[August 15, 2011] Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) General information about 21st Century Holding Company can be found at www.21stcenturyholding.com; however, the information that can be accessed through our web site is not part of our report. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 available free of charge on our web site, as soon as reasonably practicable after they are electronically filed with the SEC. Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion in conjunction with our condensed consolidated financial statements and related notes and information included under this Item 2 and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on March 31, 2011 ("Form 10-K"). Unless the context requires otherwise, as used in this Form 10-Q, the terms "21st Century" "Company," "we," "us" and "our," refers to 21st Century Holding Company and its subsidiaries. Forward-Looking Statements Statements in this Quarterly Report on Form 10-Q for the six months ended June 30, 2011 ("Form 10-Q") or in documents that are incorporated by reference that are not historical fact are forward-looking statements that are subject to certain risks and uncertainties that could cause actual events and results to differ materially from those discussed herein. Without limiting the generality of the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "would," "estimate," or "continue" or the negative other variations thereof or comparable terminology are intended to identify forward-looking statements. The risks and uncertainties include, without limitation, uncertainties related to estimates, assumptions and projections relating to unpaid losses and loss adjustment expenses and other accounting policies, losses from the nine hurricanes that occurred in fiscal years 2005 and 2004 and in other estimates, assumptions and projections contained in this Form 10-Q; inflation and other changes in economic conditions (including changes in interest rates and financial markets); the impact of new regulations adopted in Florida which affect the property and casualty insurance market; the costs of reinsurance, assessments charged by various governmental agencies; pricing competition and other initiatives by competitors; our ability to obtain regulatory approval for requested rate changes and the timing thereof; legislative and regulatory developments; the outcome of various litigation matters pending against us, including the terms of any settlements; risks related to the nature of our business; dependence on investment income and the composition of our investment portfolio; the adequacy of our liability for loss and loss adjustment expense; insurance agents; claims experience; ratings by industry services; catastrophe losses; reliance on key personnel; weather conditions (including the severity and frequency of storms, hurricanes, tornadoes and hail); changes in driving patterns and loss trends; acts of war and terrorist activities; court decisions and trends in litigation and health care and auto repair costs; and other matters described from time to time by us in this report, and in our other filings with the SEC, including the Company's Form 10-K. You are cautioned not to place reliance on these forward-looking statements, which are valid only as of the date they were made. The Company undertakes no obligation to update or revise any forward-looking statements to reflect new information or the occurrence of unanticipated events or otherwise. In addition, readers should be aware that Generally Accepted Accounting Principles ("GAAP") prescribes when a company may reserve for particular risks, including litigation exposures. Accordingly, results for a given reporting period could be significantly affected when a reserve is established for a major contingency. Reported results may therefore appear to be volatile in certain accounting periods. - 35 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Overview 21st Century is an insurance holding company, which, through our subsidiaries and our contractual relationships with our independent agents and general agents, controls substantially all aspects of the insurance underwriting, distribution and claims processes. We are authorized to underwrite homeowners' multi-peril ("homeowners"), commercial general liability, personal and commercial automobile, personal umbrella, following form commercial excess liability, fire, allied lines, workers' compensation, business personal property and commercial inland marine insurance. We are authorized to underwrite in various states on behalf of our wholly owned subsidiary, Federated National Insurance Company ("Federated National") and other insurance carriers. Federated National is the resulting entity following the merger of Federated National with and into our other wholly owned subsidiary, American Vehicle Insurance Company ("American Vehicle"), in January 2011. In connection with this merger, the Company, Federated National and American Vehicle entered into a Consent Order with the Florida Office of Insurance Regulation ("Florida OIR"). We market and distribute our own and third-party insurers' products and our other services through a network of independent agents. We also utilize a select number of general agents for the same purpose. Our executive offices are located at 3661 West Oakland Park Boulevard, Suite 300, Lauderdale Lakes, Florida, 33311 and our telephone number is (954) 581-9993. Recent Developments In May 2011, the Florida Legislature passed and Governor Scott signed legislation intended to reform Florida's property insurance market. Among other things, the legislation provides: · A claim, supplemental claim, or reopened windstorm or hurricane claim must be given to the insurer within 3 years after the hurricane first makes landfall or the windstorm causes covered damage. An initial, supplemental or reopened sinkhole claim must be given to the insurer within 2 years after the policyholder knew or reasonably should have known about the sinkhole loss. The bill also enacts a 5 year statute of limitations for bringing an action for the breach of a property insurance contract that runs from the date of loss. · The surplus requirements for insurers transacting residential property insurance that are not a wholly owned subsidiary of an insurer domiciled in another state are increased. For a new insurer, the bill raises the surplus requirement from $5 million to $15 million. An existing insurer that holds a certificate of authority before July 1, 2011, must have a surplus of at least $5 million until June 30, 2016; from July 1, 2016 until June 30, 2021, a surplus of at least $10 million; and on or after July 1, 2021, a surplus of at least $15 million. · Property insurance rate filings must be submitted via the "file and use" method until May 1, 2012. In a "file and use" rate filing the insurer must receive approval from the OIR before implementing the insurer's proposed rate. Residential property insurers are authorized to make a separate rate filing limited solely to an adjustment of its rates for reinsurance and financing products used as a replacement for reinsurance. The rate filing may not result in a premium increase of more than 15% for an individual policyholder and must be approved or disapproved by the OIR within 45 days. The OIR retains the authority to deny the filing if the proposed rate is excessive, inadequate, or unfairly discriminatory. An insurer may make only one such filing per 12-month period. · Public adjuster fees related to reopened or supplemental claims will be limited to a maximum of 20% of the reopened or supplemental claim payment. The legislation also limits public adjuster fees to 20% of an insurance claim payment made by the insurer more than one year after events that are the subject of a declaration of a state of emergency by the governor. A public adjuster fee related to a policy issued by Citizens Property Insurance Corporation may not exceed 10% of the additional amount actually paid in excess of the amount originally offered by Citizens on the claim. Public adjusters must give prompt notice of a property loss claim to the insurer and include with the notice the public adjuster's employment contract. The public adjuster must also ensure that the insurer has access to inspect the property, can interview the insured directly about the loss and claim, and allow the insurer to obtain information necessary to investigate and respond to the claim. - 36 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations · The legislation enacts numerous revisions and clarifications to the Florida statutes governing sinkhole and catastrophic ground cover collapse insurance. These changes are intended to reduce the number and cost of sinkhole claims and disputes, increase reliance on scientific or technical determinations relating to sinkhole claims, and ensure that repairs are made in accordance with scientific and technical determinations and insurance claims payments, including by authorizing insurers to restrict catastrophic ground cover collapse and sinkhole loss coverage to the principal building as defined in the insurance policy and allowing an insurer to require a property inspection prior to issuing sinkhole loss coverage. The bill changes the definition of "sinkhole loss," primarily by creating a statutory definition of "structural damage" for purposes of determining whether a sinkhole loss has occurred. The legislation also creates a substantially new process for an insurer's investigation of a sinkhole claim. Coverage for sinkhole loss is not available if structural damage is not present or sinkhole activity is not the cause of structural damage. The insurer may limit payment to the actual cash value of the sinkhole loss not including below-ground repair techniques until the policyholder enters into a contract for the performance of building stabilization repairs. Any contract for below-ground repairs to be made in accordance with the recommendations set forth in the insurer's sinkhole report must be entered into within 