Insurance Services leases facilities with an aggregate square footage of approximately 97,165 at five locations in four states. The latest expiration date of the existing leases is in May 2019.
On September 17, 2012, the Company announced that it was restructuring its Insurance Underwriting and Insurance Services segments under two separate management teams. As a result of the Company's intent to streamline its non-standard property and casualty insurance business operations under one management team, KAI Advantage Auto, Inc. ("Advantage Auto"), formerly included in Insurance Services, is now part of Insurance Underwriting. All segmented information has been restated for all periods presented to include Advantage Auto in Insurance Underwriting.
Insurance Underwriting includes the following subsidiaries of the Company: Mendota Insurance Company ("Mendota"), Mendakota Insurance Company ("Mendakota"), Universal Casualty Company ("UCC"), Maison Insurance Company ("Maison"), Kingsway Amigo Insurance Company ("Amigo"), Advantage Auto, Kingsway Reinsurance Corporation and Kingsway Reinsurance (Bermuda) Ltd. Throughout this 2012 Annual Report, the term "Insurance Underwriting" is used to refer to this segment.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. On November 19, 2012, the Florida Office of Insurance Regulation (“OIR”) approved Amigo's plan to withdraw from the business of offering commercial lines insurance in Florida. On January 30, 2013, the OIR approved Amigo's plan to withdraw from the business of offering personal lines insurance in Florida. Kingsway has commenced discussions with the OIR to outline plans for Amigo's run-off. Any comprehensive run-off plan would be subject to OIR approval.
Insurance Services includes the following subsidiaries of the Company: Assigned Risk Solutions Ltd. ("ARS"), Northeast Alliance Insurance Agency, LLC ("NEA") and IWS Acquisition Corporation ("IWS"). Throughout this 2012 Annual Report, the term "Insurance Services" is used to refer to this segment. Insurance Services is organized under ARS and IWS.
Throughout this 2012 Annual Report, we present our operations in the way we believe will be most meaningful, useful and transparent to anyone using this financial information to evaluate our performance. In addition to the U.S. GAAP presentation of net loss, we show certain statutory reporting information and other non-U.S. GAAP financial measures that we believe are relevant in managing our business and drawing comparisons to our peers. These measures are operating loss, gross premiums written, net premiums written and underwriting ratios.
While net premiums earned is the related U.S. GAAP measure used in the consolidated statements of operations, net premiums written is the component of net premiums earned that measures the difference between gross premiums written and the impact of ceding reinsurance premiums, but without respect to when those premiums will be recognized as actual revenue. We use this measure as an indication of retained or net business volume in Insurance Underwriting.
Gains and losses realized on the disposition of investments are determined on the first-in first-out basis and credited or charged to the consolidated statements of operations. Premium and discount on investments are amortized and accredited using the interest method and charged or credited to net investment income.
The Company did not recognize any impairment related to its fixed maturities or equity investments that was considered other-than-temporary for the years ended December 31, 2012 and 2011. As further discussed in the "Results of Continuing Operations" section below, the Company recorded write-downs for other-than-temporary impairments related to investment in investee and other investments of $2.2 million and $0.5 million, respectively, for the year ended December 31, 2012.
Future events may result in the valuation allowance being adjusted, which could materially impact our financial position and results of operations. If sufficient positive evidence were to arise in the future indicating that all or a portion of the deferred income tax assets would meet the more likely than not standard, the valuation allowance would be reversed in the period that such a conclusion were reached.
Intangible assets with definite useful lives consist of vehicle service agreements in-force ("VSA in-force"), database, customer-related relationships, and non-compete agreement. A discounted cash flow analysis was used to determine the fair value of the VSA in-force asset. The multi-period excess earnings method was used to determine the fair value of the customer-related intangible asset. A form of the income method, known as the "with and without" method, was utilized to determine the fair values of the database and non-compete agreement intangible assets.
Indefinite-lived intangible assets consist of insurance licenses, renewal rights and trade name. Intangible assets with an indefinite life are assessed for impairment annually as of December 31, or more frequently if events or circumstances indicate that the carrying value may not be recoverable, by applying a fair value-based test. Management must make estimates and assumptions in determining the fair value of indefinite-lived intangible assets that may affect any resulting impairment write-down. This includes assumptions regarding future cash flows and future revenues from the related intangible assets or their reporting units. Management then compares the fair value of the indefinite-lived intangible assets to their respective carrying amounts. If the carrying amount of an intangible asset exceeds the fair value of that intangible asset, an impairment is recorded. Additional information regarding our intangible assets is included in Note 11, "Intangible Assets," to the Consolidated Financial Statements.
Our Linked Return of Capital ("LROC") preferred units, senior unsecured debentures and subordinated debt are measured and reported at fair value. The fair value of the LROC preferred units is based on quoted market prices, and the fair value of the subordinated debt is estimated using an internal model based on significant market observable inputs. The fair values of senior unsecured debentures, for which no active market exists, are derived from quoted market prices of similar instruments or other third-party evidence. Any change in the estimated fair value of our debt is reflected in the gain or loss on change in fair value of debt we record in the consolidated statements of operations and in the carrying value for our debt on our consolidated balance sheets.
In 2012, we incurred a net loss of $53.3 million compared to $27.4 million in 2011. The diluted loss per share was $4.05 for 2012 compared to a diluted loss per share of $2.09 for 2011.
