UNICO AMERICAN CORP
Losses and loss adjustment expense reserves are based on estimates and may not - ------------------------------------------------------------------------------ be sufficient to cover future losses. - ------------------------------------ Losses and loss adjustment expense reserves represent an estimate of amounts needed to pay and administer claims with respect to insured events that have occurred, including events that have been incurred which have not yet been reported to the Company. There is a high level of uncertainty inherent in the evaluation of the required losses and loss adjustment expense reserves for the Company. The long-tailed nature of liability claims and the volatility of jury awards exacerbate that uncertainty. The Company sets losses 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 related loss adjustment expenses incurred as of that date for both reported and unreported losses. The ultimate cost of claims is dependent upon future events, the outcomes of which are affected by many factors. Company claim reserving procedures and settlement philosophy, current and perceived social and economic inflation, current and future court rulings and jury attitudes, improvements in medical technology, and many other economic, scientific, legal, political, and social factors all can have significant effects on the ultimate costs of claims. Changes in Company operations and management philosophy also may cause actual developments to vary from the past. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made.   The Company's success depends on its ability to accurately underwrite risks and - ------------------------------------------------------------------------------- to charge adequate premiums to policyholders. - -------------------------------------------- The Company's financial condition, liquidity and results of operations depend in large part on the Company's ability to underwrite and set premiums accurately for the risks it faces. Premium rate adequacy is necessary to generate sufficient premium to offset losses, loss adjustment expenses and underwriting expenses and to earn a profit. In order to price its products accurately, the Company must collect and properly analyze a substantial volume of data; develop, test and apply appropriate rating formulae; closely monitor and timely recognize changes in trends; and project both severity and frequency of losses with reasonable accuracy. The Company's ability to undertake these efforts successfully is subject to a number of risks and uncertainties, including, without limitation:       o  Availability of sufficient reliable data.      o  Incorrect or incomplete analysis of available data.      o  Uncertainties inherent in estimates and assumptions.      o  Selection and application of appropriate rating formulae or other           pricing methodologies.      o  Adoption of successful pricing strategies.      o  Prediction of policyholder retention (e.g., policy life expectancy).      o  Unanticipated court decisions, legislation or regulatory action.      o  Ongoing changes in the Company's claim settlement practices.      o  Unexpected inflation.      o  Social changes, particularly such as those effecting litigious           inclinations.  Such risks may result in the Company's pricing being based on outdated, inadequate or inaccurate data or inappropriate analyses, assumptions or methodologies, and may cause the Company to estimate incorrectly future changes in the frequency or severity of claims. As a result, the Company could underprice risks, which would negatively affect the Company's margins, or it could overprice risks, which could reduce the Company's volume and competitiveness. In either event, the Company's operating results, financial condition and cash flow could be materially adversely affected.  Inability to obtain reinsurance or to collect on ceded reinsurance could - ------------------------------------------------------------------------ adversely affect the Company's ability to write new policies. - ------------------------------------------------------------ The availability, amount and cost of reinsurance depend on market conditions and may vary significantly. Any decrease in the amount of the Company's reinsurance will increase the risk of loss and could materially adversely affect its business and financial condition. Ceded reinsurance does not discharge the Company's direct obligations under the policies it writes. The Company remains liable to its policyholders, even if the Company is                                          11   unable to make recoveries that it believes its entitled to under the reinsurance contracts. Losses may not be recovered from the reinsurers until claims are paid.  The insurance business is subject to extensive regulation and legislative - ------------------------------------------------------------------------- changes, which may impact the manner in which the company operates its business. - ------------------------------------------------------------------------------- The insurance business is subject to extensive regulation by the California Department of Insurance. The California Department of Insurance has broad regulatory powers implemented to protect policyholders, not stockholders or other investors. These powers include, among other things, the ability to:       o  Place limitations on the Company's investments and dividends.      o  Place limitations on the Company's ability to transact business with its          affiliates.      o  Establish standards of solvency including minimum reserves and capital          surplus requirements.      o  Prescribe the form and content of, and to examine, the Company's          financial statements.  Federal legislation typically does not directly impact the property and casualty business, but the business can be indirectly affected by changes in federal regulations.  This extensive regulation may affect the cost or demand for the Company's products and may limit the ability to obtain rate increases or to take other actions that the Company might desire to do in order to increase its profitability.  A downgrade in the financial strength rating of the insurance company could - --------------------------------------------------------------------------- reduce the amount of business it may be able to write. - -----------------------------------------------------  Rating agencies rate insurance companies based on financial strength as an indication of an ability to pay claims. Crusader currently has a financial strength rating of B+ (Very Good) from A.M. Best. The financial strength rating of A.M. Best is subject to periodic review using, among other things, proprietary capital adequacy models, and is subject to revision or withdrawal at any time. Insurance financial strength ratings are directed toward the concerns of policyholders and insurance agents and are not intended for the protection of investors. Any downgrade in the Company's A.M. Best rating could cause a reduction in the number of policies it writes and could have a material adverse effect on its results of operations and financial position.  Intense competition could adversely affect the ability to sell policies at - -------------------------------------------------------------------------- premium rates the Company deem adequate. - --------------------------------------- The Company faces significant competition which, at times, is intense. If the Company is unable to compete effectively its business and financial condition could be materially adversely affected. Competition in the property and casualty marketplace is based on many factors including premiums charged, services provided, financial strength ratings assigned by independent rating agencies, speed of claims payments, reputation, perceived financial strength and general experience. The Company competes with regional and national insurance companies. Some competitors have greater financial, marketing and management resources than the Company. Intense competitive pressure on prices can result from the actions of even a single large competitor. The Company uses its own premium rates to determine the price for its property and casualty policies.  The Company's earnings may be affected by changes in interest rates. - ------------------------------------------------------------------- Investment income is an important component of the Company's revenues and net income. The ability to achieve investment objectives is affected by factors that are beyond the Company's control. Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. Any significant decline in investment income as a result of falling interest rates or general market conditions would have an adverse effect on net income and, as a result, on the Company's stockholders' equity and policyholders' surplus.  The outlook of the Company's investment income is dependent on the future direction of interest rates and the amount of cash flows from operations that are available for investment. The fair values of fixed maturity investments that are "available-for-sale" fluctuate with changes in interest rates and cause fluctuations in the stockholders' equity.  The Company's geographic concentration ties its performance to the business, - --------------------------------------------------------------------------- economic and regulatory conditions in California. - ------------------------------------------------ The Company's insurance business is concentrated in California (100% of 2005 and 2004 net written premiums). Accordingly, unfavorable business, economic or regulatory conditions in the state of California could negatively                                          12   impact the business. In addition, California is exposed to severe natural perils, such as earthquakes and fires, along with the possibility of terrorist acts. Accordingly, the Company could suffer losses as a result of catastrophic events. Because the Company's business is concentrated in this manner, it may be exposed to economic and regulatory risks or risks from natural perils that are greater than the risks associated with greater geographic diversification.  The Company relies on independent insurance agents and brokers. - -------------------------------------------------------------- The failure or inability of independent insurance agencies and brokers to market the Company's insurance programs successfully could have a material adverse effect on its business, financial condition and results of operations. Agents and brokers are not obligated to promote the Company's insurance programs and may sell competitors' insurance programs. As a result, the Company's business depends in part on the marketing efforts of agents and brokers and on the Company's ability to offer insurance programs and services that meet the requirements of the their customers.  Litigation may have an adverse effect on the Company's business. - --------------------------------------------------------------- The insurance industry is the target of an increasing number of class action lawsuits and other types of litigation, some of which involve claims for substantial and/or indeterminate amounts and the outcomes of which are unpredictable. This litigation is based on a variety of issues including insurance and claim settlement practices. Although the Company has not been the target of any specific class action lawsuits it is possible that a suit of this type could have a negative impact on the Company's business.  The Company relies on its information technology systems to manage many aspects - ------------------------------------------------------------------------------- of its business, and any failure of these systems to function properly or any - ----------------------------------------------------------------------------- interruption in their operation could result in a material adverse effect on the - -------------------------------------------------------------------------------- Company's business, financial condition and results of operations. - -----------------------------------------------------------------  The Company depends on the accuracy, reliability and proper functioning of its information technology systems. The Company relies on these information technology systems to effectively manage many aspects of its business, including underwriting, policy acquisition, claims processing and handling, accounting, reserving and actuarial processes and policies, and to maintain its policyholder data. The failure of hardware or software that supports the Company's information technology systems, the loss of data contained in the systems could disrupt its business and could result in decreased premiums, increased overhead costs and inaccurate reporting, all of which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, despite system redundancy, the implementation of security measures and the existence of a disaster recovery plan for the Company's information technology systems, these systems are vulnerable to damage or interruption from events such as:       o  Earthquake, fire, flood and other natural disasters.      o  Terrorist attacks and attacks by computer viruses or hackers.      o  Power loss.      o  Unauthorized access.      o  Computer systems or data network failure  It is possible that a system failure, accident or security breach could result in a material disruption to the Company's business. In addition, substantial costs may be incurred to remedy the damages caused by these disruptions. To the extent that a critical system fails or is not properly implemented and the failure cannot be corrected in a timely manner, the Company may experience disruptions to the business that could have a material adverse effect on the Company's results of operations.  The Company's disclosure controls and procedures may not prevent or detect all - ------------------------------------------------------------------------------ acts of fraud. - ------------- The Company's disclosure controls and procedures are designed to reasonably ensure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act is accumulated and communicated to management and is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. The Company's management believes that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, they cannot provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been prevented or detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more                                          13   people, or by an unauthorized override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and the Company cannot ensure that any design will succeed in achieving its stated goals under all potential future conditions. Accordingly, because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.  The ability of the Company to attract, develop and retain talented employees, - ----------------------------------------------------------------------------- managers and executives, and to maintain appropriate staffing levels, is - ------------------------------------------------------------------------ critical to the Company's success. - --------------------------------- The Company must hire and train new employees, and retain current employees to handle its operations. The failure of the Company to successfully hire and retain a sufficient number of skilled employees could result in the Company having to slow the growth of its business. In addition, the failure to adequately staff its claims department could result in decreased quality of the Company's claims operations. The Company's success also depends heavily upon the continued contributions of its executive officers, both individually and as a group. The Company's future performance will be substantially dependent on its ability to retain and motivate its management team. The loss of the services of any of the Company's executive officers could prevent the Company from successfully implementing its business strategy, which could have a material adverse effect on the Company's business, financial condition and results of operations.
Item 2.  Properties - ------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin Cheldin, the Company's president, chairman and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties.  The Company utilizes for its own operations approximately 100% of the space it leases.
Item 4.  Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ None                                          14                                        PART II                                      -------
The Company's common stock is traded on the NASDAQ National Market System under the symbol "UNAM." The high and low sales prices (by quarter) during the last two comparable twelve-month periods are as follows:                                            High          Low       Quarter Ended                       Price        Price       -------------                       -----        -----       March 31, 2004                      $6.52        $5.22       June 30, 2004                       $6.45        $5.78       September 30, 2004                  $6.69        $5.78       December 31, 2004                   $9.59        $7.20        March 31, 2005                     $11.50        $8.76       June 30, 2005                       $9.15        $8.00       September 30, 2005                  $9.58        $8.41       December 31, 2005                   $9.38        $8.45   As of December 31, 2005, the approximate number of shareholders of record of the Company's common stock was 425. In addition, the Company estimates beneficial owners of the Company's common stock held in the name of nominees to be approximately 850.  The Company last declared a cash dividend on its common stock in 2002. Declaration of future annual cash dividends will be subject to the Company's profitability and its cash requirements. Because the Company is a holding company and operates through its subsidiaries, its cash flow and, consequently, its ability to pay dividends are dependent upon the earnings of its subsidiaries and the distribution of those earnings to the Company. Also, the ability of Crusader to pay dividends to the Company is subject to certain regulatory restrictions under the Holding Company Act (see Item 1 - "Business - Insurance Company Operation - Holding Company Act"). Based on Crusader's statutory surplus as regards policyholders as of December 31, 2005, the maximum dividend that can be made by Crusader to Unico without prior regulatory approval in 2005 is $3,658,644.  The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company (see Note 17 of "Notes to Consolidated Financial Statements"). No shares were repurchased during the year ended December 31, 2005. As of December 31, 2005, the Company has purchased and retired under the Board of Directors authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.
Year ended December 31                                           ---------------------------------------------------------------------------------                                              2005             2004             2003               2002             2001                                              ----             ----             ----               ----             ----        Total revenues                           $61,182,522      $61,903,310      $51,130,439       $46,028,642       $42,116,906  Total costs and expenses                  50,716,092       53,230,852       48,981,068        50,842,701        58,840,015                                            ----------       ----------       ----------        ----------       -----------  Income (loss) before taxes               $10,466,430       $8,672,458       $2,149,371       $(4,814,059)     $(16,723,109)  Net income (loss)                         $6,715,004       $5,681,500       $1,068,650       $(3,224,689)     $(10,870,018)  Basic earnings (loss) per share                $1.22            $1.03            $0.19            $(0.59)           $(1.97)  Diluted earnings (loss) per share              $1.20            $1.02            $0.19            $(0.59)           $(1.97)  Cash dividends per share                           -                -                -             $0.05             $0.05  Total assets                            $186,297,179     $172,570,276     $161,493,695      $148,686,605      $128,823,273  Stockholders' equity                     $48,394,373      $42,425,325      $38,470,857       $38,408,990       $40,620,376                                           15
The Company's net income was $6,715,004 in 2005, $5,681,500 in 2004, and $1,068,650 in 2003.  This overview discusses some of the relevant factors that management considers in evaluating the Company's performance, prospects and risks. It is not all-inclusive and is meant to be read in conjunction with the entirety of the management discussion and analysis, the Company's financial statements and notes thereto, and all other items contained within the report on this Annual Report on Form 10-K.  Revenue and Income Generation - ----------------------------- The Company receives its revenue primarily from earned premium derived from the insurance company operations, commission and fee income generated from the insurance agency operations, finance charges and fee income from the premium finance operations, and investment income from cash generated primarily from the insurance company operation. The insurance company operation generates approximately 90% of the Company's total revenue. The Company's remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually not material to consolidated revenues.  Insurance Company Operation - --------------------------- The property and casualty insurance industry is highly competitive and includes many insurers, ranging from large companies offering a wide variety of products worldwide to smaller, specialized companies in a single state or region offering only a single product. Many of the Company's existing or potential competitors have considerably greater financial and other resources, have a higher rating assigned by independent rating organizations such as A.M. Best Company, have greater experience in the insurance industry and offer a broader line of insurance products than the Company. Currently, Crusader is writing primarily Commercial Multiple Peril business only in the state of California and is rated B+ (Very Good) with a rating outlook of stable by A.M. Best Company.  A primary challenge of the property and casualty insurance company operation is contending with the fact that the Company sells its products before the ultimate costs are actually known. When pricing its products, the Company projects the ultimate claim and loss adjustment cost that it anticipates will be incurred after the policy is sold. In addition, other factors such as changes in regulations and legal environment, among other things, can all impact the ultimate cost.  The property and casualty insurance industry is characterized by periods of soft market conditions, in which premium rates are stable or falling and insurance is readily available, and by periods of hard market conditions, where rates rise, coverage may be more difficult to find and insurers' profits increase. The Company believes that the "hard market" that existed in California in the past few years has transitioned to a "soft market." The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change. Despite the increased competition in the property and casualty marketplace, the Company believes that rate adequacy is more important than premium growth, and that underwriting profit is the Company's primary goal. For the year ended December 31, 2005, gross written premium was $60,268,784, a decrease of $8,603,237 (12%) compared to 2004.  For the twelve months ended December 31, 2005, losses and loss adjustment expenses for insured events of the current year were $35,338,196, offset by $3,824,464 favorable development for events of prior years. For the twelve months ended December 31, 2004, losses and loss adjustment expenses for insured events of the current year were $35,286,172, offset by $835,434 favorable development for events of prior years. The favorable developments resulted from settling or re-estimating claims for lesser amounts than they were initially reserved.                                          16   Other Operations - ---------------- The Company's other operations generate commissions, fees, and finance charges from various insurance products. The events that have the most significant economic impact on other operations are as follows:  Unifax primarily sells and services insurance policies for Crusader. The commissions paid by Crusader to Unifax are eliminated as intercompany transactions and are not reflected as income in the financial statements. As a result of the decrease in the number of policies sold by Unifax during 2005 as compared to 2004, policy fee income for the 12 months ended December 31, 2005, decreased 12% as compared to the prior year period.  AIB sells and services health insurance policies for individual/family and small business groups and receives commissions based on the premiums that it writes. Commissions decreased 25% in the year ended December 31, 2005, compared to 2004. The decrease is primarily due to CIGNA's decision to discontinue its individual/family health insurance program over the period from November 1, 2003, through October 1, 2004. AIB had been assisting former CIGNA policyholders to find health coverage with other insurance carriers that AIB represents.  AAQHC provides various consumer benefits to its members, including participation in group health care and life insurance policies. For these services, AAQHC receives membership and fee income from its members. Membership and fee income decreased 5% in the year ended December 31, 2005, compared to 2004. The decrease is a result of the 9% decrease in the number of members.  AAC provides premium financing for Crusader policies that are produced by Unifax in California. Finance charges and fees earned by AAC during 2005 decreased 19% as compared to 2004. The decrease is primarily a result of a 19% decrease in the number of loans issued in 2005 compared to 2004. Average premium financed decreased 2% from $2,606 in 2004 to $2,557 in 2005.  Investments and Liquidity - ------------------------- The Company generates revenue from its investment portfolio, which consisted of approximately $140.6 million (at amortized cost) at December 31, 2005, compared to $132.1 million (at amortized cost) at December 31, 2004. Although the investment portfolio increased approximately 8.5 million (at amortized cost) or 6% in 2005 compared to 2004, investment income for the twelve months ended December 31, 2005 and 2004 remained relatively unchanged. Due primarily to the maturity of higher yielding investments and reinvestments in shorter maturities, the annualized yield on the average invested assets decreased from 3.39% in 2004 to 3.17% in 2005. Due to the interest rate environment in the past few years, management believed it was prudent to purchase fixed maturity investments with shorter maturities with minimal credit risk. As of December 31, 2005, the weighted average maturity of the Company's fixed maturity investments was 1.2 years compared to 1.4 years and 1.9 years as of December 31, 2004 and December 31, 2003, respectively.                           Liquidity and Capital Resources                          ------------------------------- Due to the nature of the Company's business (insurance and insurance services) and whereas Company growth does not normally require material reinvestments of profits into property or equipment, the cash flow generated from operations usually results in improved liquidity for the Company. Because the Company is a holding company and operates through its subsidiaries, its cash flow is dependent upon the earnings of its subsidiaries and the distributions of those earnings to the Company.  The cash flow provided by operations in the year ended December 31, 2005, was $9,798,342, a decrease in cash flow of $5,025,495 compared to the cash flow for the year ending December 31, 2004. Cash flow provided by operations for the year ended December 31, 2004, was $14,823,837, a decrease of $701,549 in cash provided compared to the year ended December 31, 2003. The Company has utilized the cash provided from operating activities and from the maturity of its fixed maturity investments primarily to purchase $59.4 million of fixed maturity securities.  