The Company leases a facility for its corporate office with an aggregate square footage of approximately 6,338 at one location in one state. The expiration date of the existing lease is in January 2023.
Leased Real Estate includes the Company's subsidiary, CMC Industries, Inc. ("CMC"). CMC owns, through an indirect wholly owned subsidiary (the "Property Owner"), a parcel of real property consisting of approximately 192 acres located in the State of Texas (the "Real Property"), which is subject to a long-term triple net lease agreement. The Real Property is also subject to a mortgage, which is recorded as note payable in the consolidated balance sheets (the "Mortgage"). Throughout this 2019 Annual Report, the term "Leased Real Estate" is used to refer to this segment.
In March 2020, the outbreak of COVID-19 caused by a novel strain of the coronavirus was recognized as a pandemic by the World Health Organization, and the outbreak has become increasingly widespread in the United States, including in the markets in which we operate. The COVID-19 outbreak has had a notable impact on general economic conditions, including but not limited to the
The near-term impacts of COVID-19 are primarily with respect to our Extended Warranty segment. As consumer spending has been impacted, including a decline in the purchase of new and used vehicles, and many businesses through which we distribute our products remain closed, we have seen cash flows being affected by a reduction in new warranty sales for vehicle service agreements. With respect to homeowner warranties, we have seen a reduction in new enrollments in our home warranty programs associated with the impact of COVID-19 on new home sales in the United States.
On March 27, 2020, the President of the United States signed the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, a substantial tax-and-spending package intended to provide additional economic stimulus to address the impact of the COVID-19 pandemic. We continue to monitor the impact of the COVID-19 outbreak closely, as well as any effects that may result from the CARES Act. However, the extent to which the COVID-19 outbreak will impact our operations or financial results is uncertain.
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and classification of assets and liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing basis. Changes in estimates are recorded in the accounting period in which they are determined. The critical accounting estimates and assumptions in the accompanying consolidated financial statements include the provision for unpaid loss and loss adjustment expenses; valuation of fixed maturities and equity investments; impairment assessment of investments; valuation of limited liability investments, at fair value; valuation of real estate investments; valuation of deferred income taxes; valuation of mandatorily redeemable preferred stock; valuation and impairment assessment of intangible assets; goodwill recoverability; deferred acquisition costs; fair value assumptions for subordinated debt obligations; fair value assumptions for warrant liability; and revenue recognition.
Incurred Loss Development - we use historical case incurred loss and loss adjustment expenses (the sum of cumulative loss and loss adjustment expense payments plus outstanding unpaid case losses) over discrete periods of time to estimate future loss and loss adjustment expenses. Incurred development methods assume that the case loss and loss adjustment expenses reserving practices are consistently applied over time.
We review the adequacy of the provision for unpaid loss and loss adjustment expenses quarterly. For our year-end analysis, we re-estimate the ultimate losses for each coverage, by accident year. This involves performing a complete update of the historical development factors used in our analysis, incorporating the experience of the most recent calendar year. On a quarterly basis, we perform a more limited review, which can entail, for example, a comparison of the expected losses to be paid during the quarter versus actual payments, or other similar comparisons to determine the extent to which a given segment is performing as expected. In some cases, a re-estimation (similar to the year-end analysis) may be determined to be useful as part of a quarterly analysis, and we may make adjustments to ultimate losses in response to the results of this analysis. We adjust carried unpaid loss and loss adjustment expenses as we learn additional information, and reflect these adjustments in the accounting periods in which they are determined.
A basic premise in most actuarial analyses is that past patterns demonstrated in the data will repeat themselves in the future, absent a material change in the associated risk factors. Significant structural changes to the available data, product mix or organization can materially affect the provision for loss and loss adjustment expenses.
To the extent that the ultimate paid losses are higher or lower than the provision for unpaid loss and loss adjustment expenses recorded by the Company at December 31, 2019, the differences would be recorded in the Company’s consolidated statements of operations in the accounting periods in which they are determined. There can be no assurance that such differences would not be material.
Limited liability investments, at fair value represent the Company's investment in 1347 Investors LLC ("1347 Investors") as well as the underlying investments of the Company’s consolidated entities Net Lease Investment Grade Portfolio LLC ("Net Lease") and Argo Holdings Fund I, LLC ("Argo Holdings"). During the fourth quarter of 2019, the Company’s investment in 1347 Investors was dissolved. The Company accounts for these investments at fair value with changes in fair value reported in the consolidated statements of operations.
Argo Holdings makes investments in limited liability companies and limited partnerships that hold investments in search funds and private operating companies. The fair value of Argo Holdings' limited liability investments that hold investments in search funds is based on the initial investment in the search funds. The fair value of Argo Holdings' limited liability investments that hold investments in private operating companies is valued using a market approach.
The fair value of real estate investments involves a combination of the market and income valuation techniques. Under this approach, a market-based capitalization rate is derived from comparable transactions, adjusted for any unique characteristics of each asset, and applied to the asset under consideration. The cap rates used during underwriting and subsequent valuations incorporate the consideration of risks of vacancy and collection loss, administrative costs of owning net leased assets and possible capital expenditures that could be determined a landlord expense.
deferred income tax asset balances, including the Company's past and anticipated future performance, the reversal of deferred income tax liabilities, and the availability of tax planning strategies.
Mandatorily redeemable preferred stock is recorded at the time of issuance based upon the gross proceeds of the offering less (i) proceeds of the offering allocated to additional paid-in capital based upon the relative fair values of equity-classified warrants issued as part of the offering and the preferred stock without the warrants; (ii) proceeds of the offering allocated to additional paid-in capital based upon the calculation of a beneficial conversion feature; and (iii) costs of the offering allocated to the preferred stock. The discount to the carrying value of the preferred stock created by the allocation of proceeds to the warrants and a beneficial conversion feature and the allocation of offering costs to the preferred stock is accreted over time as dividend expense. Additional information regarding our mandatorily redeemable preferred stock is included in Note 23, "Redeemable Class A Preferred Stock," to the Consolidated Financial Statements.
Goodwill is assessed for impairment annually as of December 31, or more frequently if events or circumstances indicate that the carrying value may not be recoverable. The Company has the option to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If facts and circumstances indicate that it is more likely than not that the goodwill is impaired, a fair value-based impairment test would be required.
techniques, including a discounted cash flow model using revenue and profit forecasts, and comparing those estimated fair values with the carrying values of the assets and liabilities of the reporting unit, which includes the allocated goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment, if any, by determining an implied fair value of goodwill. The determination of the implied fair value of goodwill of a reporting unit requires management to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the implied fair value of goodwill, which is compared to its corresponding carrying value. For reporting units with a negative book value, qualitative factors are evaluated to determine whether it is necessary to perform the second step of the goodwill impairment test.
No impairment charges were recorded against goodwill in 2019 or 2018, as the estimated fair values of the reporting units exceeded their respective carrying values. Additional information regarding our goodwill is included in Note 11, "Goodwill," to the Consolidated Financial Statements.
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 and agency expenses related to issuing vehicle service agreements, are deferred and charged against income consistent with the pattern revenue is recognized. Management regularly reviews the categories of acquisition costs that are deferred and assesses the recoverability of this asset.
Our subordinated debt is measured and reported at fair value. The fair value of the subordinated debt is calculated using a model based on significant market observable inputs and inputs developed by a third-party. These inputs include credit spread assumptions developed by a third-party and market observable swap rates.
A reconciliation of total segment operating income to net loss for the years ended December 31, 2019 and December 31, 2018 is presented in Table 1 below:
For the year ended December 31, 2019, we incurred a loss from continuing operations of $2.8 million (loss of $0.25 per diluted share) compared to $22.3 million (loss of $1.13 per diluted share) for the year ended December 31, 2018. The loss from continuing operations for the year ended December 31, 2019 is primarily attributable to interest expense not allocated to segments, other income and expenses not allocated to segments, net and amortization of intangible assets, partially offset by net investment income, gain on change in fair value of limited liability investments, at fair value, gain on change in fair value of debt and operating income in Extended Warranty and Leased Real Estate.
The inclusion of Geminus in 2019 following its acquisition effective March 1, 2019. Geminus service fee and commission income was $9.9 million for the year ended December 31, 2019.
An increase at IWS, primarily driven by an increase in policies-in-force; and
The Extended Warranty operating income was $4.6 million for the year ended December 31, 2019 compared with $4.2 million for the year ended December 31, 2018. The increase in operating income is primarily due to the inclusion of Geminus in 2019 following its acquisition effective March 1, 2019. Geminus operating income was $0.5 million for the year ended December 31, 2019.
