Our corporate headquarters is located at 150 Northwest Point Boulevard, Elk Grove Village, Illinois 60007, USA. The facility consists of one office building totaling 176,844 net rentable square feet of office space on 7.2 acres. We are leasing approximately 30,600 square feet for a term of 60 months that began May 22, 2012, unless terminated or extended pursuant to the lease agreement. We are paying an annual rent equal to approximately $768,000, or approximately $64,000 per month, with a nominal annual escalation beginning on the first anniversary date of the lease agreement. We believe the facility is suitable and adequate for our current business needs. Prior to the expiration of the aforementioned lease, we will explore alternatives to meet our future needs.
Common shares for 2012 and 2011 have been restated for the one-for-three stock split on January 29, 2013, and per share data has been restated to reflect the common share restatement.
These statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP"). However, some of the measurements we use are "non-U.S. GAAP financial measurements" under SEC rules and regulations. We use these non-U.S. GAAP financial measurements in order to present our financial condition and results of operations in the way we believe will be most meaningful and representative of our business results. When we use these measures, reconciliations to the most comparable GAAP measure are provided in the Results of Operations section of this MD&A on a consolidated basis. The non-GAAP financial measurements that we present may not be comparable to similarly-named measures reported by other companies.
Income from operating activities, before tax includes both underwriting income and loss and net investment income, but excludes net realized capital gains and losses, legal and professional expense incurred related to business combinations, net impairment charges recognized in earnings and other items. Underwriting income is derived by reducing net premiums earned by losses and loss adjustment expenses incurred, policy acquisition costs and general operating expenses.
After-tax return on average common equity ("ROCE") is derived by subtracting preferred share dividends accrued from net income and dividing by average common equity. Common equity is total shareholders' equity less preferred shares and cumulative preferred share dividends accrued. Average common equity is the average of common equity at the beginning and the ending of the reporting period.
Return on average common equity from operating activities ("Operating ROCE") is the sum of the underwriting income ratio, operating leverage ratio and investment income ratio. The underwriting income ratio is derived by dividing underwriting income (net of statutory income tax expense) by net earned premiums. The operating leverage ratio is derived by dividing net premiums earned by average common equity. The investment income ratio is the product of the annualized investment return ratio multiplied by the investment leverage ratio. The investment return ratio is derived by dividing investment income before realized gains (net of statutory income tax expense) by average cash and invested assets. The investment leverage ratio is derived by dividing average cash and invested assets by average common equity.
Over the past five years, we have disposed of non-core assets, consolidated infrastructure and placed into run-off certain non-core lines of business previously written by the insurance subsidiaries. Our focus going forward is the underwriting of commercial automobile insurance in the U.S. Substantially all of our new premiums written are in “light” commercial automobile lines of business.
Consistent with Atlas’ focus on commercial automobile insurance, Atlas has transitioned away from the non-standard auto line. Our insurance subsidiaries ceased writing new and renewal policies of this type in 2011, and earned premium discontinued in 2012, allowing surplus and resources to be devoted to the expected growth of the commercial automobile business.
After-tax income from operating activities was $15.5 million, or $1.22 per diluted share, compared to $8.1 million, or $0.71 per diluted share
Underwriting income improved to $19.8 million as compared to $9.1 million
Net income was $14.4 million, compared to net income of $17.7 million which included $9.4 million of tax benefit resulting from the Company's treatment of DTAs in 2014
Net earnings per diluted common share were $1.13, compared to $1.56 which included $0.87 per diluted share of tax benefit resulting from the Company's treatment of DTAs in 2014
Annualized after-tax ROCE was 12.3% for the year ended December 31, 20151
Atlas’ combined ratio for the year ended December 31, 2015 was 87.0%, compared to 90.7% for the year ended December 31, 2014.
Atlas generated net investment income of $4.0 million and $3.1 million for the years ended December 31, 2015 and 2014, respectively, as well as $455,000 and $382,000 of realized gains, respectively. This resulted in an overall annualized investment yield of 2.2% for the years ended December 31, 2015 and 2014.
Overall, Atlas generated net income of $14.4 million for the year ended December 31, 2015. After taking the dilutive impact of the convertible preferred shares and stock options, diluted earnings per common share for the year ended December 31, 2015 was $1.13. This compares to net income of $17.7 million or diluted earnings per common share of $1.56 for the year ended December 31, 2014.
The decrease in Atlas' net income and the impact on earnings per diluted common share for the years ended December 31, 2015 and 2014 are summarized in the table below:
For the year ended December 31, 2015, pre-tax and after-tax income from operating activities increased $0.80 and $0.51 per diluted common share, respectively, primarily due to premium growth, rate increases and the results of Atlas' commercial auto program. The Company had no valuation allowance on its deferred tax asset to offset tax expense in calendar year 2015 as was the case during 2014 and as a result earnings per diluted common share for the year ended December 31, 2015 decreased by $0.43.
Atlas’ combined ratio for the year ended December 31, 2014 was 90.7%, compared to 94.2% for the year ended December 31, 2013.
Overall, Atlas generated net income of $17.7 million for the year ended December 31, 2014. After taking the dilutive impact of the convertible preferred shares and stock options, diluted earnings per common share for the year ended December 31, 2014 was $1.56. This compares to net income of $6.2 million or diluted earnings per common share of $0.74 for the year ended December 31, 2013.
management’s new evaluation or new interpretation of information that was available in a previous financial reporting period. Accordingly, the Company reduced its valuation allowance during its 2014 year-end closing process commensurate with this conclusion. This resulted in a book value increase of $9.4 million or $0.81 per diluted common share.
