10-Q 1 fnhc3311910-q.htm 10-Q Document
 
 
  

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 
 þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED March 31, 2019
OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________________TO _______________________
Commission File number 000-25001
 FedNat Holding Company
(Exact name of registrant as specified in its charter)
Florida
 
65-0248866
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification Number)
 
 
 
14050 N.W. 14th Street, Suite 180, Sunrise, FL
 
33323
(Address of principal executive offices)
 
(Zip Code)
800-293-2532
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ   No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes þ   No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer," “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
 
 
 
 
Large accelerated filer ¨
Accelerated filer þ
Non‑accelerated filer ¨
Smaller reporting company ¨
 
 
 
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.      ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes ¨   No þ
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock
FNHC
Nasdaq Global Market
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of May 1, 2019, the registrant had 12,836,401 shares of common stock outstanding.


 
 



FEDNAT HOLDING COMPANY
TABLE OF CONTENTS
 



- 2-



PART I: FINANCIAL INFORMATION
Item 1.  Financial Statements
FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)
໿
 
 
March 31,
 
December 31,
 
 
2019
 
2018
ASSETS
 
 
 
 
Investments:
 
 
 
 
Debt securities, available-for-sale, at fair value (amortized cost of $439,254 and $433,664, respectively)
 
$
443,458

 
$
428,641

Debt securities, held-to-maturity, at amortized cost
 
4,552

 
5,126

Equity securities, at fair value
 
20,824

 
17,758

Total investments
 
468,834

 
451,525

Cash and cash equivalents
 
100,589

 
64,423

Prepaid reinsurance premiums
 
69,858

 
108,577

Premiums receivable, net of allowance of $67 and $77, respectively
 
22,684

 
29,791

Reinsurance recoverable, net
 
301,922

 
211,424

Deferred acquisition costs, net
 
40,232

 
39,436

Income taxes, net
 
4,027

 
5,220

Other assets
 
27,441

 
14,975

Total assets
 
$
1,035,587

 
$
925,371

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
Liabilities
 
 
 
 
Loss and loss adjustment expense reserves
 
$
374,124

 
$
296,230

Unearned premiums
 
275,860

 
281,992

Reinsurance payable
 
31,399

 
63,599

Long-term debt, net of deferred financing costs of $1,599 and $596, respectively
 
98,401

 
44,404

Deferred revenue
 
4,567

 
4,585

Other liabilities
 
33,320

 
19,302

Total liabilities
 
817,671

 
710,112

 
 
 
 
 
Commitments and contingencies (see Note 9)
 
 
 
 
 
 
 
 
 
Shareholders' Equity
 
 
 
 
Preferred stock, $0.01 par value: 1,000,000 shares authorized
 

 

Common stock, $0.01 par value: 25,000,000 shares authorized; 12,836,401 and 12,784,444 shares issued and outstanding, respectively
 
128

 
128

Additional paid-in capital
 
141,803

 
141,128

Accumulated other comprehensive income (loss)
 
3,138

 
(3,750
)
Retained earnings
 
72,847

 
77,753

Total shareholders’ equity
 
217,916

 
215,259

Total liabilities and shareholders' equity
 
$
1,035,587

 
$
925,371


The accompanying notes are an integral part of the unaudited consolidated financial statements.

- 3-



FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
Revenues:
 
 
 
 
Net premiums earned
 
$
88,784

 
$
82,109

Net investment income
 
3,710

 
2,943

Net realized and unrealized investment gains (losses)
 
2,301

 
(1,052
)
Direct written policy fees
 
2,391

 
3,576

Other income
 
4,011

 
5,501

Total revenues
 
101,197

 
93,077

 
 
 

 
 

Costs and expenses:
 
 

 
 

Losses and loss adjustment expenses
 
66,839

 
46,071

Commissions and other underwriting expenses
 
28,234

 
30,221

General and administrative expenses
 
6,311

 
6,085

Interest expense
 
5,051

 
1,084

Total costs and expenses
 
106,435

 
83,461

 
 
 

 
 

Income (loss) before income taxes
 
(5,238
)
 
9,616

Income tax expense (benefit)
 
(1,373
)
 
2,371

Net income (loss)
 
(3,865
)
 
7,245

Net income (loss) attributable to non-controlling interest
 

 
(218
)
Net income (loss) attributable to FedNat Holding Company shareholders
 
$
(3,865
)
 