For the year ended December 31, 2012, Insurance Underwriting gross premiums written were $145.9 million compared to $138.4 million for the year ended December 31, 2011, representing a 5.4% increase. Net premiums written decreased 9.1% to $115.3 million for the year ended December 31, 2012 compared with $126.9 million for the year ended December 31, 2011. Net premiums earned decreased 26.5% to $114.9 million for the year ended December 31, 2012 compared with $156.4 million for the year ended December 31, 2011.
The increase in gross premiums written is the result of modestly increased non-standard automobile premium volumes across all of our non-standard automobile companies as well as new premium volume at Maison, which began operations in November of
The Insurance Underwriting loss ratio for 2012 was 86.5% compared to 91.5% for 2011 due to decreasing ultimate loss estimates for current and prior accident years. This improvement was primarily driven by the increased premium rate adequacy which Insurance Underwriting implemented throughout 2012, which is having a positive influence on the loss ratio for losses incurred during 2012. This improvement more than offset the unfavorable development of $13.8 million recorded during 2012 in the provision for property and casualty unpaid loss and loss adjustment expenses for losses incurred as of December 31, 2011. The unfavorable development recorded in 2012 is primarily due to the increase in property and casualty unpaid loss and loss adjustment expenses of $11.4 million as a result of the Insurance Underwriting restructuring announced by the Company on September 17, 2012.
The Insurance Underwriting expense ratio was 45.5% in 2012 compared with 38.4% in 2011. The increase in the expense ratio for the year ended December 31, 2012 is a derivative effect of the decrease in net premiums written and earned cited above which has made it more difficult for Insurance Underwriting to cover its fixed overhead expenses. In response to the shrinkage in its volume of business, Insurance Underwriting has been taking steps to reduce its fixed overhead expenses.
The Insurance Underwriting operating loss includes policy fee income of $7.4 million and $9.2 million for the years ended December 31, 2012 and 2011, respectively; however, when calculating expense and combined ratios under U.S. GAAP, policy fee income is excluded.
Other income and expenses not allocated to segments was a net expense of $8.6 million in 2012 compared to $12.6 million in 2011. The decrease was primarily due to $0.9 million more of professional fees, including outside legal and audit fees, recorded in 2011 than in 2012; $1.1 million more of write-off, depreciation, and amortization of computer hardware and software in 2011 than in 2012; and $1.9 million more of general and administrative expenses recorded in 2011 than 2012.
Interest expense for 2012 was $7.6 million compared to $7.5 million in 2011. The increase is the result of higher interest rates on the Company's subordinated debt in 2012 compared to 2011.
Income tax expense on continuing operations for 2012 was $3.0 million compared to income tax benefit of $0.2 million in 2011. The increase in income tax expense for 2012 is primarily attributable to a tax benefit recorded in 2011 for a loss carryback; an increase in the change in unrecognized tax benefits recorded in 2012; and a decrease in the tax expense recorded in 2012 compared to 2011 related to indefinite life intangibles.
Market risk is the risk that we will incur losses due to adverse changes in interest or currency exchange rates and equity prices. Given our U.S. operations typically invest in U.S. dollar denominated instruments and own a relatively insignificant investment in equity instruments, our primary market risk exposures in the investments portfolio are to changes in interest rates.
Table 4 below summarizes the composition of the fair value of fixed maturities, excluding cash and cash equivalents, at December 31, 2012 and 2011, by rating as assigned by Standard and Poor's ("S&P") or Moody's Investors Service ("Moody's"). Fixed maturities consist of predominantly high-quality instruments in corporate and government bonds with approximately 83.8% of those investments rated 'A' or better at December 31, 2012. The increase in BBB/Baa rated instruments is due to reinvestment of cash into fixed maturities and is not due to rating downgrades. These investment grade fixed maturities purchased during 2012 provide a better yield while maintaining compliance with conservative credit risk guidelines adopted by the Company.
As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, the Company recorded write-downs for other-than-temporary impairments related to investment in investee and other investments of $2.2 million and $0.5 million, respectively, for the year ended December 31, 2012. The Company did not incur impairment losses
The Company owns investments in limited liability companies ("LLC's") and a limited partnership ("LP") that primarily invest in income-producing real estate. The Company's investments in the LLC's and LP are reported as limited liability investments in the consolidated balance sheets. The real estate investments are held on a triple net lease basis whereby the lessee agrees to pay all real estate taxes, building insurance and maintenance. The real estate investments yield between 7.5% - 8% minimum preferred return on invested capital. Table 5 below presents additional information pertaining to its limited liability investments at December 31, 2012 and 2011.
At December 31, 2012 and 2011, the gross provisions for property and casualty unpaid loss and loss adjustment expenses for our commercial automobile business were $19.9 million and $22.4 million, respectively. This decrease primarily reflects the actions begun by the Company during the fourth quarter of 2012 to place Amigo into voluntary run-off as well as the payment of claims related to UCC's continuing voluntary run-off, offset by the addition of $3.5 million related to property and casualty unpaid loss and loss adjustment expenses resulting from prior years' adverse development in 2012. Further information regarding Amigo and UCC is discussed within "Liquidity and Capital Resources" below.
