As of December 31, 2018, the Company owned 45 single family properties in our insurance segment consisting of REO properties resulting from our investments in non-performing residential mortgage loans.
During 2018 and early 2019, we executed on several strategic initiatives:
Delivered total annual return of 9.6% for 2018, as measured by growth in book value per share plus dividends paid.
On April 10, 2018, we completed a corporate reorganization that eliminated Tiptree’s dual class stock structure.
Consistent with our total return objectives, throughout 2018 we invested $50.0 million in shipping sector at what we believe is a favorable point in the cycle.
In 2019, began re-positioning our asset management platform, by agreeing to invest $75 million to seed new investment funds in exchange for management control of and a profit participation in Tricadia.
Our insurance company investment portfolio primarily serves as a source to pay claims and secondarily as a source of income for our operations. Our investments include fixed maturity securities, loans, credit investment funds, equity securities, real estate and CLOs. Many of our investments are held at fair value. Changes in fair value for loans, credit investment funds, equity securities and CLO assets and liabilities are reported quarterly as unrealized gains or losses in revenues and can be impacted by changes in interest rates, credit risk, or market risk, including specific company or industry factors. When credit markets are performing well, loans held in our CLOs and credit fund investments may prepay, subjecting those investments to reinvestment risk. In deteriorating credit environments, default risk can impact the performance of our investments, as well as flowing through income as unrealized losses. Our equity holdings are relatively concentrated. General equity market trends, along with company and industry specific factors, can impact the fair value of our holdings and can result in unrealized gains and losses affecting our results. In addition, both as part of our insurance company investments and separately in Tiptree Capital, as of February 1, 2018, common shares of Invesque represent a significant asset on our balance sheet. Any change in the fair value of Invesque’s common stock or Invesque’s dividend policy could have a significant impact on our financial condition and results of operations.
(1) For further information relating to the Company’s Operating EBITDA, Adjusted EBITDA and book value per share, including a reconciliation to GAAP financials, see “-Non-GAAP Reconciliations.”
(2) For periods prior to April 10, 2018, book value per share assumed full exchange of the limited partners units of TFP for Common Stock.
premiums. The combination of unearned premiums and deferred revenues on the balance sheet grew by $115.0 million, or 20.5%, from December 31, 2017 to December 31, 2018 as a result of an increase in credit protection and other specialty programs written premiums.
For the year ended December 31, 2018, net income before non-controlling interests was $29.9 million compared to income of $5.2 million in the 2017 period, an increase of $24.7 million. The increase was primarily driven by improved insurance operating performance and $43.8 million of income from discontinued operations, including the net gain on sale of Care. These factors were partially offset by unrealized mark-to-market losses on Invesque common shares and 2017 results contained a one-time net tax benefit of $15.2 million from remeasurement of our net deferred tax liabilities as a result of the Tax Act’s change in federal income tax rate from 35% to 21%.
For the year ended December 31, 2017, net income before non-controlling interests was $5.2 million compared to net income of $32.3 million in the 2016 period, a decrease of $27.1 million, or 83.8%. The decline was primarily a result of the unrealized losses on equities in our insurance investment portfolio, compared to unrealized gains in the prior period. Increased stock-based compensation expense in specialty insurance and increased earn-out expense associated with our Reliance acquisition also contributed to the decline. We reduced our exposure to CLO subordinated notes throughout 2017 which resulted in less distributions compared to 2016. Those factors were partially offset by decreases in corporate expenses and a net tax benefit of $15.2 million described above.
Adjusted EBITDA includes the impact of realized and unrealized gains and losses, stock based compensation and non-controlling interests. Adjusted EBITDA for the year ended December 31, 2018 was $28.8 million compared to $38.0 million for the 2017 period driven by improved specialty insurance operations, which was offset by unrealized mark-to-market on Invesque common shares and lower investment income and realized gains on credit related investments. Adjusted EBITDA for the year ended December 31, 2017 was $38.0 million compared to $78.9 million for the 2016 period, a decrease of $40.9 million, or 51.8%. The key drivers of the change in Adjusted EBITDA from 2016 to 2017 were the same as those which impacted our net income before non controlling interests, excluding the increase in the Reliance earn-out expense, the change in the tax provision and non-recurring expenses which were added back to Adjusted EBITDA in 2017. See “- Non-GAAP Reconciliations” for a reconciliation to GAAP net income.
Total stockholders’ equity was $399.3 million as of December 31, 2018 compared to $396.8 million as of December 31, 2017, primarily driven by 2018 net income, net of share repurchases and dividends paid. Book value per share for the period ended December 31, 2018 was $10.79, an increase from book value per share, as exchanged, of $9.97 as of December 31, 2017. The key drivers of the period-over-period impact were 2018 earnings per share and the purchase of 2.2 million shares at an average 39% discount to book value. Those increases were partially offset by dividends paid of $0.135 per share and officer compensation share issuances. In 2018, Tiptree returned $19.2 million to shareholders through share repurchases and dividends paid.
Tiptree is a holding company that combines insurance operations with investment management capabilities. Our principal operating subsidiary is a leading provider of specialty insurance products and related services. We also allocate capital across a broad spectrum of businesses, assets and other investments, which we refer to as Tiptree Capital. As such, we classify our business into one reportable segment, specialty insurance, with the remainder of our non-insurance operations aggregated into Tiptree Capital. For the year ended December 31, 2018, Mortgage and Asset Management, which previously were reportable segments, no longer meet the quantitative threshold for disclosure. Those are now reported in Other, which we refer to as Tiptree Capital. Prior year segments have been conformed to the current year presentation. Corporate activities include holding company interest expense, employee compensation and benefits, and other expenses. The following table presents the components of total pre-tax income including continuing and discontinued operations.
Includes Care for the year ended December 31, 2018, 2017 and 2016. Includes $56.9 million pre-tax gain on sale of Care in 2018.
Management evaluates the return on Invested Capital and Total Capital, which are non-GAAP financial measures, when making capital investment decisions. Invested Capital represents its total equity investment, including any re-investment of earnings, and acquisition costs, net of tax. Total Capital represents Invested Capital plus Corporate Debt. Management believes the use of these financial measures provide supplemental information useful to investors as they are frequently used by the financial community to analyze how the Company has allocated capital over-time and provide a basis for determining the return on capital to shareholders. Management uses both of these measures when making capital investment decisions, including reinvesting cash, and evaluating the relative performance of its businesses and investments. The following tables present the components of Invested Capital, Total Capital, Operating EBITDA and Adjusted EBITDA.
For further information relating to the Company’s Invested Capital, Total Capital, Operating EBITDA and Adjusted EBITDA, including a reconciliation to GAAP total stockholders equity and pre-tax income, see “-Non-GAAP Reconciliations.”
Includes discontinued operations related to Care. As of February 1, 2018, invested capital from Care discontinued operations is represented by our investment in Invesque common shares. For more information, see “Note-(3) Dispositions, Assets Held for Sale and Discontinued Operations.”
Excludes Mortgage realized and unrealized gains and losses - Performing and NPLs.
