PROBLEM 4:

Homeowners Choice, Inc. is a holding company which, through its subsidiaries, is engaged in the property and casualty insurance business. Through its subsidiaries it provides property and casualty homeowners' insurance, condominium-owners' insurance and tenants' insurance to individuals own- ing property in Florida.

Homeowners has two significant accounting issues for financial reporting to its shareholders:

1. (1) It capitalizes its policy acquisition costs. According to HCI, deferred policy acquisition costs primarily represent commissions paid to outside agents at the time of collection of the policy premium and are amortized over the life of the related policy in relation to the amount of gross premiums earned.

2. (2) It records unearned premium revenue as premium revenue is earned on a daily pro-rata basis over the term of the policies. Unearned premiums represent the portion of the premium related to the unexpired policy term.

Exhibits 1 through 4 provide condensed financial statements and the income tax footnote for Home- owners fiscal years ended December 31, 2013 through December 31, 2017.

1. If Homeowners did not capitalize its policy acquisition costs, what would the Companys In- come before Income Taxes have been in:

   a. 2016

   b. 2017

2. Is Homeowners accounting for its policy acquisition costs differently for book purposes than for tax purposes? If so, in what way? On what do you base your answer?

3. Is Homeowners accounting for its unearned premium revenue differently for book purposes than for tax purposes? If so, in what way? On what do you base your answer?

4. 4. Assume it is January 1, 2018 and Homeowners is required to immediately recognize all of its capitalized deferred policy acquisition costs as an expense. What would be the impact on Home- owners balance sheet, income statement and cash flows? Please show/explain support for your answer.

5. 5. How would you characterize Homeowners quality of earnings? On what do you base your answer? Please show/explain support for your answer.

EXHIBIT 1 Homeowners Choice, Inc. - Condensed Balance Sheets at 12/31/14 12/31/15 12/31/16 12/31/17 $ 27,582 81,060 5, 691 6,292 267 3,563 7,534 $ 131,989 $ 48, 343 43, 453 24, 600 10, 496 399 2,438 8,163 $ 137,892 $ 43, 481 54,849 6,028 9,407 7,755 584 18,844 $ 140,948 $ 58,759 100,355 14, 317 12,321 10,499 2,368 16,199 $ 214,818 (in thousands) 12/31/13 ASSETS Investments $ 17,055 Cash & cash equivalents 15,729 Receivables, net 3,316 Deferred policy acquisition costs 3,163 Property and equipment, net 36 Deferred income taxes, net 653 Other assets 41 Total assets 39,993 LIABILITIES & STOCKHOLDERS' EQUITY Insured customer benefits payable $ 1,688 Unearned premiums 19,814 Other payables & accrued expenses 3,991 Other liabilities 162 Total liabilities 25,655 Stockholders' equity: Common stock & additional paid-in capital 13,383 Retained earnings 955 Total shareholders' equity 14,338 Total liabilities & shareholders' equity $_39,993 $ $ 14,763 67,219 12,375 239 94,596 $ 19,178 68,509 3,786 1,041 92,514 $ 22,146 65,034 3,809 3,330 94,319 27,424 108, 677 10,784 4,103 150,988 23,783 13, 610 37,393 20,858 24,520 45, 378 18,564 28,065 46,629 29,844 33,986 63,830 $_131,989 $_137,892 $_140,948 $_214.818 EXHIBIT 2 Homeowners Choice, Inc. - Condensed Income Statements for the Years Ended (in thousands) 12/31/13 12/31/14 12/31/15 12/31/16 Net premiums earned 7,034 $ 47,266 $ 65,337 $ 62, 435 Other revenue, including investment income 626 2,267 3,041 6,180 Total revenue 7,660 49,533 68,378 68, 615 Insured customer benefit expenses 2,742 21,528 35,230 37,667 Amortized policy acquisition costs 2,868 3,086 9, 611 14,878 Other operating expenses 419 4,124 5,788 7,484 Total expenses 6,029 28,738 50, 629 60,029 Income before income taxes 1,631 20,795 17,749 8,586 Income taxes 614 8,140 6,839 3,164 Net income 1.017 $ 12,655 $ 10,910 $ 5, 422 12/31/17 $ 87,246 7,593 94,839 48,243 18,129 12,062 78,434 16,405 6,441 $ 9.964 12/31/17 $ 9,964 EXHIBIT 3 Homeowners Choice, Inc. - Condensed Cash Flow Statements for the Years Ended NOTE: Only includes the Cash Flow from Operations section (in thousands) 12/31/13 12/31/14 12/31/15 12/31/16 Net income $ 1,017 $ 12,655 $ 10,910 $ 5, 422 Adjustments to reconcile to cash provided by operations: Depreciation and amortization 37 74 178 Deferred income taxes (benefit) (653) (2,910) 1,316 1,690 Amortization of policy acquisition costs 2,868 3,086 9, 611 14,878 Policy acquisition costs (5,736) (6,215) (13,815) (13,789) Unearned premiums, net 19,814 47, 405 1,290 (3, 475) Net change in other working capital items 2,554 12 584 (22 860) 11, 227 Net cash provided by operations 19,864 $_66, 642 $(13,474) $_16, 131 576 (1,984) 18,129 (21,043) 43, 643 6,748 56,033 $ EXHIBIT 4 Homeowners Choice, Inc. - Income Tax Footnote for the Year Ended December 31, (in thousands) 12/31/13 12/31/14 12/31/15 12/31/16 12/31/17 Income tax provision Current $ 1,267 $ 11,050 $ 5,523 $ 1,474 $ 8, 425 Deferred (benefit) (653) (2,910) 1. 316 1,690 (1,984) Income taxes 614 8,140 6,839 3,164 6,441 Temporary differences causing a significant portion of deferred tax assets and liabilities were as follows: (in thousands) 12/31/13 12/31/14 12/31/15 12/31/16 12/31/17 Deferred tax assets: Unearned premiums $ 1,491 $ 5,186 $ 5,286 $ 3,262 $ 6,768 Other 352 818 1,273 1 140 1,592 Total deferred tax as assets $ 1,843 $ 6,004 $ 6.559 $ 4,402 $ 8,360 Deferred tax liabilities: Deferred policy acquisition costs $ (1,190) $ (2,427) $ (4,049) $ (3,690) $ (4,870) Other (14) (72) (128) (1,122) Total deferred tax liabilities (1,190) $ (2,441) $ (4,121) (3,818) $ (5,992)