Gain (Loss) on Change in Fair Value of Limited Liability Investments, at Fair Value
Gain on change in fair value of limited liability investments, at fair value was $4.5 million in 2019 compared to a loss of $7.4 million in 2018. The change from 2018 to 2019 is primarily explained by the difference between the $2.2 million fair value gain recorded during 2019 related to 1347 Investors compared to the $10.1 million fair value loss recorded during 2018 related to 1347 Investors.
The fair value of the Company’s investment in 1347 Investors is calculated based on a model that distributes the net equity of 1347 Investors to all classes of membership interests. The model uses quoted market prices and significant market observable inputs. The most significant input to the model is the observed stock price of Limbach Holdings, Inc. ("Limbach") common stock, which was $3.68 on December 31, 2018 and $3.78 on December 31, 2019. During the fourth quarter of 2019, the Company’s investment in 1347 Investors was dissolved, which resulted in the Company holding shares of Limbach common stock directly. As a result of this distribution, the Company no longer owns membership units in 1347 Investors.
The gain on change in fair value of limited liability investments, at fair value also includes increases in fair value of $3.0 million and $1.2 million related to Net Lease during 2019 and 2018, respectively, and a decrease in fair value of $0.7 million and an increase in fair value of $1.5 million related to Argo Holdings during 2019 and 2018, respectively.
See Note 28, "Related Parties," to the Consolidated Financial Statements, for further information about the dissolution of 1347 Investors.
Net change in unrealized loss on private company investments was $0.3 million in 2019 compared to $1.6 million in 2018. The Company recorded decreases of $0.2 million and $0.6 million during 2019 and 2018, respectively, to adjust the fair values of certain investments in private companies for observable price changes. Also, as a result of the quarterly impairment analyses performed, the Company recorded impairments of $0.2 million and $1.0 million during 2019 and 2018, respectively, related to investments in private companies.
Other income and expenses not allocated to segments was a net expense of $8.5 million in 2019 compared to $9.0 million in 2018. Included in other income and expenses not allocated to segments are expenses of $0.9 million and $1.8 million for Amigo for the years ended December 31, 2019 and December 31, 2018, respectively. Amigo was previously included in the Insurance Underwriting segment along with Mendota, Mendakota and MCC. As a consequence of classifying Mendota, Mendakota and MCC as discontinued operations, the remaining composition of the Insurance Underwriting segment no longer meets the criteria of a reportable segment. As such, all segmented information has been restated to exclude the Insurance Underwriting segment for all periods presented. The operating results of Amigo previously included in the Insurance Underwriting segment are now included in other income and expenses not allocated to segments, net.
Also included in other income and expenses not allocated to segments is stock-based compensation, net of forfeitures, of an expense of $1.2 million and a benefit of $1.7 million for the years ended December 31, 2019 and December 31, 2018, respectively. The years ended December 31, 2019 and December 31, 2018 also included $0.1 million and $0.4 million, respectively, of payroll tax expense related to stock-based transactions. See Note 21, "Stock-Based Compensation," to the Consolidated Financial Statements, for further discussion.
The 2018 income tax expense is primarily related to (1) the change in unrecognized tax benefits, (2) the change in indefinite life intangible deferred income tax liabilities and (3) state income taxes.
See Note 19, "Income Taxes," to the Consolidated Financial Statements, for additional detail of the income tax (benefit) expense recorded for the years ended December 31, 2019 and December 31, 2018, respectively.
Investments in fixed maturities are classified as available-for-sale and are reported at fair value.
Limited liability investments are accounted for under the equity method of accounting. The most recently available financial statements of the limited liability investments are used in applying the equity method. The difference between the end of the reporting period of the limited liability investments and that of the Company is no more than three months.
Investments in private companies consist of: convertible preferred stocks and notes in privately owned companies; and investments in limited liability companies in which the Company’s interests are deemed minor. These investments do not have readily determinable fair values and, therefore, are reported at cost, adjusted for observable price changes and impairments.
At December 31, 2019, we held cash and cash equivalents, restricted cash and investments with a carrying value of $97.1 million.
The Company performs a quarterly analysis of its investments classified as available-for-sale to determine if declines in market value are other-than-temporary. Further information regarding our detailed analysis and factors considered in establishing an other-than-temporary impairment on an available-for-sale investment is discussed within the "Critical Accounting Estimates and Assumptions" section of MD&A.
As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, there were no write-downs recorded for other-than-temporary impairments related to available-for sale investments for the years ended December 31, 2019 and December 31, 2018.
As a result of the analysis performed with respect to investments in private companies, the Company recorded impairments of $0.2 million and $1.0 million for the years ended December 31, 2019 and December 31, 2018, respectively, which are included in net change in unrealized loss on private company investments in the consolidated statements of operations.
The length of time a fixed maturity investment may be held in an unrealized loss position may vary based on the opinion of the 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 the case of a fixed maturity investment where the investment manager determines that there is little or no risk of default prior to the maturity of a holding, we would elect to hold the investment in an unrealized loss
At December 31, 2019 and December 31, 2018, the gross unrealized losses for fixed maturities amounted to $0.0 million and $0.2 million, respectively, and there were no unrealized losses attributable to non-investment grade fixed maturities. At each of December 31, 2019 and December 31, 2018, all unrealized losses on individual investments were considered temporary.
As discussed in Note 32, "Subsequent Events" to the Consolidated Financial Statements, in March 2020 the outbreak of COVID-19 caused by a novel strain of the coronavirus was recognized as a pandemic by the World Health Organization, and the outbreak has become increasingly widespread in the United States, including in the markets in which we operate. The COVID-19 outbreak has had a notable impact on general economic conditions, including but not limited to the temporary closures of many businesses; "shelter in place" and other governmental regulations; and reduced consumer spending due to both job losses and other effects attributable to COVID-19. There remain many unknowns.
At December 31, 2019 and December 31, 2018, the gross provisions for unpaid loss and loss adjustment expenses for our other business were $1.2 million and $0.6 million, respectively. The increase is due to unfavorable development in unpaid loss adjustment expenses at Amigo, partially offset by favorable development in unpaid loss and loss adjustment expenses at Kingsway Re. Amigo recorded $0.9 million of unfavorable development during the year ended December 31, 2019 related to the re-estimation of potential loss and loss adjustment expenses for three construction defect claims following a court-ordered mediation. Kingsway Re recorded $0.2 million of favorable development during the year ended December 31, 2019 related to the release of the provision for unpaid loss and loss adjustment expenses associated with closing its last remaining open claim.
On March 1, 2019, the Company borrowed a principal amount of $10.0 million from a bank to finance its acquisition of Geminus (the "KWH Loan"). The KWH Loan matures on March 1, 2024 and has an annual interest rate equal to LIBOR, having a floor of 2.00%, plus 9.25%. The KWH Loan is carried in the consolidated balance sheets at its amortized cost, which reflects the quarterly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. See Note 16, "Debt," to the Consolidated Financial Statements for further details.
As part of its acquisition of CMC in July 2016, the Company assumed the Mortgage and recorded the Mortgage at its estimated fair value of $191.7 million, which included the unpaid principal amount of $180.0 million as of the date of acquisition plus a premium of $11.7 million. The Mortgage matures on May 15, 2034 and has a fixed interest rate of 4.07%. The Mortgage is carried
On January 5, 2015, Flower Portfolio 001, LLC assumed a $9.2 million mortgage in conjunction with the purchase of investment real estate properties ("the Flower Note"). The Flower Note matures on December 10, 2031 and has a fixed interest rate of 4.81%. The Flower Note is carried in the consolidated balance sheets at its unpaid principal balance.
On October 15, 2015, Net Lease assumed a $9.0 million mezzanine debt in conjunction with the purchase of investment real estate properties ("the Net Lease Note"). The Net Lease Note matures on November 1, 2020 and has a fixed interest rate of 10.25%. The Net Lease Note is carried in the consolidated balance sheets at its unpaid principal balance. Net Lease is exploring alternatives given that the Net Lease Note matures later this year and has commenced discussions with various parties. The Net Lease Note is non-recourse and, as such, the Company’s cash flows would not be significantly impacted should the Net Lease Note come due on November 1, 2020. However, such a situation could have a material adverse impact on the value of the Net Lease investment.
