form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q

TQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE QUARTERLY PERIOD ENDED March 31, 2011
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 incorporation or organization)
 
(I.R.S. Employer Identification No)

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 T No £
 
Indicate by check mark whether the registrant has electronically submitted and posted on its corporate Web site, 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 definition 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 T
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).
 
Yes £   No T
 
Common Stock, $.01 par value –7,946,384 outstanding as of May 16, 2011
 


 
 

 
21ST CENTURY HOLDING COMPANY

INDEX

PART I: FINANCIAL INFORMATION
PAGE
     
ITEM 1
3
     
ITEM 2
34
     
ITEM 3
53
     
ITEM 4
55
     
PART II: OTHER INFORMATION
 
     
ITEM 1
56
     
ITEM 1A
56
     
ITEM 2
56
     
ITEM 3
56
     
ITEM 4
56
     
ITEM 5
56
     
ITEM 6
57
     
58
 
 
2


PART I: FINANCIAL INFORMATION
Item 1 Financial Statements

21st CENTURY HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

    Period Ending  
   
March 31, 2011
   
December 31, 2010
 
ASSETS
 
(Dollars in Thousands)
 
Investments
           
Debt maturities, available for sale, at fair value
  $ 98,853     $ 98,350  
Debt maturities, held to maturity, at amortized cost
    6,741       6,198  
Equity securities, available for sale, at fair value
    21,001       17,937  
                 
Total investments
    126,595       122,485  
                 
Cash and short term investments
    15,833       16,206  
Prepaid reinsurance premiums
    4,477       10,416  
Premiums receivable, net of allowance for credit losses of $103 and $68, respectively
    6,712       5,639  
Reinsurance recoverable, net
    5,580       8,038  
Deferred policy acquisition costs
    8,411       7,879  
Deferred income taxes, net
    8,870       7,916  
Income taxes receivable
    2,393       2,393  
Property, plant and equipment, net
    766       767  
Other assets
    2,140       2,310  
                 
Total assets
  $ 181,777     $ 184,049  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Unpaid losses and LAE
  $ 64,490     $ 66,529  
Unearned premiums
    50,111       47,136  
Premiums deposits and customer credit balances
    2,724       2,364  
Bank overdraft
    4,431       7,430  
Deferred gain from sale of property
    380       506  
Accounts payable and accrued expenses
    3,278       2,153  
                 
Total liabilities
    125,414       126,118  
                 
Shareholders' equity:
               
Common stock, $0.01 par value. Authorized 25,000,000 shares; issued and outstanding 7,946,384 and 7,946,384, respectively.
    79       79  
Preferred stock, $0.01 par value. Authorized 1,000,000 shares; none issued or outstanding
    -       -  
Additional paid-in capital
    50,726       50,654  
Accumulated other comprehensive income
    887       520  
Retained earnings
    4,671       6,678  
Total shareholders' equity
    56,363       57,931  
Total liabilities and shareholders' equity
  $ 181,777     $ 184,049  


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
3


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

   
Three Months Ended March 31,
 
   
2011
 
2010
 
   
(Dollars in Thousands except EPS and share and dividend data)
 
Revenue:
           
Gross premiums written
  $ 27,144     $ 27,021  
Gross premiums ceded
    (1,505 )     (918 )
                 
Net premiums written
    25,639       26,103  
                 
Decrease in prepaid reinsurance premiums
    (11,520 )     (13,061 )
Increase in unearned premiums
    (2,975 )     (2,026 )
                 
Net change in prepaid reinsurance premiums and unearned premiums
    (14,495 )     (15,087 )
                 
Net premiums earned
    11,144       11,016  
Commission income
    297       386  
Finance revenue
    120       72  
Managing general agent fees
    461       494  
Net investment income
    970       935  
Net realized investment  (losses) gains
    (103 )     2,225  
Regulatory assessments recovered
    106       515  
Other income
    131       137  
                 
Total revenue
    13,126       15,780  
                 
Expenses:
               
Losses and LAE
    8,447       9,063  
Operating and underwriting expenses
    2,713       2,717  
Salaries and wages
    2,199       2,072  
Policy acquisition costs - amortization
    2,940       3,460  
                 
Total expenses
    16,299       17,312  
                 
Loss before provision for income tax benefit
    (3,173 )     (1,532 )
Provision for income tax benefit
    (1,166 )     (605 )
                 
Net loss
  $ (2,007 )   $ (927 )
                 
                 
Net loss  per share - basic
  $ (0.25 )   $ (0.12 )
                 
Net  loss per share - diluted
  $ (0.25 )   $ (0.12 )
                 
Weighted average number of common shares outstanding - basic
    7,946,384       7,946,384  
                 
Weighted average number of common shares outstanding - diluted
    7,946,384       7,946,384  
                 
Dividends paid per share
  $ -     $ 0.06  


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
4


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

   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(Dollars in Thousands)
 
Cash flow from operating activities:
           
Net loss
  $ (2,007 )   $ (927 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Amortization of investment premium discount, net
    347       212  
Depreciation and amortization of property plant and equipment, net
    52       51  
Net realized investment losses (gains)
    103       (2,225 )
Provision (recovery) for credit losses, net
    9       (5 )
Recovery for uncollectible premiums receivable
    (34 )     (45 )
Non-cash compensation
    49       79  
Changes in operating assets and liabilities:
               
Premiums receivable
    (1,038 )     4,043  
Prepaid reinsurance premiums
    5,939       4,182  
Reinsurance recoverable, net
    2,458       2,237  
Income taxes recoverable
    -       (615 )
Deferred income tax expense, net of other comprehensive income
    (1,175 )     (9 )
Policy acquisition costs, net of amortization
    (532 )     (297 )
Other assets
    34       702  
Unpaid losses and LAE
    (2,039 )     (2,362 )
Unearned premiums
    2,975       2,026  
Premium deposits and customer credit balances
    361       1,089  
Bank overdraft
    (3,000 )     9,836  
Accounts payable and accrued expenses
    1,125       3,047  
Net cash provided by operating activities
    3,627       21,019  
Cash flow (used) provided by investing activities:
               
Proceeds from sale of investment securities
    41,532       31,135  
Purchases of investment securities available for sale
    (45,505 )     (26,708 )
Purchases of property and equipment
    (51 )     (199 )
Net cash (used) provided  by investing activities
    (4,024 )     4,228  
Cash flow provided (used) by financing activities:
               
Dividends paid
    -       (477 )
Tax benefit related to non-cash compensation
    24       36  
Net cash provided (used) by financing activities
    24       (441 )
Net (decrease) increase in cash and short term investments
    (373 )     24,806  
Cash and short term investments at beginning of period
    16,206       28,197  
Cash and short term investments at end of period
  $ 15,833     $ 53,003  


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
5


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

   
Three Months Ended March 31,
 
(continued)
 
2011
   
2010
 
   
(Dollars in Thousands)
 
Supplemental disclosure of cash flow information:
           
Cash paid during the period for:
           
Income taxes
  $ -     $ 2  
Non-cash investing and finance activities:
               
Accrued dividends payable
  $ -     $ 477  


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
6


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 (“homeowners”), commercial general liability, personal and commercial automobile, personal umbrella, following form commercial excess liability, fire, allied lines, workers’ compensation, business personal property and commercial inland marine insurance. We are authorized to underwrite in various states on behalf of our wholly owned subsidiary, Federated National Insurance Company (“Federated National”) and other insurance carriers. Federated National is the resulting entity following the merger of Federated National with and into our other wholly owned subsidiary, American Vehicle Insurance Company (“American Vehicle”), in January 2011. In connection with this merger, the Company, Federated National and American Vehicle entered into a Consent Order with the Florida Office of Insurance Regulation (“Florida OIR”).  We market and distribute our own and third-party insurers’ products and our other services through a network of independent agents. We also utilize a select number of general agents for the same purpose.

As part of its approval of the merger between Federated National and American Vehicle, the Florida OIR, the Company, Federated National and American Vehicle entered into a consent order with the Florida OIR dated January 25, 2011 (the “Consent Order”) pursuant to which the Company and the resulting company in the merger (the “Merged Company”) have agreed to the following:

 
·
The Merged Company shall retain the following licenses: (010) Fire, (020) Allied Lines, (040) Homeowners Multi Peril, (050) Commercial Multi Peril, (090) Inland Marine, (170) Other Liability, (192) Private Passenger Auto Liability, (194) Commercial Auto Liability, (211) Private Passenger Auto Physical Damage and (212) Commercial Auto Physical Damage.

 
·
The Merged Company shall not write commercial multi peril policy premium without prior approval from the Florida OIR. The Merged Company currently has no commercial multi peril policy premium in force.