The increase in Atlas' net income and the impact on earnings per diluted common share for the years ended December 31, 2014 and 2013 are summarized in the table below:
For the year ended December 31, 2014, pre-tax and after-tax income from operating activities increased $0.50 (includes $0.17 related to the discount on the preferred share buyback) and $0.32 per diluted common share, respectively, primarily due to premium growth, rate increases and higher than expected returns on certain investments.
Atlas employs specific control processes to determine the reasonableness of the fair value of its financial assets. These processes are designed to supplement those performed by our external portfolio manager to ensure that the values received from them are accurately recorded and that the data inputs and the valuation techniques utilized are appropriate, consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. For example, on a continuing basis, Atlas assesses the reasonableness of individual security values which have stale prices or whose changes exceed certain thresholds as compared to previous values received from our external portfolio manager or to expected prices. The portfolio is reviewed routinely for transaction volumes, new issuances, any changes in spreads, as well as the overall movement of interest rates along the yield curve to determine if sufficient activity and liquidity exists to provide a credible source for market valuations. When fair value determinations are expected to be more variable, they are validated through reviews by members of management or the Board of Directors who have relevant expertise and who are independent of those charged with executing investment transactions.
Deferred policy acquisition costs - Atlas defers brokers’ commissions, premium taxes and other underwriting and marketing costs directly relating to the successful acquisition of premiums written to the extent they are considered recoverable. These costs are
Atlas considers the impact of inflation when establishing adequate rates and estimating the provision for unpaid claims. We establish reserves to cover our estimated liability for the payment of losses and expenses related to the administration of claims incurred on the insurance policies we write. Inflation has a larger impact the longer the time between the issuance of the policy and the final settlement of claims. Greater than expected claims costs above the established reserves will require an increase in claims reserves and reduce the earnings in the period the deficiency was established. We consider the impact of inflation on these reserves to establish policy rates that maintain adequate underwriting income.
In assessing the need for a valuation allowance, Atlas considers both positive and negative evidence related to the likelihood of realization of the deferred tax assets. If, based on the weight of available evidence, it is more likely than not the deferred tax assets will not be realized, a valuation allowance is recorded.
As of December 31, 2015, there was no valuation allowance recorded against the Company's DTA.
Reinsurance - As part of Atlas’ insurance risk management policies, portions of its insurance risk is ceded to reinsurers. Reinsurance premiums and claims 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 claims ceded to other companies have been reported as a reduction of premium revenue and claims incurred expense. Commissions paid to Atlas by reinsurers on business ceded have been accounted for as a reduction of the related policy acquisition costs. Reinsurance receivables are recorded for that portion of paid and unpaid losses and loss adjustment expenses that are ceded to other companies. Prepaid reinsurance premiums are recorded for unearned premiums that have been ceded to other companies.
For the year ended December 31, 2015, gross premium written was $209.3 million compared to $122.4 million for the year ended December 31, 2014, representing a 70.9% increase. Global Liberty accounted for $39.8 million or 45.6% of this increase of gross premium written. During 2012, we implemented a new business arrangement in New York to provide excess coverage above the levels of risk retained by the insured. Total gross premium written related to this program, which renews in the third quarter, was $12.4 million and $13.0 million for the years ended December 31, 2015 and 2014, respectively, and is included in the "commercial automobile" line of business. Below we will refer to the arrangement as the "excess taxi program" where it is relevant to explain certain distinctions.
For the year ended December 31, 2015, gross premium written from commercial automobile was $207.8 million, representing a 73.8% increase relative to the year ended December 31, 2014. This substantial increase is primarily the result of the planned expansion of the commercial auto business. Excluding Global Liberty, we wrote $66.2 million and $44.8 million of new gross premium written business for the years ended December 31, 2015 and 2014, respectively. Our traditional commercial automobile, which excludes excess taxi, gross premium written was $195.4 million, an increase of 83.4% versus the year ended December 31, 2014. As a percentage of the insurance subsidiaries’ overall book of business, commercial auto gross premium written represented 99.3% of gross, and 99.4% of net, premium written in the year ended December 31, 2015 compared to 97.6% and 99.6%, respectively, during the year ended December 31, 2014.
Investment income (excluding net realized gains) net of investment expenses increased by 27.8% to $4.0 million for the year ended December 31, 2015, compared to $3.1 million for the year ended December 31, 2014. These amounts are primarily comprised of interest income. This increase is primarily due to higher return on certain securities in our investment portfolio.
Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the combined ratio. The combined ratio is the sum of the loss and loss adjustment expense (LAE) ratio, the acquisition cost ratio and the underwriting expense ratio. The table below indicates the impact of quota share reinsurance, amortization of intangible assets and share based compensation on the combined ratio for the years ended December 31, 2015 and 2014:
1 - Excludes income tax expense of $204,000 for the year ended December 31, 2015.
Upon the transaction forming Atlas on December 31, 2010, a yearly limitation as required by IRC Section 382 that applies to changes in ownership on the future utilization of Atlas’ net operating loss carryforwards was calculated. The insurance subsidiaries’ prior parent retained those tax assets previously attributed to the insurance subsidiaries which could not be utilized by Atlas as a result of this limitation. As a result, Atlas’ ability to recognize future tax benefits associated with a portion of its deferred tax assets generated during prior years have been permanently limited to the amount determined under IRC Section 382. The result is a maximum expected net deferred tax asset, which Atlas has available after the merger and believed more-likely-than-not to be utilized in the future, after consideration of valuation allowance.
For the year ended December 31, 2014, gross premium written was $122.4 million compared to $93.1 million for the year ended December 31, 2013, representing a 31.6% increase. The increase relative to the year ended December 31, 2013 is due primarily to the substantial growth of the core commercial auto business. Total gross premium written related to excess taxi program, was $13.0 million and $12.8 million for the years ended December 31, 2014 and 2013, respectively, and is included in the "commercial automobile" line of business.
