 31, 2021, Crusader’s Risk Based Capital (“RBC”) total adjusted capital was less than 300% of its Authorized Control Level RBC, and its statutory accounting basis combined ratio was in excess of 120% for the years then ended. The RBC level when coupled with the statutory accounting basis combined ratio triggered a Company Action Level Event under the RBC. Crusader submitted to the CA DOI a comprehensive Risk Based Capital Plan (the “RBC Plan”) to increase the adjusted capital above 300% and to address the actions that Crusader will take to correct the conditions that resulted in the Company Action Level Event and on July 2, 2021, submitted a revised RBC Plan which addressed questions raised by the CA DOI. As of the date of the filing of this Quarterly Report on Form 10-Q, the CA DOI has not accepted the revised RBC Plan. The CA DOI may request additional changes to the revised RBC Plan to address various corrective actions that Crusader and/or the Company will take, including, without limitation, increasing the capital of Crusader. Depending on the scope and nature of any such requests from the CA DOI, the Company and Crusader may not be able to take certain corrective actions, including the potential infusion of capital to Crusader. The Company continues to be engaged in discussions with the CA DOI on various strategic alternatives to address the RBC issues. The Company has until April 15, 2022 to submit another RBC plan for the year-ended December 31, 2021.
In 2021, the policyholder surplus of Crusader decreased because Crusader experienced net losses for the quarters ended March 31, 2021, June 30, 2021, and September 30, 2021.
As of September 30, 2021, all of the Company’s investments are in U.S. Treasury securities, FDIC insured certificates of deposit, corporate fixed maturity securities, agency mortgage-backed securities, common stock and short-term investments. All of the Company’s investments, except for the certificates of deposit, are readily marketable.
The composition of Company’s investment portfolio is as follows:
| | September 30, 2021 | | | December 31, 2020 | |
| | Amortized | | | Fair | | | Amortized | | | Fair | |
| | Cost | | | Value | | | Cost | | | Value | |
| | | | | | | | | | | | |
Fixed maturities: | | | | | | | | | | | | |
U.S. Treasury securities | | $ | 7,271,118 | | | $ | 7,347,117 | | | $ | 10,596,808 | | | $ | 10,832,181 | |
Corporate securities | | | 46,124,041 | | | | 47,469,519 | | | | 44,159,926 | | | | 46,451,905 | |
Agency mortgage-backed securities | | | 23,452,719 | | | | 23,892,554 | | | | 25,314,546 | | | | 26,125,608 | |
Certificates of deposit | | | 548,000 | | | | 548,000 | | | | 798,000 | | | | 798,000 | |
Total fixed maturity investments | | | 77,395,878 | | | | 79,257,190 | | | | 80,869,280 | | | | 84,207,694 | |
Equity securities | | | 3,466,331 | | | | 3,683,154 | | | | 2,548,440 | | | | 2,746,706 | |
Short-term investments | | | 2,661,690 | | | | 2,661,690 | | | | 200,000 | | | | 200,000 | |
Total investments | | $ | 83,523,899 | | | $ | 85,602,034 | | | $ | 83,617,720 | | | $ | 87,154,400 | |
The short‑term investments include U.S. Treasury bills and certificates of deposit that are all highly rated and have initial maturity between three and twelve months. Amortized costs of the short-term investments approximate their fair values.
The Company is required to classify its investment securities into one of three categories: held‑to‑maturity, available‑for‑sale, or trading securities. Historically, the Company’s investment guidelines placed primary emphasis on buying and holding high‑quality investments to maturity. It is expected the Company will sell securities to support its operations.
The Company’s Board of Directors approved investment guidelines which reflect the Company’s risk, balance sheet, and profile.
Under the Company’s investment guidelines, investments may only include U.S. Treasury notes, U.S. government agency notes, mortgage-backed securities (including pass through securities and collateralized mortgage obligations) that are backed by agency and non-agency collateral, commercial mortgage-backed securities, U.S. corporate obligations, asset-backed securities, (including but not limited to credit card, automobile and home equity backed securities), tax-exempt bonds, preferred stocks, common stocks, commercial paper, repurchase agreements (treasuries only), mutual funds, exchange traded funds, bank certificates of deposits and time deposits. The investment guidelines provide for certain investment limitations in each investment category.
Unless agreed to in advance in writing by Crusader, investments in the following types of securities are prohibited:
| · | Mortgage loans, except for mortgage-backed securities issued by an agency of the U.S. government. |
| · | Derivative mortgage-backed securities including interest only, principal only and inverse floating rate securities. |
| · | All fixed maturity real estate securities, except mortgage-backed securities (including pass through securities and collateralized mortgage obligations) that are backed by agency and non-agency collateral and commercial mortgage-backed securities. |
| · | Options and futures contracts. |
| · | All non-U.S. dollar denominated securities. |
| · | Any security that would not be in compliance with the regulations of Crusader’s state of domicile. |
An independent investment advisor manages Crusader’s investments. The advisor’s role currently is limited to maintaining Crusader’s portfolio within the investment guidelines and providing investment accounting services to the Company. Through July 31, 2021, the investments were held by Crusader’s previous custodian, Union Bank Global Custody Services (“Union Bank”). Effective, August 2, 2021, the investments were held by Crusader’s current custodian, U.S Bank, Institutional Trust and Custody (“U.S. Bank”) as a result of sale of the custodial business by Union Bank to U.S. Bank.
As of September 30, 2021, three U.S. Treasury securities and three agency mortgage-back securities, included in available-for-sale fixed maturities, were held as collateral with Comerica, pursuant to the reinsurance trust agreement among Crusader, USIC and Comerica to secure payment of Crusader’s liabilities and performance of its obligations under the reinsurance arrangement with USIC. The estimated fair value and amortized cost of these securities was $8,584,173 and $8,446,981 on September 30, 2021, respectively.