 
·
The Merged Company shall surrender its surety license. The Merged Company currently has no Surety policy premium in force.

 
·
The Merged Company shall not write new commercial habitation condominium associations without prior approval from the Florida OIR. The current commercial habitation book of business is approximately $2.4 million of policy premium, which will be renewed pursuant to normal underwriting guidelines.

 
·
The Merged Company has agreed to reduce the total number of its homeowners’ policies in Miami-Dade, Broward and Palm Beach counties (the “Tri-County Area”) to 40% of its entire homeowners’ book by December 31, 2011 and limit its new homeowners’ policies in the Tri-County Area to $500,000 of new policy premium per month. The 40% will be achieved through the increased writing of property located outside of the Tri-County Area, the non-renewal of certain policies located within the Tri-County Area, and limiting the writing of new property located within the Tri-County Area. As of March 31, 2011, the Company had approximately 43.4% of its homeowners’ policies located within Tri-County Area.

 
·
The managing general agency fees payable by the Merged Company to Assurance Managing General Agents, Inc. (“Assurance MGA”), a wholly owned subsidiary of the Company, which were traditionally 6% of gross written premium, were reduced and will not exceed 4% without prior approval from the Florida OIR. The Merged Company has lowered the fee to 2% of gross written premium for the first quarter of 2011, 3% of gross written premium for the second quarter of 2011, and 4% of gross written premium thereafter.  This will have no impact on the Company’s consolidated financial results.

 
7

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

 
·
The claims service fees payable by the Merged Company to Superior Adjusting, Inc. (“Superior”) were reduced from the traditional 4.5% of gross earned premium to 3.6% of gross earned premium. This will have no impact on the Company’s consolidated financial results.

 
·
The Consent Order continues the prohibition on the Company from the payment of dividends until the Merged Company reports two consecutive quarters of net underwriting income.

 
·
The Company provided the Florida OIR with a plan of operation and has agreed to provide certain reports to the Florida OIR on a monthly basis, and agreed to obtain the Florida OIR’s approval prior to making any changes to the officers of the Merged Company during the first year following the effective date of the Merger.

The merger of Federated National and American Vehicle will be an ongoing transition, many aspects of which will take effect over time. References to the companies contained herein are intended to be references to the operations of the newly formed Federated National. References to the historical activities of American Vehicle are appropriately identified throughout this document.

Federated National is licensed as an admitted carrier in Florida. Through contractual relationships with a network of approximately 3,000 independent agents, of which approximately 400 actively sell and service our products, Federated National is authorized to underwrite homeowners’, fire, allied lines and personal and commercial automobile insurance in Florida. Effective January 26, 2011, Federated National merged with and into American Vehicle and American Vehicle changed its name to Federated National.

American Vehicle, prior to the January 2011 merger, was licensed as an admitted carrier in Florida, and underwrote commercial general liability, and personal and commercial automobile insurance. American Vehicle was also licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas, and underwrote commercial general liability insurance in those states. American Vehicle operated as a non-admitted carrier in Arkansas, California, Kentucky, Maryland, Missouri, Nevada, Oklahoma, South Carolina, Tennessee and Virginia, and could underwrite commercial general liability insurance in all of these states. Subsequent to the merger, these operations may continue under the newly formed Federated National.

An admitted carrier is an insurance company that has received a license from the state department of insurance giving the company the authority to write specific lines of insurance in that state. These companies are also bound by rate and form regulations, and are strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Admitted carriers are also required to financially contribute to the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.

A non-admitted carrier is not licensed by the state, but is allowed to do business in that state and is strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Sometimes, non-admitted carriers are referred to as “excess and surplus” lines carriers.  Non-admitted carriers are subject to considerably less regulation with respect to policy rates and forms. Non-admitted carriers are not required to financially contribute to and benefit from the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.

During the three months ended March 31, 2011, 82.5%, 10.3%, 3.6% and 3.6% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and automobile insurance, respectively. During the three months ended March 31, 2010, 78.0%, 13.0%, 3.0% and 6.0% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and personal automobile insurance, respectively.

Our business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on our business, results of operations and financial condition. When our estimated liabilities for unpaid losses and loss adjustment expenses (“LAE”) are less than the actuarially determined amounts, we increase the expense in the current period. Conversely, when our estimated liabilities for unpaid losses and LAE are greater than the actuarially determined amounts, we decrease the expense in the current period.

 
8

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

We are focusing our marketing efforts on continuing to expand our distribution network and market our products and services throughout Florida and in other states by establishing relationships with additional independent agents and general agents. As this occurs, we will seek to replicate our distribution network in those states. For example, we became an admitted insurer in the state of Georgia during the quarter ended September 30, 2010. There can be no assurance, however, that we will be able to obtain the required regulatory approvals to offer additional insurance products or expand into other states.

Assurance MGA, a wholly owned subsidiary of the Company, acts as Federated National’s and American Vehicle’s exclusive managing general agent in the state of Florida and is also licensed as a managing general agent in the states of Alabama, Arkansas, Georgia, Illinois, Louisiana, North Carolina, Mississippi, Missouri, New York, Nevada, South Carolina, Texas and Virginia. Assurance MGA has contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation, personal umbrella and inland marine insurance through Assurance MGA’s existing network of agents.

Assurance MGA earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. Assurance MGA earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliates Federated National and American Vehicle. During the fourth quarter of 2010, Assurance MGA reduced its’ fee, to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date. A formal agreement reflecting this fee modification was executed during January 2011.

We internally process claims made by our insureds through our wholly owned claims adjusting company, Superior. Our agents have no authority to settle claims or otherwise exercise control over the claims process. Furthermore, we believe that the retention of independent adjusters, in addition to the employment of salaried claims personnel, results in reduced ultimate loss payments, lower LAE and improved customer service for our claimants and policyholders. We also employ an in-house legal department to cost-effectively manage claims-related litigation and to monitor our claims handling practices for efficiency and regulatory compliance.

We also offer premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc. (“Federated Premium”). Premium financing has been marketed through our distribution network of general agents and independent agents. Premiums for property and casualty insurance, in certain circumstances, are payable at the time a policy is placed in-force or renewed. Federated Premium's services allow the insured to pay a portion of the premium when the policy is placed in-force and the balance in monthly installments over a specified term, generally between six and nine months. As security, Federated Premium retains a contractual right, if a premium installment is not paid when due, to cancel the insurance policy and to receive the unearned premium from the insurer, or in the event of insolvency of an insurer, from Florida Insurance Guaranty Association (“FIGA”), subject to a $100 per policy deductible. In the event of cancellation, Federated Premium applies the unearned premium towards the payment obligation of the insured.

Insure-Link, Inc. (“Insure-Link”) was formed in March 2008 to serve as an independent insurance agency. The insurance agency markets direct to the public to provide a variety of insurance products and services to individual clients, as well as business clients, by offering a full line of insurance products including, but not limited to,  homeowners’, personal and commercial automobile, commercial general liability and workers’ compensation insurance through their agency appointments with over fifty different carriers. Insure-Link will expand its business through marketing and by acquiring other insurance agencies. There were no other agency relationships with affiliated captive or franchised agents during 2010 or the three months ended March 31, 2011.

(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 March 31, 2011 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, 2011. 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, 2010 included in the Company’s Form 10-K, which was filed with the SEC on March 31, 2011.

 
9

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements
 
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.

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, 2010, which we included in the Company’s Annual Report on Form 10-K which was filed with the SEC on March 31, 2011.

We believe that there were no significant changes in those critical accounting policies and estimates during the first three months of fiscal 2011. 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.

 
10


21st Century Holding Company
Notes to Condensed Consolidated Financial Statements
 
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.

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.

 
11

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

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 March 31, 2011 and December 31, 2010. Changes in interest rates subsequent to March 31, 2011 and December 31, 2010 may affect the fair value of our investments.

The carrying amounts for the following financial instrument categories approximate their fair values at March 31, 2011 and December 31, 2010 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.

(B) Impact of New Accounting Pronouncements

In December 2010, the FASB issued Accounting Standard Update (“ASU”) No. 2010-29:  Business Combinations (Topic 805):  Disclosure of Supplementary Pro Forma Information for Business Combinations a consensus of the FASB Emerging Issues Task Force.  The objective of this update is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. Paragraph 805-10-50-2(h) requires a public entity to disclose pro forma information for business combinations that occurred in the current reporting period. The disclosures include pro forma revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma revenue and earnings of the combined entity for the comparable prior reporting period should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period.  In practice, some preparers have presented the pro forma information in their comparative financial statements as if the business combination that occurred in the current reporting period had occurred as of the beginning of each of the current and prior annual reporting periods. Other preparers have disclosed the pro forma information as if the business combination occurred at the beginning of the prior annual reporting period only, and carried forward the related adjustments, if applicable, through the current reporting period.  The amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  The adoption of this update did not have a material impact on the Company’s financial statements.