For the year ended December 31, 2014, gross premium written from commercial automobile was $119.5 million, representing a 35.0% increase relative to the year ended December 31, 2013. This substantial increase is primarily the result of the planned expansion of the commercial auto business. Excluding the excess taxi program, our traditional commercial automobile gross premium written was $106.5 million, an increase of 40.6% versus the year ended December 31, 2013. Gross premium written attributable to the Gateway acquisition and subsequent organic growth related to that subsidiary in 2014, was approximately $17.3 million and $12.6 million for the years ended December 31, 2014 and 2013, respectively. As a percentage of the insurance subsidiaries’ overall book of business, commercial auto gross premium written represented 97.6% of gross, and 99.6% of net, premium written for the year ended December 31, 2014 compared to 95.2% and 105.9%, respectively, during the year ended December 31, 2013.
Ceded premium written is equal to premium ceded under the terms of Atlas’ inforce reinsurance treaties. Ceded premium written decreased 12.5% to $11.0 million for the year ended December 31, 2014 compared with $12.6 million for the year ended December 31, 2013. The primary driver of the decrease in ceded premium written relates to the run off of non-core lines of business that are heavily reinsured. The percentage of premium ceded is driven by the business mix within our total premium base. As of July 1, 2014, Atlas implemented the Quota Share for its commercial auto and general liability lines of business, which provides the Company with financial flexibility to manage expected growth and the timing of potential future capital raising activities. With the exception of this quota share reinsurance agreement, all of our reinsurance partners have remained consistent since 2013.
Net premium written is equal to gross premium written less the ceded premium written under the terms of Atlas’ inforce reinsurance treaties. Net premium written increased 38.4% to $111.4 million for the year ended December 31, 2014 compared with $80.5 million for the year ended December 31, 2013. These changes are attributed to the combined effects of the issues cited in the ‘Gross Premium Written’ and ‘Ceded Premium Written’ sections above.
The loss ratio relating to the claims incurred for the year ended December 31, 2014 was 62.3% compared to 63.9% for the year ended December 31, 2013. Loss ratios improved for the year ended December 31, 2014 relative to prior periods primarily due to the increased percentage of commercial auto, which has historically had a better overall underwriting result, relative to total written premium. In both years, the excess taxi program contributed significantly to favorable loss results in the year as we expect better than average claim experience from this program. We believe that our extensive experience and expertise with respect to underwriting and claims management in all our commercial lines will allow us to continue this decreasing trend since we expect 100% of net premium earned to be related to core lines of business moving forward. The Company is committed to retain this claim handling expertise as a core competency as the volume of business increases.
Acquisition costs represent commissions and taxes incurred on net premium earned. Acquisition costs were $14.0 million for the year ended December 31, 2014 or 14.3% of net premium earned, as compared to 14.5% for the year ended December 31, 2013.
Atlas recorded other income for the year ended December 31, 2014 of $2,000 compared to other income of $13,000 for the year ended December 31, 2013. Other income was primarily comprised of miscellaneous balances recovered.
Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the combined ratio. The table below indicates the impact of quota share reinsurance, amortization of intangible assets and share based compensation on the combined ratio for the years ended December 31, 2014 and 2013:
Atlas generated pre-tax income of $11.9 million for the year ended December 31, 2014, compared to pre-tax income of $6.3 million for year ended December 31, 2013. The causes of these changes are attributed to the combined effects of the issues cited in the 'Net Premium Earned', 'Claims Incurred', 'Acquisition Costs', 'Other Underwriting Expenses', 'Net Investment Income', 'Net Realized Investment Gains', and 'Other Income' sections above.
Atlas' net income was $17.7 million for the year ended December 31, 2014 versus net income of $6.2 million for the year ended December 31, 2013. After taking the impact of the liquidation preference of the preferred shares into consideration and the discount generated as a result of the repurchase of 18,000,000 preferred shares, the diluted earnings per common share for the year ended December 31, 2014 was $1.56 versus diluted earnings per common share of $0.74 for the year ended December 31, 2013.
For the year ended December 31, 2014, there were 10,937,181 weighted average common shares outstanding used to compute basic earnings per common share, and 11,341,588 were used for the diluted earnings per common share computation. For the year ended December 31, 2013, there were 8,007,458 weighted average common shares outstanding used to compute basic earnings per common share, and 10,840,868 used for the diluted earnings per common share computation.
Atlas held securities with a fair value of $188.0 million at December 31, 2015, which was primarily comprised of fixed income securities. The securities held by the insurance subsidiaries must comply with applicable regulations that prescribe the type, quality and concentration of securities. These regulations in the various jurisdictions in which the insurance subsidiaries are domiciled permit investments in government, state, municipal and corporate bonds, preferred and common equities, and other high quality investments, within specified limits and subject to certain qualifications.
The amortized cost, gross unrealized gains and losses and fair value for Atlas’ investments in fixed maturities and equity by type and sector are as follows (all amounts in '000s):
The following table summarizes the amortized cost and fair value by contractual maturities of the fixed income securities portfolio, excluding cash and cash equivalents, at the dates indicated.
As of December 31, 2015, Atlas' allowance for bad debt was $846,000. Atlas' allowance for bad debt increased by $286,000 compared to $560,000 as of December 31, 2014. This increase in the allowance for bad debt is due to the increase in the level of written premium.
The following table summarizes the composition of the fair value of the fixed income securities portfolio, excluding cash and cash equivalents, as of the dates indicated, by ratings assigned by Fitch, S&P or Moody’s Investors Service. The fixed income securities portfolio consists of predominantly very high quality securities in corporate and government bonds with 84.9% rated ‘A’ or better at December 31, 2015 compared to 87.4% at December 31, 2014.
