We are leasing three additional office spaces. The St. Louis, Missouri lease is 4,375 square feet of office space and effective through June 2021. We currently pay a monthly rent equal to approximately $10,000. The Manhattan, New York lease is 1,796 square feet of office space and effective through February 2018. We currently pay a monthly rent equal to approximately $6,000. Upon completion of the Anchor acquisition, we assumed a lease for 25,396 square feet of office space in Melville, New York, which is effective through February 2022. We currently pay a monthly rent equal to approximately $60,000.
For 2015 and 2014, we reclassified our presentation for costs related to acquisition and stock purchase agreements from non-operating expenses to other underwriting expenses. The reclassification increased the combined ratio by 1.2% and 0.7% for the years ended December 31, 2015 and 2014, respectively.
These results include the acquisitions of Gateway on January 2, 2013 and Anchor on March 11, 2015, which will affect the comparability of the data. See Note 3, 'Acquisitions,' to the Consolidated Financial Statements for further discussion of the impact of these acquisitions.
Over the past six years, we have disposed of non-core assets, consolidated infrastructure and placed into run-off certain non-core lines of business previously written by the Insurance Subsidiaries. Our focus going forward is the underwriting of commercial automobile insurance in the U.S. Substantially all of our new premiums written are in “light” commercial automobile lines of business.
Our primary target market is made up of small to mid-size taxi, limousine, other livery (including certain "TNC" drivers/operators) and non-emergency para-transit operators. The “light” commercial automobile policies we underwrite provide coverage for lightweight commercial vehicles typically with the minimum limits prescribed by statute, municipal or other regulatory requirements. The majority of our policyholders are individual owners or small fleet operators. In certain jurisdictions like Illinois, Louisiana, Nevada and New York, we have also been successful working with larger operators who retain a meaningful amount of their own risk of loss through higher retentions, self-insurance or self-funded captive insurance entity arrangements. In these cases, we provide support in the areas of day to day policy administration and claims handling consistent with the value proposition we offer to all of our insureds, generally on a fee for service basis. We may also provide excess coverage above the levels of risk retained by the insureds where a better than average loss ratio is expected. Through these arrangements, we are able to effectively utilize the significant specialized operating infrastructure we maintain to generate revenue from business segments that may otherwise be more price sensitive in the current market environment.
We believe that there is a positive correlation between the economy and commercial automobile insurance in general. Operators of “light” commercial automobiles may be less likely than other business segments within the commercial automobile insurance market to take vehicles out of service, as their businesses and business reputations rely heavily on availability. With respect to certain business lines such as the taxi line, there are also other factors such as the cost and limited supply of medallions, which may discourage a policyholder from taking vehicles out of service in the face of reduced demand for the use of the vehicle. The significant expansion of transportation network companies ("TNC") has resulted in a reduction in taxi vehicles available to insure; however, we believe that the aforementioned factor relating to medallion values has mitigated the overall decline. Market research also suggests that the combined addressable markets between traditional taxi, livery and TNC companies expanded during this period.
Our surety program primarily consists of U.S. Customs bonds (currently in run off). We engage a former affiliate, Avalon Risk Management, to help coordinate customer service and claims handling for the surety bonds written. This non-core program is 100% reinsured to an unrelated third party. For 2016, all policies were not renewed.
The other line of business is comprised of Gateway's truck and workers' compensation programs (currently in run off), American Services' non-standard personal lines business (currently in run off), Atlas' workers' compensation related to taxi, other liability, Global Liberty's homeowners program (currently in run off) and assigned risk pool business.
The non-renewal process for Global Liberty's homeowners program began prior to Atlas' acquisition and remains underway. This book of business is relatively small and substantially reinsured.
Atlas' workers' compensation related to taxi and other liability are ancillary products that are offered only to insureds who purchase our commercial automobile insurance products.
A brief summary of each of these critical accounting estimates follows. For a more detailed discussion of the effect of these estimates on our consolidated financial statements, and the judgments and assumptions related to these estimates, see the referenced sections of this document. For a complete summary of our significant accounting policies, see Note 1, 'Nature of Operations,' to the Consolidated Financial Statements.
Fair values of financial instruments - Atlas has used the following methods and assumptions in estimating fair value:
the debt service pattern of non-investment grade securities may not reflect future debt service capabilities and may not reflect a company’s unknown underlying financial problems.
Under U.S. GAAP, with respect to an investment in an impaired debt security, other-than-temporary impairment ("OTTI") occurs if (a) there is intent to sell the debt security, (b) it is more likely than not it will be required to sell the debt security before its anticipated recovery, or (c) it is probable that all amounts due will be unable to be collected such that the entire cost basis of the security will not be recovered. If Atlas intends to sell the debt security, or will more likely than not be required to sell the debt security before the anticipated recovery, a loss in the entire amount of the impairment is reflected in net realized gains (losses) on investments in the consolidated statements of income and comprehensive income. If Atlas determines that it is probable it will be unable to collect all amounts and Atlas has no intent to sell the debt security, a credit loss is recognized in net realized gains (losses) on investments in the consolidated statements of income and comprehensive income to the extent that the fair value is less than the amortized cost basis; any difference between fair value and the new amortized cost basis (net of the credit loss) is reflected in accumulated other comprehensive income (losses), net of applicable income taxes.
For equity securities, the Company evaluates its ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Evidence considered to determine anticipated recovery are analysts' reports on the near-term prospects of the issuer and the financial condition of the issuer or the industry, in addition to the length and extent of the market value decline. If an OTTI is identified, the equity security is adjusted to fair value through a charge to earnings. Refer to Note 5, 'Investments' to the Consolidated Financial Statements for further discussion of the other-than-temporary impairment on equity securities.
Reinsurance - As part of Atlas' insurance risk management policies, portions of its insurance risk is ceded to reinsurers. Reinsurance premiums and claims adjustment expenses are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums and claims and claims adjustment expenses ceded to other companies have been reported as a reduction of premium revenue and incurred claims. Commissions paid to Atlas by reinsurers on business ceded have been accounted for as a reduction of the related policy acquisition costs. Reinsurance recoverables are recorded for that portion of paid and unpaid claims and claims adjustment expenses that are ceded to other companies. Prepaid reinsurance premiums are recorded for unearned premiums that have been ceded to other companies.
2016 Full Year Financial Performance Summary (comparisons to 2015 unless otherwise noted):
In-force premium as of December 31, 2016 was $224.6 million, compared to $210.6 million as of December 31, 2015
There was an underwriting loss of $5.0 million, compared to underwriting income of $18.0 million, primarily due to $32.6 million of claims reserve strengthening related to prior accident years
The following financial data is derived from Atlas’ consolidated financial statements for the years ended December 31, 2016, December 31, 2015, and December 31, 2014. Ratios are calculated as a percentage of net premium earned.
2 - For 2015, we restated our presentation for amortization of loan costs from other underwriting expense to interest expense in accordance with the Company's adoption of Accounting Standards Update 2015-03. As a result, other underwriting expense and total underwriting expense decreased and income from operating activities, before tax and interest expense increased by $56,000. This restatement had a negligible impact on the other underwriting expense ratio, the total underwriting expense ratio and the combined ratio for the year ended December 31, 2015.