The most significant liquidity risk faced by the Company would be adverse development of the insurance company claims, both reported and unreported. The Company has taken measures to address the underlying causes of prior adverse development; however, no assurance can be given that the measures taken will be successful or that the Company's estimate of ultimate losses and loss adjustment expenses will be sufficient. Based on the                                          17   Company's current loss and loss expense reserves and expected current and future payments, the Company believes that there are no current liquidity issues.  Crusader generates a significant amount of cash as a result of its holdings of unearned premium reserves, its reserves for loss payments, and its capital and surplus. Crusader's loss and loss adjustment expense payments are the most significant cash flow requirement of the Company. These payments are continually monitored and projected to ensure that the Company has the liquidity to cover these payments without the need to liquidate its investments. Cash and investments (excluding net unrealized gains or losses) at December 31, 2005, were $140,617,062 compared to $132,122,792 at December 31, 2004, a 6% increase. Crusader's cash and investments at December 31, 2005, was $137,990,174 or 98% of the total held by the Company, compared to $129,887,431 or 98% of the total held by the Company at December 31, 2004.  The Company's investments are as follows:                                                         December 31, 2005      December 31, 2004       December 31, 2003                                                       -----------------      -----------------       -----------------                                                           Amount        %         Amount         %        Amount           %                                                           ------        -         ------         -        ------           -         Fixed maturities (at amortized cost)    Certificates of deposit                                $500,000       -         $500,000       -         $500,000        -    U.S. treasury securities                            107,290,653      79       77,765,616      60       38,305,041       34    U.S. government sponsored      enterprise securities                               6,000,000       4       11,998,772      10       11,997,264       11    Industrial and miscellaneous (taxable)               21,403,239      16       37,754,927      29       58,493,396       53    State and municipal (tax exempt)                        934,536       1          970,343       1        2,029,891        2                                                        -----------     ---      -----------     ---      -----------      ---         Total fixed maturity investments               136,128,428     100      128,989,658     100      111,325,592      100                                                        -----------     ===      -----------     ===      -----------      ===  Short-term cash investments (at cost)    Certificates of deposit                                 100,000       2          400,000      13          425,000        6    Cash deposit in lieu of bond*                           200,000       5          752,659      24          752,659       10    Commercial paper                                      1,830,000      41        1,005,000      32        2,000,000       28    Bank money market accounts                              182,673       4          803,949      26          902,517       13    U.S. gov't obligation money market fund               2,150,671      48          144,925       5          147,666        2    Short-term U.S. treasury                                      -       -                -       -        2,998,850       41    Bank savings accounts                                    11,818       -           11,585       -            2,623        -                                                          ---------     ---        ---------     ---        ---------      ---         Total short-term cash investments                4,475,162     100        3,118,118     100        7,229,315      100                                                          ---------     ===        ---------     ===        ---------      ===          Total investments                             $140,603,590             $132,107,776             $118,554,907                                                        ===========              ===========              ===========   * Deposits with superior courts to stay execution of judgment pending appeal of Crusader claims.  In accordance with Statement of Financial Accounting Standard No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company is required to classify its investment securities into one of three categories: held-to-maturity, available-for-sale or trading securities. Although all of the Company's investments are classified as available-for-sale and the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity.  The tax-exempt interest income earned (net of bond premium and discount amortization) during the year ended December 31, 2005, was $14,416 compared to $36,719 in the year ended December 31, 2004. In the year ended December 31, 2003, tax-exempt interest income earned totaled $117,892.  The Company's investment guidelines on equity securities limit investments in equity securities to an aggregate maximum of $2,000,000. The Company's investment guidelines on fixed maturities limit those investments to high-grade obligations with a maximum term of eight years. The maximum investment authorized in any one issuer is $2,000,000 and the maximum in any one U.S. government agency or U.S. government sponsored enterprise is $3,000,000. This dollar limitation excludes bond premiums paid in excess of par value and U.S. government or U.S. government guaranteed issues. Investments in municipal securities are primarily pre-refunded and secured by U.S. treasury securities. The short-term investments are either U.S. government obligations, FDIC insured, or are in an institution with a Moody's rating of P2 and/or a Standard & Poor's rating of A1. As of December 31, 2005, all of the Company's fixed maturity investments were investment grade and readily marketable and could be liquidated without any materially adverse financial impact.                                          18   On September 29, 2003, the Company borrowed $1,000,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer. As of April 29, 2005, the note was paid in full.  During 2005 the Company began its conversion to a "paperless office" including improvements to its computer network, hardware, switching, and other related computer infrastructure. The "paperless office" conversion of the insurance company underwriting operations was completed in October 2005. The Company estimates that the remaining planned conversion and improvements may take up to one year. As of December 31, 2005, the Company had incurred approximately $650,000 of capital expenditures and anticipates incurring an additional $100,000 to complete the above projects. Upon full implementation of these projects, the Company anticipates its potential payback on these capital expenditures in approximately two to three years due to productivity improvements, improved customer service, and lower operating costs.  Crusader's statutory capital and surplus as of December 31, 2005, was $36,586,441, an increase of $7,150,098 (24.3%) from December 31, 2004. Crusader's statutory capital and surplus as of December 31, 2004, was $29,436,343, an increase of $3,332,903 (12.8%) from December 31, 2003.  No dividends were declared or paid by Crusader to Unico in 2005, 2004 or 2003. Based on Crusader's statutory surplus as regards policyholders as of December 31, 2005, the maximum dividend that can be made by Crusader to Unico without prior regulatory approval in 2006 is $3,658,644.  The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company (see Note 17 of "Notes to Consolidated Financial Statements"). During the year ended December 31, 2005, the Company did not repurchase any shares of the Company's common stock. As of December 31, 2005, the Company has purchased and retired under the Board of Directors' authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.  Although material capital expenditures may also be funded through borrowings, the Company believes that its cash and short-term investments at year end, net of trust restriction of $265,668, statutory deposits of $700,000, cash deposited (with superior courts) in lieu of bond of $200,000 and California insurance company statutory dividend restrictions applicable to Crusader plus the cash to be generated from operations, should be sufficient to meet its operating requirements during the next twelve months without the necessity of borrowing funds.  As a California insurance company, Crusader is obligated to pay a premium tax on gross premiums written in all states that Crusader is admitted. Premium taxes are deferred and amortized as the related premiums are earned. The premium tax is in lieu of state franchise taxes and is not included in the provision for state taxes.  The Company has certain obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2005, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:                                                                     Within          1-3           3-5            After Contractual Obligations                           Total          1 Year         Years         Years          5 years - -----------------------                           -----          ------         -----         -----          -------       Building lease                                  $1,282,440     $1,025,952       $256,488              -              - Losses and loss adjustment expense reserves*   101,914,548     33,682,548     35,807,000    $15,745,000    $16,680,000                                                -----------     ----------     ----------     ----------     ----------    Total                                      $103,196,988    $34,708,500    $36,063,488    $15,745,000    $16,680,000                                                ===========     ==========     ==========     ==========     ==========   *  Unlike many other forms of contractual obligations, loss and loss adjustment    expense reserves do not have definitive due dates and the ultimate payment    dates are subject to a number of variables and uncertainties. As a result,    the total loss and loss adjustment expense reserve payments to be made by    period, as shown above, are estimates.                                          19                                 Results of Operations                               --------------------- General - ------- The Company had net income of $6,715,004 for the year ended December 31, 2005, compared to net income of $5,681,500 for the year ended December 31, 2004, and net income of $1,068,650 for the year ended December 31, 2003. Total revenue for the year ended December 31, 2005, was $61,182,522 compared to $61,903,310 for the year ended December 31, 2004, and $51,130,439 for the year ended December 31, 2003.  For the year ended December 31, 2005, the Company had income before taxes of $10,466,430 compared to income before taxes of $8,672,458 in the year ended December 31, 2004, an increase in income before taxes of $1,793,972. The increase in pre-tax income was primarily due to an increase of $3,114,856 in the underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader offset by $995,849 decrease in gross commissions and fees income.  For the year ended December 31, 2004, the Company had income before taxes of $8,672,458 compared to income before taxes of $2,149,371 in the year ended December 31, 2003, an increase in income before taxes of $6,523,087. The increase in pre-tax income was primarily due to an increase of $7,892,277 in the underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) from Crusader offset by $1,605,512 decrease in gross commissions and fees income.  The effect of inflation on the net income of the Company during the years ended December 31, 2005, 2004, and 2003 was not significant.  The Company derives revenue from various sources as discussed below.  Insurance Company Operation - --------------------------- Premium and loss information of Crusader are as follows:                                                                   Year ended December 31                                                                 ----------------------                                                           2005            2004            2003                                                           ----            ----            ----      Gross written premium                                 $60,268,784     $68,872,021     $64,047,717  Net written premium (net of reinsurance ceded)        $46,030,707     $51,089,573     $47,420,157  Earned premium before reinsurance ceded               $64,712,764     $67,890,808     $53,754,119  Earned premium (net of reinsurance ceded)             $50,477,920     $50,106,568     $37,106,099  Losses and loss adjustment expenses                   $31,513,732     $34,450,738     $31,720,533  Gross unpaid losses and loss adjustment expenses     $101,914,548     $87,469,000     $78,139,090  Net unpaid losses and loss adjustment expenses        $76,235,467     $67,349,989     $58,883,861   Crusader's primary line of business is commercial multiple peril policies. This line of business represented approximately 97% of Crusader's total written premium for the year ended December 31, 2005, 98% for the year ended December 31, 2004, and 97% for the year ended December 31, 2003.  As of December 31, 2005, Crusader was licensed as an admitted insurance company in the states of Arizona, California, Montana, Nevada, Oregon, and Washington and is approved as a non-admitted surplus lines writer in other states.  For the year ended December 31, 2005, gross written premium decreased by $8,603,237 (12%) over 2004. Gross written premium for the year ended December 31, 2004, increased by $4,824,304 (8%) over 2003. The decrease in written premium in 2005 and the increase in written premium in 2004 are primarily the result of the fluctuations in written premium in the Company's apartment program, a program within the Company's commercial multiple peril line of business. Written premium in the apartment program was $25,265,294 for the twelve months ended December 31, 2005, a decrease of $6,622,191 (21%) from $31,887,485 for the twelve months ended December 31, 2004. Written premium in the apartment program increased $4,582,381 (17%) from $27,305,104 for the twelve months ended December 31, 2003, to $31,887,485 for the twelve months ended December 31, 2004. The decrease in written premium in the Company's apartment program in 2005 was primarily due to increased competition in that market. The Company believes that the "hard market" that existed in California in the past few years has transitioned to a "soft market." The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change. The Company's future writings and growth are dependent on market conditions, competition, and the Company's ability to introduce new and profitable products.                                          20   The Company's average premium per policy issued is as follows:         Year Ended    Direct Written   Policies    Average        December 31      Premium        Issued     Premium        -----------      -------        ------     -------           2005        $60,268,784      17,927     $3,362           2004        $68,872,021      20,885     $3,298           2003        $64,047,717      21,425     $2,989  As indicated in the above table, the number of policies issued during the 12 months ended December 31, 2005, decreased by 2,958 (14%) as compared to the prior year. The average premium per policy in 2005 increased by $64 (2%) as compared to the 12 months ended December 31, 2004. As previously discussed, the decrease in the number of policies issued in 2005 compared to 2004 is primarily a result of the increased competition. The Company believes that rate adequacy is more important than premium growth and that underwriting profit is the Company's primary goal. Thus, the average premium per policy issued remained relatively comparable to the prior year. Management's assessment of trends and underwriting results is a primary factor in its decisions to expand or contract its business. The Company continues to believe that it can compete effectively and profitably by offering better service and by marketing its policies through independent agents and brokers.  Beginning July 1, 2003, the Company had placed moratoriums on all non-California business, primarily due to the fact that much of the Company's business outside of California has not been profitable. The Company has no short-term plan to expand into additional states or to expand its marketing channels. Instead, the Company intends to allocate its resources toward improving its California business rates, rules, and forms.  The Company writes annual policies and, therefore, earns written premium daily over the one-year policy term. Premium earned before reinsurance decreased $3,178,044 (5%) in the year ended December 31, 2005, compared to the year ended December 31, 2004, and increased $14,136,689 (26%) in the year ended December 31, 2004, compared to the year ended December 31, 2003. The decrease in earned premium before reinsurance in 2005 is a direct result of the decrease in written premium in 2005. The increase in earned premium before reinsurance in 2004 is a direct result of the increase in written premium during 2004 and 2003.  Earned ceded premium for the 12 months ended December 31, 2005, decreased $3,594,396 (20%) to $14,234,844 compared to $17,784,240 for the 12 months ended December 31, 2004. Earned ceded premiums as a percentage of direct earned premiums were 22% and 26% for 2005 and 2004, respectively. Although direct earned premiums in 2005 decreased 5% as compared to 2004, earned ceded premiums decreased 20% primarily as a result of a rate decrease by the Company's reinsurers effective January 1, 2005. Earned ceded premiums for the 12 months ended December 31, 2004, increased $1,136,220 (7%) to $17,784,240 compared to $16,648,020 for the 12 months ended December 31, 2003. Earned ceded premiums as a percentage of direct earned premiums were 26% and 31% for 2004 and 2003, respectively. The 2005 and 2004 earned ceded premium to direct earned premium ratio decreased primarily as a result of rate decrease by the Company's reinsurers. The rates decreased primarily due to the Company's improving ceded loss experience.  Ceding commissions on the Company's excess of loss treaties is 35% and is a component of policy acquisition costs. Primarily due to favorable loss experience in 2004 and 2003, reinsurance premium on the Company's 1st layer primary excess of loss treaty ($700,000 in excess of $300,000) decreased in 2005 by 24% compared to 2004. In 2005, Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($700,000 in excess of $300,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2004 Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2003 Crusader retained a participation in its excess of loss reinsurance treaties of 5% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. Premium ceded under the provisionally rated contract, which was canceled on a runoff basis effective December 31, 1997, is subject to adjustment based on the amount of losses ceded, limited by a maximum percentage that can be charged by the reinsurer.  Crusader's 2004 and 2003 1st layer primary excess of loss treaty provides for a contingent commission equal to 45% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2003, through December 31, 2005. The Company will calculate and report to the reinsurer its net profit, if any, within 90 days after 36 months following the end of the first accounting period,                                          21   and within 90 days after the end of each 12 month period thereafter until all losses subject the to agreement have been finally settled. Based on losses and loss adjustment expenses ceded (including incurred but not reported losses) as of December 31, 2005, no contingent commission has been accrued. The 2005 1st layer primary excess of loss treaty does not provide for a contingent commission.  Crusader's direct earned premium, earned ceded premium, and ceding commission are as follows:                                                                       Year ended December 31                                                                    ----------------------                                                           2005              2004              2003                                                           ----              ----              ----     Direct earned premium                                  $64,712,764       $67,890,808        $53,754,119  Earned ceded premium   Excluding provisionally rated ceded premium           14,281,810        17,843,805         16,414,611   Provisionally rated ceded premium                        (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                                                          =========        ==========         ==========  Ratios to direct earned premium      Direct ceded premium                                       22%               26%                31%      Earned ceded premium, net of ceding commission             15%               17%                21%    The combined ratio is the sum of (1) the net ratio of losses and loss adjustment expenses incurred (including a provision for incurred-but-not-reported losses "IBNR") to net premiums earned (loss ratio) and (2) the ratio of policy acquisition costs to net premiums earned (expense ratio). The following table shows the loss ratios, expense ratios, and combined ratios of Crusader as derived from data prepared in accordance with GAAP.                           Year ended December 31                          ----------------------                      2005        2004         2003                      ----        ----         ----  Loss ratio          62.4%        68.8%        85.5% Expense ratio       20.8%        20.6%        21.4%                     ----         ----        ----- Combined ratio      83.2%        89.4%       106.9%                     ====         ====        =====  As indicated in the above table, the loss ratio for the year ended December 31, 2005, decreased to 62.4% from 68.8% in 2004 and 85.5% in 2003. The continuous decrease in the loss ratio was primarily due to improvements in the provision for prior years' incurred losses. Generally, if the combined ratio is below 100%, an insurance company has an underwriting profit; if it is above 100%, a company has an underwriting loss.  Reserves for losses and loss adjustment expenses before reinsurance increased $14,445,548 (17%) from $87,469,000 as of December 31, 2004, to $101,914,548 as of December 31, 2005. The increase in loss and loss adjustment expense reserves in 2005 is primarily a result of an $11,030,000 increase to direct IBNR reserves, from $67,770,000 as of December 31, 2004 to $78,800,000 as of December 31, 2005.  Reserves for losses and loss adjustment expenses before reinsurance increased $9,329,910 (12%) from $78,139,090 as of December 31, 2003, to $87,469,000 as of December 31, 2004. The increase in loss and loss adjustment expense reserves in 2004 is primarily a result of a $14,330,000 increase to direct IBNR reserves, from $53,440,000 as of December 31, 2003 to $67,770,000 as of December 31, 2004.  Reserves for losses and loss adjustment expenses before reinsurance for each of Crusader's lines of business were as follows:                                                      Year ended December 31                                                   ---------------------- Line of Business                2005                      2004                      2003 - ----------------          ------------------        -----------------         -----------------          CMP                    $98,758,298    96.9%      $83,677,560   95.7%       $73,708,553   94.3%   Other Liability          2,967,804     2.9%        3,592,719    4.1%         4,279,021    5.5%   Other                      188,446     0.2%          198,721    0.2%           151,516    0.2%                          -----------   -----        ----------  -----         ----------  -----      Total              $101,914,548   100.0%      $87,469,000  100.0%       $78,139,090  100.0%                          ===========   =====        ==========  =====         ==========  =====                                           22   The Company`s consolidated financial statements include estimated reserves for unpaid losses and related loss adjustment expenses of the insurance company operation. Crusader 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 related loss adjustment expenses incurred as of that date for both reported and unreported losses. Estimating 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. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates based on experience and industry data for development of case estimates and for unreported losses and loss adjustment expenses. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.  Losses and loss adjustment expenses - ----------------------------------- Losses and loss adjustment expenses were $31,513,732 or 62% of net premium earned for the year ended December 31, 2005, compared to $34,450,738 or 69% of net premium earned for the year ended December 31, 2004, and compared to $31,720,533 or 85% of net premium earned for the year ended December 31, 2003. The Company incurred favorable development of prior years' losses of $3,824,464 for the year ended December 31, 2005, compared to favorable development of prior years' losses of $835,434 for the year ended December 31, 2004. The Company incurred adverse development of prior years' losses of $2,751,585 for the year ended December 31, 2003.  Analysis of the roll forward of losses and loss adjustment expenses - ------------------------------------------------------------------- The following table provides an analysis of the roll forward of Crusader's losses and loss adjustment expenses, including a reconciliation of the ending balance sheet liability for the periods indicated:                                                                                       Year ended December 31                                                                                    ----------------------                                                                           2005              2004               2003                                                                           ----              ----               ----     Reserve for unpaid losses and loss adjustment expenses   at beginning of year - net of reinsurance                            $67,349,989       $58,883,861        $53,596,945                                                                         ----------        ----------         ----------  Incurred losses and loss adjustment expenses    Provision for insured events of current year                         35,338,196        35,286,172         28,968,948    Increase (decrease) in provision for events of prior years           (3,824,464)         (835,434)         2,751,585                                                                         ----------        ----------         ----------        Total losses and loss adjustment expenses                        31,513,732        34,450,738         31,720,533                                                                         ----------        ----------         ----------  Payments    Losses and loss adjustment expenses attributable to      insured events of the current year                                  8,001,808         7,438,331          5,106,929    Losses and loss adjustment expenses attributable to      insured events of prior years                                      14,626,446        18,546,279         21,326,688                                                                         ----------        ----------         ----------        Total payments                                                   22,628,254        25,984,610         26,433,617                                                                         ----------        ----------         ----------  Reserve for unpaid losses and loss adjustment expenses   at end of year - net of reinsurance                                   76,235,467        67,349,989         58,883,861  Reinsurance recoverable on unpaid losses and loss   adjustment expenses at end of year                                    25,679,081        20,119,011         19,255,229                                                                         ----------        ----------         ---------- Reserve for unpaid losses and loss adjustment expenses at   end of year per balance sheet, gross of reinsurance *               $101,914,548       $87,469,000        $78,139,090                                                                        ===========        ==========         ==========    * In accordance with Financial Accounting Standards Board Statement No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," reinsurance recoverable on unpaid losses and loss adjustment expenses are reported for GAAP as assets rather than netted against the corresponding liability for such items on the balance sheet.                                          