We are a smaller reporting company as defined in Rule 12b-2 of the Exchange Act; therefore, pursuant to Regulation S-K, we are not required to make disclosures under this Item.
Effective March 31, 2014, the Company's wholly owned subsidiary, 1347 Property Insurance Holdings, Inc. ("PIH"), formerly known as Maison Insurance Holdings, Inc., completed an initial public offering of its common stock. Upon completion of the transaction, the Company maintained a minority ownership interest in the common shares of PIH. The earnings of PIH are included in the consolidated statements of operations through the March 31, 2014 transaction date. Prior to the transaction, PIH was included in the Insurance Underwriting segment. As a result of the disposal of the Company's majority interest in PIH on March 31, 2014, all segmented information has been adjusted to exclude PIH from the Insurance Underwriting segment.
Insurance Underwriting includes the following subsidiaries of the Company: Mendota Insurance Company ("Mendota"), Mendakota Insurance Company ("Mendakota"), Universal Casualty Company ("UCC"), Kingsway Amigo Insurance Company ("Amigo") and Kingsway Reinsurance Corporation. Throughout this 2014 Annual Report, the term "Insurance Underwriting" is used to refer to this segment.
The Company previously placed Amigo and UCC into voluntary run-off in 2012 and 2011, respectively. Each of Amigo and UCC has entered into a comprehensive run-off plan which has been approved by its respective state of domicile. Kingsway continues to manage Amigo and UCC in a manner consistent with the run-off plans.
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed by credit unions in 26 states to their members.
Following is a list of non-U.S. GAAP measures found throughout this report with their definitions, relationships to U.S. GAAP measures and explanations of their importance to our operations.
Segment operating income (loss) represents one measure of the pretax profitability of our segments and is derived by subtracting direct segment expenses from direct segment revenues. Revenues and expenses are presented in the consolidated statements of operations, but are not subtotaled by segment. However, this information is available in total and by segment in Note 24, "Segmented Information," to the Consolidated Financial Statements, regarding reportable segment information. The nearest comparable U.S. GAAP measure is loss from continuing operations before income tax benefit which, in addition to operating income (loss), includes net investment income, net realized gains, other-than-temporary impairment loss, other income not allocated to segments, general and administrative expenses, restructuring expense, interest expense, amortization of intangible assets, contingent consideration (benefit) expense, impairment of asset held for sale, loss on change in fair value of debt, loss on disposal of subsidiary, loss on disposal of asset held for sale, loss on buy-back of debt and equity in net (loss) income of investee. A reconciliation of segment operating income (loss) to loss from continuing operations before income tax benefit for the year ended December 31, 2014 is presented in Table 1 of the "Results of Continuing Operations" section of MD&A.
Kingsway, like many insurance companies, analyzes performance based on underwriting ratios such as loss and loss adjustment expense ratio, expense ratio and combined ratio. The loss and loss adjustment expense ratio is derived by dividing the amount of net loss and loss adjustment expenses incurred by net premiums earned. The expense ratio is derived by dividing the sum of commissions and premium taxes; general and administrative expenses; and policy fee income by net premiums earned. The combined ratio is the sum of the loss and loss adjustment expense ratio and the expense ratio. A combined ratio below 100% demonstrates underwriting profit whereas a combined ratio over 100% demonstrates an underwriting loss.
Our equity investments are recorded at fair value using quoted prices from active markets. For fixed maturities, we use observable inputs such as quoted prices in inactive markets, quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs. We do not have any investments in our portfolio which require us to use unobservable inputs. Any change in the estimated fair value of our investments could impact the amount of unrealized gain or loss we have recorded, which could change the amount we have recorded for our investments and other comprehensive loss on our consolidated balance sheets.
reviewing the trading range of certain investments over the preceding calendar period;
the past trading patterns of individual investments may not reflect future valuation trends;
Intangible assets were initially recoded at their estimated fair values at the date of acquisition. Intangible assets with definite useful lives consist of vehicle service agreements in-force ("VSA in-force"), database, customer-related relationships and non-compete agreement. A discounted cash flow analysis was used to determine the fair value of the VSA in-force asset. The multi-period excess earnings method was used to determine the fair value of the customer-related intangible assets. A form of the income method, known as the "with and without" method, was utilized to determine the fair values of the database and non-compete agreement intangible assets.
Deferred acquisition costs represent the deferral of expenses that we incur related to successful efforts to acquire new business or renew existing business. Acquisition costs, primarily commissions, premium taxes and underwriting and agency expenses related to issuing insurance policies and vehicle service agreements, are deferred and charged against income ratably over the terms of the related insurance policies and vehicle service agreements. Management regularly reviews the categories of acquisition costs that are deferred and assesses the recoverability of this asset. For Insurance Underwriting, a premium deficiency and a corresponding charge to income is recognized if the sum of the expected losses and loss adjustment expenses, unamortized acquisition costs and maintenance costs exceeds related unearned premiums and anticipated net investment income.