For the year ended December 31, 2016, gross premium written was $225.1 million compared to $209.3 million for the year ended December 31, 2015, representing a 7.6% increase. This increase primarily resulted from growth in livery/limousine and para-transit gross premiums written of approximately $41.1 million offset by a $25.6 million decrease in taxi gross premiums written. The growth in livery/limousine and para-transit gross premiums written resulted from having a full year's worth of Global Liberty premium for 2016 as compared to the 9-1/2 months we had in 2015, coupled with market share growth in those products. The decrease in taxi business included overall reduction in available vehicles to insure, a $4.3 million excess taxi account and a few larger fleet accounts that were not renewed during 2016 due to our disciplined underwriting practice.
For the year ended December 31, 2016, gross premium written from commercial automobile was $223.8 million, representing a 7.7% increase relative to the year ended December 31, 2015. This increase is attributable to Atlas' continued geographic expansion as a positive response from both new and existing agents and insureds to Atlas' value proposition. We wrote $75.8 million and $86.8 million of new gross premium written business for the years ended December 31, 2016 and 2015, respectively. Of these amounts, Global Liberty, our most recent acquisition, contributed $19.3 million and $20.6 million in new premiums written for the years ended December 31, 2016 and 2015, respectively. With respect to our traditional commercial automobile, which excludes excess taxi, gross premium written was $215.7 million, an increase of 10.4% versus the year ended December 31, 2015. As a percentage of the Insurance Subsidiaries’ overall book of business, commercial auto gross premium written represented 99.4% of gross, and 99.9% of net, premium written for the year ended December 31, 2016 compared to 99.3% and 99.4%, respectively, during the year ended December 31, 2015.
For 2015, Global Liberty had a 20% quota share reinsurance agreement with SCOR Reinsurance Company ("SCOR Re"). In 2016, this contract was replaced by a 25% quota share reinsurance agreement with Swiss Re for its commercial auto and general liability lines of business ("Global Quota Share").
Ceded premium written increased 13.7% to $45.0 million for the year ended December 31, 2016 compared with $39.6 million for the year ended December 31, 2015 primarily due to Atlas' participation in the Quota Share and Global Quota Share, product mix and overall gross premium growth. As our limousine and para-transit business grows, we expect ceded premium written to increase because, under the current market conditions, the reinsurance costs are more expensive for these products. Excluding the Quota Share and Global Quota Share, ceded premiums written were $13.4 million and $10.5 million for the years ended December 31, 2016 and 2015, respectively.
Net premium written is equal to gross premium written less the ceded premium written under the terms of Atlas’ in-force reinsurance treaties. Net premium written increased 6.1% to $180.1 million for the year ended December 31, 2016 compared with $169.7 million for the year ended December 31, 2015. These changes are attributed to the combined effects of the reasons cited in the ‘Gross Premium Written’ and ‘Ceded Premium Written’ sections above.
Atlas will only write its products in states where it believes the Company can generate an above average underwriting profit. Having taken actions to eliminate this exposure, the Company anticipates business in Michigan to be less than 1% of Atlas’ in-force business by the end of 2017.
As a specialist, Atlas puts a priority on addressing changes in our market in a nimble way. To this end, in recent years Atlas enhanced and initiated numerous underwriting and claim related processes designed to leverage our expertise in the specialty light commercial auto sector, including the elevated use of predictive analytics. We have proactively compressed settlement time, particularly with respect to larger claims, providing earlier visibility into potentially changing claim trends. It is important to acknowledge our entire claims team’s excellent work, including our Michigan adjusters who are diligently addressing the challenges in that market. Observations from the year-end 2016 reserve analysis that led to the conclusion that reserve strengthening for older years appears appropriate also confirm our belief that the changes made in our claim process may yield an overall better result in our ultimate loss costs going forward. The Company is committed to learn from the factors surrounding our reserve strengthening to ensure we can react to changes in our industry and niche as quickly as possible in the future.
Acquisition costs represent commissions and taxes incurred on net premium earned offset by ceding commission on business reinsured by the Quota Share and Global Quota Share. Acquisition costs were $18.8 million for the year ended December 31, 2016, or 11.0% of net premium earned, as compared to 12.2% for the year ended December 31, 2015. The decrease in the ratio is primarily due to the Quota Share's and Global Quota Share's ceding commissions. On a pro-forma basis, without the effect of the Quota Share and Global Quota Share, the acquisition costs would have been 15.1% for the year ended December 31, 2016, as compared to 14.7% for the year ended December 31, 2015.
Also, while the Quota Share and Global Quota Share provide a ceding commission to offset underwriting expense, this commission reduces acquisition costs rather than other underwriting expenses on the income statement. With this in mind, acquisition costs and other underwriting expenses should be examined collectively as total underwriting expenses to understand operating efficiency.
Atlas' combined ratio for the year ended December 31, 2016 was 102.9%, compared to 88.2% for the year ended December 31, 2015.
Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the combined ratio. The combined ratio is the sum of the claims and claims adjustment expense ratio, the acquisition cost ratio, and the underwriting expense ratio. The change in underwriting profitability is attributable to the factors described in the 'Net Premium Earned', ‘Net Claims Incurred’, ‘Acquisition Costs and Other Underwriting Expenses’ sections above.
Net investment income is primarily comprised of interest income, dividend income, and income from other invested assets, net of investment expenses, which are comprised of investment management fees, custodial fees, and allocated salaries. Net investment income, net of investment expenses, increased by 21.3% to $4.8 million for the year ended December 31, 2016, compared to $4.0 million for the year ended December 31, 2015. These amounts are primarily comprised of interest income. This increase was primarily due to the acquisition of Anchor and change in investment mix with higher yields. The gross yield on our fixed income securities was 2.2% for each of the years ended December 31, 2016 and 2015. The gross yield on our cash and cash equivalents was 0.1% for each of the years ended December 31, 2016 and 2015. For the year ended December 31, 2016, equity method investments and collateral loans generated investment income of $1.9 million, compared to investment income of $1.3 million for the year ended December 31, 2015. This increase is primarily due to interest income on our collateral loan investments.
Atlas recovered $6.3 million of expenses pursuant to the contingent adjustments of the Gateway and Anchor stock purchase agreements that included the redemption and cancellation of preferred shares for the year ended December 31, 2016. For the year ended December 31, 2015, Atlas recognized total expenses of $1.9 million related to the acquisition of Anchor and pursuant to the contingent adjustments relative to the Gateway stock purchase agreement. The Anchor costs of $999,000 were incurred to effect the business combination and included legal fees, advisory services, accounting fees, and internal general and administrative costs. The Gateway expense of $942,000 related to the terms of the Gateway stock purchase agreement and the issuance of preferred shares pursuant to the terms of such agreement.
Atlas had net income of $2.6 million for the year ended December 31, 2016 compared to $14.4 million for the year ended December 31, 2015. After taking the impact of the liquidation preference of the preferred shares into consideration, the earnings per common share diluted for the year ended December 31, 2016 was $0.19 versus earnings per common share diluted of $1.13 for the year ended December 31, 2015.
The following chart illustrates Atlas' potential dilutive common shares for the years ended December 31, 2016 and 2015:
For the year ended December 31, 2015, gross premium written was $209.3 million compared to $122.4 million for the year ended December 31, 2014, representing a 70.9% increase. Global Liberty accounted for $39.8 million or 45.6% of this increase of gross premium written. Total gross premium written related to the excess taxi program was $12.4 million and $13.0 million for the years ended December 31, 2015 and 2014, respectively, and is included in the "commercial automobile" line of business.