During the year ended December 31, 2019, the market observable swap rates changed, and the Company experienced a decrease in the credit spread assumption developed by the third-party. Changes in the market observable swap rates affect the fair value model in different ways. An increase in the LIBOR swap rates has the effect of increasing the fair value of the Company's subordinated debt while an increase in the risk-free swap rates has the effect of decreasing the fair value. An increase in the credit spread assumption has the effect of decreasing the fair value of the Company's subordinated debt while a decrease in the credit spread assumption has the effect of increasing the fair value. The other primary variable affecting the fair value of debt calculation is the passage of time, which will always have the effect of increasing the fair value of debt. The changes to the credit spread and swap rate variables during 2019, along with the passage of time, contributed to the $4.6 million increase in fair value of the Company’s subordinated debt between December 31, 2018 and December 31, 2019.
Effective January 1, 2018, the Company adopted ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. As a result of the adoption, a cumulative $40.5 million change in fair value of subordinated debt attributable to instrument-specific credit risk was reclassified from accumulated deficit to accumulated other comprehensive income (loss) as of January 1, 2018. As long as the Company repays its subordinated debt at maturity, it can be expected that this $40.5 million reclassification will reverse without being reported in the Company’s consolidated
During 2019, the Company reported on the consolidated statements of cash flows $0.8 million of net cash used in operating activities from continuing operations. The reconciliation between the Company's reported net loss of $4.3 million and the $0.8 million of net cash used in operating activities from continuing operations can be explained primarily by the $6.9 million non-cash depreciation and amortization expense and the $9.6 million change in other assets and liabilities, net, offset by the $4.5 million increase in other receivables, the $4.5 million gain on change in fair value of limited liability investments, at fair value, the $1.4 million increase in deferred service fees and the $1.7 million increase in deferred acquisition costs.
During 2019, the net cash used in investing activities from continuing operations as reported on the consolidated statements of cash flows was $6.5 million. This use of cash was driven primarily by $4.9 million for acquisition of business, net of cash acquired and by purchases of fixed maturities in excess of proceeds from sales and maturities of fixed maturities and proceeds related to other investments.
Separately, pursuant to covenants under the PWSC Loan secured to partially finance the acquisition of PWSC on October 12, 2017, PWSC was not permitted to make distributions to the holding company without the consent of the lender. The PWSC Loan was scheduled to mature on October 12, 2022; however, the remaining principal totaling $0.3 million was fully repaid on January 30, 2020 and, as such, PWSC is no longer subject to such restrictions.
Pursuant to the terms of the management services agreement entered into at the closing of the acquisition of CMC, an affiliate of the seller (the "Service Provider") will provide certain services to CMC and its subsidiaries in exchange for service fees. Such services (collectively, the "Services") will include (i) causing an affiliate of the Service Provider to guaranty certain obligations of the Property Owner (pursuant to an Indemnity and Guaranty Agreement between such affiliate and the holder of the Mortgage (the "Mortgagor")), (ii) providing certain individuals to serve as members of the board of directors and/or certain executive officers of CMC and/or its subsidiaries and (iii) providing asset management services with respect to the Real Property. In exchange for the Services, the Property Owner will pay certain fees to the Service Provider. The payment of such service fees may be triggered by (i) a sale of the Real Property, (ii) a restructuring of the lease to which the Real Property is subject or (iii) a refinancing or restructuring of the Mortgage. The amount of the service fees will range from 40%-80% of the net proceeds generated by the event triggering the payment of the service fees (depending on the nature and timing of the triggering event). The Company has concluded the Lease Amendment has not triggered the payment of service fees to the Service Provider. See Note 29, "Commitments and Contingent Liabilities," to the consolidated financial statements, for further discussion.
The holding company’s liquidity, defined as the amount of cash in the bank accounts of Kingsway Financial Services Inc. and Kingsway America Inc., was $2.3 million and $1.9 million at December 31, 2019 and December 31, 2018, respectively. These amounts are reflected in the cash and cash equivalents of $13.5 million and $14.6 million reported at December 31, 2019 and December 31, 2018, respectively, on the Company’s consolidated balance sheets. The cash and cash equivalents and restricted cash other than the holding company’s liquidity represent restricted and unrestricted cash held by Amigo, Kingsway Re and the Company's Extended Warranty and Leased Real Estate subsidiaries and are not considered to be available to meet holding company obligations, except as described above with respect to the Company’s Extended Warranty subsidiaries, which primarily consist of holding company operating expenses; transaction-related expenses; investments; and any other extraordinary demands on the holding company.
The holding company’s liquidity of $2.3 million at December 31, 2019 represented approximately four months of regularly recurring operating expenses before any transaction-related expenses, any new holding company investments or any other extraordinary demands on the holding company. As of the filing date of the Company’s 2019 Annual Report, the holding company’s liquidity of $1.7 million represented approximately four months of regularly recurring operating expenses before any transaction-related expenses, any new holding company investments or any other extraordinary demands on the holding company. During the third quarter of 2018, the Company gave notice to its Trust Preferred 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 Trust Preferred indentures, which permit interest deferral.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. As of December 31, 2012, Amigo’s RBC was 157%. In April 2013, Kingsway filed a comprehensive run-off plan with the Florida Office of Insurance Regulation, which outlines plans for Amigo's run-off. Amigo remains in compliance with that plan. As of December 31, 2019, Amigo's RBC was 1,023%.
Kingsway Re, our reinsurance subsidiary domiciled in Barbados, is required by the regulator in Barbados to maintain minimum statutory capital of $125,000. Kingsway Re is currently operating with statutory capital near the regulatory minimum, requiring us to periodically contribute capital to fund operating expenses. Kingsway Re incurs operating expenses of approximately $0.1 million per year. As of December 31, 2019, the capital maintained by Kingsway Re was in excess of the regulatory capital requirements in Barbados.
On April 17, 2020, the Company received notification from the New York Stock Exchange ("NYSE") of the Company's noncompliance with certain NYSE standards for continued listing of its common shares. Specifically, Kingsway is below the NYSE's continued listing criteria because its average total market capitalization over a recent 30 consecutive trading day period was less than $50.0 million at the same time that reported shareholders' equity was below $50.0 million. Under the NYSE's continued listing criteria, a NYSE-listed company must maintain average market capitalization of not less than $50.0 million over a 30 consecutive trading day period or reported shareholders' equity of not less than $50.0 million.
The Company had 90 days from the date of the notice to submit a business plan to the NYSE demonstrating its ability to achieve compliance with the listing standards within 18 months of receiving the notice. The Company submitted a business plan to the NYSE on June 1, 2020, intended to demonstrate its ability to achieve compliance with the listing standards within 18 months of receiving the notice. On July 9, 2020, the NYSE notified us that our plan has been accepted. There can be no assurances that the Company will maintain compliance with the plan. If we are unable to comply with the plan or we are unable to meet the continued listing standard by December 26, 2021, we will be subject to the prompt initiation of NYSE suspension and delisting procedures.
Table 6 summarizes cash disbursements related to the Company's contractual obligations 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 6 related to the subordinated debt and KWH Loan 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 6 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 a substantial amount in short-term investments to provide adequate cash flows for the projected payments in Table 6.
Refer to Note 23, "Redeemable Class A Preferred Stock," to the Consolidated Financial Statements for further information regarding the Preferred Shares.
The Company has off-balance sheet arrangements related to guarantees, which are further described in Note 29, "Commitments and Contingent Liabilities," to the Consolidated Financial Statements.
Consolidated Statements of Operations for the Years Ended December 31, 2019 and 2018
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting 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.
The accompanying information in the 2019 Annual Report has been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").
The consolidated financial statements are prepared as of December 31, 2019 based on individual company financial statements at the same date, or in the case of certain limited liability companies that are consolidated, on a three-month lag basis. 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; Argo Holdings Fund I, LLC ("Argo Holdings"); Argo Management Group, LLC ("Argo Management"); CMC Acquisition LLC; CMC Industries, Inc. ("CMC"); Flower Portfolio 001, LLC ("Flower"); Geminus Holding Company, Inc. ("Geminus"); Geminus Reinsurance Company, Ltd.; IWS Acquisition Corporation ("IWS"); Kingsway America II Inc.; Kingsway America Inc. ("KAI"); Kingsway Amigo Insurance Company ("Amigo"); Kingsway General Insurance Company; Kingsway LGIC Holdings, LLC; Kingsway Reinsurance Corporation ("Kingsway Re"); Kingsway Warranty Holdings LLC ("KWH"); Net Lease Investment Grade Portfolio LLC ("Net Lease"); Prime Auto Care Inc. ("Prime"); Professional Warranty Service Corporation ("PWSC"); Professional Warranty Services LLC; Texas Rail Terminal LLC; The Penn Warranty Corporation ("Penn"); Trinity Warranty Solutions LLC ("Trinity"); and TRT LeaseCo, LLC ("TRT LeaseCo").