For the year ended December 31, 2014, we incurred a loss from continuing operations of $11.2 million ($0.75 per diluted share) compared to $43.3 million ($3.12 per diluted share) for the year ended December 31, 2013. The loss from continuing operations for the year ended December 31, 2014 is primarily attributable to corporate general expenses, interest expense, impairment of asset held for sale, loss on change in fair value of debt and loss on disposal of subsidiary, partially offset by net realized gains and operating income in Insurance Services and Insurance Underwriting. The loss from continuing operations for the year ended December 31, 2013 is attributable to operating losses in Insurance Underwriting, corporate general expenses, interest expense, other-than-temporary impairment loss, impairment of asset held for sale and loss on change in fair value of debt.
For the year ended December 31, 2014, we incurred a net loss of $11.2 million ($0.75 per diluted share) compared to $36.1 million ($2.56 per diluted share) for the year ended December 31, 2013.
The Insurance Underwriting operating income increased to $1.3 million for the year ended December 31, 2014 compared to a loss of $15.7 million for the year ended December 31, 2013. The increase in operating income is primarily attributed to an increase in net premiums earned in 2014 as compared to 2013.
The Insurance Underwriting expense ratio was 29.5% in 2014 compared with 40.7% in 2013. The decrease in the expense ratio is primarily due to an overall reduction in general expenses. The Insurance Underwriting expense ratio includes policy fee income of $8.1 million and $9.0 million, respectively, for the years ended December 31, 2014 and December 31, 2013.
The Insurance Underwriting combined ratio was 99.2% in 2014 compared with 115.1% in 2013, reflecting the dynamics which affected the loss and loss adjustment expense ratio and expense ratio.
Net investment income decreased to $1.6 million in 2014 compared to $2.2 million in 2013. The decrease is primarily related to less dividend income in 2014 as a result of the Company's sale of its holdings of Atlas preferred stock during the third quarter of 2013. See "Other-Than-Temporary Impairment Loss" section below for further details.
The Company's intangible assets with definite useful lives are amortized over their estimated useful lives. Amortization of intangible assets was $1.6 million in 2014 compared to $2.2 million in 2013. The decrease is primarily attributed to less amortization expense related to the IWS VSA in-force intangible asset in 2014 compared to 2013. The VSA in-force asset is amortized over a seven-year term as the corresponding deferred service fees acquired are earned as revenue.
The loss on change in fair value of debt amounted to $11.0 million in 2014 compared to $9.1 million in 2013. The 2014 loss is primarily due to an increase in the fair value of the Company's subordinated debt, whereas the 2013 loss is due to an increase in the fair values of the Company's senior unsecured debentures, subordinated debt and LROC preferred units.
During the fourth quarter of 2014, the Company completed a sale and leaseback transaction involving building and land located in Miami, Florida, which was previously recorded as asset held for sale. Net proceeds were $4.3 million after deducting direct costs of the transaction. The Company recognized a loss of $0.1 million equal to the difference between the fair market value and the carrying value of the property at the date of the transaction. See Note 12, "Property and Equipment," to the Consolidated Financial Statements, for further details.
Equity in net loss of investee of $0.2 million for the year ended December 31, 2014 represents the loss related to the Company's investment in 1347 Capital Corp. See Note 7, "Investment in Investee," to the Consolidated Financial Statements, for further discussion. As discussed further in Note 5, "Dispositions and Liquidations," to the Consolidated Financial Statements, during the second quarter of 2013, the Company discontinued the use of the equity method of accounting for its former investee, Atlas. Prior to discontinuing the use of the equity method of accounting for Atlas, the Company used a reporting lag of three months to report
All of our investments in fixed maturities and equity investments are classified as available-for-sale and are reported at fair value. At December 31, 2014, we held cash and cash equivalents and investments with a carrying value of $161.1 million. As of December 31, 2014, we held an investments portfolio comprised primarily of fixed maturities issued by the U.S. Government, government agencies and high quality corporate issuers. Investments held by our insurance subsidiaries must comply with applicable domiciliary state regulations that prescribe the type, quality and concentration of investments. Our U.S. operations typically invest in U.S. dollar-denominated instruments to mitigate their exposure to currency rate fluctuations.
Table 3 below summarizes the fair value by contractual maturities of the fixed maturities portfolio, excluding cash and cash equivalents, at December 31, 2014 and 2013.
Table 4 below summarizes the composition of the fair values of fixed maturities, excluding cash and cash equivalents, at December 31, 2014 and 2013, by rating as assigned by Standard and Poor's ("S&P") or Moody's Investors Service ("Moody's"). Fixed maturities consist of predominantly high-quality instruments in corporate and government bonds with approximately 95.6% of those investments rated 'A' or better at December 31, 2014.
The Company owns investments in limited liability companies ("LLCs") and a limited partnership ("LP") that primarily invest in income-producing real estate or real estate related investments. The Company's investments in the LLCs and LP are accounted for under the equity method of accounting and reported as limited liability investments in the consolidated balance sheets. The real estate investments are held on a triple net lease basis whereby the lessee agrees to pay all real estate taxes, building insurance and maintenance. The real estate investments yield between 7.5% - 8% minimum preferred return on invested capital. Table 5 below presents additional information pertaining to the limited liability investments at December 31, 2014 and 2013.