In October 2010, the FASB issued ASU No. 2010-26: Financial Services – Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, a consensus of FASB Emerging Issues Task Force.  The amendments in this update modify the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. The amendments in this update specify that the costs must be based on successful efforts (that is, acquiring a new or renewal contract).  The amendments also specify that advertising costs should be included as deferred acquisition costs under certain circumstances.  The amendments in this update are effective for fiscal years, and interim period within those fiscal years, beginning after December 15, 2011.  The amendments in this update should be applied prospectively upon adoption.  Retrospective application to all prior periods presented upon the date of adoption also is permitted, but not required.  Early adoption is permitted, but only at the beginning of an entity’s annual reporting period.  The adoption of this update is not expected to have a material impact on the Company’s consolidated financial statements.   

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. 

 
12

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

In January 2010, the FASB issued 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 May 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 165, “Subsequent Events” (“SFAS No. 165”), which is now part of 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 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 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.  This new accounting guidance 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.  The accounting guidance 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.  The new guidance 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.  The accounting guidance 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.

 
13

 
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 three months ended March 31, 2011 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 2010 financial statements was necessary to conform to the 2011 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. The amount of liability for these claims and lawsuits is uncertain. 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 may 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. During 2010, one such suit was brought against one of the Company’s affiliates. This suit was dismissed and the dismissal is currently under appeal. In the opinion of management, the ultimate disposition of this matter will not have a material adverse effect on our financial condition or results of operations. 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.

 
14

 
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, 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 years ended December 31, 2008 or 2010 or during the three months ended March 31, 2011. Through 2007, we were 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 were not charged to operations, in contrast, GAAP treatment is to charge current operations for the assessments. Through policyholder surcharges, as approved by the Florida OIR, we have since recouped $7.2 million in connection with these assessments. 

Related to statutory accounting, in October 2010, the National Association of Insurance Commissioners (“NAIC”) issued substantive revisions in Statement of Statutory Accounting Principles  (“SSAP”) No. 35 Revised (“SSAP No. 35R”), Guaranty Fund and Other Assessments.  For statutory accounting, SSAP No. 35R, effective January 1, 2011, requires assessments that could be recouped through future premium surcharges be expensed and an asset cannot be recognized.  The impact is there might be an effect on statutory policyholder surplus once the liability for the assessments is recognized.  The adoption of SSAP No. 35R rule will not have a material effect on our current operations.

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.

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.

Florida OIR issued an Order April 29, 2010, levying an increase to the emergency assessment to 1.3% 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 1.4% 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.

 
15

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

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 the three months ended March 31, 2011 or during the years 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”). Tax years prior to 2005 are closed for review by the 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 2005 and 2006 income tax returns remain open due to net operating loss carry-back from tax year 2009, which is currently being reviewed by the Joint Committee on Taxation.

The Florida Department of Revenue examination of the Company’s consolidated Florida income tax returns for 2007, 2006, 2005 and 2004 was settled and closed in early November 2010 with no change to tax years 2007, 2006 and 2005. The audit resulted in an immaterial adjustment to the 2004 tax year. The Florida income tax returns for 2008 and 2009 are open for review.

The Company has recorded a net deferred tax asset of $8.9 million as of March 31, 2011.  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. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At March 31, 2011, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. 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, we sold our interest in the building housing our operations in Lauderdale Lake on or about March 1, 2006 to an unrelated party. As part of this transaction, we agreed to lease the same facilities for a five-year term.  We amended the lease agreement and the note receivable on September 1, 2010. As part of the amendment, we discounted the note receivable and have discontinued the interest on the note. In consideration, we will pay a reduced lease payment for the remainder of the lease. Our lease for this office space expires in December 2011.

 
16

 
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)
 
2011
    549  
Total
  $ 549  

The Company is not currently involved in any legal actions arising from the ordinary course of business that are 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 increased $4.1 million, or 3.4%, to $126.6 million as of March 31, 2011, compared with $122.5 million as of December 31, 2010.

The debt and equity securities that are available-for-sale and carried at fair value represent 95% of total investments as of March 31, 2011and of December 31, 2010, respectively.

We did not hold any trading investment securities during the three months ended March 31, 2011.

The FASB issued guidance also addresses the determination as to when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. The Company’s policy for the valuation of temporarily impaired securities is to determine impairment based on the analysis of the following factors.

 
·
rating downgrade or other credit event (eg., failure to pay interest when due);

 
·
length of time and the extent to which the fair value has been less than amortized cost;
 
 
·
financial condition and near term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology or discontinuance of a business segment;
 
 
·
prospects for the issuer’s industry segment;
 
 
·
intent and ability of the Company to retain the investment for a period of time sufficient to allow for anticipated recovery in market value;

 
·
historical volatility of the fair value of the security.

 
17

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

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 three months ended March 31, 2011, in connection with this process, we have not charged any net realized investment loss to operations.

As of March 31, 2011 and December 31, 2010 respectively, all of our securities are in good standing and not impaired as defined by FASB issued guidance.

The investments held as of March 31, 2011 and December 31, 2010 were comprised mainly of corporate bonds held in various industries and United States government bonds.

As of March 31, 2011, 54% of the investment portfolio is in corporate bonds, 26% is in United States government bonds, 2% is in obligations of states and political subdivisions, 1% is in international bonds and 17% is in common stock and mutual funds. Approximately 16% of the common stock holdings are related to foreign entities.

As of December 31, 2010, 56% of the investment portfolio is in corporate bonds, 2% is in obligations of states and political subdivisions, 28% is in United States government bonds and 14% is in common stock and mutual funds. Approximately 1% of the common stock holdings are related to foreign entities.

As of March 31, 2011, 69% of the debt portfolio is in diverse industries and 31% is in United States government bonds.  As of March 31, 2011, approximately 84% of the equity holdings are in equities related to diverse industries and 16% are in mutual funds.

As of December 31, 2010, 72% of the debt portfolio was in diverse industries and 28% was in United States government bonds.  As of December 31, 2010, approximately 77% of the equity holdings were in equities related to diverse industries and 23% were in mutual funds.

During the three months ended March 31, 2011, we did not re-classify any of our bond portfolio between available for sale and held-to-maturity.

As of March 31, 2011 and December 31, 2010, we have classified $6.7 million and $6.2 million, respectively, of our bond portfolio as held-to-maturity. We only classify bonds as held-to-maturity to support securitization of credit requirements. Fully funded trust agreements or outstanding irrevocable letters of credit, used for such purposes, total $3.6 million for the period ended March 31, 2011 and December 31, 2010, 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, 2010, the letter of credit in favor of Republic was replaced by a fully funded trust agreement that totaled $1.0 million.

 
18

 
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 March 31, 2011 and December 31, 2010.

   
March 31, 2011
   
December 31, 2010
 
   
Carrying
   
Percent
   
Carrying
   
Percent
 
   
Amount
   
of Total
   
Amount
   
of Total
 
   
(Dollars in Thousands)
 
Debt securities, at market:
                       
United States government obligations and authorities
  $ 26,512       20.94 %   $ 28,196       23.02 %
Obligations of states and political subdivisions
    2,956       2.34 %     2,963       2.42 %
Corporate
    67,883       53.62 %     65,808       53.73 %
International
    1,502       1.19 %     1,383       1.13 %
      98,853       78.09 %     98,350       80.30 %
Debt securities, at amortized cost:
                               
Corporate
    926       0.73 %     818       0.67 %
United States government obligations and authorities
    5,815       4.59 %     5,380       4.39 %
      6,741       5.32 %     6,198       5.06 %
Total debt securities
    105,594       83.41 %     104,548       85.36 %
                                 
Equity securities, at market:
    21,001       16.59 %     17,937       14.64 %
Total investments
  $ 126,595       100.00 %   $ 122,485       100.00 %
 
The following table shows the realized gains (losses) for debt and equity securities for the three months ended March 31, 2011 and 2010.

   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
Gains
   
Fair Value
   
Gains
   
Fair Value
 
   
(Losses)
   
at Sale
   
(Losses)
   
at Sale
 
   
(Dollars in Thousands)
 
                         
Debt securities
  $ 225     $ 21,733     $ 348     $ 14,584  
Equity securities
    319       1,989       2,093       13,349  
Total realized gains
    544       23,722       2,441       27,933  
                                 
Debt securities
    (432 )     13,833       (25 )     1,481  
Equity securities
    (215 )     1,472       (191 )     1,439  
Total realized losses
    (647 )     15,305       (216 )     2,920  
                                 
Net realized (losses) gains on investments
  $ (103 )   $ 39,027     $ 2,225     $ 30,853  

 
19

 
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 March 31, 2011 and December 31, 2010 is as follows.

