Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED June 30, 2010
OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ___________________TO _______________________
  
Commission File number 0-2500111
   
21st Century Holding Company
(Exact name of registrant as specified in its charter)

Florida
 
65-0248866
(State or Other Jurisdiction of
 
(IRS Employer
Incorporation or Organization)
 
Identification Number)

3661 West Oakland Park Boulevard, Suite 300, Lauderdale Lakes, Florida 33311
(Address of principal executive offices) (Zip Code)

954-581-9993
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the registrant has electronically submitted and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨      Accelerated filer ¨      Non-accelerated filer ¨      Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, $.01 par value –7,946,384 outstanding as of August 16, 2010

 

 

21ST CENTURY HOLDING COMPANY

INDEX

   
PAGE
PART I: FINANCIAL INFORMATION
 
     
ITEM 1
Financial Statements
3
     
ITEM 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
32
     
ITEM 3
Quantitative and Qualitative Disclosures about Market Risk
54
     
ITEM 4
Controls and Procedures
56
     
PART II: OTHER INFORMATION
 
     
ITEM 1
Legal Proceedings
57
     
ITEM 1A  
Risk Factors
57
     
ITEM 2
Unregistered Sales of Equity Securities and Use of Proceeds
57
     
ITEM 3
Defaults upon Senior Securities
57
     
ITEM 4
(Removed and Reserved)
57
     
ITEM 5
Other Information
58
     
ITEM 6
Exhibits
58
     
SIGNATURES
59

 
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PART I: FINANCIAL INFORMATION
Item 1 Financial Statements
21st CENTURY HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

   
Period Ending
 
   
June 30, 2010
   
December 31, 2009
 
   
(Dollars in Thousands)
 
ASSETS
           
Investments
           
Debt maturities, available for sale, at fair value
  $ 60,417     $ 91,513  
Debt maturities, held to maturity, at amortized cost
    5,787       2,650  
Equity securities, available for sale, at fair value
    14,289       20,056  
                 
Total investments
    80,493       114,219  
                 
Cash and short term investments
    67,301       28,197  
Prepaid reinsurance premiums
    2,068       10,319  
Premiums receivable, net of allowance for credit losses of $102 and $24, respectively
    6,180       10,311  
Reinsurance recoverable, net
    13,918       15,302  
Deferred policy acquisition costs
    9,127       8,267  
Deferred income taxes, net
    4,439       4,675  
Income taxes receivable
    9,969       7,069  
Property, plant and equipment, net
    691       859  
Other assets
    2,382       3,671  
                 
Total assets
  $ 196,568     $ 202,889  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Unpaid losses and LAE
  $ 66,366     $ 70,611  
Unearned premiums
    55,104       50,857  
Premiums deposits and customer credit balances
    2,560       2,129  
Bank overdraft
    7,499       8,251  
Deferred gain from sale of property
    758       1,006  
Accounts payable and accrued expenses
    1,988       2,593  
                 
Total liabilities
    134,275       135,447  
                 
Shareholders' equity:
               
                 
Common stock, $0.01 par value. Authorized 25,000,000 shares; issued and outstanding 7,946,384 and 7,953,384, respectively.
    79       80  
Preferred stock, $0.01 par value. Authorized 1,000,000 shares; none issued or outstanding
    -       -  
Additional paid-in capital
    50,421       50,185  
Accumulated other comprehensive income
    395       2,026  
Retained earnings
    11,398       15,151  
Total shareholders' equity
    62,293       67,442  
Total liabilities and shareholders' equity
  $ 196,568     $ 202,889  

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
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21ST CENTURY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
    
2010
   
2009
   
2010
   
2009
 
   
(Dollars in Thousands except EPS and share and dividend data)
   
(Dollars in Thousands except EPS and share and dividend data)
 
                         
Revenue:
                       
Gross premiums written
  $ 27,597     $ 33,601     $ 54,619     $ 62,032  
Gross premiums ceded
    (20,907 )     (19,588 )     (21,825 )     (19,916 )
                                 
Net premiums written
    6,690       14,013       32,794       42,116  
                                 
Increase (decrease) in prepaid reinsurance premiums
    6,422       10,305       (6,639 )     2,236  
Increase in unearned premiums
    (2,220 )     (10,053 )     (4,247 )     (16,182 )
                                 
Net change in prepaid reinsurance premiums and unearned premiums
    4,202       252       (10,886 )     (13,946 )
                                 
Net premiums earned
    10,892       14,265       21,908       28,170  
Commission income
    558       383       944       621  
Finance revenue
    103       91       176       174  
Managing general agent fees
    439       478       933       909  
Net investment income
    1,011       782       1,945       1,463  
Net realized investment gains (losses)
    1,599       69       3,824       (468 )
Regulatory assessments recovered
    51       1,188       567       1,736  
Other income
    381       70       518       382  
                                 
Total revenue
    15,034       17,326       30,815       32,987  
                                 
Expenses:
                               
Losses and LAE
    10,196       8,974       19,261       17,848  
Operating and underwriting expenses
    3,013       2,506       5,729       4,459  
Salaries and wages
    2,176       1,897       4,248       3,806  
Policy acquisition costs, net of amortization
    3,035       2,915       6,495       5,659  
                                 
Total expenses
    18,420       16,292       35,733       31,772  
                                 
 (Loss) income before provision for income tax (benefit) expense
    (3,386 )     1,034       (4,918 )     1,215  
Provision for income tax (benefit) expense
    (1,037 )     250       (1,642 )     128  
                                 
Net (loss) income
  $ (2,349 )   $ 784     $ (3,276 )   $ 1,087  
                                 
Net (loss) income  per share - basic
  $ (0.30 )   $ 0.10     $ (0.42 )   $ 0.14  
                                 
Net  (loss) income per share - diluted
  $ (0.30 )   $ 0.10     $ (0.42 )   $ 0.14  
                                 
Weighted average number of common shares outstanding - basic
    7,946,384       8,013,894       7,946,384       8,013,894  
                                 
Weighted average number of common shares outstanding - diluted
    7,946,384       8,013,894       7,946,384       8,013,894  
                                 
Dividends paid per share
  $ -     $ 0.06     $ 0.06     $ 0.24  

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
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21ST CENTURY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

   
Six Months Ended June 30,
 
   
2010
   
2009
 
   
(Dollars in Thousands)
 
Cash flow from operating activities:
           
Net (loss) income
  $ (3,276 )   $ 1,087  
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
               