For the year ended December 31, 2015, gross premium written from commercial automobile was $207.8 million, representing a 73.8% increase relative to the year ended December 31, 2014. This substantial increase is primarily the result of the planned expansion of the commercial auto business. Excluding Global Liberty, we wrote $66.2 million and $44.8 million of new gross premium written business for the years ended December 31, 2015 and 2014, respectively. With respect to our traditional commercial automobile, which excludes excess taxi, gross premium written was $195.4 million, an increase of 83.4% versus the year ended December 31, 2014. As a percentage of the Insurance Subsidiaries’ overall book of business, commercial auto gross premium written represented 99.3% of gross, and 99.4% of net, premium written for the year ended December 31, 2015 compared to 97.6% and 99.6%, respectively, during the year ended December 31, 2014.
As illustrated by the table above, 29.3% of Atlas’ gross premium written for the year ended December 31, 2015 came from New York and 58.2% came from the five states currently producing the most premium volume, as compared to 55.8% for the year ended December 31, 2014. Our commitment to expanding geographically resulted in 29 states with more than $1 million in written premium in 2015 compared to 23 in 2014.
Net premium written is equal to gross premium written less the ceded premium written under the terms of Atlas’ in-force reinsurance treaties. Net premium written increased 52.3% to $169.7 million for the year ended December 31, 2015 compared with $111.4 million for the year ended December 31, 2014. These changes are attributed to the combined effects of the reasons cited in the ‘Gross Premium Written’ and ‘Ceded Premium Written’ sections above.
Acquisition costs represent commissions and taxes incurred on net premium earned offset by ceding commission on business reinsured by the Quota Share. Acquisition costs were $18.6 million for the year ended December 31, 2015, or 12.2% of net premium earned, as compared to 14.3% for the year ended December 31, 2014. On a pro-forma basis, without the effect of the Quota Share, the acquisition costs would have been 14.7% for the year ended December 31, 2015, as compared to 14.6% for the year ended December 31, 2014.
The other underwriting expense ratio (including share-based compensation expenses and expenses incurred related to acquisitions and stock purchase agreements) was 16.8% for the year ended December 31, 2015 compared to 14.8% for the year ended December 31, 2014. This increase in the ratio was primarily due the effects of the Quota Share. On a pro-forma basis, without the effect of the Quota Share, the other underwriting costs would have been 14.9% for the year ended December 31, 2015, as compared to 14.7% for the year ended December 31, 2014.
Atlas' combined ratio for the year ended December 31, 2015 was 88.2%, compared to 91.4% for the year ended December 31, 2014. The change in underwriting profitability is attributable to the factors described in the 'Net Premium Earned', ‘Net Claims Incurred’, ‘Acquisition Costs and Other Underwriting Expenses’ sections above.
1 - For 2015, we restated our presentation for amortization of loan costs from other underwriting expense to interest expense in accordance with the Company's adoption of Accounting Standards Update 2015-03. The restatement decreased other insurance general and administrative expense and increased the total underwriting profit by $56,000. The restatement had a negligible impact on the other insurance general and administrative expense ratio and the combined ratio for the year ended December 31, 2015. For 2015, we combined our presentation of amortization of intangible assets and other insurance general and administrative expenses.
For the year ended December 31, 2015, Atlas recognized total expenses of $1.9 million related to the acquisition of Anchor and pursuant to the contingent adjustments relative to the Gateway stock purchase agreement. The Anchor costs of $999,000 were incurred to effect the business combination and included legal fees, advisory services, accounting fees, and internal general and administrative costs. The Gateway expense of $942,000 related to the terms of the Gateway stock purchase agreement and the issuance of preferred shares pursuant to the terms of such agreement.
Atlas' net income was $14.4 million for the year ended December 31, 2015 versus net income of $17.7 million for the year ended December 31, 2014. After taking the impact of the liquidation preference of the preferred shares into consideration, the earnings per common share diluted for the year ended December 31, 2015 was $1.13 versus earnings per common share diluted of $1.56 for the year ended December 31, 2014.
The following chart illustrates Atlas' potential dilutive common shares for the years ended December 31, 2015 and 2014:
Atlas held securities with a fair value of $162.7 million as of December 31, 2016, which were primarily comprised of fixed income securities. The securities held by the Insurance Subsidiaries must comply with applicable regulations that prescribe the type, quality and concentration of securities. These regulations in the various jurisdictions in which the Insurance Subsidiaries are domiciled permit investments in government, state, municipal and corporate bonds, preferred and common equities, and other high quality investments, within specified limits and subject to certain qualifications.
Most of the Company’s holdings are impacted by the U.S economy, and we anticipate a very moderate impact from global economic conditions on the domestic economy. Global economic conditions may create brief periods of market volatility, but we do not believe it will alter the fundamental outlook of the Company’s investment holdings.
The following table summarizes investments in equity method investments by investment type as of December 31, 2016 and December 31, 2015:
As of December 31, 2016, 33.6% of the fixed income securities, including treasury bills, bankers’ acceptances, government bonds and corporate bonds had contractual maturities of five years or less, compared to 36.1% as of December 31, 2015. Actual maturities may differ from contractual maturities, because certain issuers have the right to call or prepay obligations with or without call or prepayment penalties. Atlas holds cash and high grade short-term assets, which, along with fixed income security maturities, management believes are sufficient for the payment of claims on a timely basis. In the event that additional cash is required to meet obligations to policyholders, Atlas believes that a high quality securities portfolio provides us with sufficient liquidity. As of December 31, 2016, the fixed income securities had a weighted average life of 4.1 years and a duration of 3.4 years, compared to a weighted average life of 4.1 years and a duration of 3.3 years as of December 31, 2015. Changes in interest rates may have a modest market value impact on the Atlas portfolio relative to longer duration portfolios. Atlas can and typically does hold bonds to maturity by matching duration with the anticipated liquidity needs.
The debt-to-equity ratio is the sum of the Company's long-term debt and interest payable divided by total shareholders' equity. The Company's debt-to-equity ratio as of December 31, 2016 and December 31, 2015 was 15.2% and 14.9%, respectively. The increase is primarily the result of the redemption and cancellation of preferred shares and additional draws on our line of credit with Fifth Third Bank. Refer to the 'Shareholders' Equity' and 'Liquidity and Capital Resources' subsections of the 'Financial Condition' section for further information.
As of December 31, 2016, Atlas' allowance for bad debt was $2.4 million, compared to $846,000 as of December 31, 2015. This increase in the allowance for bad debt was related to the re-estimation of the allowance and the reserving for specific premium receivable accounts past due.
1 - In 2016, our external investment portfolio manager switched rating agencies for U.S. Treasury, agency and mortgage backed securities from Fitch or Moody's 'AAA' to S&P 'AA.' As a result, we have restated fair values of these fixed income securities as of December 31, 2015 using the S&P rating for comparative purposes.
Estimating amounts of reinsurance recoverables is also impacted by the uncertainties involved in the establishment of provisions for unpaid claims and claims adjustment expenses. As underlying reserves potentially develop, the amounts ultimately recoverable may vary from amounts currently recorded. Atlas’ reinsurance recoverables are generally unsecured, with the exception of the new reinsurance agreement established as a condition to close the Gateway acquisition, which is secured by a letter of credit valued at 150% of the claims and claims adjustment expense reserves. Atlas regularly evaluates its reinsurers, and the respective amounts recoverable, and an allowance for uncollectible reinsurance is provided for, if needed.