The net movements in prior years' provisions for property and casualty unpaid loss and loss adjustment expenses, net of reinsurance, for the years ended December 31, 2012 and 2011 were increases of $13.8 million and $7.9 million, respectively. Table 8 identifies the relative contribution of the increases / (decreases) in the provisions for property and casualty unpaid loss and loss adjustment expenses attributable to the respective lines of business and accident years.
During 2012, the net cash used in operating activities as reported on the consolidated statements of cash flows was $46.7 million. This use of cash can be explained primarily by the net loss of $53.3 million and the decrease in the provision for unpaid loss and loss adjustment expenses of $17.4 million offset by a number of smaller sources of cash.
During 2012, the net cash provided by investing activities as reported on the consolidated statements of cash flows was $46.0 million. This source of cash was driven by net cash acquired of $14.9 million from the acquisition of certain tangible and intangible assets and liabilities of Intercontinental Warranty Services, Inc. and proceeds from sales and maturities of fixed maturities in excess of purchases of fixed maturities. As previously explained, the Company's insurance subsidiaries hold investments portfolios comprised primarily of fixed maturities issued by the U.S. Government, government agencies and high quality corporate issuers which are of generally short duration and are highly liquid which enables the insurance subsidiaries to meet their liquidity needs.
As of December 31, 2012, the Company has $27.0 million principal value of outstanding debt due February 1, 2014. In January of 2013, the Company repurchased $0.6 million principal value of this debt, leaving $26.4 million principal value outstanding. On February 12, 2013, Kingsway announced the sale of 2,625,000 shares of the common stock of Atlas for approximately $13.8 million of proceeds net of estimated transaction costs. While this sale of Atlas common stock added substantially to the Company's liquidity, the Company still does not have the funds necessary to both retire the remaining $26.4 million of principal value of debt due on February 1, 2014 as well as meet all of its other continuing obligations. In the event that funds available to the Company are inadequate to service its obligations, specifically the retirement of the remaining $26.4 million principal value of debt due February 1, 2014, the Company would need to raise capital, sell additional assets or restructure its debt obligations. The Company believes that it has the flexibility to obtain the funds needed to meet its obligations and continue to satisfy regulatory capital requirements at its insurance underwriting subsidiaries, though there can be no assurance that it will be able to meet its outstanding debt obligation due February 1, 2014.
The Company launched a debt buy-back initiative during 2009, pursuant to which it has retired a substantial amount of its outstanding debt. During 2012, the Company did not buy-back any of its outstanding debt. During 2011, the Company repurchased $11.4 million (C$10.8 million) of par value of senior unsecured debentures maturing in 2012. For further detail related to the Company's debt, see "Debt" below and Note 15, "Debt," to the Consolidated Financial Statements.
In the United States, a risk based capital (“RBC”) formula is used by the National Association of Insurance Commissioners (“NAIC”) to identify property and casualty insurance companies that may not be adequately capitalized. Most states, including the domiciliary states of our insurance subsidiaries, have adopted the NAIC RBC requirements. In general, insurers reporting surplus as regards policyholders below 200% of the authorized control level, as defined by the NAIC, at December 31 are subject to varying levels of regulatory action, including discontinuation of operations. As of December 31, 2012, surplus as regards policyholders reported by each of our insurance subsidiaries, with the exception of Amigo, exceeded the 200% threshold.
On July 10, 2007, a general partnership of the Company, Kingsway 2007 General Partnership, issued C$100.0 million Senior Unsecured Debentures at 6% due on July 11, 2012. These debentures bore interest at a fixed rate of 6% per annum payable semi-annually from the date of issuance until July 11, 2012. Interest payments were made on January 10 and July 10 of each year, commencing January 10, 2008. The net proceeds to the Company amounted to C$99.2 million. The debentures were unconditionally guaranteed by the Company and its subsidiary, Kingsway America Inc. ("KAI").
Pursuant to the debt buy-back initiative previously mentioned, KAI has repurchased and retired most of the originally issued par value, and, as of December 31, 2012 and 2011, only $27.0 million par value of this issue remains outstanding.
Table 9 summarizes certain payments projected by period, including debt maturities, interest payments on outstanding debt, future minimum payments under operating leases and the provision for unpaid loss and loss adjustment expenses. Interest payments in Table 9 related to the subordinated debt reflect the interest deferral described in the "Subordinated Debt" section above and assume LIBOR remains constant throughout the projection period.
As of December 31, 2012 and 2011, the Company does not engage in any off-balance sheet financing arrangements.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kingsway Financial Services Inc. at December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying information in the 2012 Annual Report has been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").