Amortization of investment premium (discount), net
    427       (233 )
                 
Depreciation and amortization of property plant and equipment, net
    107       94  
Net realized investment gains
    (3,824 )     (468 )
Provision for credit losses, net
    4       26  
(Recovery) provision for uncollectible premiums receivable
    (77 )     70  
Non-cash compensation
    198       229  
Changes in operating assets and liabilities:
               
Premiums receivable
    4,208       (1,278 )
Prepaid reinsurance premiums
    8,251       4,396  
Reinsurance recoverable, net
    1,385       (1,999 )
Income taxes recoverable
    (2,900 )     (614 )
Deferred income tax expense, net of other comprehensive income
    1,220       1,096  
Policy acquisition costs, net of amortization
    (860 )     (3,290 )
Other assets
    1,036       (1,324 )
Unpaid losses and LAE
    (4,244 )     2,996  
Unearned premiums
    4,247       16,182  
Premium deposits and customer credit balances
    431       325  
Bank overdraft
    (752 )     (302 )
Accounts payable and accrued expenses
    (605 )     (1,252 )
Net cash provided by operating activities
    4,976       15,741  
Cash flow provided (used)  by investing activities:
               
Proceeds from sale of investment securities
    81,072       26,966  
Purchases of investment securities available for sale
    (46,565 )     (103,128 )
Purchases of property and equipment
    60       (9 )
Net cash provided (used) by investing activities
    34,567       (76,171 )
Cash flow used by financing activities:
               
Dividends paid
    (477 )     (962 )
Tax benefit related to non-cash compensation
    38       51  
Net cash used by financing activities
    (439 )     (911 )
Net increase (decrease) in cash and short term investments
    39,104       (61,341 )
Cash and short term investments at beginning of period
    28,197       124,577  
Cash and short term investments at end of period
  $ 67,301     $ 63,236  

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
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21ST CENTURY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

   
Six Months Ended June 30,
 
(continued)
 
2010
   
2009
 
   
(Dollars in Thousands)
 
Supplemental disclosure of cash flow information:
           
Cash paid during the period for:
           
Income taxes
  $ -     $ 178  
Non-cash investing and finance activities:
               
Accrued dividends payable
  $ -     $ 481  

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
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21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

(1) Organization and Business

In this Quarterly Report on Form 10-Q, “21st Century” and the terms “Company”, “we”, “us” and “our” refer to 21st Century Holding Company and its subsidiaries, unless the context indicates otherwise.

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, personal umbrella, commercial general liability, following form commercial excess liability, personal and commercial automobile, 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 subsidiaries, Federated National Insurance Company (“Federated National”) and American Vehicle Insurance Company (“American Vehicle”) and other insurance carriers. 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.

Federated National is licensed as an admitted carrier in Florida. Through contractual relationships with a network of approximately 4,200 independent agents, of which approximately 300 actively sell and service our products, Federated National is authorized to underwrite homeowners’ multi-peril, fire, allied lines and personal automobile insurance in Florida.

American Vehicle is licensed as an admitted carrier in Florida, and underwrites commercial general liability, and personal and commercial automobile insurance. American Vehicle is also licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas, and underwrites commercial general liability insurance in those states. American Vehicle operates as a non-admitted carrier in Arkansas, California, Kentucky, Maryland, Missouri, Nevada, Oklahoma, South Carolina, Tennessee and Virginia, and can underwrite commercial general liability insurance in all of these states.

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, 2010, 79.3%, 12.3%, 3.4% and 5.0% of the premiums we underwrote were for homeowners’ property and casualty, commercial general liability, federal flood, and personal automobile insurance, respectively. During the six months ended June 30, 2009, 83.3%, 13.6%, 2.8% and 0.3% of the premiums we underwrote were for homeowners’ property and casualty, 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.

 
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21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

We internally process claims made by our insureds through our wholly owned claims adjusting company, Superior Adjusting, Inc. (“Superior”). We also offer premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc. (“Federated Premium”).

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. 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 Managing General Agents, Inc. (“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, Mississippi, Missouri, New York, Nevada, South Carolina, Texas and Virginia. During 2009, Assurance MGA contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation and inland marine insurance through Assurance MGA’s existing network of agents. This process will continue throughout 2010 as Assurance MGA benefits from the arrangement by receiving commission revenue from policies sold by its insurance partners, while minimizing its risks.

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 a 6% commission fee from its affiliates Federated National and American Vehicle.

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.

(2) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements for the Company and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America referred to as Generally Accepted Accounting Principles (“GAAP”) for interim financial information, and the Securities and Exchange Commission (“SEC”) rules for interim financial reporting. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, the accompanying financial statements reflect all normal recurring adjustments necessary to present fairly the Company’s financial position as of June 30, 2010 and the results of operations and cash flows for the periods presented. The results of operations for the interim periods presented are not necessarily indicative of the results of operations to be expected for any subsequent interim period or for the fiscal year ending December 31, 2010. The accompanying unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2009 included in the Company’s Form 10-K, which was filed with the SEC on March 26, 2010.

In preparing the interim unaudited condensed consolidated financial statements, management was required to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the periods being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of loss and LAE, ceded reinsurance balances payable, the recoverability of Deferred Policy Acquisition Costs (“DPAC”), the determination of federal income taxes, and the net realizable value of reinsurance recoverables. Although considerable variability is inherent in these estimates, management believes that the amounts provided are reasonable. These estimates are continually reviewed and adjusted as necessary. Such adjustments are reflected in current operations.

 
- 8 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

All significant intercompany balances and transactions have been eliminated. Certain reclassifications have been made to the prior-period balances to conform to the current-period presentation.

(3) Summary of Significant Accounting Policies and Practices

(A) Critical Accounting Policies

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.

The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with management’s evaluation of the determination of (i) liability for unpaid losses and LAE, (ii) the amount and recoverability of amortization of DPAC, and (iii) estimates for our reserves with respect to finance contracts, premiums receivable and deferred income taxes. Various assumptions and other factors underlie the determination of these significant estimates, which are described in greater detail in Footnote 2 of the Company’s audited consolidated financial statements for the fiscal year ended December 31, 2009, which we included in the Company’s Annual Report on Form 10-K which was filed with the SEC on March 26, 2010.

We believe that there were no significant changes in those critical accounting policies and estimates during the first six months of fiscal 2010. Senior management has reviewed the development and selection of our critical accounting policies and estimates and their disclosure in this Form 10-Q with the Audit Committee of our Board of Directors.