Our principal operating subsidiary is a provider of specialty insurance products and related services, including credit protection insurance, warranty products, and insurance programs which underwrite niche personal and commercial lines of insurance. We also offer fee-based administration and fronting services for our self-insured clients who own captive producer owned reinsurance companies (“PORCs”). We generate income from insurance underwriting operations and our investment portfolio. Insurance underwriting revenues are primarily generated from net earned premiums, service and administrative fees and ceding commissions. We measure insurance underwriting operations performance by adjusted underwriting margin, combined ratio and Operating EBITDA. The investment portfolio income consists of investment income, gains and losses and is measured by net portfolio income.
Pre-tax income was $5.4 million for the year ended December 31, 2017, a decrease of $41.4 million, over the prior year period. The primary drivers of the decline were reductions in net realized and unrealized gains and losses of $31.3 million related to equities held in the portfolio, increases in interest expense of $5.8 million primarily associated with asset-based interest expense in the investment portfolio, partially offset by increases in net investment income of $3.3 million. Insurance operations results declined versus prior year driven primarily by increases in stock-based compensation expense of $2.8 million and increased other expenses of $5.6 million primarily related to premium taxes which increased consistent with growth in written premiums, which was partially offset by increased underwriting margin of $4.4 million.
was driven by growth in credit, warranty and other specialty product lines. For the year ended December 31, 2018, revenues on the investment portfolio contributed income of $7.5 million compared to losses of $0.2 million in the 2017 period, an increase of $7.7 million. The improved performance was driven by a combination of higher net investment income of $2.9 million and lower net realized and unrealized investment losses of $4.8 million. See “-Specialty Insurance Investment Portfolio” for further discussion of the investment results.
For the year ended December 31, 2017, total revenues were $479.0 million, up $84.8 million, or 21.5%, over the prior year period. The increase was primarily driven by an increase in earned premiums of $142.3 million, which was partially offset by decreases in service and administrative fees of $14.2 million and ceding commissions of $16.0 million. For the year ended December 31, 2017, revenues on the investment portfolio, including net investment income and realized and unrealized gains, were a loss of $0.2 million compared to $27.7 million of income in the 2016 period, a decrease of $28.0 million. This was primarily driven by unrealized losses on equities of $23.8 million in 2017 compared to unrealized gains of 7.3 million in 2016.
Commission expense is incurred on most product lines, the majority of which are retrospective commissions paid to distributors and retailers selling our products, including credit insurance policies, warranty and mobile device protection service contracts, and motor club memberships. Credit insurance commission rates are, in many cases, set by state regulators and are also impacted by market conditions and retention levels. Total commission expense for the year ended December 31, 2018 was $262.5 million compared to $241.8 million in the 2017 period. The primary drivers of the increase were the commission expense associated with the growth in written premiums and higher retention rate on our credit protection and warranty products.
Operating expenses include employee compensation and benefits, interest expense, depreciation and amortization expenses and other expenses. For the year ended December 31, 2018, total employee compensation and benefits were $45.8 million, up $4.5 million, driven by increased compensation associated with warranty and program products. Interest expense of $18.2 million in 2017 increased by $3.1 million versus the prior year, primarily from interest expense related to the Junior Subordinated Notes partially offset by reduced asset based borrowings on certain investments within the investment portfolio. Other expenses for the year ended December 31, 2018 were $41.9 million, up $3.3 million from 2017 primarily from a combination of expenses of pursuing acquisition opportunities, and premium taxes, the latter of which increased consistent with growth in written premiums. Depreciation and amortization expense was lower period-over-period as a result of the decline in VOBA purchase accounting impact from the amortization of the fair value attributed to the insurance policies and contracts acquired.
For 2017, total employee compensation and benefits were $41.3 million, up $3.4 million from 2016 primarily as a result of increased stock based compensation expense. Interest expense of $15.1 million in 2017 increased by $5.8 million versus the prior year, primarily from one quarter of interest expense on the Junior Subordinated Notes and increased asset based borrowings on certain investments
(1) For further information relating to the Company’s Operating EBITDA, Invested and Total Capital, adjusted combined ratio, and Net Portfolio Income (Loss), including a reconciliation to GAAP financials, see “-Non-GAAP Reconciliations.”
The combined ratio was 92.5% for the year ended December 31, 2018, compared to 92.9% for the prior year period. The improvement was a combination of improved product underwriting margins offset partially by expenses associated with the pursuit of acquisitions and stock-based compensation expense in the 2018 period. The combined ratio from 2015-2017 averaged 90.3%. The increase from our three-year average in recent quarters has been driven primarily by our investment in new products and geographies which we believe will result in premium growth in future periods.
For the year ended December 31, 2018, Underwriting Operating EBITDA was $45.9 million, an increase of $8.2 million from the respective prior year period, driven by the same factors discussed above under “Results.” Operating EBITDA from investments was $18.6 million, an increase of $3.1 million over 2017. See “-Specialty Insurance Investment Portfolio” for further discussion of the investment results and “-Non-GAAP Reconciliations” for a reconciliation to GAAP pre-tax income.
Our net investment income includes interest, dividends and rental income, net of investment expenses, on our invested assets. Our loans, at fair value, are generally floating rate and therefore earn LIBOR plus a spread. Generally, our interest income on those loans will increase in a rising interest rate environment, or decrease in a declining rate environment, subject to any LIBOR floors. Our held to maturity investments generally carry fixed coupons, which can impact our returns on investment. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment. We report net unrealized gains (losses) on securities classified as available-for-sale separately within accumulated other comprehensive income on our balance sheet. For loans, at fair value, and equity securities, we report unrealized gains (losses) within net realized gains (losses) on investment on the consolidated statement of income.
(1) Includes $9.2 million of dividends and $17.1 million of unrealized losses within Tiptree Capital.
(2) Includes discontinued operations related to Care for the year ended December 31, 2018, 2017 and 2016. Includes $56.9 million pre-tax gain on sale of Care in 2018.
Revenues for the year ended December 31, 2018 were $76.0 million, a decrease of $26.9 million from the prior year period. In the 2018 period, the results from our investment in Invesque shares include dividends received and unrealized gains and losses impacting our financial results. The decline was primarily driven by $17.1 million of unrealized losses on our Invesque equity securities, the loss of income from the sale of our commercial lending business in October 2017 and declines in mortgage gains. This was partially offset by dividends from our ownership of Invesque common shares.
Pre-tax income from continuing operations for the year ended December 31, 2018 was a loss of $7.8 million compared to income of $20.3 million in the 2017 period. For the year ended December 31, 2018, we received $9.2 million of dividends from Invesque. This was more than offset by unrealized losses of $17.1 million, which were a result of a lower Invesque stock price at December 31, 2018 versus the Invesque stock acquisition date of February 1, 2018. During 2017, we reduced exposure to subordinated notes by selling our interests, which contributed a one-time $10.7 million increase in pre-tax income in 2017. Lastly, pre-tax income from our mortgage originator contributed a lower amount of pre-tax income period over period driven by declines in volumes and gain on sale margins.