The consolidated financial statements are prepared as of December 31, 2012 based on individual company financial statements at the same date. Accounting policies of subsidiaries have been aligned where necessary to ensure consistency with those of Kingsway. The consolidated financial statements include the following subsidiaries, all of which are owned, directly or indirectly, with the jurisdiction of incorporation indicated in brackets: 1347 Advisors LLC ("1347 Advisors") (Delaware); 1347 Capital LLC (Delaware); Appco Finance Corporation (Pennsylvania); American Country Underwriting Agency Inc. (Illinois); ARM Holdings, Inc. (Illinois); Assigned Risk Solutions Ltd. ("ARS") (New Jersey); Auto Underwriters Holdings LLC (Delaware); Boston General Agency, Inc. (Texas); Hamilton Risk Management Company ("Hamilton") (Florida); Insurance Management Services Inc. (Florida); IWS Acquisition Corporation ("IWS") (Florida); KAI Advantage Auto, Inc. ("Advantage Auto") (Illinois); KFS Capital LLC ("KFS Capital") (Delaware); Kingsway 2007 General Partnership (Delaware); Kingsway 2009 LLC (Delaware); Kingsway America II Inc. (Delaware); Kingsway America Inc. ("KAI") (Delaware); Kingsway America Agency Inc. (Illinois); Kingsway Amigo Insurance Company ("Amigo") (Florida); Kingsway General Insurance Company (Ontario); Kingsway LGIC Holdings, LLC (Delaware); Kingsway Linked Return of Capital Trust ("KLROC Trust") (Ontario); Kingsway Reinsurance (Bermuda) Ltd. (Bermuda); Kingsway Reinsurance Corporation (Barbados); Maison Insurance Company ("Maison") (Louisiana); Maison Insurance Holdings, Inc. (Delaware); Maison Managers, Inc. (Delaware); Market Solutions Insurance Agency LLC (Delaware); Mattoni Insurance Brokerage, Inc. (Washington); Mendakota Insurance Company ("Mendakota") (Minnesota); Mendota Insurance Agency, Inc. (Texas); Mendota Insurance Company ("Mendota") (Minnesota); MIC Insurance Agency Inc. (Texas); Northeast Alliance Insurance Agency, LLC ("NEA") (Delaware); and Universal Casualty Company ("UCC") (Illinois).
The consolidated financial statements have been presented in U.S. dollars because the Company's principal investments and cash flows are denominated in U.S. dollars. Effective January 1, 2011, the Company's functional currency is the U.S. dollar since, with the sale of its Canadian insurance subsidiaries, the substantial majority of its operations is conducted in the U.S. Assets and liabilities of subsidiaries with non-U.S. dollar functional currencies are translated to U.S. dollars at period-end exchange rates, while revenue and expenses are translated at average monthly rates and shareholders' equity is translated at the rates in effect at dates of capital transactions. The net unrealized gains or losses which result from the translation of non-U.S. subsidiaries financial statements are recognized in accumulated other comprehensive income. Such currency translation gains or losses are recognized in the consolidated statements of operations upon the sale of a foreign subsidiary.
Investment in investee is accounted for using the equity method and is comprised of investments in entities where the Company has the ability to exercise significant influence but not control. Significant influence is presumed to exist when the Company owns, directly or indirectly, between 20% and 50% of the outstanding voting rights of the investee. Assessment of significant influence is based on the substance of the relationship between the Company and the investee and includes consideration of both existing voting rights and, if applicable, potential voting rights that are currently exercisable and convertible. These investments are reported as investment in investee in the consolidated balance sheets, with the Company's share of income (loss) and other comprehensive income (loss) of the investee reported in the corresponding line in the consolidated statements of operations and consolidated statements of comprehensive income (loss), respectively. Under the equity method of accounting, an investment in investee is initially recognized at cost and adjusted thereafter for the post-acquisition change in the Company's share of net assets of the investee.
Reinsurance premiums, losses, and loss adjustment expenses are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums and losses ceded to other companies have been reported as a reduction of premium revenue and incurred loss and loss adjustment expenses. Commissions paid to the Company by reinsurers on business ceded have been accounted for as a reduction of the related policy acquisition costs. Reinsurance
The Company follows the asset and liability method of accounting for income taxes, whereby deferred income tax assets and liabilities are recognized for (i) the differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and (ii) loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not and a valuation allowance is established for any portion of a deferred tax asset that management believes will not be realized. Current federal income taxes are charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of taxable operations for the current year. The Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken, or expected to be taken, in an income tax return. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense (benefit).
Property and equipment are reported in the consolidated financial statements at cost. Depreciation of property and equipment has been provided using the straight-line method over the estimated useful lives of such assets. Repairs and maintenance are recognized in operations during the period incurred. Land is not depreciated. The Company estimates useful to be five to ten years for leasehold improvements; three to ten years for furniture and equipment; three to five years for computer hardware; and two to five years for automobiles.
Goodwill is tested for impairment annually as of December 31, or more frequently if events or circumstances indicate that the carrying value may not be recoverable, to ensure that its fair value is greater than or equal to the carrying value. Any excess of carrying value over fair value is charged to the consolidated statements of operations in the period in which the impairment is determined.
Service fee and commission income represents policy and claim service fees and vehicle service agreement fees based on terms of various agreements with insurance partners, state agencies and credit unions.
The fair values of the Company's investments in fixed maturities and equity investments, LROC preferred units, senior unsecured debentures and subordinated debt are estimated using a fair value hierarchy to categorize the inputs it uses in valuation techniques. The fair value of the Company's investment in investee is based on quoted market prices. Fair values for other investments approximate their unpaid principal balance. The carrying amounts reported in the consolidated balance sheets approximate fair values for cash, short-term investments and certain other assets and other liabilities because of their short-term nature.