Atlas recognizes losses on securities for which a decline in market value was deemed to be other-than-temporary. Management performs a quarterly analysis of the securities holdings to determine if declines in market value are other-than-temporary. Atlas did not recognize any charges that were considered other-than-temporary for the years ended December 31, 2015 and 2014 and recognized charges of $311,000 for securities impairments for the year ended December 31, 2013.
The length of time securities may be held in an unrealized loss position may vary based on the opinion of the appointed investment manager and their respective analyses related to valuation and to the various credit risks that may prevent us from recapturing the principal investment. In cases of securities with a maturity date where the appointed investment manager determines that there is little or no risk of default prior to the maturity of a holding, Atlas would elect to hold the security in an unrealized loss position until the price recovers or the security matures. In situations where facts emerge that might increase the risk associated with recapture of principal, Atlas may elect to sell securities at a loss. Atlas had no material gross unrealized losses in its portfolio at December 31, 2015 or at December 31, 2014.
Atlas generally purchases reinsurance to limit net exposure to a maximum amount on any one loss of $500,000 with respect to commercial automobile liability claims. Atlas also purchases reinsurance to protect against awards in excess of its policy limits. Atlas continually evaluates and adjusts its reinsurance needs based on business volume, mix, and supply levels. As a result, the Company has entered into the Quota Share with Swiss Re for the companies in our ASI Pool (American Country, American Service and Gateway). Our initial cession was 5% of subject written premiums, which was increased to 15% effective April 1, 2015. Under this contract, cessions can be increased at our election should we want to utilize it as a means of deleveraging. This facility gives us flexibility in terms of the timing and approach to potential future capital raising activities in light of anticipated increased operating leverage. Global Liberty historically maintained lower reinsurance retention limits. For 2015, we have left the reinsurance program for this subsidiary unchanged.
Our surety program primarily consists of U.S. Customs bonds. We engage a former affiliate, Avalon Risk Management, to help coordinate customer service and claim handling for the surety bonds written. This non-core program is 100% reinsured to an unrelated third party and is being transitioned to another carrier. No new premium was written in connection with this program in 2015, however, there was a small amount of renewals recorded in 2015.
Claims liabilities - The changes in the provision for unpaid claims, net of amounts recoverable from reinsurers, for the years ended December 31, 2015, 2014, and 2013 were as follows ($ in '000s):
The table below summarizes future payments under contractual obligations and estimated claims settlements for the year ended December 31, 2015:
Notes Payable does not include the interest payments and non-utilization fees related to the balance outstanding at December 31, 2015. The interest on the notes payable is variable and cannot be reasonably estimated. See the "Liquidity and Capital Resources" section below for further details regarding notes payable and the non-utilization fees. The note payable is due after five years with interest only payments until the principal is due.
Estimated claims liability are calculated based on actuarial assumptions and will differ from actual future claim settlements. The amounts in the table above have been presented net of reinsurance.
The Company has entered into subscription agreements to commit up to $6.8 million of capital to allow for participation by the Company in limited liability investments that invest in income-producing real estate, small business loans and equity securities.
At December 31, 2015, we did not have any material off-balance sheet arrangements as defined by SEC rules.
The table below identifies changes in shareholders’ equity for the years ended years ended December 31, 2015, 2014, and 2013:
On February 11, 2013, an aggregate of 4,125,000 Atlas ordinary voting shares were offered in Atlas' initial public offering in the United States. 1,500,000 ordinary shares were offered by Atlas, and 2,625,000 ordinary shares were sold by KAI, a wholly-owned subsidiary of Kingsway Financial Services Inc., or other Kingsway subsidiaries (collectively, "Kingsway") at a price of $5.85 per share, less underwriting discounts and expenses. Atlas also granted the underwriters an option to purchase up to an aggregate of 618,750 additional shares at the public offering price of $5.85 per share to cover over-allotments, if any. On March 11, 2013, the underwriters exercised this option and purchased an additional 451,500 shares. After underwriting and other expenses, Atlas realized combined proceeds of $9.8 million.
The remaining preferred shares are beneficially owned or controlled by the former owners of Gateway and Anchor. Preferred shareholders are entitled to dividends on a cumulative basis, whether or not declared by the Board of Directors, at the rate of
During the years ended December 31, 2015 and 2014, Atlas did not declare or pay dividends earned through the preferred shares. During the year ended December 31, 2013, Atlas declared and paid $2.1 million in dividends earned through the preferred shares to Kingsway, the cumulative amount to which they were entitled through the end of July 2013. The cumulative amount of dividends to which the preferred shareholders are entitled upon liquidation or sooner, if Atlas declares dividends, is $460,000 as of the year ended December 31, 2015, or $0.04 per common share.
On October 18, 2013 and on November 13, 2013, Kingsway notified the Company that it had sold 529,608 and 600,000 of its restricted voting common shares, respectively, bringing its restricted voting common share count to 132,863 or 1.4% of the outstanding common shares as of December 31, 2013.
During the year ended December 31, 2013, 1,327,840 warrants and 1,000 options were exercised, which resulted in the issuance of 1,328,840 common shares.
As a holding company, Atlas may derive cash from its subsidiaries generally in the form of dividends and in the future may charge management fees to the extent allowed by statute or other regulatory approval requirements to meet its obligations. The insurance subsidiaries fund their obligations primarily through premium and investment income and maturities in their securities portfolio. Refer also to the discussion “Investments Overview and Strategy." The insurance subsidiaries require regulatory approval for the return of capital and, in certain circumstances, payment of dividends. In the event that dividends and management fees available to the holding company are inadequate to service its obligations, the holding company would need to raise capital, sell assets or incur debt obligations.