On July 21, 2014, 1347 Capital Corp. completed an initial public offering of 4.0 million units at a price to the public of $10.00 per unit for total gross proceeds of $40.0 million. Each unit issued in the initial public offering consists of one share of common stock, one right to receive one-tenth of a share of common stock automatically on the consummation of an initial business combination, and one warrant to acquire one-half of one share of common stock at a price of $11.50 per full share of common stock. On July 23, 2014, the option to purchase an additional 0.6 million units that 1347 Capital Corp. had granted to the underwriters for additional gross proceeds of $6.0 million was completed. As a result, 1347 Capital Corp. issued a total of 4.6 million units in its initial public offering, generating total gross proceeds of $46.0 million.
At December 31, 2014 and 2013, the gross provisions for property and casualty unpaid loss and loss adjustment expenses for our non-standard automobile business were $58.5 million and $75.5 million, respectively. The decrease is primarily due to the continuing voluntary run-offs of Amigo and UCC.
For the year ended December 31, 2014 (in millions of dollars)
The net movements in prior years' provisions for property and casualty unpaid loss and loss adjustment expenses, net of reinsurance, was a decrease of $5.1 million and $1.2 million, respectively, for the years ended December 31, 2014 and 2013. Table 8 identifies the relative contribution of the increases (decreases) in the provisions for property and casualty unpaid loss and loss adjustment expenses attributable to the respective lines of business and accident years.
The favorable development in 2014 was primarily related to the decrease in property and casualty unpaid loss and loss adjustment expenses at Amigo and UCC. In 2013, the majority of the favorable development is attributable to a decrease in property and casualty unpaid loss and loss adjustment expenses at UCC. Original estimates are increased or decreased as additional information becomes known regarding individual claims.
During 2014, the net cash used in investing activities as reported on the consolidated statements of cash flows was $16.7 million. This use of cash was driven primarily by the purchases of fixed maturities, equity investments, limited liability investments and other investments in excess of proceeds from sales and maturities of fixed maturities, equity investments and other investments as well as from the sale of property.
During 2014, the net cash provided by financing activities as reported on the consolidated statements of cash flows was $6.8 million. This source of cash is attributed to the net proceeds received from the Company's private placement of $6.3 million and exercise of warrants of $14.8 million, as further discussed in Note 22, "Shareholders' Equity," to the Consolidated Financial Statements, offset by the redemption of $14.4 million of par value of senior unsecured debentures due February 1, 2014.
On February 3, 2014, the Company closed on its previously announced private placement totaling $6.6 million, as further discussed in Note 22, "Shareholders' Equity," to the Consolidated Financial Statements. At closing, the Company received gross proceeds of $6.6 million, resulting from the sale and issuance of 262,876 units for a purchase price of $25.00 per unit. Net proceeds to the Company were $6.3 million after deducting expenses.
On August 18, 2014, the Company announced its intention to redeem its outstanding Series A Warrants, which were issued pursuant to the September 2013 rights offering. Refer to Note 22, "Shareholders' Equity," to the Consolidated Financial Statements for further discussion of the rights offering. Holders of Series A Warrants could exercise their outstanding Series A Warrants at $4.50 per common share. Any Series A Warrants that remained unexercised after September 19, 2014 were automatically redeemed by the Company at the redemption price of $0.25 per Series A Warrant. During 2014, Series A Warrants to purchase 3,279,945 shares of common stock were exercised, resulting in cash proceeds of $14.8 million. The 845 Series A Warrants that remained unexercised were redeemed by the Company at the redemption price of $0.25.
Kingsway previously placed UCC into voluntary run-off in early 2011. At the time it was placed into voluntary run-off, UCC's RBC was 160%. UCC entered into a comprehensive run-off plan approved by the Illinois Department of Insurance in June 2011. UCC remains in compliance with that plan. As of December 31, 2014, UCC's RBC was 3,626%.
Our reinsurance subsidiary, which is domiciled in Barbados, is required by the regulator in Barbados to maintain minimum capital levels. As of December 31, 2014, the capital maintained by Kingsway Reinsurance Corporation was in excess of the regulatory capital requirements in Barbados.
On January 29, 2004, the Company's subsidiary, Kingsway America Inc. ("KAI") completed the sale of $100.0 million 7.50% senior notes due 2014. In March 2004, an additional $25.0 million of these senior notes were issued. Interest payments were made on February 1 and August 1 of each year. The notes were fully and unconditionally guaranteed by the Company. The notes were redeemable at KAI's option in whole at any time or in part from time to time on or after February 1, 2009 subject to the conditions stated in the trust indenture.
Pursuant to the debt buy-back initiative previously mentioned, KAI repurchased and retired most of the originally issued par value. On October 15, 2013, the Company completed a partial, early redemption of its senior unsecured debentures due February 1, 2014. The Company used the proceeds from the September 2013 rights offering to partially redeem the senior unsecured debentures due February 1, 2014. The partial early redemption was completed in the amount of $12.0 million at par plus accrued interest of $0.2 million. In February 2014, the Company repaid the $14.4 million remaining amount outstanding on its senior unsecured debentures due February 1, 2014.