23   As a result of Crusader underwriting losses that began in the year ended December 31, 2000, Crusader's management has been analyzing and acting upon various components of its underwriting activity which it believed was primarily attributable to those losses. The Company believes that implementation of management's actions on these underwriting components has contributed to improved operating results. The development of prior years' losses and loss adjustment expenses in 2005 and 2004 was lower than previously anticipated. Accordingly, the Company reduced the estimate of its ultimate losses and loss adjustment expenses for those prior accident years.  Other Insurance Operations - --------------------------                               Association Operation                               --------------------- Membership and fee income from the association program of AAQHC is as follows:                                            Year ended December 31                                           ----------------------                                   2005            2004            2003                                   ----            ----            ----  Membership and fee income      $318,349        $333,470        $481,366  Membership and fee income for the year ended December 31, 2005, decreased $15,121 (5%), compared to the year ended December 31, 2004. Membership and fee income for the year ended December 31, 2004, decreased $147,896 (31%), compared to the year ended December 31, 2003. Beginning in April 2003, CIGNA discontinued its individual and family health insurance program to new policyholders in the State of California and on November 1, 2003, CIGNA began terminating approximately 2,200 individual and family policyholders on a runoff basis. The termination of policyholders continued through October 1, 2004. The discontinuance of CIGNA's individual and family health insurance program did not affect the CIGNA small group program. Primarily due to the discontinuance of CIGNA's individual and family health insurance program, membership and fee income decreased as these terminated members were no longer members of the association.                          Health and Life Insurance Program                         --------------------------------- Commission income from the health and life insurance sales is as follows:                                           Year ended December 31                                          ----------------------                                  2005            2004            2003                                  ----            ----            ----  Commission income            $1,628,061      $2,156,924      $3,312,715  AIB markets health and life insurance in California through non-affiliated insurance companies for individuals and groups. For these services, AIB receives commission based on the premiums that it writes. Commission income decreased $528,863 (25%) in the year ended December 31, 2005, compared to 2004. Commission income decreased $1,155,791 (35%) in the year ended December 31, 2004, compared to 2003. The decrease in commission in 2005 and 2004 was primarily due to the discontinuance of CIGNA's individual and family health insurance program in the state of California as discussed under the results from the association operation above.  Commissions from other carriers for the year ended December 31, 2005, remained relatively comparable to 2004. Commissions from other carriers for the year ended December 31, 2004, increased 96% over 2003 as AIB was able secure other insurance for approximately half of the 2,200 Cigna members that were terminated by CIGNA. AIB could not obtain insurance for the remaining CIGNA individuals and family members primarily due to their pre-existing health conditions or that they were able to secure other insurance.                                  Policy Fee Income                                 ----------------- Unifax sells and services insurance policies for Crusader. The policy fee charged to the policyholder by Unifax is recognized as income in the consolidated financial statements. Policy fee income of Unifax is as follows:                                           Year ended December 31                                          ----------------------                                  2005            2004            2003                                  ----            ----            ---- Policy fee income             $3,001,966      $3,394,783      $3,458,559 Policies issued                   17,927          20,885          21,425   Policy fee income for the year ended December 31, 2005, decreased $392,817 (12%) as compared to the year ended December 31, 2004. The 12% decrease in policy fee income is primarily a result of a 2,958 (14%)                                          24   decrease in the number of policies issued during 2005 as compared to 2004 offset by the increase in policy fee from $165 per policy to $178 effective on and after August 2005.  Policy fee income for the year ended December 31, 2004, decreased $63,776 (2%) as compared to the year ended December 31, 2003. The slight decrease in policy fee income is a result of a 540 (3%) decrease in the number of policies issued during 2004 as compared to 2003.                      Daily Automobile Rental Insurance Program                     ----------------------------------------- The daily automobile rental insurance program is produced by Bedford. Bedford receives a commission from a non-affiliated insurance company based on premium written. Prior to December 31, 2003, Bedford also received a claim administration fee from the non-affiliated insurance company.  Commission and fee income from the daily automobile rental insurance program are as follows:                                                  Year ended December 31                                                 ----------------------                                         2005            2004            2003                                         ----            ----            ---- Rental program commission             $411,189        $555,964        $574,197 Claim administration fee                70,000               -         241,428 Contingent commission                   29,877           9,488               -                                        -------         -------         -------   Total commission and fee income     $511,066        $565,452        $815,625                                        =======         =======         =======  Commission and fee income during the year ended December 31, 2005, were $511,066, a decrease of $54,386 (10%) as compared to the year ended December 31, 2004. Commission and fee income during the year ended December 31, 2004, were $565,452, a decrease of $250,173 (31%) as compared to the year ended December 31, 2003.  The daily automobile rental insurance program commission income (excluding contingent commission) decreased $144,775 (26%) in 2005 compared to 2004. The daily automobile rental insurance program commission income (excluding contingent commission) decreased $18,233 (3%) in 2004 compared to 2003. Premium written in 2005 decreased 24% compared to premium written in 2004, and premium written in 2004 decreased 6% compared to premium written in 2003. The decrease in written premium in 2005 and 2004 is primarily due to the continued intense price competition in the daily automobile rental insurance program, which is causing these reductions in the Company's written premium and related commission income. To avoid underwriting losses for the non-affiliated insurance Company that it represents, Bedford continues to produce business only at rates that it believes to be adequate. The Company cannot determine how long the existing market conditions will continue, nor in which direction they might change.  The Company's subsidiary U.S. Risk Managers, Inc., (U.S. Risk) ceased providing insurance claim administration services to the non-affiliated daily automobile insurer as of December 31, 2003; and it is currently inactive. As of December 31, 2003, the non-affiliated insurer assumed the claim administration responsibility for all outstanding and IBNR claims. During 2003, the Company recognized $200,000 of claim administration fees that were unearned as of December 31, 2002. Although U.S. Risk is inactive, the Company is still responsible for all claim administration cost arising from losses covered by premiums for which it received a claim administration fee. During 2004 and 2005, the Company did not receive any claim administration fees and did not incur any future internal claim administration costs. During 2005, the Company recognized an additional amount of $70,000 of the $100,000 claim administration fees that were unearned as of December 31, 2004. Thus, the unearned claim administration reserve as of December 31, 2005, is $30,000 and it reflects the estimated costs to complete the claim administration by the non-affiliated insurer. As of December 31, 2005, the non-affiliated insurer had not yet billed the Company for these costs.                                          25                            Other Commission and Fee Income                          ------------------------------- Other commission and fee income are as follows:                                                      Year ended December 31                                                     ----------------------                                                2005         2004          2003                                                ----         ----          ---- Earthquake program commission income         $48,519      $53,140       $40,015 Miscellaneous commission and fee income           70          111         1,112                                               ------       ------        ------    Total other commission and fee income     $48,589      $53,251       $41,127                                               ======       ======        ======  Unifax began producing commercial earthquake insurance policies in California for non-affiliated insurance companies in 1999. Unifax receives a commission from these insurance companies based on premium written. Commission income on the earthquake program for the year ended December 31, 2005, decreased $4,621 (9%) compared to 2004. Commission income on the earthquake program for the year ended December 31, 2004, increased $13,125 (33%) compared to 2003.  The commissions paid by Crusader to Unifax are eliminated as intercompany transactions and are not reflected in commission income or commission expense.                               Premium Finance Program                              ----------------------- Premium finance charges and late fees earned from financing policies are as follows:                                                     Year ended December 31                                                    ----------------------                                               2005         2004          2003                                               ----         ----          ----  Premium finance charges and fees earned    $758,325     $933,529      $952,543  New loans                                     4,200        5,156         6,216  AAC provides premium financing for Crusader policies produced by Unifax in California. The growth of this program is dependent and directly related to the growth of Crusader's written premium and AAC's ability to market its competitive rates and service. Premium finance charges and fees earned decreased $175,204 (19%) in the year ended December 31, 2005, compared to 2004 due primarily to the fact that there were 956 (19%) fewer loans financed in the current year. Premium finance charges and fees earned decreased $19,014 (2%) in the year ended December 31, 2004, compared to 2003 due to the fact that there were 1,060 (17%) fewer loans financed in the current year offset by the 13% increase in the average premium financed as compared to 2003. During 2005, 32% of all Unifax policies were financed and 75% of those policies were financed by AAC. During 2004, 33% of all Unifax policies were financed and 74% of those policies were financed by AAC.  Investment Income and Net Realized Gains - ---------------------------------------- Investment income and net realized gains are as follows:                                                  Year ended December 31                                                 ----------------------                                         2005            2004           2003                                         ----            ----           ----  Average Invested Assets            $136,355,683    $125,331,342   $110,614,379   Interest income    Insurance company operations       $4,248,399      $4,204,573     $4,801,133    Other operations                       68,828          38,250         47,010                                        ---------       ---------      ---------      Total investment income       and realized gains              $4,317,227      $4,242,823     $4,848,143                                        =========       =========      =========   Yield on Average Invested Assets           3.17%           3.39%          4.38%  In the year ended December 31, 2005, while the Company's average invested assets (at amortized value) increased $11,024,341 (9%) compared to the year ended December 31, 2004, investment income earned increased $74,404 (2%) compared to the year ended December 31, 2004. The yield on average invested assets decreased to 3.17% in 2005 from 3.39% in 2004. The decrease in the yield on average invested assets is primarily the result of a decline in the average return on reinvested assets in the Company's investment portfolio. Also contributing to the decline in the yield on average invested assets is a shorter weighted average maturity of new and reinvested assets. Due to the current interest rate environment, management believes it prudent to                                          26   purchase fixed maturity investments with shorter maturities, and therefore, the weighted average maturity of the Company's fixed maturity investments has decreased to 1.2 years as of December 31, 2005, from 1.4 years as of December 31, 2004. The Company's average invested assets increased in the year ending December 31, 2005, primarily as a result of increased cash flows from operations. The mix of taxable and tax-exempt securities in the portfolio affects the investment income return percentage. Tax-exempt securities generally carry a lower yield than taxable securities. These securities (at amortized value) decreased to $934,536 (1% of total investments) at December 31, 2005, compared to $970,343 (1% of total investments) at December 31, 2004.  In the year ended December 31, 2004, while the Company's average invested assets (at amortized value) increased $14,716,855 (13%) compared to the year ended December 31, 2003, investment income earned (excluding net realized gains) decreased $605,320 (12%) compared to the year ended December 31, 2003. The decrease in investment income is primarily the result of a decline in the average return on new and reinvested assets in the Company's investment portfolio. Also contributing to the decline in average return is a shorter weighted average maturity of new and reinvested assets. Due to the 2004 interest rate environment, management believed it was prudent to purchase fixed maturity investments with shorter maturities, and therefore, the weighted average maturity of the Company's fixed maturity investments has decreased to 1.4 years as of December 31, 2004, from 1.9 years as of December 31, 2003. In the year ended December 31, 2004, the Company's average yield on invested assets (at amortized value) was 3.39% compared to 4.38% at the year ended December 31, 2003. The Company's average invested assets increased in the year ending December 31, 2004, primarily as a result of increased cash flows from operations. The mix of taxable and tax-exempt securities in the portfolio affects the investment income return percentage. Tax-exempt securities generally carry a lower yield than taxable securities. These securities (at amortized value) decreased to $970,343 (1% of total investments) at December 31, 2004, compared to $2,029,891 (2% of total investments) at December 31, 2003.  The par value, amortized cost, estimated market value and weighted average yield of fixed maturity investments at December 31, 2005, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.                                                                                           Weighted Maturities by Calendar Year      Par Value      Amortized Cost     Market Value     Average Yield - ---------------------------      ---------      --------------     ------------     -------------      December 31, 2006               $62,672,000       $62,721,805       $62,292,261         2.79% December 31, 2007                63,875,000        63,801,855        63,520,607         4.13% December 31, 2008                 2,410,000         2,467,891         2,489,677         5.45% December 31, 2009                 7,000,000         7,136,877         7,246,755         5.27%                                 -----------       -----------       -----------    Total                       $135,957,000      $136,128,428      $135,549,300         3.59%                                 ===========       ===========       ===========    The following table sets forth the composition of the investment portfolio of the Company at the dates indicated:                                                                                (Amounts in Thousands)                                                                               As of December 31                                                                               -----------------                                                           2005                       2004                      2003                                                           ----                       ----                      ----                                                   Amortized      Market      Amortized     Market      Amortized      Market Type of Security                                     Cost         Value        Cost         Value        Cost         Value - ----------------                                     ----         -----        ----         -----        ----         -----         Certificates of deposit                               $500          $500         $500        $500          $500         $500 U.S. treasury securities                           107,291       106,563       77,766      77,299        38,305       38,550 U.S. government sponsored enterprise securities      6,000         5,933       11,999      11,853        11,997       11,987 Industrial and miscellaneous taxable bonds          21,403        21,631       37,755      38,950        58,494       61,447 State and municipal tax-exempt bonds                   934           922          970         958         2,030        2,040                                                    -------       -------      -------     -------       -------      -------      Total fixed maturity investments              136,128       135,549      128,990     129,560       111,326      114,524 Short-term cash investments                          4,475         4,475        3,118       3,118         7,229        7,229                                                    -------       -------      -------     -------       -------      -------      Total investments                            $140,603      $140,024     $132,108    $132,678      $118,555     $121,753                                                    =======       =======      =======     =======       =======      =======                                           27   The following table summarizes, for all fixed maturities in an unrealized loss position at December 31, 2005, the aggregate fair value and gross unrealized loss by length of time those fixed maturities have been continuously in an unrealized loss. No securities were sold at a loss during 2005, 2004 or 2003.                        Amortized                            Gross                         Cost            Fair Value     Unrealized Loss                         ----            ----------     --------------- 0-6 months           $46,834,903       $46,585,392        $249,511 7-12 months           14,327,095        14,166,247         160,848 Over 12 months        50,421,376        49,989,695         431,681                      -----------        -----------        -------   Total             $111,583,374       $110,741,334       $842,040                      ===========        ===========        =======  At December 31, 2005, the fixed maturity investments with a gross unrealized loss for a continuous periods of 0 to 6 months and 7 to 12 months, both consisted of U.S. treasury securities and investment grade industrial securities. The fixed maturity investments with a gross unrealized loss position for a continuous period over 12 months consisted of U.S. treasury securities, U.S. government sponsored enterprise securities, and pre-refunded municipal bonds. The unrealized loss is primarily due to rising interest rates.  The Company monitors its investments closely. If an unrealized loss is determined to be other than temporary, it is written off as a realized loss through the Consolidated Statements of Operations. The Company's methodology of assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, and the Company's intent to hold the investment for a period of time sufficient to allow the Company to recover its costs. The Company has concluded that the gross unrealized losses of $842,040 at December 31, 2005, were temporary in nature. However, facts and circumstances may change which could result in a decline in market value considered to be other than temporary. The Company did not sell any fixed maturity investment in the years ended December 31, 2005 and 2004.                                 Operating Expenses                                ------------------ POLICY ACQUISITION COSTS are as follows:                                                   Year ended December 31                                                   ----------------------                                               2005         2004         2003                                               ----         ----         ---- Policy acquisition costs                  $10,512,688   $10,319,186   $7,941,199 Ratio to net earned premium (GAAP ratio)       21%           21%          21%  Policy acquisition costs consist of commissions, premium taxes, inspection fees, and certain other underwriting costs that are directly related to and vary with the production of Crusader insurance policies. These costs include both Crusader expenses and allocated expenses of other Unico subsidiaries. On certain reinsurance treaties, Crusader receives a ceding commission from its reinsurer that represents a reimbursement of the acquisition costs related to the premium ceded. No ceding commission is received on facultative, catastrophe, or provisionally rated ceded premium. Policy acquisition costs, net of ceding commission, are deferred and amortized as the related premiums are earned. The ratio of policy acquisition cost to net earned premium in 2005, 2004 and 2003 were comparable at 21%.  SALARIES AND EMPLOYEE BENEFITS are as follows:                                                                           Year ended December 31                                                                        ----------------------                                                              2005               2004                2003                                                              ----               ----                ----     Total salaries and employee benefits incurred             $9,401,757         $9,126,929          $8,777,582 Less: charged to losses and loss adjustment expenses      (1,387,198)        (1,335,778)         (1,137,090) Less: capitalized to policy acquisition costs             (2,873,586)        (2,921,985)         (2,679,726)                                                            ---------          ---------           --------- Net amount charged to operating expenses                  $5,140,973         $4,869,166          $4,960,766                                                            =========          =========           =========   Total salaries and employee benefits incurred for the year ended December 31, 2005, increased $274,828 (3%) compared to the year ended December 31, 2004. Factors that affected the 3% were general salary increases (less than 6%) and increases in employee benefits costs, offset by reduction in the number of employees.                                          28   Total salaries and employee benefits incurred for the year ended December 31, 2004, increased $349,347 (4%) compared to the year ended December 31, 2003.  COMMISSIONS TO AGENTS/BROKERS are as follows:                                                    Year ended December 31                                                    ----------------------                                               2005         2004          2003                                               ----         ----          ---- Commission to agents/brokers                $674,674     $934,452     $1,460,684  Commissions to agents/brokers (not including commissions on Crusader policies that are reflected in policy acquisition costs) are generally related to gross commission income from the health and life insurance program, the daily automobile rental insurance program, and the earthquake program. Commissions to agents and brokers decreased $259,778 (28%) for the year ended December 31, 2005, as compared to the year ended December 31, 2004. Commissions to agents and brokers decreased $526,232 (36%) for the year ended December 31, 2004, as compared to the year ended December 31, 2003. The decreases in both years are primarily the result of a decrease in premiums written and the related decrease in the commission expense in the health and life insurance program.  OTHER OPERATING EXPENSES are as follows:                                                   Year ended December 31                                                   ----------------------                                              2005          2004          2003                                              ----          ----          ----  Other operating expenses                 $2,874,025    $2,657,310    $2,897,886  Other Operating Expenses generally do not change significantly with changes in production. This is true for both increases and decreases in production. Operating expenses increased $216,715 (8%) for the year ended December 31, 2005, compared to the year ended December 31, 2004. Operating expenses decreased $240,576 (8%) for the year ended December 31, 2004, compared to the year ended December 31, 2003.                                    Income Taxes                                   ------------ Income tax expense for the year ended December 31, 2005, was $3,751,426 compared to an income tax expense of $2,990,958 for the year ended December 31, 2004. The effective combined income tax rates for 2005 and 2004 were 36% and 34%, respectively. The pre-tax income increased $1,793,972 for the year ended December 31, 2005, compared to the year ended December 31, 2004, which resulted in an increased income tax expense in 2005. The income tax expense for the year ended December 31, 2004, was $2,990,958 compared to an income tax expense of $1,080,721 for the year ended December 31, 2003. The effective combined income tax rates for 2004 and 2003 were 34% and 50%, respectively.  