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
   
Cost
   
Gains
   
Losses
   
Fair Value
 
   
(Dollars in Thousands)
 
March 31, 2011
                       
Debt Securities  - Available-For-Sale:
                       
United States government obligations and authorities
  $ 26,831     $ 130     $ 449     $ 26,512  
Obligations of states and political subdivisions
    2,918       47       9       2,956  
Corporate
    67,741       721       579       67,883  
International
    1,483       21       2       1,502  
    $ 98,973     $ 919     $ 1,039     $ 98,853  
                                 
Debt Securities  - Held-To-Maturity:
                               
United States government obligations and authorities
  $ 5,815     $ 185     $ 28     $ 5,972  
Corporate
    926       2       6       922  
    $ 6,741     $ 187     $ 34     $ 6,894  
                                 
Equity securities - common stocks
  $ 19,460     $ 2,393     $ 852     $ 21,001  
                                 
December 31, 2010
                               
Debt Securities  - Available-For-Sale:
                               
United States government obligations and authorities
  $ 28,389     $ 191     $ 384     $ 28,196  
Obligations of states and political subdivisions
    2,920       49       6       2,963  
Corporate
    65,540       850       581       65,809  
International
    1,358       25       1       1,382  
    $ 98,207     $ 1,115     $ 972     $ 98,350  
                                 
Debt Securities  - Held-To-Maturity:
                               
United States government obligations and authorities
  $ 5,381     $ 212     $ 20     $ 5,573  
Corporate
    818       1       3       816  
    $ 6,199     $ 213     $ 23     $ 6,389  
                                 
Equity securities - common stocks
  $ 17,245     $ 1,425     $ 733     $ 17,937  

 
20

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements
 
The table below reflects our unrealized investment losses by investment class, aged for length of time in a continuous unrealized loss position as of March 31, 2011.

   
Unrealized (Losses)
   
Less than 12 months
   
12 months or longer
 
   
(Dollars in Thousands)
 
Debt securities:
                 
United States government obligations and authorities
  $ (449 )   $ (449 )   $ -  
Obligations of states and political subdivisions
    (9 )     (9 )     -  
Corporate
    (579 )     (579 )     -  
International
    (2 )     (2 )     -  
      (1,039 )     (1,039 )     -  
Equity securities:
                       
Common stocks
    (852 )     (556 )     (296 )
                         
Total debt and equity securities
  $ (1,891 )   $ (1,595 )   $ (296 )


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, 2010.

   
Unrealized (Losses)
   
Less than 12 months
   
12 months or longer
 
   
(Dollars in Thousands)
 
Debt securities:
                 
United States government obligations and authorities
  $ (384 )   $ (384 )   $ -  
Obligations of states and political subdivisions
    (6 )     (6 )     -  
Corporate
    (581 )     (581 )     -  
International
    (1 )     (1 )     -  
      (972 )     (972 )     -  
Equity securities:
                       
Common stocks
    (733 )     (435 )     (298 )
                         
Total debt and equity securities
  $ (1,705 )   $ (1,407 )   $ (298 )
 
Below is a summary of debt securities at March 31, 2011 and December 31, 2010, 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.

   
March 31, 2011
   
December 31, 2010
 
   
Amortized
   
Estimated
   
Amortized
   
Estimated
 
   
Cost
   
Fair Value
   
Cost
   
Fair Value
 
   
(Dollars in Thousands)
 
                         
Due in one year or less
  $ 8,174     $ 8,201     $ 13,231     $ 13,268  
Due after one through five years
    42,165       42,526       49,982       50,360  
Due after five through ten years
    40,238       40,034       30,066       29,971  
Due after ten years
    15,137       14,986       11,127       11,140  
                                 
Total
  $ 105,714     $ 105,747     $ 104,406     $ 104,739  

 
21

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements
 
United States Treasury notes with a book value of $2,009,868 and $65,133, maturing in 2012 and 2016 respectively, were on deposit with the Florida OIR as of March 31, 2011, as required by law for Federated National respectively, and are included with other investments held until maturity.

The table below sets forth investment results for the three months ended March 31, 2011 and 2010.

   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(Dollars in Thousands)
 
             
Interest on debt securities
  $ 899     $ 845  
Dividends on equity securities
    70       87  
Interest on cash and cash equivalents
    1       3  
                 
Total investment income
  $ 970     $ 935  
                 
Net realized (losses) gains
  $ (103 )   $ 2,225  
 
Proceeds from sales of debt and equity securities during the three months ended March 31, 2011 and 2010, were approximately $41.5 million and $31.1 million, respectively.

The table below sets forth a summary of net realized investment (losses) gains during the three months ended March 31, 2011 and 2010.

   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(Dollars in Thousands)
 
Net realized (losses) gains
           
Debt securities
  $ (207 )   $ 323  
Equity securities
    104       1,902  
                 
Total
  $ (103 )   $ 2,225  
 
The table below sets forth a summary of net unrealized investment (losses) gains during the three months ended March 31, 2011 and 2010.

   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(Dollars in Thousands)
 
Net unrealized (losses) gains
           
Debt securities
  $ (120 )   $ 143  
Equity securities
    1,541       692  
                 
Total
  $ 1,421     $ 835  

 
22

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements
 
(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.

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. 

 
23


Assets measured at fair value on a recurring basis as of March 31, 2011, presented in accordance with this guidance, are as follows.

   
As of March 31, 2011
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(Dollars in Thousands)
 
Debt securities:
                       
United States government obligations and authorities
  $ -     $ 26,512     $ -     $ 26,512  
Obligations of states and political subdivisions
    -       2,956       -       2,956  
Corporate
    67,883       -       -       67,883  
International
    -       1,502       -       1,502  
      67,883       30,970       -       98,853  
                                 
Equity securities:
                               
Common stocks
    21,001       -       -       21,001  
      21,001       -       -       21,001  
                                 
Total debt and equity securities
  $ 88,884     $ 30,970     $ -     $ 119,854  

Assets measured at fair value on a recurring basis as of December 31, 2010, presented in accordance with this guidance, are as follows.

   
As of December 31, 2010
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(Dollars in Thousands)
 
Debt securities:
                       
United States government obligations and authorities
  $ -     $ 28,196     $ -     $ 28,196  
Obligations of states and political subdivisions
    -       2,963       -       2,963  
Corporate
    65,809       -       -       65,809  
International
    -       1,382       -       1,382  
      65,809       32,541       -       98,350  
                                 
Equity securities:
                               
Common stocks
    17,937       -       -       17,937  
      17,937       -       -       17,937  
                                 
Total debt and equity securities
  $ 83,746     $ 32,541     $ -     $ 116,287  
 
 
24

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

(7)  Comprehensive Loss

For the three months ended March 31, 2011 and 2010, comprehensive loss consisted of the following.

   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(Dollars in Thousands)
 
             
Net loss
  $ (2,007 )   $ (927 )
                 
Change in net unrealized gains (losses) on investments available for sale
    587       (869 )
Comprehensive loss before tax
    (1,420 )     (1,796 )
                 
Income tax (expense) benefit  related to items of other comprehensive loss
    (221 )     327  
Comprehensive loss
  $ (1,641 )   $ (1,469 )
 
(8) Reinsurance Agreements

Financing risk generally involves a combination of risk retention and risk transfer techniques. Retention, similar to a deductible, 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, Inc. (“Demotech”).

 
25

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

Our property lines of business include homeowners’ and fire. For the 2010-2011 hurricane season, the excess of loss and FHCF treaties will insure the property lines for approximately $360.7 million of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $285.5 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 $220.4 million, or 61.1% of the $360.7 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 $19.1 million payable to the FHCF and the prepaid automatic premium reinstatement protection, is approximately $46.5 million.

The cost and amounts of reinsurance were originally based on management's analysis of Federated National's exposure to catastrophic risk as of June 30, 2010. Our data was 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 produced changes in limits and reinsurance premiums because of increase in our exposure level. The September 30, 2010 change to limits total limits was an increase of $10.3 million or 2.9% and the change to reinsurance premiums was an increase of $3.7 million or 8.7%. The change to management’s June 30, 2010 analysis will be amortized over the remaining balance of the underlying policy term. The Company’s retention did not change.

 
26

 
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.
 