On August 10, 2020, the Board authorized a share repurchase program (the “2020 Program”) for the repurchase of up to $5,000,000 of the currently outstanding shares of the Company’s common stock. The 2020 Program was effective immediately and replaced the Company’s existing share repurchase program that was adopted by the Board of Directors on December 19, 2008 called the 2008 Program to acquire, from time to time, up to an aggregate of 500,000 shares of the Company’s common stock. The purchases under the 2020 Program may be made, from time to time, in the open market through block trades, 10b5-1 trading plans, privately negotiated transactions or otherwise and in accordance with applicable laws, rules and regulations. The timing and actual number of the shares repurchased under the 2020 Program will depend on a variety of factors including price, market conditions and corporate and regulatory requirements. The Company intends to fund the share repurchases under the 2020 Program from cash on hand. The 2020 Program does not commit the Company to repurchase shares of its common stock and it may be amended, suspended, or discontinued at any time. The Company repurchased its shares under the 2020 Program and 2008 Program in unsolicited transactions as follows:
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | 2021 | | | 2020 | |
| | | | | | | | | | | | |
2020 Program | | | | | | | | | | | | |
Number of shares repurchased | | | 22 | | | | 630 | | | | 22 | | | | 630 | |
Cost of shares repurchased | | | | | | | | | | | | | | | | |
Allocated to retained earnings | | $ | 92 | | | $ | 2,969 | | | $ | 92 | | | $ | 2,969 | |
Allocated to capital | | | 10 | | | | 310 | | | | 10 | | | | 310 | |
Total cost of shares repurchased | | $ | 102 | | | $ | 3,279 | | | $ | 102 | | | $ | 3,279 | |
| | | | | | | | | | | | | | | | |
2008 Program | | | | | | | | | | | | | | | | |
Number of shares repurchased | | | 0 | | | | -0 | | | | 0 | | | | 978 | |
Cost of shares repurchased | | | | | | | | | | | | | | | | |
Allocated to retained earnings | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 5,760 | |
Allocated to capital | | | 0 | | | | 0 | | | | 0 | | | | 480 | |
Total cost of shares repurchased | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 6,240 | |
The Company has remaining authority under the 2020 Program to repurchase up to $4,995,406 of the currently outstanding shares of the Company’s common stock as of September 30, 2021. The Company has not retired or will retire all stock repurchased under the 2020 Program and 2008 Program: it can retire all stock repurchased under the 2020 Program and 2008 Program.
The Company reported $111,442 net cash used by operating activities for the nine months ended September 30, 2021, compared to $3,634,617 net cash used by operating activities for the nine months ended September 30, 2020. Fluctuations in cash flows from operating activities relate to changes in loss and loss adjustment expense payments, unearned premium holdings, and the timing of the collection and the payment of insurance-related receivables and payables. The variability of the Company’s losses and loss adjustment expenses is due primarily to its small population of claims which may result in greater fluctuations in claim frequency and/or severity.
RESULTS OF OPERATIONS
All comparisons made in this discussion compare the three and nine months ended September 30, 2021, to the three and nine months ended September 30, 2020, unless otherwise indicated. Because Crusader has been placed into runoff some of the financial metrics will not be comparable now or in the future.
For the three and nine months ended September 30, 2021, total revenues were $8,595,648, an increase of $335,962 (4%) and $28,199,908, an increase of $3,958,814 (16%) compared to total revenues of $8,259,686 and $24,241,094 for the three and nine months ended September 30, 2020, respectively. For the three and nine months ended September 30, 2021, the Company had a loss before taxes of $1,601,908 and $490,403, respectively, compared to a loss before taxes of $14,345,916 and $15,875,975 for the three and nine months ended September 30, 2020, respectively. For the three and nine months ended September 30, 2021, the Company had net loss of $2,510,198 and net loss of $1,649,305 , respectively, compared to net loss of $17,940,488 and $19,419,128, for the three and nine months ended September 30, 2020, respectively.
The increase in revenues of $335,962 for the three months ended September 30, 2021, when compared to the three months ended September 30, 2020, was primarily due to an increase in net earned premium of $613,350 (9%). The increase in revenues of $3,958,814 for the nine months ended September 30, 2021, when compared to the nine months ended September 30, 2020, was primarily due to the realized gain of $3,693,858 on the sale of the Calabasas Building.
The loss before tax of $2,450,619 for the three months ended September 30, 2021, compared to loss before taxes of $14,345,916 for the three months ended September 30, 2020, was due primarily to a decrease in losses and loss adjustment expenses of $10,468,153 (60%) and a decrease in salaries and employee benefits of $1,412,534 (55%). The loss before tax of $1,339,114 for the nine months ended September 30, 2021, compared to loss before taxes of $15,875,975 for the nine months ended September 30, 2020, was due primarily to the realized gain of $3,693,858 on the sale of the Calabasas Building, an increase in policy acquisition costs of $452,409 (12%), a decrease in losses and loss adjustment expenses of $9,564,524 (34%) and a decrease in salaries and employee benefits of $1,423,235 (29%). As a result of the runoff of Crusader, revenues and losses in future periods will not be comparable to past periods because Crusader ceased writing new policies in September 2021, and ceased renewing policies as of December 8, 2021
Crusader premium
Crusader’s primary lines of business are CMP policies. These policies represented approximately 99.6% and 99.8% of Crusader’s total written premium for the years ended September 30, 2021, and 2020, respectively.
Gross written premium (direct and assumed written premium before cessions to reinsurers under reinsurance treaties) reported on Crusader’s statutory financial statements increased $3,023,347 (31%) and $7,084,997 (26%) to $12,680,108 and $34,729,771 for the three and nine months ended September 30, 2021, respectively, compared to $9,656,761 and $27,644,774 for the three and nine months ended September 30, 2020, respectively.
The increase in gross written premium for the three and nine months ended September 30, 2021, was due primarily to growth in the Company’s Transportation Business. The Transportation Business transacts insurance primarily for long-haul trucking operations domiciled in California. The growth in the Company’s Transportation Business was partially offset by the decrease in the Building’s Business.
As a result of the runoff of Crusader, Crusader will not generate significant levels of written premium in the future. Crusader was obligated by regulatory requirements to offer renewal policies to those policyholders who could not be issued non-renewal notices immediately after the commencement of the runoff of Crusader, which are policies with policy renewal dates of 60 days or less from the date Crusader went into runoff. Accordingly, Crusader ceased generating any renewal premium on December 8, 2022.