Foreign currency translation adjustments are included in shareholders' equity under the caption accumulated other comprehensive income. Foreign currency gains and losses resulting from transactions denominated in currencies other than the entity's functional currency are reflected in non-operating other income in the consolidated statements of operations.
Investments in fixed maturities are classified as available-for-sale and reported at fair value. Unrealized gains and losses are included in accumulated other comprehensive income, net of tax, until sold or until an other-than-temporary impairment is recognized, at which point cumulative unrealized gains or losses are transferred to the consolidated statements of operations.
Limited liability investments, at fair value represent the Company's investment in 1347 Investors LLC ("1347 Investors") as well as the underlying investments of Net Lease and Argo Holdings. During the fourth quarter of 2019, the Company’s investment in 1347 Investors was dissolved. The Company accounts for these investments at fair value with changes in fair value reported in the consolidated statements of operations. Income or loss from limited liability investments, at fair value is included in gain (loss) on change in fair value of limited liability investments, at fair value.
The investment in investee included the Company's investment in the common stock of ICL, which was sold during the fourth quarter of 2019. Refer to Note 8, "Investment in Investee," for further information.
Property and equipment are reported in the consolidated financial statements at cost. Depreciation of property and equipment has been provided using the straight-line method over the estimated useful lives of such assets. Repairs and maintenance are recognized in operations during the period incurred. Land is not depreciated. The Company estimates useful life to be forty years for buildings; five to fifty years for site improvements; four to fifteen years for leasehold improvements; three to ten years for furniture and equipment; and three to five years for computer hardware.
When the Company acquires a subsidiary or other business where it exerts significant influence, the fair value of the net tangible and intangible assets acquired is determined and compared to the amount paid for the subsidiary or business acquired. Any excess of the amount paid over the fair value of those net assets is considered to be goodwill.
The Company has the option to assess goodwill for impairment by first performing a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If facts and circumstances indicate that it is more likely than not that the goodwill is impaired, a fair value-based impairment test would be required. The goodwill impairment test is a two-step process that requires management to make judgments in determining what assumptions to use in the calculation. In the first step, the fair value of the reporting unit is compared to its book value including goodwill. If the fair value of the reporting unit is in excess of its book value, the related goodwill is not impaired and no further analysis is necessary. If the
The Company's bank loans are reported at their unpaid principal balance.
Effective January 1, 2019 the Company records a right of use asset and lease liability for all leases in which the estimated term exceeds twelve months. Refer to Note 3, "Recently Issued Accounting Standards," and Note 17, "Leases," for information regarding the adoption of Accounting Standards Update 2016-02, Leases.
Rental expense for operating leases is recognized on a straight-line basis over the lease term, net of any applicable lease incentive amortization. Below market lease liabilities recorded in connection with the acquisition method of accounting are amortized on a straight-line basis over the remaining term of the lease, as determined at the acquisition date, and are included in accrued expenses and other liabilities in the consolidated balance sheets. Amortization of below market lease liabilities is included in rental income in the consolidated statements of operations.
Homebuilder warranty service fees include fees collected from the sale of warranties issued by new homebuilders. PWSC receives a single warranty service fee as its transaction price at the time it enters into a written contract with each of its builder customers. Each contract contains two separate performance obligations - warranty administrative services and other warranty services. Warranty administrative services include enrolling each home sold by the builder into the program and the warranty administrative system and delivering the warranty product. Warranty administrative services are earned at the time the home is enrolled and the warranty product is delivered. Other warranty services include answering builder or homeowner questions regarding the home
The fair values of the Company's investments in fixed maturities and equity investments, limited liability investments, at fair value, real estate investments, subordinated debt and warrant liability are estimated using a fair value hierarchy to categorize the inputs it uses in valuation techniques. The fair value of the Company's investment in investee is based on quoted market prices. Fair values for other investments approximate their unpaid principal balance. The carrying amounts reported in the consolidated balance sheets approximate fair values for cash and cash equivalents, restricted cash, short-term investments and certain other assets and other liabilities because of their short-term nature.
Actions available to the holding company to increase liquidity in order to meet its obligations include the sale of passive investments; sale of subsidiaries; issuance of debt or equity securities; distributions from the Company’s Extended Warranty subsidiaries, subject to certain restrictions; and giving notice to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters on the six subsidiary trusts of the Company’s subordinated debt, which right the Company exercised during the third quarter of 2018.
Effective January 1, 2019, the Company adopted Accounting Standards Update ("ASU") 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 was issued to improve the financial reporting of leasing transactions. Under current guidance for lessees, leases are only included on the balance sheet if certain criteria, classifying the agreement as a capital lease, are met. This update requires the recognition of a right-of-use asset and a corresponding lease liability, discounted to the present value, for all leases that extend beyond 12 months. For operating leases, the asset and liability will be amortized over the lease term on a straight-line basis, with all cash flows included within operating activities in the statement of cash flows. The accounting treatment for lessors will remain relatively unchanged. The Company adopted ASU 2016-02 using the modified retrospective transition method and did not restate comparative periods.
The adoption of ASU 2016-02 had no impact on the Company's shareholders' equity as of January 1, 2019, but resulted in a significant effect on the balance sheet as the Company recorded a right-of-use asset of $2.7 million; a corresponding lease liability of $2.9 million; and a reversal of December 31, 2018 accrued rent expense of $0.2 million. Refer to Note 17, "Leases," for further information regarding the adoption of ASU 2016-02.
In June 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 replaces the current incurred loss model used to measure impairment losses with an expected loss model for trade, reinsurance, and other receivables as well as financial instruments measured at amortized cost. ASU 2016-13 will require a financial asset measured at amortized cost, including reinsurance balances recoverable, to be presented at the net amount expected to be collected by means of an allowance for credit losses that runs through net loss. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses. However, the amendments would limit the amount of the allowance to the amount by which fair value is below amortized cost. The measurement of credit losses on available-for-sale investments is similar under current GAAP, but the update requires the use of the allowance account through which amounts can be reversed, rather than through irreversible write-downs. On November 15, 2019, the FASB issued ASU 2019-10, which (1) provides a framework to stagger effective dates for future major accounting standards and (2) amends the effective dates for certain major new accounting standards to give implementation relief to certain types of entities. Specifically, per ASU 2019-10 the Company would adopt ASU 2016-13 beginning January 1, 2023, as the Company is considered to be a smaller reporting company. The Company is currently evaluating ASU 2016-13 to determine the potential impact that adopting this standard will have on its consolidated financial statements.
On March 1, 2019, the Company acquired 100% of the outstanding shares of Geminus for cash consideration of $8.4 million, comprised of $7.7 million of cash and an installment payable to the seller of $0.7 million due February 15, 2020. The payable to seller was paid in full by February 15, 2020. At December 31, 2019, the balance of the payable to seller was $0.1 million.
This acquisition was accounted for as a business combination using the acquisition method of accounting. The purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. Goodwill of $7.4 million was recognized, and $5.7 million of separately identifiable intangible assets were recognized resulting from the valuations of acquired customer relationships and trade names. Refer to Note 12, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition. The goodwill represents the premium paid over the fair value of the net tangible and intangible assets acquired, which the Company paid to grow its portfolio of warranty companies and acquire an assembled workforce. The goodwill is not deductible for tax purposes.
The consolidated statements of operations include the earnings of Geminus from the date of acquisition. From the date of acquisition through December 31, 2019, Geminus earned revenue of $9.9 million and net income of $0.6 million. The following unaudited pro forma summary presents the Company's consolidated financial statements for the year ended December 31, 2019 and December 31, 2018 as if Geminus had been acquired on January 1, 2018. The pro forma summary is presented for illustrative purposes only and does not purport to represent the results of our operations that would have actually occurred had the acquisition occurred on January 1, 2018 or project our results of operations as of any future date or for any future period, as applicable.
On July 16, 2018, the Company announced it had entered into a definitive agreement to sell its non-standard automobile insurance companies Mendota Insurance Company, Mendakota Insurance Company and Mendakota Casualty Company (collectively "Mendota"). On October 18, 2018, the Company completed the previously announced sale of Mendota. As a result of this announcement, Mendota, which was previously disclosed as part of the Insurance Underwriting segment, has been classified as a discontinued operation and the results of their operations are reported separately for all periods presented. The Company recognized a loss on disposal of Mendota of $1.5 million and $8.5 million for the years ended December 31, 2019 and December 31, 2018, respectively.