The process of determining significant estimates is fact-specific and takes into account factors such as historical experience, current and expected economic conditions, and in the case of unpaid losses and LAE, an actuarial valuation. Management regularly reevaluates these significant factors and makes adjustments where facts and circumstances dictate. In selecting the best estimate, we utilize various actuarial methodologies. Each of these methodologies is designed to forecast the number of claims we will be called upon to pay and the amounts we will pay on average to settle those claims. In arriving at our best estimate, our actuaries consider the likely predictive value of the various loss development methodologies employed in light of underwriting practices, premium rate changes and claim settlement practices that may have occurred, and weight the credibility of each methodology. Our actuarial methodologies take into account various factors, including, but not limited to, paid losses, liability estimates for reported losses, paid allocated LAE, salvage and other recoveries received, reported claim counts, open claim counts and counts for claims closed with and without payment for loss.

Accounting for loss contingencies pursuant to Financial Accounting Standards Board (“FASB”) issued guidance involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur. Additionally, accounting for a loss contingency requires management to assess each event as probable, reasonably possible or remote. Probable is defined as the future event or events are likely to occur. Reasonably possible is defined as the chance of the future event or events occurring is more than remote but less than probable, while remote is defined as the chance of the future event or events occurring is slight. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: First, the amount can be reasonably estimated, and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements. It is implicit in this condition that it is probable that one or more future events will occur confirming the fact of the loss or incurrence of a liability.

 
- 9 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

We are required to review the contractual terms of all our reinsurance purchases to ensure compliance with FASB-issued guidance. The guidance establishes the conditions required for a contract with a reinsurer to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. Contracts that do not result in the reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed generally do not meet the conditions for reinsurance accounting and must be accounted for as deposits. The guidance also requires us to disclose the nature, purpose and effect of reinsurance transactions, including the premium amounts associated with reinsurance assumed and ceded. It also requires disclosure of concentrations of credit risk associated with reinsurance receivables and prepaid reinsurance premiums.

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. The guidance requires that these securities be classified into one of three categories, Held-to-maturity, Trading, or Available-for-sale securities.

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 the 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”.

A decline in the fair value of an available-for-sale security below cost that is deemed other-than temporary results in a charge to income, resulting in the establishment of a new cost basis for the security.  Premiums and discounts are amortized or accreted, respectively, over the life of the related debt security as an adjustment to yield using a method that approximates the effective interest method. Dividends and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific-identification method for determining the cost of securities sold.

Financial instruments, which potentially expose us to concentrations of credit risk, consist primarily of investments, premiums receivable, amounts due from reinsurers on paid and unpaid losses and finance contracts. We have not experienced significant losses related to premiums receivable from individual policyholders or groups of policyholders in a particular industry or geographic area. We believe no credit risk beyond the amounts provided for collection losses is inherent in our premiums receivable or finance contracts. In order to reduce credit risk for amounts due from reinsurers, we seek to do business with financially sound reinsurance companies and regularly review the financial strength of all reinsurers used. Additionally, our credit risk in connection with our reinsurers is mitigated by the establishment of irrevocable clean letters of credit in favor of Federated National.

The fair value of our investments is estimated based on prices published by financial services or quotations received from securities dealers and is reflective of the interest rate environment that existed as of the close of business on June 30, 2010 and December 31, 2009. Changes in interest rates subsequent to June 30, 2010 and December 31, 2009 may affect the fair value of our investments.

The carrying amounts for the following financial instrument categories approximate their fair values at June 30, 2010 and December 31, 2009 because of their short-term nature: cash and short term investments, premiums receivable, finance contracts, due from reinsurers, revolving credit outstanding, bank overdraft, accounts payable and accrued expenses.

 
- 10 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

(B) Impact of New Accounting Pronouncements

In April 2009, the FASB issued FASB Staff Position (“FSP”) FAS 115-2 and FSP FAS 124-2, “Recognition and Presentation of Other-Than Temporary Impairments” (“FSP FAS 115-2 and FSP FAS 124-2”) related to the recognition and presentation of other-than temporary impairments.  In April 2009, the SEC also adopted similar guidance with Staff Accounting Bulletin (“SAB”) No. 111 (“SAB 111”) on Other-Than Temporary Impairment. FSP FAS 115-2 and FSP FAS 124-2 establishes a new method of recognizing and reporting other-than temporary impairments of debt securities and contains additional disclosure requirements related to debt and equity securities. For debt securities, the “ability and intent to hold” provision is eliminated, and impairment is considered to be other-than temporary if an entity (i) intends to sell the security, (ii) more likely than not will be required to sell the security before recovering its cost, or (iii) does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell).  This new framework does not apply to equity securities (i.e., impaired equity securities will continue to be evaluated under previously existing guidance).  The “probability” standard relating to the collectability of cash flows is eliminated, and impairment is now considered to be other-than temporary if the present value of cash flows expected to be collected from the debt security is less than the amortized cost basis of the security.  FSP FAS 115-2 and FSP FAS 124-2 provides that for debt securities which (i) an entity does not intend to sell and (ii) it is not more likely than not that the entity will be required to sell before the anticipated recovery of its remaining amortized cost basis, the impairment is separated into the amount related to estimated credit losses and the amount related to all other factors. The amount of the total impairment related to all other factors is recorded in other comprehensive loss and the amount related to estimated credit loss is recognized as a charge against current period earnings.  FSP FAS 115-2 and FSP FAS 124-2 expands disclosure requirements for both debt and equity securities and requires a more detailed, risk-oriented breakdown of security types and related information, and requires that the annual disclosures be made in interim periods.  FSP FAS 115-2 and FSP FAS 124-2 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted.  At the time of adoption, the Company did not have any Other-Than Temporary Impairments for debt securities, and, the adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4“).  FSP FAS 157-4 is related to determining fair value when the volume and level of activity for an asset or liability have significantly decreased and identifying transactions that are not orderly.  The guidance indicates that if an entity determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. The guidance is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted and must be applied prospectively. The adoption of FSP FAS 157-4 did not have a material impact on the Company’s financial statements or condition.