Written premium
Written premium is a non-GAAP financial measure that is defined, under statutory accounting principles (“SAP”) as the contractually determined amount charged by the insurance company to the policyholder for the effective period of the contract based on the expectation of risk, policy benefits, and expenses associated with the coverage provided by the terms of the policies. Written premium is a required statutory measure. Written premium is defined under GAAP in Accounting Standards Codification Topic 405, “Liabilities,” as “premiums on all policies an entity has issued in a period.” Earned premium, the most directly comparable GAAP measure to written premium, represents the portion of written premium that is recognized as income in the financial statements for the period presented and earned on a pro-rata basis over the terms of the policies. Written premium is intended to reflect production levels and is meant as supplemental information and not intended to replace earned premium. Such information should be read in connection with the Company’s GAAP financial results.
Gross earned premium
Gross earned premium increased $1,733,552 (19%) to $10,885,544 and $3,324,981 (12%) to $30,147,662 for the three and nine months ended September 30, 2021, respectively, compared to $9,151,992 and $26,822,681 for the three and nine months ended September 30, 2020, respectively. All policies are written on annual basis. Earned premium represents a portion of written premium that is recognized as income in the consolidated financial statements for the period presented and earned daily on a pro-rata basis over the terms of the policies, and, therefore, premiums earned in the current year are related to policies written during both the current year and immediately preceding year. The increase in gross earned premium was due primarily to an increase in gross written premium in 2020 and 2021.
As a result of the runoff of Crusader, the gross earned premium is expected to gradually decrease over time. Crusader does not expect any gross earned premium in 2023.
Ceded earned premium
Ceded earned premium (premium ceded to reinsurers under reinsurance treaties) increased $1,120,202 (55%) to $3,147,922 and $2,821,368 (47%) to $8,838,532 for the three and nine months ended September 30, 2021, compared to $2,027,720 and $6,017,164 for the three and nine months ended September 30, 2020, respectively. Ceded earned premium as a percentage of gross earned premium was 29% for the three and nine months ended September 30, 2021, respectively, and 22% for both the three and nine months ended September 30, 2020. The increase in the ceded earned premium as a percentage of gross earned premium for the three and nine months ended September 30, 2021, compared to the three and nine months ended September 30, 2020, was due primarily to higher rates on the excess of loss reinsurance treaty.
Ceded earned premium is based on gross earned premium. As a result of the runoff of Crusader, the ceded earned premium will gradually decrease over time. Crusader does not expect any ceded earned premium in 2023.
Reinsurance treaties are generally structured in layers, with different negotiated economic terms and retention of participation, or liability, in each layer. In calendar years 2021 and 2020, Crusader retained participation in its excess of loss reinsurance treaties of 0% in its 1st layer (reinsured losses between $500,000 and $1,000,000), 0% in its 2nd layer (reinsured losses between $1,000,000 and $4,000,000), and 0% in its property and casualty clash treaty.
Crusader also has catastrophe reinsurance treaties from various highly rated California authorized and California unauthorized reinsurance companies. These reinsurance treaties help protect Crusader against losses in excess of certain retentions from catastrophic events that may occur on property risks which Crusader insures. In calendar years 2021 and 2020, Crusader retained a participation in its catastrophe excess of loss reinsurance treaties of 5% in its 1st layer (reinsured losses between $1,000,000 and $10,000,000) and 0% in its 2nd layer (reinsured losses between $10,000,000 and $46,000,000).
Crusader evaluates each of its ceded reinsurance contracts at its inception to determine if there is a sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting literature. As of September 30, 2021, all such ceded contracts are accounted for as risk transfer reinsurance.
A tabular presentation of Crusader’s direct, assumed, ceded and net earned premium is as follows:
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | 2021 | | | 2020 | |
| | | | | | | | | | | | |
Direct earned premium | | $ | 10,184,451 | | | $ | 9,091,002 | | | $ | 29,149,775 | | | $ | 26,744,646 | |
Assumed earned premium | | | 701,093 | | | | 60,989 | | | | 997,887 | | | | 78,035 | |
Ceded earned premium | | | (3,147,922 | ) | | | (2,027,720 | ) | | | (8,838,532 | ) | | | (6,017,164 | ) |
Net earned premium | | $ | 7,737,622 | | | $ | 7,124,272 | | | $ | 21,309,130 | | | $ | 20,805,517 | |
Ratio of ceded earned premium to gross earned premium (direct and assumed earned premium) | | | 29 | % | | | 22 | % | | | 29 | % | | | 22 | % |
Net Investment Income, Net Realized Investment Gains and Losses, and Net Unrealized Investment Losses on Equity Securities
Investment income decreased $49,901 (10%) to $427,244 and $16,489 (1%) to $1,470,846 for the three and nine months ended September 30, 2021, respectively, compared to $477,145 and $1,487,335 for the three and nine months ended September 30, 2020, respectively. This decrease in investment income was due primarily to an increase in the lower yielding cash equivalents during the three and nine months ended September 30, 2021, and a smaller overall portfolio than in the 2020. The Company had net realized investment gains of $57,173 and $218,982 for the three and nine months ended September 30, 2021, respectively, compared to net realized investment gains of $38,214 and $39,789 for the three and nine months ended September 30, 2020, respectively. The Company had net unrealized investment losses on equity securities of $147,722 and gains of $18,559 for the three and nine months ended September 30, 2021, compared to net unrealized gains of $19,670 and $42,629 for the three and nine months ended September 30, 2020, respectively.