 
27

 
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    
UNITED STATES
       
Everest Reinsurance Company
 
A+
 
**
Munich Reinsurance America, Inc.
 
A+
 
**
QBE Reinsurance Corporation
 
A
 
**
         
BERMUDA
       
ACE Tempest Reinsurance Limited
 
A+
*
 
Amlin Bermuda Limited
 
A
   
Ariel Reinsurance Company Limited
 
A-
*
 
DaVinci Reinsurance Limited
 
A
*
 
Flagstone Reinsurance Limited
 
A-
   
Hiscox Insurance Company Limited
 
A
*
 
Montpelier Reinsurance Limited
 
A-
   
Platinum Underwriters Bermuda Limited
 
A
*
 
Renaissance Reinsurance Limited
 
A+
*
 
Torus Insurance (Bermuda) Limited
 
A-
*
 
         
LONDON & EUROPE
       
Amlin Syndicate No. 2001 (AML)
 
A+
 
**
Antares Syndicate No. 1274 (AUL)
 
A
 
**
Arrow Syndicate No. 1910 (ARW)
 
A
*
**
Broadgate Syndicate No. 1301 (BGT)
 
A
 
**
Liberty Syndicates Services Limited, Paris for and on behalf of Lloyd's Syndicate No. 4472 (LIB)
 
A
 
**
Novae Syndicate No. 2007 (NVA)
 
A
 
**
SCOR Switzerland AG
 
A-
   
         
HEDGE FUNDS / COLLATERALIZED
       
Actua Re Limited
 
NR
*
(1)
Allianz Risk Transfer AG (Bermuda Branch)
 
NR-5
*
(2)
         
         
* 2009 Reinstatement Premium Protection Program Participants        
         
** Admitted in Florida as a reinsurer, whether through licensing, accreditation or other means.        
         
(Blank) Non admitted reinsurer in Florida.        
         
(1) Participant has funded a trust agreement for their partcipation with approximately $6.4 million of cash and U.S. Government obligations of American institutions at fair market value.  
         
(2) Standard & Poor's rated "AA" (Obligor's capacity to meet its financial commitment on the obligation is very strong)  
 
As a result of the January 2011 merger of Federated National with and into American Vehicle, we are better capitalized and anticipate more favorable terms in connection with our upcoming reinsurance structure.

We entered into an 80% quota share treaty with Scor Reinsurance Company effective May 1, 2010 for all private passenger automobile policies in effect on May 1, 2010. This treaty included a ceding of unearned premium to the reinsurers. Our insurance companies will retain 20% of the policy risk for the term of the quota share agreement.

 
28

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

American Vehicle became an admitted insurer in the state of Georgia during the quarter ended September 30, 2010. As part of the ramp-up of our business in Georgia, we entered into an arrangement to write non-standard private passenger automobile insurance through a reputable managing general agent familiar with the Georgia market. A quota share treaty will cede 100% of the risk and be fully collateralized for unearned premium and unpaid loss and LAE. 

Pursuant to commutation provisions contained in the original 2004 FHCF agreement, on August 10, 2010 Federated National and the FHCF negotiated such a commutation agreement for the 2004 contract year. The terms of the agreement provide that Federated National release the FHCF from all its obligations under the original reinsurance agreement for a negotiated consideration as a final payment for all unpaid claims subject to the treaty. This negotiation resulted in a final commutation payment received by us for a total of $0.75 million, which the Company believes is adequate to pay loss and LAE including incurred but not yet reported (“IBNR”) for the subject losses. The benefit of the FHCF treaty inures to the benefit of the private reinsurers participating in the treaty.  Should our estimations for unpaid loss and LAE exceed our commutation with the FHCF and ultimately prove inadequate, our coverage in the private market will continue to indemnify us. We do not expect the private market coverage to be exhausted. Additionally, this commutation agreement did not have an effect on operational net income.

Pursuant to commutation provisions contained in the original 2005 FHCF agreement, we anticipate negotiating a commutation agreement for the 2005 contract year.

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 years ended December 31, 2008 or 2010 or during the three months ended March 31, 2011. Through 2007, we were 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 OIR, we have since recouped $7.2 million in connection with these assessments. 

Related to statutory accounting, in October 2010, the NAIC issued substantive revisions in SSAP No. 35R, Guaranty Fund and Other Assessments.  For statutory accounting, SSAP No. 35R, effective January 1, 2011, requires assessments that could be recouped through future premium surcharges be expensed and an asset cannot be recognized.  The impact is there might be an effect on statutory policyholder surplus once the liability for the assessments is recognized.  The adoption of SSAP No. 35R rule will not have a material effect on our current operations.

The 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.

The FHCF reimbursement contract and addendums are all effective June 1, 2010, and the private excess of loss type treaties are all effective July 1, 2010; all treaties have a term of one year. Our reinsurance treaty with the FHCF has a significant credit risk, including the fact that the FHCF may not be able to raise sufficient money to pay their claims or impair their ability to pay their claims in a timely manner. This could result in significant financial, legal and operational challenges to all companies, including ours. Additionally, the FHCF treaty contains an exclusion for “Losses in excess of the sum of the Balance of the Fund as of December 31 of the Contract Year and the amount the SBA is able to raise through the issuance of revenue bonds or by the use of other financing mechanisms, up to the limit pursuant to Section 215.555(4) (c), Florida Statutes.” This credit risk is mitigated by a fund cash buildup due to the absence of covered events in recent years.

 
29

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

To date, there have been no claims asserted against the reinsurers in connection with the 2010–2011 and 2009–2010 excess of loss and FHCF treaties.

As regards to the commercial multi-peril property program that began recording premium on August 28, 2009, we have secured an automatic facultative reinsurance agreement with Munich Reinsurance America, Inc. and Ascot Underwriting Limited for bound risks with total insured values not to exceed $10.0 million, with additional coverage in excess of $10.0 million available upon submission and subjected to underwriting guidelines. This coverage excludes catastrophic wind-storm risk. A.M. Best ratings for Munich Re and Ascot are A+ and A, respectively.

During 2009, the Company secured casualty reinsurance affording coverage totaling $4.0 million in excess of $1.0 million. This reinsurance also protects the Company against extra contractual obligations and losses in excess of policy limits. Any loss occurrence that involves liability exposure written by either Federated National or American Vehicle or a combination of both will be covered. The cost of this coverage totaled approximately $0.4 million.

In order to expand our commercial business, American Vehicle entered into various quota share reinsurance agreements whereby American Vehicle is the assuming reinsurer. On March 26, 2009, we announced that American Vehicle received approval from the Florida OIR to enter into a reinsurance relationship allowing the opportunity to market and underwrite commercial insurance through a company that has an "A" rating with A.M. Best. This agreement is designed to enable the deployment of commercial general liability and other commercial insurance products in most of the contiguous 48 states to policyholders who require their commercial insurance policy to come from an insurance company with an A- or better A.M. Best rating. Operations began during the quarter ended June 30, 2009. During 2011, the companies mutually agreed to suspend this treaty effective May 15, 2011.

The quota share retrocessionaire reinsurance agreements require American Vehicle to securitize credit, regulatory and business risk. As of December 31, 2010, irrevocable letters of credit fully collateralized by American Vehicle and further guaranteed by the parent company, 21st Century, were replaced by fully funded trust agreements. Fully funded trust agreements and outstanding irrevocable letters of credit totaled $4.6 million as of March 31, 2011 and December 31, 2010, respectively.

We are selective in choosing reinsurers and consider numerous factors, the most important of which are the financial stability of the reinsurer, their history of responding to claims and their overall reputation. In an effort to minimize our exposure to the insolvency of a reinsurer, we evaluate the acceptability and review the financial condition of the reinsurer at least annually.

 (9) Stock Compensation Plans

We implemented a stock option plan in September 1998, which expired in September 2008, and provided for the granting of stock options to officers, key employees and consultants.  The objectives of this plan included attracting and retaining the best personnel, providing for additional performance incentives, and promoting our success by providing employees the opportunity to acquire common stock. Options outstanding under this plan were granted at prices either equal to or above the market value of the stock on the date of grant, typically vest over a four-year or five-year period and expire six or ten years after the grant date. Under this plan, we were authorized to grant options to purchase up to 900,000 common shares, and, as of both March 31, 2011 and December 31, 2010, we had outstanding exercisable options to purchase 89,750 shares.

In 2001, we implemented a franchisee stock option plan that was terminated during September 2008, and provided for the granting of stock options to individuals purchasing Company owned agencies that were then converted to franchised agencies.  The purpose of the plan was to advance our interests by providing an additional incentive to encourage managers of Company owned agencies to purchase the agencies and convert them to franchises. Options outstanding under the plan were granted at prices, which were above the market value of the stock on the date of grant, vested over a ten-year period, and expired ten years after the grant date. Under this plan, we were authorized to grant options to purchase up to 988,500 common shares, and, as of March 31, 2011 and December 31, 2010, we had no outstanding exercisable options to purchase shares.