In May 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 165, “Subsequent Events” (“SFAS No. 165”), which is now part of Accounting Standard Update (“ASU”) ASU Topic 855, Subsequent Events.  In SFAS No. 165, the FASB establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued.  Our adoption of SFAS No. 165 on April 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued Accounting Standard Update (“ASU”) ASU No. 2010-06: Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.  The amendments in ASU 2010-06  require additional disclosures about fair value measurements, including transfers in and out of Levels 1 and 2 and activity in Level 3 on a gross basis, and clarifies certain other existing disclosure requirements including level of disaggregation and disclosures around inputs and valuation techniques. The provisions of the new standards are effective for interim or annual reporting periods beginning after December 15, 2009, except for the additional Level 3 disclosures, which will become effective for fiscal years beginnings after December 15, 2010. These standards are disclosure only in nature and do not change accounting requirements. Accordingly, adoption of the new standard had no impact on the Company’s consolidated financial position, results of operations or cash flows.

In February 2010, the FASB issued ASU No. 2010-09:  Amendments to Certain Recognition and Disclosure Requirements, an amendment to Topic 855 Subsequent Events, to address potentially conflicting interactions of the requirements in this Topic with the SEC’s reporting requirements. This update amends Topic 855 as follows: i) an entity that either is a SEC filer or a conduit bond obligor is required to evaluate subsequent events through the date that the financial statements are issued, if the entity does not meet either of these criteria then it should evaluate subsequent events through the date the financial statements are available to be issued; and ii) an SEC filer is not required to disclose the date through which subsequent events have been evaluated. All amendments in this ASU are effective upon issuance of this ASU, except for the use of the issued date for conduit debt obligors which effective date is for interim and annual periods ending after June 15, 2010. The Company’s subsequent events disclosure will reflect the new guidance.               

 
- 11 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

Other recent accounting pronouncements issued by the FASB, the American Institute of Certified Public Accountants (“AICPA”), and the SEC did not or are not believed by management to have a material impact on the Company’s present or future financial statements.

(C) Stock Options

Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB-issued guidance using the modified-prospective-transition method. Under that transition method, compensation cost recognized during the six months ended June 30, 2010 includes compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the guidance.

(D) Earnings per Share

Basic earnings per share (“Basic EPS”) is computed by dividing net income by the weighted average number of common shares outstanding during the period presented.  Diluted earnings per share (“Diluted EPS”) is computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding during the period presented; outstanding warrants and stock options are considered common stock equivalents and are included in the calculation using the treasury stock method.

(E) Reclassifications

No reclassification of the 2009 financial statements was necessary to conform to the 2010 presentation.

 (4) Commitments and Contingencies

Management has a responsibility to continually measure and monitor its commitments and its contingencies. The nature of the Company’s commitments and contingencies can be grouped into three major categories: insured claim activity, assessment related activities and operational matters.

(A) Insured Claim Activity

We are involved in claims and legal actions arising in the ordinary course of business. 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. 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. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, results of operations, or liquidity.

 The Company’s subsidiaries are, from time to time, named as defendants in various lawsuits incidental to their insurance operations. Legal actions relating to claims made in the ordinary course of seeking indemnification for a loss covered by the insurance policy are considered by the Company in establishing loss and LAE reserves.

 The Company also faces, in the ordinary course of business, lawsuits that seek damages beyond policy limits, commonly known as bad faith claims. The Company continually evaluates potential liabilities and reserves for litigation of these types using the criteria established by FASB-issued guidance. Under this guidance, reserves for a loss are recorded if the likelihood of occurrence is probable and the amount can be reasonably estimated. If a loss, while not probable, is judged to be reasonably possible, management will make an estimate of a possible range of loss or state that an estimate cannot be made. Management considers each legal action using this guidance and records reserves for losses as warranted.

 
- 12 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

(B) Assessment Related Activity

We operate in a regulatory environment where certain entities and organizations have the authority to require us to participate in assessments. Currently these entities and organizations include, but are not limited to, Florida Insurance Guaranty Association (“FIGA”), Citizens Property Insurance Corporation (“Citizens”), Florida Hurricane Catastrophe Fund (“FHCF”) and Florida Joint Underwriters Insurance Company (“JUA”).

As a direct premium writer in the state of Florida, we are required to participate in certain insurer solvency associations under Florida Statutes Section 631.57(3) (a), administered by FIGA. Participation in these pools is based on our written premium by line of business to total premiums written statewide by all insurers. Participation has resulted in assessments against us, as it had in 2006 and 2007, and again on October 30, 2009. There were no assessments made during the six months ended June 30, 2010 or for the year ended December 31, 2008. Through 2007, we have been assessed $6.6 million and in 2009 we were assessed an additional $0.6 million in connection with the insolvencies of domestic insurance companies. For statutory accounting these assessments are not charged to operations; in contrast, GAAP treatment is to charge current operations for the assessments. Through policyholder surcharges, as approved by the Florida Office of Insurance Regulation (“Florida OIR”), we have since recouped $6.8 million in connection with these assessments. 

The State Board of Administration (“SBA”) and the FHCF Financing Corporation agreed to a resolution that would authorize the issuance and sale of FHCF post-event revenue bonds not to exceed $710 million. The proceeds of the bonds would be used for the reimbursement of insurance companies for additional claims due to hurricanes during the 2005 season. These bonds will have fixed interest rates, be exempt from federal income taxes and be secured by not yet implemented emergency assessments and reimbursement premiums. The inability to issue these bonds could result in the FHCF's need to accelerate additional assessments. We have not recorded any liability in connection with this initiative.

During its regularly scheduled meeting on August 17, 2005, the Board of Governors of Citizens determined a 2004 plan year deficit existed in the High Risk Account. Citizens decided that a $515 million Regular Assessment was in the best interest of Citizens and consistent with Florida Statutes. On this basis, Citizens certified for a Regular Assessment.  Federated National’s participation in this assessment totaled $2.0 million.

During a subsequent regularly scheduled meeting on or about December 18, 2006, Citizens Board determined an additional 2004 plan year deficit existed in the High Risk Account. Citizens decided that a $515 million Regular Assessment was in the best interest of Citizens and consistent with Florida Statutes. On this basis, Citizens certified for a Regular Assessment. Federated National’s participation in this assessment totaled $0.3 million.

Pursuant to Florida Statutes Section 627.3512, Federated National has since recouped the assessments by adding a surcharge to policies. Provisions contained in our excess of loss reinsurance policies provided for participation of our reinsurers totaling $1.8 million of the $2.3 million in assessments. There was no assessment made during the years 2007-2010.

