Unico American Corporation
23251 Mulholland Drive
Woodland Hills, California 91364-2732
(818) 591-9800 FAX (818) 591-9822
VIA EDGAR
July 31, 2006
Mr. Jim B. Rosenberg
Senior Assistant Chief Accountant
Division of Corporate Finance
Securities and Exchange Commission
Washington, D.C. 20549
Re: Unico American Corporation
Form 10-K for the Fiscal Year Ended December 31, 2005
File No. 000-03978
Dear Mr. Rosenberg:
Set forth below are the responses of Unico American Corporation (the "Company")
to the comments contained in your letter of June 22, 2006, addressed to Mr.
Erwin Cheldin, President and Chief Executive Officer of the Company. We
appreciate that the nature of your review of our filing was to assist us in our
compliance with the applicable disclosure requirements and to enhance the
overall disclosure in our filing. For the convenience of the reader, each
response, which is in disclosure-type format, is preceded by the comment to
which it is responding.
* * * * * *
SEC Comment
-----------
Management's Discussion and Analysis of Financial Condition and Results of
- --------------------------------------------------------------------------
Operations. page 16
-------------------
Significant Accounting Policies. Page 30
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Losses and Loss Adjustment Expense. page 30
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1. We believe your disclosure regarding the estimation of the reserve for
loss and loss adjustment expenses could be improved to better explain
the judgments and uncertainties surrounding this estimate and the
potential impact on your financial statements. We believe in order to
meet the principal objectives of MD&A this disclosure should enable
the investor to understand 1) management's process for establishing
the estimate, 2) the reasons for changes in the historical estimate,
3) whether and to what extent management has adjusted their
assumptions used in the most recent estimate for trends or other
factors identified from past experience, and 4) the potential
variability in the most recent estimate and the impact this
variability may have on reported results, financial condition and
liquidity. Please keep this objective in mind in providing us your
responses to comments listed below. Your response should be in
disclosure-type format. Please also consider providing any additional
information, in disclosure-type format, to achieve this objective.
1
SEC Comment
-----------
o Please disclose the amount of the reserve for loss and loss adjustment
expense for each year presented. Because IBNR reserve estimates are
more imprecise, please disclose these amounts separately from case
reserves.
Company Response
----------------
In future filings, we will enhance the document by adding a disclosure similar
to the following:
The Company's loss and loss adjustment expense reserves are as follows:
Year ended December 31
----------------------
2005 2004 2003
---- ---- ----
Direct reserves
Case reserves $23,114,548 $19,699,000 $24,699,090
IBNR reserves 78,800,000 67,770,000 53,440,000
----------- ---------- ----------
Total direct reserves 101,914,548 87,469,000 78,139,090
=========== ========== ==========
Reserves net of reinsurance
Case reserves 19,135,467 17,879,989 21,543,861
IBNR reserves 57,100,000 49,470,000 37,340,000
---------- ---------- ----------
Total net reserves $76,235,467 $67,349,989 $58,883,861
========== ========== ==========
SEC Comment
-----------
o We are aware that there are different methodologies for the short-tail
vs. long-tail business. As it appears that you have short-tail and
long-tail contracts grouped within your commercial multiple peril
business line, please provide a description of the methodology used by
tail in addition to your current disclosures. In addition please
disclose the following:
1) Please disclose your process for calculating the IBNR reserve.
It is our understanding that companies may calculate this
reserve by estimating the ultimate unpaid liability first and
then reducing that amount by cumulative paid claims and by case
reserves, but there may be other methods as well.
2) Please describe the nature and frequency of your procedures for
determining management's best estimate of loss reserves on both
an annual and interim reporting basis.
Company Response
----------------
In future filings, we will enhance the document by adding a disclosure similar
to the following:
2
Some lines of insurance are commonly referred to as "long-tail" lines because of
the extended time required before claims are ultimately settled. Lines of
insurance in which claims are settled relatively quickly are called "short-tail"
lines. It is generally more difficult to estimate loss reserves for long-tail
lines because of the long period that elapses between the occurrence of a claim
and its final disposition, and the difficulty of estimating the settlement value
of the claim. The Company's short-tail lines consist of its property coverages
and its long-tail lines consist of its liability coverages. However, compared to
other "long-tail" liability lines that are not underwritten by the Company, such
as workers' compensation, professional liability, umbrella liability, and
medical malpractice, the Company's liability claims tend to be settled
relatively quicker.
The Company's consolidated financial statements include estimated reserves for
unpaid losses and related loss adjustment expenses of the insurance company
operation. The Company sets loss and loss adjustment expense reserves at each
balance sheet date, at management's best estimate of the ultimate payments that
it anticipates will be made to settle all losses incurred and all related loss
adjustment expenses incurred as of that date, for both reported and unreported
claims.