Average yields on the Company’s average invested assets and investment income, excluding net realized investment gain and losses and net unrealized investment losses on equity securities, are as follows:
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | 2021 | | | 2020 | |
| | | | | | | | | | | | |
Average invested assets (1) - at amortized cost | | $ | 89,173,860 | | | $ | 82,652,749 | | | $ | 83,570,810 | | | $ | 82,931,005 | |
Net investment income from: | | | | | | | | | | | | | | | | |
Invested assets (2) | | $ | 427,222 | | | $ | 477,103 | | | $ | 1,470,405 | | | $ | 1,483,670 | |
Invested Cash | | | 22 | | | | 42 | | | | 441 | | | | 3,665 | |
Total investment income | | $ | 427,244 | | | $ | 477,145 | | | $ | 1,470,846 | | | $ | 1,487,335 | |
Average yield on average invested assets (3) | | | 1.9 | % | | | 2.3 | % | | | 2.3 | % | | | 2.4 | % |
(1) | The average is based on the beginning and ending balance of the amortized cost of the invested assets for each respective period. |
| |
(2) | Investment income from insurance company operation included $38,855 and $110,887 of investment expense for the three and nine months ended September 30, 2021, respectively, compared to $32,974 and $100,761 of investment expense for the three and nine months ended September 30, 2020, respectively. |
| |
(3) | Average yield on average invested assets did not include the investment income from cash equivalents. |
As Crusader entered into runoff, it will need to liquidate some of its investment holdings to support its operations. Accordingly, the size of Crusader’s investment portfolio and investment income are expected to decrease.
The par value, amortized cost, estimated market value and weighted average yield of fixed maturity investments by contractual maturity are as follows:
Maturities by Year at September 30, 2021 | | Par Value | | | Amortized Cost | | | Fair Value | | | Weighted Average Yield | |
| | | | | | | | | | | | |
Due in one year | | $ | 14,995,000 | | | $ | 15,011,137 | | | $ | 15,178,570 | | | | 2.19 | % |
Due after one year through five years | | | 22,696,119 | | | | 22,804,524 | | | | 23,363,295 | | | | 1.82 | % |
Due after five years through ten years | | | 18,717,649 | | | | 18,793,070 | | | | 19,502,697 | | | | 2.41 | % |
Due after ten years and beyond | | | 20,319,818 | | | | 20,787,147 | | | | 21,212,628 | | | | 2.34 | % |
Total | | $ | 76,728,586 | | | $ | 77,395,878 | | | $ | 79,257,190 | | | | 2.17 | % |
Maturities by Year at December 31, 2020 | | Par Value | | | Amortized Cost | | | Fair Value | | | Weighted Average Yield | |
| | | | | | | | | | | | |
Due in one year | | $ | 11,070,641 | | | $ | 11,064,202 | | | $ | 11,169,232 | | | | 2.57 | % |
Due after one year through five years | | | 30,065,671 | | | | 30,090,910 | | | | 31,260,694 | | | | 2.59 | % |
Due after five years through ten years | | | 18,363,570 | | | | 18,476,051 | | | | 19,806,444 | | | | 2.51 | % |
Due after ten years and beyond | | | 20,927,571 | | | | 21,238,117 | | | | 21,971,324 | | | | 2.63 | % |
Total | | $ | 80,427,453 | | | $ | 80,869,280 | | | $ | 84,207,694 | | | | 2.58 | % |
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
The weighted average maturity of the Company’s fixed maturity investments was 6.9 years as of September 30, 2021, and 8.0 years as of December 31, 2020.
A summary of estimated fair value, gross unrealized losses, and number of securities in a gross unrealized loss position by the length of time in which the securities have continually been in that position is shown below:
| | Less than 12 Months | | | 12 Months or Longer | |
| | Estimated Fair Value | | | Gross Unrealized Losses | | | Number of Securities | | | Estimated Fair Value | | | Gross Unrealized Losses | | | Number of Securities | |
September 30, 2021 | | | | | | | | | | | | | | | | | | |
U.S. treasury securities | | $ | 960,235 | | | $ | (33,947 | ) | | | 2 | | | $ | - | | | $ | - | | | | - | |
Corporate securities | | | 12,229,369 | | | | (67,056 | ) | | | 14 | | | | 1,186,701 | | | | (60,464 | ) | | | 1 | |
Agency mortgage-backed securities | | | 1,521,290 | | | | (15,100 | ) | | | 2 | | | | 472,074 | | | | (24,583 | ) | | | 1 | |
Total debt securities | | | 14,710,894 | | | | (116,103 | ) | | | 18 | | | | 1,658,775 | | | | (85,047 | ) | | | 2 | |
Equity securities | | | 1,315,491 | | | | (109,566 | ) | | | 32 | | | | 84,903 | | | | (10,138 | ) | | | 4 | |
Total | | $ | 16,026,385 | | | $ | (225,669 | ) | | | 50 | | | $ | 1,743,678 | | | $ | (95,185 | ) | | | 6 | |
| | Less than 12 Months | | | 12 Months or Longer | |
| | Estimated Fair Value | | | Gross Unrealized Losses | | | Number of Securities | | | Estimated Fair Value | | | Gross Unrealized Losses | | | Number of Securities | |
December 31, 2020 | | | | | | | | | | | | | | | | | | |
Corporate securities | | $ | 2,101,986 | | | $ | (55,847 | ) | | | 2 | | | $ | - | | | $ | - | | | | - | |
Agency mortgage-backed securities | | | 3,223,329 | | | | (22,274 | ) | | | 12 | | | | - | | | | - | | | | - | |
Total debt securities | | | 5,325,315 | | | | (78,121 | ) | | | 14 | | | | - | | | | - | | | | - | |
Equity securities | | | 723,346 | | | | (37,357 | ) | | | 25 | | | | - | | | | - | | | | - | |
Total | | $ | 6,048,661 | | | $ | (115,478 | ) | | | 39 | | | $ | - | | | $ | - | | | | - | |
While the fair value of Company’s investment portfolio at September 30, 2021 has recovered from the declines recorded in the first half of 2020, the effects of the coronavirus pandemic were a major contributor to the variability in fair value of the Company’s fixed income and equity investments during the nine months ended September 30, 2021, and the economic uncertainty caused by the pandemic may lead to further investment valuation volatility. In addition, the recent decline in investment yields resulted in lower reinvestment rates, compared to the previous years, which will cap the Company’s investment portfolio’s ability to generate higher levels of investment income, absent a larger invested asset base or a change in investment philosophy. Additionally, the Company has a smaller portfolio balance than in the past and will continue to withdrawal funds from the investment portfolio to pay for claims and operations of the business.