Atlas’ largest reinsurance partners are Great American Insurance Company (“Great American”), a subsidiary of American Financial Group, Inc., General Reinsurance Corporation ("Gen Re"), a subsidiary of Berkshire Hathaway, Inc., SCOR Re, a subsidiary of SCOR U.S. Corporation, Swiss Re, a subsidiary of Swiss Reinsurance Company Ltd. and White Rock Insurance (SAC) Ltd. ("White Rock"). Great American has a financial strength rating of A1 from Moody's, Gen Re has a financial strength rating of AA+ from Standard & Poor's, SCOR Re has a financial strength rating of Aa3 from Moody's, Swiss Re has a financial strength rating of Aa3 from Moody's, and White Rock is unrated. The White Rock balances are specifically related to the Gateway workers' compensation program that was exited during 2013 and are fully secured by a letter of credit and funds held on deposit.
Based on Atlas’ expectations of future taxable income, its ability to change its investment strategy, as well as reversing gross future tax liabilities, management believes it is more likely than not that Atlas will fully realize the net future tax assets. The Company, therefore, released its remaining valuation allowance as of December 31, 2014.
On July 22, 2013, as a result of shareholder activity, a "triggering event" as determined under IRC Section 382 occurred. As a result, under IRC Section 382, the use of the Company's net operating loss and other carry-forwards will be limited as a result of this "ownership change” for tax purposes, which is defined as a cumulative change of more than 50% during any three-year period by shareholders owning 5% or greater portions of the Company's shares.
Due to this triggering event, the Company estimates that it will retain total tax effected federal net operating loss carryforwards of approximately $14.5 million as of December 31, 2016.
On November 13, 2015, Atlas sold one of its two properties located in Alabama and recognized a loss of $20,000. The remaining property is listed for sale for an amount greater than its carried value.
Atlas experienced $166,000 in unfavorable prior year development for the year ended December 31, 2015 as reflected as incurred related to prior years in the table above. Prior accident year development on non-core lines and assigned risk pools was $870,000 for the year ended December 31, 2015. This increase was offset by favorable prior accident year development of $475,000 and $230,000 on our core lines and pre-acquisition Global Liberty claims reserves, respectively. This favorable development on our core lines was attributable to our traditional taxi and excess taxi products.
The table below summarizes future payments under contractual obligations and estimated claims settlements for the year ended December 31, 2016:
Notes payable does not include the interest payments and non-utilization fees related to the balance outstanding as of December 31, 2016. The interest rate is variable based on the one-month LIBOR rate and non-utilization fees are variable based on the level of borrowing. The notes payable require interest-only payments until the principal is due. Refer to 'Liquidity and Capital Resource' section below for further discussion of the notes payable.
The operating leases do not include the future sublease income related to Atlas' New York lease due to the uncertain timing of the commencement of the sublease.
The table below identifies changes in shareholders’ equity for the years ended years ended December 31, 2016, 2015, and 2014:
As of March 10, 2017, there were 11,902,512 ordinary voting common shares outstanding and 128,191 restricted voting common shares outstanding.
The holders of restricted voting common shares are entitled to vote at all meetings of shareholders, except at meetings of holders of a specific class that are entitled to vote separately as a class. The restricted voting common shares as a class shall not carry more than 30% of the aggregate votes eligible to be voted at a general meeting of common shareholders. All of the issued and outstanding restricted voting common shares are beneficially owned or controlled by Kingsway Financial Services, Inc. (including its subsidiaries and affiliated companies, "Kingsway"). The restricted voting common shares will convert to ordinary voting common shares in the event that these Kingsway owned shares are sold to non-affiliates of Kingsway. During 2016, 4,672 restricted voting common shares were converted to ordinary voting common shares due to the sale by Kingsway of the shares to a non-affiliate.
The former owners of Gateway and Anchor earned $94,000 and $187,000, respectively, in dividends on the preferred shares during the year ended December 31, 2016. On September 30, 2016, Atlas paid $409,000 in dividends earned on the preferred shares to the former owner of Gateway, the cumulative amount to which they were entitled through September 15, 2016, leaving no accrued and unpaid dividends owed to the former owner of Gateway. The cumulative amount of accrued and unpaid dividends to the former owner of Anchor was $333,000 as of December 31, 2016. As of December 31, 2016, the paid claims development on Global Liberty's pre-acquisition reserves was in excess of $4.0 million, and as a result, pursuant to the terms of Anchor stock purchase agreement, dividends will no longer accrue to the former owner of Anchor. As of December 31, 2016, there were no preferred shares outstanding. Although the re-issuance of preferred shares to the former owner of Anchor may be highly unlikely, the contingent consideration terms of the Anchor stock purchase agreement will remain in effect for period of five years from the date of acquisition.
Book value per common share increased by $0.39 relative to December 31, 2015 as follows: a decrease of $0.38 related to net income after tax (excluding expenses recovered pursuant to stock purchase agreements), an increase of $0.07 related to realized investment gains after tax, an increase of $0.07 related to the change in unrealized gains/losses after tax, a net increase of $0.13 related to share-based compensation impacts, a $0.02 decrease related to preferred dividends and an increase of $0.52 related to expenses recovered pursuant to stock purchase agreements. The causes of these changes are attributed to the combined effects of the reasons cited in the 'Net Premium Earned', 'Net Claims Incurred', 'Acquisition Costs and Other Underwriting Expenses', 'Net Investment Income', 'Net Realized Investment Gains', and 'Other Income' subsections of the 'Operating Results' section.
The Loan Agreement requires American Acquisition to comply with customary affirmative and negative covenants, including those governing indebtedness, liens, investments, sales of assets, issuance of securities, and distributions. The Loan Agreement also requires American Acquisition to make mandatory prepayments under certain conditions and to comply with certain financial covenants, including the ASI Pool Subsidiaries maintaining a combined statutory net worth in an amount not less than $60 million (subject to adjustment) and maintaining a minimum funded debt to Earnings Before Interest, Taxes, Depreciation and Amortization ratio (the "EBITDA Ratio"). The Loan Agreement is secured by substantially all of the property of American Acquisition, including all of the outstanding shares of the ASI Pool Subsidiaries.
As of December 31, 2016, $3.9 million in funds were accessed from the Revolver, of which $2,000,000 was accessed during 2016, including a portion that was used to repurchase preferred shares from the former owner of Gateway while $100,000 was repaid during 2016. $15.5 million in funds were accessed against the Draw Amount as of December 31, 2016. All $15.5 million of the Draw Amount was accessed in 2015 and contributed to the ASI Pool Subsidiaries in exchange for surplus notes that carry a variable interest rate of prime plus 2% with a maturity date of April 30, 2020. No letters of credit were issued under the terms of this Loan
Agreement as of December 31, 2016. As of December 31, 2016, the unused funds for the Revolver and the Draw Amount were $1.1 million and $14.5 million, respectively. The unused funds for the Draw Amount can no longer be drawn.
Cash provided by operations during the years ended December 31, 2016, 2015, and 2014 was primarily as a result of net income. We receive most premiums in advance of the payment of claims. Our ability to generate positive operating cash flows depends on the frequency and severity of claims and the timing of collection of premiums receivable and reinsurance recoverables on paid claims.