The accurate establishment of loss reserves is a difficult process as there are
many factors that can ultimately affect the final settlement of a claim and,
therefore, the reserve that is needed. Estimates are based on a variety of
industry data and on the Company's current and historical accident year claims
data, including but not limited to reported claim counts, open claim counts,
closed claim counts, closed claim counts with payments, paid losses, paid loss
adjustment expenses, case loss reserves, case loss adjustment expense reserves,
earned premiums and policy exposures, salvage and subrogation, and unallocated
loss adjustment expenses paid. Many other factors including changes in
reinsurance, changes in pricing, changes in policy forms and coverage, changes
in underwriting and risk selection, and legislative changes are also taken into
account. The information that management uses to arrive at its best reserve
estimate comes from many sources within the Company, including its accounting,
legal, claims, and underwriting departments. Informed managerial judgment is
applied throughout the reserving process.
The Company utilizes several standard actuarial methods in estimating its claims
liability. Standard methods include loss development methods and
Bornhuetter-Ferguson methods, both of which can be applied to paid claims costs,
reported incurred (paid plus case reserve) claims costs, and/or claim counts.
These methodologies do not vary by tail length; however, certain parameters do
vary. In particular, loss development factors for (short-tail) property claims
are different than for (long-tail) liability claims. When utilizing loss
development methods, IBNR reserves are determined by subtracting paid losses and
expenses and case reserves on losses and expenses from the calculated ultimate
claims cost. Bornhuetter-Ferguson methods calculate IBNR reserves directly, not
total ultimate claims costs.
At the end of each fiscal quarter, the Company's reserves are re-evaluated for
each accident year (i.e., for all claims incurred within each year) by a
committee consisting of the Company's president, the Company's chief financial
officer, and an independent consulting actuary. In addition to applying the
various standard methods to the data, an extensive series of diagnostic tests of
the resultant reserve estimates are applied to determine management's best
estimate of the unpaid claims liability.
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SEC Comment
-----------
o Recorded loss reserves for property and casualty insurers generally
include a provision for uncertainty, when management determines that
existing actuarial methodologies and assumptions do not adequately
provide for ultimate loss development. Such a provision may be
explicit (i.e. represented by the excess of recorded reserves over
actuarial indications) or implicit in the assumption setting process.
So that investors can better understand the inherent uncertainties in
your business and degree of conservatism that you have incorporated in
your loss reserve estimates, please address as part of your discussion
of the loss reserving methodology herein, how you determine the
provision for uncertainty.
Company Response
----------------
In future filings, we will enhance the document by adding a disclosure similar
to the following:
The Company's actuarially based loss reserve methodology does not include an
implicit or explicit provision for uncertainty. Insurance claims costs are
inherently uncertain. There is not a precise means of quantifying a provision
for uncertainty when determining an appropriate liability for unpaid claims
costs. Rather, the potential for claims costs being less than estimated and the
potential for claims costs being more than estimated are considered when
selecting the parameters to be used in the application of the actuarial methods
and when testing the estimates for reasonableness. Management believes that its
recorded loss reserve makes reasonable provision for its liability for unpaid
claims costs.
SEC Comment
-----------
o It appears that you have significantly revised your estimate of loss
reserves recorded in prior years. You state in your disclosures that
loss emergence related to prior accident years was favorable due to
settlement of claims at lesser amounts than initially reserved, but it
is unclear to us the reason(s) for the favorable development. As such
identify and describe in reasonable specificity the nature and extent
of a) new events that occurred orb) additional experience/information
obtained since the last reporting date that led to the change in
estimates. Ensure that your disclosure clarifies the timing of the
change in estimate such as why recognition occurred in the periods
that it did and why recognition in earlier periods was not required.
Disclose any trends necessary to understand the change in estimate.
Please explain the rationale for a change in estimate that does not
correlate with trends.
Company Response
----------------
In future filings, we will enhance the document by adding a disclosure similar
to the following:
As claims costs develop, estimated claims costs for the current development
period are replaced by actual claims costs that emerge during that development
period. Sometimes the estimates prove to have been too high; sometimes they
prove to have been too low. In the case of the Company, the estimates proved to
be too high in two of the past three years and too low in one of the past three
years. No single year exceeded a variance of more than 5.7% and the average for
all three years was less than 1%, as documented in the following table.