On March 9, 2015, American Acquisition entered into a loan and security agreement (“Loan Agreement”) for a $35.0 million loan facility with Fifth Third Bank. The Loan Agreement includes a $30.0 million line of credit ("Draw Amount"), which can be drawn in increments at any time during the first twelve months of the agreement effective date of March 9, 2015. The $30.0 million line of credit has a five year term and bears interest at one-month LIBOR plus 4.5%. The Loan Agreement also includes a $5.0 million revolving line of credit ("Revolver") that bears interest at one month LIBOR plus 2.75%. This $5.0 million revolving line of credit replaces the $10.0 million revolving line of credit American Acquisition previously had in place with Fifth Third Bank under the Former Loan Agreement.
Cash provided by operations during the years ended December 31, 2015 and 2014 was primarily as a result of net income. Cash used by operating activities during the year ended December 31, 2013 was due to an increase in premiums receivable that was billed on an installment basis and the timing of the reinsurance recoverable collections. Cash provided by financing activities during the year ended December 31, 2015 resulted from proceeds from the Revolver and Draw Amount and the exercise of options. Cash provided by financing activities during the year ended December 31, 2014 was the result of the capital raise in the second quarter of 2014. Cash used by financing activities during the year ended December 31, 2013 was for the redemption of preferred shares offset by proceeds from our initial U.S. public offering and the exercise of warrants. Cash used by investing activities during the years ended December 31, 2015, 2014, and 2013 was due to the net purchase of invested assets and purchases of subsidiaries. For the year ended December 31, 2015, investing activities included $11.0 million in cash used in the Anchor acquisition net of the cash received. For the year ended December 31, 2013, investing activities included $11.1 million in cash provided by the Gateway acquisition. Net cash received in this acquisition was greater than the cash paid in the acquisition.
We have audited Atlas Financial Holdings, Inc.’s internal control over financial reporting as of December 31, 2015 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Atlas Financial Holdings, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial position of Atlas Financial Holdings, Inc. as of December 31, 2015 and December 31, 2014, and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for the years ended December 31, 2015 and December 31, 2014, and our report dated March 7, 2016 expressed an unqualified opinion thereon.
We have audited the accompanying consolidated statements of financial position of Atlas Financial Holdings, Inc. as of December 31, 2015 and 2014 and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for the years ended December 31, 2015 and 2014. In connection with our audits of the consolidated financial statements, we have also audited the financial statements schedules listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by Management, as well as evaluating the overall presentation of the financial statements and schedules. We believe that our audits provide a reasonable basis for our opinion.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Atlas Financial Holdings, Inc.’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 7, 2016 expressed an unqualified opinion thereon.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. As of December 31, 2013, the Company was not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audit of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
(in '000s of US dollars, except for share and per share data)
Atlas' ordinary voting common shares were previously listed on the TSX Venture Exchange (“TSXV”) under the symbol “AFH” from January 6, 2011 to June 4, 2013, when Atlas' application for the voluntary delisting of its ordinary voting common shares from the TSXV was approved.
Atlas' ordinary voting common shares became listed on the NASDAQ stock exchange on February 11, 2013, under the same symbol, "AFH."
On December 7, 2012, a shareholder meeting was held where a one-for-three reverse stock split was unanimously approved. When the reverse stock split took effect on January 29, 2013, it decreased the authorized and outstanding ordinary voting common shares and restricted voting common shares at a ratio of one-for-three. The primary objective of the reverse stock split was to increase the per share price of Atlas' common shares to meet certain listing requirements of the NASDAQ Capital Market. Unless otherwise noted, all historical share and per share values in this Annual Report on Form 10-K reflect the one-for-three reverse stock split.
Principles of consolidation - The consolidated financial statements include the accounts of Atlas and the entities it controls. Subsidiaries are entities over which Atlas, directly or indirectly, has the power to govern the financial and operating policies in order to obtain the benefits from their activities, generally accompanying an equity shareholding of more than one half of the voting rights. Subsidiaries are fully consolidated from the date on which control is transferred to Atlas and would be de-consolidated from the date that control ceases. The operating results of subsidiaries acquired or disposed of during the year will be included in the consolidated statements of income and comprehensive income from the effective date of acquisition and up to the effective date of disposal, as appropriate. All significant intercompany transactions and balances are eliminated in consolidation. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by Atlas.
Estimates and assumptions - The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates and changes in estimates are recorded in the accounting period in which they are determined. The liability for unpaid loss and loss adjustment expenses and related amounts recoverable from reinsurers represents the most significant estimate in the accompanying financial statements. Significant estimates in the accompanying financial statements also include the fair values of investments, deferred tax asset valuation, premium receivable bad debt allowance and deferred policy acquisition cost recoverability.
Atlas employs a fair value hierarchy to categorize the inputs it uses in valuation techniques to measure the fair value. The hierarchy is comprised of quoted prices in active markets (Level 1), third party pricing models using available trade, bid and market information (Level 2) and internal models without observable market information (Level 3). The Company recognizes transfers
between levels of the fair value hierarchy at the end of the period in which events occur impacting the availability of inputs to the fair value methodology.
When anticipated losses, loss adjustment expenses, commissions and other acquisition costs exceed recorded unearned premium and any future installment premiums on existing policies, a premium deficiency reserve is recognized by recording a reduction to DPAC with a corresponding charge to operations. Atlas utilizes anticipated investment income as a factor in its premium deficiency calculation. Atlas concluded that no premium deficiency adjustments were necessary in either of the years ended December 31, 2015, December 31, 2014, and December 31, 2013.
Pertinent accounting and disclosure pronouncements issued from time to time by the Financial Accounting Standards Board ("FASB") are adopted by the Company as they become effective. All recently issued accounting pronouncements with effective dates prior to January 1, 2016 have been adopted by the Company.