The Company closely monitors its investments. If an unrealized loss is determined to be other-than-temporary, it is written off as a realized loss through the Condensed Consolidated Statements of Operations. The Company’s methodology of assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near-term prospects of the issuer, and whether the debtor is current on its contractually obligated interest and principal payments. The unrealized losses on all securities as of September 30, 2021, and December 31, 2020, were determined to be temporary.
The fixed maturity securities previously held by the Company were sold and called prior to maturity as follows:
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | 2021 | | | 2020 | |
| | | | | | | | | | | | |
Fixed maturities securities sold | | | | | | | | | | | | |
Number of securities sold | | | - | | | | 6 | | | | 3 | | | | 7 | |
Amortized cost of sold securities | | $ | - | | | $ | 2,923,386 | | | $ | 2,193,393 | | | $ | 3,524,702 | |
Realized gains on sales | | $ | - | | | $ | 30,057 | | | $ | 710 | | | $ | 31,171 | |
| | | | | | | | | | | | | | | | |
Fixed maturities securities called | | | | | | | | | | | | | | | | |
Number of securities called | | | 4 | | | | 1 | | | | 7 | | | | -3 | |
Amortized cost of called securities | | $ | 2,929,834 | | | $ | 249,998 | | | $ | 5,323,613 | | | $ | 1,949,536 | |
Realized (losses) gains on calls | | $ | 166 | | | $ | 2 | | | $ | (18,613 | ) | | $ | 464 | |
The unrealized gains or losses from fixed maturities are reported as “Accumulated other comprehensive income or loss,” which is a separate component of stockholders’ equity, net of any deferred tax effect.
Other income
Other income included in Insurance Company Revenues and Other Insurance Operations was $95,225 and $123,585 for the three and nine months ended September 30, 2021, respectively, compared to $81,860 and $285,640 for the three and nine months ended September 30, 2020, respectively. The decrease in other income during the nine months ended September 30, 2021, is primarily attributable to a decrease in rental income as a result of the sale of the building owned by Crusader, while the increase in the three months ended September 30, 2021, is due to a receipt of commission from a reinsurance contract.
Gross commissions and fees
Gross commissions and fees decreased $75,992 (16%) to $385,548 and $153,774 (11%) to $1,234,720 for the three and nine months ended September 30, 2021, respectively, compared to gross commissions and fees of $461,540 and $1,388,494 for the three and nine months ended September 30, 2020, respectively.
The comparison in gross commission and fee income for the three and nine months ended September 30, 2021, as compared to the three and nine months ended September 30, 2020, are as follows:
| | Three Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2021 | | | 2020 | | | Change | | | 2021 | | | 2020 | | | Change | |
| | | | | | | | | | | | | | | | | | |
Brokerage fee income | | $ | 207,027 | | | $ | 233,818 | | | $ | (26,791 | ) | | $ | 650,519 | | | $ | 760,486 | | | $ | (109,967 | ) |
Health insurance program | | | 170,138 | | | | 204,352 | | | | (34,214 | ) | | | 547,600 | | | | 557,634 | | | | (10,034 | ) |
Membership and fee income | | | 8,383 | | | | 23,370 | | | | (14,987 | ) | | | 36,601 | | | | 70,374 | | | | (33,773 | ) |
Gross commissions and fees | | $ | 385,548 | | | $ | 461,540 | | | $ | (75,992 | ) | | $ | 1,234,720 | | | $ | 1,388,494 | | | $ | (153,774 | ) |
Unifax sells and services insurance policies for Crusader and did the same for USIC, until its contract with USIC ended on August 31, 2021. For these brokerage services, Unifax received commissions from insurance companies and fees from policyholders. The commissions paid by Crusader to Unifax are eliminated as intercompany transactions and are not reflected as income in the condensed consolidated financial statements. Policy fee income received by Unifax is related to the Crusader policies and service fee income received by Unifax is related to the USIC policies. For financial statement reporting purposes, brokerage fees are earned ratably over the life of the related insurance policy. The unearned portion of the brokerage fees is recorded as a liability on the Condensed Consolidated Balance Sheets under “Accrued expenses and other liabilities.” The earned portion of the brokerage fees charged to the policyholder by Unifax is recognized as income in the condensed consolidated financial statements. Brokerage fee income decreased $26,791 (11%) and $109,967 (14%) in the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020, due primarily to reduction in policy counts. As a result of Crusader’s entering into runoff, the brokerage fee income, which is generated from production of Crusader insurance policies, is expected to gradually decrease over time. The Company does not expect any brokerage fee income in 2023.
AIB markets health insurance in California through non-affiliated insurance companies for individuals and groups. For these services, AIB receives commissions based on the premiums that it writes. Commission income decreased $34,214 (17%) and $10,034 (2%) in the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020. The decreases in the commissions during the three and nine months ended September 30, 2021, is due to the cancellation of a few large groups.
AAQHC is a third-party administrator for contracted insurance companies and is a membership association that provides various consumer benefits to its members, including participation in group health care insurance policies that AAQHC negotiates for the association. For these services, AAQHC receives membership and fee income from its members. Membership and fee income decreased $14,987 (64%) and $33,773 (48%) for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020. The decreases in the membership and fee income during the three and nine months ended September 30, 2021, are due primarily to a decrease the cancellation of a few large groups.
Finance charges and fees earned
Finance charges and fees earned consist of finance charges, late fees, returned check fees and payment processing fees. These charges and fees earned by AAC decreased $16,527 (29%) to $40,458 and $61,462 (32%) to $130,228 for the three and nine months ended September 30, 2021, respectively, compared to $56,985 and $191,690 in fees earned during the three and nine months ended September 30, 2020, respectively, due primarily to the decrease in the number of policies financed. During the three and nine months ended September 30, 2021, AAC issued 131 and 563 loans, respectively, and had 572 loans outstanding as of September 30, 2021. During the three and nine months ended September 30, 2020, AAC issued 288 and 929 loans, respectively, and had 944 loans outstanding as of September 30, 2020. AAC provides premium financing for Crusader and USIC policies produced by Unifax in California. Effective August 6, 2021, the Company decided to discontinue loan issuance through AAC. The Company will continue servicing existing loans but is no originating loans as per above.