In September 2011, the FASB issued ASU 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment ("ASU 2011-08"). The standard became effective for the first interim or annual period beginning on or after December 15, 2011, with early adoption permitted. The standard amends Accounting Standards Codification Topic 350, Intangibles-Goodwill and
In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which is intended to improve the reporting of reclassifications out of accumulated other comprehensive income. The ASU requires an entity to report, either on the face of the income statement or in the notes to the financial statements, the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the income statement if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other required disclosures that provide additional detail about those amounts. This ASU is effective prospectively in the first quarter of 2013, and is not expected to have a material effect on our results of operations or financial position.
As a result of the disposal of American Country, American Service and Southern United, the Company recognized an after-tax gain of zero and $0.6 million for the years ended December 31, 2012 and 2011, respectively.
On January 25, 2010, the Company entered into a definitive purchase agreement with The Westaim Corporation (“Westaim”) to sell all of the issued and outstanding shares of Jevco to Westaim. On March 29, 2010, after receipt of all required regulatory approvals, the sale was completed for a purchase price of C$263.3 million subject to certain future contingent adjustments. The contingent adjustments included up to a C$20.0 million decrease in the purchase price relating to specific future adverse development in Jevco's provision for unpaid loss and loss adjustment expenses at the end of 2012. On March 31, 2011, the Company settled the C$20.0 million contingent adjustments related to the Jevco transactions for C$17.8 million, recording a pre-tax loss of $2.3 million. As a result of the disposal of Jevco, the Company realized an after-tax loss of zero and $1.9 million for the years ended December 31, 2012 and 2011, respectively.
On March 30, 2011, the Company's subsidiary, KAI, sold all of the issued and outstanding shares of its wholly owned subsidiary Hamilton and its subsidiaries, including Amigo, to HRM Acquisition Corp., a wholly owned subsidiary of Acadia Acquisition Partners, L.P. (“Acadia”), in exchange for a $10.0 million senior promissory note due March 30, 2014, a $5.0 million junior promissory note due March 30, 2016, and a Class B partnership interest in Acadia representing a 40% economic interest. A third-party and members of the Hamilton management team held Class A partnership interests in Acadia representing a 60% economic interest. KAI acted as the general partner of Acadia. As general partner, KAI controlled the policies and financial affairs of Hamilton; therefore, Kingsway continued to consolidate the financial statements of Hamilton. During the second quarter of 2011, HRM Acquisition Corp. merged into Hamilton.
As a result of this transaction, as of December 31, 2011, Hamilton had notes payable balances of $2.2 million maturing in March 2014 with the third-party and $0.2 million maturing in June 2015 with members of the Hamilton management team. The notes bore interest at 2% annually. On August 14, 2012, Hamilton repaid the note payable from the third-party with a carrying value of $2.2 million for $1.7 million, recording a gain of $0.5 million. On August 31, 2012, Hamilton repaid the notes payable from the members of the Hamilton management team with a carrying value of $0.2 million for $0.2 million, recording a gain of zero.
Gross realized gains and losses on fixed maturities and equity instruments for the years ended December 31, 2012 and 2011 were as follows:
The following tables highlight the aggregate unrealized loss position, by investment type, of fixed maturities and equity investments in unrealized loss positions as of December 31, 2012 and 2011. The tables segregate the holdings based on the period of time the investments have been continuously held in unrealized loss positions.
Fixed maturities and equity investments contain approximately 19 and 12 individual investments that were in unrealized loss positions as of December 31, 2012 and 2011, respectively.
identifying other circumstances which management believes may impact the recoverability of the unrealized loss positions;
Other investments include mortgage loans and are reported at their unpaid principal balance. As of December 31, 2012 and December 31, 2011, the carrying value of other investments totaled $2.0 million and $0.5 million, respectively.
Net investment income for the years ended December 31, 2012 and 2011, respectively, is comprised as follows:
Investment in investee includes the Company's investment in the preferred and restricted voting common stock of Atlas and is accounted for under the equity method. The Company's investment in Atlas is recorded on a three-month lag basis. The carrying value, estimated fair value and approximate voting and equity percentages at December 31, 2012 and December 31, 2011 were as follows:
The fair values of the Company's investment in Atlas at December 31, 2012 and December 31, 2011 in the table above are calculated based on the published closing prices of Atlas at September 30, 2012 and September 30, 2011, respectively, to be consistent with the three-month lag in reporting its carrying value under the equity method. The estimated fair value of the Company's investment in Atlas based on the published closing price of Atlas at December 31, 2012 is $42.6 million.
Equity in net (loss) income of investee was a loss of $1.0 million and income of $0.4 million, for the years ended December 31, 2012 and 2011, respectively. The Company also recognized an increase to shareholders' equity attributable to common shareholders of $0.9 million for the year ended December 31, 2012 for the Company's pro rata share of its investee's accumulated other comprehensive income.
During the fourth quarter of 2012, the Company sold 2,142,454 shares of Atlas common stock. The Company received proceeds of $4.0 million and realized losses of $0.5 million from the sales. On February 12, 2013, the Company executed an underwriting agreement to sell 2,625,000 shares of Atlas common stock. The shares were being offered as part of Atlas' United States initial public offering at a price per share of $5.85. Net of commissions and certain transaction expenses, the Company received proceeds of $14.1 million from the sale during the first quarter of 2013. The Company expects to incur approximately $0.3 million of additional expenses related to the transaction.