In January 2016, the FASB issued updated guidance on recognition and measurement of financial assets and liabilities. One provision of this update requires equity investments, except those accounted for under the equity method, to be measured at fair
In May 2015, the FASB issued guidance requiring additional disclosures about short-duration insurance contracts. The new disclosures, which are required for annual periods beginning after December 31, 2015 and for interim periods beginning after December 31, 2016, are intended to provide additional information about insurance liabilities including the nature, amount, timing, and uncertainty of future cash flows related to those liabilities. Except for the retrospective application of additional disclosure requirements, the new guidance will not impact the Company's consolidated financial statements.
All other recently issued accounting pronouncements with effective dates after December 31, 2015 are not expected to have a material impact on the Consolidated Financial Statements.
Global Liberty is a New York-based insurance company that was writing approximately $40.0 million of annual taxi and limousine net written premium in states deemed favorable to Atlas at the time of our acquisition. Global Liberty is an admitted carrier in 13 states plus the District of Columbia. Atlas' acquisition of Anchor expands our distribution channel for core commercial automobile lines and provides incremental licensure as well as important infrastructure in the large New York market.
Under the terms of the stock purchase agreement, the purchase price was based on the combined U.S. GAAP book value of Anchor at December 31, 2014. Additional consideration, principally in the form of preferred shares, may be paid to the seller, or returned to us by the seller, depending upon the future development of Global Liberty’s actual loss reserves for certain lines of business over time.
The total purchase price for the combined entities of Anchor was $23.2 million, consisting of a combination of cash and Atlas preferred shares, and is estimated at approximately 1.3 times combined U.S. GAAP book value. Consideration consisted of approximately $19.2 million in cash and $4.0 million of Atlas preferred shares (consisting of a total of 4,000,000 preferred shares at $1.00 per preferred share), subject to future price adjustments, as noted above. We have contractual protections to offset up to $4.0 million of future adverse reserve development during the five year period after the acquisition.
The value of certain assets and liabilities acquired are subject to adjustment as additional information is obtained, including, but not limited to, valuation of separately identifiable intangibles, the preferred stock issued to the seller, and deferred taxes. The valuations were finalized during the year ended December 31, 2015 (not including loss reserve development consideration). The changes upon finalization to the preliminary valuation of assets and liabilities resulted in an adjustment to identifiable intangible assets, goodwill, deferred tax and other liabilities. The following table presents the adjusted values of assets acquired and liabilities assumed for the Anchor acquisition based on its estimated fair value on March 11, 2015.
Under the terms of the stock purchase agreement, the purchase price equaled the tangible GAAP book value of Camelot Services at December 31, 2012, subject to certain pre and post-closing adjustments, including, among others, claim development between the signing of the stock purchase agreement and December 31, 2012. Additional consideration may be paid to the seller, or returned to us by the seller, depending upon, among other things, the future development of Gateway’s actual loss reserves for certain lines of business and the utilization of certain deferred tax assets over time. Gateway also writes workers’ compensation insurance. However, an indemnity reinsurance agreement was entered into pursuant to which 100% of Gateway’s workers’ compensation business was ceded to a third party captive reinsurer funded by the seller as part of the transaction.
The total purchase price for all of Camelot Services’ outstanding shares was $14.3 million, consisting of a combination of cash and Atlas preferred shares. Consideration consisted of a $6.0 million dividend paid by Gateway immediately prior to the closing, $2.0 million of Atlas preferred shares (consisting of a total of 2,000,000 preferred shares at $1.00 per preferred share) and $6.3 million in cash. The agreement includes contractual protections to offset up to $2.0 million of future reserve development. We have also agreed to provide the sellers up to $2.0 million in additional consideration in the event of favorable reserve development during the five year period after the acquisition.
The acquisition of Gateway resulted in the recognition of intangible assets, comprised entirely of state insurance licenses valued at $740,000. The state insurance licenses are considered to have an indefinite life and will not be amortized, but will be evaluated for impairment at least annually. Thus, Atlas recognized no amortization expense during the years ended December 31, 2015, 2014, and 2013 related to intangible assets acquired in the Gateway transaction.
Diluted earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding for each period plus the incremental number of shares added as a result of converting dilutive potential ordinary voting common shares, calculated using the treasury stock method (or, in the case of the convertible preferred shares, using the "if-converted" method).
share). The effects of these convertible instruments are excluded from the computation of diluted earnings per share in periods in which the effect would be anti-dilutive. Convertible preferred shares are anti-dilutive when the amount of dividend declared or accumulated in the current period per common share obtainable upon conversion exceeds basic earnings per share. For the years ended December 31, 2015, 2014, and 2013, convertible preferred shares and stock options were deemed to be dilutive.
In computing the diluted earnings per share on a year to date basis, the Company included the dilutive impact of the convertible preferred shares that were redeemed during the third quarter of 2013 on a pro-rata basis for the period during which those convertible preferred shares were outstanding. This dilutive impact increased the denominator in the full year 2013 diluted EPS computation by 1,333,500 shares; however, this has no impact on the actual earnings used for the numerator in the EPS computation. The preferred shares redeemed decreased diluted earnings per share for the year by $0.10. Future diluted earnings per share computations will not be impacted by the preferred shares redeemed.
The amortized cost, gross unrealized gains and losses and fair value for Atlas’ investments in fixed maturities and equities are as follows (all amounts in '000s):
the opinion of professional investment managers could prove to be incorrect;
The aging of unrealized losses on the Company's investments in fixed income and equity securities is presented as follows (all amounts in '000s):
The following table presents the gross realized gains and gross realized losses from sales of fixed income and equity securities for the years ended December 31, 2015, 2014, and 2013 (all amounts in '000s):
The following table summarizes the components of net investment realized gains (losses) for the years ended December 31, 2015, 2014, and 2013 (all amounts in '000s):
The Company's investments in fixed income securities that are classified as Level 1 in the two preceding tables consist only of U.S. Treasury Securities. The Company's investments in equity securities that are classified as Level 1 in the two preceding tables consist of investments in publicly-traded common stocks.