90 days after the policyholder receives notice that the insurer has confirmed coverage for sinkhole loss and all stabilization and repairs to the structure and contents generally must be completed within 12 months after the policyholder enters into the contract for repairs. Once stabilization or foundation repairs are completed, the professional engineer responsible for monitoring the repairs must issue a report to the property owner detailing the repairs performed and certifying that the repairs were performed properly. Last, the circumstances that allow an insurer to nonrenew a policy on the basis of filing a sinkhole claim have been modified to permit nonrenewal only if the insurer makes payments for sinkhole loss that equal or exceed policy limits or the policyholder does not repair the structure in accordance with the engineering recommendations. · The legislation provides that at least 120 days notice of nonrenewal, cancellation or termination (reduced from 180 days) must be given to a named insured whose residential structure has been insured by the insurer or its affiliate for at least 5-years. Insurers are now also authorized to renew a property and casualty insurance policy under different policy terms by providing to the policyholder a written "Notice of Change in Policy Terms" instead of a written "Notice of Non-Renewal." The Notice must be titled "Notice of Change in Policy Terms," give the insured written notice of the change, and be enclosed with the written notice of renewal premium. The insured is deemed to have accepted the change in policy terms upon the insurer's receipt of the premium payment for the renewal policy. If the insurer fails to provide the Notice of Change in Policy Terms, the original policy terms remain in effect. · The legislation requires the Florida Hurricane Catastrophe Fund to provide reimbursement for all incurred losses, including amounts paid as fees on behalf of the policyholder. The legislation also specifies, however, a number of losses that are excluded from payment. · The legislation repeals various requirements imposed on Citizens to reduce the areas of Florida that were eligible for coverage in the Florida Windstorm Underwriting Association. The legislation also specifies that Citizens may not levy regular assessments until the full Citizens policyholder surcharge has been levied and that the Citizens policyholder surcharge must be paid upon cancellation, termination, or renewal of an existing policy or upon issuance of every new policy issued within 12 months after the surcharge is levied or the time needed to fully collect the policyholder surcharge. - 37 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsMerger of Federated National and American Vehicle As part of its approval of the merger between Federated National and American Vehicle, the Florida OIR, the Company, Federated National and American Vehicle entered into a consent order with the Florida OIR dated January 25, 2011 (the "Consent Order") pursuant to which the Company and the resulting company in the merger (the "Merged Company") have agreed to the following: · The Merged Company shall retain the following licenses: (010) Fire, (020) Allied Lines, (040) Homeowners Multi Peril, (050) Commercial Multi Peril, (090) Inland Marine, (170) Other Liability, (192) Private Passenger Auto Liability, (194) Commercial Auto Liability, (211) Private Passenger Auto Physical Damage and (212) Commercial Auto Physical Damage. · The Merged Company shall not write commercial multi peril policy premium without prior approval from the Florida OIR. The Merged Company currently has no commercial multi peril policy premium in force. · The Merged Company shall surrender its surety license. The Merged Company currently has no Surety policy premium in force. · The Merged Company shall not write new commercial habitation condominium associations without prior approval from the Florida OIR. The current commercial habitation book of business is approximately $2.3 million of policy premium, which will be renewed pursuant to normal underwriting guidelines. · The Merged Company has agreed to reduce the total number of its homeowners' policies in Miami-Dade, Broward and Palm Beach counties (the "Tri-County Area") to 40% of its entire homeowners' book by December 31, 2011 and limit its new homeowners' policies in the Tri-County Area to $500,000 of new policy premium per month. The 40% was achieved through the increased writing of property located outside of the Tri-County Area, the non-renewal of certain policies located within the Tri-County Area, and limiting the writing of new property located within the Tri-County Area. As of June 30, 2011, the Company had approximately 38.6% of its homeowners' policies located within Tri-County Area. · The managing general agency fees payable by the Merged Company to Assurance Managing General Agents, Inc. ("Assurance MGA"), a wholly owned subsidiary of the Company, which were traditionally 6% of gross written premium, were reduced and will not exceed 4% without prior approval from the Florida OIR. The Merged Company has lowered the fee to 2% of gross written to further support the insurance company's results of operations. This will have no impact on the Company's consolidated financial results. · The claims service fees payable by the Merged Company to Superior Adjusting, Inc. ("Superior") were reduced from the traditional 4.5% of gross earned premium to 3.6% of gross earned premium. This will have no impact on the Company's consolidated financial results. · The Consent Order continues the prohibition on the Company from the payment of dividends until the Merged Company reports two consecutive quarters of net underwriting income. · The Company provided the Florida OIR with a plan of operation and has agreed to provide certain reports to the Florida OIR on a monthly basis, and agreed to obtain the Florida OIR's approval prior to making any changes to the officers of the Merged Company during the first year following the effective date of the Merger. Our Subsidiaries The merger of Federated National and American Vehicle will be an ongoing transition, many aspects of which will take effect over time. References to the companies contained herein are intended to be references to the operations of the Federated National following the January 2011 merger. References to the historical activities of American Vehicle are appropriately identified throughout this report. - 38 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Federated National is licensed as an admitted carrier in Florida. Through contractual relationships with a network of approximately 3,000 independent agents, of which approximately 600 actively sell and service our products, Federated National is authorized to underwrite homeowners', fire, allied lines and personal and commercial automobile insurance in Florida. Effective January 26, 2011, Federated National merged with and into American Vehicle and American Vehicle changed its name to Federated National. American Vehicle, prior to the January 2011 merger, was licensed as an admitted carrier in Florida, and underwrote commercial general liability, and personal and commercial automobile insurance. American Vehicle was also licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas, and underwrote commercial general liability insurance in those states. American Vehicle operated as a non-admitted carrier in Arkansas, California, Kentucky, Maryland, Missouri, Nevada, Oklahoma, South Carolina, Tennessee and Virginia, and could underwrite commercial general liability insurance in all of these states. Subsequent to the merger, these operations may continue under the newly formed Federated National. An admitted carrier is an insurance company that has received a license from the state department of insurance giving the company the authority to write specific lines of insurance in that state. These companies are also bound by rate and form regulations, and are strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Admitted carriers are also required to financially contribute to the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders. A non-admitted carrier is not licensed by the state, but is allowed to do business in that state and is strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Sometimes, non-admitted carriers are referred to as "excess and surplus" lines carriers. Non-admitted carriers are subject to considerably less regulation with respect to policy rates and forms. Non-admitted carriers are not required to financially contribute to and benefit from the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders. During the six months ended June 30, 2011, 81.5%, 10.2%, 4.1% and 4.2% of the premiums we underwrote were for homeowners', commercial general liability, federal flood, and automobile insurance, respectively. During the six months ended June 30, 2010, 79.3%, 12.3%, 3.4% and 5.0% of the premiums we underwrote were for homeowners', commercial general liability, federal flood, and personal automobile insurance, respectively. Our business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on our business, results of operations and financial condition. When our estimated liabilities for unpaid losses and loss adjustment expenses ("LAE") are less than the actuarially determined amounts, we increase the expense in the current period. Conversely, when our estimated liabilities for unpaid losses and LAE are greater than the actuarially determined amounts, we decrease the expense in the current period. We are focusing our marketing efforts on continuing to expand our distribution network and market our products and services throughout Florida and in other states by establishing relationships with additional independent agents and general agents. As this occurs, we will seek to replicate our distribution network in those states. For example, we became an admitted insurer in the state of Georgia during the quarter ended September 30, 2010. There can be no assurance, however, that we will be able to