 
30

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

In 2002, we implemented the 2002 Stock Option Plan.  The purpose of this plan is to advance our interests by providing an additional incentive to attract, retain and motivate highly qualified and competent persons who are key to the Company, including employees, consultants, independent contractors, officers and directors. Our success is largely dependent upon their efforts and judgment; therefore, by authorizing the grant of options to purchase common stock, we encourage stock ownership. Options outstanding under the plan were granted at prices either equal to or above the market value of the stock on the date of grant, typically vest over a five-year period, and expire six or ten years after the grant date. Under this plan, we are authorized to grant options to purchase up to 1,800,000 common shares, and, as of March 31, 2011 and December 31, 2010, we had outstanding exercisable options to purchase 562,098 and 574,800 shares, respectively.

Activity in our stock option plans for the period from January 1, 2009 to March 31, 2011 is summarized below.

   
1998 Plan
   
2002 Plan
 
   
Number of Shares
   
Weighted Average Option Exercise Price
   
Number of Shares
   
Weighted Average Option Exercise Price
 
Outstanding at January 1, 2009
    130,099     $ 16.07       658,151     $ 13.69  
Granted
    -     $ -       147,000     $ 4.37  
Exercised
    -     $ -       -     $ -  
Cancelled
    (5,500 )   $ 20.23       (68,200 )   $ 11.58  
Outstanding at January 1, 2010
    124,599     $ 15.88       736,951     $ 12.03  
Granted
    -     $ -       109,500     $ 3.59  
Exercised
    -     $ -       -     $ -  
Cancelled
    (34,849 )   $ 23.74       (271,651 )   $ 14.78  
Outstanding at January 1, 2011
    89,750     $ 12.83       574,800     $ 9.12  
Granted
    -     $ -       -     $ -  
Exercised
    -     $ -       -     $ -  
Cancelled
    -     $ -       (12,702 )   $ 8.65  
Outstanding at March 31, 2011
    89,750     $ 12.83       562,098     $ 9.13  


Options outstanding as of March 31, 2011 are exercisable as follows.

   
1998 Plan
   
2002 Plan
 
Options Exercisable at:
 
Number of Shares
   
Weighted Average Option Exercise Price
   
Number of Shares
   
Weighted Average Option Exercise Price
 
                         
March 31, 2011
    53,650     $ 12.83       314,908     $ 9.13  
December 31, 2011
    17,700     $ 12.83       57,757     $ 9.13  
December 31, 2012
    17,700     $ 12.83       83,433     $ 9.13  
December 31, 2013
    700     $ 12.83       52,400     $ 9.13  
December 31, 2014
    -     $ 12.83       33,000     $ 9.13  
December 31, 2015
    -     $ 12.83       20,600     $ 9.13  
Thereafter
    -     $ 12.83       -     $ 9.13  
Total options exercisable
    89,750               562,098          


 
31

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements
 
Prior to January 1, 2006, we accounted for the plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by the APB and related Interpretation, as permitted by FASB issued guidance. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.

Upon the exercise of options, the Company issues authorized shares.

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 costs recognized during 2010 and 2009 include the following.

 
·
Compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FASB issued guidance, and

 
·
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 provisions of FASB issued guidance. Results for prior periods have not been restated, as not required to be by the pronouncement.

As a result of adopting FASB issued guidance on January 1, 2006, the Company’s income from continuing operations before provision for income taxes and net income for the three months ended March 31, 2011 are lower by approximately $62,000 and $39,000, respectively, than if it had continued to account for share-based compensation under APB guidance.

As a result of adopting FASB issued guidance on January 1, 2006, the Company’s income from continuing operations before provision for income taxes and net income for the three months ended March 31, 2010 were lower by approximately $96,000 and $60,000, respectively, than if it had continued to account for share-based compensation under APB guidance.

Basic and diluted earnings per share for the three months ended March 31, 2011 would have been ($0.25), if the Company had not adopted FASB issued guidance, compared with the unchanged reported basic and diluted earnings per share of ($0.25).

Basic and diluted earnings per share for the three months ended March 31, 2010 would have been ($0.11), if the Company had not adopted FASB issued guidance, compared with reported basic and diluted earnings per share of ($0.12).

Because the change in income taxes payable includes the effect of excess tax benefits, those excess tax benefits also must be shown as a separate operating cash outflow so that operating cash flows exclude the effect of excess tax benefits. FASB issued guidance requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.

There were no options granted during the three months ended March 31, 2011. The weighted average fair value of options granted during the three months ended March 31, 2010 was $1.81, estimated on the date of grant using the Black-Scholes option-pricing model.

The fair value of options granted is estimated on the date of grant using the following assumptions.

   
March 31, 2011
   
March 31, 2010
 
Dividend yield
  N/A     5.80%  
Expected volatility
  N/A     82.36%  
Risk-free interest rate
  N/A     1.33%  
Expected life (in years)
  N/A     3.06  
 
 
32

 
21st Century Holding Company
Notes to Condensed Consolidated Financial Statements

Summary information about the Company’s stock options outstanding at March 31, 2011 follows.

   
Range of
Exercise Price
   
Outstanding at
March 31, 2011
   
Weighted Average
Contractual
Periods in Years
   
Weighted
Average
Exercise Price
   
Exercisable at
March 31, 2011
 
1998 Plan
  $ 6.67 - $16.59       89,750       2.44     $ 12.83       53,650  
2002 Plan
  $ 3.03 - $18.21       562,098       3.78     $ 9.13       314,908  
 
(10) Stockholders’ Equity

Capital Stock

The Company’s authorized capital consists of 1,000,000 shares of preferred stock, par value $0.01 per share, and 25,000,000 shares of common stock, par value $0.01 per share. As of March 31, 2011, there were no preferred shares issued or outstanding and there were 7,946,384 shares of common stock outstanding.

(11) Subsequent Events

The Company has determined that there are no events or transactions occurring subsequent to March 31, 2011, that would have a material impact on the Company’s results of operations or financial condition as of March 31, 2011.
 
 
33

 
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and Results of Operations

General information about 21st Century Holding Company can be found at www.21stcenturyholding.com; however, the information that can be accessed through our web site is not part of our report. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 available free of charge on our web site, as soon as reasonably practicable after they are electronically filed with the SEC.

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion in conjunction with our condensed consolidated financial statements and related notes and information included under this Item 2 and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K  filed with the Securities and Exchange Commission (“SEC”) on March 31, 2011 (“Form 10-K”). Unless the context requires otherwise, as used in this Form 10-Q, the terms “21st Century” “Company,” “we,” “us” and “our,” refers to 21st Century Holding Company and its subsidiaries.

Forward-Looking Statements

Statements in this Quarterly Report on Form 10-Q for the three months ended March 31, 2011 (“Form 10-Q”)  or in documents that are incorporated by reference that are not historical fact are forward-looking statements that are subject to certain risks and uncertainties that could cause actual events and results to differ materially from those discussed herein.  Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” or “continue” or the negative other variations thereof or comparable terminology are intended to identify forward-looking statements.  The risks and uncertainties include, without limitation, uncertainties related to estimates, assumptions and projections relating to unpaid losses and loss adjustment expenses and other accounting policies, losses from the nine hurricanes that occurred in fiscal years 2005 and 2004 and in other estimates, assumptions and projections contained in this Form 10-Q; inflation and other changes in economic conditions (including changes in interest rates and financial markets); the impact of new regulations adopted in Florida which affect the property and casualty insurance market; the costs of reinsurance, assessments charged by various governmental agencies; pricing competition and other initiatives by competitors; our ability to obtain regulatory approval for requested rate changes and the timing thereof; legislative and regulatory developments; the outcome of various litigation matters pending against us, including the terms of any settlements; risks related to the nature of our business; dependence on investment income and the composition of our investment portfolio; the adequacy of our liability for loss and loss adjustment expense; insurance agents; claims experience; ratings by industry services; catastrophe losses; reliance on key personnel; weather conditions (including the severity and frequency of storms, hurricanes, tornadoes and hail); changes in driving patterns and loss trends; acts of war and terrorist activities; court decisions and trends in litigation and health care and auto repair costs; and other matters described from time to time by us in this report, and in our other  filings with the SEC, including the Company’s Form 10-K.
 
You are cautioned not to place reliance on these forward-looking statements, which are valid only as of the date they were made.  The Company undertakes no obligation to update or revise any forward-looking statements to reflect new information or the occurrence of unanticipated events or otherwise.  In addition, readers should be aware that Generally Accepted Accounting Principles (“GAAP”) prescribes when a company may reserve for particular risks, including litigation exposures.  Accordingly, results for a given reporting period could be significantly affected when a reserve is established for a major contingency.  Reported results may therefore appear to be volatile in certain accounting periods.