(2) Includes management and incentive fees net of operating expenses including compensation.
(3) Includes discontinued operations related to Care. For more information, see “Note-(3) Dispositions, Assets Held for Sale and Discontinued Operations.”
Invested Capital increased from $161.8 million as of December 31, 2017 to $182.0 million as of December 31, 2018. On February 1, 2018, we completed the sale of Care to Invesque. We received consideration of 16.6 million shares of which 13.7 million shares are held as equity securities in Tiptree Capital, and 2.9 million shares are held in the insurance investment portfolio. Care was classified as held for sale and a discontinued operation as of December 31, 2017. In 2018, we invested approximately $50 million into three
unlevered vessels which are reported in other investments. As a result of the investments in Tiptree Capital and capital returned to shareholders in 2018, cash held at Tiptree corporate decreased from $66.1 million as of December 31, 2017 to $27.7 million as of December 31, 2018.
Invested Capital decreased from $215.3 million as of December 31, 2016 to $161.8 million as of December 31, 2017. The primary driver was reduced exposure to subordinated notes which were sold in 2017. Also, in the fourth quarter 2017, we sold our interest in our commercial lending business and signed a definitive agreement to sell our interest in our jumbo mortgage business, currently in assets held for sale.
For the year ended December 31, 2018, Operating EBITDA declined from $29.8 million in the 2017 period to $13.7 million in the 2018 period. From 2016 to 2017, Operating EBITDA declined by $11.7 million. The decline in both periods was primarily driven by reduced credit investment distributions (from CLO subordinated notes) and lower incentive fees on older CLOs under management. Specialty finance and other declined from 2017 to 2018 as a result of the sale of our commercial lending business (including the related $2.0 million gain on sale in 2017), along with reduced Operating EBITDA from our mortgage origination business as margins and volumes declined from the prior year periods. In 2018, we received $9.2 million of dividends from our ownership of Invesque, which was partially offset by losses associated with our shipping investments.
Corporate expenses include expenses of the holding company for interest, employee compensation and benefits, and other costs. Corporate employee compensation and benefits includes the expense of management, legal and accounting staff. Other expenses primarily consisted of audit and professional fees, insurance, office rent and other related expenses.
Employee compensation and benefits increased $0.8 million from 2016 to 2017 as corporate staff increased as a result of improvements to our reporting and controls infrastructure, which was partially offset by lower accrued incentive compensation. Interest expense remained flat period-over-period as reduced borrowings were partially offset by increases in LIBOR. Other expenses were $9.8 million for 2017 as compared to $16.4 million in 2016, a reduction of $6.6 million, or 40.2%. The period-over-period decrease was driven by reduced audit fees and external consulting expenses as a result of our improved reporting and controls infrastructure.
The total income tax expense of $7.8 million for the year ended December 31, 2018 and total income tax benefit of $14.8 million for the year ended December 31, 2017 is reflected as a component of net income (loss). For the year ended December 31, 2018, the Company’s effective tax rate was equal to 20.6%, lower than the statutory rate of 21.0% primarily due to the dividends received deduction and other discrete items. For the year ended December 31, 2017, the Company’s effective tax rate was equal to 154.8%, which was significantly higher than the statutory rates due to the revaluation of deferred tax attributes following US federal tax reform.
The Company had a tax benefit from continuing operations of $5.9 million for the year ended December 31, 2018 as compared to a tax benefit of $12.6 million for the year ended December 31, 2017. The effective tax rate on income from continuing operations for the year ended December 31, 2018 was approximately 29.9% compared to 377.2% for the year ended December 31, 2017. Differences from the U.S. federal statutory income tax rate of 21% for the year ended December 31, 2018 are primarily the result of the dividends received deduction offset by other discrete items.
Balance Sheet Information - as of December 31, 2018 compared to the year ended December 31, 2017
Tiptree’s total assets were $1.9 billion as of December 31, 2018, compared to $2.0 billion as of December 31, 2017. The $124.7 million decrease in assets is primarily attributable to the sale of Care on February 1, 2018. Loans at fair value and amortized cost and assets held for sale decreased, partially offset by increases in equity securities, notes and accounts receivable and reinsurance receivable. In addition, the combination of unearned premiums and deferred revenues increased as a result of growth in written premiums and extending contract durations in the insurance business.
The tables below present Adjusted EBITDA and Operating EBITDA by business component.
The footnotes below correspond to the tables above, under “-Adjusted EBITDA and Operating EBITDA - Non-GAAP”
For Reliance, within our mortgage operations, Adjusted EBITDA excludes the impact of changes in contingent earn-outs. For our specialty insurance operations, depreciation and amortization on senior living real estate that is within net investment income is added back to Adjusted EBITDA. For Care (Discontinued Operations), the reduction in EBITDA is related to accumulated depreciation and amortization, and certain operating expenses, which were previously included in Adjusted EBITDA in prior periods.
(1) For periods prior to April 10, 2018, book value per share assumes full exchange of the limited partners units of TFP for Common Stock.
Underwriting margin is a measure of the underwriting profitability of our specialty insurance operations. It represents net earned premiums, service and administrative fees, ceding commissions and other income less policy and contract benefits and commission expense. We use the combined ratio as an insurance operating metric to evaluate our underwriting performance, both overall and relative to peers. Expressed as a percentage, it represents the relationship of policy and contract benefits, commission expense (net of ceding commissions), employee compensation and benefits, and other expenses to net earned premiums, service and administrative fees, and other income. The following table provides a reconciliation between underwriting margin and pre-tax income for the following periods:
Our mortgage business relies on short term uncommitted sources of financing as a part of their normal course of operations. To date, we have been able to obtain and renew uncommitted warehouse credit facilities. If we were not able to obtain financing, then we may need to draw on other sources of liquidity to fund our mortgage business. See Note-(10) Debt, net for additional information regarding our mortgage warehouse borrowings.
Our credit facility with Fortress carries a rate of LIBOR (with a minimum LIBOR rate of 1.25%), plus a margin of 5.50% per annum. We are required to make quarterly principal payments of approximately $1.0 million, subject to adjustment based on the Net Leverage Ratio (as defined in the credit agreement) at the end of each fiscal quarter. The outstanding debt under the Fortress credit agreement was $72.1 million as of December 31, 2018 compared to $28.5 million as of December 31, 2017. On May 4, 2018, we amended the Fortress credit agreement to increase the amount outstanding, while extending the maturity date to September 18, 2020 and lowering the interest rate margin from 6.50% to 5.50%.
Cash provided by operating activities (excluding VIEs) was $49.9 million for the year ended December 31, 2017. The primary sources of cash from operating activities included mortgage loan sales outpacing originations in our mortgage business, and increases in unearned premiums, reinsurance payables and policy liabilities in our specialty insurance business. The primary uses of cash from operating activities included an increase in reinsurance receivables and accounts and premiums receivables in our specialty insurance business.
Cash provided by investing activities - VIEs was $225.3 million for the year ended December 31, 2017 driven primarily by loan payments and sales of investments in a consolidated CLO.