As a holding company, Atlas could derive cash from its insurance subsidiaries generally in the form of dividends to meet its obligations, which will primarily consist of operating expense payments and debt payments. Atlas’ insurance subsidiaries fund their obligations primarily through premium and investment income and maturities in the securities portfolio. The insurance subsidiaries require regulatory approval for the return of capital and, in certain circumstances, prior to the payment of dividends. In the event that dividends available to the holding company are inadequate to cover its operating expenses and debt payments, the holding company would need to raise capital, sell assets or incur future debt.
Net income computed under statutory-basis accounting was $3.4 million, $6.1 million, $2.0 million, and $1.2 million for American Country, American Service, Gateway and Global Liberty, respectively, for the year ended December 31, 2015. Net income for the year ended December 31, 2014 was $2.0 million, $4.0 million, and $1.7 million for American Country, American Service and Gateway, respectively. The combined statutory capital and surplus of the insurance subsidiaries was $118.5 million and $63.0 million as of December 31, 2015 and December 31, 2014, respectively.
The effective tax rate was 34.5%, (48.3)%, and 1.2% for the years ended December 31, 2015, 2014, and 2013, respectively. The table below reconciles the U.S. statutory income tax rate to the effective tax rate ($ in '000s):
Upon the transaction forming Atlas on December 31, 2010, a yearly limitation as required by U.S. Internal Revenue Code of 1986 (as amended, "IRC") Section 382 that applies to changes in ownership on the future utilization of Atlas’ net operating loss carryforwards was calculated. The insurance subsidiaries’ prior parent retained those tax assets previously attributed to the insurance subsidiaries, which could not be utilized by Atlas as a result of this limitation. As a result, Atlas’ ability to recognize future tax benefits associated with a portion of its deferred tax assets generated during prior years has been permanently limited to the amount determined under IRC Section 382. The result is a maximum expected net deferred tax asset that Atlas has available after the merger, which is believed more-likely-than-not to be utilized in the future, after consideration of valuation allowance.
Atlas has not established a valuation allowance for its gross future deferred tax assets as of December 31, 2015 or as of December 31, 2014. Based on Atlas’ expectations of future taxable income, its ability to change its investment strategy, as well as reversing gross future tax liabilities, management believes it is more likely than not that Atlas will fully realize the net future tax assets. The Company, therefore, released its remaining valuation allowance at December 31, 2014.
Depreciation expense and amortization was $966,000, $856,000, and $795,000 for the years ended December 31, 2015, 2014, and 2013, respectively.
Effective July 1, 2015, the Company implemented a new policy management software and began amortizing the cost of the software. Total capitalized cost of the software was approximately $2.0 million. Amortization expense for the new software for the year ended December 31, 2015 was $186,000.
Claims liabilities - The changes in the provision for unpaid claims, net of amounts recoverable from reinsurers, for the years ended December 31, 2015, 2014, and 2013 were as follows (all amounts in '000s):
The process of establishing the estimated provision for unpaid claims is complex and imprecise, as it relies on the judgment and opinions of a large number of individuals, on historical precedent and trends, on prevailing legal, economic, social and regulatory trends and on expectations as to future developments. The process of determining the provision necessarily involves risks that the actual results will deviate, perhaps substantially, from the best estimates made.
The establishment of reserves is an inherently uncertain process involving estimates; and current provisions may not be sufficient. Adjustments to reserves, both positive and negative, are reflected in the statement of income and comprehensive income as estimates are updated.
Atlas experienced $166,000 in unfavorable prior year development for the year ended December 31, 2015 as reflected as incurred related to prior years in the table above. Prior year development on non-core lines, assigned risk and pre-acquisition Global Liberty reserves was $641,000 for the year ended December 31, 2015. This increase was offset by $475,000 of favorable prior year development on our core lines. Atlas experienced favorable prior year development during the year ended December 31, 2014 of $352,000 on its core lines and $250,000 on its non-core lines as reflected as incurred related to prior years in the table above. Atlas experienced minimal unfavorable prior year development for the year ended December 31, 2013, reflected as incurred related to prior years in the table above, on its non-core lines.
On January 6, 2011, Atlas adopted a stock option plan (the “Stock Option Plan”) in order to advance the interests of Atlas by providing incentives to eligible persons defined in the plan. In the second quarter of 2013, a new equity incentive plan (the “Equity Incentive Plan”) was approved by the Company's common shareholders at the Annual General Meeting, and Atlas ceased to grant new stock options under the preceding Stock Option Plan. The Equity Incentive Plan is a securities based compensation plan, pursuant to which Atlas may issue restricted stock grants for ordinary voting common shares, restricted units, stock grants for ordinary voting common shares, stock options and other forms of equity incentives to eligible persons as part of their compensation. The Equity Incentive Plan is considered an amendment and restatement of the Stock Option Plan, although outstanding stock options issued pursuant to the Stock Option Plan will continue to be governed by the terms of the Stock Option Plan.
Stock options - Stock option activity for the years ended December 31, 2015 and 2014 follows (prices in Canadian dollars designated with "C$" and United States dollars designated with "US$"):
The awards vest in 5 equal annual installments of 20%, provided that an installment shall not vest unless an annual performance target based on specific return on average equity growth rates is met. In the event the performance target is not met in any year, the 20% installment for such year shall not vest, but such non-vested installment shall carry forward and can become vested in future years (up to the fifth year from the date of grant), subject to achievement in a future year of the applicable performance target for such year.