The Florida OIR issued Information Memorandum OIR-06-008M, titled Notice of Anticipated Florida Hurricane Catastrophe Fund Assessment, and dated May 4, 2006, to all property and casualty insurers, surplus lines insurers, and surplus lines agents in the state of Florida placing them on notice of an anticipated FHCF assessment. Sighting the unprecedented hurricane seasons of 2004 and 2005, the FHCF exhausted nearly all of the $6 billion in reserves it had accumulated since its inception in 1993. The Florida SBA issued its directive to levy an emergency assessment upon all property and casualty business in the state of Florida. There is no statutory requirement that policyholders be notified of the FHCF assessment. The FHCF and Florida OIR are, however, recommending that insurers include the FHCF assessment in a line item on the declaration page for two reasons: (1) this is a multi-year assessment and (2) there may be concurrent assessments and the insureds should know what amount is for which assessment. The assessment became effective on all policies effective after January 1, 2007 and will be remitted to the administrator of the assessment as collected.

 
- 13 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

Florida OIR issued an Order April 29, 2010, levying an increase to the emergency assessment to 1.30% from 1.0%, of direct written premium on all property and casualty lines of business written in the state of Florida for the benefit of the FHCF. The assessment was approved by the Florida SBA to fund FHCF losses stemming from the 2005 hurricane season. This order requires insurers to begin collecting the emergency assessment for policies issued or renewed on or after January 1, 2011. The FHCF emergency assessment will be remitted to the administrator of the assessment as collected and therefore accounted for in a manner such that amounts collected or receivable are not recorded as revenues and amounts due or paid are not expensed. Previously and still in effect, the Florida OIR issued a similar order dated January 11, 2007, levying an emergency assessment of 1.40% of direct written premium on all property and casualty lines of business written in the state of Florida for the benefit of Citizens’ High Risk Account. This order requires insurers to collect the emergency assessment for policies issued or renewed on or after July 1, 2007. Similar to the FHCF assessment discussed above, the Citizens emergency assessment is remitted to the administrator of the assessment as collected and therefore accounted for in a manner such that amounts collected or receivable are not recorded as revenues and amounts due or paid are not expensed.

Federated National and American Vehicle are also required to participate in an insurance apportionment plan under Florida Statutes Section 627.351, which is referred to as a JUA Plan. The JUA Plan provides for the equitable apportionment of any profits realized, or losses and expenses incurred, among participating automobile insurers. In the event of an underwriting deficit incurred by the JUA Plan which is not recovered through the policyholders in the JUA Plan, such deficit shall be recovered from the companies participating in the JUA Plan in the proportion that the net direct written premiums of each such member during the preceding calendar year bear to the aggregate net direct premiums written in this state by all members of the JUA Plan. Neither Federated National nor American Vehicle was assessed by the JUA Plan during 2010, 2009 or 2008.  Future assessments by this association are undeterminable at this time.

(C) Operational Matters

The Company’s consolidated federal income tax returns for 2009, 2008, 2007, 2006 and 2005 are open for review by the Internal Revenue Service (“IRS”). The federal income tax returns for 2003 and 2002 have been examined by the IRS. The IRS concluded its’ examination for 2003 and 2002 and there were no material changes in the tax liability for those years. The 2004 income tax return remains open due to net operating loss carryforward to open years.

The Company’s consolidated Florida income tax returns for 2007, 2006 and 2005 are currently under review by the Florida Department of Revenue. The Florida income tax return for 2008 is open for review.

The Company has recorded a net deferred tax asset of $4.4 million as of June 30, 2010.  Realization of net deferred tax asset is dependent on generating sufficient taxable income in future periods. Management believes that it is more likely than not that the deferred tax assets will be realized and as such no valuation allowance has been recorded against the net deferred tax asset. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would record valuation allowances as deemed appropriate in the period that the change in circumstances occurs, along with a corresponding increase or charge to net income. The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.

Relative to the Company’s commitments stemming from operational matters, effective on or about March 1, 2006, 21st Century sold its interest in the Lauderdale Lakes property to an unrelated party. As part of this transaction, 21st Century agreed to lease the same facilities for a five-year term. Our lease for this office space expires in December 2011.

 
- 14 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

The expected future lease payouts in connection with this lease are as follows.

Fiscal Year
 
Lease payments
 
   
(Dollars in Thousands)
 
2010
  $ 320  
2011
    650  
Total
  $ 970  

The Company is also involved in various legal actions arising in the ordinary course of business and not related to the insured claims activity. Please see the Company's Form 10-Q for the quarter ended March 31, 2010 for information regarding the settlement of the previously reported pending securities class action.

(5) Investments

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 decreased $33.7 million, or 29.5%, to $80.5 million as of June 30, 2010, compared with $114.2 million as of December 31, 2009.

The debt and equity securities that are available for sale and carried at fair value represent 93% of total investments as of June 30, 2010, compared with 98% as of December 31, 2009.

We did not hold any trading investment securities during the six months ended June 30, 2010.

Additional provisions contained in FASB-issued guidance address 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;

 
- 15 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

 
·
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, 2010, in connection with this process, we have not charged any net realized investment loss to operations.

As of June 30, 2010, all of our securities are in good standing and not impaired as defined by FASB-issued guidance, except for our holdings in Blackrock Pfd, Inc., which continues to be impaired by $0.1 million as of June 30, 2010, compared to the total $0.4 million as of December 31, 2009.

The investments held as of June 30, 2010 and December 31, 2009, were comprised mainly of corporate bonds held in various industries and municipal and United States government bonds. As of June 30, 2010, 73% of the debt portfolio is in diverse industries and 27% is in United States government bonds.  As of June 30, 2010, approximately 81% of the equity holdings are in equities related to diverse industries and 19% are in mutual funds.

As of June 30, 2010, 43% of the investment portfolio is in corporate bonds, 16% is in obligations of states and political subdivisions, and 22% is in United States government bonds. Approximately 10% of the common stock holdings are related to foreign entities.

During the three months ended March 31, 2010, we re-classified $3.1 million of our bond portfolio from available for sale to held-to-maturity.

During the three months ended June 30, 2010, we did not reclassify any of our bond portfolio from available for sale to held-to-maturity.

As of June 30, 2010 and December 31, 2009, we have classified $5.8 million and $2.7 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 $3.1 million for the period ended June 30, 2010 and December 31, 2009, respectively.

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, 2010, the letter of credit in favor of Republic totaled zero, and was replaced by a fully funded trust agreement that totaled $1.0 million.

 
- 16 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

(A) Debt and Equity Securities

The following table summarizes, by type, our investments as of June 30, 2010 and December 31, 2009.