Cash used in financing activities - VIEs was $223.4 million for the year ended December 31, 2017 driven primarily by payments on debt in a consolidated CLO.
Cash provided by operating activities (excluding VIEs) was $45.3 million for the year ended December 31, 2016. The primary sources
ASC Topic 820 establishes a three level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels, from highest to lowest, are defined as follows:
The Company evaluates whether insurance related deferred acquisition costs are recoverable at year-end, and considers investment income in the recoverability analysis. As a result of the Company's evaluations, no write-offs for unrecoverable insurance related deferred acquisition costs were recognized during the years ended December 31, 2018, 2017 and 2016, respectively.
Other deferred acquisition costs are limited to prepaid direct costs, typically commissions and contract transaction fees, that resulted from successful contract transactions and would not have been incurred by the Company had the transactions not occurred. These capitalized costs are amortized as the related service and administrative fees are earned.
Service Fees. Service fee revenue is recognized as the services are performed. These services include fulfillment, software
development, and claims handling for our customers. Collateral tracking fee income is recognized when the service is performed and billed. Management reviews the financial results under each significant contract on a monthly basis. Any losses that may occur due to a specific contract would be recognized in the period in which the loss is determined probable. During the years ended December 31, 2018, 2017 and 2016, respectively, the Company did not incur a loss with respect to a specific significant service fee contract.
Commissions are paid to distributors and retailers selling credit insurance policies, motor club memberships, mobile device protection, and warranty service contracts, and are generally deferred and expensed in proportion to the earning of related revenue. Credit insurance commission rates, in many instances, are set by state regulators and are also impacted by market conditions. In certain instances, credit insurance commissions are subject to retrospective adjustment based on the profitability of the related policies. Under these retrospective commission arrangements, the producer of the credit insurance policies receives a retrospective commission if the premium generated by that producer in the accounting period exceeds the costs associated with those policies, which includes the Company's administrative fees, claims, reserves, and premium taxes. The Company analyzes the retrospective commission calculation periodically for each producer and, based on the analysis associated with each such producer, the Company records a liability for any positive net retrospective commission earned and due to the producer or, conversely, records a receivable, net of allowance, for amounts due from such producer for instances where the net result of the retrospective commission calculation is negative.
The Company measures compensation cost for share-based awards at fair value and recognizes compensation over the service period for awards expected to vest. The fair value of restricted stock is based on the number of shares granted and the quoted price of our Common Stock at the time of grant. In addition, the estimation of share-based awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period that the estimates are revised. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results, and future changes in estimates, may differ substantially from our current estimates.
The Company establishes valuation allowances for deferred tax assets when, in its judgment, it concludes that it is more likely than not that the deferred tax assets will not be realized. These judgments are based on projections of future income, including
reviews its methodology annually or more often if representation and warranty claims patterns change.
Rental revenue from residents in Managed Properties are recognized monthly as services are provided, as lease periods for residents are short-term in nature. The Company recognizes rental revenue from triple net lease properties on a straight-line basis over the non-cancelable term of the lease unless another systematic and rational basis is more representative of the time pattern in which the use benefit is derived from the leased property. Renewal options in leases with rental terms that are higher than those in the primary term are excluded from the calculation of straight-line rent if the renewals are not reasonably assured. The Company commences rental revenue recognition when the tenant takes control of the leased space. The Company recognizes lease termination payments as a component of rental revenue in the period received, provided that there are no further obligations under the lease.
For a discussion of recently issued accounting standards see Note-(2) Summary of Significant Accounting Policies, in the accompanying consolidated financial statements.
Further disclosure on our off-balance sheet arrangements as of December 31, 2018 is presented in the “Notes to Consolidated Financial Statements” in “Part II. Item 8. Financial Statements and Supplementary Data” of this filing as follows:
To the Stockholders and the Board of Directors of Tiptree Inc.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2018, of the Company and our report dated March 13, 2019, expressed an unqualified opinion on those financial statements.
March 13, 2017, except for Note 3C, as to which the date is March 14, 2018
(1) Deconsolidated as part of the sale of Care. See Note (3) Dispositions, Assets Held for Sale and Discontinued Operations.
(1) Includes the exchange of 424,399 units of TFP for 1,187,468 shares of Common Stock.
In this report “Common Stock” means Class A common stock $0.001 par value for periods prior to June 7, 2018 and thereafter the common stock $0.001 par value. See Note (16) Stockholders’ Equity for more information.
Tiptree consolidates those entities in which it has an investment 50% or more of voting rights or has control over significant operating, financial and investing decisions of the entity as well as variable interest entities (VIEs) in which Tiptree is determined to be the primary beneficiary. VIEs are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity risk for the entity to finance its activities without additional subordinated financial support from other parties.
Fair value of financial assets and liabilities, including, but not limited to, securities, loans and derivatives
Reserves for unpaid losses and loss adjustment expenses, estimated future claims and losses, potential litigation and other claims;
In certain instances, the Company may acquire less than 100% ownership of an entity, resulting in the recording of a non-controlling interest. The measurement of assets and liabilities acquired and non-controlling interest is initially established at a preliminary estimate of fair value, which may be adjusted during the measurement period, primarily due to the results of valuation studies applicable to the business combination.
The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels, from highest to lowest, are defined as follows:
In addition to the financial instruments the Company is required to measure at fair value, the Company has elected to make an irrevocable election to utilize fair value as the initial and subsequent measurement attribute for certain eligible financial assets and liabilities. Unrealized gains and losses on items for which the fair value option has been elected are reported in Net realized and unrealized gains (losses) within the consolidated statements of operations. The decision to elect the fair value option is determined on an instrument-by-instrument basis and must be applied to an entire instrument and is irrevocable once elected. Assets and liabilities measured at fair value pursuant to this guidance are reported separately in our consolidated balance sheets from those instruments using another accounting method.
Deferred tax assets and liabilities are determined using the asset and liability method. Under this method, deferred tax assets and liabilities are established for future tax consequences of temporary differences between the financial statement carrying amounts of assets and liabilities and their tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to reverse. A valuation allowance is established when necessary to reduce a deferred tax asset to the amount expected to be realized. Several of the Company’s subsidiaries, file state tax returns on a standalone basis. Two of our subsidiaries file federal and state tax returns on a stand alone basis, one of which is held for sale. These U.S. federal and state income tax returns, when filed, will be subject to examination by the Internal Revenue Service and state departments of revenue. See Note -(19) Income Taxes.
The Company presents both basic and diluted earnings per Common Share in its consolidated financial statements and footnotes thereto. Basic earnings per Common Share (Basic EPS) excludes dilution and is computed by dividing net income or loss available to common stockholders by the weighted average number of common shares outstanding, including vested restricted share units, for the period. Diluted earnings per Common Share (Diluted EPS) reflects the potential dilution that could occur if securities or other contracts to issue common shares were exercised or converted into common shares where such exercise or conversion would result in a lower earnings per share amount.