In the year ended December 31, 2003, the Company recognized an income tax expense of $287,000 resulting from an assessment for the years 1999 and 2000 from the California Franchise Tax Board. The assessment resulted from a court ruling in Ceridian vs. Franchise Tax Board that held that the California statute permitting the tax deductibility of dividends received from a wholly owned insurance subsidiary was unconstitutional because it discriminated against out-of-state holding companies and thus was in violation of the interstate commerce clause of the United States Constitution. The ruling concluded that the discriminatory sections of the statute are not severable and the entire statute was invalid and unenforceable. California law provides that the proper remedy in such circumstances is to disallow the deduction to those taxpayers that benefited from the deduction. As a result of the court ruling, in February 2003, the Franchise Tax Board (FTB) notified the Company that it would issue a Notice of Proposed Assessment (NPA) for tax years 1999 and 2000 of approximately $287,000 representing California state franchise taxes plus related interest of approximately $80,000. In September 2004, California enacted legislation (AB 263) that addresses many aspects of the tax treatment of insurance company owners, including holding companies such as Unico. The legislation provides for an election, applicable if made to all tax years ending after December 1, 1997, and before January 1, 2005, under which a dividend-received deduction of up to 80% of dividends paid by an insurer to a non-insurer parent is allowed. The Company made the election authorized by AB 263 and, therefore, has reversed 80% of the $287,000 income tax expense and 80% of the interest accrued thereon. In addition, as a result of AB 263, the Company is obligated to establish a state deferred tax liability which represents the Company's future state tax liability for all undistributed earnings of Crusader since January 1, 1993, in accordance with FASB 109.                                          29   Recently Issued Accounting Standards - ------------------------------------ In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R") that will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity instrument issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123R replaces Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees" and its related implementation guidance; the principles that the Company currently employs to account and report its employee stock option awards. On April 14, 2005, the Securities and Exchange Commission issued a Final Rule amending Regulation S-X to revise the date for compliance with SFAS No. 123R so that each registrant that is not a small business issuer will be required to prepare financial statements in accordance with SFAS No. 123R beginning with the first interim reporting period of the registrant's first fiscal year beginning on or after June 15, 2005. The Company will adopt the provisions of SFAS No. 123R in January 2006. The Company does not believe that the adoption of SFAS No. 123R will have a material impact on its consolidated financial statements.  In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections" ("SFAS No. 154"). SFAS No. 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to a newly adopted accounting principle. The statement will be effective for the Company for all accounting changes and any error corrections occurring after January 1, 2006.  FASB Staff Position (FSP) No. 115-I, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." FSP 115-1 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. If, after consideration of all available evidence to evaluate the realizable value of its investment, impairment is determined to be other-than-temporary, then an impairment loss should be recognized equal to the difference between the investment's cost and its fair value. FSP 115-1 nullifies certain provisions of Emerging Issues Task Force (EITF) Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," while retaining the disclosure requirements of EITF 03-1 which were adopted in 2003. FSP 115-1 is effective for reporting periods beginning after December 15, 2005. The Company does not expect FSP 115-1 will significantly impact its financial statements upon its adoption on January 1, 2006.  There were no other accounting standards issued during 2005 that are expected to have a material impact on the Company's consolidated financial statements.  Significant Accounting Policies - ------------------------------- The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While every effort is made to ensure the integrity of such estimates, actual results could differ.  Management believes the Company's current critical accounting policies comprise the following:                         Losses and Loss Adjustment Expenses                        ----------------------------------- The preparation of the Company's financial statements requires judgments and estimates. The most significant is the estimate of loss reserves as required by Statement of Financial Accounting Standards No. 60 (SFAS No. 60), "Accounting and Reporting by Insurance Enterprises" and Statement of Financial Accounting Standards No. 5 (SFAS No. 5), "Accounting for Contingencies." Estimating 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. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported                                          30   prior to the close of the accounting period plus estimates based on experience and industry data for development of case estimates and for unreported losses and loss adjustment expenses. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.                                     Reinsurance                                    ----------- 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.                                     Investments                                    ----------- In accordance with Statement of Financial Accounting Standard No. 115, "Accounting for Certain Investments in Debt and Equity Securities", the Company is required to classify its investments in debt and equity securities into one of three categories: held-to-maturity, available-for-sale or trading securities.  The Company's fixed maturity investments are classified as available-for-sale and are stated at market value. Although all of the Company's investments are classified as available-for-sale and the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates market value. Investments in equity securities are carried at market value. The unrealized gains or losses from fixed maturities and equity securities are reported as accumulated other comprehensive income (loss), which is a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses are included in the consolidated statements of operations based on the specific identification method.  Related Party Transactions - -------------------------- The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The lease provides for an annual gross rent of $1,025,952. Erwin Cheldin, the Company's president, chairman and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties. The Company utilizes for its own operations approximately 100% of the space it leases.  On September 29, 2003, the Company borrowed $1,000,000 from Erwin Cheldin, the Company's president, chairman and principal stockholder. As of April 29, 2005, the note was paid in full.                                          31   Forward Looking Statements - -------------------------- Certain statements contained herein, including the Sections entitled "Business," "Legal Proceedings" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," that are not historical facts are forward looking. These statements, which may be identified by forward looking words or phrases such as "anticipate," "appears," "believe," "estimates," "expect," "intend," "may," "should," and "would," involve risks and uncertainties, many of which are beyond the control of the Company. Such risks and uncertainties could cause actual results to differ materially from these forward looking statements. Factors which could cause actual results to differ materially include those described under Item 1 - "Business - Competition" and Item 1A - "Risk Factors"; premium rate adequacy relating to competition or regulation; actual versus estimated claim experience; the outcome of rate change filings with regulatory authorities; acceptance by insureds of rate changes; adequacy of rate changes; changes in Crusader's A.M. Best rating; regulatory changes or developments; the outcome of regulatory proceedings; unforeseen calamities; general market conditions; and the Company's ability to introduce new profitable products.
The Company's invested assets at December 31, 2005 and 2004 consisted of the following:                                                        2005              2004                                                       ----              ---- Fixed maturity bonds (at amortized cost)          $135,628,428      $128,489,658 Short-term cash investments (at cost)                4,475,162         3,118,118 Certificates of deposit - over 1 year (at cost)        500,000           500,000                                                    -----------       -----------    Total invested assets                          $140,603,590      $132,107,776                                                    ===========       ===========  The Company's interest rate risk is primarily in its fixed maturity bond portfolio. As market interest rates decrease, the value of the portfolio increases with the opposite holding true in rising interest rate environments. In addition, the longer the maturity, the more sensitive the asset is to market interest rate fluctuations. The Company limits this risk by investing in securities with maturities no greater than eight years. In addition, although fixed maturity bonds are classified as available-for-sale, the Company's investment guidelines place primary emphasis on buying and holding high-quality bonds to maturity. Because fixed maturity bonds are primarily held to maturity, the change in the market value of these bonds resulting from interest rate movements is unrealized and no gains or losses are recognized in the consolidated statements of operations. Unrealized gains and losses are reported as separate components of stockholders' equity, net of any deferred tax effect. As of December 31, 2005, the Company's unrealized losses (net of unrealized gains) before income taxes on its fixed maturity bond portfolio were $579,128 compared to unrealized gains (net of unrealized losses) before income taxes of $569,957 as of December 31, 2004. Given a hypothetical parallel increase of 100 basis points in interest rates, the fair value of the fixed maturity bond portfolio as of December 31, 2005, would decrease by approximately $1,536,000. This decrease would not be reflected in the statements of operations except to the extent that the securities were sold.  The Company's short-term investments and certificates of deposit have only minimal interest rate risk.                                          32
INDEX TO                         CONSOLIDATED FINANCIAL STATEMENTS                                                                            Page                                                                         Number                                                                         ------ Report of Independent Registered Public Accounting Firm                   34  Consolidated Balance Sheets as of December 31, 2005, and   December 31, 2004                                                       35  Consolidated Statements of Operations for the years ended   December 31, 2005, December 31, 2004, and December 31, 2003             36  Consolidated Statements of Comprehensive Income for the years   ended December 31, 2005, December 31, 2004, and December 31, 2003       37  Consolidated Statements of Changes in Stockholders' Equity for the years   ended December 31, 2005, December 31, 2004, and December 31, 2003       38  Consolidated Statements of Cash Flows for the years ended  December 31, 2005, December 31, 2004, and December 31, 2003              39  Notes to Consolidated Financial Statements                                40                                          33                REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM              -------------------------------------------------------    The Board of Directors and Stockholders Unico American Corporation   We have audited the accompanying consolidated balance sheets of Unico American Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.  We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.  In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Unico American Corporation and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.                                      KPMG LLP  Los Angeles, California March 23, 2006                                          34                              UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                             CONSOLIDATED BALANCE SHEETS                                                                                                   December 31         December 31                                                                                                 2005                2004                                                                                                 ----                ----                                                            ASSETS                                                            ------    Investments    Available for sale:      Fixed maturities, at market value (amortized cost:  December 31,        2005  $136,128,428; December 31, 2004  $128,989,658)                                 $135,549,300        $129,559,615    Short-term investments, at cost                                                             4,475,162           3,118,118                                                                                              -----------         -----------       Total Investments                                                                      140,024,462         132,677,733 Cash                                                                                              13,472              15,016 Accrued investment income                                                                      1,207,278           1,047,278 Premiums and notes receivable, net                                                             6,740,793           7,770,560 Reinsurance recoverable:    Paid losses and loss adjustment expenses                                                    1,711,710              18,512    Unpaid losses and loss adjustment expenses                                                 25,679,081          20,119,011 Deferred policy acquisition costs                                                              7,356,179           8,203,238 Property and equipment (net of accumulated depreciation)                                         824,504             278,404 Deferred income taxes                                                                          1,769,286           1,667,195 Other assets                                                                                     970,414             773,329                                                                                              -----------         -----------         Total Assets                                                                        $186,297,179        $172,570,276                                                                                              ===========         ===========                                              LIABILITIES AND STOCKHOLDERS' EQUITY                                             ------------------------------------  LIABILITIES - ----------- Unpaid losses and loss adjustment expenses                                                  $101,914,548         $87,469,000 Unearned premiums                                                                             31,212,433          35,656,393 Advance premium and premium deposits                                                             867,404           1,067,224 Income taxes payable                                                                                   -             227,551 Notes payable - related parties                                                                        -             500,000 Accrued expenses and other liabilities                                                         3,908,421           5,224,783                                                                                              -----------         -----------         Total Liabilities                                                                   $137,902,806        $130,144,951                                                                                              -----------         -----------  STOCKHOLDERS' EQUITY - -------------------- Common stock, no par - authorized 10,000,000 shares, issued and outstanding    shares 5,496,315 at December 31, 2005, and 5,492,315    at December 31, 2004                                                                       $2,720,487          $2,708,047 Accumulated other comprehensive income (loss)                                                   (382,224)            376,172 Retained earnings                                                                             46,056,110          39,341,106                                                                                               ----------          ----------         Total Stockholders' Equity                                                           $48,394,373         $42,425,325                                                                                               ----------          ----------          Total Liabilities and Stockholders' Equity                                          $186,297,179        $172,570,276                                                                                              ===========         ===========               See accompanying notes to consolidated financial statements.                                          35                              UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                        CONSOLIDATED STATEMENTS OF OPERATIONS                         FOR THE YEARS ENDED DECEMBER 31,                                                                2005                   2004                 2003                                                           ----                   ----                 ----     REVENUES - -------- Insurance Company Revenues    Premium earned                                      $64,712,764            $67,890,808          $53,754,119    Premium ceded                                        14,234,844             17,784,240           16,648,020                                                         ----------             ----------           ----------      Net premium earned                                 50,477,920             50,106,568           37,106,099    Net investment income                                 4,248,399              4,204,573            4,801,133    Other income                                            107,193                103,806               98,242                                                         ----------             ----------           ----------         Total Insurance Company Revenues                54,833,512             54,414,947           42,005,474  Other Revenues from Insurance Operations      Gross commissions and fees                          5,508,031              6,503,880            8,109,392      Investment income                                      68,828                 38,250               47,010      Finance charges and fees earned                       758,325                933,529              952,543      Other income                                           13,826                 12,704               16,020                                                         ----------             ----------           ----------           Total Revenues                                61,182,522             61,903,310           51,130,439                                                         ----------             ----------           ----------  EXPENSES - -------- Losses and loss adjustment expenses                     31,513,732             34,450,738           31,720,533 Policy acquisition costs                                10,512,688             10,319,186            7,941,199 Salaries and employee benefits                           5,140,973              4,869,166            4,960,766 Commissions to agents/brokers                              674,674                934,452            1,460,684 Other operating expenses                                 2,874,025              2,657,310            2,897,886                                                         ----------             ----------           ----------          Total Expenses                                 50,716,092             53,230,852           48,981,068                                                         ----------             ----------           ----------  Income Before Taxes                                     10,466,430              8,672,458            2,149,371 Income Tax                                               3,751,426              2,990,958            1,080,721                                                          ---------              ---------            ---------          Net Income                                     $6,715,004             $5,681,500           $1,068,650                                                          =========              =========            =========   PER SHARE DATA: - -------------- Basic Shares Outstanding                                 5,495,948              5,490,346            5,489,604 Basic Earnings Per Share                                     $1.22                  $1.03                $0.19 Diluted Shares Outstanding                               5,612,426              5,581,295            5,533,112 Diluted Earnings Per Share                                   $1.20                  $1.02                $0.19               See accompanying notes to consolidated financial statements.                                          36                              UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                   CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME                         FOR THE YEARS ENDED DECEMBER 31,                                                                 2005            2004            2003                                                            ----            ----            ----     Net income                                              $6,715,004      $5,681,500      $1,068,650 Other changes in comprehensive income, net of tax:   Unrealized (losses) on securities classified as    available-for-sale arising during the period           (758,396)     (1,734,807)     (1,006,783)                                                          ---------       ---------       ---------             Comprehensive Income                        $5,956,608      $3,946,693         $61,867                                                          =========       =========          ======               See accompanying notes to consolidated financial statements.                                          37                              UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES             CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY               FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 and 2003                                                                                     Accumulated                                                    Common Shares                 Other                                             -------------------------        Comprehensive                                             Issued and                           Income           Retained                                             Outstanding        Amount           (Losses)          Earnings         Total                                             -----------        ------            ------           --------         -----       Balance - December 31, 2002                   5,489,533      $2,700,272        $3,117,762       $32,590,956     $38,408,990  Shares canceled or adjusted                         282               -                 -                 -               - Change in comprehensive income,   net of deferred income tax                          -               -        (1,006,783)                -      (1,006,783) Net income                                            -               -                 -         1,068,650       1,068,650                                               ---------       ---------         ---------        ----------      ---------- Balance - December 31, 2003                   5,489,815      $2,700,272        $2,110,979       $33,659,606     $38,470,857  Net shares issued for exercise of   stock options                                   2,500           7,775                 -                 -           7,775 Change in comprehensive income,   net of deferred income tax                          -               -        (1,734,807)                -      (1,734,807) Net income                                            -               -                 -         5,681,500       5,681,500                                               ---------       ---------           -------        ----------      ---------- Balance - December 31, 2004                   5,492,315      $2,708,047          $376,172       $39,341,106     $42,425,325  Net shares issued for exercise of   stock options                                   4,000          12,440                 -                 -          12,440 Change in comprehensive income,   net of deferred income tax                          -               -          (758,396)                -        (758,396) Net income                                            -               -                 -         6,715,004       6,715,004                                               ---------       ---------           -------        ----------      ---------- Balance - December 31, 2005                   5,496,315      $2,720,487         $(382,224)      $46,056,110     $48,394,373                                               =========       =========           =======        ==========      ==========              See accompanying notes to consolidated financial statements.                                          