Between December 4, 2002 and December 16, 2003, six subsidiary trusts of the Company issued $90.5 million of 30-year capital securities to third-parties in separate private transactions. In each instance, a corresponding floating rate junior subordinated deferrable interest debenture was then issued by KAI to the trust in exchange for the proceeds from the private sale. The floating rate debentures bear interest at the rate of the London interbank offered interest rate for three-month U.S. dollar deposits ("LIBOR"), plus spreads ranging from 3.85% to 4.20%, but until dates ranging from December 4, 2007 to January 8, 2009, the interest rates will not exceed 12.45% to 12.75%. The Company has the right to call each of these securities at par value any time after five years from their issuance until their maturity. During the first quarter of 2011, the Company gave notice to its trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters, pursuant to the contractual terms of its outstanding indentures, which permit interest deferral. This action does not constitute a default under the Company's indentures or any of its other debt indentures. At December 31, 2014 and 2013, deferred interest payable of $17.4 million and $12.8 million, respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets.
Table 9 summarizes certain payments projected by period, including debt maturities, interest payments on outstanding debt, the provision for unpaid loss and loss adjustment expenses and future minimum payments under operating leases. Interest payments in Table 9 related to the subordinated debt reflect the interest deferral described in the "Subordinated Debt" section above and assume LIBOR remains constant throughout the projection period.
Our provision for unpaid loss and loss adjustment expenses does not have contractual payment dates. In Table 9 below, we have included a projection of when we expect our unpaid loss and loss adjustment expenses to be paid, based on historical payment patterns. The exact timing of the payment of unpaid loss and loss adjustment expenses cannot be predicted with certainty. We maintain an investments portfolio with varying maturities and a substantial amount in short-term investments to provide adequate cash flows for the projected payments in Table 9. The unpaid loss and loss adjustment expenses in Table 9 have not been reduced by amounts recoverable from reinsurers.
Consolidated Statements of Operations for the Years Ended December 31, 2014 and 2013
Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2014 and 2013
We have audited the accompanying consolidated balance sheets of Kingsway Financial Services Inc. as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive loss, shareholders’ equity, and cash flows for the years then ended. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedules listed in the accompanying index. These consolidated financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.
Certain prior year amounts have been reclassified to conform to current year presentation. Such reclassifications had no impact on previously reported net loss or total shareholders' equity.
The consolidated financial statements are prepared as of December 31, 2014 based on individual company financial statements at the same date. Accounting policies of subsidiaries have been aligned where necessary to ensure consistency with those of Kingsway. The consolidated financial statements include the following subsidiaries, all of which are owned, directly or indirectly: 1347 Advisors LLC ("1347 Advisors"); 1347 Capital LLC ("1347 Capital"); 1347 Investors LLC ("1347 Investors"); Appco Finance Corporation; American Country Underwriting Agency Inc.; ARM Holdings, Inc.; Assigned Risk Solutions Ltd. ("ARS"); Boston General Agency, Inc.; Congress General Agency, Inc.; Hamilton Risk Management Company; Insurance Management Services Inc.; Itasca Investors LLC; IWS Acquisition Corporation ("IWS"); KAI Advantage Auto, Inc.; KFS Capital LLC ("KFS Capital"); Kingsway America II Inc.; Kingsway America Inc. ("KAI"); Kingsway America Agency Inc.; Kingsway Amigo Insurance Company ("Amigo"); Kingsway General Insurance Company; Kingsway LGIC Holdings, LLC; Kingsway Linked Return of Capital Trust ("KLROC Trust"); Kingsway Reinsurance Corporation; Market Solutions Insurance Agency LLC; Mattoni Insurance Brokerage, Inc.; Mendakota Insurance Company ("Mendakota"); Mendota Insurance Agency, Inc.; Mendota Insurance Company ("Mendota"); MIC Insurance Agency Inc.; Trinity Warranty Solutions LLC ("Trinity"); and Universal Casualty Company ("UCC").
The investment in common stock and private units of the Company's investee, 1347 Capital Corp. is accounted for under the equity method of accounting and reported as investment in investee in the consolidated balance sheets at December 31, 2014. Investment in investee is comprised of investments in entities where the Company has the ability to exercise significant influence but not control. Significant influence is presumed to exist when the Company owns, directly or indirectly, between 20% and 50% of the outstanding voting rights of the investee. Assessment of significant influence is based on the substance of the relationship between the Company and the investee and includes consideration of both existing voting rights and, if applicable, potential voting rights that are currently exercisable and convertible. These investments are reported as investment in investee in the consolidated balance sheets, with the Company's share of income (loss) and other comprehensive income (loss) of the investee reported in the corresponding line in the consolidated statements of operations and consolidated statements of comprehensive loss, respectively. Under the equity method of accounting, an investment in investee is initially recognized at cost and adjusted thereafter for the post-acquisition change in the Company's share of net assets of the investee.