$
7,463

 
 
 

 
 

Net Income (Loss) Per Common Share
 
 

 
 

Basic
 
$
(0.30
)
 
$
0.58

Diluted
 
$
(0.30
)
 
$
0.58

 
 
 

 
 

Weighted Average Number of Shares of Common Stock Outstanding
 
 

 
 

Basic
 
12,795

 
12,850

Diluted
 
12,795

 
12,945

 
 
 

 
 

Dividends Declared Per Common Share
 
$
0.08

 
$
0.08


The accompanying notes are an integral part of the unaudited consolidated financial statements.

- 4-



FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)
໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
 
 
 
Net income (loss)
 
$
(3,865
)
 
$
7,245

 
 
 
 
 
Change in net unrealized gains (losses) on investments, available-for-sale, net of tax
 
6,888

 
(4,561
)
Comprehensive income (loss)
 
3,023

 
2,684

 
 
 
 
 
Less: comprehensive income (loss) attributable to non-controlling interest, net of tax
 

 
(447
)
Comprehensive income (loss) attributable to FedNat Holding Company shareholders
 
$
3,023

 
$
3,131


The accompanying notes are an integral part of the unaudited consolidated financial statements.
 


- 5-



FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(In thousands, except share data)
(Unaudited)

໿
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders'
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
Attributable to
 
 
 
 
 
 
 
 
Common Stock
 
Additional
 
Other
 
 
 
FedNat Holding
 
Non-
 
Total
 
 
Preferred
 
Issued
 
 
 
Paid-in
 
Comprehensive
 
Retained
 
Company
 
Controlling
 
Shareholders'
 
 
Stock
 
Shares
 
Amount
 
Capital
 
Income (Loss)
 
Earnings
 
Shareholders
 
Interest
 
Equity
Balance as of January 1, 2019
 
$

 
12,784,444

 
$
128

 
$
141,128

 
$
(3,750
)
 
$
77,753

 
$
215,259

 
$

 
$
215,259

Net income (loss)
 

 

 

 

 

 
(3,865
)
 
(3,865
)
 

 
(3,865
)
Other comprehensive income (loss)
 

 

 

 

 
6,888

 

 
6,888

 

 
6,888

Dividends declared
 

 

 

 

 

 
(1,041
)
 
(1,041
)
 

 
(1,041
)
Shares issued under share-based compensation plans
 

 
51,957

 

 

 

 

 

 

 

Share-based compensation
 

 

 

 
675

 

 

 
675

 

 
675

Balance as of March 31, 2019
 
$

 
12,836,401

 
$
128

 
$
141,803

 
$
3,138

 
$
72,847

 
$
217,916

 
$

 
$
217,916


 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders'
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
Attributable to
 
 
 
 
 
 
 
 
Common Stock
 
Additional
 
Other
 
 
 
FedNat Holding
 
Non-
 
Total
 
 
Preferred
 
Issued
 
 
 
Paid-in
 
Comprehensive
 
Retained
 
Company
 
Controlling
 
Shareholders'
 
 
Stock
 
Shares
 
Amount
 
Capital
 
Income (Loss)
 
Earnings
 
Shareholders
 
Interest
 
Equity
Balance as of January 1, 2018
 
$

 
12,988,247

 
$
130

 
$
139,728

 
$
1,770

 
$
70,009

 
$
211,637

 
$
15,822

 
$
227,459

Net income (loss)
 

 

 

 

 

 
7,463

 
7,463

 
(218
)
 
7,245

Other comprehensive income (loss)
 

 

 

 

 
(4,332
)
 

 
(4,332
)
 
(229
)
 
(4,561
)
Dividends declared
 

 

 

 

 

 
(1,043
)
 
(1,043
)
 

 
(1,043
)
Cumulative effect of new accounting standards
 

 

 

 

 
(994
)
 
994

 

 

 

Acquisition of non-controlling interest
 

 

 

 
(1,005
)
 
(305
)
 

 
(1,310
)
 
(15,375
)
 
(16,685
)
Shares issued under share-based compensation plans
 

 
53,571

 

 

 

 

 

 

 

Repurchases of common stock
 

 
(322,865
)
 
(3
)
 

 

 
(4,997
)
 
(5,000
)
 

 
(5,000
)
Share-based compensation
 

 

 

 
665

 

 

 
665

 

 
665

Balance as of March 31, 2018
 
$

 
12,718,953

 
$
127

 
$
139,388

 
$
(3,861
)
 
$
72,426

 
$
208,080

 
$

 
$
208,080


The accompanying notes are an integral part of the unaudited consolidated financial statements.