38                              UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                        CONSOLIDATED STATEMENTS OF CASH FLOWS                         FOR THE YEARS ENDED DECEMBER 31,                                                                                         2005              2004             2003                                                                                    ----              ----             ----     Cash flows from operating activities:    Net income                                                                   $6,715,004        $5,681,500       $1,068,650    Adjustments to reconcile net income to net cash from operations       Depreciation and amortization                                                160,571            95,084           89,821       Bond amortization, net                                                       109,840           251,318          317,389    Changes in assets and liabilities       Premium, notes and investment income receivable                              869,767           723,457       (1,371,053)       Reinsurance recoverable                                                   (7,253,268)         (259,330)       4,235,194       Deferred policy acquisition costs                                            847,059          (148,875)      (2,107,353)       Other assets                                                                (197,085)          156,375          147,792       Reserve for unpaid losses and loss adjustment expenses                    14,445,548         9,329,910        3,233,806       Unearned premium reserve                                                  (4,443,960)          981,213       10,293,597       Advance premium and premium deposits                                        (199,820)          (51,394)        (488,654)       Accrued expenses and other liabilities                                    (1,316,362)       (1,750,505)      (1,658,188)       Income taxes current/deferred                                                 61,048          (184,916)         215,558       Federal income tax recoverable                                                     -                 -        1,548,827                                                                                  ---------        ----------       ----------          Net Cash Provided from Operations                                       9,798,342        14,823,837       15,525,386                                                                                  ---------        ----------       ---------- Cash flows from investing activities:    Purchase of fixed maturity investments                                      (59,444,701)      (51,447,350)     (55,234,166)    Proceeds from maturity of fixed maturity investments                         52,196,090        33,530,817       37,228,000    Proceeds from sale of fixed maturity investments                                      -                 -                -    Net (increase) decrease in short-term investments                            (1,357,044)        4,112,347        1,807,719    Additions to property and equipment                                            (706,671)          (50,398)         (58,717)                                                                                  ---------        ----------       ----------          Net Cash (Used) by Investing Activities                                (9,312,326)      (13,854,584)     (16,257,164)                                                                                  ---------        ----------       ---------- Cash flows from financing activities:    Proceeds from issuance of common stock                                           12,440             7,775                -    Proceeds from notes payable - related parties                                         -                 -        1,500,000    Repayment of notes payable - related parties                                   (500,000)       (1,000,000)        (750,000)                                                                                    -------         ---------          -------          Net Cash Provided (Used) by Financing Activities                         (487,560)         (992,225)         750,000                                                                                    -------           -------          -------  Net increase (decrease) in cash                                                     (1,544)          (22,972)          18,222       Cash at beginning of year                                                      15,016            37,988           19,766                                                                                     ------            ------           ------         Cash at End of Year                                                        $13,472           $15,016          $37,988                                                                                     ======            ======           ======  Supplemental cash flow information Cash paid during the period for:          Interest                                                                   $6,330           $13,666         $124,788          Income taxes                                                           $3,740,922        $3,383,876         $370,520               See accompanying notes to consolidated financial statements.                                          39                              UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------- Nature of Business - ----------------- Unico American Corporation is an insurance holding company that underwrites property and casualty insurance through its insurance company subsidiary; provides property, casualty, health and life insurance through its agency subsidiaries; and provides insurance premium financing and membership association services through its other subsidiaries. Unico American Corporation is referred to herein as the "Company" or "Unico" and such references include both the corporation and its subsidiaries, all of which are wholly owned, unless otherwise indicated. Unico was incorporated under the laws of Nevada in 1969.  Principles of Consolidation - --------------------------- The consolidated financial statements include the accounts of Unico American Corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.  Basis of Presentation - --------------------- The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (GAAP). As described in Note 14, the Company's insurance subsidiary also files financial statements with regulatory agencies prepared on a statutory basis of accounting that differs from GAAP.  Use of Estimates - ---------------- The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of certain assets, liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. While every effort is made to ensure the integrity of such estimates, actual results may differ.  Investments - ----------- All of the Company's fixed maturity investments are classified as available-for-sale and are stated at market value. Although all of the Company's investments are classified as available-for-sale and the Company may sell investment securities from time to time in response to economic and market conditions, its investment guidelines place primary emphasis on buying and holding high-quality investments to maturity. Short-term investments are carried at cost, which approximates market value. The unrealized gains or losses from fixed maturities are reported as "accumulated other comprehensive income (loss)," which is a separate component of stockholders' equity, net of any deferred tax effect. When a decline in value of a fixed maturity or equity security is considered other than temporary, a loss is recognized in the consolidated statements of operations. Realized gains and losses, if any, are included in the consolidated statements of operations based on the specific identification method.  The Company had unrealized investment losses, net of deferred taxes, of $382,224 as of December 31, 2005, and unrealized investment gains, net of deferred taxes, of $376,172 as of December 31, 2004.  Property and Equipment - ---------------------- Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight line methods over the estimated useful lives of the related assets.  Income Taxes - ------------ The provision for federal income taxes is computed on the basis of income as reported for financial reporting purposes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and are measured using the enacted tax rates and laws expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Income tax expense provisions increase or decrease in the same period in which a change in tax rates is enacted.                                          40                              UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   Fair Value of Financial Instruments - ----------------------------------- The Company has used the following methods and assumptions in estimating its fair value disclosures:         o Investment Securities - Fair values for fixed maturity securities are          obtained from a national quotation service. The fair values for equity          securities are based on quoted market prices.         o Cash and Short-Term  Investments - The carrying amounts reported in the          balance sheet for these instruments  approximate their fair values.         o Premiums and Notes  Receivable - The carrying amounts reported in the          balance sheet for these  instruments  approximate  their fair values.  Earnings Per Share - ------------------ Basic earnings per share exclude the impact of common share equivalents and are based upon the weighted average common shares outstanding. Diluted earnings per share utilize the average market price per share when applying the treasury stock method in determining common share dilution. When dilutive, outstanding stock options are treated as common share equivalents for purposes of computing diluted earnings per share and represent the difference between basic and diluted weighted average shares outstanding. In loss periods, options are excluded from the calculation of diluted earnings per share, as the inclusion of such options would have antidilutive effect.  Revenue Recognition - -------------------      a.  General Agency Operations      -----------------------------      Commissions and policy fees due the Company are recognized as income on the      effective date of the insurance policies.       b.  Insurance Company Operations      --------------------------------      Premiums are earned on a pro-rata basis over the terms of the policies.      Premiums applicable to the unexpired terms of policies in force are      recorded as unearned premiums. The Company earns a commission on policies      that are ceded to its reinsurers. This commission is considered earned on a      pro-rata basis over the terms of the policies.       c.  Insurance Premium Financing Operations      ------------------------------------------      Premium finance interest is charged to policyholders who choose to finance      insurance premiums. Interest is charged at rates that vary with the amount      of premium financed. Premium finance interest is recognized using a method      that approximates the interest (actuarial) method.  Losses and Loss Adjustment Expenses - ----------------------------------- The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates based on experience and industry data for development of case estimates and for unreported losses and loss adjustment expenses.  There is a high level of uncertainty inherent in the evaluation of the required loss and loss adjustment expense reserves for the Company. The long-tailed nature of liability claims and the volatility of jury awards exacerbate that uncertainty. 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 related expenses incurred as of that date for both reported and unreported losses. The ultimate cost of claims is dependent upon future events, the outcomes of which are affected by many factors. Company claim reserving procedures and settlement philosophy, current and perceived social and economic inflation, current and future court rulings and jury attitudes, improvements in medical technology, and many other economic, scientific, legal, political, and social factors all can have significant effects on the ultimate costs of claims. Changes in Company operations and management philosophy also may cause actual developments to vary from the past. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle claims may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made. Management believes that the aggregate reserves for losses and loss adjustment expenses are reasonable and adequate to cover the cost of claims, both reported and unreported.                                          41                              UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   Restricted Funds - ---------------- Restricted funds are as follows:                                                    Year ended December 31                                                    ----------------------                                                   2005                2004                                                   ----                ---- Premium trust funds (1)                         $265,668            $773,404 Cash deposited in lieu of bond (2)               200,000             752,659 Assigned to state agencies (3)                   700,000             700,000                                                ---------           ---------   Total restricted funds                      $1,165,668          $2,226,063                                                =========           =========        (1)  As required by law, the Company segregates from its operating            accounts the premiums collected from insurers which are payable to            insurance companies into separate trust accounts. These amounts are            included in cash and short-term investments.        (2)  Included in short-term investments are two deposits assigned and held            by Travis County and the Los Angeles Superior courts. These deposits            are filed with the superior courts in lieu of a bond in order to stay            execution of judgments and to allow the Company to appeal the            judgment in these matters.        (3)  Included in fixed maturity investments are statutory deposits            assigned to and held by the California State Treasurer and the            Insurance Commissioner of the State of Nevada. These deposits are            required for writing certain lines of business in California and for            admission in states other than California.  Deferred Policy Acquisition Costs - --------------------------------- Policy acquisition costs consist of costs associated with the production of insurance policies such as commissions, premium taxes, and certain other underwriting expenses that vary with and are primarily related to the production of the insurance policy. Policy acquisition costs are deferred and amortized as the related premiums are earned and are limited to their estimated realizable value based on the related unearned premiums plus investment income less anticipated losses and loss adjustment expenses. Ceding commission applicable to the unexpired terms of policies in force is recorded as unearned ceding commission, which is included in deferred policy acquisition costs.  Reinsurance - ----------- The Company cedes reinsurance to provide for greater diversification of business, to allow management to control exposure to potential losses arising from large risks by reinsuring certain levels of risk in various areas of exposure, to reduce the loss that may arise from catastrophes, and to provide additional capacity for growth. Prepaid reinsurance premiums and reinsurance receivables are reported as assets and represent ceded unearned premiums and reinsurance recoverable on both paid and unpaid losses, respectively. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies.  Segment Reporting - ----------------- Statement of Financial Accounting Standards No. 131 (SFAS No. 131), "Disclosures about Segments of an Enterprise and Related Information", became effective for fiscal years effective after December 15, 1997. SFAS No. 131 establishes standards for the way information about operating segments is reported in financial statements. The Company has identified its insurance company operation as its primary reporting segment. Revenues from this segment comprised 90% of consolidated revenues in the year ended December 31, 2005, 88% of consolidated revenues in the year ended December 31, 2004, and 82% for the year ended December 31, 2003. The Company's remaining operations constitute a variety of specialty insurance services, each with unique characteristics and individually insignificant to consolidated revenues.  The insurance company operation is conducted through the Company's wholly owned subsidiary Crusader Insurance Company (Crusader), which as of December 31, 2005, was licensed as an admitted insurance carrier in the states of Arizona, California, Montana, Nevada, Oregon, and Washington. Crusader is a multiple-line property and casualty insurance company, which began transacting business on January 1, 1985. As of December 31, 2005, 97% of Crusader's business was commercial multiple peril insurance policies. Commercial multiple peril                                          42                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   policies provide a combination of property and liability coverage for businesses. Commercial property coverages insure against loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, hail, water, explosions, severe winter weather and other events such as theft and vandalism, fires and storms and financial loss due to business interruption resulting from covered property damage. Commercial liability coverages insure against third party liability from accidents occurring on the insured's premises or arising out of its operations, such as injuries sustained from products sold or operation of the insured premises. In addition to commercial multiple peril policies, Crusader also writes separate policies to insure commercial property and commercial liability risks on a mono-line basis.  Revenues, income before income taxes and assets by segment are as follows:                                                 Year ended December 31                                                ----------------------                                          2005           2004           2003                                          ----           ----           ---- Revenues - -------- Insurance company operation          $54,833,512    $54,414,947     $42,005,474                                       ----------     ----------      ----------  Other insurance operations            22,847,069     26,380,789      26,684,721 Intersegment elimination (1)         (16,498,059)   (18,892,426)    (17,559,756)                                       ----------     ----------       ---------   Total other insurance operations     6,349,010      7,488,363       9,124,965                                        ---------      ---------       ---------     Total revenues                    $61,182,522    $61,903,310     $51,130,439                                       ==========     ==========      ==========  Income (loss) before income taxes - --------------------------------- Insurance company operation           $9,615,682     $5,333,273     $(3,208,657) Other insurance operations               850,748      3,339,185       5,358,028                                       ----------      ---------       ---------   Total income before income taxes   $10,466,430     $8,672,458      $2,149,371                                       ==========      =========       =========  Assets - ------ Insurance company operation         $166,911,366   $151,963,707    $138,247,845 Intersegment eliminations (2)         (2,180,548)    (2,285,589)     (2,302,224)                                      -----------    -----------     -----------   Total insurance company operation  164,730,818    149,678,118     135,945,621 Other insurance operations            21,566,361     22,892,158      25,548,074                                       ----------    -----------     -----------   Total assets                      $186,297,197   $172,570,276    $161,493,695                                      ===========    ===========     ===========  (1) Intersegment revenue eliminations reflect commissions paid by Crusader to Unifax. (2) Intersegment asset eliminations reflect the elimination of Crusader receivables and Unifax payables.  Concentration of Risks - ---------------------- In 2005 100% of Crusader's gross premium written was derived from California. In 2005 approximately 72% of the $1,628,062 commission and fee income from the Company's health and life insurance program was from CIGNA HealthCare medical and dental plan programs.  At December 31, 2005, the Company's reinsurance recoverable on paid and unpaid losses and loss adjustment expenses of $27,390,791 were as follows:                                    A.M. Best        Amount Name of Reinsurer                  Rating        Recoverable - -----------------                  ------        ----------- Platinum Reinsurance                  A          $13,163,454 Partners Reinsurance of the U.S.      A+           4,779,820 Hannover Ruckversicherungs AG         A            6,866,748 General Reinsurance Corporation       A++          1,725,709 QBE Reinsurance Corporation           A              855,060                                                   ----------      Total                                       $27,390,791                                                   ==========                                          43                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   Stock-Based Compensation - ------------------------ The Company applies the intrinsic-value based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations including FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation," an interpretation of APB Opinion No. 25, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. FASB Statement No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," and FASB Statement No. 148, "Accounting for Stock Based Compensation - Transition and Disclosure," an amendment of SFAS 123, established accounting and disclosure requirements using a fair-value based method of accounting for stock-based employee compensation plans. As permitted by existing accounting standards, the Company has elected to continue to apply the intrinsic-value based method of accounting described above and has adopted only the disclosure requirements of SFAS 123, as amended. In December 2004, FASB Statement No. 123R (SFAS 123R) which revised SFAS 123 was issued and will be applicable for the Company in 2006 (see Note 15).  On December 30, 2005, the Company accelerated the vesting of all of its outstanding stock-based compensation awards granted under the Company's 1999 Omnibus Stock Plan. All accelerated options were "in the money." The number shares covered by the options accelerated totaled 67,500 of which 37,500 were originally scheduled to vest on January 1, 2006 and 30,000 were originally scheduled to vest on January 1, 2007. The Company accelerated vesting of the options in order to minimize the compensation costs associated with the adoption of SFAS 123R. All accelerated options were granted to long-term management employees who were not expected to leave the Company prior to the originally scheduled vesting date. The estimated compensation cost that will be excluded from future periods as a result of the acceleration of the vesting of the options is approximately $89,100.  Had compensation cost for the Company's stock-based compensation plan been reflected in the accompanying consolidated financial statements based on the fair value at the grant dates for option awards consistent with the method of SFAS 123, the Company's net income would have been reduced to the pro forma amounts indicated below:                                                    Year ended December 31                                                   ----------------------                                                2005         2004         2003                                                ----         ----         ---- Net income   As reported                               $6,715,004   $5,681,500   $1,068,650  Deduct:   Total stock-based employee compensation    expense determined under fair value    based method for all awards,    net of related tax effects                        -       43,604       51,639    Estimated stock-based employee compensation   expense due to the acceleration of future   stock options net of related tax effects      89,100            -            -                                              ---------    ---------    ---------       Pro forma                             $6,625,904   $5,637,896   $1,017,011                                              =========    =========    =========  Income per share   As reported                                    $1.22        $1.03        $0.19   Pro forma                                      $1.21        $1.03        $0.19  Income per share - assuming dilution:   As reported                                    $1.20        $1.02        $0.19   Pro forma                                      $1.18        $1.01        $0.18                                          44                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   Calculations of the fair value under the method prescribed by SFAS No. 123 were made using the Black-Scholes Option-Price Model with the following weighted average assumptions used for the 1999 and 2002 grants:                                          2002         1999                                         ----         ---- Dividend yield                          1.40%        2.46% Expected volatility                      34%          43% Expected lives                        10 Years     10 Years Risk-free interest rates                4.05%        6.09% Fair value of options granted           $1.32        $4.30  Recently Issued Accounting Standards - ------------------------------------ In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R") that will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity instrument issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123R replaces Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees" and its related implementation guidance; the principles that the Company currently employs to account and report its employee stock option awards. On April 14, 2005, the Securities and Exchange Commission issued a Final Rule amending Regulation S-X to revise the date for compliance with SFAS No. 123R so that each registrant that is not a small business issuer will be required to prepare financial statements in accordance with SFAS No. 123R beginning with the first interim reporting period of the registrant's first fiscal year beginning on or after June 15, 2005. The Company will adopt the provisions of SFAS No. 123R in January 2006. The Company does not believe that the adoption of SFAS No. 123R will have a material impact on its consolidated financial statements.  In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections" ("SFAS No. 154"). SFAS No. 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to a newly adopted accounting principle. The statement will be effective for the Company for all accounting changes and any error corrections occurring after January 1, 2006.  FASB Staff Position (FSP) No. 115-I, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." FSP 115-1 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. If, after consideration of all available evidence to evaluate the realizable value of its investment, impairment is determined to be other-than-temporary, then an impairment loss should be recognized equal to the difference between the investment's cost and its fair value. FSP 115-1 nullifies certain provisions of Emerging Issues Task Force (EITF) Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," while retaining the disclosure requirements of EITF 03-1 which were adopted in 2003. FSP 115-1 is effective for reporting periods beginning after December 15, 2005. The Company does not expect FSP 115-1 will significantly impact its financial statements upon its adoption on January 1, 2006.  There were no other accounting standards issued during 2005 that are expected to have a material impact on the Company's consolidated financial statements.   NOTE 2 - ADVANCE PREMIUM AND PREMIUM DEPOSITS - --------------------------------------------- Some of the Company's health and life programs require payments of premium prior to the effective date of coverage; and, accordingly, invoices are sent out as early as two months prior to the coverage effective date. Insurance premiums received for coverage months effective after the balance sheet date are recorded as advance premiums. The Company received deposits to guarantee the payment of premiums for past coverage months on its daily automobile rental program. These deposits are required when information such as gross receipts or                                          45                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   number of rental cars is required to compute the actual premium due, but is not available until after the coverage month.   