The Company defers commissions, premium taxes and other underwriting and agency expenses that are directly related to successful efforts to acquire new or existing insurance policies and vehicle service agreements to the extent they are considered recoverable. Costs deferred on property and casualty insurance products are amortized over the period in which premiums are earned. Costs deferred on vehicle service agreements are amortized as the related revenues are earned. The method followed in determining the deferred acquisition costs limits the deferral to its realizable value by giving consideration to estimated future loss and loss adjustment expenses to be incurred as revenues are earned. Changes in estimates, if any, are recorded in the accounting period in which they are determined. Anticipated investment income is included in determining the realizable value of the deferred acquisition costs. The Company's deferred acquisition costs are reported net of ceding commissions.
The consideration for certain of the Company's acquisitions includes future payments to the former owners that are contingent upon the achievement of certain targets over future reporting periods. Liabilities for contingent consideration are measured and reported at fair value at the date of acquisition and are included in accrued expenses and other liabilities in the consolidated balance sheets. Changes in the fair value of contingent consideration liabilities can result from changes to one or multiple inputs, including adjustments to the discount rates or changes in the assumed achievement or timing of any targets. These fair value measurements are based on significant inputs not observable in the market. Changes in assumptions could have an impact on the payout of contingent consideration liabilities. Changes in fair value are reported in the consolidated statements of operations as contingent consideration (benefit) expense.
Service fee and commission income represents policy and claim service fees, vehicle service agreement fees and warranty product and maintenance support fees based on terms of various agreements with insurance partners, state agencies, credit unions, consumers and businesses.
The Company has a stock-based compensation plan for key officers of the Company. The Company uses the fair-value method of accounting for stock-based compensation awards granted to employees. Expense is recognized on a straight-line basis over the service period during which awards are expected to vest, with a corresponding increase to additional paid-in capital. The Company determines the fair value of stock options on their grant date using the Black-Scholes option pricing model. When these stock options are exercised, the amount of proceeds together with the amount recorded in additional paid-in capital is recorded in shareholders' equity.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The core principle of ASU 2014-09 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 is effective for reporting periods beginning after December 15, 2016 and early adoption is not permitted. Insurance contracts are not within the scope of ASU 2014-09, therefore this standard would not apply to the Company's Insurance Underwriting segment. The Company is currently evaluating the impact of the adoption of ASU 2014-09 on its consolidated financial statements.
Effective May 22, 2013, the Company's subsidiary, Trinity, acquired certain intangible assets and liabilities of Trinity Warranty Corp. for total consideration consisting of approximately $1.1 million in cash and future contingent payments. The consolidated
This acquisition was accounted for as a business combination using the acquisition method of accounting. The purchase price was allocated to the assets purchased and liabilities assumed based upon their estimated fair values at the date of acquisition. During the fourth quarter of 2013, the Company completed its fair value analysis on the assets acquired and liabilities assumed. Goodwill of $1.1 million was recognized in addition to $0.5 million of a separately identifiable intangible asset for customer-related relationships. Refer to Note 11, "Intangible Assets," for further disclosure of the intangible asset related to this acquisition. The fair value analysis performed included $0.6 million related to the present value of future contingent payments. The maximum the Company can pay in future contingent payments is $2.4 million, on an undiscounted basis. The contingent payments are payable annually beginning in 2014 through 2023 and are subject to the achievement of certain targets and may be adjusted in future periods based on actual performance achieved. No contingent payment was made in 2014. During 2014, the Company adjusted the fair value of the contingent consideration liability. See Note 25, "Fair Value of Financial Instruments," for further details. As of December 31, 2014, the recorded value of the contingent earn-out agreement is $0.3 million, which is included in accrued expenses and other liabilities in the consolidated balance sheets.
The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition.
PIH common stock is included in equity investments and reported at its fair value of $8.5 million in the consolidated balance sheets at December 31, 2014.
Equity in net income of investee related to Atlas was zero and $0.3 million for the years ended December 31, 2014 and 2013, respectively. The Company also recognized an increase to shareholders' equity attributable to common shareholders of zero and $0.6 million for the years ended December 31, 2014 and 2013, respectively, for the Company's pro rata share of Atlas' accumulated other comprehensive income.
During the fourth quarter of 2013, the Company further reduced its investment in the common stock of Atlas. The Company's investment in Atlas common stock at December 31, 2014 is included in equity investments and reported at its fair value of $2.2 million in the consolidated balance sheets.
During 2013, the Company's subsidiaries, Kingsway Reinsurance (Bermuda) Ltd. ("KRL") and Kingsway 2007 General Partnership ("2007 GP"), were liquidated. As a result of the liquidations of these subsidiaries, the Company realized a net after-tax gain of $7.2 million for the year ended December 31, 2013. This gain represents the foreign exchange gain previously recorded in accumulated other comprehensive income and now recognized in the statements of operations as a result of the liquidations of KRL and 2007 GP. Summarized financial information for liquidation of subsidiaries is shown below:
The following tables highlight the aggregate unrealized loss position, by security type, of fixed maturities and equity investments in unrealized loss positions as of December 31, 2014 and December 31, 2013. The tables segregate the holdings based on the period of time the investments have been continuously held in unrealized loss positions.