obtain the required regulatory approvals to offer additional insurance products or expand into other states. Assurance MGA, a wholly owned subsidiary of the Company, acts as Federated National's and American Vehicle's exclusive managing general agent in the state of Florida and is also licensed as a managing general agent in the states of Alabama, Arkansas, Georgia, Illinois, Louisiana, North Carolina, Mississippi, Missouri, New York, Nevada, South Carolina, Texas and Virginia. Assurance MGA has contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation, personal umbrella and inland marine insurance through Assurance MGA's existing network of agents. Assurance MGA earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. Assurance MGA earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliates Federated National and American Vehicle. During the fourth quarter of 2010, Assurance MGA reduced its' fee, to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date. A formal agreement reflecting this fee modification was executed during January 2011. - 39 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations We internally process claims made by our insureds through our wholly owned claims adjusting company, Superior. Our agents have no authority to settle claims or otherwise exercise control over the claims process. Furthermore, we believe that the retention of independent adjusters, in addition to the employment of salaried claims personnel, results in reduced ultimate loss payments, lower LAE and improved customer service for our claimants and policyholders. We also employ an in-house legal department to cost-effectively manage claims-related litigation and to monitor our claims handling practices for efficiency and regulatory compliance. Until June 2011, we offered premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc. ("Federated Premium"). Premium financing has been marketed through our distribution network of general agents and independent agents. Premiums for property and casualty insurance, in certain circumstances, are payable at the time a policy is placed in-force or renewed. Federated Premium's services allow the insured to pay a portion of the premium when the policy is placed in-force and the balance in monthly installments over a specified term, generally between six and nine months. As security, Federated Premium retains a contractual right, if a premium installment is not paid when due, to cancel the insurance policy and to receive the unearned premium from the insurer, or in the event of insolvency of an insurer, from Florida Insurance Guaranty Association ("FIGA"), subject to a $100 per policy deductible. In the event of cancellation, Federated Premium applies the unearned premium towards the payment obligation of the insured. In June 2011, we determined to stop providing financing for new policies although we continue to provide financing for existing policies. Insure-Link, Inc. ("Insure-Link") was formed in March 2008 to serve as an independent insurance agency. The insurance agency markets direct to the public to provide a variety of insurance products and services to individual clients, as well as business clients, by offering a full line of insurance products including, but not limited to, homeowners', personal and commercial automobile, commercial general liability and workers' compensation insurance through their agency appointments with over fifty different carriers. Insure-Link will expand its business through marketing and by acquiring other insurance agencies. There were no other agency relationships with affiliated captive or franchised agents during 2010 or the six months ended June 30, 2011. We operate in highly competitive markets and face competition from national, regional and residual market insurance companies in the homeowners', commercial residential property, commercial general liability, and automobile markets, many of whom are larger, have greater financial and other resources, and offer more diversified insurance coverage. Our competitors include companies that market their products through agents, as well as companies that sell insurance directly to their customers. Large national writers may have certain competitive advantages over agency writers, including increased name recognition, increased loyalty of their customer base and reduced policy acquisition costs. Insurance Markets in Which We Operate Significant competition also emerged because of fundamental changes in 2007 made to the property and casualty insurance business in Florida, which resulted in a multi-pronged approach to address the cost of residential property insurance in Florida. First, the law increased the capacity of reinsurance that stabilized the reinsurance market to the benefit of the insurance companies writing properties lines in Florida. Secondly, the law provided for rate relief to all policyholders. The law also authorized the state-owned insurance company, Citizens Property Insurance Corporation ("Citizens"), which is free of many of the restraints on private carriers such as surplus, ratios, income taxes and reinsurance expense, to reduce its premium rates and begin competing against private insurers in the residential property insurance market and expands the authority of Citizens to write commercial insurance. We believe that these aggressive marketplace changes in 2007 forced some carriers to pursue market share based on "best case" pricing models that may ultimately prove unprofitable from an underwriting perspective. For example, during 2009 we noted that the Florida OIR placed at least four property and casualty insurance companies in some form of receivership while several other Florida domiciled insurance companies have recapitalized in order to remain viable in the Florida market. The insolvency of these companies poses a risk to all other remaining carriers in the state in terms of assessments to support those failed companies. Through June 30, 2011, we are not aware of any such assessments in connection with the takeovers during 2009; however, no guarantee can be made that no assessments will be imposed. - 40 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsIn recent years, approximately two-dozen new homeowner insurance companies received authority by the Florida OIR to commence business as admitted carriers in the state. In 2006, the state of Florida created the Insurance Capital Build-Up Incentive Program in response to the catastrophic events that occurred during 2004 and 2005. This program provided matching capital funds to any new or existing carrier licensed to write homeowners' insurance in Florida under certain conditions. This program resulted in a significant erosion of our homeowners' insurance market since 2007. We did not participate in the Insurance Capital Build-Up Incentive Program. Although our pricing is inevitably influenced to some degree by that of our competitors, we believe that it is generally not in our shareholders' best interest to compete solely on price. We face increased competition from existing carriers and new entrants in our niche markets. As mentioned earlier, in an effort to foster competition after the hurricanes of 2004 and 2005, the State of Florida loaned money to multiple carriers with certain debt covenants, including the maintenance of minimum written premium. Our competition has attempted to gain market share through aggressive pricing and generous policy acquisition costs, which has had an adverse affect on our ability to maintain market share. Although our pricing is inevitably influenced to some degree by that of our competitors, we believe that it is generally not in our best interest to compete solely on price. We compete based on underwriting criteria, our distribution network and superior service to our agents and insureds. In Florida, more than 200 companies are authorized to underwrite homeowners' insurance. National and regional companies that compete with us in the homeowners' market include Castle Key Indemnity Insurance Company (formerly Allstate Floridian) and Fidelity National Insurance Company. In addition to these nationally recognized companies, we also compete with several Florida domestic property and casualty companies such as, but not limited to, Universal Property and Casualty Insurance Company, Royal Palm Insurance Company, St. Johns Insurance Company, Cypress Property and Casualty Insurance Company, and American Strategic Insurance Company. Companies, which compete with us nationally in the commercial general liability insurance market, include Century Surety Insurance Company, Atlantic Casualty Insurance Company, Colony Insurance Company and Burlington/First Financial Insurance Companies. Comparable companies in the personal automobile insurance market include Kingsway Amigo Insurance Company, United Automobile Insurance Company, Direct General Insurance Company, and Ocean Harbor Insurance Company, as well as national insurers such as Progressive Casualty Insurance Company and GEICO. Critical Accounting Policies See Note 3, "Summary of Significant Accounting Policies" in the Notes to the Company's condensed consolidated financial statements for the quarter ended June 30, 2011 included in Item 1 of this Report on Form 10-Q for a discussion of the Company's critical accounting policies. New Accounting Pronouncements See Note 3, "Summary of Significant Accounting Policies" in the Notes to the Company's condensed consolidated financial statements for the quarter ended June 30, 2011 included in Item 1 of this Report on Form 10-Q for a discussion of recent accounting pronouncements and their effect, if any, on the Company. - 41 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Analysis of Financial Condition As of June 30, 2011 Compared with December 31, 2010 Total Investments The Financial Accounting Standards Board ("FASB") issued guidance addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. FASB issued guidance requires that these securities be classified into one of three categories: (i) held-to-maturity, (ii) trading