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 our insurance affiliate. 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. At December 31, 2013, and during the twelve months then ended, our insurance affiliate met all regulatory requirements of the states in which it operates, and did not incur any significant assessments.

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 our insurance affiliate:



	2013			2012			2011
Expected recoveries of assessments, January 1	$	1,646		$	10		$	413
Assessments expensed	31			1,646			—
Assessments recovered	(1,457		)	—			(403		)
Assessments not recoverable	(141		)	(10		)	—
Expected recoveries of assessments, December 31	$	79		$	1,646		$	10

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.

During 2012, our insurance affiliate received a mandatory assessment from the Florida Insurance Guaranty Association, Inc. (FIGA), a nonprofit corporation created by the Florida legislature. The assessment, which was approved by the Florida Office of Insurance Regulation, is equal to 0.9% of our insurance affiliate's net direct written premiums in Florida for the 2011 calendar year and is applicable to all members of FIGA's “All Other Account,” which includes our insurance affiliate.

The assessment resulted in a pre-tax charge to consolidated operations of $1,646,000 in the fourth quarter of 2012. The mandatory assessment was recouped through a surcharge on our insurance affiliate's Florida policies during 2013. The remaining $79,000 assessment will be recouped during 2014.

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.

Our insurance subsidiary is domiciled in Florida, and the laws of that state require that our insurance affiliate maintain capital and surplus equal to the greater of 10% of its total liabilities or $5,000,000. Our statutory capital surplus was $78,362,000 at December 31, 2013. State law also requires our insurance affiliate to adhere to prescribed premium-to-capital surplus ratios, with which we were in compliance at December 31, 2013.

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.

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, 2013 and 2012.

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 our insurance affiliate’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.

The note payable to the SBA is considered a surplus note pursuant to statutory accounting principles. As a result, our insurance affiliate 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 to the extent recoverable and amortize policy acquisition costs over the estimated life of the policies.


•	Statutory accounting dictates how much of a deferred income tax asset that we can admit on a statutory balance sheet.


•	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 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.


•	Statutory accounting allows bonds to be carried at amortized cost or fair value based on the rating received from the Securities Valuation Office of the National Association of Insurance Commissioners, while they are recorded at fair value for GAAP.


•	Statutory accounting allows ceding commission income to be recognized when written if the cost of acquiring and renewing the associated business exceeds the ceding commissions, but under GAAP such income is deferred and recognized over the coverage period.


•	Statutory accounting requires that unearned premiums and loss reserves are presented net of related reinsurance rather than on a gross basis under GAAP.

•

Statutory accounting requires a provision for reinsurance liability be established for reinsurance recoverable on paid losses aged over ninety days and for unsecured amounts recoverable from unauthorized reinsurers. Under GAAP there is no charge for uncollateralized amounts ceded to a company not licensed in the insurance affiliate's domiciliary state and a reserve for uncollectable reinsurance is charged through earnings rather than surplus or equity.


•	Statutory accounting requires an additional admissibility test outlined in Statements on Statutory Accounting Principles, No. 101 and the change in deferred income tax is reported directly in capital and surplus, rather than being reported as a component of income tax expense under GAAP.

The level of required risk-based capital (RBC) is calculated and reported annually. There are five outcomes to the RBC calculation set forth by the NAIC which are as follows:


1.	No Action Level - If RBC is greater than 200%, no further action is required.


2.	Company Action Level - If RBC is between 150% -200%, the insurer must prepare a report to the regulator outlining a comprehensive financial plan that identifies conditions that contributed to the insurer's financial condition and proposes corrective actions.


3.	Regulatory Action Level - If RBC is between 100% -150%, the state insurance commissioner is required to perform any examinations or analyses to the insurer's business and operations that he or she deems necessary as well as issuing appropriate corrective orders.


4.	Authorized Control Level - If RBC is between 70% - 100%, this is the first point that the regulator may take control of the insurer even if the insurer is still technically solvent and is in addition to all the remedies available at the higher action levels.


5.	Mandatory Control Level - If RBC is less than 70%, the regulator is required to take steps to place the insurer under its control regardless of the level of capital and surplus.

At December 31, 2013, our insurance affiliate's RBC ratio was 632%.

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

The table below reconciles our consolidated GAAP net income to the statutory net income (loss) of our insurance affiliate:



	Year Ended December 31,
	2013			2012			2011
Consolidated GAAP net income	$	20,342		$	9,705		$	8,088
Increase (decrease) due to:
Commissions	2,281			10,438			56
Deferred income taxes	(3,992		)	(4,262		)	(1,278		)
Deferred policy acquisition costs	(868		)	(688		)	(98		)
Allowance for doubtful accounts	5			(53		)	16
Assessments	(1,567		)	1,636			(453		)
Prepaid expenses	22			131			187
Premium deficiency reserve	—			(302		)	302
Operations of non-statutory subsidiaries	(9,023		)	(10,696		)	(11,452		)
Statutory net income (loss) of insurance affiliate	$	7,200		$	5,909		$	(4,632	)

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



	December 31,
	2013			2012
Consolidated GAAP stockholders’ equity	$	107,587		$	87,986
Increase (decrease) due to:
Deferred policy acquisition costs	(3,281		)	(2,413		)
Deferred income taxes	(4,861		)	(4,162		)
Investments	1,478			(2,427		)
Non-admitted assets	(247		)	(354		)
Surplus debentures	14,706			15,882
Provision for reinsurance	(341		)	(225		)
Equity of non-statutory subsidiaries	(49,531		)	(38,397		)
Commissions	12,796			10,515
Assessments	79			1,646
Prepaid expenses	(23		)	(44		)
Statutory surplus as regards policyholders of insurance affiliate	$	78,362		$	68,007