NOTE 3 - INVESTMENTS - -------------------- The amortized cost and estimated fair values of investments in fixed maturities by categories are as follows:                                                                                     Gross             Gross         Estimated                                                              Amortized         Unrealized       Unrealized         Fair                                                                 Cost             Gains             Losses          Value                                                                 ----             -----             ------          -----      December 31, 2005 - ----------------- Available for sale:   Fixed maturities   ----------------   Certificates of deposit                                       $500,000               -                 -           $500,000   U.S. treasury securities                                   107,290,653               -          $727,741        106,562,912   U.S. government sponsored enterprise securities              6,000,000               -            66,570          5,933,430   State and municipal tax-exempt bonds                           934,536               -            12,551            921,985   Industrial and miscellaneous taxable bonds                  21,403,239        $262,912            35,178         21,630,973                                                              -----------         ------            -------        -----------      Total fixed maturities                                 $136,128,428        $262,912          $842,040       $135,549,300                                                              ===========         =======           =======        ===========  December 31, 2004 - ----------------- Available for sale:   Fixed maturities   ----------------   Certificates of deposit                                       $500,000               -                 -           $500,000   U.S. treasury securities                                    77,765,616         $47,620          $514,331         77,298,905   U.S. government sponsored enterprise securities             11,998,772               -           145,712         11,853,060   State and municipal tax-exempt bonds                           970,343               -            12,024            958,319   Industrial and miscellaneous taxable bonds                  37,754,927       1,194,404                 -         38,949,331                                                              -----------       ---------           -------        -----------      Total fixed maturities                                 $128,989,658      $1,242,024          $672,067       $129,559,615                                                              ===========       =========           =======        ===========   A summary of the unrealized appreciation (depreciation) on investments carried at fair value and the applicable deferred federal income taxes are shown below:                                                                                              Year ended December 31                                                                                           ----------------------                                                                                   2005             2004               2003                                                                                   ----             ----               ----     Gross unrealized appreciation of fixed maturities:                              $262,912        $1,242,024         $3,236,623 Gross unrealized (depreciation) of fixed maturities:                            (842,040)         (672,067)           (38,169)                                                                                  -------           -------          --------- Net unrealized appreciation (depreciation) on investments                       (579,128)          569,957          3,198,454 Deferred federal tax income (expense)                                            196,904          (193,785)        (1,087,475)                                                                                  -------           -------          ---------    Net unrealized appreciation (depreciation), net of deferred income taxes    $(382,224)         $376,172         $2,110,979                                                                                  =======           =======          =========   The amortized cost and estimated fair value of fixed maturity investments at December 31, 2005, by contractual maturity are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.                                                     Amortized          Estimated                                                     Cost            Fair Value                                                   ----------         ---------- Due in one year or less                          $62,721,805        $62,292,261 Due after one year through five years             73,406,623         73,257,039 Due after five years through ten years                     -                  -                                                  -----------        -----------    Total fixed maturities                       $136,128,428       $135,549,300                                                  ===========        ===========                                          46                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   The following table illustrates the gross unrealized losses included in the Company's investment portfolio and the fair value of those securities, aggregated by investment category. The table also illustrates the length of time that they have been in a continuous unrealized loss position as of December 31, 2005.                        Amortized                                  Gross                         Cost              Fair Value         Unrealized Loss                         ----              ----------         --------------- 0-6 months           $46,834,903          $46,585,392           $249,511 7-12 months           14,327,095           14,166,247            160,848 Over 12 months        50,421,376           49,989,695            431,681                      -----------          -----------            -------   Total             $111,583,374         $110,741,334           $842,040                      ===========          ===========            =======  At December 31, 2005, the fixed maturity investments with a gross unrealized loss for a continuous period of 0 to 6 months consisted of U.S. treasury securities and investment grade industrial securities. The fixed maturity investments with a gross unrealized loss position for a continuous period of 7 to 12 months consisted of U.S. treasury securities and investment grade industrial securities. The fixed maturity investments with a gross unrealized loss position for a continuous period over 12 months consisted of U.S. treasury securities, U.S. government sponsored enterprise securities, and pre-refunded municipal bonds. The unrealized loss is primarily due to rising interest rates. The Company monitors its investments closely. If an unrealized loss is determined to be other than temporary, it is written off as a realized loss through the Consolidated Statements of Operations. The Company's methodology of assessing other-than-temporary impairments is based on security-specific analysis as of the balance sheet date and considers various factors including the length of time to maturity and the extent to which the fair value has been less than the cost, the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, and the Company's intent to hold the investment for a period of time sufficient to allow the Company to recover its costs. The Company has concluded that the gross unrealized losses of $842,040 at December 31, 2005, were temporary in nature. However, facts and circumstances may change which could result in a decline in market value considered to be other than temporary. The Company did not sell any fixed maturity investment in the years ended December 31, 2005 and 2004.  Short-term investments have an initial maturity of one year or less and consist of the following:                                                         Year ended December 31                                                        ----------------------                                                         2005             2004                                                         ----             ----  Certificates of deposit                               $100,000         $400,000 Cash deposited in lieu of bond*                        200,000          752,659 Commercial paper                                     1,830,000        1,005,000 Bank money market accounts                             182,673          803,949 U.S. government obligation money market fund         2,150,671          144,925 Bank savings accounts                                   11,818           11,585                                                      ---------        ---------    Total short-term investments                     $4,475,162       $3,118,118                                                      =========        =========  *Deposits with superior courts to stay execution of judgment pending appeal of Crusader claims.  The Company manages its own investment portfolio. A summary of net investment and related income is as follows:                                                Year ended December 31                                               ----------------------                                     2005               2004             2003                                     ----               ----             ----  Fixed maturities                 $4,218,302         $4,200,190       $4,742,204 Short-term investments               98,925             42,633          105,939                                   ---------          ---------        ---------      Total investment income     $4,317,227         $4,242,823       $4,848,143                                   =========           ========        =========                                          47                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   NOTE 4 - PROPERTY AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION) - ---------------------------------------------------------------- Property and equipment consist of the following:                                                        Year ended December 31                                                        ----------------------                                                        2005              2004                                                        ----              ---- Furniture, fixtures, computer, office,   and transportation equipment                      $2,197,041        $1,599,077 Accumulated depreciation                             1,372,537         1,320,673                                                      ---------         ---------    Net property and equipment                         $824,504          $278,404                                                        =======           =======   NOTE 5 - PREMIUMS, COMMISSIONS AND NOTES RECEIVABLE, NET - -------------------------------------------------------- Premiums, commissions and notes receivable, net are as follows:                                                         Year ended December 31                                                        ----------------------                                                        2005               2004                                                        ----               ---- Premiums and commission receivable                  $2,690,402        $2,947,130 Premium finance notes receivable                     4,057,137         4,843,060                                                      ---------         ---------    Total premiums and notes receivable               6,747,539         7,790,190 Less allowance for doubtful accounts                     6,746            19,630                                                      ---------         ---------    Net premiums and notes receivable                $6,740,793        $7,770,560                                                      =========         =========  Premiums and notes receivable are substantially secured by unearned premiums and funds held as security for performance.  Bad debt expense for the year ended December 31, 2005, and the year ended December 31, 2004, were $8,927 and $29,402, respectively. Premium finance notes receivable represent the balance due to the Company's premium finance subsidiary from policyholders who elect to finance their premiums over the policy term. These notes are net of unearned finance charges.   NOTE 6 - NOTES PAYABLE - RELATED PARTIES - ---------------------------------------- Notes payable - related parties consist of the following:                                                         Year ended December 31                                                        ----------------------                                                        2005              2004                                                        ----              ---- Note payable - Erwin Cheldin                                 -         $500,000                                                                         -------    Notes payable - related parties                           -         $500,000                                                                         =======  In 2003, Unico made capital contributions totaling $3,000,000 to its Crusader subsidiary. The contributions were made to ensure that Crusader's capital remained above $25,000,000. The funding of Unico's capital contribution to Crusader was derived from available cash from the Company's other operations and the proceeds of two notes. On September 29, 2003, the Company borrowed $1,000,000 from Erwin Cheldin, a director and the Company's principal shareholder, president and chief executive officer, and $500,000 from The Cary and Danielle Cheldin Family Trust. Cary L. Cheldin is a director and the Company's executive vice president. As of December 31, 2004, the Company repaid the note from The Cary and Danielle Cheldin Family Trust in full and repaid $500,000 of the Erwin Cheldin note. On April 29, 2005, the note to Erwin Cheldin was paid in full.                                          48                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   NOTE 7 - UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES - --------------------------------------------------- The following table provides an analysis of the roll forward of Crusader's losses and loss adjustment expenses, including a reconciliation of the ending balance sheet liability for the periods indicated:                                                                                   Year ended December 31                                                                                ----------------------                                                                       2005              2004               2003                                                                       ----              ----               ----     Reserve for unpaid losses and loss adjustment expenses   at beginning of year - net of reinsurance                        $67,349,989       $58,883,861        $53,596,945                                                                     ----------        ----------         ----------  Incurred losses and loss adjustment expenses    Provision for insured events of current year                     35,338,196        35,286,172         28,968,948    Increase (decrease) in provision for events of prior years       (3,824,464)         (835,434)         2,751,585                                                                     ----------        ----------         ----------        Total losses and loss adjustment expenses                    31,513,732        34,450,738         31,720,533                                                                     ----------        ----------         ----------  Payments    Losses and loss adjustment expenses attributable to      insured events of the current year                              8,001,808         7,438,331          5,106,929    Losses and loss adjustment expenses attributable to      insured events of prior years                                  14,626,446        18,546,279         21,326,688                                                                     ----------        ----------         ----------        Total payments                                               22,628,254        25,984,610         26,433,617                                                                     ----------        ----------         ----------  Reserve for unpaid losses and loss adjustment expenses   at end of year - net of reinsurance                               76,235,467        67,349,989         58,883,861 Reinsurance recoverable on unpaid losses and loss   adjustment expenses at end of year                                25,679,081        20,119,011         19,255,229                                                                     ----------        ----------         ---------- Reserve for unpaid losses and loss adjustment expenses at   end of year per balance sheet, gross of reinsurance*            $101,914,548       $87,469,000        $78,139,090                                                                    ===========        ==========         ==========   * In accordance with Financial Accounting Standards Board Statement No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts", reinsurance recoverable on unpaid losses and loss adjustment expenses are reported for GAAP as assets rather than netted against the corresponding liability for such items on the balance sheet.  Loss and loss adjustment expense reserves by line of business before reinsurance are as follows:                                                                     Year ended December 31                                                                  ---------------------- Line of Business                         2005                             2004                             2003 - ----------------                  ------------------                -----------------                -------------------            CMP                            $98,758,298    96.9%              $83,677,560   95.7%              $73,708,553     94.3%   Other Liability                  2,967,804     2.9%                3,592,719    4.1%                4,279,021      5.5%   Other                              188,446     0.2%                  198,721    0.2%                  151,516      0.2%                                  -----------   -----                ----------  -----                ----------    -----      Total                      $101,914,548   100.0%              $87,469,000  100.0%              $78,139,090    100.0%                                  ===========   ======               ==========  =====                ==========    =====   The Company`s consolidated financial statements include estimated reserves for unpaid losses and related claim settlement or loss adjustment expenses of our insurance company operation. Crusader 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 related expenses incurred as of that date for both reported and unreported losses. The process of estimating loss and loss adjustment reserves involves significant judgment and is complex and imprecise due to the number of variables and assumptions inherent in the estimating process. Crusader establishes reserves for reported losses based on historical experience, upon case-by-case evaluation of facts surrounding each known loss and the related policy provisions. The amount of reserves for unreported losses is estimated by analysis of historical and statistical information. Reserves are monitored and adjusted when appropriate and reflected in the statement of operations in the period of adjustment.  Losses and loss adjustment expenses were $31,513,732 or 62% of net premium earned for the year ended December 31, 2005, compared to $34,450,738 or 69% of net premium earned for the year ended December 31, 2004, and compared to $31,720,533 or 85% of net premium earned for the year ended December 31, 2003. Incurred losses of prior years were $3,824,464 (favorable development) for the year ended December 31, 2004,                                          49                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   compared to incurred losses of prior years of $835,434 (favorable development) for the year ended December 31, 2004, and incurred losses of prior years of $2,751,585 (adverse development) for the year ended December 31, 2003.   NOTE 8 - DEFERRED POLICY ACQUISITION COSTS - ------------------------------------------ The following table provides an analysis of the roll forward of Crusader's deferred policy acquisition costs:                                                                            Year ended December 31                                                                         ----------------------                                                                 2005             2004              2003                                                                 ----             ----              ----     Deferred policy acquisition costs at beginning of year       $8,203,238        $8,054,363        $5,947,010 Policy acquisition costs incurred during year                 9,665,629        10,468,061        10,048,552 Policy acquisition costs amortized during year              (10,512,688)      (10,319,186)       (7,941,199)                                                               ---------        ----------         ---------    Deferred policy acquisition costs at end of year          $7,356,179        $8,203,238        $8,054,363                                                               =========         =========         =========   Deferred policy acquisition costs consist of commissions (net of ceding commission), premium taxes, inspection fees, and certain other underwriting costs, which are related to and vary with the production of Crusader policies. Policy acquisition costs are deferred and amortized as the related premiums are earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future income, including investment income.  The 8% decrease in policy acquisition incurred during the year ended December 31, 2005, is a direct result of the 5% decrease in direct earned premium during the year ended December 31, 2005, compared to the year ended December 31, 2004.  The 30% increase in policy acquisition amortized during the year ended December 31, 2004, is a direct result of the 26% increase in direct earned premium during the year ended December 31, 2004, compared to the year ended December 31, 2003.   NOTE 9 - LEASE COMMITMENT TO RELATED PARTY - ------------------------------------------ The lease commitment provides for the following minimum annual rental commitments:     Year ending    December 31, 2006                                           1,025,952    December 31, 2007 (through March 31, 2007)                    256,488                                                                ---------         Total minimum payments                                $1,282,440                                                                =========  The Company presently occupies a 46,000 square foot building located at 23251 Mulholland Drive, Woodland Hills, California, under a master lease expiring March 31, 2007. The total rent expense under this lease agreement was $1,025,952 for the year ended December 31, 2005; $1,025,952 for the year ended December 31, 2004; and $1,025,952 for the year ended December 31, 2003.  Erwin Cheldin, the Company's president, chairman, and principal stockholder, is the owner of the building. On February 22, 1995, the Company signed an extension to the lease with no increase in rent to March 31, 2007. The Company believes that the terms of the lease at inception and at the time the lease extension was signed were at least as favorable to the Company as could have been obtained from non-affiliated third parties. The Company utilizes for its own operations 100% of the space it leases.                                          50                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   NOTE 10 - ACCRUED EXPENSES AND OTHER LIABILITIES - ------------------------------------------------  Accrued expenses and other liabilities consist of the following:                                                         Year ended December 31                                                        ----------------------                                                        2005              2004                                                        ----              ----     Premium payable                                  $2,494,285        $3,394,181    Unearned claim administration income                 30,000           100,000    Profit sharing contributions                        645,000           636,186    Accrued salaries                                    333,354           331,054    Commission payable                                  210,451           333,525    Other                                               195,331           429,837                                                      ---------         ---------       Total accrued expenses and other liabilities  $3,908,421        $5,224,783                                                      =========         =========   NOTE 11 - COMMITMENT AND CONTINGENCIES - -------------------------------------- The Company, by virtue of the nature of the business conducted by it, becomes involved in numerous legal proceedings as either plaintiff or defendant. The Company is also required to resort to legal proceedings from time to time in order to enforce collection of premiums, commissions, or fees for the services rendered to customers or to their agents. These routine items of litigation do not materially affect the Company and are handled on a routine basis by the Company through its general counsel.  Likewise, the Company is sometimes named as a cross-defendant in litigation, which is principally directed against that insurer who was issued a policy of insurance directly or indirectly through the Company. Incidental actions are sometimes brought by customers or others, which relate to disputes concerning the issuance or non-issuance of individual policies. These items are also handled on a routine basis by the Company's general counsel, and they do not materially affect the operations of the Company. Management is confident that the ultimate outcome of pending litigation should not have an adverse effect on the Company's consolidated operation or financial position.   NOTE 12 - REINSURANCE - --------------------- A reinsurance transaction occurs when an insurance company transfers (cedes) a portion of its exposure on policies written by it to a reinsurer that assumes that risk for a premium (ceded premium). Reinsurance does not legally discharge the Company from primary liability under its policies. If the reinsurer fails to meet its obligations, the Company must nonetheless pay its policy obligations.  Crusader's primary excess of loss reinsurance agreements are as follows:         Loss                                                                                 Annual Aggregate Year       Reinsurer Company(s)                             Rating       Retention       Deductible - ----       -----------------------------------------        ------       ---------       ---------- 2005       Platinum Underwriters Reinsurance, Inc. &           A            Hannover Ruckversicherungs AG                       A         $300,000        $500,000 - ----       -----------------------------------------        ------        -------         ------- 2004       Platinum Underwriters Reinsurance, Inc. &           A            Hannover Ruckversicherungs AG                       A         $250,000        $500,000 - ----       -----------------------------------------        ------        -------         ------- 2003       Platinum Underwriters Reinsurance, Inc. &           A            Hannover Ruckversicherungs AG &                     A            QBE Reinsurance Corporation                         A         $250,000        $500,000 - ----       -----------------------------------------        ------        -------         ------- 2002       Partner Reinsurance Company of the U.S.             A+        $250,000        $675,000 - ----       -----------------------------------------        ------        -------         ------- 2001       Partner Reinsurance Company of the U.S.             