securities or (iii) available-for-sale. Investments classified as held-to-maturity include debt securities wherein the Company's intent and ability are to hold the investment until maturity. The accounting treatment for held-to-maturity investments is to carry them at amortized cost without consideration to unrealized gains or losses. Investments classified as trading securities include debt and equity securities bought and held primarily for sale in the near term. The accounting treatment for trading securities is to carry them at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments. The accounting treatment for available-for-sale securities is to carry them at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders' equity, namely "Other Comprehensive Income". Total investments increased $7.1 million, or 5.8%, to $129.6 million as of June 30, 2011, compared with $122.5 million as of December 31, 2010. The debt and equity securities that are available-for-sale and carried at fair value represent 94% and 95% of total investments as of June 30, 2011 and of December 31, 2010, respectively. We did not hold any trading investment securities during the six months ended June 30, 2011. Below is a summary of net unrealized gains and losses as of June 30, 2011 and December 31, 2010, by category. Unrealized Gains and (Losses) June 30, 2011 December 31, 2010 (Dollars in Thousands) Debt securities: United States government obligations and authorities $ 102 $ (192 ) Obligations of states and political subdivisions 168 43 Corporate 887 268 International 36 24 1,193 143 Equity securities: Common stocks 855 692 Total debt and equity securities $ 2,048 $ 835 The net unrealized gain of $2.0 million is inclusive of $1.5 million of unrealized losses. The $1.5 million of unrealized losses is inclusive of $1.0 million unrealized losses from equity securities and $0.5 million unrealized losses from debt securities. The $1.0 million of unrealized losses from equity securities is from common stocks and mutual funds held in diverse industries as of June 30, 2011. The Company evaluated the near-term prospects in relation to the severity and duration of the impairment. Based on this evaluation and the Company's ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2011. - 42 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations The $0.5 million of unrealized losses from debt securities consists of $0.2 million and $0.3 million from United States government, federal agency mortgage-backed securities and corporate bonds, respectively. The unrealized losses on the Company's investment in federal agency mortgage-backed securities are due to interest rate changes. The contractual cash flows of those investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company's investments. The Company does not currently intend to sell these investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis and does not consider these investments to be other-than-temporarily impaired at June 30, 2011. The unrealized losses on the Company's investment in corporate bonds relates to $17.2 million invested in bonds across diverse sectors; 63% of these bonds had at least an "A" rating and the unrealized losses were caused by interest rate changes. The Company does not expect to settle at prices less than the amortized cost basis. Because the Company does not currently intend to sell these investments and it is not more likely than not that the Company will be required to sell these investments before recovery of the amortized cost basis, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2011. The FASB issued guidance also addresses the determination as to when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. The Company's policy for the valuation of temporarily impaired securities is to determine impairment based on the analysis of the following factors. · rating downgrade or other credit event (eg., failure to pay interest when due); · length of time and the extent to which the fair value has been less than amortized cost; · financial condition and near term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology or discontinuance of a business segment; · prospects for the issuer's industry segment; · intent and ability of the Company to retain the investment for a period of time sufficient to allow for anticipated recovery in market value; · historical volatility of the fair value of the security. Pursuant to FASB issued guidance, the Company records the unrealized losses, net of estimated income taxes that are associated with that part of our portfolio classified as available-for-sale through the shareholders' equity account titled "Other Comprehensive Income". Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. Factors used in such consideration include, but are not limited to, the extent and length of time over which the market value has been less than cost, the financial condition and near-term prospects of the issuer and our ability and intent to keep the investment for a period sufficient to allow for an anticipated recovery in market value. In reaching a conclusion that a security is either other-than-temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor's and Moody's Investors Service, Inc. ("Moody's"), as well as information released via the general media channels. During the six months ended June 30, 2011, in connection with this process, we have not charged any net realized investment loss to operations. As of June 30, 2011 and December 31, 2010, respectively, all of our securities are in good standing and not impaired as defined by FASB-issued guidance. During the six months ended June 30, 2011, in connection with the other-than-temporarily or permanently impaired process, we did not charge any net realized investment loss to operations. - 43 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations The investments held as of June 30, 2011 and December 31, 2010, were comprised mainly of corporate bonds held in various industries and municipal and United States government bonds. As of June 30, 2011, 62% of the debt portfolio is in diverse industries and 38% is in United States government bonds. As of June 30, 2011, approximately 91% of the equity holdings are in equities related to diverse industries and 9% are in mutual funds. As of June 30, 2011, 48% of the investment portfolio is in corporate bonds, 2% is in obligations of states and political subdivisions, and 32% is in United States government bonds. Approximately 9% of the common stock holdings are related to foreign entities. The following table summarizes, by type, our investments as of June 30, 2011 and December 31, 2010. June 30, 2011 December 31, 2010 Carrying Percent Carrying Percent Amount of Total Amount of Total (Dollars in Thousands) Debt securities, at market: United States government obligations and authorities $ 34,591 26.70 % $ 28,196 23.02 % Obligations of states and political subdivisions 3,085 2.38 % 2,963 2.42 % Corporate 62,519 48.25 % 65,808 53.73 % International 1,259 0.97 % 1,383 1.13 % 101,454 78.30 % 98,350 80.30 % Debt securities, at amortized cost: Corporate 923 0.71 % 818 0.67 % United States government obligations and authorities 6,297 4.86 % 5,380 4.39 % 7,220 5.57 % 6,198 5.06 % Total debt securities 108,674 83.87 % 104,548 85.36 % Equity securities, at market: 20,894 16.13 % 17,937 14.64 % Total investments $ 129,568 100.00 % $ 122,485 100.00 % As of June 30, 2011 and December 31, 2010, we have classified $7.2 million and $6.2 million, respectively, of our bond portfolio as held-to-maturity. We only classify bonds as held-to-maturity to support securitization of credit requirements. Fully funded trust agreements or outstanding irrevocable letters of credit, used for such purposes, total $4.6 and $3.6 million for the period ended June 30, 2011 and December 31, 2010, respectively. During the three months ended March 31, 2011, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity. During the three months ended March 31, 2010, we re-classified $3.1 million of amortized cost to held-to-maturity from available-for-sale to fund trust agreements. During the three months ended June 30, 2011 and 2010, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity. During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic Underwriters Insurance Company ("Republic") which was terminated in April 2007. As of December 31, 2007, the letter of credit in favor of Republic totaled $10.0 million. As of December 31, 2008, the letter of credit in favor of Republic totaled $3.0 million. As of December 31, 2009, the letter of credit in favor of Republic totaled $1.0 million. As of June 30, 2011 and December 31, 2010, respectively, the letter of credit in favor of Republic totaled zero, and was replaced by a fully funded trust agreement that totaled $1.0 million. - 44 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsCash and Short-Term Investments Cash and short-term investments, which include cash, certificates of deposits, and money market accounts, increased $5.9 million, or 36.6%, to $22.1 million as of June 30, 2011, compared with $16.2 million as of December 31, 2010. Prepaid Reinsurance Premiums Prepaid reinsurance premiums decreased $8.1 million, or 78.0%, to $2.3 million as of June 30, 2011, compared with $10.4 million as of December 31, 2010. The change is due to $14.2 million of payments to reinsurers, net of $22.3 million amortization of prepaid reinsurance premiums associated with our reinsurance programs. We believe concentrations of credit risk associated with our prepaid reinsurance premiums are not significant. Premiums Receivable, Net of Allowance for Credit Losses Premiums receivable, net of allowance for credit losses, increased $1.3 million, or 23.0%, to $6.9 million as of June 30, 2011, compared with $5.6 million as of December 31, 2010. Our homeowners' insurance premiums receivable increased $0.4 million, or 11.2%, to $3.9 million as of June 30, 2011, compared with $3.5 million as of December 31, 2010. Our commercial general liability insurance premiums receivable