Fixed maturities and equity investments contain approximately 71 and 27 individual investments that were in unrealized loss positions as of December 31, 2014 and 2013, respectively.
Investment in investee includes the Company's investment in the common stock and private units of 1347 Capital Corp. and is accounted for under the equity method. 1347 Capital Corp. was formed for the purpose of entering into a merger, share exchange, asset acquisition or other similar business combination with one or more businesses or entities. The carrying value, estimated fair value and approximate equity percentage for the Company's investment in 1347 Capital Corp. at December 31, 2014 were as follows:
The maximum amount of return commission, which would have been due to reinsurers if they or the Company had canceled all of the Company's reinsurance, with the return of the unearned premium, is as follows at December 31, 2014:
The components of deferred acquisition costs and the related amortization expense as of and for the years ended December 31, 2014 and 2013, respectively, are comprised as follows:
Goodwill was $10.6 million at each of December 31, 2014 and 2013, respectively. The Company's goodwill at December 31, 2014 and 2013 is attributable to the Insurance Services reportable segment.
The insurance licenses, renewal rights and trade name intangible assets have indefinite useful lives and are not amortized. The renewal rights intangible assets, recognized related to the acquisitions of Northeast Alliance Insurance Agency, LLC ("NEA") and ARS, were originally being amortized on a straight-line basis over 10 to 15 years. As a result of the acquisition of ARS during 2010, the Company determined that it was necessary to re-examine the useful lives assigned to the renewal rights intangible assets due to the fact that NEA and ARS service the assigned risk business in the states of New York and New Jersey and operate in the New York voluntary markets where there is limited competition for the renewal rights. As a result of the review performed, the Company determined that there were no legal, regulatory, contractual, competitive, economic, or other factors limiting the useful life of the renewal rights intangible assets; therefore, effective January 1, 2011, the renewal rights intangible assets were deemed to have indefinite useful lives and are no longer being amortized. The renewal rights had accumulated amortization of $15.4 million at December 31, 2010.
Prior to the fourth quarter of 2014, property consisting of building and land located in Miami, Florida with a carrying value of $5.2 million was classified as held for sale. As a result of declines in the fair value of the property, the Company recorded write-downs of $1.2 million and $2.4 million, respectively, related to the asset held for sale during the years ended December 31, 2014 and 2013. On October 2, 2014, the Company closed on the sale of the property. See Note 12, "Property and Equipment," for further details.
The establishment of the provision for unpaid loss and loss adjustment expenses is based on known facts and interpretation of circumstances and is therefore a complex and dynamic process influenced by a large variety of factors. These factors include the Company's experience with similar cases and historical trends involving loss payment patterns, pending levels of unpaid loss and loss adjustment expenses, product mix or concentration, loss severity and loss frequency patterns.
The results of this comparison and the changes in the provision for property and casualty unpaid loss and loss adjustment expenses, net of amounts recoverable from reinsurers, as of December 31, 2014 and December 31, 2013 were as follows:
During 2013, the Company purchased for $0.6 million, including accrued interest, $0.6 million of par value of its senior unsecured debentures due February 1, 2014 with a carrying value of $0.6 million, including accrued interest, recording a loss of $0.0 million. The Company subsequently canceled the acquired debentures. During the fourth quarter of 2013, the Company completed a partial, early redemption of its senior unsecured debentures due February 1, 2014. The partial early redemption was completed in the amount of $12.0 million at par plus accrued interest of $0.2 million. In February 2014, the Company repaid the $14.4 million remaining amount outstanding on its senior unsecured debentures due February 1, 2014.
Income tax benefit varies from the amount that would result by applying the applicable United States corporate income tax rate of 34% to loss from continuing operations before income tax benefit. The following table summarizes the differences:
The U.S. operating loss carryforward amounts disclosed above contain consolidated and separate company operating loss carryforwards, the most significant of which is the KAI Tax Group operating loss carryforward of approximately $863.0 million. In addition, there are operating loss carryforwards relating to the operations in Barbados in the amount of $85.3 million, which losses will expire by 2023, and operating loss carry forwards relating to operations in Canada in the amount of $21.1 million, which losses will expire by 2034.
A reconciliation of the beginning and ending unrecognized tax benefits is as follows:
The Company classifies interest and penalty accruals related to unrecognized tax benefits as income tax (benefit) expense. During the years ended December 31, 2014 and 2013, the Company recognized a benefit of $1.3 million and an expense of $0.2 million, respectively, in interest and penalty (benefit) expense. At December 31, 2014 and December 31, 2013, the Company had an accrual of zero and $1.4 million, respectively, for the payment of interest and penalties.
Loss from continuing operations per share is based on the weighted-average number of shares outstanding. Diluted weighted-average shares is calculated by adjusting basic weighted-average shares outstanding by all potentially dilutive securities. Potentially dilutive securities consist of stock options, unvested restricted stock awards, warrants and convertible preferred stock. Since the Company is reporting a loss from continuing operations for the years ended December 31, 2014 and 2013, all potentially dilutive securities outstanding were excluded from the calculation of both basic and diluted loss from continuing operations per share since their inclusion would have been anti-dilutive.