Ceded premiums, loss and loss adjustments expenses, and commissions as of and for the years ended December 31, 2012 and 2011 are summarized as follows:
The maximum amount of return commission, which would have been due to reinsurers if they or the Company had canceled all of the Company's reinsurance, with the return of the unearned premium, is as follows at December 31, 2012:
The amounts of assumed premiums written were $15.5 million and $12.1 million for the years ended December 31, 2012 and 2011, respectively. The amounts of assumed premiums earned were $13.4 million and $12.5 million for the years ended December 31, 2012 and 2011, respectively.
Policy acquisition costs consist primarily of commissions, premium taxes, and underwriting and agency expenses incurred related to successful efforts to acquire new or renewal insurance contracts, net of ceding commission income, and vehicle service agreements. Acquisition costs deferred on property and casualty insurance products are amortized over the period in which premiums are earned. Acquisition costs deferred on vehicle service agreements are amortized as the related revenues are earned.
As described in Note 3, "Recently Issued Accounting Standards," the Company adopted ASU 2010-26 effective January 1, 2012 on a prospective basis. The new standard affects the timing of recognition of policy acquisition costs. Costs associated with unsuccessful efforts or costs that cannot be tied directly to a successful policy acquisition are expensed as incurred, as opposed to being deferred and amortized as the premium is earned. The application of the new standard resulted in capitalized acquisition costs of $23.3 million for the year ended December 31, 2012 compared with $27.0 million if the Company had not adopted the new standard. As a result, the Company recorded $3.7 million more in expense for the year ended December 31, 2012 than it would have had it not adopted the new standard.
Goodwill was $8.4 million and $0.5 million at December 31, 2012 and 2011. As further discussed in Note 4, "Acquisition," the Company recorded goodwill of $7.9 million related to the acquisition of certain tangible and intangible assets and liabilities of Intercontinental Warranty Services, Inc. on November 16, 2012. The Company's goodwill at December 31, 2012 and 2011 is attributable to the Insurance Services segment.
The Company tested goodwill associated with each of its reporting units for recoverability at December 31, 2012 and 2011. Based on the assessment performed, the Company concluded that goodwill was recoverable at December 31, 2012.
The Company's intangible assets with indefinite useful lives are not amortized. The Company's intangible assets with definite useful lives are amortized over their estimated useful lives. Accumulated amortization for these intangibles as of December 31, 2012 and 2011 was $19.3 million and $18.3 million, respectively. Amortization of intangible assets was $1.0 million and $0.1 million for the years ended December 31, 2012 and 2011, respectively.
As further discussed in Note 4, "Acquisition," the Company recorded $12.4 million of separately identifiable intangible assets, related to acquired VSA in-force, database, customer-related relationships, trade name and non-compete agreement, as part of the acquisition of certain tangible and intangible assets and liabilities of Intercontinental Warranty Services, Inc.
The VSA in-force asset is amortized over a seven-year term as the corresponding deferred service fees acquired are earned as revenue. The database and non-compete agreement assets are being amortized on a straight-line basis over ten years and three years, respectively. The customer-related relationships intangible asset is being amortized over 15 years based on the pattern in which the economic benefits of the intangible asset are expected to be consumed.
The insurance licenses, renewal rights and trade name intangible assets have indefinite useful lives and are not amortized. The renewal rights intangible assets, recognized related to the acquisitions of NEA and ARS, were being amortized on a straight-line basis over 10 to 15 years. Effective January 1, 2011, the renewal rights intangible assets were deemed to have indefinite useful lives and, therefore, are no longer being amortized.
The estimated aggregate future amortization expense of all intangible assets is $2.1 million for 2013, $1.5 million for 2014, $1.1 million for 2015, $1.1 million for 2016 and $1.0 million for 2017.
The establishment of the provision for unpaid loss and loss adjustment expenses is based on known facts and interpretation of circumstances and is therefore a complex and dynamic process influenced by a variety of factors. These factors include the Company's experience with similar cases and historical trends involving loss payment patterns, pending levels of unpaid loss and loss adjustment expenses, product mix or concentration, loss severity and loss frequency patterns.
Other factors include the continually evolving and changing regulatory and legal environment; actuarial studies; professional experience and expertise of the Company's claims departments' personnel and independent adjusters retained to handle individual claims; the quality of the data used for projection purposes; existing claims management practices including claims-handling and
The results of the comparison and the changes in the provision for property and casualty unpaid loss and loss adjustment expenses, net of amounts recoverable from reinsurers, as of December 31, 2012 and December 31, 2011 were as follows:
The Company reported unfavorable development on property and casualty unpaid loss and loss adjustment expenses of $13.8 million in 2012 compared to an unfavorable development of $7.9 million in 2011. Non-standard automobile business contributed $10.3 million of the prior years' adverse development in 2012 compared to $6.0 million in 2011. Business other than non-standard automobile contributed $3.5 million of the prior years' adverse development in 2012 compared to $1.9 million in 2011. The majority of the unfavorable development in 2012 is attributable to an increase in unpaid loss and loss adjustment expenses of $11.4 million at Amigo and Mendota as part of the Company's September 17, 2012 announcement that is was restructuring its Insurance Underwriting and Insurance Services segments. The remaining adverse development in 2012 is generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims.