Restricted shares - The activity for the restricted shares and restricted share units for the years ended December 31, 2015 and 2014 are as follows:
Defined Contribution Plan - In the first quarter of 2011, Atlas formed a defined contribution 401(k) plan covering all qualified employees of Atlas and its subsidiaries. Employees can choose to contribute up to 60% of their annual earnings, but not more than $18,000 for 2015, to the plan. Qualifying employees age 50 and older can contribute an additional $6,000 during 2015. Effective April 2014, Atlas matches 100% of the employee contribution up to 2.5% of annual earnings, plus 50% of additional contributions up to 2.5% of annual earnings, for a total maximum expense of 3.75% of annual earnings per participant. Atlas' matching contributions are discretionary. Employees are 100% vested in their own contributions and vest in Atlas contributions based on years of service equally over 5 years with 100% vested after 5 years. Company contributions were $300,000, $204,000, and $118,000 for the years ended December 31, 2015, December 31, 2014, and December 31, 2013, respectively.
All of the issued and outstanding restricted voting common shares are beneficially owned or controlled by Kingsway Financial Services, Inc. (including its subsidiaries and affiliated companies, "Kingsway"). The restricted voting common shares are entitled to vote at all meetings of shareholders, except at meetings of holders of a specific class that are entitled to vote separately as a class. The restricted voting common shares as a class shall not carry more than 30% of the aggregate votes eligible to be voted at a general meeting of common shareholders. The restricted voting common shares will convert to ordinary voting common shares in the event that these Kingsway-owned shares are sold to non-affiliates of Kingsway.
During the year ended December 31, 2015, the Company issued 7,407 ordinary voting common shares as a result of the vesting of RSUs and 200,000 non-vested restricted shares to a director and the officers, respectively. During the year ended December 31, 2015, the Company issued 36,895 ordinary voting common shares to a director as a result of exercising options. These shares were granted and issued under the Company's Equity Incentive Plan.
During the first quarter of 2015, the Company issued 4,000,000 preferred shares as a portion of the consideration related to the Anchor acquisition and an additional 940,500 preferred shares pursuant to the Gateway stock purchase agreement. At December 31, 2015, there were 6,940,500 preferred shares outstanding. These preferred shares are beneficially owned or controlled by the former
Preferred shareholders are entitled to dividends on a cumulative basis, whether or not declared by the Board of Directors, at the rate of $0.045 per share per year (4.5%) and may be paid in cash or in additional preferred shares at the option of Atlas. In liquidation, dissolution or winding-up of Atlas, preferred shareholders receive the greater of $1.00 per share plus all declared and unpaid dividends or the amount they would receive in liquidation if the preferred shares had been converted to restricted voting common shares or ordinary voting common shares immediately prior to liquidation. The preferred shares are redeemable at the option of Atlas at a price of $1.00 per share plus accrued and unpaid dividends, subject to certain conditions, prior to the conversion date. Preferred shareholders are not entitled to vote. Preferred shares are convertible into ordinary voting common shares at the option of the former owners of Gateway and Anchor at any date after the fifth year of issuance at the rate of 0.1270 and 0.0500, respectively, ordinary voting common shares for each preferred share. The conversion rate is subject to change if the number of ordinary voting common shares or restricted voting common shares changes by way of an anti-dilution event.
During 2013, Atlas declared and paid $2.1 million in dividends earned through the preferred shares to Kingsway, the cumulative amount to which they were entitled through the end of July 2013.
On May 13, 2014, an aggregate of 2,000,000 Atlas ordinary shares were offered in a subsequent public offering in the United States at a price of $12.50 per share. Atlas also granted the underwriters an option to purchase up to an aggregate of 300,000 additional shares at the public offering price of $12.50 per share to cover over-allotments, if any. On May 27, 2014, the underwriters exercised this option and purchased an additional 161,000 shares. After underwriting and other expenses, total proceeds of $25.0 million were realized on the issuance of the shares. A portion of the net proceeds from the offering was used to support the acquisition of Anchor Holdings Group, Inc. and its affiliated entities.
During 2015 and 2014, a small percentage of the Company’s investment portfolio was allocated to investment vehicles, primarily focused on income generating real estate, that are considered related-party transactions. In these cases, one or more of the Company’s directors may be deemed to control unrelated entities that may invest in these vehicles and may also manage these vehicles.
December 31, 2015, 2014, and 2013, respectively. The decrease in rental expense on the headquarters building for the year ended December 31, 2015 was due to lower utility costs.
Atlas has the following future minimum rentals, related principally to office space, required under operating leases having initial or remaining noncancelable lease terms in excess of one year as of December 31, 2015 (all amounts in '000s):
In the ordinary course of its business, Atlas is involved in legal proceedings, including lawsuits, regulatory examinations and inquiries. Based on currently available information, the Company does not believe that it is reasonably possible that any of its pending legal proceedings will have a material effect on the Company's Consolidated Financial Statements.
In addition, as a condition to the ability to conduct business in certain states (and within the jurisdiction of some local governments), insurance companies are subject to or required to participate in various premium or loss based insurance-related assessments, including mandatory (a/k/a “involuntary”) insurance pools, underwriting associations, workers' compensation second-injury funds, reinsurance funds and other state insurance facilities.
principal amount outstanding under such credit lines (plus, in the case of the $30.0 million line of credit, the aggregate amount of the letter of credit obligations outstanding).
For the year ended December 31, 2015, American Acquisition incurred interest expense, including non-utilization fees, of $638,000 and bank fees of $56,000 in connection with the Loan Agreement. As of December 31, 2015, unamortized bank fees associated with the Loan Agreement were $281,000. These bank fees will be amortized over the next 50 months.
The following table provides the rollforward of Atlas' total debt outstanding for the year ended December 31, 2015 (all amounts in '000s):