The Company records all investment transactions on a trade-date basis. Realized gains (losses) are determined using the specific-identification method. The Company classifies its investments in debt securities as available-for-sale or held-to-maturity based on the Company’s intent and ability to hold the debt security to maturity. The Company did not have any held-to-maturity securities at December 31, 2018 and 2017.
AFS are securities that are not classified as trading or held-to-maturity and are intended to be held for indefinite periods of time. AFS securities include those debt securities that management may sell as part of its asset/liability management strategy or in response to changes in interest rates, resultant prepayment risk or other factors. AFS securities are held at fair value on the consolidated balance sheet with changes in fair value, net of related tax effects, recorded in the accumulated other comprehensive income (AOCI) component of stockholders’ equity in the period of change. Upon the disposition of an AFS security, the Company reclassifies the gain or loss on the security from accumulated other comprehensive income (loss) to net realized and unrealized gains (losses) on the consolidated statements of operations.
The Company regularly reviews AFS securities, held-to-maturity and cost investments with unrealized losses in order to evaluate whether the impairment is other-than-temporary. Under the guidance for debt securities, other-than-temporary impairment (OTTI) is recognized in earnings in the consolidated statements of operations for debt securities that the Company has an intent to sell or that it believes it is more likely than not that it will be required to sell prior to recovery of the amortized cost basis. For those securities that the Company does not intend to sell nor expect to be required to sell, credit-related impairment is recognized in
earnings, with the non-credit-related impairment recorded in accumulated other comprehensive income (AOCI). An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. Unrealized losses for AFS securities that are determined to be temporary in nature are recorded, net of tax, in AOCI.
Mortgage loans held for sale represent loans originated and held until sold to secondary market investors. Such loans are typically warehoused for a period after origination or purchase before sale into the secondary market. Loans are sold either servicing released, or in select instances, servicing maintained into the secondary loan market. The Company has elected to measure all mortgage loans held for sale at fair value. These loans are considered sold when the Company surrenders control to the purchaser. The gains or losses on sales of such loans, net of any accrual for standard representations and warranties, are reported in operating results as a component of net realized and unrealized gains (losses) in the consolidated statement of operations in the period when the sale occurs.
The Company has elected the fair value option for NPLs as we have concluded that fair value timely reflects the results of our investment performance. As substantially all of our loans were non-performing when acquired, we generally look to the estimated fair value of the underlying property collateral to assess the recoverability of our investments. We primarily utilize the local broker price opinion (BPO) but also consider any other comparable home sales or other market data, as considered necessary, in estimating a property’s fair value. For further discussion on the observable and unobservable inputs to the model and determination of fair value of NPLs, see Note-(11) Fair Value of Financial Instruments.
Certain non-performing loans are loans that are delinquent on obligated payments of principal and interest. Certain other non-performing loans are making some payments, generally as a result of a modification or a workout plan.
Equity securities, at fair value are investments consisting of equity securities that are purchased principally for the purpose of selling them in the near term. Changes in fair value are recorded in net realized and unrealized gains (losses) on investments on the consolidated statements of operations in the period of change.
As of December 31, 2018 the undiscounted future cash flows were higher than the carrying amount of each of the vessels in the Company’s fleet and, as such, no loss on impairment was recognized.
The Company’s notes receivable, net includes receivables related to the specialty insurance business for its premium financing programs.
The Company defers certain costs of acquiring new and renewal insurance policies and other products within the Company’s specialty insurance business. Amortization of deferred acquisition costs was $246,330, $221,362 and $142,337 for the years ended December 31, 2018, 2017 and 2016, respectively.
The initial measurement of goodwill and intangibles requires judgment concerning estimates of the fair value of the acquired assets and liabilities. Goodwill and indefinite-lived intangible assets are not amortized but subject to tests for impairment annually or if events or circumstances indicate it is more likely than not they may be impaired. Other intangible assets are amortized over their estimated useful lives and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The Company carries intangible assets, which represent customer and agent relationships, trade names, insurance licenses (certificates of authority granted by individual state departments of insurance), the value of in-force insurance policies acquired, software acquired or internally developed, and leases in-place. Management has deemed the insurance licenses to have indefinite useful life. Costs incurred to renew or maintain insurance licenses are recorded as operating costs in the period in which they arise. See Note -(8) Goodwill and Intangible Assets, net.
Premiums written are earned over the life of the respective policy using the Rule of 78's, pro rata, or other actuarial methods as appropriate for the type of business. Unearned premiums represent the portion of premiums that will be earned in the future. A premium deficiency reserve is recorded if anticipated losses, loss adjustment expenses, deferred acquisition costs and policy maintenance costs exceed the recorded unearned premium reserve and anticipated investment income. As of December 31, 2018 and December 31, 2017, no deficiency reserves were recorded.
to compute ultimate losses. The indicated required reserve is the difference between the ultimate losses and the reported losses. The actuarial methods used include but are not limited to the chain ladder method, the Bornhuetter-Ferguson method, and the expected loss ratio method. The actuarial analyses are performed on a basis gross of ceded reinsurance, and the resulting factors and estimates are then used in calculating the net loss reserves which take into account the impact of reinsurance. The Company has not made any changes to its methodologies for determining claim reserves in the periods presented.
Deferred revenues represent the portion of income that will be earned in the future attributable to motor club memberships, mobile device protection plans, and other non-insurance service contracts that are earned over the respective contract periods using Rule of 78's, modified Rule of 78's, pro rata, or other methods as appropriate for the contract. A deficiency reserve would be recorded if anticipated contract benefits, deferred acquisition costs and contract service costs exceed the recorded deferred revenues and anticipated investment income. As of December 31, 2018 and 2017, respectively, no deficiency reserves were recorded.
Other liabilities primarily consists of accounts payable and accrued expenses, deferred tax liabilities, net, commissions payable and accrued interest payable. See Note-(14) Other Assets and Other Liabilities and Accrued Expenses.
Management selects the appropriate method based on available information, and periodically reviews the selections as additional information becomes available. Direct and assumed premiums are offset by premiums ceded to the Company's reinsurers, including producer owned reinsurance companies (PORCs), earned in the same manner. The amount ceded is proportional to the amount of risk assumed by the reinsurer.
Service Fees. Service fee revenue is recognized as the services are performed. These services include fulfillment, software development, and claims handling for our customers. Collateral tracking fee income is recognized when the service is performed and billed. Management reviews the financial results under each significant contract on a monthly basis. Any losses that may occur due to a specific contract would be recognized in the period in which the loss is determined probable. During the years ended December 31, 2018, 2017 and 2016, respectively, the Company did not incur a loss with respect to a specific significant service fee contract.