Summary financial information for Mendota and ARS included in (loss) income from discontinued operations, net of taxes in the statements of operations for the years ended December 31, 2019 and December 31, 2018 is presented below:
The following table summarizes the Company’s non-consolidated VIEs by category at December 31, 2019 and December 31, 2018:
The following table presents aggregated summarized financial information of the Company’s non-consolidated VIEs at December 31, 2019 and December 31, 2018. For certain of the non-consolidated VIEs, the financial information is presented on a lag basis, consistent with how the changes in the Company’s share of the net asset values of these equity method investees are recorded in net investment income. The difference between the end of the reporting period of an equity method investee and that of the Company is typically no more than three months.
The table below summarizes the Company's fixed maturities at December 31, 2019 by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of these obligations.
There are approximately 48 and 64 individual available-for-sale investments that were in unrealized loss positions as of December 31, 2019 and December 31, 2018, respectively.
obtaining a valuation analysis from third-party investment managers regarding the intrinsic value of these investments based on their knowledge and experience together with market-based valuation techniques;
As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, the Company recorded write downs for other-than-temporary impairment related to limited liability investments of $0.1 million and zero for the years ended December 31, 2019 and December 31, 2018, respectively. There were no write-downs recorded for other-than-temporary impairments related to available-for sale investments for the years ended December 31, 2019 and December 31, 2018.
The Company has reviewed currently available information regarding investments with estimated fair values less than their carrying amounts and believes these unrealized losses are not other-than-temporary and are primarily due to temporary market and sector-related factors rather than to issuer-specific factors. The Company does not intend to sell those investments, and it is not likely it will be required to sell those investments before recovery of its amortized cost.
Limited liability investments include investments in limited liability companies and limited partnerships. The Company's interests in these investments are not deemed minor and, therefore, are accounted for under the equity method of accounting. The most recently available financial statements are used in applying the equity method. The difference between the end of the reporting period of the limited liability entities and that of the Company is no more than three months. As of December 31, 2019 and December 31, 2018, the carrying value of limited liability investments totaled $3.8 million and $4.8 million, respectively. At December 31, 2019, the Company has no unfunded commitments related to limited liability investments.
The fair value of the Company's investment in 1347 Investors is calculated based on a model that distributed the net equity of 1347 Investors to all classes of membership interests. The model used quoted market prices and significant market observable inputs. The most significant input to the model was the observed stock price of Limbach Holdings, Inc. ("Limbach") common stock.
The Company performs a quarterly impairment analysis of its investments in private companies. The analysis includes some or all of the following procedures as deemed appropriate by the Company:
As a result of the analysis performed, the Company recorded impairments related to investments in private companies of $0.2 million and $1.0 million for the years ended December 31, 2019 and December 31, 2018, respectively, which are included in net change in unrealized loss on private company investments in the consolidated statements of operations.
Gross realized gains and losses on available-for-sale investments, limited liability investments and limited liability investments, at fair value for the years ended December 31, 2019 and December 31, 2018 is comprised as follows:
Company's ownership percentage in ICL was reduced to 13.8%. As a result of this change in ownership, the Company determined that its investment in the common stock of ICL no longer qualified for the equity method of accounting and reclassified this investment to equity investments. On October 31, 2019, the Company executed an agreement with its former Chief Executive Officer to sell its remaining 3,011,447 shares of ICL common stock, at a price of C$0.35 per share, for consideration totaling C$1.1 million, comprised of cash proceeds of C$0.2 million and 247,450 shares of the Company’s common stock. The Company recognized a loss of $0.0 million on this transaction, which is included in gain on change in fair value of equity investments in the consolidated statements of operations.
The components of deferred acquisition costs and the related amortization expense as of and for the years ended December 31, 2019 and December 31, 2018 are comprised as follows:
As further discussed in Note 4, "Acquisition," the Company recorded goodwill of $7.4 million related to the acquisition of Geminus on March 1, 2019. During 2018, the Company completed its fair value analysis of the assets acquired and liabilities assumed related to the acquisition of PWSC on October 12, 2017. As a result, the Company recorded a decrease to goodwill of $6.2 million related to the acquisition of PWSC from the amount recorded at December 31, 2017.
Intangible assets at December 31, 2019 and December 31, 2018 are comprised as follows:
As further discussed in Note 4, "Acquisition," during the first quarter of 2019, the Company recorded $5.7 million of separately identifiable intangible assets, related to acquired customer relationships and trade names, as part of the acquisition of Geminus. The customer relationships intangible asset of $3.7 million is being amortized over ten years based on the pattern in which the economic benefits of the intangible asset are expected to be consumed. The trade name intangible assets of $2.0 million are deemed to have indefinite useful lives and are not amortized.
The tenant relationship and trade names intangible assets have indefinite useful lives and are not amortized. All intangible assets with indefinite useful lives are reviewed annually by the Company for impairment. No impairment charges were recorded in 2019 or 2018.
The vehicle service agreement liability is presented as components of deferred services fees and accrued expenses and other liabilities in the consolidated balance sheets as follows:
The results of this comparison and the changes in the provision for unpaid loss and loss adjustment expenses, net of amounts recoverable from reinsurers, as of December 31, 2019 and December 31, 2018, were as follows:
The following tables contain information about incurred and paid loss and loss adjustment expenses development as of and for the year December 31, 2019, net of reinsurance, as well as cumulative claim frequency and the total of IBNR liabilities, including expected development on reported unpaid loss and loss adjustment expenses included within the net incurred losses and allocated loss adjustment expenses amounts. The information about incurred and paid loss and loss adjustment expenses development for the years ended December 31, 2010 through 2018, and the average annual percentage payout of incurred claims by age as of December 31, 2019, is presented as supplementary information.
The following table reconciles the unpaid loss and allocated loss adjustment expenses, net of reinsurance presented in the tables above to the unpaid loss and loss adjustment expenses reported in the consolidated balance sheets at December 31, 2019 and December 31, 2018:
As part of the acquisition of Geminus on March 1, 2019, the Company formed KWH and contributed IWS and Trinity to KWH, which then borrowed a principal amount of $10.0 million from a bank at an annual interest rate equal to LIBOR, having a floor of 2.00%, plus 9.25% (the "KWH Loan"), using most of the proceeds to acquire Geminus. The KWH Loan matures on March 1, 2024. As part of the KWH Loan, KWH also issued warrants (the "KWH Warrants") to the lender exercisable to purchase an aggregate 1.25% membership interest in KWH. The Company allocated $0.4 million of the KWH loan proceeds to a liability, recorded as part of accrued expenses and other liabilities in the consolidated balance sheets, to reflect the estimated fair value of the KWH Warrants, as the warrants contain a put right exercisable by the holder. Changes in the estimated fair value of the KWH Warrants are recorded in the consolidated statements of operations. The Company also recorded as a discount to the carrying value of the KWH Loan issuance costs of $1.0 million specifically related to the KWH Loan. The KWH Loan is carried in the consolidated balance sheets at its amortized cost, which reflects the quarterly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. The fair value of the KWH Loan disclosed in the table above is derived from quoted market prices of B and BB minus rated industrial bonds with similar maturities. The KWH Loan is secured by certain of the equity interests and assets of KWH and its subsidiaries.
The KWH Loan contains a number of covenants, including, but not limited to, minimum adjusted EBITDA, a leverage ratio and fixed charge ratio, all of which are as defined in and calculated pursuant to the KWH Loan that, among other things, restrict the Company’s ability to incur additional indebtedness, create liens, make dividends and distributions, engage in mergers, acquisitions and consolidations, make certain payments and investments and dispose of certain assets.
On January 5, 2015, Flower assumed a $9.2 million mortgage in conjunction with the purchase of investment real estate properties, which is recorded as note payable in the consolidated balance sheets ("the Flower Note"). The Flower Note requires monthly payments of principal and interest and is secured by certain investments of Flower. The Flower Note matures on December 10, 2031 and has a fixed interest rate of 4.81%. The carrying value of the Flower Note at December 31, 2019 of $7.3 million represents its unpaid principal balance. The fair value of the Flower Note disclosed in the table above is derived from quoted market prices of A and BBB plus rated industrial bonds with similar maturities.
On October 15, 2015, Net Lease assumed a $9.0 million mezzanine debt in conjunction with the purchase of investment real estate properties, which is recorded as note payable in the consolidated balance sheets ("the Net Lease Note"). The Net Lease Note requires monthly payments of interest and is secured by certain investments of Net Lease. The Net Lease Note matures on November 1, 2020 and has a fixed interest rate of 10.25%. The carrying value of the Net Lease Note at December 31, 2019 of $9.0 million represents its unpaid principal balance. The fair value of the Net Lease Note disclosed in the table above is derived from quoted market prices of B and B minus rated industrial bonds with similar maturities.