On May 13, 2013, the Company's shareholders approved the 2013 Equity Incentive Plan ("2013 Plan"). The 2013 Plan replaced the Company's previous Amended and Restated Stock Option Plan ("Prior Plan"), with respect to the granting of future equity awards. Under the 2013 Plan, the Company may grant new stock options ("New Stock Options") to purchase up to an additional 300,000 common shares to key employees selected by the Company. During the year ended December 31, 2014, the Company granted 260,000 New Stock Options to employees of the Company.
On May 13, 2013, the Company's shareholders also approved the Option Exchange Program whereby the outstanding stock options under the Prior Plan held by current employees will be canceled and replaced with stock options granted under the 2013 Plan ("Replacement Options"). The maximum number of common shares available to be granted as Replacement Options is 355,625. Each stock option outstanding under the Prior Plan that is not exchanged for a Replacement Option shall remain outstanding in accordance with the terms of the Prior Plan and the applicable award agreement. Under the Prior Plan, the options vest evenly over a three or four-year period and are exercisable for periods not exceeding 10 years. During the year ended December 31, 2014, the Company granted 351,875 Replacement Options to employees of the Company.
The exercise price of Replacement Options and New Stock Options (collectively, the "Stock Options") is equal to $4.50. The Stock Options were fully vested and exercisable at the date of grant and are exercisable for a period of four years.
The following table summarizes the stock option activity during the year ended December 31, 2014:
The Company uses the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. The assumptions used in the Black-Scholes pricing model for options granted or exchanged during the year ended December 31, 2014 were as follows:
Total stock-based compensation expense, net of forfeitures, was $1.2 million and $0.3 million for the years ended December 31, 2014 and 2013, respectively.
The contributions for the plan vest based on years of service with 100% vesting after five years of service. The Company's contribution is expensed as paid and for the years ended December 31, 2014 and 2013 totaled $0.6 million and $0.6 million, respectively. All Company obligations to the plans were fully funded as of December 31, 2014.
As part of the restructuring, the Company reduced staffing levels to be consistent with placing Amigo into run-off. The Company estimated that Insurance Underwriting would incur approximately $2.0 million in cash severance expenses due to reductions-in-force as part of the restructuring during the period beginning with the announcement through the end of 2013. As of December 31, 2014, the Company has paid $2.0 million related to severance incurred as part of the restructuring. At December 31, 2014, the remaining severance liability related to the restructuring is zero.
Each unit consists of one class A convertible preferred share, series 1 (the "Preferred Shares"), and 6.25 common share class C purchase warrants. Each Preferred Share is convertible into 6.25 common shares at a conversion price of $4.00 per common share any time at the option of the holder prior to April 1, 2021. The maximum number of common shares issuable upon conversion of the Preferred Shares is 1,642,975 common shares. Each warrant will entitle the subscriber to purchase one common share of Kingsway at a price of $5.00 per common share at any time after September 16, 2016 and prior to expiry on September 15, 2023.
In accordance with FASB ASC Topic 480-10-S99-3A, SEC Staff Announcement: Classification and Measurement of Redeemable Securities, redemption features which are not solely within the control of the issuer are required to be presented outside of permanent equity on the consolidated balance sheets. As described above, the holder has the option to convert the Preferred Shares at any time; however, if not converted, they are required to be redeemed on April 1, 2021. As such, the Preferred Shares are presented in temporary or mezzanine equity on the consolidated balance sheets.
On July 8, 2014, the holders of the Company's series B warrants approved certain amendments to the terms of the Series B Warrant Agreement dated September 16, 2013. The Series B Warrant Agreement Amendments permitted the Company to issue up to 1,642,975 additional Series B Warrants and complete the Series C Warrant Exchange. Under the Series C Warrant Exchange, each class C purchase warrant was automatically exchanged for a Series B Warrant.
Under the rights offering, each shareholder of record as of August 9, 2013 (the "Record Date") received, at no charge, one subscription right for each Common Share owned on the Record Date (the "Subscription Right"). Four Subscription Rights entitled the holder to purchase one unit (a "Unit") consisting of one Common Share, one Series A Warrant (a "Series A Warrant") and one Series B Warrant (a "Series B Warrant", and together with the Series A Warrants, the "Warrants"). Each Warrant entitled the holder to purchase one Common Share. The subscription price was $4.00 per Unit. The exercise prices per Common Share for each Series A Warrant is $4.50 and for each Series B Warrant is $5.00. Each Series A Warrant is redeemable by the Company and has a term of seven years from its date of issuance. Each Series B Warrant is non-redeemable and has a term of ten years from its date of issuance. The Company may redeem the Series A Warrants at a price of $0.25 per Warrant if, and only if, the closing price of the Common Shares equals or exceeds $6.00 per Common Share for twenty consecutive trading days on the New York Stock Exchange or such other market or exchange as the Common Shares of the Company trade on or are quoted at the time of redemption; but in any event, no earlier than the first anniversary date of issuance. Subject to applicable securities laws, the Warrants may be exercised at any time starting on the first day of the thirty-seventh month after the date of issuance until any time on or before the seventh anniversary after the date of issuance for the Series A Warrants and the tenth anniversary after the date of issuance for the Series B Warrants. Holders who fully exercise their Subscription Rights will be entitled to subscribe for an additional amount of Units, if any, that are not purchased by other shareholders or their transferees through the exercise of their basic subscription privileges, in an amount equal to up to five Units for each Unit for which such holder was otherwise entitled to subscribe.