We have audited Atlas Financial Holdings, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Atlas Financial Holdings, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
In our opinion, Atlas Financial Holdings, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial position of Atlas Financial Holdings, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016, and our report dated March 13, 2017 expressed an unqualified opinion thereon.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Atlas Financial Holdings, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 13, 2017 expressed an unqualified opinion thereon.
The Insurance Subsidiaries distribute their insurance products through a network of retail independent agents. Together, the Insurance Subsidiaries are licensed to write property and casualty insurance in 49 states and the District of Columbia in the United States. Atlas' core products are actively distributed in 42 of those states plus the District of Columbia. The Insurance Subsidiaries share common management and operating infrastructure.
Basis of presentation - These statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The consolidated financial statements include the accounts of Atlas and the entities it controls. Equity investments in entities that we do not consolidate, including corporate entities in which we have significant influence and partnership and partnership-like entities in which we have more than minor influence over operating and financial policies, are accounted for under the equity method unless we have elected the fair value option. All significant intercompany accounts and transactions have been eliminated.
Camelot Services, Inc. (Missouri) - merged into American Insurance Acquisition Inc. during the fourth quarter of 2014
Estimates and assumptions - The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates and changes in estimates are recorded in the accounting period in which they are determined. The liability for unpaid claims and claims adjustment expenses and related amounts recoverable from reinsurers represents the most significant estimate in the accompanying financial statements, such changes could be material. Significant estimates in the accompanying financial statements also include the fair values of investments, deferred policy acquisition cost recoverability, deferred tax asset valuation and business combinations.
Under Accounting Standards Codification ("ASC"), with respect to an investment in an impaired debt security, other-than-temporary impairment ("OTTI") occurs if (a) there is intent to sell the debt security, (b) it is more likely than not it will be required to sell the debt security before its anticipated recovery, or (c) it is probable that all amounts due will be unable to be collected such that the entire cost basis of the security will not be recovered. If Atlas intends to sell the debt security, or will more likely than not be required to sell the debt security before the anticipated recovery, a loss in the entire amount of the impairment is reflected in net investment gains (losses) on investments in the consolidated statements of income. If Atlas determines that it is probable it will be unable to collect all amounts and Atlas has no intent to sell the debt security, a credit loss is recognized in net investment gains (losses) on investments in the consolidated statements of income to the extent that the present value of expected cash flows is less than the amortized cost basis; any difference between fair value and the new amortized cost basis (net of the credit loss) is reflected in other comprehensive income (losses), net of applicable income taxes.
Atlas' fixed income portfolio is managed by a SEC registered investment advisor specializing in the management of insurance company portfolios. Management works directly with them to ensure that Atlas benefits from their expertise and also evaluates investments as well as specific positions independently using internal resources. Atlas' investment advisor has a team of credit analysts for all investment grade fixed income sectors. The investment process begins with an independent analyst review of each security's credit worthiness using both quantitative tools and qualitative review. At the issuer level, this includes reviews of past financial data, trends in financial stability, projections for the future, reliability of the management team in place, market data (credit spread, equity prices, trends in this data for the issuer and the issuer's industry). Reviews also consider industry trends and the macro-economic environment. This analysis is continuous, integrating new information as it becomes available. As of December 31, 2016, this process did not generate any significant difference in the rating assessment between Atlas' review and the rating agencies.
When anticipated claims, claims adjustment expenses, commissions and other acquisition costs exceed recorded unearned premium and any future installment premiums on existing policies, a premium deficiency reserve is recognized by recording a reduction to DPAC with a corresponding charge to operations. Atlas utilizes anticipated investment income as a factor in its premium deficiency calculation. Atlas concluded that no premium deficiency adjustments were necessary in any of the years ended December 31, 2016, 2015, and 2014.
When considering the extent of the valuation allowance on Atlas' deferred tax asset, weight is given by management to both positive and negative evidence. U.S. GAAP states that a cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome in determining that a valuation allowance is not needed against deferred tax assets. However, the strength and trend of earnings, as well as other relevant factors are considered.
Intangible assets - Atlas recognized intangible assets as part of the acquisitions of Gateway and Anchor Holdings Group, Inc. The intangible assets are classified as either indefinite-lived or definite-lived depending on whether the useful lives can be identified. Atlas indefinite-lived intangible assets consist of state insurance licenses, and these intangible assets are reviewed for impairment at least annually. Atlas concluded that there was no indefinite-lived intangible asset impairment in any of the years ended December 31, 2016, 2015, and 2014. Definite-lived intangible assets are amortized over their useful lives on a straight-line basis except for customer related intangibles, which are on an accelerated basis. Atlas definite-lived intangible assets consist of trade names and trademarks with useful lives of 15 years and customer relationships with useful lives of 10 years.
Insurance contracts - Contracts under which Atlas’ Insurance Subsidiaries accept risk at the inception of the contract from another party (the insured holder of the policy) by agreeing to compensate the policyholder or other insured beneficiary if a specified future event (the insured event) adversely affects the holder of the policy are classified as insurance contracts. All policies are short-duration contracts.
Revenue recognition - Premium income is recognized on a pro rata basis over the terms of the respective insurance contracts. Unearned premiums represent the portion of premiums written that are related to the unexpired terms of the policies in force.
Claims liabilities - The provision for unpaid claims represent the estimated liabilities for reported claims, plus those incurred but not yet reported and the related estimated claims adjustment expenses, such as legal fees. Unpaid claims adjustment expenses are determined using case-basis evaluations and statistical analyses, including insurance industry claims data, and represent estimates of the ultimate cost of all claims incurred. Although considerable variability is inherent in such estimates, management believes that the liability for unpaid claims and claims adjustment expenses is adequate. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations and are accounted for as changes in estimates.
Share-based compensation - Atlas has a share-based compensation plan that is described in Note 12, 'Share-Based Compensation,' to the Consolidated Financial Statements. Atlas uses the fair-value method of accounting to determine and account for equity settled transactions and to determine stock-based compensation for awards granted to employees and non-employees. For stock-based compensation for awards granted to employees and non-employees that include a performance provision, the Monte-Carlo simulation model is utilized to determine fair value. Stock-based compensation prior to 2015 was valued using the Black-Scholes option pricing model. Compensation expense is recognized over the period that the stock options vest, with a corresponding increase to additional paid in capital.
Pertinent Accounting Standard Updates ("ASUs") are issued from time to time by the Financial Accounting Standards Board ("FASB") and are adopted by the Company as they become effective. All recently issued accounting pronouncements with effective dates prior to January 1, 2017 have been adopted by the company.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718). The provisions of this update simplify certain areas around share-based compensation transactions including income taxes and cash flow classifications. Each amendment within this update has specific guidance on the method of application, which includes prospective, retrospective, and modified retrospective applications. For public entities, this guidance is effective for years beginning after December 15, 2016, including interim periods within those years. Early adoption is permitted. The Company plans on adopting the update on the required effective date. Atlas did not have any tax "windfall" net operating loss carryforwards as of January 1, 2017, therefore no cumulative effect adjustment is needed. All tax related cash flows will be included in the operating section of the Consolidated Statements of Cash Flows with other taxes retrospectively. Reclassifications will be made between the "Share-based compensation expense" and "Premiums receivable and other assets, net" lines of "Operating activities" for all prior periods. Atlas is making the election to estimate future forfeitures, which is consistent with current accounting treatment.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The provisions of this update impact the classification criteria, disclosure requirements, and other specific transactions in lease accounting. The update requires the use of a modified retrospective approach, which requires leases to be measured at the beginning of the earliest period presented. For public entities, this guidance is effective for years beginning after December 15, 2018, including interim periods within those years. Early adoption is permitted. The Company plans on adopting the update on the required effective date using the modified retrospective approach to restate beginning with the earliest period presented. See Note 8, 'Commitments and Contingencies,' to the Consolidated Financial Statements for further discussion of the future lease commitments. The adoption of this update is expected to increase both assets and liabilities, equally, on the Consolidated Statements of Financial Positions by the present value of the leases at each reporting date. There is no expected impact to any of Atlas' current financial covenants as a result of the increase to reported liabilities.