The results of the comparison and the changes in the provision for vehicle service agreement unpaid loss and loss adjustment expenses as of December 31, 2012 were as follows:
During 2011, the Company repurchased $11.4 million (C$10.8 million) of par value of this offering and realized a gain of $0.6 million in 2011. As of December 31, 2011, C$1.7 million par value of this issue remained outstanding. On July 11, 2012, Kingsway 2007 General Partnership redeemed the remaining outstanding principal balance of C$1.7 million.
The trust indenture for the 7.50% senior notes due 2014 contains negative covenants placing limitations and restrictions over certain actions without the prior written consent of the indenture trustee. Included in the negative covenants is the limitation on the incurrence of additional debt in the event that the total debt-to-total capital ratio or the senior debt-to-total capital ratio exceeds 50% or 35%, respectively. The total debt is calculated on a pro-forma basis taking into account the issuance of additional debt. The indenture also includes covenants limiting the issuance and sale of voting stock of restricted subsidiaries, the payment of dividends or any other payment in respect of capital stock of the Company, or the retirement of debt subordinate to these notes if, after giving effect to such payments as described in the trust indenture, the total debt-to-total capital ratio exceeds 50%. As of December 31, 2012, the Company's total debt-to-capital and senior debt-to-capital ratios were 51.8% and 28.2%, respectively.
On July 14, 2005, KLROC Trust completed its public offering of C$78.0 million of 5.00% LROC preferred units due June 30, 2015 of which the Company was a promoter. KLROC Trust's net proceeds of the public offering was C$74.1 million.
During the first quarter of 2011, the Company gave notice to its trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters, pursuant to the contractual terms of its outstanding indentures, which permit interest deferral. This action does not constitute a default under the Company's indentures or any of its other debt indentures. At December 31, 2012, deferred interest payable of $8.3 million is included in accounts payable and accrued liabilities in the consolidated balance sheets. The cash interest due in 2016 is subject to changes in LIBOR over the deferral period. Prior to the interest deferral election, the Company paid interest of $0.9 million in 2011.
changes in the fair value of the hedging instruments were recorded in other comprehensive income (loss) until the hedged item affects the consolidated statement of operations.
On June 2, 2009, the Company discontinued the swap transaction which was designated as a cash flow hedge. When a cash flow hedge is discontinued, any cumulative adjustment to the hedging instrument that had been recorded through other comprehensive income (loss) is recognized in the consolidated statements of operations over the remaining term of the hedged item. The amount of loss recorded in other comprehensive income at the time of the discontinuance of the cash flow hedge was $6.2 million before tax, of which zero and $1.3 million has been reclassified to other income in the consolidated statements of operations for the years ended December 31, 2012 and December 31, 2011, respectively. As of December 31, 2012 and 2011, zero remains in other comprehensive income (loss) to be reclassified to the consolidated statements of operations.
The amount of unrecognized tax benefits that, if recognized as of December 31, 2012, would affect the Company's effective tax rate was $3.0 million.
The Company classifies interest and penalty accruals related to unrecognized tax benefits as income tax expense. During the year ended December 31, 2012, the Company recognized $1.1 million in interest and penalty expense. At December 31, 2012, the Company had an accrual of $1.1 million for the payment of interest and penalties.
The federal income tax returns of the Company's U.S. operations for the years through 2008 are closed for Internal Revenue Service ("IRS") examination. The Company's U.S. operations federal income tax returns are not currently under examination by the IRS for any open tax years. The Company's 2009 Canadian federal income tax return is currently under examination by the Canada Revenue Agency ("CRA"). The federal income tax returns of the Company's Canadian operations for the years through 2005 are closed for CRA examination.
The intrinsic value of a stock option grant is the difference between the current market price for the Company's common shares and the exercise price of the option. The aggregate intrinsic values for the stock options outstanding at each of December 31, 2012 and 2011 were zero. The aggregate intrinsic values for stock options exercisable at each of December 31, 2012 and 2011 were zero.
On September 17, 2012, the Company announced that it was restructuring its Insurance Underwriting and Insurance Services segments under two separate management teams. As part of the restructuring, the Company intends to streamline its non-standard property and casualty insurance business operations. Specific to Insurance Underwriting, during the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. On November 19, 2012, the Florida Office of Insurance Regulation (“OIR”) approved Amigo's plan to withdraw from the business of offering commercial lines insurance in Florida. On January 30, 2013, the OIR approved Amigo's plan to withdraw from the business of offering personal lines insurance in Florida. Kingsway has commenced discussions with the OIR to outline plans for Amigo's run-off. Any comprehensive run-off plan would be subject to OIR approval.
As part of the restructuring, the Company will reduce staffing levels to be consistent with placing Amigo into run-off. The Company continues to estimate that Insurance Underwriting will incur approximately $2.0 million in cash severance expenses due to reductions-in-force as part of the restructuring, and the Company now expects that these expenses will be incurred during the period beginning with the announcement through the end of 2013.