 
34

 
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

21st Century is an insurance holding company, which, through our subsidiaries and our contractual relationships with our independent agents and general agents, controls substantially all aspects of the insurance underwriting, distribution and claims processes. We are authorized to underwrite homeowners’ multi-peril (“homeowners”), commercial general liability, personal and commercial automobile, personal umbrella, following form commercial excess liability, fire, allied lines, workers’ compensation, business personal property and commercial inland marine insurance. We are authorized to underwrite in various states on behalf of our wholly owned subsidiary, Federated National Insurance Company (“Federated National”) and other insurance carriers. Federated National is the resulting entity following the merger of Federated National with and into our other wholly owned subsidiary, American Vehicle Insurance Company (“American Vehicle”), in January 2011. In connection with this merger, the Company, Federated National and American Vehicle entered into a Consent Order with the Florida Office of Insurance Regulation (“Florida OIR”).  We market and distribute our own and third-party insurers’ products and our other services through a network of independent agents. We also utilize a select number of general agents for the same purpose.

Our executive offices are located at 3661 West Oakland Park Boulevard, Suite 300, Lauderdale Lakes, Florida, 33311 and our telephone number is (954) 581-9993.

Recent Developments
 
In May 2011, the Florida Legislature passed legislation intended to reform Florida’s property insurance market. This legislation is now awaiting the governor’s signature. These changes would become effective immediately upon signing.

Among other things, the legislation provides:

 
·
A claim, supplemental claim, or reopened windstorm or hurricane claim must be given to the insurer within 3 years after the hurricane first makes landfall or the windstorm causes covered damage. An initial, supplemental or reopened sinkhole claim must be given to the insurer within 2 years after the policyholder knew or reasonably should have known about the sinkhole loss. The bill also enacts a 5 year statute of limitations for bringing an action for the breach of a property insurance contract that runs from the date of loss.

 
·
The surplus requirements for insurers transacting residential property insurance that are not a wholly owned subsidiary of an insurer domiciled in another state are increased. For a new insurer, the bill raises the surplus requirement from $5 million to $15 million. An existing insurer that holds a certificate of authority before July 1, 2011, must have a surplus of at least $5 million until June 30, 2016; from July 1, 2016 until June 30, 2021, a surplus of at least $10 million; and on or after July 1, 2021, a surplus of at least $15 million.

 
·
Property insurance rate filings must be submitted via the “file and use” method until May 1, 2012. In a “file and use” rate filing the insurer must receive approval from the OIR before implementing the insurer’s proposed rate.  Residential property insurers are authorized to make a separate rate filing limited solely to an adjustment of its rates for reinsurance and financing products used as a replacement for reinsurance. The rate filing may not result in a premium increase of more than 15% for an individual policyholder and must be approved or disapproved by the OIR within 45 days. The OIR retains the authority to deny the filing if the proposed rate is excessive, inadequate, or unfairly discriminatory. An insurer may make only one such filing per 12-month period.

 
·
Public adjuster fees related to reopened or supplemental claims will be limited to a maximum of 20% of the reopened or supplemental claim payment. The legislation also limits public adjuster fees to 20% of an insurance claim payment made by the insurer more than one year after events that are the subject of a declaration of a state of emergency by the governor. A public adjuster fee related to a policy issued by Citizens Property Insurance Corporation may not exceed 10% of the additional amount actually paid in excess of the amount originally offered by Citizens on the claim.  Public adjusters must give prompt notice of a property loss claim to the insurer and include with the notice the public adjuster’s employment contract. The public adjuster must also ensure that the insurer has access to inspect the property, can interview the insured directly about the loss and claim, and allow the insurer to obtain information necessary to investigate and respond to the claim.

 
35

 
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
·
The legislation enacts numerous revisions and clarifications to the Florida statutes governing sinkhole and catastrophic ground cover collapse insurance.  These changes are intended to reduce the number and cost of sinkhole claims and disputes, increase reliance on scientific or technical determinations relating to sinkhole claims, and ensure that repairs are made in accordance with scientific and technical determinations and insurance claims payments, including by authorizing insurers to restrict catastrophic ground cover collapse and sinkhole loss coverage to the principal building as defined in the insurance policy and allowing an insurer to require a property inspection prior to issuing sinkhole loss coverage. The bill changes the definition of “sinkhole loss,” primarily by creating a statutory definition of “structural damage” for purposes of determining whether a sinkhole loss has occurred. The legislation also creates a substantially new process for an insurer’s investigation of a sinkhole claim. Coverage for sinkhole loss is not available if structural damage is not present or sinkhole activity is not the cause of structural damage. The insurer may limit payment to the actual cash value of the sinkhole loss not including below-ground repair techniques until the policyholder enters into a contract for the performance of building stabilization repairs.  Any contract for below-ground repairs to be made in accordance with the recommendations set forth in the insurer’s sinkhole report must be entered into within 90 days after the policyholder receives notice that the insurer has confirmed coverage for sinkhole loss and all stabilization and repairs to the structure and contents generally must be completed within 12 months after the policyholder enters into the contract for repairs. Once stabilization or foundation repairs are completed, the professional engineer responsible for monitoring the repairs must issue a report to the property owner detailing the repairs performed and certifying that the repairs were performed properly.  Last, the circumstances that allow an insurer to nonrenew a policy on the basis of filing a sinkhole claim have been modified to permit nonrenewal only if the insurer makes payments for sinkhole loss that equal or exceed policy limits or the policyholder does not repair the structure in accordance with the engineering recommendations.

 
·
The legislation provides that at least 120 days notice of nonrenewal, cancellation or termination (reduced from 180 days) must be given to a named insured whose residential structure has been insured by the insurer or its affiliate for at least 5-years.  Insurers are now also authorized to renew a property and casualty insurance policy under different policy terms by providing to the policyholder a written “Notice of Change in Policy Terms” instead of a written “Notice of Non-Renewal.” The Notice must be titled “Notice of Change in Policy Terms,” give the insured written notice of the change, and be enclosed with the written notice of renewal premium. The insured is deemed to have accepted the change in policy terms upon the insurer’s receipt of the premium payment for the renewal policy. If the insurer fails to provide the Notice of Change in Policy Terms, the original policy terms remain in effect.

 
·
The legislation requires the Florida Hurricane Catastrophe Fund to provide reimbursement for all incurred losses, including amounts paid as fees on behalf of the policyholder. The legislation also specifies, however, a number of losses that are excluded from payment.

 
·
The legislation repeals various requirements imposed on Citizens to reduce the areas of Florida that were eligible for coverage in the Florida Windstorm Underwriting Association. The legislation also specifies that Citizens may not levy regular assessments until the full Citizens policyholder surcharge has been levied and that the Citizens policyholder surcharge must be paid upon cancellation, termination, or renewal of an existing policy or upon issuance of every new policy issued within 12 months after the surcharge is levied or the time needed to fully collect the policyholder surcharge.

Merger of Federated National and American Vehicle

As part of its approval of the merger between Federated National and American Vehicle, the Florida OIR, the Company, Federated National and American Vehicle entered into a consent order with the Florida OIR dated January 25, 2011 (the “Consent Order”) pursuant to which the Company and the resulting company in the merger (the “Merged Company”) have agreed to the following:

 
36

 
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
·
The Merged Company shall retain the following licenses: (010) Fire, (020) Allied Lines, (040) Homeowners Multi Peril, (050) Commercial Multi Peril, (090) Inland Marine, (170) Other Liability, (192) Private Passenger Auto Liability, (194) Commercial Auto Liability, (211) Private Passenger Auto Physical Damage and (212) Commercial Auto Physical Damage.

 
·
The Merged Company shall not write commercial multi peril policy premium without prior approval from the Florida OIR. The Merged Company currently has no commercial multi peril policy premium in force.

 
·
The Merged Company shall surrender its surety license. The Merged Company currently has no Surety policy premium in force.

 
·
The Merged Company shall not write new commercial habitation condominium associations without prior approval from the Florida OIR. The current commercial habitation book of business is approximately $2.4 million of policy premium, which will be renewed pursuant to normal underwriting guidelines.

 
·
The Merged Company has agreed to reduce the total number of its homeowners’ policies in Miami-Dade, Broward and Palm Beach counties (the “Tri-County Area”) to 40% of its entire homeowners’ book by December 31, 2011 and limit its new homeowners’ policies in the Tri-County Area to $500,000 of new policy premium per month. The 40% will be achieved through the increased writing of property located outside of the Tri-County Area, the non-renewal of certain policies located within the Tri-County Area, and limiting the writing of new property located within the Tri-County Area. As of March 31, 2011, the Company had approximately 43.4% of its homeowners’ policies located within Tri-County Area.