In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Topic 835-30): Simplifying the Presentation of Debt Issuance Costs. The new disclosures require debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. The amendments in this disclosure are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The Company adopted this new disclosure in the first quarter of 2016. See Note 20, 'Change in Accounting Principle,' to the Consolidated Financial Statements for further discussion.
All other recently issued pronouncements with effective dates after December 31, 2016 are not expected to have a material impact on the Consolidated Financial Statements.
Under the terms of the stock purchase agreement, the purchase price was based on the combined U.S. GAAP book value of Anchor as of December 31, 2014. The total purchase price for the combined entities of Anchor was $23.2 million, consisting of a combination of cash and Atlas preferred shares, and is estimated at approximately 1.3 times combined U.S. GAAP book value. Consideration consisted of approximately $19.2 million in cash and $4.0 million of Atlas preferred shares (consisting of a total of 4,000,000 preferred shares at $1.00 per preferred share), subject to the future development of Global Liberty’s actual claims reserves for certain lines of business during the five year period after the acquisition. During the fourth quarter of 2016, Atlas canceled all 4,000,000 of the preferred shares pursuant to the terms of the Anchor stock purchase agreement due to the adverse development of Global Liberty’s pre-acquisition claims reserves.
The Anchor acquisition was accounted for using the acquisition method. Atlas began consolidating Anchor on March 11, 2015, therefore their financial results are included in Atlas' consolidated financial results starting with the three month period ended March 31, 2015. However, the following unaudited pro forma summary presents Atlas' consolidated financial information for the years ended December 31, 2015 and 2014 as if Anchor had been acquired on January 1, 2014. These amounts have been calculated after applying the Company's accounting policies had the acquisition been completed on January 1, 2014. These results were prepared for comparative purposes only and do not purport to be indicative of the results of operations that may have actually resulted had the acquisition occurred on the indicated dates, nor are they indicative of potential future operating results of the Company.
The value of certain assets and liabilities acquired are subject to adjustment as additional information is obtained, including, but not limited to, valuation of separately identifiable intangibles, the preferred stock issued to the seller, and deferred taxes. The valuations were finalized during the year ended December 31, 2015 (not including claims reserve development consideration). The changes upon finalization to the preliminary valuation of assets and liabilities resulted in an adjustment to identifiable intangible assets, goodwill, deferred tax and other liabilities. The following table presents the adjusted values of assets acquired and liabilities assumed for the Anchor acquisition based on its estimated fair value on March 11, 2015.
The acquisition of Anchor resulted in the recognition of intangible assets and goodwill valued at $4.5 million and $2.7 million, respectively. The Company recorded an adjustment to the purchase price allocation and amortization related to the identified intangible assets during the fourth quarter of 2015. Atlas recognized amortization expense of $390,000 and $315,000 for the years ended December 31, 2016 and 2015, respectively, related to intangible assets acquired in the Anchor transaction. Atlas incurred no transaction expenses related to the Anchor acquisition for the year ended December 31, 2016, $999,000 in transaction expenses for the year ended December 31, 2015 and $694,000 in transaction expenses for the year ended December 31, 2014.
Earnings per ordinary voting common share, restricted voting common share, and participative restricted stock unit ("RSU") (collectively, the "common shares") for the years ended December 31, 2016, December 31, 2015, and December 31, 2014 are as follows ($ in '000s, except share and per share amounts):
Earnings per common share diluted is computed by dividing net income by the weighted average number of common shares outstanding for each period plus the incremental number of shares added as a result of converting dilutive potential ordinary voting common shares, calculated using the treasury stock method (or, in the case of the convertible preferred shares, using the "if-converted" method).
Atlas’ dilutive potential ordinary voting common shares consist of outstanding stock options to purchase ordinary voting common shares and preferred shares potentially convertible to ordinary voting common shares at the option of the holder at any date after December 31, 2018 (2,538,560 preferred shares at the rate of 0.1270 ordinary voting common shares for each preferred share related to the Gateway acquisition, all of which were redeemed during the third quarter of 2016, are considered to have been redeemed on the last day of the third quarter of 2016) and after March 11, 2020 (4,000,000 preferred shares at the rate of 0.0500 ordinary voting common shares for each preferred share related to the Anchor acquisition, all of which were canceled as of December 31, 2016). Refer to Note 14, 'Share Capital,' to the Consolidated Financial Statements for further discussion regarding the redemption and cancellation of the preferred shares.
The effects of these convertible instruments are excluded from the computation of earnings per common share diluted in periods in which the effect would be anti-dilutive. Convertible preferred shares are anti-dilutive when the amount of dividend declared or accumulated in the current period per common share obtainable upon conversion exceeds earnings per common share basic. For the year ended December 31, 2016, all exercisable stock options were deemed to be dilutive and all of the convertible preferred shares were deemed to be anti-dilutive. The potentially dilutive impact for the convertible preferred stock excluded from the calculation due to anti-dilution is 441,357 common shares for the year ended December 31, 2016. For the years ended December 31, 2015 and 2014, all of the convertible preferred shares and all exercisable stock options were deemed to be dilutive.
The cost or amortized cost, gross unrealized gains and losses and fair value for Atlas’ investments in fixed income securities and equities are as follows as of ($ in '000s):
The following table summarizes the amortized cost and fair value of fixed income securities by contractual maturity ($ in '000s). As certain securities and debentures have the right to call or prepay obligations, the actual settlement dates may differ from contractual maturity.
The aging of unrealized losses on the Company's investments in fixed income securities and equities is presented as follows ($ in '000s):
As of December 31, 2016, we held 316 individual fixed income securities that were in an unrealized loss position, of which 39 individual fixed income securities were in a continuous loss position for longer than 12 months. As of December 31, 2015, we held 435 and 1 individual fixed income and equity securities, respectively, that were in an unrealized loss position, of which 35 individual fixed income securities were in a continuous loss position for longer than 12 months. We did not recognize the unrealized losses in earnings on these fixed income securities for the years ended December 31, 2016 and 2015, because we neither intend to sell the securities nor do we believe that it is more likely than not that we will be required to sell these securities before recovery of their amortized costs.
The following table presents the aggregate proceeds, gross realized gains and gross realized losses from sales of fixed income securities and equities for the years ended December 31, 2016, 2015, and 2014 ($ in '000s):
The following table summarizes the components of net investment realized gains (losses) for the years ended December 31, 2016, 2015, and 2014 ($ in '000s):
Atlas' other investments are comprised of collateral loans and various limited partnerships that invest in income-producing real estate, equities, or catastrophe bonds. Atlas accounts for these limited partnership investments using the equity method of accounting. As of December 31, 2016, the carrying values of these other investments were approximately $32.2 million versus approximately $22.9 million as of December 31, 2015. The carrying values of the equity method limited partnerships were $24.9 million and $22.8 million as of December 31, 2016 and December 31, 2015, respectively. The carrying value of these investments is Atlas' share of the net book value for each limited partnership, an amount that approximates fair value. Atlas receives payments on a routine basis that approximate the income earned on one of the limited partnerships that invest in income-producing real estate. The carrying values of the collateral loans were $7.2 million and $98,000 as of December 31, 2016 and December 31, 2015, respectively.