Losses and loss adjustment expenses
Loss and loss adjustment expenses are the Company’s largest expense item. The loss ratio, which is calculated by dividing losses and loss adjustment expenses by net earned premium, was 89% and 87% for the three and nine months ended September 30, 2021, compared to 243% and 135% for the three and nine months ended September 30, 2020.
Losses and loss adjustment expenses and loss ratios are as follows:
| | Three Months Ended September 30 | |
| | 2021 | | | Loss Ratio | | | 2020 | | | Loss Ratio | | | Change | |
| | | | | | | | | | | | | | | |
Net earned premium | | $ | 7,737,622 | | | | | | $ | 7,124,272 | | | | | | $ | 613,350 | |
Losses and loss adjustment expenses: | | | | | | | | | | | | | | | | | | |
Provision for insured events of current year | | | 8,017,701 | | | | 104 | % | | | 9,385,389 | | | | 132 | % | | | (1,367,688 | ) |
Development of insured events of prior years | | | (1,165,803 | ) | | | (15 | )% | | | 7,934,662 | | | | 111 | % | | | (9,100,465 | ) |
Total losses and loss adjustment expenses | | $ | 6,851,898 | | | | 89 | % | | $ | 17,320,051 | | | | 243 | % | | | (10,468,153 | ) |
| | | |
| | Nine Months Ended September 30 | |
| | 2021 | | | Loss Ratio | | | 2020 | | | Loss Ratio | | | Change | |
| | | | | | | | | | | | | | | |
Net earned premium | | $ | 21,309,130 | | | | | | $ | 20,805,517 | | | | | | $ | 503,613 | |
Losses and loss adjustment expenses: | | | | | | | | | | | | | | | | | | |
Provision for insured events of current year | | | 20,529,747 | | | | 96 | % | | | 19,925,024 | | | | 96 | % | | | 604,723 | |
Development of insured events of prior years | | | (2,007,929 | ) | | | (9 | )% | | | 8,161,318 | | | | 39 | % | | | (10,169,247 | ) |
Total losses and loss adjustment expenses | | $ | 18,521,818 | | | | 87 | % | | $ | 28,086,342 | | | | 135 | % | | $ | (9,564,524 | ) |
Some lines of insurance are commonly referred to as “long-tail” lines because of the extended time required before claims are ultimately settled. Lines of insurance in which claims are settled relatively quickly are called “short-tail” lines. It is generally more difficult to estimate loss reserves for long-tail lines because of the long period of time that elapses between the occurrence of a claim and its final disposition and the difficulty of estimating the settlement value of the claim. Crusader’s short-tail lines consist of its property coverages, and its long-tail lines consist of its liability coverages.
The $8,017,701 provision for insured events of current year for the three months ended September 30, 2021, was $1,367,688 less than the $9,385,389 provision for insured events of current year for the three months ended September 30, 2020, due primarily to increases in the IBNR reserves associated with the Buildings and Transportation business during the three months ended September 30, 2020. As reported previously, in 2020 there was a large increase in IBNR which is also impacted this analysis.
The $1,165,803 favorable development of insured events of prior years for the three months ended September 30, 2021, was $9,100,465 higher compared to the $7,934,662 adverse development for the three months ended September 30, 2020, due primarily to increases in 2018 and 2019 accident year IBNR reserves associated with the Buildings and Transportation business during the three months ended September 30, 2020.
The $20,529,747 provision for insured events of current year for the nine months ended September 30, 2021, was $604,723 higher than the $19,925,024 provision for insured events of current year for the nine months ended September 30, 2020, due primarily to the increase in the 2021 accident year IBNR reserves associated with the Transportation business as a result of premium growth in that line of business. Also, contributing to the increase was a higher frequency and severity of liability claims related to the Transportation business. The higher severity of the Transportation liability claims was caused by several fatal accidents which involved drivers insured by Crusader.
The $2,007,929 favorable development of insured events of prior years for the nine months ended September 30, 2021, was $10,169,247 higher compared to the $8,161,318 adverse development for the nine months ended September 30, 2020, due primarily to increases in 2018 and 2019 accident year IBNR reserves associated with the Buildings and Transportation business during the three months ended September 30, 2020.
Crusader has received a number of COVID-19-related business interruption claims. With the exception of one claim for which the investigation is still ongoing, all claims were denied after the individual circumstances of each claim were reviewed to determine whether insurance coverage applied. Like many companies in the property casualty insurance industry, Crusader was named as defendant in lawsuits seeking insurance coverage under the policies issued by Crusader for alleged economic losses resulting from the shutdown or suspension of their businesses due to COVID-19. Although the allegations vary, the plaintiffs generally seek a declaration of insurance coverage, damages for breach of contract in unspecified amounts for claim denials, interest and attorney fees. Some of the lawsuits also allege that the insurance claims were denied in bad faith or otherwise in violation of state laws and seek extra-contractual or punitive damages.
While the Company does not believe it is exposed to substantial risk from those claims under the insurance policies written by Crusader, the individual circumstances of each such claim are reviewed to fulfill Crusader’s obligation to its policyholders if coverage applies. Further, there may be impacts to the timing of loss emergence and ultimate loss ratios for certain Crusader’s products due to postponements of civil court cases, extensions of various statutes of limitations, changes in settlement trends and other new legislative, regulatory or judicial developments which could result in loss reserve deficiencies and negative impact on results of operations.
Crusader has received seven claims related to civil unrest through March 1, 2022. One claim remains open for potential subrogation. The losses and loss adjustment expenses associated with those claims will not exceed Crusader’s $500,000 excess of loss reinsurance treaty retention.