 
·
The managing general agency fees payable by the Merged Company to Assurance Managing General Agents, Inc. (“Assurance MGA”), a wholly owned subsidiary of the Company, which were traditionally 6% of gross written premium, were reduced and will not exceed 4% without prior approval from the Florida OIR. The Merged Company has lowered the fee to 2% of gross written premium for the first quarter of 2011, 3% of gross written premium for the second quarter of 2011, and 4% of gross written premium thereafter.  This will have no impact on the Company’s consolidated financial results.

 
·
The claims service fees payable by the Merged Company to Superior Adjusting, Inc. (“Superior”) were reduced from the traditional 4.5% of gross earned premium to 3.6% of gross earned premium. This will have no impact on the Company’s consolidated financial results.

 
·
The Consent Order continues the prohibition on the Company from the payment of dividends until the Merged Company reports two consecutive quarters of net underwriting income.

 
·
The Company provided the Florida OIR with a plan of operation and has agreed to provide certain reports to the Florida OIR on a monthly basis, and agreed to obtain the Florida OIR’s approval prior to making any changes to the officers of the Merged Company during the first year following the effective date of the Merger.

Our Subsidiaries

The merger of Federated National and American Vehicle will be an ongoing transition, many aspects of which will take effect over time. References to the companies contained herein are intended to be references to the operations of the newly formed Federated National. References to the historical activities of American Vehicle are appropriately identified throughout this document.

Federated National is licensed as an admitted carrier in Florida. Through contractual relationships with a network of approximately 3,000 independent agents, of which approximately 400 actively sell and service our products, Federated National is authorized to underwrite homeowners’, fire, allied lines and personal and commercial automobile insurance in Florida. Effective January 26, 2011, Federated National merged with and into American Vehicle and American Vehicle changed its name to Federated National.

American Vehicle, prior to the January 2011 merger, was licensed as an admitted carrier in Florida, and underwrote commercial general liability, and personal and commercial automobile insurance. American Vehicle was also licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas, and underwrote commercial general liability insurance in those states. American Vehicle operated as a non-admitted carrier in Arkansas, California, Kentucky, Maryland, Missouri, Nevada, Oklahoma, South Carolina, Tennessee and Virginia, and could underwrite commercial general liability insurance in all of these states. Subsequent to the merger, these operations may continue under the newly formed Federated National.

 
37

 
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
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 three months ended March 31, 2011, 82.5%, 10.3%, 3.6% and 3.6% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and automobile insurance, respectively. During the three months ended March 31, 2010, 78.0%, 13.0%, 3.0% and 6.0% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and personal automobile insurance, respectively.

Our business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on our business, results of operations and financial condition. When our estimated liabilities for unpaid losses and loss adjustment expenses (“LAE”) are less than the actuarially determined amounts, we increase the expense in the current period. Conversely, when our estimated liabilities for unpaid losses and LAE are greater than the actuarially determined amounts, we decrease the expense in the current period.

We are focusing our marketing efforts on continuing to expand our distribution network and market our products and services throughout Florida and in other states by establishing relationships with additional independent agents and general agents. As this occurs, we will seek to replicate our distribution network in those states. For example, we became an admitted insurer in the state of Georgia during the quarter ended September 30, 2010. There can be no assurance, however, that we will be able to obtain the required regulatory approvals to offer additional insurance products or expand into other states.

Assurance MGA, a wholly owned subsidiary of the Company, acts as Federated National’s and American Vehicle’s exclusive managing general agent in the state of Florida and is also licensed as a managing general agent in the states of Alabama, Arkansas, Georgia, Illinois, Louisiana, North Carolina, Mississippi, Missouri, New York, Nevada, South Carolina, Texas and Virginia. Assurance MGA has contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation, personal umbrella and inland marine insurance through Assurance MGA’s existing network of agents.

Assurance MGA earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. Assurance MGA earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliates Federated National and American Vehicle. During the fourth quarter of 2010, Assurance MGA reduced its’ fee, to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date. A formal agreement reflecting this fee modification was executed during January 2011.

We internally process claims made by our insureds through our wholly owned claims adjusting company, Superior. Our agents have no authority to settle claims or otherwise exercise control over the claims process. Furthermore, we believe that the retention of independent adjusters, in addition to the employment of salaried claims personnel, results in reduced ultimate loss payments, lower LAE and improved customer service for our claimants and policyholders. We also employ an in-house legal department to cost-effectively manage claims-related litigation and to monitor our claims handling practices for efficiency and regulatory compliance.

 
38

 
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
We also offer premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc. (“Federated Premium”). Premium financing has been marketed through our distribution network of general agents and independent agents. Premiums for property and casualty insurance, in certain circumstances, are payable at the time a policy is placed in-force or renewed. Federated Premium's services allow the insured to pay a portion of the premium when the policy is placed in-force and the balance in monthly installments over a specified term, generally between six and nine months. As security, Federated Premium retains a contractual right, if a premium installment is not paid when due, to cancel the insurance policy and to receive the unearned premium from the insurer, or in the event of insolvency of an insurer, from Florida Insurance Guaranty Association (“FIGA”), subject to a $100 per policy deductible. In the event of cancellation, Federated Premium applies the unearned premium towards the payment obligation of the insured.

Insure-Link (“Insure-Link”) was formed in March 2008 to serve as an independent insurance agency. The insurance agency markets direct to the public to provide a variety of insurance products and services to individual clients, as well as business clients, by offering a full line of insurance products including, but not limited to,  homeowners’, personal and commercial automobile, commercial general liability and workers’ compensation insurance through their agency appointments with over fifty different carriers. Insure-Link will expand its business through marketing and by acquiring other insurance agencies. There were no other agency relationships with affiliated captive or franchised agents during 2010 or the three months ended March 31, 2011.

We operate in highly competitive markets and face competition from national, regional and residual market insurance companies in the homeowners’, commercial residential property, commercial general liability, and automobile markets, many of whom are larger, have greater financial and other resources, and offer more diversified insurance coverage. Our competitors include companies that market their products through agents, as well as companies that sell insurance directly to their customers. Large national writers may have certain competitive advantages over agency writers, including increased name recognition, increased loyalty of their customer base and reduced policy acquisition costs.

Insurance Markets in Which We Operate

Significant competition also emerged because of fundamental changes in 2007 made to the property and casualty insurance business in Florida, which resulted in a multi-pronged approach to address the cost of residential property insurance in Florida. First, the law increased the capacity of reinsurance that stabilized the reinsurance market to the benefit of the insurance companies writing properties lines in Florida. Secondly, the law provided for rate relief to all policyholders. The law also authorized the state-owned insurance company, Citizens Property Insurance Corporation (“Citizens”), which is free of many of the restraints on private carriers such as surplus, ratios, income taxes and reinsurance expense, to reduce its premium rates and begin competing against private insurers in the residential property insurance market and expands the authority of Citizens to write commercial insurance. We believe that these aggressive marketplace changes in 2007 forced some carriers to pursue market share based on “best case” pricing models that may ultimately prove unprofitable from an underwriting perspective.

For example, during 2009 we noted that the Florida OIR placed at least four property and casualty insurance companies in some form of receivership while several other Florida domiciled insurance companies have recapitalized in order to remain viable in the Florida market. The insolvency of these companies poses a risk to all other remaining carriers in the state including Federated National and American Vehicle in terms of assessments to support those failed companies. Through March 31, 2011, we are not aware of any such assessments in connection with the takeovers during 2009; however, no guarantee can be made that no assessments will be imposed.

In recent years, approximately two-dozen new homeowner insurance companies received authority by the Florida OIR to commence business as admitted carriers in the state.

In 2006, the state of Florida created the Insurance Capital Build-Up Incentive Program in response to the catastrophic events that occurred during 2004 and 2005. This program provided matching capital funds to any new or existing carrier licensed to write homeowners’ insurance in Florida under certain conditions.  This program resulted in a significant erosion of our homeowners’ insurance market since 2007.  We did not participate in the Insurance Capital Build-Up Incentive Program. Although our pricing is inevitably influenced to some degree by that of our competitors, we believe that it is generally not in our shareholders’ best interest to compete solely on price. 

 
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21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and Results of Operations

We face increased competition from existing carriers and new entrants in our niche markets. As mentioned earlier, in an effort to foster competition after the hurricanes of 2004 and 2005, the State of Florida loaned money to multiple carriers with certain debt covenants, including the maintenance of minimum written premium. Our competition has attempted to gain market share through aggressive pricing and generous policy acquisition costs, which has had an adverse affect on our ability to maintain market share. Although our pricing is inevitably influenced to some degree by that of our competitors, we believe that it is generally not in our best interest to compete solely on price. We compete based on underwriting criteria, our distribution network and superior service to our agents and insureds.