The subordinated debt is carried in the consolidated balance sheets at fair value. See Note 27, "Fair Value of Financial Instruments," for further discussion of the subordinated debt. The portion of the change in fair value of subordinated debt related to the instrument-specific credit risk is recognized in other comprehensive (loss) income. Of the $4.6 million increase in fair value of the Company’s subordinated debt between December 31, 2018 and December 31, 2019, $5.7 million is reported as increase in fair value of debt attributable to instrument-specific credit risk in the Company's consolidated statements of comprehensive loss, partially offset by $1.1 million reported as gain on change in fair value of debt in the Company’s consolidated statements of operations. Of the $2.1 million decrease in fair value of the Company’s subordinated debt between December 31, 2017 and December 31, 2018, $3.8 million is reported as decrease in fair value of debt attributable to instrument-specific credit risk in the Company's consolidated statements of comprehensive loss, partially offset by $1.7 million is reported as loss on change in fair value of debt in the Company’s consolidated statements of operations.
Financial Statement Impact of Adopting Accounting Standards Update No. 2016-02 "Leases (Topic 842)" ("ASU 2016-02" or "ASC 842")
The guidance requires lessees to recognize right-of-use assets and lease liabilities in the balance sheet and disclose key information about leasing arrangements, such as information about variable lease payments and options to renew and terminate leases. The amended guidance will require both operating and finance leases to be recognized in the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset ("ROU") representing its right to use the underlying asset for the lease term.
The main difference between the guidance in ASU 2016-02 and prior guidance for lessees is the recognition of right-of-use assets and lease liabilities for those leases classified as operating leases. Recognition of the right-of-use assets and liabilities had a material impact to the Company’s consolidated balance sheet upon adoption. However, since all its leases are operating leases under ASC 840 and the Company will carryforward the historical lease classification, the new standard did not have a material impact on the Company’s consolidated statements of operations, consolidated statements of shareholder’s equity, or consolidated statements of cash flows.
The adoption resulted in an increase of the ROU assets of approximately $2.7 million and lease liabilities of $2.9 million. The difference of $0.2 million relates to straight-line rent accruals and lease incentive liabilities that were reclassified to ROU assets for operating leases.
The Company determines lease classification at commencement date. Leases not classified as sales-type (lessor) or financing leases (lessor and lessee) are classified as operating leases. The primary accounting criteria the Company uses that results in operating lease classification are: (a) the lease does not transfer ownership of the underlying asset to the lessee by the end of the lease term, (b) the lease does not grant the lessee a purchase option that the lessee is reasonably certain to exercise, (c) using a seventy-five percent or more threshold, the lease term is not for a major part of the remaining economic life of the underlying asset, (d) using a ninety percent or more threshold, the present value of the sum of the lease payments and residual value guarantee from the lessee does not equal or substantially exceeds all of the fair value of the underlying asset.
The Company has operating leases for office space which include fixed base rent payments, as well as variable rent payments to reimburse the landlord for operating expenses and taxes. The Company’s variable lease payments do not depend on a published index or rate, and therefore, are expensed as incurred. The Company includes only fixed payments for lease components in the measurement of the right-of-use asset and lease liability. There are no residual value guarantees. The Company does not currently have leases that meet the finance lease classification as defined under ASC 842.
The Company treats contracts as a lease when the contract: (1) conveys the right to use a physically distinct asset for a period of time in exchange for consideration, (2) the Company directs the use of the asset and (3) the Company obtains substantially all the economic benefits of the asset. Right-of-use assets and lease liabilities are measured and recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. As the Company’s leases are office leases, the Company is unable to determine an implicit rate; therefore, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of future payments for those leases. The Company includes options to extend or terminate the lease in the measurement of the right-of-use asset and lease liability when it is reasonably certain that such options will be exercised. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.
The annual maturities of lease liabilities as of December 31, 2019 were as follows:
The weighted-average remaining lease term for our operating leases was 5.71 years as of December 31, 2019. The weighted average discount rate of our operating leases was 5.33% as of December 31, 2019. Cash paid for amounts included in the measurement of lease liabilities was $1.0 million for the year ended December 31, 2019.
The Company owns a parcel of real property consisting of approximately 192 acres located in the State of Texas (the "Real Property") that is subject to a long-term triple net lease agreement with an unrelated third-party. The lease provides for future rent escalations and renewal options. The initial lease term ends in May 2034. The lessee bears the cost of maintenance and property taxes. Rental income from operating leases is recognized on a straight-line basis, based on contractual lease terms with fixed and determinable increases over the non-cancellable term of the related lease when collectability is reasonably assured. Rental income includes amortization of below market lease liabilities of $0.1 million and $0.1 million for the years ended December 31, 2019 and December 31, 2018, respectively. The estimated aggregate future amortization of below market lease liabilities is $0.1 million for 2020, $0.1 million for 2021, $0.1 million for 2022, $0.1 million for 2023 and $0.1 million for 2024. Realization of the residual values of the assets under lease is dependent on the future ability to market the assets under prevailing market conditions. The lease is classified as an operating lease and the underlying leased assets are included in Property and Equipment (Note 13, "Property and Equipment").
Lease income related to operating leases for the years ended December 31, 2019 and December 31, 2018 was $13.4 million and $13.4 million, respectively.
The following table provides the net book value of operating lease property included in property and equipment in the consolidated balance sheets:
Revenue from contracts with customers relates to Extended Warranty segment service fee and commission income. Service fee and commission income represents vehicle service agreement fees, GAP commissions, maintenance support service fees, warranty product commissions, homebuilder warranty service fees and homebuilder warranty commissions based on terms of various agreements with credit unions, consumers, businesses and homebuilders. Customers either pay in full at the inception of a warranty contract or commission product sale, or on terms subject to the Company’s customary credit reviews.
IWS' vehicle service agreement fees include the fees collected to cover the costs of future automobile mechanical breakdown claims and the associated administration of those claims. Vehicle service agreement contract fees are earned over the duration of the vehicle service agreement contracts as the single performance obligation is satisfied.
PWSC’s homebuilder warranty commissions include commissions from the sale of warranty contracts for those builders who have requested and receive insurance backing of their warranty obligations. PWSC acts as an agent on behalf of the third-party insurance company that underwrites and guaranties these warranty contracts. Homebuilder warranty commissions are earned on the certification date, which is typically the date of the closing of the sale of the home to the buyer. The Company also earns fees to manage remediation or repair services related to claims on insurance-backed warranty obligations, which are earned when the claims are closed, and a profit-sharing bonus on eligible warranties, which is determined based on expected ultimate loss ratio targets and is earned at the time the profit-sharing bonus is received.
Receivables from contracts with customers are reported as service fee receivable, net in the consolidated balance sheets and at December 31, 2019 and December 31, 2018 were $3.4 million and $3.4 million, respectively.
The Company is subject to the provisions of the ASC 740-10, Income Taxes, which requires that the effect on deferred income tax assets and liabilities of a change in tax rates be recognized in the period the tax rate change was enacted. In December of 2017, the SEC staff issued Staff Accounting Bulletin 118 ("SAB 118"), which provided that companies that have not completed their accounting for the effects of the Tax Act but can determine a reasonable estimate of those effects should include a provisional amount based on their reasonable estimate in their financial statements.
Income tax (benefit) expense varies from the amount that would result by applying the applicable U.S. corporate income tax rate of 21% to loss from continuing operations before income tax (benefit) expense. The following table summarizes the differences:
In addition, not reflected in the table above, are net operating loss carryforwards of (i) $9.7 million relating to losses generated in separate U.S. tax return years, which losses will expire over various years through 2037 and (ii) $1.5 million, relating to operations in Barbados which losses will expire over various years through 2027.
A reconciliation of the beginning and ending unrecognized tax benefits, exclusive of interest and penalties, is as follows:
The amount of unrecognized tax benefits that, if recognized as of December 31, 2019 and December 31, 2018 would affect the Company's effective tax rate, was an expense of $0.3 million and $0.2 million, respectively.
As of December 31, 2019 and December 31, 2018, the Company carried a liability for unrecognized tax benefits of $1.4 million and $1.4 million, respectively, that is included in income taxes payable in the consolidated balance sheets. The Company classifies interest and penalty accruals, if any, related to unrecognized tax benefits as income tax expense. During the years ended December 31, 2019 and December 31, 2018, the Company recognized an expense for interest and penalties of $0.3 million and $0.2 million, respectively. At December 31, 2019 and December 31, 2018, the Company carried an accrual for the payment of interest and penalties of $1.3 million and $1.1 million, respectively, that is included in income taxes payable in the consolidated balance sheets.