The following table breaks out adverse (favorable) development from total losses and loss adjustment expenses quarterly since September 30, 2019:
| | Provision for Insured Events of Current Year | | | Adverse (Favorable) Development of Insured Events of Prior Years | | | Total Losses and Loss Adjustment Expenses | |
| | | | | | | | | |
Three Months Ended: | | | | | | | | | |
September 30, 2021 | | $ | 8,017,701 | | | $ | (1,165,803 | ) | | $ | 6,851,898 | |
June 30, 2021 | | | 5,754,482 | | | | 330,225 | | | | 6,084,707 | |
March 31, 2021 | | | 6,757,564 | | | | (1,172,351 | ) | | | 5,585,213 | |
December 31, 2020 | | | 6,758,848 | | | | (202,270 | ) | | | 6,556,578 | |
September 30, 2020 | | | 9,385,389 | | | | 7,934,662 | | | | 17,320,051 | |
June 30, 2020 | | | 5,378,459 | | | | (489,553 | ) | | | 4,888,906 | |
March 31, 2020 | | | 5,161,176 | | | | 716,209 | | | | 5,877,385 | |
December 31, 2019 | | | 5,400,410 | | | | 1,824,349 | | | | 7,224,759 | |
September 30, 2019 | | | 4,299,018 | | | | 838,956 | | | | 5,137,974 | |
At the end of each fiscal quarter, Crusader’s loss and loss adjustment expense reserves for each accident year (i.e., for all claims incurred within each year) are re-evaluated independently by the Company’s president, the Company’s chief financial officer, and by an independent consulting actuary. Generally accepted actuarial methods, including the widely used Bornhuetter-Ferguson and loss development methods, are employed to estimate ultimate claims costs. An actuarial central estimate of the ultimate claims costs and IBNR reserves is ultimately determined by management and tested for reasonableness by the independent consulting actuary.
Repeated and sustained underwriting losses in Crusader’s Buildings line of business and growth in Crusader’s Transportation line of business, a product which is generally known for its difficulty to be underwritten profitably, coupled with changes in the market conditions, caused Crusader management to reevaluate the assumptions used in its process for estimating loss and loss adjustment expense reserves during the three months ended September 30, 2020. This reevaluation and the use of updated assumptions led to significantly more conservative estimates for expected claims frequency, claims severity and ultimate incurred losses and loss adjustment expenses during the quarterly re-evaluation of the loss and loss adjustment expense reserves as of September 30, 2020. The increase in the ultimate incurred losses and loss adjustment expenses manifested primarily through higher IBNR reserves for 2018, 2019, and 2020 accident year claims pertaining to Buildings and Transportation liability coverages during the three months ended September 30, 2020. During the three months ended September 30, 2021, primarily lower ultimate estimates for Transportation liability coverage for the 2020 accident year and favorable case developments in 2017 and 2020 accident year Mainstreet liability claims resulted in favorable development of insured events of prior years.
The variability of Crusader’s losses and loss adjustment expenses for the periods presented is primarily due to the small and diverse population of Crusader’s policyholders and claims, which may result in greater fluctuations in claim frequency and/or severity. In addition, Crusader’s reinsurance retention, which is relatively high in relationship to its net earned premium, can result in increased loss ratio volatility when large losses are incurred in a relatively short period of time. Nevertheless, management believes that its reinsurance retention is reasonable given the amount of Crusader’s surplus and its goal to minimize ceded premium.
The preparation of the Company’s condensed consolidated financial statements requires that management makes an estimation of certain liabilities, most significantly the liability for unpaid losses and loss adjustment expenses. Management makes its best estimate of the liability for these unpaid claims costs as of the end of each fiscal quarter. Due to the inherent uncertainties in estimating the Crusader’s unpaid claims costs, actual loss and loss adjustment expense payments are expected to vary, perhaps significantly, from any estimate made prior to the settling of all claims. Variability is inherent in establishing loss and loss adjustment expense reserves, especially for a small insurer such as Crusader. For any given line of insurance, accident year, or other group of claims, there is a continuum of possible loss and loss adjustment expense reserve estimates, each having its own unique degree of propriety or reasonableness. Due to the complexity and nature of the insurance claims process, there are potentially an infinite number of reasonably likely scenarios. Management draws on its collective experience to judgmentally determine its best estimate. In addition to applying a variety of standard actuarial methods to the data, an extensive series of diagnostic tests are applied to the resultant loss and loss adjustment expense reserve estimates to determine management’s best estimate of the unpaid claims liability. The statistics reviewed for each accident year include: loss and loss adjustment expense development patterns; frequencies; severities; and ratios of loss to premium, loss adjustment expense to premium, and loss adjustment expense to loss.
When there is clear evidence that the actual claims costs emerged are different than expected for any prior accident year, the claims cost estimates for that year are revised accordingly. If the claims costs that emerge are less favorable than initially anticipated, generally, Crusader increases its loss and loss adjustment expense reserves immediately. However, if the claims costs that emerge are more favorable than initially anticipated, generally, Crusader reduces its loss and loss adjustment expense reserves over time while it continues to assess the validity of the observed trends based on the subsequent emerged claim costs.
The establishment of loss and loss adjustment expense reserves is a detailed process as there are many factors that can ultimately affect the final settlement of a claim. Estimates are based on a variety of industry data and on Crusader’s current and historical accident year claims data, including but not limited to reported claim counts, open claim counts, closed claim counts, closed claim counts with payments, paid losses, paid loss adjustment expenses, case loss reserves, case loss adjustment expense reserves, earned premiums and policy exposures, salvage and subrogation, and unallocated loss adjustment expenses paid. Many other factors, including changes in reinsurance, changes in pricing, changes in policy forms and coverage, changes in underwriting and risk selection, legislative changes, results of litigation and inflation are also considered.