In the first quarter of 2018 the Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606) and applicable amendments, ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing and ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. These standards establish a comprehensive new revenue recognition model designed to depict the transfer of goods or services to a customer in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (COLIs) (including bank-owned life insurance policies (BOLIs)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2017 and interim periods within those annual periods. Early adoption is permitted, including the adoption in an interim period. The amendments in this Update should be applied using a retrospective transition method to each period presented. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480) and Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features; II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. Part I of this update addresses the complexity of accounting for certain financial instruments with down round features. Down round features are features of certain equity-linked instruments (or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings. Current accounting guidance creates cost and complexity for entities that issue financial instruments (such as warrants and convertible instruments) with down round features that require fair value measurement of the entire instrument or conversion option. Part II of this update addresses the difficulty of navigating Topic 480, Distinguishing Liabilities from Equity, because of the existence of extensive pending content in the FASB Accounting Standards Codification. This pending content is the result of the indefinite deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests. The amendments in Part II of this update do not have an accounting effect. The Company elected to early adopt this standard as of December 31, 2017. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. ASU 2016-02 supersedes the previous leases standard, Leases (Topic 840). The standard is effective on January 1, 2019, with early adoption permitted. The Company adopted the standard in the first quarter of 2019. The adoption of ASU 2016-02 will result in an gross up within the consolidated balance sheet of a Right of use asset and Lease liability, with no impact to retained earnings. The Company does not believe the adoption of this standard will have a material impact on the Company’s consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. ASU 2017-04 does not change the qualitative assessment; however, it removes “the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test.” Instead, all reporting units, even those with a zero or negative carrying amount will apply the same impairment test. Therefore, as the FASB notes in the ASU’s Basis for Conclusions, the goodwill of reporting units with zero or negative carrying values will not be impaired, even when conditions underlying the reporting unit indicate that goodwill is impaired. Entities will, however, be required to disclose any reporting units with zero or negative carrying amounts and the respective amounts of goodwill allocated to those reporting units. The amendments in ASU 2017-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the effect on its consolidated financial
In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which permits companies to reclassify stranded tax effects caused by Public Law no. 115-97, commonly referred to as the Tax Cuts and Jobs Act (Tax Act) from accumulated other comprehensive income (AOCI) to retained earnings. Deferred tax assets (DTA) related to available for sale (AFS) securities unrealized gains and losses that were revalued as of December 31, 2017 created stranded tax effects in accumulated other comprehensive income (AOCI) due to the enactment of the tax act, due to the nature of existing GAAP requiring recognition of tax rate change effects on the DTA revaluation related to AFS securities as an adjustment to provision for income taxes. Specifically, ASU 2018-02 permits a reclassification from AOCI to retained earnings for stranded tax effects resulting from the Tax Act. Additionally, the ASU requires new disclosures by all companies, whether they opt to do the reclassification or not. The amendments in ASU 2018-02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The Company believes that the adoption of ASU 2018-02 will not have a material impact on its consolidated financial statements.
When the Company entered into a purchase agreement on November 16, 2017 to sell Care, the Company concluded that the sale met the requirements to be classified as a discontinued operation. As a result, the Company reclassified the income and expenses attributable to Care to net income (loss) from discontinued operations for the years ended December 31, 2017 and
The Company has entered into a definitive agreement to sell Luxury, which is pending a regulatory review, and is classified as held for sale at December 31, 2018 and 2017. The agreement did not meet the requirements to be classified as a discontinued operation.
On January 18, 2017 and November 7, 2017, the Company sold its ownership in the subordinated notes in two CLOs (collectively, the Disposed CLOs). As a result of the sales, the Company determined that it no longer had the controlling interest in such entities. The Company, therefore, deconsolidated its ownership in the subordinated notes of the Disposed CLOs and is no longer reporting the assets and liabilities of the Disposed CLOs in its consolidated balance sheet as of December 31, 2017. The operations of the Disposed CLOs were consolidated in the results of the Company through the respective dates.
The Company sold its interest in its commercial lending business on October 1, 2017. Consideration consisted of $2,500 in cash and $11,000 of seller provided financing at the time of sale. The financing had an interest rate of 10% and was settled in cash in December of 2018. The operations of this business were consolidated in the results of the Company through the sale date.
(1) Reflects the closing of the sale of Care discussed above. The reduction in net assets and liabilities held for sale included approximately $13.4 million related to non-controlling interest.
The following table represents a summary of cash flows related to discontinued operation included in the consolidated statements of cash flows for the following periods:
Real estate properties were reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. If such reviews indicated that the asset was impaired, the asset’s carrying amount was written down to its fair value. There were no material impairments on the Company’s real estate investments for the years ended December 31, 2017 and 2016, respectively.
Tiptree is a holding company that combines specialty insurance operations with investment management expertise. We allocate our capital across our insurance operations and other investments. As such, we classify our business into one reportable segment - Specialty Insurance. Our non-insurance operations, assets and other investments which is comprised of our non-reportable operating segments and other business activities, we refer to as Tiptree Capital. Corporate activities include holding company interest expense, employee compensation and benefits, and other expenses.
Our reportable segment’s income (loss) is reported before income taxes, discontinued operations and non-controlling interests. Segment results incorporate the revenues and expenses of these subsidiaries since they commenced operations or were acquired. For the year ended December 31, 2018, Mortgage and Asset Management, which previously were reportable segments, no longer meet the quantitative threshold for disclosure. Those are now reported in Other, which we refer to as Tiptree Capital. Prior year segments have been conformed to the current year presentation. Intercompany transactions are eliminated.
A description of our reportable segment and of Tiptree Capital are as follows:
Asset Management operations which are primarily conducted through Tiptree Asset Management Company, LLC (TAMCO), an SEC-registered investment advisor owned by the Company. Results prior to deconsolidation include net income (loss) from consolidated CLOs.
Additional operations include the investment in Invesque not held in Specialty Insurance, as well as the operations of our dry bulk vessels, and certain assets classified as held for sale.
The following table presents the Company's investments related to insurance operations (Specialty Insurance) and investments from other Tiptree investing activities (Tiptree Capital), measured at fair value as of the following periods:
The Company does not intend to sell the investments that were in an unrealized loss position as of December 31, 2018, and management believes that it is more likely than not that the Company will be able to hold these securities until full recovery of their amortized cost basis for fixed maturity securities. The unrealized losses were attributable to changes in interest rates and not credit-related issues. As of December 31, 2018 and December 31, 2017, based on the Company's review, none of the fixed maturity securities were deemed to be other-than-temporarily impaired based on the Company's analysis of the securities and its intent to hold the securities until recovery.
The following tables present the Company’s investments in loans measured at fair value and the Company’s investments in loans, measured at fair value pledged as collateral:
(2) The cost basis of NPLs was approximately $21,555 and $32,398 at December 31, 2018 and December 31, 2017, respectively.
As of December 31, 2018 and December 31, 2017, there were no mortgage loans held for sale 90 days or more past due.
Net investment income represents investment income and expense from investments related to insurance operations as disclosed within net investment income on the consolidated statements of operations. The following tables present the components of net investment income by source of income:
The following table presents the components of net realized and unrealized gains (losses) recorded on the consolidated statements
The Company has established an allowance for uncollectible amounts against its notes receivable of $97 and $66 as of December 31, 2018 and December 31, 2017, respectively. As of December 31, 2018 and December 31, 2017, there were $368 and $416 in balances classified as 90 days plus past due, respectively. Bad debt expense totaled $195, $374 and $932 for the years ended December 31, 2018, 2017 and 2016, respectively.