A+        $250,000        $500,000 - ----       -----------------------------------------        ------        -------         ------- 2000       Partner Reinsurance Company of the U.S.             A+        $250,000        $500,000 - ----        ----------------------------------------        ------        -------         ------- 1999       General Reinsurance Corporation                     A++       $250,000        $750,000 - ----       -----------------------------------------        ------        -------         ------- 1998       General Reinsurance Corporation                     A++       $250,000        $750,000 - ----       -----------------------------------------        ------        -------         -------                                           51                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   Prior to January 1, 1998, National Reinsurance Corporation (acquired by General Reinsurance Corporation in 1996) charged a provisional rate on exposures up to $500,000 that was subject to adjustment and was based on the amount of losses ceded, limited by a maximum percentage that could be charged. That provisionally rated treaty was cancelled on a runoff basis and replaced by a flat rated treaty on January 1, 1998. In 2005, Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($700,000 in excess of $300,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2004 Crusader retained a participation in its excess of loss reinsurance treaties of 10% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. In 2003 Crusader retained a participation in its excess of loss reinsurance treaties of 5% in its 1st layer ($750,000 in excess of $250,000), 10% in its 2nd layer ($1,000,000 in excess of $1,000,000), and 30% in its property and casualty clash treaties. Crusader also has catastrophe reinsurance from various highly rated California admitted and Bermuda reinsurance companies. These reinsurance agreements help protect Crusader 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 Crusader insures. The Company has no reinsurance recoverable balances in dispute.  Crusader's 2004 and 2003 1st layer primary excess of loss treaty provides for a contingent commission to the Company equal to 45% of the net profit, if any, accruing to the reinsurer. The first accounting period for the contingent commission covers the period from January 1, 2003, through December 31, 2005. The Company will calculate and report to the reinsurer its net profit, if any, within 90 days after 36 months following the end of the first accounting period and within 90 days after the end of each 12 month period thereafter until all losses subject the to agreement have been finally settled. Based on losses and loss adjustment expenses ceded (including incurred but not reported losses) as of December 31, 2005, no contingent commission has been accrued. The 2005 1st layer primary excess of loss treaty does not provide for a contingent commission.  On most of the premium that Crusader cedes to the reinsurer, the reinsurer pays a commission to Crusader, which includes a reimbursement of the cost of acquiring the portion of the premium, which is ceded. Ceding commission was $4,647,748 in 2005, $6,031,987 in 2004, and $5,429,330 in 2003. Crusader does not currently assume any reinsurance. The Company intends to continue obtaining reinsurance although the availability and cost may vary from time to time. The unpaid losses ceded to the reinsurer are recorded as an asset on the balance sheet.  The effect of reinsurance on premiums written, premiums earned, and incurred losses is as follows:                                                                            Year ended December 31                                                                         ----------------------                                                              2005                2004                2003                                                              ----                ----                ----     Premiums written:    Direct business                                        $60,268,784         $68,872,021         $64,047,717    Reinsurance assumed                                              -                   -                   -    Reinsurance ceded                                      (14,238,077)        (17,782,448)        (16,627,560)                                                            ----------          ----------          ----------       Net premiums written                                $46,030,707         $51,089,573         $47,420,157                                                            ==========          ==========          ==========  Premiums earned:    Direct business                                        $64,712,764         $67,890,808         $53,754,119    Reinsurance assumed                                              -                   -                   -    Reinsurance ceded                                      (14,234,844)        (17,784,240)        (16,648,020)                                                            ----------          ----------          ----------       Net premiums earned                                 $50,477,920         $50,106,568         $37,106,099                                                            ==========          ==========          ==========  Incurred losses and loss adjustment expenses:    Direct                                                 $43,901,853         $40,436,295         $39,036,895    Assumed                                                       -                   -                   -    Ceded                                                  (12,388,121)         (5,985,557)         (7,316,362)                                                            ----------          ----------          ----------       Net incurred losses and loss adjustment expenses    $31,513,732         $34,450,738         $31,720,533                                                            ==========          ==========          ==========   Reinsurance ceded premium as a percentage of direct earned premium was 22% in 2005, 26% in 2004 and 31% in 2003. The decrease in the ratio is primarily the result of rate decreases by the Company's reinsurers due to the Company's improving ceded loss experience.                                          52                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   NOTE 13 - RETIREMENT PLANS - -------------------------- Profit Sharing Plan - ------------------- During the fiscal year ended March 31, 1986, the Company adopted the Unico American Corporation Profit Sharing Plan. Company employees who are at least 21 years of age and have been employed by the Company for at least two years are participants in such Plan. Pursuant to the terms of such Plan, the Company annually contributes for the account of each participant an amount equal to a percentage of the participant's eligible compensation as determined by the Board of Directors. Participants must be employed by the Company on the last day of the plan year to be eligible for contribution. Participants are entitled to receive distribution of benefits under the Plan upon retirement, termination of employment, death or disability.  Money Purchase Plan - ------------------- During the year ended December 31, 1999, the Company adopted the Unico American Corporation Money Purchase Plan. This plan covers the present executive officers of the Company. Pursuant to the terms of such Plan, the Company annually contributes for the account of each participant an amount equal to a percentage of the participant's eligible compensation as determined by the Board of Directors. However, amounts contributed to the Unico American Corporation Profit Sharing Plan will be considered first in determining the actual amount available under the Internal Revenue Service maximum contribution limits. Participants must be employed by the Company on the last day of the plan year to be eligible for contribution. Participants are entitled to receive distribution of benefits under the Plan upon retirement, termination of employment, death or disability.  Retirement plans expense was as follows:     Year ended December 31, 2005          $867,532    Year ended December 31, 2004          $759,482    Year ended December 31, 2003          $674,977   NOTE 14 - STATUTORY CAPITAL AND SURPLUS - --------------------------------------- Crusader is required to file an annual statement with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory). Statutory accounting practices differ in certain respects from GAAP. The more significant of these differences for statutory accounting are (a) premium income is taken into earnings over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) fixed maturity securities are reported at amortized cost, or the lower of amortized cost or market value, depending on the quality of the security as specified by the NAIC; (c) equity securities are valued by the NAIC as required by Statutory Accounting Principles; d) non-admitted assets are charged directly against surplus; (e) loss reserves and unearned premium reserves are stated net of reinsurance; and (f) federal income taxes are recorded when payable and deferred taxes, subject to limitations, are recognized but only to the extent that they do not exceed 10% of statutory surplus; changes in deferred taxes are recorded directly to surplus as regards policyholders. Additionally, the cash flow presentation is not consistent with U.S. generally accepted accounting principles and reconciliation from net income to cash provided by operations is not presented. Comprehensive income is not presented under statutory accounting.  Crusader Insurance Company statutory capital and surplus are as follows:     As of December 31, 2005                    $36,586,441    As of December 31, 2004                    $29,436,343  Crusader Insurance Company statutory net income (loss) is as follows:     Year ended December 31, 2005                $6,817,451    Year ended December 31, 2004                $3,343,859    Year ended December 31, 2003               $(3,106,103)                                          53                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   The insurance department also conducts periodic financial examinations of Crusader. The insurance department has completed its financial examination of Crusader's December 31, 2004, statutory financial statements. A preliminary report on the examination was issued by the department of insurance on January 13, 2006. No significant issues were reported in the preliminary report.  The Company believes that Crusader's statutory capital and surplus were sufficient to support the insurance premiums written based on guidelines established by the NAIC.  Crusader is restricted in the amount of dividends it may pay to its parent in any twelve (12) month period without prior approval of the California Department of Insurance. Presently, without prior approval, Crusader may pay a dividend in any twelve (12) month period to its parent equal to the greater of (a) 10% of Crusader's statutory policyholders' surplus or (b) Crusader's statutory net income for the preceding calendar year. There were no dividends paid by Crusader to Unico in 2005, 2004, or in 2003. Based on Crusader's statutory surplus as regards policyholders as of December 31, 2005, the maximum dividend that could be made by Crusader to Unico without prior regulatory approval in 2006 is $3,658,644.  In December 1993, the National Association of Insurance Commissioners (NAIC) adopted a Risk-Based Capital (RBC) Model Law for property and casualty companies. The RBC Model Law is intended to provide standards for calculating a variable regulatory capital requirement related to a company's current operations and its risk exposures (asset risk, underwriting risk, credit risk and off-balance sheet risk). These standards are intended to serve as a diagnostic solvency tool for regulators that establishes uniform capital levels and specific authority levels for regulatory intervention when an insurer falls below minimum capital levels. The RBC Model Law specifies four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer if its RBC is equal to or less than 200% of its computed authorized control level RBC. A company's RBC is required to be disclosed in its statutory annual statement. The RBC is not intended to be used as a rating or ranking tool nor is it to be used in premium rate making or approval. Crusader's adjusted capital at December 31, 2005, was 400% of authorized control level risk-based capital.  Insurance Regulatory Information System (IRIS) was developed by a committee of state insurance regulators primarily to assist state insurance departments in executing their statutory mandate to oversee the financial condition of insurance companies. IRIS helps those companies that merit highest priority in the allocation of the regulators' resources on the basis of 12 financial ratios that are calculated annually. The analytical phase is a review of annual statements and the financial ratios. The ratios and trends are valuable in pointing to companies likely to experience financial difficulties, but are not themselves indicative of adverse financial condition. The ratio and benchmark comparisons are mechanically produced and are not intended to replace the state insurance department's own in-depth financial analysis or on-site examinations.  An unusual range of ratio results has been established from studies of the ratios of companies that have become insolvent or have experienced financial difficulties. In the analytical phase, companies that receive four or more financial ratio values outside the usual range are analyzed in order to identify those companies that appear to require immediate regulatory action. Subsequently, a more comprehensive review of the ratio results and an insurer's annual statement is performed to confirm that an insurer's situation calls for increased or closer regulatory attention. In 2005, the Company was not outside the usual values on any of the twelve IRIS ratio tests.   NOTE 15 - STOCK PLANS - --------------------- The Company's 1999 Omnibus Stock Plan that covers 500,000 shares of the Company's common stock (subject to adjustment in the case of stock splits, reverse stock splits, stock dividends, etc.) was approved by shareholders on June 4, 1999. On August 26, 1999, the Company granted 135,000 incentive stock options of which 40,000 were terminated and 95,000 were outstanding and exercisable as of December 31, 2005. These options expire 10 years from the date of the grant.  On December 18, 2002, the Company granted 182,000 incentive stock options under the Company's 1999 Omnibus Stock Plan. On December 30, 2005, the Company accelerated the vesting of 37,500 options that were originally schedule to vest on January 1, 2006, and 30,000 options that were originally schedule to vest on January 1, 2007 (see Note 1). As of December 31, 2005, 173,000 of those options were outstanding and exercisable,                                          54                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   6,500 options had been exercised and 2,500 options had been terminated. These options expire 10 years from the date of the grant.  The changes in the number of common shares under option are summarized as follows:                                                                Weighted Average                                                 Options        Exercise Price                                                 -------        --------------    Outstanding at December 31, 2002             287,000            $5.356       Options granted                                 -                 -       Options exercised                               -                 -       Options terminated                        (10,000)            9.250                                                 -------    Outstanding at December 31, 2003             277,000             5.216       Options granted                                 -                 -       Options exercised                          (2,500)            3.110       Options terminated                         (2,500)            3.110                                                 -------    Outstanding at December 31, 2004             272,000             5.254       Options granted                                 -                 -       Options exercised                          (4,000)            3.110       Options terminated                              -                 -                                                 -------    Outstanding at December 31, 2005             268,000            $5.286                                                 =======  Options exercisable were 268,000 at December 31, 2005, at a weighted average exercise price of $5.286; 149,500 at December 31, 2004, at a weighted average exercise price of $7.01; 95,000 at December 31, 2003, at a weighted average exercise price of $9.25.  The following table summarizes information regarding the stock options outstanding at December 31, 2005:                                  Weighted           Weighted                               Weighted                               Average             Average                                Average               Number of       Remaining        Exercise Price        Number of       Exercise Price  Exercise      Options     Contractual Life    of Outstanding         Options        of Exercisable   Price      Outstanding       (Years)            Options           Exercisable          Options   -----      -----------        -----             -------           -----------          -------           $9.25         95,000           3.65               9.25               95,000              $9.25   $3.11        173,000           6.96               3.11              173,000              $3.11    NOTE 16 - TAXES ON INCOME - ------------------------- The provision for taxes on income consists of the following:                                                Year ended December 31                                               ----------------------                                      2005             2004              2003                                      ----             ----              ---- Current provision:    Federal                        $3,319,904       $2,947,668          $703,663    State                             142,923           64,400           572,822                                    ---------         ---------        ---------       Total federal and state      3,462,827        3,012,068         1,276,485    Deferred                          288,599          (21,110)         (195,764)                                    ---------        ---------         ---------       Provision for taxes         $3,751,426       $2,990,958        $1,080,721                                    =========        =========         =========                                          55                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   The income tax provision reflected in the consolidated statements of operations is different than the expected federal income tax on income as shown in the table below:                                                               Year ended December 31                                                            ----------------------                                                     2005            2004             2003                                                     ----            ----             ----      Computed income tax expense                      $3,558,586      $2,948,636        $730,786    Tax effect of:       State tax, net of federal tax benefit         272,789          65,237         370,784       Tax exempt income                              (4,166)        (10,612)        (34,071)       Other                                         (75,783)        (12,303)         13,222                                                   ---------       ---------       ---------          Income tax per financial statements     $3,751,426      $2,990,958      $1,080,721                                                   =========       =========       =========   The components of the net federal income tax asset included in the financial statements as required by the assets and liability method are as follows:                                                           Year ended December 31                                                          ----------------------                                                            2005          2004                                                            ----          ---- Deferred tax assets:    Discount on loss reserves                            $2,270,225    $2,368,238    Unearned premiums                                     2,116,186     2,418,595    Unrealized loss on investments                          196,904             -    State income tax deductible in future periods           145,270       152,306    Other                                                   112,072       104,644                                                          ---------     ---------       Total deferred tax assets                         $4,840,657    $5,043,783                                                          ---------     ---------  Deferred tax liabilities:    Deferred acquisition costs                           $2,501,101    $2,789,102    Unrealized gain on investments                                -       193,785    State tax on undistributed insurance company earnings   283,663       157,249    Tax depreciation in excess of book depreciation         112,758        66,913    Other                                                   173,849       169,539                                                          ---------     ---------       Total deferred tax liabilities                    $3,071,371    $3,376,588                                                          ---------     ---------        Net deferred tax assets                           $1,769,286    $1,667,195                                                          =========     =========  Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. The amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.  The Company and its wholly owned subsidiaries file consolidated federal and combined California income tax returns. Pursuant to the tax allocation agreement, Crusader and American Acceptance Corporation are allocated taxes or (in the case of losses) tax credits at current corporate rates based on their own taxable income or loss.  As a California insurance company, Crusader is obligated to pay a premium tax on gross premiums written in all states that Crusader is admitted. Premium taxes are deferred and amortized as the related premiums are earned. The premium tax is in lieu of state franchise taxes and is not included in the provision for state taxes.   NOTE 17 - REPURCHASE OF COMMON STOCK - EFFECT ON STOCKHOLDERS' EQUITY - --------------------------------------------------------------------- The Company has previously announced that its Board of Directors had authorized the repurchase in the open market from time to time of up to an aggregate of 945,000 shares of the common stock of the Company. During the year ended December 31, 2005, the Company did not purchase any shares of the Company's common stock. As of December 31, 2005, the Company had purchased and retired under the Board of Directors authorization an aggregate of 868,958 shares of its common stock at a cost of $5,517,465.                                          56                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   NOTE 18 - EARNINGS PER SHARE - ---------------------------- A reconciliation of the numerator and denominator used in the basic and diluted earnings per share calculation is presented below:                                                                      Year ended December 31                                                                   ----------------------                                                        2005               2004               2003                                                        ----               ----               ----     Basic Earnings Per Share - ------------------------  Net income numerator                               $6,715,004         $5,681,500         $1,068,650                                                      =========          =========          =========  Weighted average shares outstanding denominator     5,495,948          5,490,346          5,489,604                                                      =========          =========          =========   Per share amount                                        $1.22              $1.03              $0.19  Diluted Earnings Per Share - --------------------------  Net income numerator                               $6,715,004         $5,681,500         $1,068,650                                                      =========          =========          =========   Weighted average shares outstanding                 5,495,948          5,490,346          5,489,604  Effect of diluted securities                          116,478             90,949             43,508                                                      ---------          ---------          ---------  Diluted shares outstanding denominator              5,612,426          5,581,295          5,533,112                                                      =========          =========          =========   Per share amount                                        $1.20              $1.02              $0.19    NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) - ------------------------------------------------------ Summarized unaudited quarterly financial data for each of the calendar years 2005 and 2004 is set forth below:                                                      Comparable Period by Quarter Ended                                                   ----------------------------------                                  March 31            June 30         September 30        December 31                                  --------            -------         ------------        -----------      Calendar Year 2005 - ------------------ Total revenues                 $15,481,114         $15,662,323        $15,204,435        $14,834,650 Income before taxes              2,356,327           2,643,991          2,585,017          2,881,095 Net income                       1,505,180           1,693,313          1,661,458          1,855,053 Earnings per share: Basic            $0.27               $0.31              $0.30              $0.34                     Diluted          $0.27               $0.30              $0.30              $0.33  Calendar Year 2004 - ------------------ Total revenues                 $15,680,191         $15,243,414        $15,477,954        $15,501,751 Income before taxes              1,968,444           1,945,412          2,119,372          2,639,230 Net income                       1,257,997           1,233,390          1,426,213          1,763,900 Earnings per share: Basic            $0.23               $0.22              $0.26              $0.32                     Diluted          $0.23               $0.22              $0.26              $0.32                                            57
Item 9A.  Controls and Procedures - --------------------------------- An evaluation was carried out by the Company's management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of December 31, 2005, (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective.  During the period covered by this report, there have been no changes in the Company's internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.
PART III                                     -------- Item 10.  Directors and Executive Officers of the Registrant - ------------------------------------------------------------ Information in response to Item 10 is incorporated by reference from the Company's definitive proxy statement to be used in connection with the Company's Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
Item 12.  Security Ownership of Certain Beneficial Owners and Management and - ----------------------------------------------------------------------------           Related Stockholder Matters           --------------------------- Information in response to Item 12 is incorporated by reference from the Company's definitive proxy statement to be used in connection with the Company's Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.