The following table summarizes investments in equity method investments by investment type as of December 31, 2016 and December 31, 2015 ($ in '000s):
The Company recognizes an impairment loss for equity method limited partnerships when evidence demonstrates that the loss is other-than-temporary. To determine if an other-than-temporary impairment has occurred, the Company evaluates whether or not the investee could sustain a level of earnings that would justify the carrying amount of the investment. Collateral loans are considered impaired when it is probable that the Company will not collect the contractual principal and interest. Valuation allowances are established for impaired loans equal to the fair value of the collateral less costs to sell or the present value of the loan's expected future repayment cash flows discounted at the loan's original effective interest rate. Valuation allowances are adjusted for subsequent changes in the fair value of the collateral less costs to sell or the present value of the loan's expected future repayment cash flows. As of December 31, 2016 and as of December 31, 2015, the Company had no valuation allowances established for impaired loans.
Level 3 - Unobservable inputs that are not corroborated by market data. These inputs reflect management's best estimate of fair value using its own assumptions about the assumptions a market participant would use in pricing the asset or liability.
Mortgage-backed and Other asset-backed: Comprised of securities that are collateralized by mortgage obligations and other assets. The primary inputs to the valuation include quoted prices for identical assets in inactive markets or similar assets in active or inactive markets, contractual cash flows, benchmark yields, collateral performance and credit spreads.
Upon the transaction forming Atlas on December 31, 2010, a yearly limitation as required by U.S. Internal Revenue Code of 1986 (as amended, "IRC") Section 382 that applies to changes in ownership on the future utilization of Atlas’ net operating loss carryforwards was calculated. The Insurance Subsidiaries’ prior parent retained those tax assets previously attributed to the Insurance Subsidiaries, which could not be utilized by Atlas as a result of this limitation. As a result, Atlas’ ability to recognize future tax benefits associated with a portion of its deferred tax assets generated during prior years has been permanently limited to the amount determined under IRC Section 382. The result is a maximum expected net deferred tax asset that Atlas has available after the merger, which is believed more-likely-than-not to be utilized in the future, after consideration of valuation allowance.
Amounts and expiration dates of the operating loss carryforwards as of December 31, 2016 are as follows ($ in '000s):
Atlas has not established a valuation allowance for its gross future deferred tax assets as of December 31, 2016 or as of December 31, 2015. Based on Atlas’ expectations of future taxable income, its ability to change its investment strategy, as well as reversing gross future tax liabilities, management believes it is more likely than not that Atlas will fully realize the net future tax assets. The Company, therefore, released its remaining valuation allowance as of December 31, 2014.
Atlas accounts for uncertain tax positions in accordance with the income taxes accounting guidance. Atlas has analyzed filing positions in the federal and state jurisdictions where it is required to file tax returns, as well as the open tax years in these jurisdictions. Atlas believes that its federal and state income tax filing positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material change to its financial position. Therefore, no reserves for uncertain federal and state income tax positions have been recorded. Atlas would recognize interest and penalties related to unrecognized tax benefits as a component of the provision for federal income taxes. Atlas did not incur any federal income tax related interest income, interest expense or penalties for the years ended December 31, 2016, 2015, and 2014. The IRS completed its audit of tax year 2012 during the three month period ended March 31, 2016. No changes to tax year 2012 were made to our reported tax. Tax years 2013 and years thereafter are subject to examination by the Internal Revenue Service ("IRS").
On May 22, 2012, Atlas closed the sale and leaseback of the headquarters building to 150 Northwest Point, LLC, a Delaware limited liability company. Atlas recognized a gain on the sale of this property of $213,000, which will be deferred and recognized over the five year lease term, which ends in May 2017. Atlas recognized $43,000 as an offset to rent expense for the years ended December 31, 2016, 2015, and 2014. Total rental expense recognized on the headquarters building was $743,000, $704,000 and $707,000 for the years ended December 31, 2016, 2015, and 2014, respectively. The increase in rental expense on the headquarters building for the year ended December 31, 2016 was primarily due to the leasing of additional space.
As of December 31, 2016, Atlas has the following future minimum rentals, related principally to office space, required under operating leases having initial or remaining noncancelable lease terms in excess of one year ($ in '000s):
Excluded from the table above is the remaining amount for the headquarter building due to a remaining noncancelable lease term of less than one year and future sublease income related to an existing lease due to the uncertain timing of the beginning of the sublease. Total rental expense for the headquarter building in 2017 will be approximately $661,000.
The Company has entered into subscription agreements to allow for participation by the Company in limited liability investments, which invest in income-producing real estate, equities and insurance linked securities. As of December 31, 2016, the unfunded commitments are $2.8 million.
Depreciation expense and amortization was $1.0 million, $966,000, and $856,000 for the years ended December 31, 2016, 2015, and 2014, respectively.
Atlas experienced favorable prior year development during the year ended December 31, 2014 of $352,000 on its core lines and $250,000 on its non-core lines as reflected as incurred related to prior years in the table above. The favorable development on our core lines was primarily related to pre-acquisition Gateway claims reserves.
For purposes of this discussion, Atlas will disaggregate data based on the type of coverage into commercial automobile liability, including personal injury protection, and all other lines. Commercial automobile liability is the main line of business that Atlas operates. All other lines includes commercial automobile physical damage, taxi workers' compensation, other liability and Atlas' short duration lines that are currently in run-off. Amounts related to the Gateway and Global Liberty acquisitions have been included retrospectively for all years presented in the tables below.
The reconciliation of the net incurred and paid claims and claims adjustment expenses development tables to the liability for claims and claims adjustment expenses in the consolidated statement of financial position as of December 31, 2016 is as follows ($ in '000s):
Stock options - Stock option activity for the years ended December 31, 2016 and 2015 follows (prices in Canadian dollars designated with "C$" and United States dollars designated with "US$"):
There are 304,395 stock options that are exercisable as of December 31, 2016. The stock option grants outstanding have a weighted average remaining life of 6.82 years and have an intrinsic value of $3.4 million as of December 31, 2016. On March 12, 2015, the Board of Directors of Atlas granted equity awards of (i) 200,000 restricted voting common shares of the Company and (ii) 200,000 options to acquire ordinary voting common shares to the executive officers of the Company as part of the Company’s annual compensation process. The awards were made under the Company’s Equity Incentive Plan.
The Monte-Carlo simulation model was used, for both the options and restricted voting common share grants, to estimate the fair value of compensation expense as a result of the performance based component of these grants. Utilizing the Monte-Carlo simulation model, the fair values were $1.5 million and $1.9 million for the options and restricted voting common share grants, respectively. This expense will be amortized over the anticipated vesting period.