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 reserved for issuance to key employees selected by the Company new stock options ("New Stock Options") to purchase up to an additional 300,000 common shares. No New Stock Options were granted during the year ended December 31, 2019. There are no New Stock Options remaining for future grants.
The following table summarizes the stock option activity during the year ended December 31, 2019:
The Company uses the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. No options were granted during the years ended December 31, 2019 and December 31, 2018.
On September 5, 2018, the Company executed an Amended and Restated Restricted Stock Award Agreement ("Amended RSA Agreement") with its former Chief Executive Officer. Under the terms of the Amended RSA Agreement, the former Chief Executive Officer was deemed to have forfeited 1,382,665 shares of the 2014 Restricted Stock Awards. The Company’s accounting policy is to account for forfeitures when they occur. As a result, the Company reversed during the third quarter of 2018 $2.4 million of compensation expense previously recognized from March 28, 2014 through June 30, 2018.
During the fourth quarter of 2019, the Company recorded $0.6 million of compensation expense equal to the fair value of the remaining 247,450 fully vested shares of the 2018 Modified Restricted Stock Award. The grant-date fair value of the 2018 Modified Restricted Stock Award was determined using the closing price of Kingsway common stock on the modification date. Total unamortized compensation expense related to the unvested 2018 Modified Restricted Stock Award at December 31, 2019 was zero.
On September 15, 2018, the Company executed an Employee Separation Agreement and Release ("Separation Agreement") with a former officer. Under the terms of the Separation Agreement, the former officer forfeited 112,500 shares of the 2014 Restricted Stock Awards. The Company’s accounting policy is to account for forfeitures when they occur. As a result, the Company reversed during the third quarter of 2018 $0.4 million of compensation expense previously recognized from March 28, 2014 through June 30, 2018.
The Company also recorded during the third quarter of 2018 $0.2 million of compensation expense equal to the fair value of the remaining 79,538 fully vested shares of the Modified Restricted Stock Award. The grant-date fair value of the Modified Restricted Stock Award was determined using the closing price of Kingsway common stock on the modification date.
to the vesting terms. The 2018 Restricted Stock Award shall become fully vested and the restriction period shall lapse as of March 28, 2024 subject to the officer's continued employment through the vesting date. The 2018 Restricted Stock Award is amortized on a straight-line basis over the requisite service period. The grant-date fair value of the 2018 Restricted Stock Award was determined using the closing price of Kingsway common stock on the date of grant. Total unamortized compensation expense related to unvested 2018 Restricted Stock Award at December 31, 2019 was $1.6 million.
PWSC granted 1,000 restricted common stock awards ("PWSC Restricted Stock Award") to an officer of PWSC pursuant to an agreement dated September 7, 2018. The PWSC Restricted Stock Award contains both a service and a performance condition that affects vesting. The service condition vests according to a graded vesting schedule and shall become fully vested on February 20, 2022 subject to the officer's continued employment through the applicable vesting dates. The service condition component of the PWSC Restricted Stock Award is amortized on a straight-line basis over the requisite service period. The performance condition vests on February 20, 2022 and is based on the internal rate of return of PWSC. Accruals of compensation expense for the performance condition component of the PWSC Restricted Stock Award is estimated based on the probable outcome of the performance condition. At December 31, 2019, the Company determined that the performance condition component is not probable of being achieved. As a result, no compensation expense has been recorded related to the performance condition component through December 31, 2019. The grant-date fair value of the PWSC Restricted Stock Award was estimated using a valuation model. At December 31, 2019, there were 875 unvested shares of the PWSC Restricted Stock Award with a weighted-average grant date fair value of $824.47 per share. Total unamortized compensation expense related to unvested PWSC Restricted Stock Award at December 31, 2019 was $0.6 million.
There were 222,876 shares of Preferred Shares outstanding at December 31, 2019 and December 31, 2018. 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. As of December 31, 2019, the maximum number of common shares issuable upon conversion of the Preferred Shares is 1,392,975 common shares.
During the first quarter of 2020, 40,000 Preferred Shares were converted into 250,000 common shares at the conversion price of $4.00 per common share, or $1.0 million, at the option of the holder. As of March 31, 2020, there are 182,876 shares of the Company’s Preferred Shares, issued and outstanding. As of March 31, 2020, the maximum number of common shares issuable upon conversion of the Preferred Shares is 1,142,975 common shares.
The Preferred Shares are not entitled to vote. The holders of the Preferred Shares are entitled to receive fixed, cumulative, preferential cash dividends at a rate of $1.25 per Preferred Share per year. The cash dividend rate shall be revised to $1.875 per Preferred Share per year if the dividend accumulates for a period greater than 30 consecutive months from the date of the most recent dividend payment. On and after February 3, 2016, the Company may redeem all or any part of the then outstanding Preferred Shares for the price of $28.75 per Preferred Share, plus accrued but unpaid dividends thereon, whether or not declared, up to and including the date specified for redemption. The Company will redeem any Preferred Shares not previously converted into common shares, and which remain outstanding on April 1, 2021, for the price of $25.00 per Preferred Share, plus accrued but unpaid dividends, whether or not declared, up to and including the date specified for redemption. At December 31, 2019 and December 31, 2018, accrued dividends of $2.1 million and $1.7 million were included in Class A preferred stock in the consolidated balance sheets. The redemption amount of the Preferred Shares as if they were currently redeemable was $7.7 million and $7.3 million at December 31, 2019 and December 31, 2018, respectively.
As further described in Note 28, "Related Parties," on October 31, 2019, the Company executed an agreement to acquire the remaining 247,450 shares of the 2018 Modified Restricted Stock Award as partial consideration in exchange for selling its remaining investment in the common stock of ICL. The Company records treasury stock at cost. There were 247,450 and zero shares of treasury stock outstanding at December 31, 2019 and December 31, 2018, respectively.
The Company has warrants outstanding, recorded in shareholders' equity, that will entitle each subscriber to purchase one common share of Kingsway for each warrant. The following table summarizes information about warrants outstanding at December 31, 2019:
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, 2019 and December 31, 2018 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) income, net of tax, only for the years ended December 31, 2019 and December 31, 2018 and inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
Components of accumulated other comprehensive income were reclassified to the following lines of the consolidated statements of operations for the years ended December 31, 2019 and December 31, 2018:
The Company previously conducted its business through a third reportable segment, Insurance Underwriting. Insurance Underwriting included the following subsidiaries of the Company: Mendota, Amigo and Kingsway Re. As further discussed in
Extended Warranty includes the following subsidiaries of the Company: IWS, Trinity, PWSC and Geminus (collectively, "Extended Warranty").
Revenues by reportable segment reconciled to consolidated revenues for the years ended December 31, 2019 and December 31, 2018 were:
Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best evidenced by quoted bid or ask price, as appropriate, in an active market. Where bid or ask prices are not available, such as in an illiquid or inactive market, the closing price of the most recent transaction of that instrument subject to appropriate adjustments as required is used. Where quoted market prices are not available, the quoted prices of similar financial instruments or valuation models with observable market-based inputs are used to estimate the fair value. These valuation models may use multiple observable market inputs, including observable interest rates, foreign exchange rates, index levels, credit spreads, equity prices, counterparty credit quality, corresponding market volatility levels and option volatilities. Minimal management judgment is required for fair values calculated using quoted market prices or observable market inputs for models. Greater subjectivity is required when making valuation adjustments for financial instruments in inactive markets or when using models where observable parameters do not exist. Also, the calculation of estimated fair value is based on market conditions at a specific point in time and may not be reflective of future fair values. For the Company's financial instruments carried at cost or amortized cost, the book value is not adjusted to reflect increases or decreases in fair value due to market fluctuations, including those due to interest rate changes, as it is the Company's intention to hold them until there is a recovery of fair value, which may be to maturity.
The Company engages a third-party vendor who utilizes third-party pricing sources and primarily employs a market approach to determine the fair values of our fixed maturities. The market approach includes primarily obtaining prices from independent third-party pricing services as well as, to a lesser extent, quotes from broker-dealers. Our third-party vendor also monitors market indicators, as well as industry and economic events, to ensure pricing is appropriate. All classes of our fixed maturities are valued using this technique. The Company has obtained an understanding of our third-party vendor’s valuation methodologies and inputs. Fair values obtained from our third-party vendor are not adjusted by the Company.
Limited liability investments, at fair value - Limited liability investments, at fair value include the Company's investment in 1347 Investors as well as the underlying investments of Net Lease and Argo Holdings. 1347 Investors owns common stock in Limbach Holdings, Inc., a publicly traded company. During the fourth quarter of 2019, the Company’s investment in 1347 Investors was dissolved. See Note 28, "Related Parties," for further discussion. Net Lease owns investments in limited liability companies that hold investment properties. Argo Holdings makes investments in limited liability companies and limited partnerships that hold investments in search funds and private operating companies.