Item 14.  Principal Accountant Fees and Services - ------------------------------------------------ Information in response to Item 14 is incorporated by reference from the Company's definitive proxy statement to be used in connection with the Company's Annual Meeting of Shareholders pursuant to Instruction G(3) of Form 10-K.                                          58                                        PART IV                                      -------
1. Financial statements:         The consolidated financial statements for the fiscal year ended December        31, 2005, are contained herein as listed in the index to consolidated        financial statements on page 34.  2. Financial schedules:                    Index to Consolidated Financial Statements                    ------------------------------------------         Independent Registered Public Accounting Firms' Report on Financial           Statement Schedules         Schedule II   - Condensed Financial Information of Registrant         Schedule III  - Supplemental Insurance Information          Schedules other than those listed above are omitted, since they are not         applicable, not required, or the information required being set forth is         included in the consolidated financial statements or notes.  3. Exhibits:    3.1   Articles of Incorporation of Registrant, as amended.  (Incorporated          herein by reference to Exhibit 3.1 to the Registrant's Annual Report          on Form 10-K for the fiscal year ended March 31, 1984.)     3.2   By-Laws of Registrant, as amended.  (Incorporated herein by reference          to Exhibit 3.2 to Registrant's Annual Report on Form 10-K for the          fiscal year ended March 31, 1991.)     10.1  Unico American Corporation Profit Sharing Plan & Trust.  (Incorporated          herein by reference to Exhibit 10.1 to the Registrant's Annual Report          on Form 10-K for the fiscal year ended March 31, 1985.)*     10.2  The Lease dated July 31, 1986, between Unico American Corporation and          Cheldin Management Company. (Incorporated herein by reference to          Exhibit 10.5 to Registrant's Annual Report on Form 10-K for the fiscal          year ended March 31, 1987.)     10.3  The Lease Amendment #1 dated February 22, 1995, between Unico American          Corporation and Cheldin Management amending the lease dated July 31,          1986. (Incorporated herein by reference to Exhibit 10.5 to          Registrant's Annual Report on Form 10-K for the fiscal year ended          March 31, 1995.)     10.4  1999 Omnibus Stock Plan of Unico American Corporation (Incorporated          herein by reference to Exhibit A to Registrant's Proxy Statement for          its Annual Meeting of Shareholders held June 4, 2000.)*     21    Subsidiaries of Registrant.  (Incorporated herein by reference to          Exhibit 22 to Registrant's Annual Report on Form 10-K for the fiscal          year ended March 31, 1984.)     23    Consent of Independent Registered Public Accounting Firm - KPMG LLP.     31.1  Certificate of Chief Executive Officer pursuant to Rule 13a-14(a) or          Rule 15d-14(a), as adopted pursuant to Section 302 of the          Sarbanes-Oxley Act of 2002.     31.2  Certificate of Chief Financial Officer pursuant to Rule 13a-14(a) or          Rule 15d-14(a), as adopted pursuant to Section 302 of the          Sarbanes-Oxley Act of 2002.     32.1  Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section          1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of          2002.     32.2  Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section          1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of          2002.           * Indicates management contract or compensatory plan or arrangement.                                          59                                       SIGNATURES                                    ----------  Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.  Date:  March 28, 2006                                                       UNICO AMERICAN CORPORATION                                                         By:  /s/ Erwin Cheldin                                                            -----------------                                                       Erwin Cheldin                                                       Chairman of the Board  Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.  Signature                                Title                       Date - ---------                                -----                       ----  /s/ Erwin Cheldin                Chairman of the Board,           March 28, 2006 - -----------------                President and Chief     Erwin Cheldin                Executive Officer,                                  (Principal Executive Officer)   /s/ Lester A. Aaron              Treasurer, Chief Financial       March 28, 2006     ---------------              Office and Director     Lester A. Aaron              (Principal Accounting and                                  Principal Financial Officer)   /s/ Cary L. Cheldin              Executive Vice President         March 28, 2006     ---------------              and Director     Cary L. Cheldin   /s/ George C. Gilpatrick         Vice President, Secretary        March 28, 2006     --------------------         and Director     George C. Gilpatrick   /s/ David A. Lewis               Director                         March 28, 2006     --------------     David A. Lewis   /s/ Warren D. Orloff             Director                         March 28, 2006     --------------------     Warren D. Orloff   /s/ Donald B. Urfrig             Director                         March 28, 2006 - --------------------     Donald B. Urfrig                                          60                REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM              -------------------------------------------------------  The Board of Directors and Stockholders Unico American Corporation:  Under date of March 23, 2006, we reported on the consolidated balance sheets of Unico American Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2005, as contained in the 2005 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 2005. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed under Item 15(a)2. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.  In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.                                       KPMG LLP   Los Angeles, California March 23, 2006                                          61    SCHEDULE II                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                    CONDENSED FINANCIAL INFORMATION OF REGISTRANT                        BALANCE SHEETS - PARENT COMPANY ONLY                                                          December 31   December 31                                                           2005          2004                                                           ----          ----                                      ASSETS                                      ------  Investments  Short-term investments                                    $9,358         $9,147                                                             -----          -----      Total Investments                                      9,358          9,147 Cash                                                        7,017          8,317 Accrued investment and other income                        12,902          6,000 Investments in subsidiaries                            67,740,804     61,038,810 Property and equipment (net of accumulated depreciation)  824,504        278,404 Other assets                                              470,442        456,787                                                        ----------     ----------      Total Assets                                     $69,065,027    $61,797,465                                                        ==========     ==========                        LIABILITIES AND STOCKHOLDERS' EQUITY                       ------------------------------------  LIABILITIES - ----------- Accrued expenses and other liabilities                   $156,352       $149,797 Payables to subsidiaries (net of receivables) (1)      20,514,302     18,494,793 Income taxes payable                                            -        227,550 Notes Payable - related parties                                 -        500,000                                                        ----------     ----------       Total Liabilities                                $20,670,654    $19,372,140                                                        ----------     ----------  STOCKHOLDERS' EQUITY - -------------------- Common stock                                           $2,720,487     $2,708,047 Net unrealized investment gains (losses)                 (382,224)       376,172 Retained earnings                                      46,056,110     39,341,106                                                        ----------     ----------      Total Stockholders' Equity                       $48,394,373    $42,425,325                                                        ----------     ----------       Total Liabilities and Stockholders' Equity       $69,065,027    $61,797,465                                                        ==========     ==========  (1) The Company and its wholly owned subsidiaries file consolidated federal and     combined California income tax returns. Pursuant to a tax allocation     agreement, Crusader Insurance Company and American Acceptance Corporation     are allocated taxes or (in the case of losses) tax credits at current     corporate rates based on their own taxable income or loss. The payable to     subsidiaries includes their income tax receivable or liability included in     the consolidated return.   The condensed financial statements should be read in conjunction with the consolidated financial statements and notes.                                          62    SCHEDULE II (continued)                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                    CONDENSED FINANCIAL INFORMATION OF REGISTRANT                   STATEMENTS OF OPERATIONS - PARENT COMPANY ONLY                         FOR THE YEARS ENDED DECEMBER 31,                                                  2005          2004        2003                                                 ----          ----        ----  REVENUES - -------- Net investment income                           $6,120       $9,293       $9,315 Other income                                    13,820       11,981       15,974                                                 ------       ------       ------      Total Revenue                              19,940       21,274       25,289  EXPENSES - -------- General and administrative expenses              6,930        9,257       18,670                                                  -----        -----       ------ Income before equity in net income of  of subsidiaries                                13,010       12,017        6,619 Equity in net income of subsidiaries         6,701,994    5,669,483    1,062,031                                              ---------    ---------    ---------      Net Income                             $6,715,004   $5,681,500   $1,068,650                                              =========    =========    =========  The Company and its subsidiaries file a consolidated federal income tax return.  Unico received cash dividends from American Acceptance Corporation of $500,000 in the year ended December 31, 2005, and $200,000 in the year ended December 31, 2004.   The condensed financial statements should be read in conjunction with the consolidated financial statements and notes.                                          63   SCHEDULE II (continued)                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                    CONDENSED FINANCIAL INFORMATION OF REGISTRANT                   STATEMENTS OF CASH FLOWS - PARENT COMPANY ONLY                          FOR THE YEARS ENDED DECEMBER 31                                                                                 2005               2004               2003                                                                              ----               ----               ----      Cash flows from operating activities: Cash flows from operating activities:    Net income                                                              $6,715,004         $5,681,500         $1,068,650     Adjustments to reconcile net income to net cash     from operations       Undistributed equity in net (income) of subsidiaries                 (6,701,994)        (5,669,483)        (1,062,031)       Depreciation and amortization                                           160,571             95,084             89,821       Accrued expenses and other liabilities                                    6,555           (138,543)           (44,338)       Accrued investment and other income                                      (6,902)             6,000             (6,000)       Income taxes receivable (payable)                                      (227,550)                 -          1,548,427       Other assets                                                            (13,655)          (298,227)           (20,963)                                                                                ------            -------          ---------          Net cash provided (used) from operations                             (67,971)          (323,669)         1,573,566                                                                                ------            -------          ---------  Cash flows from investing activities    (Increase) in short-term investments                                          (211)               (50)               (35)    Additions to property and equipment                                       (706,671)           (50,398)           (58,717)                                                                               -------             ------            -------          Net cash (used) by investing activities                             (706,882)           (50,448)           (58,752)                                                                               -------             ------             ------  Cash flows from financing activities    Proceeds from issuance of common stock                                      12,440              7,775                  -    Proceeds from notes payable - related parties                                    -                  -          1,500,000    Repayment of notes payable - related parties                              (500,000)        (1,000,000)          (750,000)    Net change in payables and receivables from subsidiaries                 1,261,113          1,357,540         (2,256,145)                                                                             ---------          ---------          ---------          Net cash provided (used) by financing activities                     773,553            365,315         (1,506,145)                                                                               -------            -------          ---------  Net increase (decrease) in cash                                                (1,300)            (8,802)             8,669  Cash at beginning of year                                                       8,317             17,119              8,450                                                                                 -----             ------            -------  Cash at end of year                                                            $7,017             $8,317            $17,119                                                                                 =====              =====             ======   The condensed financial statements should be read in conjunction with the consolidated financial statements and notes.                                          64   SCHEDULE III                             UNICO AMERICAN CORPORATION                                 AND SUBSIDIARIES                         SUPPLEMENTARY INSURANCE INFORMATION                                     Future                                 Benefits,                                          Benefits,   Amortization                    Deferred      Losses,                                            Claims,    of Deferred                     Policy      and Loss                                 Net       Losses and    Policy        Other        Net                   Acquisition  Adjustment     Unearned      Premium   Investment   Settlement  Acquisition   Operating    Premium                      Cost       Expenses      Premiums      Revenue     Income      Expenses      Costs        Costs      Written                      ----       --------      --------      -------     ------      --------      -----        -----      -------           Year Ended December 31, 2005 Property & Casualty           $7,356,179  $101,914,548  $31,212,433  $50,477,920  $4,248,399  $31,513,732  $10,512,688  $2,402,397  $46,030,707  Year Ended December 31, 2004 Property & Casualty           $8,203,238   $87,469,000  $35,656,393  $50,106,568  $4,204,573  $34,450,738  $10,319,186  $1,746,815  $51,089,573  Year Ended December 31, 2003 Property & Casualty           $8,054,363   $78,139,090  $34,675,180  $37,106,099  $4,801,133  $31,720,533   $7,941,199  $2,418,935  $47,420,157                                           65                                     EXHIBIT INDEX                                   -------------  Exhibit    No.     Description    --      -----------     3.1     Articles of Incorporation of Registrant, as amended.  (Incorporated            herein by reference to Exhibit 3.1 to the Registrant's Annual Report            on Form 10-K for the fiscal year ended March 31, 1984.)     3.2     By-Laws of Registrant, as amended.  (Incorporated  herein by            reference to Exhibit 3.2 to Registrant's Annual Report on Form 10-K            for the fiscal year ended March 31, 1991.)     10.1    Unico American Corporation Profit Sharing Plan & Trust.            (Incorporated  herein  by  reference  to  Exhibit  10.1 to the            Registrant's Annual Report on Form 10-K for the fiscal year ended            March 31, 1985.)*     10.2    The Lease dated July 31, 1986, between Unico American Corporation and            Cheldin Management Company. (Incorporated herein by reference to            Exhibit 10.5 to Registrant's Annual Report on Form 10-K for the            fiscal year ended March 31, 1987.)     10.3    The Lease Amendment #1 dated February 22, 1995, between Unico            American Corporation and Cheldin Management amending the lease dated            July 31, 1986. (Incorporated herein by reference to Exhibit 10.5 to            Registrant's Annual Report on Form 10-K for the fiscal year ended            March 31, 1995.)     10.4    1999 Omnibus Stock Plan of Unico American Corporation (Incorporated            herein by reference to Exhibit A to Registrant's Proxy Statement for            its Annual Meeting of Shareholders held June 4, 2000.)*     21      Subsidiaries of Registrant.  (Incorporated herein by reference to            Exhibit 22 to Registrant's Annual Report on Form 10-K for the fiscal            year ended March 31, 1984.)     23      Consent of Independent Registered Public Accounting Firm - KPMG LLP.     31.1    Certificate of Chief Executive Officer pursuant to Rule 13a-14(a) or            Rule 15d-14(a), as adopted pursuant to Section 302 of the            Sarbanes-Oxley Act of 2002.     31.2    Certificate of Chief Financial Officer pursuant to Rule 13a-14(a) or            Rule 15d-14(a), as adopted pursuant to Section 302 of the            Sarbanes-Oxley Act of 2002.     32.1    Certification of Chief Executive Officer Pursuant to 18 U.S.C.            Section 1350, as adopted pursuant to Section 906 of the            Sarbanes-Oxley Act of 2002.     32.2    Certification of Chief Financial Officer Pursuant to 18 U.S.C.            Section 1350, as adopted pursuant to Section 906 of the            Sarbanes-Oxley Act of 2002.               * Indicates management contract or compensatory plan or arrangement.     EX-23 3 consent.txt AUDITORS' CONSENT              CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM     The Board of Directors Unico American Corporation:  We consent to the incorporation by reference in the registration statement (No. 333-101842) on Form S-8 of Unico American Corporation of our report dated March 23, 2006, with respect to the consolidated balance sheets of Unico American Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2005, and all related financial statement schedules, which report appears in the December 31, 2005, annual report on Form 10-K of Unico American Corporation.                                       KPMG LLP  Los Angeles, California March 23, 2006     EX-32 4 ex32-1.txt EXHIBIT 32.1                                                                      EXHIBIT 32.1                                                                     ------------                            CERTIFICATION UNDER SECTION 906                                      OF THE                            SARBANES-OXLEY ACT OF 2002   In connection with the annual report on Form 10-K of Unico American Corporation (the "Company") for the period ended December 31, 2005, as filed with the Securities and Exchange Commission (the "Report"), I, Erwin Cheldin, Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:  (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of     the Securities Exchange Act of 1934, as amended; and  (2) the information contained in the Report fairly presents, in all material     respects, the financial condition and results of operations of the Company.                        /s/  Erwin Cheldin                     ------------------            Name:    Erwin Cheldin            Title:   Chairman of the Board, President and Chief Executive Officer            Date:    March 28, 2006     A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Unico American Corporation, and will be retained by Unico American Corporation, and furnished to the Securities and Exchange Commission or its staff upon request.        EX-31 5 ex31-2.txt EXHIBIT 31.2                                                                      EXHIBIT 31.2                                      CERTIFICATION                        Pursuant to 18 U.S.C. Section 1350,       as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   I, Lester A. Aaron, certify that:  1. I have reviewed this annual report on Form 10-K of Unico American    Corporation;  2. Based on my knowledge, this report does not contain any untrue statement of a    material fact or omit to state a material fact necessary to make the    statements made, in light of the circumstances under which such statements    were made, not misleading with respect to the period covered by this report;  3. Based on my knowledge, the financial statements, and other financial    information included in this report, fairly present in all material respects    the financial condition, results of operations and cash flows of the    registrant as of, and for, the periods presented in this report;  4. The registrant's other certifying officer(s) and I are responsible for    establishing and maintaining disclosure controls and procedures (as defined    in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:       a) Designed such disclosure controls and procedures, or caused such         disclosure controls and procedures to be designed under our supervision,         to ensure that material information relating to the registrant,         including its consolidated subsidiaries, is made known to us by others         within those entities, particularly during the period in which this         report is being prepared;       b) Evaluated the effectiveness of the registrant's disclosure controls and         procedures and presented in this report our conclusions about the         effectiveness of the disclosure controls and procedures, as of the end         of the period covered by this report based on such evaluation; and       c) Disclosed in this report any change in the registrant's internal control         over financial reporting that occurred during the registrant's most         recent fiscal quarter (the registrant's fourth fiscal quarter in the         case of an annual report) that has materially affected, or is reasonably         likely to materially affect, the registrant's internal control over         financial reporting; and  5.     The registrant's other certifying officer(s) and I have disclosed, based        on our most recent evaluation of internal control over financial        reporting, to the registrant's auditors and the audit committee of the        registrant's board of directors (or persons performing the equivalent        functions):         (a)    All significant deficiencies and material weaknesses in the design               or operation of internal control over financial reporting which               are reasonably likely to adversely affect the registrant's ability               to record, process, summarize and report financial information;               and         (b)    Any fraud, whether or not material, that involves management or               other employees who have a significant role in the registrant's               internal control over financial reporting.    Date: March 28, 2006.  /s/  Lester A. Aaron - -------------------- Lester A. Aaron Treasurer, Chief Financial Officer      EX-31 6 ex31-1.txt EXHIBIT 31.1                                                                      EXHIBIT 31.1                                      CERTIFICATION                        Pursuant to 18 U.S.C. Section 1350,       as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   I, Erwin Cheldin, certify that:  1. I have reviewed this annual report on Form 10-K of Unico American    Corporation;  2. Based on my knowledge, this report does not contain any untrue statement of a    material fact or omit to state a material fact necessary to make the    statements made, in light of the circumstances under which such statements    were made, not misleading with respect to the period covered by this report;  3. Based on my knowledge, the financial statements, and other financial    information included in this report, fairly present in all material respects    the financial condition, results of operations and cash flows of the    registrant as of, and for, the periods presented in this report;  4. The registrant's other certifying officer(s) and I are responsible for    establishing and maintaining disclosure controls and procedures (as defined    in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:       a) Designed such disclosure controls and procedures, or caused such         disclosure controls and procedures to be designed under our supervision,         to ensure that material information relating to the registrant,         including its consolidated subsidiaries, is made known to us by others         within those entities, particularly during the period in which this         report is being prepared;       b) Evaluated the effectiveness of the registrant's disclosure controls and         procedures and presented in this report our conclusions about the         effectiveness of the disclosure controls and procedures, as of the end         of the period covered by this report based on such evaluation; and       c) Disclosed in this report any change in the registrant's internal control         over financial reporting that occurred during the registrant's most         recent fiscal quarter (the registrant's fourth fiscal quarter in the         case of an annual report) that has materially affected, or is reasonably         likely to materially affect, the registrant's internal control over         financial reporting; and  5.     The registrant's other certifying officer(s) and I have disclosed, based        on our most recent evaluation of internal control over financial        reporting, to the registrant's auditors and the audit committee of the        registrant's board of directors (or persons performing the equivalent        functions):         (a)    All significant deficiencies and material weaknesses in the design               or operation of internal control over financial reporting which               are reasonably likely to adversely affect the registrant's ability               to record, process, summarize and report financial information;               and         (b)    Any fraud, whether or not material, that involves management or               other employees who have a significant role in the registrant's               internal control over financial reporting.    Date: March 28, 2006.  /s/  Erwin Cheldin - ------------------ Erwin Cheldin Chairman of the Board, President and Chief Executive Officer       EX-32 7 ex32-2.txt EXHIBIT 32.2                                                                      EXHIBIT 32.2                                                                     ------------                            CERTIFICATION UNDER SECTION 906                                      OF THE                            SARBANES-OXLEY ACT OF 2002   In connection with the annual report on Form 10-K of Unico American Corporation (the "Company") for the period ended December 31, 2005, as filed with the Securities and Exchange Commission (the "Report"), I, Lester A. Aaron, Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:  (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of     the Securities Exchange Act of 1934, as amended; and  (2) the information contained in the Report fairly presents, in all material     respects, the financial condition and results of operations of the Company.                        /s/  Lester A. Aaron                     --------------------            Name:    Lester A. Aaron            Title:   Treasurer and Chief Financial Officer            Date:    March 28, 2006     A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Unico American Corporation, and will be retained by Unico American Corporation, and furnished to the Securities and Exchange Commission or its staff upon request.          -----END PRIVACY-ENHANCED MESSAGE-----