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Calendar Year Ended December 31,
--------------------------------
2005 2004 2003
---- ---- ----
Net reserves for unpaid losses at beginning of year $67,349,989 $58,883,861 $53,596,945
Net increase (decrease) in provision for events of prior years (3,824,464) (835,434) 2,751,585
--------- ---------- ---------
Percent of development to beginning reserves (5.7%) (1.4%) 5.1%
==== ==== ====
The differences between actual and expected claims costs are typically not due
to one specific factor, but a combination of many factors such as the period of
time between the initial occurrence and the final settlement of the claim,
current and perceived social and economic inflation, and many other economic,
legal, political, and social factors. Because of these and other factors, actual
loss and loss adjustment expense payments should be expected to vary, perhaps
significantly, from any estimate made prior to the settling of all claims. As
stated previously, insurance claims costs are inherently uncertain.
Moreover, unexpected (and sometimes unreasonable) jury, court, or arbitrator
verdicts can cause a single claim to have a significant impact on claims costs.
The adverse development in 2003 was primarily attributable to one such claim.
That claim was a loss in excess of policy limits, arising from a policy issued
in 1993. After the appellate court reversed two favorable summary judgments, the
claim was resolved through binding arbitration on August 1, 2003, for
$4 million. Available reinsurance limits in 1993 were $2,000,000 plus pro-rata
loss adjustment expenses. As a result of the binding arbitration decision, in
2003 the Company incurred adverse development on this claim, net of reinsurance,
of approximately $2,000,000 or approximately $1,320,000 net of taxes.
Supplemental Comment to Staff
-----------------------------
The information regarding the above described 1993 claim was fully disclosed in
the Company's 2004 and 2003 filings.
SEC Comment
-----------
o Please identify and describe separately for the short and long tail
business the key assumptions that materially affect the estimate of
the reserve for loss and loss adjustment expenses. In addition please
disclose the following:
1) For each of your key assumptions and for your provision for
uncertainty, quantify and explain what caused them to change
historically over the periods presented.
2) Discuss whether and to what extent management has adjusted each
of the key assumptions and the provision for uncertainty used
in calculating the most recent estimate of the reserve given
the historical changes, current trends observed and/or other
factors as discussed in 1. above. This discussion should
reconcile the historical changes, the current trends and/or
other factors observed to what management has calculated as its
most recent key assumptions.
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Company Response
----------------
In future filings, we will enhance the document by adding a disclosure similar
to the following:
The Company's actuarially based loss and loss adjustment expense reserving
methodology requires assumptions that can be grouped into two categories:
expected losses and expected development patterns. These categories apply to all
of its insurance coverages.
Expected losses are determined based on earned premiums. The premium dollar is
used to pay claims costs and company expenses. The portion of the premium dollar
expected to pay claims is referred to as the expected loss ratio. The expected
loss ratio is re-assessed quarterly.
The Company's book of business is segregated into homogeneous categories in
order to better quantify the expected development patterns. These categories are
defined both by type of business insured and type of coverage, i.e., property
coverage or liability coverage. The Company tracks development patterns
separately for each of these categories in determining its best estimate.
Development patterns are re-assessed quarterly. They do not tend to change
materially over time.
Management has not made significant adjustments to these key assumptions for any
of the years presented.
SEC Comment
-----------
o In order to show investors the potential variability in the most
recent estimate of your loss reserve, quantify and present preferably
in a tabular format and by tail the effect that reasonably likely
changes in the key assumptions identified may have on reported
results, financial position and liquidity. Explain why management
believes the scenarios quantified are reasonably likely.
Company Response
----------------
In future filings, we will enhance the document by adding a disclosure similar
to the following:
The Company's actuarially based loss reserve methodology provides for management
to make its best estimate of the liability for unpaid claims costs at each
reporting period. Variability is inherent in establishing loss reserves. The
Company's loss reserve methodology does not quantify reasonably likely scenarios
due to the complexity and nature of the actuarially based process.
The Company's net loss and loss adjustment expense reserve was $76,235,467 as of
December 31, 2005. Due to the inherent uncertainties in estimating the Company's
reserves, the actual liability will almost certainly differ from the recorded
liability. A small percentage change in reserve estimates of this magnitude may
result in a substantial effect on reported earnings. For instance, a 5% change
in the December 31, 2005 net unpaid loss and loss adjustment expense reserve
would produce a $3,811,773 change to pre-tax earnings. As previously indicated,
the percentage of development to beginning reserves was not significant in the
years ended December 31, 2005, December 31, 2004, and December 31, 2003.
Although two years proved to be too high and one year proved to be too low, no
single year exceeded a variance of more than 5.7% and the average for all three
years was less than 1%.
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SEC Comment
-----------
Reinsurance. page 31
- --------------------
2. Please discuss and quantify in disclosure-type format the effect that
your ceded reinsurance activities had on financial position, results of
operations, and cash flows for the periods presented. Also discuss
changes you have made to your past reinsurance strategies in developing
your current strategies and the expected effect that those changes may
have on your financial position, results of operations and cash flows.