The following table presents the effect of reinsurance on premiums written and earned by our specialty insurance business for the following periods:
As of December 31, 2018, the non-affiliated reinsurers from whom our specialty insurance business has the largest receivable balances were: MFI Insurance Company, LTD (A. M. Best Rating: Not rated), Freedom Insurance Company, LTD (A. M. Best Rating: Not rated) and Frandisco Property and Casualty Insurance Company (A. M. Best Rating: Not rated). The related receivables of these reinsurers are collateralized by assets on hand, assets held in trust accounts and letters of credit. As of December 31, 2018, the Company does not believe there is a risk of loss due to the concentration of credit risk in the reinsurance program given the collateralization.
(1) Related to the sale of our commercial lending business. See Note (3) Dispositions, Assets Held for Sale and Discontinued Operations.
The Company conducts annual impairment tests of its goodwill as of October 1. The Company’s impairment testing for each period did not indicate any goodwill impairment, as each of the Company’s reporting units with goodwill had a fair value that was substantially in excess of its carrying value. For the years ended December 31, 2018, 2017 and 2016, respectively, no impairment was recorded on the Company’s goodwill or intangibles.
The following table summarizes the gross notional and fair value amounts of derivatives (on a gross basis) categorized by underlying risk:
The following table presents the fair value and the related outstanding notional amounts of the Company's cash flow hedging derivative instruments and indicates where the Company records each amount in its consolidated balance sheets:
(1) Deconsolidated of as part of the sale of Care. See Note (3) Dispositions, Assets Held for Sale and Discontinued Operations.
(2) The weighted average coupon rate for asset based revolving financing was 4.30% and 4.17% at December 31, 2018 and December 31, 2017, respectively.
On May 4, 2018, the Company entered into a Fifth Amendment to the Credit Agreement with Fortress providing for an additional $47,000 borrowing for a total principal amount outstanding of $75,000 as of the borrowing date. The Fifth Amendment extends the maturity date of all term loans under the Credit Agreement from September 18, 2018 to September 18, 2020. The amended facility also has a new interest rate at a variable rate equal to one-month LIBOR with a LIBOR floor of 1.25%, plus a margin of 5.50% per annum. As of December 31, 2018 and December 31, 2017, a total of $72,090 and $28,500, respectively, was outstanding under the agreement.
On December 21, 2017, a subsidiary in our specialty insurance business entered into a $30,000 revolving line of credit which
The $11,917 balance as of December 31, 2017 of the NPL financing in our specialty insurance business was paid off and the borrowing was extinguished in 2018.
Luxury has three warehouse borrowings with a total borrowing capacity at December 31, 2018 of $95,000. As of December 31, 2018 and 2017, a total of $61,381and $53,835, respectively, was outstanding under such financing agreements. At December 31, 2018 and December 31, 2017 the debt for this subsidiary was included within liabilities held for sale.
The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs to the extent possible to measure a financial instrument’s fair value. Observable inputs reflect the assumptions market participants would use in pricing an asset or liability, and are affected by the type of product, whether the product is traded on an active exchange or in the secondary market, as well as current market conditions. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Fair value is estimated by applying the hierarchy discussed in Note (2) Summary of Significant Accounting Policies which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized within Level 3 of the fair value hierarchy.
Available for sale securities are generally classified within either Level 1 or Level 2 of the fair value hierarchy and are based
U.S Treasury Securities, Obligations of U.S. Government Authorities and Agencies, Obligations of State and Political Subdivisions, Corporate Securities, Asset-Backed Securities, and Obligations of Foreign Governments: Fair values were obtained from an independent pricing service and a third party investment manager. The prices provided by the independent pricing service are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing and fall under Level 2 or Level 3 of the fair value hierarchy.
Corporate Loans: These loans are comprised of a diversified portfolio of middle market and broadly syndicated leveraged loans and are generally classified within either Level 2 or Level 3 in the fair value hierarchy. To determine fair value, the Company uses quoted prices which include those provided from pricing vendors, where available. We perform internal price verification procedures to ensure that the prices and quotes provided from the independent pricing vendors are reasonable. Such verification procedures include comparison of pricing sources and analysis of variances among pricing sources. The Company has evaluated each loan’s respective liquidity and has additionally performed valuation benchmarking. The key characteristics which were evaluated as part of this determination were liquidity ratings, price changes to index benchmarks, depth of quotes, credit ratings and industry trends.
Nonperforming Loans and REO: The Company determines the purchase price for NPLs at the time of acquisition and for each subsequent valuation by using a discounted cash flow valuation model and considering alternate loan resolution probabilities, including modification, liquidation, or conversion to REO. The significant unobservable inputs used in the fair value measurement of our NPLs are discount rates, loan resolution timeline, and the value of underlying properties. The fair values of NPLs which are making payments (generally based on a modification or a workout plan) are primarily based upon secondary market transaction prices, which are expressed as a percentage of unpaid principal balance (UPB). Observable inputs to the model include loan amounts, payment history, and property types. Our NPLs are on nonaccrual status at the time of purchase as it is probable that principal or interest is not fully collectible. NPLs are included in loans, at fair value and fall under Level 3 of the fair value hierarchy.
NPLs that have become REOs were measured at fair value on a non-recurring basis at the time of transfer during the year ended December 31, 2018 and the year ended December 31, 2017. The carrying value of REOs at December 31, 2018 and December 31, 2017 was $10,019 and $16,056, respectively. Upon conversion to REO, the fair value is estimated using broker price opinion
(BPO). BPOs are subject to judgments of a particular broker formed by visiting a property, assessing general home values in an area, reviewing comparable listings, and reviewing comparable completed sales. These judgments may vary among brokers and may fluctuate over time based on housing market activities and the influx of additional comparable listings and sales. REO is included in other investments. Subsequent to conversion, REOs are carried at lower of cost or market.
The following table sets forth quantitative information about the significant unobservable inputs used to measure the fair value of our NPLs. For NPLs that are not making payments, discount rate, loan resolution time-line, value of underlying properties, holdings costs and liquidation costs are the primary inputs used to measure fair value. For NPLs that are making payments, note rate and secondary market transaction prices/UPB are the primary inputs used to measure fair value.
Debentures: Since interest rates on debentures are at current market rates for similar credit risks, the carrying amount approximates fair value. These values are net of allowance for doubtful accounts.
Notes and Accounts Receivable: To the extent that carrying amounts differ from fair value, fair value is determined based on contractual cash flows discounted at market rates for similar credits. Categorized as Level 2 of the fair value hierarchy.
Debt: The carrying value, which approximates fair value of LIBOR based debt, represents the total debt balance at face value excluding the unamortized discount. The fair value of the Junior subordinated notes is determined based on dealer quotes. Categorized as Level 3 of the fair value hierarchy.