   
June 30, 2010
   
December 31, 2009
 
   
Carrying
   
Percent
   
Carrying
   
Percent
 
   
Amount
   
of Total
   
Amount
   
of Total
 
   
(Dollars in Thousands)
 
Debt securities, at market:
                       
United States government obligations and authorities
  $ 12,214       15.17 %   $ 10,152       8.89 %
Obligations of states and political subdivisions
    12,693       15.77 %     39,269       34.38 %
Corporate
    34,795       43.23 %     42,092       36.85 %
International
    715       0.89 %     -       0.00 %
      60,417       75.06 %     91,513       80.12 %
Debt securities, at amortized cost:
                               
United States government obligations and authorities
    5,787       7.19 %     2,650       2.32 %
Total debt securities
    66,204       7.19 %     94,163       2.32 %
                                 
Equity securities, at market
    14,289       17.75 %     20,056       17.56 %
Total investments
  $ 80,493       100.00 %   $ 114,219       100.00 %

The following table shows the realized gains (losses) for debt and equity securities for the three months ended June 30, 2010 and 2009.

   
Three Months Ended June 30,
 
   
2010
   
2009
 
   
Gains
   
Fair Value
   
Gains
   
Fair Value
 
   
(Losses)
   
at Sale
   
(Losses)
   
at Sale
 
   
(Dollars in Thousands)
 
                         
Debt securities
  $ 1,520     $ 41,690     $ 56     $ 8,279  
Equity securities
    569       4,699       22       951  
Total realized gains
    2,089       46,389       78       9,230  
                                 
Debt securities
    (16 )     1,086       (9 )     3,962  
Equity securities
    (474 )     2,442       -       883  
Total realized losses
    (490 )     3,528       (9 )     4,845  
                                 
Net realized gains on investments
  $ 1,599     $ 49,917     $ 69     $ 14,075  

 
- 17 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

The following table shows the realized gains (losses) for debt and equity securities for the six months ended June 30, 2010 and 2009.

   
Six Months Ended June 30,
 
   
2010
   
2009
 
   
Gains
   
Fair Value
   
Gains
   
Fair Value
 
   
(Losses)
   
at Sale
   
(Losses)
   
at Sale
 
   
(Dollars in Thousands)
 
                         
Debt securities
  $ 1,868     $ 56,272     $ 17     $ 16,131  
Equity securities
    2,661       18,047       -       1,102  
Total realized gains
    4,529       74,319       17       17,233  
                                 
Debt securities
    (40 )     2,567       (228 )     4,435  
Equity securities
    (665 )     3,881       (257 )     1,664  
Total realized losses
    (705 )     6,448       (485 )     6,099  
                                 
Net realized gains (losses) on investments
  $ 3,824     $ 80,767     $ (468 )   $ 23,332  

 
- 18 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of debt and equity securities at June 30, 2010 and December 31, 2009 is as follows.

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
   
Cost
   
Gains
   
Losses
   
Fair Value
 
   
(Dollars in Thousands)
 
June 30, 2010
                       
Debt Securities  - Available For Sale:
                       
United States government obligations and authorities
  $ 11,958     $ 271     $ 16     $ 12,213  
Obligations of states and political subdivisions
    12,321       404       32       12,693  
Corporate
    32,550       2,262       17       34,795  
International
    697       19       -       716  
    $ 57,526     $ 2,956     $ 65     $ 60,417  
                                 
Debt Securities  - Held To Maturity:
                               
United States government obligations and authorities
  $ 5,787     $ 253     $ 32     $ 6,008  
Corporate
    -       -       -       -  
    $ 5,787     $ 253     $ 32     $ 6,008  
                                 
Equity securities - common stocks
  $ 16,547     $ 213     $ 2,471     $ 14,289  
                                 
December 31, 2009
                               
Debt Securities  - Available For Sale:
                               
Obligations of states and political subdivisions
  $ 49,041     $ 695     $ 315     $ 49,421  
Corporate
    40,350       1,798       56       42,092  
    $ 89,391     $ 2,493     $ 371     $ 91,513  
                                 
Debt Securities  - Held To Maturity:
                               
United States government obligations and authorities
  $ 2,650     $ 148     $ 5     $ 2,793  
Corporate
    -       -       -       -  
    $ 2,650     $ 148     $ 5     $ 2,793  
                                 
Equity securities - common stocks
  $ 18,927     $ 1,840     $ 711     $ 20,056  

 
- 19 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

The table below reflects our unrealized investment gains (losses) by investment class, aged for length of time in a continuous unrealized gain (loss) position as of June 30, 2010.

   
Unrealized Gains
(Losses)
   
Less than 12
months
   
12 months or
longer
 
   
(Dollars in Thousands)
 
Debt securities:
                 
United States government obligations and authorities
  $ 256     $ 173     $ 83  
Obligations of states and political subdivisions
    372       24       348  
Corporate
    2,243       288       1,955  
International
    17       16       1  
      2,888       501       2,387  
Equity securities:
                       
Common stocks
    (2,255 )     (1,924 )     (331 )
                         
Total debt and equity securities
  $ 633     $ (1,423 )   $ 2,056  

The table below reflects our unrealized investment losses by investment class, aged for length of time in a continuous unrealized loss position as of December 31, 2009.

   
Unrealized Losses
   
Less than 12
months
   
12 months or
longer
 
   
(Dollars in Thousands)
 
Debt securities:
                 
United States government obligations and authorities
  $ (120 )   $ (120 )   $ -  
Obligations of states and political subdivisions
    (4 )     -       (4 )
Corporate
    -       -       -  
      (124 )     (120 )     (4 )
Equity securities:
                       
Common stocks
    (237 )     -       (237 )
                         
Total debt and equity securities
  $ (361 )   $ (120 )   $ (241 )

Below is a summary of debt securities at June 30, 2010 and December 31, 2009, by contractual or expected maturity periods. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
  
   
June 30, 2010
   
December 31, 2009
 
   
Amortized
   
Estimated
   
Amortized
   
Estimated
 
   
Cost
   
Fair Value
   
Cost
   
Fair Value
 
   
(Dollars in Thousands)
 
                         
Due in one year or less
  $ 4,378     $ 4,423     $ 1,602     $ 1,615  
Due after one through five years
    28,680       29,686       49,821       50,885  
Due after five through ten years
    20,264       21,622       26,177       27,217  
Due after ten years
    9,991       10,694       14,441       14,589  
                                 
Total
  $ 63,313     $ 66,425     $ 92,041     $ 94,306  

 
- 20 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

United States Treasury notes with a book value of $1,038,000 and $1,043,000, both maturing in 2012, were on deposit with the Florida OIR as of June 30, 2010, as required by law for American Vehicle and Federated National respectively, and are included with other investments held until maturity.

