STATUTORY ACCOUNTING AND REGULATION

The insurance industry is heavily-regulated. State laws and regulations, as well as national regulatory agency requirements, govern the operations of all insurers such as UPC. The various laws and regulations require that insurers maintain minimum amounts of statutory surplus and risk-based capital, they restrict insurers' ability to pay dividends, they specify allowable investment types and investment mixes, and they subject insurers to assessments.

Our UPC subsidiary is domiciled in Florida, and the laws of that state require that UPC maintain capital and surplus equal to the greater of 10% of its total liabilities or $5,000. Our statutory capital surplus was $48,188 at December 31, 2011. State law also requires UPC to adhere to prescribed premium-to-capital surplus ratios, with which we were in compliance at December 31, 2011.

The National Association of Insurance Commissioners published risk-based capital guidelines for insurance companies that are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policy holders. Most states, including Florida, have enacted the NAIC guidelines as statutory requirements, and insurers having less statutory surplus than required will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. State insurance regulatory authorities could require an insurer to cease operations in the event the insurer fails to maintain the required statutory capital. At December 31, 2011, UPC exceeded the minimum risk-based capital requirements.

Florida law permits an insurer to pay dividends or make distributions out of that part of statutory surplus derived from net operating profit and net realized capital gains. The law further provides calculations to determine the amount of dividends or distributions that can be made without the prior approval of the insurance regulatory authority and the amount of dividends or distributions that would require prior approval of the insurance regulatory authority. Statutory risk-based capital requirements may further restrict UPC’s ability to pay dividends or make distributions if the amount of the intended dividend or distribution would cause statutory surplus to fall below minimum risk-based capital requirements.

Florida law limits an insurer’s investment in equity instruments and also restricts investments in medium to low quality debt instruments. We were in compliance with all investment restrictions at December 31, 2011, and 2010.

Governmental agencies or certain quasi-governmental entities can levy assessments upon us in the states in which we write policies. See Note 2(j) for a description of how we recover assessments imposed upon us.

The table below summarizes the activity related to assessments levied upon UPC:



	2011		2010		2009
Expected recoveries of assessments, January 1	413		1,525		2,235
Assessments expensed	—		—		1,045
Assessments recovered	(403	)	(1,103	)	(1,688	)
Assessments not recoverable	—		(9	)	(67	)
Expected recoveries of assessments, December 31	10		413		1,525

We expense an assessment when the particular governmental agency or quasi-governmental entity levies it upon us; therefore, expected recoveries in the table above are not assets and we will record the amounts as income when collected from policyholders.

Governmental agencies or certain quasi-governmental entities can also levy assessments upon policyholders, and we collect the amount of the assessments from policyholders as surcharges for the benefit of the assessing agency. We currently collect assessments levied upon policyholders on behalf of Citizens in the amount of 1.0%, and on behalf of FHCF in the amount of 1.3%. We multiply the premium written on each policy, except our flood policies, by these assessment percentages to determine the additional amount that we will collect from the policyholder and remit to the assessing agencies.

The note payable to the SBA is considered a surplus note pursuant to statutory accounting principles. As a result, UPC is subject to the authority of the Insurance Commissioner of the State of Florida with regard to its ability to repay principal and interest on the surplus note. Any payment of principal or interest requires permission from the insurance regulatory authority.

We have reported our insurance subsidiary’s assets, liabilities and results of operations in accordance with GAAP, which varies from statutory accounting principles prescribed or permitted by state laws and regulations, as well as by general industry practices. The following items are principal differences between statutory accounting and GAAP:


•	Statutory accounting requires that we exclude certain assets, called non-admitted assets, from the balance sheet.


•	Statutory accounting requires us to expense policy acquisition costs when incurred, while GAAP allows us to defer and amortize policy acquisition costs over the estimated life of the policies.


•	Statutory accounting requires that we calculate deferred income taxes differently than we would under GAAP.


•	Statutory accounting requires that we record certain investments at cost or amortized cost, while we record other investments at fair value; however, GAAP requires that we record all investments at fair value.


•	Statutory accounting requires that surplus notes, also known as surplus debentures, be recorded in statutory surplus, while GAAP requires us to record surplus notes as a liability.

Our insurance subsidiary must file with the various insurance regulatory authorities an “Annual Statement” which reports, among other items, net income (loss) and surplus as regards policyholders, which is called stockholder’s equity under GAAP.

The table below reconciles our consolidated GAAP net income to the statutory net loss of UPC:



	Year Ended December 31,
	2011		2010		2009
Consolidated GAAP net income (loss)	8,088		(925	)	4,057
Increase (decrease) due to:
Commissions	56		(11	)	(225	)
Deferred income taxes	(1,278	)	247		667
Deferred policy acquisition costs	(98	)	(310	)	652
Allowance for doubtful accounts	16		(309	)	64
Assessments	(453	)	(1,110	)	(884	)
Prepaid expenses	187		(275	)	3
Premium deficiency reserve	302		—		—
Operations of non-statutory subsidiaries	(11,452	)	(3,489	)	(12,383	)
Statutory net loss of UPC	(4,632	)	(6,182	)	(8,049	)

The table below reconciles our consolidated GAAP stockholders’ equity to the surplus as regards policyholders of UPC:



	December 31,
	2011		2010
Consolidated GAAP stockholders’ equity	54,989		45,293
Increase (decrease) due to:
Deferred policy acquisition costs	(3,452	)	(3,354	)
Deferred income taxes	(295	)	(471	)
Investments	(2,145	)	165
Non-admitted assets	(397	)	(109	)
Surplus debentures	17,059		18,235
Provision for reinsurance	(105	)	(696	)
Equity of non-statutory subsidiaries	(19,681	)	(12,978	)
Commissions	1,924		1,868
Allowance for doubtful accounts	396		380
Assessments	10		463
Prepaid expenses	(177	)	(364	)
Other, net	62		63
Statutory surplus as regards policyholders of UPC	48,188		48,495