increased $0.4 million, or 27.5%, to $1.8 million as of June 30, 2011, compared with $1.4 million as of December 31, 2010. Premiums receivable in connection with our automobile line of business increased $0.6 million, or 70.2%, to $1.4 million as of June 30, 2011, compared with $0.8 million as of December 31, 2010. Our allowance for credit losses remained unchanged at approximately $0.1 million as of June 30, 2011, compared with as of December 31, 2010. Reinsurance Recoverable, Net Reinsurance recoverable, net, decreased $2.9 million, or 37.0%, to $5.1 million as of June 30, 2011, compared with $8.0 million as of December 31, 2010. The change is due to the payment patterns by our reinsurers, as influenced by the diminishing catastrophe related claims; payments received during the six months ended June 30, 2011 totaled $3.1 million. All amounts are current and deemed collectable. We believe concentrations of credit risk associated with our reinsurance recoverables, net, are not significant. Deferred Policy Acquisition Costs ("DPAC") DPAC increased $1.0 million, or 13.4%, to $8.9 million as of June 30, 2011, compared with $7.9 million as of December 31, 2010. The change is due to increased homeowners' written and unearned premium and the related deferral of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned. Deferred Income Taxes, Net Deferred income taxes, net, increased $1.1 million, or 13.1%, to $9.0 million as of June 30, 2011, compared with $7.9 million as of December 31, 2010. Deferred income taxes, net, is comprised of approximately $11.4 million and $9.9 million of deferred tax assets, net of approximately $2.4 million and $2.0 million of deferred tax liabilities as of June 30, 2011 and December 31, 2010, respectively. The change in the net deferred tax asset is primarily due to the increase in the deferred tax assets related to discounted unearned premiums and net operating losses carry forward. - 45 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Income Taxes Receivable Income taxes receivable remained unchanged at $2.4 million as of June 30, 2011 and December 31, 2010, respectively. Other Assets Other assets decreased $0.1 million, or 6.3%, to $2.2 million as of June 30, 2011, compared with $2.3 million as of December 31, 2010. Major components of other assets are shown in the following table; the accrued interest income receivable is primarily investment related. June 30, 2011 December 31, 2010 (Dollars in Thousands) Accrued interest income receivable $ 1,178 $ 1,089 Notes receivable 183 365 Deposits 191 133 Prepaid expenses 344 376 Other 270 347 Total $ 2,166 $ 2,310 Unpaid Losses and LAE Unpaid losses and LAE decreased $1.8 million, or 2.7%, to $64.7 million as of June 30, 2011, compared with $66.5 million as of December 31, 2010. The composition of unpaid losses and LAE by product line is as follows. June 30, 2011 December 31, 2010 Case Bulk Total Case Bulk Total (Dollars in Thousands) (Dollars in Thousands) Homeowners' $ 9,279 $ 12,941 $ 22,220 $ 5,825 $ 16,847 $ 22,672 Commercial General Liability 5,608 29,491 35,099 8,230 27,819 36,049 Automobile 3,520 3,892 7,412 3,447 4,361 7,808 Total $ 18,407 $ 46,324 $ 64,731 $ 17,502 $ 49,027 $ 66,529 Factors that affect unpaid losses and LAE include the estimates made on a claim-by-claim basis known as "case reserves" coupled with bulk estimates known as incurred but not yet reported ("IBNR"). Periodic estimates by management of the ultimate costs required to settle all claim files are based on the Company's analysis of historical data and estimations of the impact of numerous factors such as (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. Management revises its estimates based on the results of its analysis. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors. Unearned Premium Unearned premiums increased $6.7 million, or 14.2%, to $53.8 million as of June 30, 2011, compared with $47.1 million as of December 31, 2010. The change was due to a $5.9 million increase in unearned homeowners' insurance premiums, a $0.2 million increase in unearned flood insurance premiums, and a $0.6 million increase in unearned automobile premiums. Generally, as is in this case, an increase in unearned premium directly relates to an increase in written premium on a rolling twelve-month basis. Competition could negatively affect our unearned premium. - 46 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsPremium Deposits and Customer Credit Balances Premium deposits and customer credit balances remained unchanged at approximately $2.4 million as of June 30, 2011, compared with as of December 31, 2010. Premium deposits are monies received on policies not yet in-force as of June 30, 2011. Bank Overdraft Bank overdraft increased $1.5 million, or 19.9%, to $8.9 million as of June 30, 2011, compared with $7.4 million as of December 31, 2010. The bank overdraft relates primarily to losses and LAE disbursements paid but not presented for payment by the policyholder or vendor. The change relates to the timing of presentation of claims checks to the issuing bank. Deferred Gain from Sale of Property Deferred gain from sale of property decreased $0.2 million, or 50.0%, to $0.3 million as of June 30, 2011, compared with $0.5 million as of December 31, 2010. As required by FASB issued guidance, we are amortizing the deferred gain over the term of the leaseback, which is scheduled to end in December 2011. Accounts Payable and Accrued Expenses Accounts payable and accrued expenses increased $0.8 million, or 39.8%, to $3.0 million as of June 30, 2011, compared with $2.2 million as of December 31, 2010. Results of Operations Three Months Ended June 30, 2011 Compared with Three Months Ended June 30, 2010 Gross Premiums Written Gross premiums written increased $0.4 million, or 1.5%, to $28.0 million for the three months ended June 30, 2011, compared with $27.6 million for the three months ended June 30, 2010. The following table denotes gross premiums written by major product line. Three Months Ended June 30, 2011 2010 (Dollars in Thousands) Amount Percentage Amount Percentage Homeowners' $ 22,568 80.59 % $ 22,205 80.46 % Commercial General Liability 2,819 10.07 % 3,240 11.74 % Federal Flood 1,274 4.55 % 1,052 3.81 % Automobile 1,341 4.79 % 1,100 3.99 % Gross written premiums $ 28,002 100.00 % $ 27,597 100.00 % The Company expects the recently approved rate increases for our voluntary homeowners' program and for our policies assumed from Citizens, which average 20.2% and 13.9% statewide, respectively, to result in improved earnings in 2011. Federated National also received approval from the Florida OIR, in April 2010, for a premium rate increase for its assumed homeowners' program within the state of Florida. This premium rate increase, which averaged approximately 15.0%, was implemented on our assumed homeowners' program with an effective date of July 1, 2010. We continue to offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. These discounts have had a significant effect on both written and earned premium. During the three months ended June 30, 2011 and 2010, the change to the cumulative wind mitigation credits afforded our policyholders totaled $0.8 million and ($1.7) million, respectively. As of June 30, 2011, 60.7% of our in-force homeowners' policyholders were receiving wind mitigation credits totaling approximately $26.4 million (a 25.6% reduction of in-force premium), while 57.6% of our in-force homeowners' policyholders were receiving wind mitigation credits totaling approximately $27.1 million, (a 24.6 % reduction of in-force premium), as of June 30, 2010. - 47 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations The Company's increase in the sale of homeowners' policies by $0.4 million, or 1.6%, to $22.6 million for the three months ended June 30, 2011, compared with $22.2 million for the three months ended June 30, 2010, is gross of reinsurance costs and net of Florida's mandated homeowners' wind mitigation discounts. Our number of in-force homeowners' policies decreased by approximately 5,200, or 10.7%, to approximately 43,400 as of June 30, 2011, as compared with approximately 48,600 as of June 30, 2010. We are required to report write-your-own flood premiums on a direct and 100% ceded basis. We are currently rated by Demotech, Inc. ("Demotech") as "A" ("Exceptional"), which is the third of seven ratings, and defined as "Regardless of the severity of a general economic downturn or deterioration in the insurance cycle, insurers earning a Financial Stability Rating ("FSR") of "A" possess "Exceptional" financial stability related to maintaining surplus as regards to policyholders". Demotech's ratings are based upon factors of concern to agents, reinsurers and policyholders and are not primarily directed toward the protection of investors. Our Demotech rating could be jeopardized by factors including adverse development and various surplus related ratio exceptions. The withdrawal of our ratings could limit or prevent us from writing or renewing desirable insurance policies, from competing with insurers who have higher ratings, from obtaining adequate reinsurance, or from borrowing on a line of credit. The withdrawal of our ratings could have a material adverse effect on the Company's results of operations and financial position because the Company's insurance products might no longer be acceptable to the secondary marketplace and mortgage lenders. Furthermore, a withdrawal of our ratings could prevent independent agents from selling and servicing our insurance products. The Company's sale of commercial general liability policies decreased by $0.4 million to $2.8 million for the three months ended June 30, 2011, compared with $3.2 million for the three months ended June 30, 2010. The primary factor for this decrease has been the slowdown in the economy, which had a dramatic impact on the artisan contractor portfolio written by American Vehicle. Additional factors include improvements to our underwriting standards and our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas. The