Policy acquisition costs
Policy acquisition costs consist of commissions, premium taxes, inspection fees, and certain other underwriting costs that are directly related to the production of Crusader insurance policies. These costs include both Crusader expenses and the allocated expenses of other Unico subsidiaries. Crusader’s reinsurers pay Crusader a ceding commission, which is primarily a reimbursement of the acquisition cost related to the ceded premium. No ceding commission is received on facultative or catastrophe ceded premium. Policy acquisition costs, net of ceding commission, are deferred and amortized as the related premiums are earned. The Company annually reevaluates its acquisition costs to determine that costs related to successful policy acquisition are capitalized and deferred. Policy acquisition costs and the ratio to net earned premium are as follows:
| | Three Months Ended September 30 | |
| | 2021 | | | 2020 | | | Change | |
Policy acquisition costs | | $ | 1,951,053 | | | $ | 1,279,703 | | | $ | 671,350 | |
Ratio to net earned premium (GAAP ratio) | | | 14 | % | | | 18 | % | | | | |
| | | | | | | | | | | | |
| | Nine Months Ended September 30 |
| | 2021 | | | 2020 | | | Change | |
Policy acquisition costs | | $ | 4,078,563 | | | $ | 3,626,154 | | | $ | 452,409 | |
Ratio to net earned premium (GAAP ratio) | | | 15 | % | | | 17 | % | | | | |
Policy acquisition costs increased due to an increase in ceded commissions, which resulted in an overall decrease in the ratio for three and nine months ended September 30, 2021, as compared to the three and nine months ended September 30, 2020.
As a result of the runoff of Crusader, policy acquisition costs, which are related to production of Crusader insurance policies, are expected to gradually decrease over time. The Company does not expect any policy acquisition costs in 2023.
Salaries and employee benefits
Salaries and employee benefits decreased $1,412,534 (55%) to $1,171,944 and $1,453,235 (29%) to $3,505,665 for the three and nine months ended September 30, 2021, respectively, compared to $2,584,478 and $4,958,900 for the three and nine months ended September 30, 2020.
Salaries and employee benefits incurred and charged to operating expenses are as follows:
| | Three Months Ended |
| | September 30 |
| | 2021 | | | 2020 | | | Change | |
| | | | | | | | | |
Total salaries and employee benefits incurred | | $ | 2,283,485 | | | $ | 3,530,182 | | | $ | (1,258,286 | ) |
Less: charged to losses and loss adjustment expenses | | | (803,902 | ) | | | (550,143 | ) | | | (253,759 | ) |
Less: capitalized to policy acquisition costs | | | (307,639 | ) | | | (328,440 | ) | | | 20,801 | |
Less: charged to IT system upgrade | | | - | | | | (67,121 | ) | | | 67,121 | |
Net amount charged to operating expenses | | $ | 1,171,944 | | | $ | 2,584,478 | | | $ | (1,424,123 | ) |
| | Nine Months Ended | |
| | September 30 |
| | 2021 | | | 2020 | | | Change | |
| | | | | | | | | |
Total salaries and employee benefits incurred | | $ | 6,607,768 | | | $ | 7,603,460 | | | $ | (1,007,281 | ) |
Less: charged to losses and loss adjustment expenses | | | (1,965,895 | ) | | | (1,459,208 | ) | | | (506,687 | ) |
Less: capitalized to policy acquisition costs | | | (967,891 | ) | | | (1,010,517 | ) | | | 42,626 | |
Less: charged to IT system upgrade | | | (168,317 | ) | | | (174,835 | ) | | | 6,518 | |
Net amount charged to operating expenses | | $ | 3,505,665 | | | $ | 4,958,900 | | | $ | (1,464,824 | ) |
The decrease in the total salaries and employee benefits incurred for the three and nine months ended September 30, 2021, compared to the three and nine months ended September 30, 2020, was due primarily to a reduction in headcount, partially offset by increases in employee benefits costs as a result of higher medical insurance rates.
As a result of the runoff of Crusader, salaries and employee benefits are expected to decrease over time as the Company reduces its employee headcount to adequately support the diminished operations. The decrease in the salaries and employee benefits is expected to be partially offset by costs of severance paid to terminated employees and retention bonuses paid to remaining employees.
Commissions to agents/brokers
Commissions to agents/brokers on the health insurance program decreased $3,213 (14%) to $20,022 and $12,166 (17%) to $61,024 for the three and nine months ended September 30, 2021, respectively, compared to $23,235 and $73,190 for the three and nine months ended September 30, 2020. These decreases in commissions to agents/brokers were due primarily to lower commissions associated with the loss of a large group account.
Other operating expenses
Other operating expenses decreased $346,785 (25%) to $1,051,350 and $531 (0%) for the three and nine months ended September 30, 2021, respectively, compared to $1,398,135 and $3,372,483 for the three and nine months ended September 30, 2020, respectively. The decreases in other operating expenses for the three and nine months ended September 30, 2021, compared to the nine months ended September 30, 2020, were primarily due to decreases in rent expense for the corporate headquarters office space leased in February 2021, fees paid under reinsurance arrangement with USIC, business insurance costs, and CA DOI financial examination of Crusader expenses, partially offset by elimination of building maintenance costs after the sale of the building owned by Crusader.
Income tax expense
Income tax expense was $59,579 (4% of pre-tax loss) and $3,594,572 (25% of pre-tax loss) for the three months ended September 30, 2021, respectively. Income tax expense was $310,191 (63% of pre-tax loss) for the nine months ended September 30, 2021, and income tax expense was $3,543,153 (22% of pre-tax loss) for the nine months ended September 30, 2020.
As of September 30, 2021, the Company had deferred tax assets of $8,075,081 generated from $38,452,769 of federal net operating loss carryforwards that will begin to expire in 2035 and deferred tax assets of $2,490,156, generated from state net operating loss carryforwards which expire between 2028 and 2040. In connection with preparation of its consolidated financial statements, the Company periodically performs an analysis of future income projections to determine the adequacy of the valuation allowance. In light of the net losses that were generated in recent years, at September 30, 2021, the Company has established a valuation allowance for the aggregate amount of the federal and state net operating losses and other deferred tax assets in the amount of $10,955,661 that, in management’s judgment, are not more-likely-than-not to be realized. At December 31, 2020, the Company has established a valuation allowance for the aggregate amount of the federal and state net operating losses and other deferred tax assets in the amount of $10,557,080.
OFF-BALANCE SHEET ARRANGEMENTS
During the periods presented, there were no off-balance sheet transactions, unconditional purchase obligations or similar instruments and the Company was not a guarantor of any other entities’ debt or other financial obligations.