Changes in the restructuring liability, which is included in accrued expenses and other liabilities in the consolidated balance sheets, as of December 31, 2012 is as follows:
On July 3, 2012, the Company announced that the Board of Directors of the Company authorized the implementation of a share consolidation at a ratio of one post-consolidation share for every four pre-consolidation shares. The share consolidation, which was approved by the stockholders at the Company's Annual and Special Meeting held on May 31, 2012, was effective as of July 3, 2012 (the "Effective Date"). As a result of the consolidation, every four of the Company's common shares that were issued and outstanding on the Effective Date were automatically combined into one issued and outstanding common share, without any change in the par value of such shares. Any fractional shares resulting from the consolidation were rounded up to the nearest whole. The consolidation had the effect of reducing the number of common shares of the Company issued and outstanding from 52,595,828 shares pre-consolidation to 13,148,971 shares post-consolidation. The issued and outstanding shares reported in the
There were no dividends declared for the 2012 or 2011 year.
Common Stock in the table above is as reported on the consolidated balance sheets.
The table below details the components of accumulated other comprehensive income, net of tax, for the years ended December 31, 2012 and 2011 as relates to shareholders' equity attributable to common shareholders on the consolidated balance sheets. On the other hand, the consolidated statements of comprehensive loss present the components of other comprehensive income, net of tax, only for the years ended December 31, 2012 and 2011 and inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
The Company is primarily engaged, through its subsidiaries, in the property and casualty insurance business. The Company conducts its business through the following two reportable segments: Insurance Underwriting and Insurance Services.
In November 2012, the Company formed Maison, a Louisiana-domiciled property and casualty insurance company, which provides homeowners policies for wind and hail-related property losses of residential dwellings and certain contents.
Segment revenues for the years ended December 31, 2012 and 2011 were:
Net premiums earned by line of business for the years ended December 31, 2012 and 2011 were:
The fair value of the LROC preferred units is based on quoted market prices, and the fair value of the subordinated debt is estimated using an internal model based on significant market observable inputs. The fair values of senior unsecured debentures, for which no active market exists, are derived from quoted market prices of similar instruments or other third-party evidence.
In August 2011, the Company and its subsidiary, 1347 Advisors, entered into a management services agreement with United Insurance Holdings Corp. ("United"), a third-party. This agreement provided that 1347 Advisors supply the services of an interim Chief Financial Officer to United, as well as certain strategy consulting, corporate development, corporate finance and actuarial services. Pursuant to the management services agreement, Hassan Baqar was appointed interim Chief Financial Officer at United. Mr. Baqar is currently a Managing Director of 1347 Advisors as well as a Vice President of KAI. Mr. Larry G. Swets, Jr., Chief Executive Officer and President of the Company, also served on the Board of Directors of United. In February 2012, Amigo received a letter from the OIR which stated that Amigo, the Company and its subsidiaries, and United were considered to be affiliated entities due to their common managerial control. As a result of the foregoing, among other things, the Company was not permitted to transfer any assets to United or any of its affiliates without the prior written approval of the OIR. Subsequently,
the Company and United mutually agreed to terminate their management services agreement effective April 2, 2012. Furthermore, Mr. Swets resigned as a member of United's Board of Directors effective April 5, 2012.
Fixed maturities and short-term investments with an estimated fair value of $15.0 million and $18.2 million were on deposit with state and provincial regulatory authorities at December 31, 2012 and 2011, respectively. Also, from time to time, the Company pledges investments to third-parties to collateralize liabilities incurred under its policies of insurance. The amount of such pledged investments was $22.3 million and $32.1 million at December 31, 2012 and 2011, respectively. Collateral pledging transactions are conducted under terms that are common and customary to standard collateral pledging and are subject to the Company's standard risk management controls.
In the normal course of business, the Company receives collateral on certain business transactions to reduce its exposure to credit risk. The amount of such pledged securities was zero and $0.5 million at December 31, 2012 and 2011, respectively. The Company is normally permitted to sell or repledge the collateral it receives under terms that are common and customary to standard collateral holding and are subject to the Company's standard risk management controls.
The Company previously placed UCC into voluntary run-off in early 2011. At the time it was placed into voluntary run-off, UCC's RBC was 160%. UCC entered into a comprehensive run-off plan approved by the Illinois Department of Insurance in June 2011. UCC remains in compliance with that plan. As of December 31, 2012, UCC's RBC was 478%.
The Company's insurance subsidiaries prepare statutory basis financial statements in accordance with accounting practices prescribed or permitted by the Departments of Insurance in states in which they are domiciled. "Prescribed" statutory accounting practices include state laws, regulations and general administrative rules, as well as a variety of publications of the NAIC. "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed. Such practices may differ from state to state; may differ from company to company within a state; and may change in the future. The Company and its subsidiaries have no material differences between accounting practices set forth in the NAIC Practices and Procedures Manual and prescribed practices in each insurer's state of domicile.
The Company's insurance subsidiaries are required to report results of operations and financial position to insurance regulatory authorities based upon statutory accounting practices ("SAP"). The application of SAP and U.S. GAAP to the Company's insurance subsidiaries generates the following significant differences in their reported results of operations and financial position:
In 2004, KAI issued $125.0 million 7.5% senior notes due in 2014 through a private offering. These notes are redeemable at KAI's option on or after February 1, 2009 and are fully and unconditionally guaranteed by the Company (a "Guarantor"). The following tables show condensed consolidating financial information for the Company as of December 31, 2012 and 2011 and for the periods ended December 31, 2012 and 2011, with a separate column for the Guarantor, the issuer and the other businesses of the Company combined ("Non-Guarantor subsidiaries").