following table sets forth the amounts and percentages of our gross premiums written in connection with our commercial general liability program by state. Three Months Ended June 30, 2011 2010 Amount Percentage Amount Percentage (Dollars in Thousands) State Alabama $ 15 0.54 % $ 12 0.37 % Arkansas - 0.00 % - 0.00 % California - 0.00 % 7 0.23 % Florida 2,339 82.96 % 2,650 81.80 % Georgia - 0.00 % 27 0.82 % Louisiana 286 10.14 % 298 9.20 % Oklahoma - 0.00 % 3 0.09 % South Carolina - 0.00 % - 0.00 % Texas 179 6.36 % 242 7.47 % Virginia - 0.00 % 1 0.02 % Total $ 2,819 100.00 % $ 3,240 100.00 % - 48 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsThe Company's sale of auto insurance policies increased to $1.3 million for the three months ended June 30, 2011, compared with $1.1 million for the three months ended June 30, 2010. Gross Premiums Ceded Gross premiums ceded decreased to $13.5 million for the three months ended June 30, 2011, compared with $20.9 million for the three months ended June 30, 2010. Gross premiums ceded relating to our homeowners', write-your-own flood and automobile programs totaled $11.8 million, $1.3 million and $0.4 million for the three months ended June 30, 2011. Gross premiums ceded relating to our homeowners', write-your-own flood and automobile programs totaled $18.4 million, $1.1 million and $1.4 million for the three months ended June 30, 2010. The decrease to gross premiums ceded relating to our homeowners' program is primarily due to the reduced cost of reinsurance purchased from the FHCF. Increase in Prepaid Reinsurance Premiums The increase in prepaid reinsurance premiums was $0.9 million for the three months ended June 30, 2011, compared with $6.4 million for the three months ended June 30, 2010. The decreased charge to written premium is associated with the timing of our reinsurance payments measured against the term of the underlying reinsurance policies. Increase in Unearned Premiums The increase in unearned premiums was $3.7 million for the three months ended June 30, 2011, compared with $2.2 million for the three months ended June 30, 2010. The increased charge to written premium was due to a $3.1 million increase in unearned homeowners' insurance premiums, a $0.2 million increase in unearned flood premiums, and a $0.4 million increase in unearned automobile premiums during the three months ended June 30, 2011. These changes are a result of differences in written premium volume during this period as compared with the same period last year. See "Gross Premiums Written" above. Net Premiums Earned Net premiums earned increased $0.8 million, or 7.1%, to $11.7 million for the three months ended June 30, 2011, compared with $10.9 million for the three months ended June 30, 2010. The following table denotes net premiums earned by product line. Three Months Ended June 30, 2011 2010 Amount Percentage Amount Percentage (Dollars in Thousands) Homeowners' $ 8,405 72.08 % $ 7,039 64.62 % Commercial General Liability 2,698 23.14 % 3,378 31.02 % Automobile 557 4.78 % 475 4.36 % Net premiums earned $ 11,660 100.00 % $ 10,892 100.00 % The change in homeowners' net premiums earned is due to a $0.4 million increase in gross written premium as discussed and a $1.0 million increase in the net change to prepaid reinsurance premiums and unearned premium. The change in commercial general liability net premiums earned is a result of a $0.4 million decrease in gross written premium, reflecting the impact of the economic slowdown on the artisan contractor portfolio written by American Vehicle and our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas. The change is also a result of a $0.3 million decrease in the net change to unearned premium. - 49 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Commission Income Commission income decreased $0.3 million, or 44.7%, to $0.3 million for the three months ended June 30, 2011, compared with $0.6 million for the three months ended June 30, 2010. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link. Net Investment Income Net investment income increased $0.1 million, or 4.1%, to $1.1 million for the three months ended June 30, 2011, compared with $1.0 million for the three months ended June 30, 2010. Our investment yield, net and gross of investment expenses, excluding equities and including cash, were 2.9% and 3.2%, respectively, for the three months ended June 30, 2011. Our investment yield, net and gross of investment expenses, excluding equities and including cash, were 2.6% and 2.8%, respectively, for the three months ended June 30, 2010. Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, were 3.3% and 3.5%, respectively, for the three months ended June 30, 2011. Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, were 3.8% and 4.2%, respectively, for the three months ended June 30, 2010. See also "Analysis of Financial Condition As of June 30, 2011 Compared with December 31, 2010 - Investments" for a further discussion on our investment portfolio. Net Realized Investment Gains Net realized investment gains were $0.4 million for the three months ended June 30, 2011, compared with net realized investment gains of $1.6 million for the three months ended June 30, 2010. Specifically, net realized gains for equity securities were $0.2 million for the three months ended June 30, 2011 compared with $0.1 million net realized gains for the three months ended June 30, 2010. For debt securities, net realized gains were $0.2 million for the three months ended June 30, 2011, compared with net realized gains of $1.5 million for the three months ended June 30, 2010. During the three months ended June 30, 2011, the Company re-balanced the investment portfolio; during the three months ended June 30, 2010, the Company had an overweight in corporate bonds that performed well and we sold these bonds to lock in gains and bolster surplus. During the three months ended June 30, 2011 and June 30, 2010, respectively, we did not mark any investments to market value pursuant to guidelines prescribed in FASB issued guidance. In reaching a conclusion that a security is either other than temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor's and Moody's, as well as information released via the general media channels. - 50 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsThe table below depicts the net realized investment gains (losses) by investment category during the three months ended June 30, 2011 and 2010. Three Months Ended June 30, 2011 2010 (Dollars in Thousands) Realized gains: Debt securities $ 200 $ 1,520 Equity securities 418 569 Total realized gains 618 2,089 Realized losses: Debt securities 0 (16 ) Equity securities (176 ) (474 ) Total realized losses (176 ) (490 ) Net realized gains on investments $ 442 $ 1,599 Other Income Other income decreased $0.3 million, or 63.3%, to $0.1 million for the three months ended June 30, 2011, compared with $0.4 million for the three months ended June 30, 2010. The major component of other income for the three months ended June 30, 2011 is approximately $0.1 million in partial recognition of our gain on the sale of our Lauderdale Lakes property. Losses and LAE Losses and LAE, our most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of our policyholders, including expenses required to settle claims and losses. We revise our estimates based on the results of analysis of estimated future payments to be made. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. Losses and LAE decreased by $2.4 million, or 23.3%, to $7.8 million for the three months ended June 30, 2011, compared with $10.2 million for the three months ended June 30, 2010. The overall change includes a $0.7 million decrease in our homeowners' program and a $1.7 million decrease in connection with our automobile program, due to favorable experience based in part on enhanced underwriting and claim processing techniques. We continue to revise our estimates of the ultimate financial impact of claims made resulting from past storms. The revisions to our estimates are based on our analysis of subsequent information that we receive regarding various factors, including: (i) per claim information; (ii) Company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages, and (iv) trends in general economic conditions, including the effects of inflation. The composition of unpaid losses and LAE by product line is as follows. June 30, 2011 December 31, 2010 Case Bulk Total Case Bulk Total (Dollars in Thousands) (Dollars in Thousands) Homeowners' $ 9,279 $ 12,941 $ 22,220 $ 5,825 $ 16,847 $ 22,672 Commercial General Liability 5,608 29,491 35,099 8,230 27,819 36,049 Automobile 3,520 3,892 7,412 3,447 4,361 7,808 Total $ 18,407 $ 46,324 $ 64,731 $ 17,502 $ 49,027 $ 66,529 - 51 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Factors that affect unpaid losses and LAE include the estimates made on a claim-by-claim basis known as "case reserves" coupled with bulk estimates known as IBNR. Periodic estimates by management of the ultimate costs required to settle all claim files are based on the Company's analysis of historical data and estimations of the impact of numerous factors such as (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. Management revises its estimates based on the results of its analysis. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors. Because of our process, reserves were decreased by approximately $1.8 million during the six months ended June 30, 2011. This overall change includes a $0.4 million decrease in reserves for our homeowners' program, a $1.0 million decrease in reserves for our commercial general liability program and a $0.4 million decrease in reserves for our automobile program. The decreases are due to favorable experience based in part on enhanced underwriting and claim processing techniques. In accordance with GAAP and as discussed above, our loss ratio is computed as losses and LAE divided by net premiums earned. A lower loss ratio generally results in higher operating income. Our loss ratio for the three-month period ended June 30, 2011 was 67.0% compared with 93.6% for the same period in 2010. The favorable decrease to our loss ratio is due to the $2.4 million decrease in losses and LAE measured against the $0.8 million increase in net premium earned during the three months ended June 30, 2011 as compared to the same period in 2010. The table below reflects the loss ratios by product line. Three Months Ended June 30, 2011 2010 Homeowners' 61.01 % 103.34 % Commercial General Liability 71.40 % 58.32 % Automobile 139.00 % 235.77 % All lines 67.04 % 93.62 % Operating and Underwriting Expenses Operating and underwriting expenses decreased $0.5 million, or 15.6%, to $2.5 million for the three months ended June 30, 2011, compared with $3.0 million for the three months ended June 30, 2010. Salaries and Wages Salaries and wages decreased $0.3 million, or 13.1%, to $1.9 million for the three months ended June 30, 2011, compared with $2.2 million for the three months ended June 30, 2010. The charge to operations for stock-based compensation, in accordance with FASB guidance, was approximately $55,000 during the three months ended June 30, 2011 compared with approximately $102,000 for the three months ended June 30, 2010. Policy Acquisition Costs - Amortization Policy acquisition costs - amortization, remained unchanged at $3.0 million for the three months ended June 30, 2011, compared with $3.0 million for the three months ended June 30, 2010. Policy acquisition costs - amortization, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned. Provision for Income Tax Benefit The provision for income tax benefit was $0.3 million for the three months ended June 30, 2011, compared with $1.0 million for the three months ended June 30, 2010. The effective rate for income taxes was 27.9% for the three months ended June 30, 2011. - 52 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Net Loss As a result of the foregoing, the Company's net loss for the three months ended June 30, 2011 was $0.8 million compared with $2.3 million for the three months ended June 30, 2010. Results of Operations Six Months Ended June 30, 2011 Compared with Six Months Ended June 30, 2010 Gross Premiums Written Gross premiums written increased $0.5 million, or 1.0%, to $55.1 million for the six months ended June 30, 2011, compared with $54.6 million for the six months ended June 30, 2010. The following table denotes gross premiums written by major product line. Six Months Ended June 30, 2011 2010 (Dollars in Thousands) Amount Percentage Amount Percentage Homeowners' $ 44,962 81.53 % $ 43,304 79.28 % Commercial General Liability 5,615 10.18 % 6,739 12.34 % Federal Flood 2,259 4.10 % 1,862 3.41 % Automobile 2,310 4.19 % 2,714 4.97 % Gross written premiums $ 55,146 100.00 % $ 54,619 100.00 % See "Results of Operations-Three Months Ended June 30, 2011" for a discussion of our recently approved rate increases. We continue to offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. These discounts have had a significant effect on both written and earned premium. During the six months ended June 30, 2011 and 2010, the change to the cumulative wind mitigation credits afforded our policyholders totaled ($1.0) million and ($0.5) million, respectively. As of June 30, 2011, 60.7% of our in-force homeowners' policyholders were receiving wind mitigation credits totaling approximately $26.3 million (a 25.6% reduction of in-force premium), while 57.5% of our in-force homeowners' policyholders were receiving wind mitigation credits totaling approximately $27.1 million, (a 24.6 % reduction of in-force premium), as of June 30, 2010. The Company's increase in the sale of homeowners' policies by $1.7 million, or 3.8%, to $45.0 million for the six months ended June 30, 2011, compared with $43.3 million for the six months ended June 30, 2010, is gross of reinsurance costs and net of Florida's mandated homeowners' wind mitigation discounts. Our number of in-force homeowners' policies decreased by approximately 5,200, or 10.7%, to approximately 43,400 as of June 30, 2011, as compared with approximately 48,600 as of June 30, 2010. See "Results of Operations-Three Months Ended June 30, 2011" for a description of Federated National's Demotech rating. The Company's sale of commercial general liability policies decreased by $1.1 million to $5.6 million for the six months ended June 30, 2011, compared with $6.7 million for the six months ended June 30, 2010. The primary factor for this decrease has been the slowdown in the economy, which had a dramatic impact on the artisan contractor portfolio written by American Vehicle. Additional factors include improvements to our underwriting standards and our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas. - 53 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations The following table sets forth the amounts and percentages of our gross premiums written in connection with our commercial general liability program by state. Six Months Ended June 30, 2011 2010 Amount Percentage Amount Percentage (Dollars in Thousands) State Alabama $ 27 0.47 % $ 29 0.43 % Arkansas - 0.00 % 1 0.01 % California 6 0.10 % 7 0.11 % Florida 4,766 84.91 % 5,573 82.71 % Georgia - 0.00 % 46 0.68 % Louisiana 519 9.24 % 672 9.97 % Oklahoma 3 0.05 % 4 0.06 % South Carolina - 0.00 % 2 0.03 % Texas 294 5.23 % 404 5.99 % Virginia - 0.00 % 1 0.01 % Total $ 5,615 100.00 % $ 6,739 100.00 % The Company's sale of auto insurance policies decreased to $2.3 million for the six months ended June 30, 2011, compared with $2.7 million for the six months ended June 30, 2010. Gross Premiums Ceded Gross premiums ceded decreased to $15.0 million for the six months ended June 30, 2011, compared with $21.8 million for the six months ended June 30, 2010. Gross premiums ceded relating to our homeowners', write-your-own flood and automobile programs totaled $11.9 million, $2.2 million and $0.9 million for the six months ended June 30, 2011. Gross premiums ceded relating to our homeowners', write-your-own flood and automobile programs totaled $18.5 million, $1.9 million and $1.4 million for the six months ended June 30, 2010. The decrease to gross premiums ceded relating to our homeowners' program is primarily due to the reduced cost of reinsurance purchased from the FHCF. Decrease in Prepaid Reinsurance Premiums The decrease in prepaid reinsurance premiums was $10.6 million for the six months ended June 30, 2011, compared with $6.6 million for the six months ended June 30, 2010. The increased charge to written premium is associated with the timing of our reinsurance payments measured against the term of the underlying reinsurance policies. Increase in Unearned Premiums The increase in unearned premiums was $6.7 million for the six months ended June 30, 2011, compared with $4.2 million for the six months ended June 30, 2010. The increased charge to written premium was due to a $5.9 million increase in unearned homeowners' insurance premiums, a $0.2 million increase in unearned flood premiums, and a $0.6 million increase in unearned automobile premiums during the six months ended June 30, 2011. These changes are a result of differences in written premium volume during this period as compared with the same period last year. See "Gross Premiums Written" above. Net Premiums Earned Net premiums earned increased $0.9 million, or 4.1%, to $22.8 million for the six months ended June 30, 2011, compared with $21.9 million for the six months ended June 30, 2010. - 54 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsThe following table denotes net premiums earned by product line. Six Months Ended June 30, 2011 2010 Amount Percentage Amount Percentage (Dollars in Thousands) Homeowners' $ 16,396 71.90 % $ 14,066 64.20 % Commercial General Liability 5,448 23.89 % 6,973 31.83 % Automobile 960 4.21 % 869 3.97 % Net premiums earned $ 22,804 100.00 % $ 21,908 100.00 % The change in homeowners' net premiums earned is due to a $1.7 million increase in gross written premium as discussed and a $0.6 million increase in the net change to prepaid reinsurance premiums and unearned premium. The change in commercial general liability net premiums earned is a result of a $1.1 million decrease in gross written premium, reflecting the impact of the economic slowdown on the artisan contractor portfolio written by American Vehicle and our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas. The change is also a result of a $0.4 million decrease in the net change to unearned premium. The change in automobile net premiums earned is a result of a $0.4 million decrease in gross written premium as discussed, and a $0.3 million change in gross premiums ceded and unearned premium. Commission Income Commission income decreased $0.3 million, or 35.9%, to $0.6 million for the six months ended June 30, 2011, compared with $0.9 million for the six months ended June 30, 2010. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link. Net Investment Income Net investment income increased $0.1 million, or 4.0%, to $2.0 million for the six months ended June 30, 2011, compared with $1.9 million for the six months ended June 30, 2010. Our investment yield, net and gross of investment expenses, excluding equities and including cash, were 2.9% and 3.2%, respectively, for the six months ended June 30, 2011. Our investment yield, net and gross of investment expenses, excluding equities and including cash, were 2.7% and 2.9%, respectively, for the six months ended June 30, 2010. Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, were 3.2% and 3.5%, respectively, for the six months ended June 30, 2011. Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, were 3.9% and 4.2%, respectively, for the six months ended June 30, 2010. See also "Analysis of Financial Condition As of June 30, 2011 Compared with December 31, 2010 - Investments" for a further discussion on our investment portfolio. Net Realized Investment Gains Net realized investment gains were $0.3 million for the six months ended June 30, 2011, compared with net realized investment gains of $3.8 million for the six months ended June 30, 2010. Specifically, net realized gains for equity securities were $0.3 million for the six months ended June 30, 2011, compared with $2.0 million net realized gains for the period ended June 30, 2010. For debt securities, net realized losses were nearly zero for the period ended June 30, 2011, compared with net realized gains of $1.8 million for the six months ended June 30, 2010. During the six months ended June 30, 2011, the Company re-balanced the investment portfolio; during the same period in 2010, the Company had an overweight in corporate bonds that performed well and we sold these bonds to lock in gains and bolster the surplus of our insurance companies. - 55 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations During the six months ended June 30, 2011 and June 30, 2010, respectively, we did not mark any investments to market value pursuant to guidelines prescribed in FASB issued guidance. In reaching a conclusion that a security is either other than temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor's and Moody's, as well as information released via the general media channels. The table below depicts the net realized investment gains (losses) by investment category during the six months ended June 30, 2011 and 2010. Six Months Ended June 30, 2011 2010 (Dollars in Thousands) Realized gains: Debt securities $ 425 $ 1,868 Equity securities 737 2,661 Total realized gains 1,162 4,529 Realized losses: Debt securities (432 ) (40 ) Equity securities (391 ) (665 ) Total realized losses (823 ) (705 ) Net realized gains on investments $ 339 $ 3,824 Other Income Other income decreased $0.2 million, or 47.8%, to $0.3 million for the six months ended June 30, 2011, compared with $0.5 million for the six months ended June 30, 2010. The major component of other income for the six months ended June 30, 2011 is approximately $0.3 million in partial recognition of our gain on the sale of our Lauderdale Lakes property. Losses and LAE Losses and LAE decreased by $3.0 million, or 15.6%, to $16.3 million for the six months ended June 30, 2011, compared with $19.3 million for the six months ended June 30, 2010. The overall change includes a $1.4 million decrease in our homeowners' program and a $1.6 million decrease in connection with our automobile program, due to favorable experience based in part on enhanced underwriting and claim processing techniques. The composition of unpaid losses and LAE by product line is as follows. June 30, 2011 December 31, 2010 Case Bulk Total Case Bulk Total (Dollars in Thousands) (Dollars in Thousands) Homeowners' $ 9,279 $ 12,941 $ 22,220 $ 5,825 $ 16,847 $ 22,672 Commercial General Liability 5,608 29,491 35,099 8,230 27,819 36,049 Automobile 3,520 3,892 7,412 3,447 4,361 7,808 Total $ 18,407 $ 46,324 $ 64,731 $ 17,502 $ 49,027 $ 66,529 Reserves for unpaid losses and LAE decreased by approximately $1.8 million during the six months ended June 30, 2011, as a result of our process of estimating claims. See "Results of Operations-Three Months Ended June 30, 2011" for a further explanation of losses and LAE. - 56 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Our loss ratio for the six-month period ended June 30, 2011 was 71.3 compared with 87.9% for the same period in 2010. The favorable decrease to our loss ratio is due to the $3.0 million decrease in losses and LAE measured against the $0.9 million increase in net premium earned during the six months ended June 30, 2011 as compared to the same period in 2010. The table below reflects the loss ratios by product line. Six Months Ended June 30, 2011 2010 Homeowners' 64.64 % 96.72 % Commercial General Liability 78.10 % 64.05 % Automobile 147.04 % 159.03 % All lines 71.33 % 87.92 % Operating and Underwriting Expenses Operating and underwriting expenses decreased $0.4 million, or 8.3%, to $5.3 million for the six months ended June 30, 2011, compared with $5.7 million for the six months ended June 30, 2010. Salaries and Wages Salaries and wages decreased $0.1 million, or 3.7%, to $4.1 million for the six months ended June 30, 2011, compared with $4.2 million for the six months ended June 30, 2010. The charge to operations for stock-based compensation, in accordance with FASB guidance, was approximately $118,000 during the six months ended June 30, 2011 compared with approximately $198,000 for the six months ended June 30, 2010. Policy Acquisition Costs - Amortization Policy acquisition costs - amortization, decreased $0.5 million, or 8.0%, to $6.0 million for the six months ended June 30, 2011, compared with $6.5 million for the six months ended June 30, 2010. Policy acquisition costs - amortization, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned. Provision for Income Tax Benefit The provision for income tax benefit was $1.5 million for the six months ended June 30, 2011, compared with $1.6 million for the six months ended June 30, 2010. The effective rate for income taxes was 34.4% for the six months ended June 30, 2011. Net Loss As a result of the foregoing, the Company's net loss for the six months ended June 30, 2011 was $2.8 million compared with $3.3 million for the six months ended June 30, 2010. - 57 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources During the six months ended June 30, 2011, our primary sources of capital included proceeds from the sale of investment securities, decreased prepaid reinsurance premiums, increased unearned premiums, decreased reinsurance recoverable, net, increased bank overdraft and increased accounts payable and accrued expenses. Additional sources of capital included amortization of investment premium, non-cash compensation, depreciation and amortization, increased premium deposits and customer credit balances and a tax benefit related to non-cash compensation. During the six months ended June 30, 2011, operations provided net operating cash flow of $12.1 million, compared with $5.0 million for the six months ended June 30, 2010. During the six months ended June 30, 2011, operations generated $21.1 million of gross cash flow, due to a $8.1 million decrease in prepaid reinsurance premiums, a $6.7 million increase in unearned premiums, a $3.0 million decrease in reinsurance recoverable, net, a $1.5 million increase in bank overdraft and a $0.9 million increase in accounts payable and accrued expenses. Additional sources of cash included $0.6 million of amortization of investment premium, $0.1 million of non-cash compensation, less than $0.1 million of depreciation and amortization and a less than $0.1 million increase in premium deposits and customer credit balances. During the six months ended June 30, 2011, operations used $8.9 million of gross cash flow, due to a $1.8 million decrease in unpaid losses and LAE, a $1.5 million increase in deferred income tax expense and a $1.2 million increase in premiums receivable. Additional uses of cash included a $1.1 million increase in policy acquisition costs, net of amortization, $0.3 million net realized investment gains and a $0.2 million increase in other assets, all in conjunction with a $2.8 million net loss. During the six months ended June 30, 2011, net cash used by investing activities was $6.2 million, compared with net cash provided by investing activities of $34.5 million during the six months ended June 30, 2010. Our available-for-sale investment portfolio is highly liquid as it consists entirely of readily marketable securities. During the six months ended June 30, 2011, investing activities generated $55.6 million and used $61.8 million. During the six months ended June 30, 2011, net financing activities provided less than $0.1 million, as compared with having used $0.4 million during the six months ended June 30, 2010. In 2011, the sources of cash in connection with financing activities included a less than $0.1 million tax benefit related to non-cash compensation. We offer direct billing in connection with our homeowners', commercial general liability and automobile programs. Direct billing is an agreement in which the insurance company accepts from the insured, as a receivable, a promise to pay the premium, as opposed to requiring the full amount of the policy at policy inception, either directly from the insured or from a premium finance company. The advantage of direct billing a policyholder by the insurance company is that we are not reliant on a credit facility, but remain able to charge and collect interest from the policyholder. We believe that our current capital resources will be sufficient to meet currently anticipated working capital requirements. There can be no assurances, however, that such will be the case. As of June 30, 2011, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as "structured finance" or "special purpose" entities, which were established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. As such, management believes that we currently are not exposed to any financing, liquidity, market or credit risks that could arise if we had engaged in transactions of that type requiring disclosure herein. - 58 --------------------------------------------------------------------------------- Index 21st Century Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsImpact of Inflation and Changing Prices The consolidated financial statements and related data presented herein have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the inflationary effect on the cost of paying losses and LAE. Insurance premiums are established before we know the amount of losses and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate premiums, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation also affects the market value of our investment portfolio and the investment rate of return. Any future economic changes that result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred losses and LAE and thereby materially adversely affect future liability requirements. - 59 --------------------------------------------------------------------------------- Index 21st Century Holding Company Item 3 [ Back To TMCnet.com's Homepage ]