The table below sets forth investment results for the three months ended June 30, 2010 and 2009.

   
Three Months Ended June 30,
 
   
2010
   
2009
 
   
(Dollars in Thousands)
 
             
Interest on debt securities
  $ 926     $ 630  
Dividends on equity securities
    82       117  
Interest on cash and cash equivalents
    3       35  
                 
Total investment income
  $ 1,011     $ 782  
                 
Net realized gains (losses)
  $ 1,599     $ 69  
  
Proceeds from sales of debt and equity securities during the three months ended June 30, 2010 and 2009, were approximately $50.1 million and $14.1 million, respectively.

The table below sets forth investment results for the six months ended June 30, 2010 and 2009.

   
Six Months Ended June 30,
 
   
2010
   
2009
 
   
(Dollars in Thousands)
 
             
Interest on debt securities
  $ 1,771     $ 1,056  
Dividends on equity securities
    169       218  
Interest on cash and cash equivalents
    5       189  
                 
Total investment income
  $ 1,945     $ 1,463  
                 
Net realized gains (losses)
  $ 3,824     $ (468 )

Proceeds from sales of debt and equity securities during the six months ended June 30, 2010 and 2009, were approximately $81.1 million and $23.3 million, respectively.

The table below sets forth a summary of net realized investment gains during the three months ended June 30, 2010 and 2009.

   
Three Months Ended June 30,
 
   
2010
   
2009
 
   
(Dollars in Thousands)
 
Net realized gains
           
Debt securities
  $ 1,504     $ 47  
Equity securities
    95       22  
                 
Total
  $ 1,599     $ 69  

 
- 21 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

The table below sets forth a summary of realized investment gains (losses) during the six months ended June 30, 2010 and 2009.

   
Six Months Ended June 30,
 
   
2010
   
2009
 
   
(Dollars in Thousands)
 
Net realized gains (losses)
           
Debt securities
  $ 1,828     $ (211 )
Equity securities
    1,996       (257 )
                 
Total
  $ 3,824     $ (468 )

A summary of net unrealized gains (losses) follows.

   
As of June 30, 2010
   
As of December 31, 2009
 
   
(Dollars in Thousands)
 
Net unrealized gains (losses)
           
Debt securities
  $ 2,888     $ 2,122  
Equity securities
    (2,255 )     1,128  
                 
Total
  $ 633     $ 3,250  

(6) Fair Value Disclosure

In April 2009, the FASB-issued accounting guidance that if an entity determines that either the volume and/or level of activity for an investment security has significantly decreased (from normal conditions for that investment security) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. This guidance was effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. This guidance was applied prospectively.  The adoption of this guidance did not have an impact on the Company’s financial statements or condition.

In October 2008, the FASB-issued accounting guidance to clarify the application of GAAP in determining fair value of financial instruments in a market that is not active.  The guidance was effective upon issuance, including prior periods for which financial statements had not been issued.  Our adoption of this guidance does not have a material effect on our financial position, results of operations, cash flows or disclosures.

In September 2006, FASB issued accounting guidance that defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants on the measurement date.  This guidance also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The guidance also categorizes assets and liabilities at fair value into one of three different levels depending on the observation of the inputs employed in the measurement, as follows:

Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.  A quoted price for an identical asset or liability in an active market provides the most reliable fair value measurement because it is directly observable to the market.

Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs are observable for an asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 
- 22 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Securities available for sale:  The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized security exchanges. 

Assets measured at fair value on a recurring basis as of June 30, 2010, which are presented in accordance with this guidance, are as follows.

   
As of June 30, 2010
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(Dollars in Thousands)
 
Debt securities:
                       
United States government obligations and authorities
  $ -     $ 12,213     $ -     $ 12,213  
Obligations of states and political subdivisions
    -       12,693        -       12,693  
Corporate
    34,795       -       -       34,795  
International
    -       716       -       716  
      34,795       25,622       -       60,417  
                                 
Equity securities:
                               
Common stocks
    14,289       -       -       14,289  
      14,289       -       -       14,289  
                                 
Total debt and equity securities
  $ 49,084     $ 25,622     $ -     $ 74,706  

Assets measured at fair value on a recurring basis as of December 31, 2009, presented in accordance with this guidance, are as follows.

   
As of December 31, 2009
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(Dollars in Thousands)
 
Debt securities:
                       
United States government obligations and authorities
  $ -     $ 10,152     $ -     $ 10,152  
Obligations of states and political subdivisions
    -       39,269       -       39,269  
Corporate
    42,092       -       -       42,092  
      42,092       49,421       -       91,513  
                                 
Equity securities:
                               
Common stocks
    20,056       -       -       20,056  
      20,056       -       -       20,056  
                                 
Total debt and equity securities
  $ 62,148     $ 49,421     $ -     $ 111,569  

 
- 23 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

(7)  Comprehensive Income

For the three and six months ended June 30, 2010 and 2009, comprehensive income consisted of the following.

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(Dollars in Thousands)
   
(Dollars in Thousands)
 
                         
Net (loss) income
  $ (2,349 )   $ 784     $ (3,276 )   $ 1,087  
                                 
Change in net unrealized (losses) gains on investments available for sale
    (1,748 )     1,503       (2,617 )     1,549  
Comprehensive (loss) income, before tax
    (4,097 )     2,287       (5,893 )     2,636  
                                 
Income tax benefit (expense) related to items of other comprehensive income
    658       (566 )     985       (583 )
Comprehensive (loss) income
  $ (3,439 )   $ 1,721     $ (4,908 )   $ 2,053  

(8) Reinsurance Agreements

Financing risk generally involves a combination of risk retention and risk transfer techniques. Retention, similar to a deductable, involves financing losses by funds internally generated. Transfer involves the existence of a contractual arrangement designed to shift financial responsibility to another party in exchange for premium. Secondary to the primary risk-transfer agreements there are reinsurance agreements. Following reinsurance agreements there are also retro-cessionary reinsurance agreements; each designed to shift financial responsibility based on predefined conditions. Generally, there are three separate kinds of reinsurance structures – quota share, excess of loss, and facultative, each considered either proportional or non-proportional. Our reinsurance structures are maintained to protect our insurance subsidiaries against the severity of losses on individual claims or unusually serious occurrences in which the frequency and or the severity of claims produce an aggregate extraordinary loss from catastrophic events.