The fair value of the Company's investment in 1347 Investors through the date of dissolution and distribution of the investment in Limbach Holdings Inc. was calculated based on a model that distributes the net equity of 1347 Investors to all classes of membership interests. The model uses quoted market prices and significant market observable inputs. This investment is categorized in Level 2 of the fair value hierarchy.
The fair value of Argo Holdings' limited liability investments that hold investments in search funds is based on the initial investment in the search funds. The fair value of Argo Holdings' limited liability investments that hold investments in private operating companies is valued using a market approach including valuation multiples applied to corresponding performance metrics, such as earnings before interest, tax, depreciation and amortization; revenue; or net earnings. The selected valuation multiples were estimated using multiples provided by the investees and review of those multiples in light of investor updates, performance reports, financial statements and other relevant information. These investments are categorized in Level 3 of the fair value hierarchy.
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for the Company's investments that are categorized as Level 3 at December 31, 2019 :
All transfers are recognized by the Company at the beginning of each reporting period. Transfers between Levels 2 and 3 generally relate to whether significant unobservable inputs are used for the fair value measurements. There were no transfers between levels in 2019 or 2018.
On February 11, 2014, the Company's subsidiary, 1347 Advisors, entered into a management services agreement 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 management services agreement. Pursuant to the transaction, 1347 Advisors received the following consideration: $2.0 million in cash; $3.0 million of 8% preferred stock of PIH, mandatorily redeemable on February 24, 2020; 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 on February 24, 2022.
On March 26, 2014, the Company entered into a Performance Share Grant Agreement with PIH, whereby the Company will be entitled to receive up to an aggregate of 375,000 shares of PIH common stock upon achievement of certain milestones for PIH’s stock price. Pursuant to the terms of the Performance Share Grant Agreement, if at any time the last sales price of PIH’s common stock equals or exceeds: (i) $12.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive 125,000 shares of PIH common stock; (ii) $15.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading
days within any 30-trading day period, the Company will receive 125,000 shares of PIH common stock (in addition to the 125,000 shares of common stock earned pursuant to clause (i) herein); and (iii) $18.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive 125,000 shares of PIH common stock (in addition to the 250,000 shares of common stock earned pursuant to clauses (i) and (ii) herein).
At December 31, 2018, investment in investee includes the Company's investment in the common stock of ICL, a publicly traded Canadian corporation, and is accounted for under the equity method. The Company owned zero and 22.9% of the common shares of ICL at December 31, 2019 and December 31, 2018, respectively.
On October 25, 2017, the Company executed an agreement to sell 900,000 shares of PIH common stock, at a price of $7.85 per share, to FGI in two separate transactions for cash proceeds totaling $7.1 million. On November 1, 2017, the Company sold 475,428 of the 900,000 shares of PIH common stock to FGI for cash proceeds totaling $3.7 million. The second transaction, for the sale of the remaining 424,572 shares of PIH common stock for cash proceeds totaling $3.4 million, closed on March 15, 2018 following FGI having obtained the necessary regulatory approvals.
IIS is a Bermuda corporation, formed in October 2017, organized to offer collateralized reinsurance in the property catastrophe market through its wholly owned operating subsidiary IIS Re Ltd. The Company held 100% of the outstanding common stock of IIS at December 31, 2019 and December 31, 2018. The Company did not invest any capital against the common shares and has not invested any capital in IIS via any other security of IIS. The Company also does not have any commitment to provide capital to IIS. See Note 6, "Variable Interest Entities," for further discussion of IIS. Swets has served as the Chairman of the Board of Directors of IIS since its formation. Swets also served as the Company’s Chief Executive Officer from July 1, 2010 until September 5, 2018 and served on the Company’s Board of Directors from September 16, 2013 through December 21, 2018.
September 5, 2018, the Company sold its investment in IGI to IGI Partners LLC for $1.5 million. Swets is a member of IGI Partners LLC.
Logistics Leasing ("Logistics") was formed on July 26, 2017 for the purpose of acquiring and leasing small vehicles. The members of Logistics entered into an operating agreement under which the Company acquired a 50% membership interest in Logistics. The Company designates one of the two managers of Logistics. Major Decisions, as defined in the operating agreement, require the approval of members holding at least 51% of the membership interest. The Company designated Swets as a manager. Swets also served as the Company’s Chief Executive Officer from July 1, 2010 until September 5, 2018 and served on the Company’s Board of Directors from September 16, 2013 through December 21, 2018. During the first quarter of 2019, the Company impaired its investment in Logistics.
ICL owned 100% and 47.6% of the membership units at December 31, 2019 and December 31, 2018, respectively. Ballantyne owned 49.9% and 40.6% of the common shares of ICL at December 31, 2019 and December 31, 2018, respectively.
Swets and Cerminara are the named managers of 1347 Investors. All acts of the managers must be unanimous. Cerminara has served as the Chief Executive Officer of Ballantyne since November 2015 and as Chairman of the Board of Ballantyne since May 2015. Cerminara was appointed to the ICL Board of Directors on June 13, 2016 and became Chairman of the Board of Directors of ICL on June 4, 2018. Since April 2012, Cerminara has also served as the Chief Executive Officer of FGI. During 2018, FGI was a shareholder known by the Company to be a beneficial owner of more than 5% of the Company’s outstanding common shares.
The Notes have been amended three times since their issuance, generally to extend payments of principal while also requiring progress payments that were not part of the original Notes. No principal has been waived, and interest continues to accrue on unpaid principal. The remaining principal amount outstanding on the Notes was $0.6 million as of December 31, 2019. The Company has concluded there are no indications the Debtors were experiencing financial difficulties at the time of the amendments, and the Company expects to collect all amounts due. The Debtors are current with the amended terms of the Notes. As a result, the Company has concluded the Notes are not impaired.
In May 2016, Aegis Security Insurance Company ("Aegis") filed a complaint for breach of contract and declaratory relief against the Company in the Eastern District of Pennsylvania alleging, among other things, that the Company breached a contractual obligation to indemnify Aegis for certain customs bond losses incurred by Aegis under the indemnity and hold harmless agreements provided by the Company to Aegis for certain customs bonds reinsured by Lincoln General Insurance Company ("Lincoln General") during the period of time that Lincoln General was a subsidiary of the Company. Lincoln General was placed into liquidation in November 2015 and Aegis subsequently invoked its rights to indemnity under the indemnity and hold harmless agreements. Effective January 20, 2020, Aegis and the Company entered into a Settlement Agreement with respect to such litigation pursuant to which the Company agreed to pay Aegis a one-time settlement amount of $0.9 million, which the Company will report in its consolidated statement of operations for the three months ended March 31, 2020, and to reimburse Aegis for 60% of future losses that Aegis may sustain in connection with such customs bonds, up to a maximum reimbursement amount of $4.8 million. The Company’s potential exposure under these agreements was not reasonably determinable at December 31, 2019, and no liability has been recorded in the consolidated financial statements at December 31, 2019.
The Company has entered into subscription agreements to commit up to $2.6 million of capital to allow for participation in limited liability investments. At December 31, 2019, the unfunded commitment was zero.
Amigo is required to report results of operations and financial position to insurance regulatory authorities based upon statutory accounting practices. In converting from statutory to U.S. GAAP, typical adjustments include the inclusion of statutory non-admitted assets in the balance sheets and the inclusion of changes in deferred tax assets and liabilities in net loss.
In March 2020, the outbreak of COVID-19 caused by a novel strain of the coronavirus was recognized as a pandemic by the World Health Organization, and the outbreak has become increasingly widespread in the United States, including in the markets in which we operate. The COVID-19 outbreak has had a notable impact on general economic conditions, including but not limited to the temporary closures of many businesses; "shelter in place" and other governmental regulations; and reduced consumer spending due to both job losses and other effects attributable to COVID-19. The near-term impacts of COVID-19 are primarily with respect to the Company’s Extended Warranty segment. As consumer spending has been impacted, including a decline in the purchase of new and used vehicles, and many businesses through which the Company distributes its products remain closed, the Company has seen cash flows being affected by a reduction in new warranty sales for vehicle service agreements. With respect to homeowner warranties, the Company has seen a reduction in new enrollments in its home warranty programs associated with the impact of COVID-19 on new home sales in the United States. There remain many unknowns and the Company continues to monitor the expected trends and related demand for its services and has and will continue to adjust its operations accordingly.