Restricted shares - The activity for the restricted voting common shares and restricted share units for the years ended December 31, 2016 and 2015 are as follows:
In accordance with ASC 718 (Stock-Based Compensation), Atlas has recognized share-based compensation expense on a straight-line basis over the requisite service period of the last separately vesting portion of the award. Share-based compensation expense is a component of other underwriting expenses on the income statement. Atlas recognized $1.6 million, $1.8 million and $1.5 million in share-based compensation expense, including income tax expense, for the years ended December 31, 2016, 2015, and 2014, respectively. Total unearned share-based compensation expense was $1.0 million related to all stock option grants and $2.2 million related to restricted voting common shares and restricted share units as of December 31, 2016. This unearned share-based compensation expense will be amortized over the next 38 months.
Employee Stock Purchase Plan - The Atlas Employee Stock Purchase Plan (the “ESPP”) encourages employee interest in the operation, growth and development of Atlas and provides an additional investment opportunity to employees. Full time and permanent part time employees working more than 30 hours per week are allowed to invest up to 7.5% of adjusted salary in Atlas ordinary voting common shares. Atlas matches 100% of the employee contribution up to 2.5% of annual earnings, plus 50% of additional contributions up to 5% of annual earnings, for a total maximum expense of 5% of annual earnings per participant. Atlas' matching contributions are discretionary. Atlas also pays all administrative costs related to this plan. For the years ended December 31, 2016, 2015, and 2014, Atlas' costs incurred related to the matching portion of the ESPP were $199,000, $151,000, and $113,000, respectively. Share purchases pursuant to this plan are made in the open market.
All of the issued and outstanding restricted voting common shares are beneficially owned or controlled by Kingsway Financial Services, Inc. (including its subsidiaries and affiliated companies, "Kingsway"). The restricted voting common shares are entitled to vote at all meetings of shareholders, except at meetings of holders of a specific class that are entitled to vote separately as a class. The restricted voting common shares as a class shall not carry more than 30% of the aggregate votes eligible to be voted at a general meeting of common shareholders. The restricted voting common shares will convert to ordinary voting common shares in the event that these Kingsway-owned shares are sold to non-affiliates of Kingsway. During 2016, 4,672 restricted voting common shares were converted to ordinary voting common shares due to the sale by Kingsway of the shares to a non-affiliate.
During the first quarter of 2015, the Company issued 4,000,000 preferred shares as a portion of the consideration related to the Anchor acquisition and an additional 940,500 preferred shares pursuant to the Gateway stock purchase agreement. During the first quarter of 2016, the company canceled 401,940 preferred shares pursuant to the Gateway stock purchase agreement. During the third quarter of 2016, the Company redeemed all 2,538,560 of the remaining preferred shares issued to the former owner of Gateway. During the fourth quarter of 2016, the company canceled 4,000,000 preferred shares pursuant to the Anchor stock purchase agreement. As of December 31, 2016, there were no outstanding preferred shares. The preferred shares redeemed and canceled during 2016 and the preferred shares issued during the first quarter of 2015 pursuant to the Gateway stock purchase agreement have been recorded as a recovery of acquisition expense and additional acquisition expense, respectively, and not as an adjustment to goodwill, because the fair value of the contingent consideration was determined to be zero at the date of acquisition. In accordance with U.S. GAAP, such adjustments are reflected in the income statement in the period that the contingency is re-estimated. The Anchor cancellation was recorded as a recovery of acquisition expense.
The former owners of Gateway and Anchor earned $94,000 and $187,000, respectively, in dividends on the preferred shares during the year ended December 31, 2016. On September 30, 2016, Atlas paid $409,000 in dividends earned on the preferred shares to the former owner of Gateway, the cumulative amount to which they were entitled through September 15, 2016, leaving no accrued and unpaid dividends owed to the former owner of Gateway. As of December 31, 2016, Atlas has accrued $333,000 in dividends on the preferred shares for the former owner of Anchor, which remains unpaid. As of December 31, 2016, the paid claims development on Global Liberty's pre-acquisition claims reserves was in excess of $4.0 million, and as a result, pursuant to the terms of the Anchor stock purchase agreement, dividends will no longer accrue to the former owner of Anchor. As of December 31, 2016, there were no preferred shares outstanding.
On May 7, 2014, American Insurance Acquisition, Inc. (“American Acquisition”), a subsidiary of Atlas, entered into a loan and security agreement (“Former Loan Agreement”) for a $10.0 million revolving loan facility with Fifth Third Bank. Under the Former Loan Agreement, funds could be borrowed and re-borrowed on a revolving basis by American Acquisition, from the closing date until (but not including) May 7, 2015, the loan maturity date. The interest rate on the advances under the revolving loan facility was generally LIBOR plus 2.75%, provided that, during a default, interest would accrue at a rate equal to LIBOR plus 5%. In addition, there was a non-utilization fee equal to 0.25% per annum of an amount equal to $10.0 million less the daily average of the aggregate principal amount of the revolving loans outstanding plus the aggregate amount of the letter of credit obligations outstanding.
The Loan Agreement requires American Acquisition to comply with customary affirmative and negative covenants, including those governing indebtedness, liens, investments, sales of assets, issuance of securities, and distributions. The Loan Agreement also requires American Acquisition to make mandatory prepayments under certain conditions and to comply with certain financial covenants, including the ASI Pool Subsidiaries (defined below) maintaining a combined statutory net worth in an amount not less than $60 million (subject to adjustment) and maintaining a minimum funded debt to Earnings Before Interest, Taxes, Depreciation and Amortization ratio (the "EBITDA Ratio"). The Loan Agreement is secured by substantially all of the property of American Acquisition, including all of the outstanding shares of American Country, American Service and Gateway, which are wholly-owned direct subsidiaries of American Acquisition (the “ASI Pool Subsidiaries”).
As of December 31, 2016, $3.9 million in funds were accessed from the Revolver, of which $2,000,000 was accessed during 2016, including a portion that was used to repurchase preferred shares from the former owner of Gateway while $100,000 was repaid during 2016. $15.5 million in funds were accessed against the Draw Amount as of December 31, 2016. All $15.5 million of the Draw Amount was accessed in 2015 and contributed to the ASI Pool Subsidiaries in exchange for surplus notes that carry a variable interest rate of prime plus 2% with a maturity date of April 30, 2020. No letters of credit were issued under the terms of this Loan Agreement as of December 31, 2016. As of December 31, 2016, the unused funds for the Revolver and the Draw Amount were $1.1 million and $14.5 million, respectively. The unused funds for the Draw Amount can no longer be drawn.
For the year ended December 31, 2016, American Acquisition incurred interest expense, including amortized loan costs, of $1.0 million in connection with the Loan Agreement. For the year ended December 31, 2015, interest expense, including amortized loan costs, was $694,000. As of December 31, 2016, unamortized bank fees associated with the Loan Agreement were $213,000. These bank fees will be amortized over the next 38 months.
Notes payable outstanding as of December 31, 2016 and 2015 ($ in '000s) were:
The Insurance Subsidiaries must each maintain a minimum statutory capital and surplus of $1.5 million, $2.4 million, and $3.5 million under the provisions of the Illinois Insurance Code, the Missouri Insurance Code, and New York Insurance Code, respectively. Dividends may only be paid from statutory unassigned surplus, and payments may not be made if such surplus is less than a stipulated amount. The dividend restriction for the ASI Pool Subsidiaries is the greater of statutory net income or 10% of total statutory capital and surplus. The dividend restriction for Global Liberty is the lower of 10% of statutory surplus or 100% of adjusted net investment income for the preceding twelve month period.