As is common practice within the insurance industry, we transfer a portion of the risks insured under our policies to other companies through the purchase of reinsurance. We utilize reinsurance to reduce exposure to catastrophic and non-catastrophic risks and to help manage the cost of capital. Reinsurance techniques are designed to lessen earnings volatility, improve shareholder return, and to support the required statutory surplus requirements. Additional rationale to secure reinsurance includes an arbitrage of premium rate, availability of reinsurer’s expertise, and improved management of a profitable portfolio of insureds by way of enhanced analytical capacities.

Although reinsurance does not discharge us from our primary obligation to pay for losses insured under the policies we issue, reinsurance does make the assuming reinsurer liable to the insurance subsidiary for the reinsured portion of the risk. A credit risk exposure exists with respect to ceded losses to the extent that any reinsurer is unable or unwilling to meet the obligations assumed under the reinsurance contracts. The collectability of reinsurance is subject to the solvency of the reinsurers, interpretation of contract language and other factors. A reinsurer's insolvency or inability to make payments under the terms of a reinsurance contract could have a material adverse effect on our results of operations and financial condition. Our reinsurance structure has significant risks, including the fact that the FHCF may not be able to raise sufficient money to pay its claims or impair its ability to pay its claims in a timely manner. This could result in significant financial, legal and operational challenges to all property and casualty companies associated with FHCF, including our company.

The availability and costs associated with the acquisition of reinsurance will vary year to year. These fluctuations, which can be significant, are not subject to our control and may limit our ability to purchase adequate coverage. For example, FHCF has restricted its very affordable reinsurance capacity for the 2010–2011 and 2009–2010 hurricane seasons and is expected to continue constricting its claim paying capacity for future seasons. This gradual restriction is requiring us to replace that capacity with more expensive private market reinsurance. The recovery of increased reinsurance costs through rate action is not immediate and cannot be presumed, as it is subject to Florida OIR approval. Our reinsurance program is subject to approval by the Florida OIR and review by Demotech.

 
- 24 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

Our property lines of business include homeowners’ multi-peril and fire. For the 2010-2011 hurricane season, the excess of loss and FHCF treaties will insure the property lines for approximately $353.3 million of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $270.2 million, with the Company retaining the first $5.0 million of losses and LAE for each event. Our reinsurance program includes coverage purchased from the private market, which affords optional reinstatement premium protection that provides coverage beyond the first event, along with any remaining coverage from the FHCF. Coverage afforded by the FHCF totals approximately $211.0 million, or 59.7% of the $353.3 million of aggregate catastrophic losses and LAE. The FHCF affords coverage for the entire season, subject to maximum payouts, without regard to any particular insurable event.

The estimated cost to the Company for the excess of loss reinsurance products for the 2010-2011 hurricane season, inclusive of approximately $18.4 million payable to the FHCF and the prepaid automatic premium reinstatement protection, is approximately $42.8 million.

The cost and amounts of reinsurance were based on management's analysis of Federated National's exposure to catastrophic risk. Our data will be subjected to exposure level analysis as of September 30, 2010. This analysis of our exposure level, in relation to the total exposures to the FHCF and excess of loss treaties, could produce changes in limits and reinsurance premiums because of the potential changes in our exposure level. Any change to management’s June 30, 2010 analysis will be amortized over the remaining balance of the underlying policy term. The Company’s retention will not change.

 
- 25 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

The 2010-2011 private reinsurance companies and their respective A.M. Best Company (“A.M. Best”) rating are listed in the table as follows.

   
Reinsurer
 
A.M. Best Rating
   
           
UNITED STATES
       
 
American Agricultural Insurance
 
A
 
(2)
 
Everest Reinsurance Company
 
A+
 
(2)
 
Munich Reinsurance America, Inc.
 
A+
 
(2)
 
QBE Reinsurance Corporation
 
A
 
(2)
           
BERMUDA
       
 
ACE Tempest Reinsurance Ltd.
 
A+
*
(2)
 
Actua Re Limited
 
NR
*
(1)
 
Amlin Bermuda Limited
 
A
 
(2)
 
Ariel Reinsurance Company Limited
 
A-
*
 
 
DaVinci Reinsurance Limited
 
A
*
(2)
 
Flagstone Reinsurance Limited
 
A-
   
 
Montpelier Reinsurance Ltd.
 
A-
 
(2)
 
Nephila/ Allianz Risk Trnsfr Zurich (BDA)
 
NR-5
*
(2)
 
Renaissance Reinsurance Limited
 
A+
*
(2)
 
Torus Insurance (Bermuda) Limited
 
A-
*
 
     
 
   
UNITED KINGDOM
       
 
Antares Syndicate No. 1274 (AUL)
 
A
 
(2)
 
Broadgate Underwriting Limited Syndicate No. 1301 (BGT)
 
A
 
(2)
 
Arrow Syndicate No. 1910 (ARW)
 
A
*
(2)
 
Amlin Syndicate No. 2001 (AML)
 
A
 
(2)
 
Novae Syndicate No. 2007 (NVA)
 
A
 
(2)
 
Houson Casualty Co. (UK Branch)
 
A+
 
(2)
     
 
   
EUROPE
       
 
Lansforsakringar Sak Forsakringsaktiebolag
 
NR-5
 
(2)
 
Liberty Syndicates Paris/Syndicate 4472
 
A
 
(2)

* Reinstatement Premium Protection Program Participants

(1) Participant has funded a trust agreement for their exposure with approximately $3.8 million of cash and U.S. Government obligations of American institutions at fair market value.

(2) Standard & Poor's rated "A" or higher (investment grade - economic situation can affect finance)

For the 2009-2010 hurricane season, the excess of loss and FHCF treaties insured the property lines for approximately $456.6 million of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $349.7 million, with the Company retaining the first $5.0 million of losses and LAE for each event. Our reinsurance program included coverage purchased from the private market, which afforded optional reinstatement premium protection that provided coverage beyond the first event, along with coverage from the FHCF. Coverage afforded by the FHCF totaled approximately $259.0 million, or 56.7% of the $456.6 million of aggregate catastrophic losses and LAE. The FHCF affords coverage for the entire season, subject to maximum payouts, without regard to any particular insurable event.

 
- 26 -

 

21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

The 2009-2010 private reinsurance companies and their respective A.M. Best rating are listed in the table as follows.

 
Reinsurer
 
A.M. Best Rating