The following table presents the activity in the net liability for unpaid losses and allocated loss adjustment expenses of short-duration contracts for the following periods:
The following table presents a reconciliation of net outstanding liabilities for unpaid loss and loss adjustment expenses of short-duration contracts to the consolidated balance sheet value of policy liabilities and unpaid claims:
Revenue from contracts with customers is primarily comprised of asset management fee income included as a part of other revenue, and warranty coverage, car club and other revenues included as a part of service and administrative fees in our specialty insurance business. The table below presents the disaggregated amounts of revenue from contracts with customers by product type for the following periods:
We do not disclose information about remaining performance obligations pertaining to contracts that have an original expected duration of one year or less. The transaction price allocated to remaining unsatisfied or partially unsatisfied performance obligations with an original expected duration exceeding one year was not material at December 31, 2018.
The table below presents the activity in the significant deferred assets and liabilities related to revenue from contracts with customers for the year ended December 31, 2018.
The following table presents the components of other assets as reported in the consolidated balance sheets:
The following table presents the components of other revenue as reported in the consolidated statement of operations. Other revenue is primarily generated by Tiptree Capital non-insurance activities except as noted in the footnote to the table.
(1) See Note (5) Investments for the components of Other investment income.
On June 5, 2017, in settlement of an option, TFP delivered 1,510,920 shares of the Company’s Common Stock to Tricadia (a related party) for total consideration of approximately $8,100. These shares were delivered using shares accounted for as treasury stock.
On April 10, 2018, the Company completed a reorganization merger whereby TFP merged with and into the Company with the Company continuing as the surviving company (Reorganization Merger). After the Reorganization Merger, TFP ceased to exist and the Company owned 100% of Operating Company. As a result of the merger, the balance of Non-controlling interest - TFP as of the merger date was allocated to Additional paid in capital and Accumulated other comprehensive income (loss), as detailed in the consolidated statement of changes in stockholders’ equity.
In connection with the Reorganization Merger, each TFP limited partner other than Tiptree received 2.798 shares of Class A common stock for each partnership unit, 6,861,561 Class A common shares were issued, and all outstanding Class B common stock was canceled. Outstanding warrants to acquire 652,500 shares of Class A common stock at an exercise price of $11.33 per share owned by TFP were canceled. In addition, warrants to acquire 103,994 shares of Class A common stock at an exercise
price of $11.33 were issued to partners of TFP other than Tiptree, and expired unexercised on December 31, 2018. Warrants to acquire 805,986 TFP LP units at $21.232 per unit were canceled and Tiptree issued warrants for 2,255,149 Tiptree shares of Class A common stock at an exercise price of $7.59 per share to holders of the canceled TFP warrants.
(1) Excludes awards granted under the Company’s subsidiary incentive plans that are exchangeable for Tiptree Common Stock.
The following table summarizes changes to the issuances of RSUs under the 2017 Equity Plan for the periods indicated:
(1) Includes grants of 46,572, 39,164 and 25,508 shares of Common Stock to directors for the years ended December 31, 2018, 2017 and 2016, respectively.
The Company values RSUs at their grant-date fair value as measured by Tiptree’s Common Stock price. Included in vested shares for 2018 are 29,286 shares surrendered to pay taxes on behalf of the employees with shares vesting. During the year ended December 31, 2018, the Company granted 268,799 RSUs to employees of the Company. 147,467 shares vest ratably over a period of three years that began in February 2018 and the remaining 121,332 shares will cliff vest in February 2021.
Certain of the Company’s subsidiaries have established RSU programs under which they are authorized to issue RSUs or their equivalents, representing equity of such subsidiaries to certain of their employees. Such awards are accounted for as equity. These RSUs are subject to performance-vesting criteria based on the performance of the subsidiary (performance vesting RSUs) and time-vesting subject to continued employment (time vesting RSUs). Following the service period, such vested RSUs may be exchanged at fair market value, at the option of the holder, for Tiptree Common Stock under the 2017 Equity Plan. The Company has the option, but not the obligation to settle the exchange right in cash.
Option awards have been granted to the Executive Committee with an exercise price equal to the fair market value of our Common Stock on the date of grant. The option awards have a 10-year term and are subject the recipient’s continuous service, a market requirement, and vest one third on each of the third, fourth and fifth anniversary of the grant date. The market requirement is a book value per share target that can be met at any time before the option expires and it only needs to be met once for the option to remain exercisable for the remainder of its term. If the service condition is met, the full amount of the compensation expense will be recognized over the appropriate vesting period whether the market requirement is met or not. The options granted in 2018 include a retirement provision and are amortized over the lesser of the service condition or expected retirement date.
The following table presents the assumptions used to estimate the fair values of the stock options granted for the following periods:
The Company accounts for its income taxes receivable or payable on a gross basis with offsetting permitted for balances booked by a filing entity in a single jurisdictional basis. The Company’s income taxes receivable as of December 31, 2018 of $2,307 is offset with an income tax payable balance of $1,692, resulting in a consolidated net receivable of $615. The Company’s income taxes receivable as of December 31, 2017 was $9,588 offset with an income tax payable balance of $1,142 resulting in a consolidated net receivable of $8,446.
The Company’s primary tax jurisdiction is the United States, which currently has a statutory income tax rate equal to 21%. On December 22, 2017, the U.S. government enacted Public Law no. 115-97, commonly referred to as the Tax Cuts and Jobs Act (Tax Act), which, among other things, reduces the federal income tax rate from 35% to 21% effective January 1, 2018, and requires mandatory deemed repatriation of foreign earnings. As a result of the Tax Act, we re-measured our net deferred tax liabilities and recognized a net tax benefit of $15,238 in 2017.
In addition to the U.S. Federal NOL, Tiptree and its subsidiaries have NOLs in various state jurisdictions totaling $5.0 million.
As of December 31, 2018, the Company had no material unrecognized tax benefits or accrued interest and penalties. This is consistent with the tax years ending December 31, 2017 and December 31, 2016 as well. Federal tax years 2015 through 2018 were open for examination as of December 31, 2018.
On February 15, 2019, the Company and Tricadia entered into a Strategic Combination Agreement and Amended and Restated Transition Services Agreement. Tricadia is a related party of the Company because Tricadia is deemed to be controlled by Michael Barnes, the Company’s Executive Chairman. Tiptree agreed to invest $75 million to seed new investment funds to be managed by Tricadia in exchange for management control of and a profit participation in Tricadia.
No consideration was paid for the acquisition of control by Tiptree. Tiptree will over time receive a 51% economic interest in certain profit shares interests in Tricadia, in increments stepping up by 10.2% each year, beginning in 2021. During the five-year period, beginning on January 1, 2026, Tiptree has the right to acquire the remaining economic interests in Tricadia that are held by Mr. Barnes, based upon a fair value-based formula. During the four-year period, beginning on January 1, 2027, Mr. Barnes has the reciprocal right to put his remaining economic interests in Tricadia to Tiptree using the same formula. Mr. Barnes has customary minority approval rights over specified actions at Tricadia while a Tricadia equity owner. Tiptree and Tricadia have agreed to provide each other with certain support services on an arms’-length basis, pursuant to a Transition Services Agreement.
On March 12, 2019, the Company’s board of directors declared a quarterly cash dividend of $0.035 per share to holders of Common Stock with a record date of March 25, 2019, and a payment date of April 1, 2019.