The following table summarizes information about warrants outstanding at December 31, 2014:
The table below details the change in the balance of each component of accumulated other comprehensive income, net of tax, for the years ended December 31, 2014 and 2013 as relates to shareholders' equity attributable to common shareholders on the consolidated balance sheets. On the other hand, the consolidated statements of comprehensive loss present the components of other comprehensive loss, net of tax, only for the years ended December 31, 2014 and 2013 and inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
The Company operates as a merchant bank primarily engaged, through its subsidiaries, in the property and casualty insurance business. The Company conducts its business through the following two reportable segments: Insurance Underwriting and Insurance Services.
Trinity is a provider of warranty products and maintenance support to consumers and businesses in the HVAC and refrigeration industry. Trinity distributes its warranty products through original equipment manufacturers, HVAC distributors and commercial and residential contractors. Trinity distributes its maintenance support directly through corporate owners of retail spaces throughout the United States.
Segment operating income (loss) reconciled to the consolidated loss from continuing operations for the years ended December 31, 2014 and 2013 were:
Fixed maturities and equity investments - Fair values of fixed maturities for which no active market exists are derived from quoted market prices of similar instruments or other third-party evidence. Fair values of equity investments are considered to approximate quoted market values based on the latest bid prices in active markets.
result from changes to one or multiple inputs, including adjustments to the discount rates or changes in the assumed achievement or timing of any targets. Changes in assumptions could have an impact on the payout of contingent consideration liabilities. Changes in fair value are reported in the consolidated statements of operations as contingent consideration (benefit) expense. As a result of the analysis performed in 2014, the Company decreased contingent consideration liabilities by $3.0 million during the fourth quarter of 2014, resulting in a total liability of $3.1 million at December 31, 2014, which is included in accrued expenses and other liabilities on the consolidated balance sheets. The maximum the Company can pay in future contingent payments is $13.5 million, on an undiscounted basis.
The following table provides a reconciliation of the fair value of recurring Level 3 fair value measurements for the years ended December 31, 2014 and December 31, 2013:
On February 11, 2014, the Company's subsidiary, 1347 Advisors entered into a Management Services Agreement ("MSA") with PIH which provides for certain services, including forecasting, analysis of capital structure and reinsurance programs, consultation in future restructuring or capital raising transactions, and consultation in corporate development initiatives, that 1347 Advisors will provide to PIH unless and until 1347 Advisors and PIH agree to terminate the services. On February 24, 2015, the Company announced that it had entered into a definitive agreement with PIH to terminate the MSA. See Note 30, "Subsequent Event," for further details.
Fixed maturities and short-term investments with an estimated fair value of $12.9 million and $14.2 million were on deposit with state and provincial regulatory authorities at December 31, 2014 and 2013, respectively. Also, from time to time, the Company pledges investments to third-parties to collateralize liabilities incurred under its policies of insurance. The amount of such pledged investments was $17.5 million and $24.4 million at December 31, 2014 and 2013, respectively. Collateral pledging transactions
are conducted under terms that are common and customary to standard collateral pledging and are subject to the Company's standard risk management controls.
The Company previously placed UCC into voluntary run-off in early 2011. At the time it was placed into voluntary run-off, UCC's RBC was 160%. UCC entered into a comprehensive run-off plan approved by the Illinois Department of Insurance in June 2011. UCC remains in compliance with that plan. As of December 31, 2014, UCC's RBC was 3,626%.
The Company's reinsurance subsidiary, which is domiciled in Barbados, is required by the regulator in Barbados to maintain minimum capital levels. As of December 31, 2014, the capital maintained by Kingsway Reinsurance Corporation was in excess of the regulatory capital requirements in Barbados.
At December 31, 2014, the U.S. insurance subsidiaries of the Company were restricted from making any dividend payments without regulatory approval pursuant to the domiciliary state insurance regulations.
On February 24, 2015, the Company announced that it had entered into a definitive agreement with PIH to terminate the MSA which was put in place on February 11, 2014, prior to the initial public offering of PIH. See Note 26, "Related Party Transactions," for further details regarding the MSA. Pursuant to the transaction, 1347 Advisors received the following consideration: $2.0 million in cash; $3.0 million of 8% preferred stock of PIH, redeemable in five years; a Performance Shares Grant Agreement with PIH, whereby 1347 Advisors will be entitled to receive 100,000 shares of PIH common stock if at any time the last sales price of PIH's common stock equals or exceeds $10.00 per share for any 20 trading days within any 30-trading day period; and warrants to purchase 1,500,000 shares of common stock of PIH with a strike price of $15.00, expiring in seven years. The Company expects to record an estimated pre-tax gain of approximately $6.7 million during the first quarter of 2015 related to this transaction.