Describe any limitations on your ability to cede future losses on a
basis consistent with historical results and their expected effect on
financial position, operating results and cash flows. Such limitations
could relate to changes in reinsurance market conditions, a
restructuring of your reinsurance treaties or the absence of remaining
limits for specific accident years under existing treaties.
Company Response
----------------
In future filings, we will enhance the document by adding a disclosure similar
to the following:
The Company's receivable from reinsurers represents an estimate of the amount of
our future loss payments that will be recoverable from the Company's reinsurers.
These estimates are based upon our estimates of the ultimate losses that the
Company expects to incur and the portion of those losses that are expected to be
allocable to reinsurers based upon the terms of the reinsurance agreements.
Given the uncertainty of the ultimate amounts of our losses, the estimates may
vary significantly from the eventual outcome. The Company's estimate of the
amounts receivable from reinsurers is regularly reviewed and updated by
management as new data becomes available. The Company's assessment of the
collectibility of the recorded amounts receivable from reinsurers is based
primarily upon public financial statements and rating agency data. Any
adjustments necessary are reflected in then current operations. We evaluate each
of our ceded reinsurance contracts at their inception to determine if there is
sufficient risk transfer to allow the contract to be accounted for as
reinsurance under current accounting literature. At December 31, 2005, all such
ceded contracts are accounted for as risk transfer reinsurance.
The following tables provide the effect of reinsurance on the Company's
financial statements:
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The effect of ceded reinsurance on financial position is as follows:
Year ended December 31
----------------------
2005 2004 2003
---- ---- ----
Ceded loss and loss adjusting expense recoverable
Ceded case loss and loss adjusting expense reserves recoverable $3,979,081 $1,819,011 $3,155,229
Ceded IBNR reserves recoverable 21,700,000 18,300,000 16,100,000
---------- ---------- ----------
Total ceded loss and loss adjusting expense reserves recoverable $25,679,081 $20,119,011 $19,255,229
========== ========== ==========
The effect of ceded reinsurance on results of operations is as follows:
Year ended December 31
----------------------
2005 2004 2003
---- ---- ----
Earned ceded premium
Excess of loss treaty premium $13,448,281 $17,210,476 $15,601,702
Catastrophe treaty premium 833,529 633,329 812,909
Other (46,966) (59,565) 233,409
---------- ---------- ----------
Total earned ceded premium 14,234,844 17,784,240 16,648,020
Ceding commission 4,647,748 6,031,987 5,429,330
--------- ---------- ----------
Earned ceded premium, net of ceding commission $9,587,096 $11,752,253 $11,218,690
========= ========== ==========
Ceded losses and loss adjustment expenses incurred*
Ceded paid losses and loss adjustment expenses $6,828,051 $5,121,775 $9,369,472
Change in ceded case loss reserves 2,160,070 (1,336,218) (2,453,110)
Change in ceded IBNR reserves 3,400,000 2,200,000 400,000
---------- --------- ---------
Total ceded losses incurred $12,388,121 $5,985,557 $7,316,362
========== ========= =========
*There were no catastrophe losses incurred for any of the years presented.
The effect of ceded reinsurance on cash flow is as follows:
Year ended December 31
----------------------
2005 2004 2003
---- ---- ----
Changes in reinsurance recoverable from Statement of Cash Flows $(7,253,268) $(259,330) $4,235,194
========= ======= =========
8
The Company's reinsurance strategy is to reduce volatility in its expected loss
and loss adjustment expense results by protecting the Company against
liabilities in excess of certain retentions, including major or catastrophic
losses that may occur from any one or more of the property and/or casualty risks
which it insures. On an annual basis, or sooner if warranted, the Company
evaluates whether any changes to its retention, participation, or retained
limits are necessary. The most significant change to the Company's reinsurance
program during the three years ended December 31, 2005, was increasing its
catastrophic reinsurance in 2005 from $15 million to $35 million.
The Company currently only writes business in the state of California. The types
of businesses and the coverage limits written by the Company are not considered
difficult lines for obtaining reinsurance. In addition, because the major
catastrophe exposure is primarily from riots and fire following earthquakes, the
Company does not anticipate significant limitations on its ability to cede
future losses on a basis consistent with its historical results.
* * * * * *
In connection with our response to the Staff's comments, the Company
acknowledges that (1) the Company is responsible for the adequacy and accuracy
of the disclosure in the filing; (2) Staff comments or changes to disclosure in
response to Staff comments do not foreclose the Commission from taking any
action with respect to the filing; and (3) the Company may not assert Staff
comments as a defense in any proceeding initiated by the Commission or any
person under the federal securities laws of the United States.
If you have any questions, please contact the undersigned at (818) 591-9800
Sincerely,
/s/ Lester A. Aaron
- -------------------
Lester A. Aaron
Chief Financial Officer
Unico American Corporation
9