- 6-



FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
Cash flow from operating activities:
 
 
 
 
Net income (loss)
 
$
(3,865
)
 
$
7,245

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
 
Net realized and unrealized investment (gains) losses
 
(2,301
)
 
1,052

Loss (gain) on early extinguishment of debt
 
3,575

 
67

Amortization of investment premium or discount, net
 
197

 
616

Depreciation and amortization
 
355

 
371

Share-based compensation
 
675

 
665

Tax impact related to share-based compensation
 
(10
)
 
(77
)
Changes in operating assets and liabilities:
 
 
 
 
Prepaid reinsurance premiums
 
38,719

 
48,291

Premiums receivable, net
 
7,107

 
726

Reinsurance recoverable, net
 
(90,498
)
 
(21,490
)
Deferred acquisition costs
 
(796
)
 
1,492

Income taxes, net
 
(1,136
)
 
2,521

Deferred revenue
 
(18
)
 
(298
)
Loss and loss adjustment expense reserves
 
77,894

 
5,699

Unearned premiums
 
(6,132
)
 
(12,026
)
Reinsurance payable
 
(32,200
)
 
(33,455
)
Other
 
1,639

 
11,019

Net cash provided by (used in) operating activities
 
(6,795
)
 
12,418

Cash flow from investing activities:
 
 
 
 
Proceeds from sales of equity securities
 
1,506

 
4,262

Proceeds from sales of debt securities
 
49,174

 
73,830

Purchases of equity securities
 
(2,188
)
 
(5,177
)
Purchases of debt securities
 
(62,741
)
 
(138,738
)
Maturities and redemptions of debt securities
 
8,271

 
50,584

Purchases of property and equipment
 
(486
)
 
(66
)
Net cash provided by (used in) investing activities
 
(6,464
)
 
(15,305
)
Cash flow from financing activities:
 
 
 
 
Issuance of long-term debt, net of issuance costs
 
98,464

 

Payment of long-term debt and prepayment penalties
 
(48,000
)
 
(5,000
)
Purchase of non-controlling interest
 

 
(16,685
)
Purchases of FedNat Holding Company common stock
 

 
(5,000
)
Dividends paid
 
(1,039
)
 
(1,065
)
Net cash provided by (used in) financing activities
 
49,425

 
(27,750
)
Net increase (decrease) in cash and cash equivalents
 
36,166

 
(30,637
)
Cash and cash equivalents at beginning-of-period
 
64,423

 
86,228

Cash and cash equivalents at end-of-period
 
$
100,589

 
$
55,591


The accompanying notes are an integral part of the unaudited consolidated financial statements.

- 7-



FEDNAT HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
(Continued)
 
໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid (received) during the period for interest
 
$
902

 
$
977

Cash paid (received) during the period for income taxes
 
$
(277
)
 
$
70

 
 
 
 
 
Significant non-cash investing and financing transactions:
 
 
 
 
Right-of-use asset
 
$
(8,103
)
 
$

Lease liability
 
$
8,103

 
$


The accompanying notes are an integral part of the unaudited consolidated financial statements.



- 8-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 2019


1. ORGANIZATION, CONSOLIDATION AND BASIS OF PREPARATION

Organization

FedNat Holding Company (“FNHC,” the “Company,” “we,” “us,” or "our") is an insurance holding company that controls substantially all aspects of the insurance underwriting, distribution and claims processes through our subsidiaries and contractual relationships with independent agents and general agents.  The Company, through its wholly owned subsidiaries, is authorized to underwrite and/or place homeowners multi-peril ("homeowners"), federal flood and other lines of insurance in Florida and other states. The Company markets, distributes and services its own and third-party insurers’ products and other services through a network of independent and general agents.

FedNat Insurance Company (“FNIC”), our largest wholly owned insurance subsidiary, is licensed as an admitted carrier, to write specific lines of insurance by the state’s insurance departments, in Florida, Louisiana, Texas, Georgia, South Carolina and Alabama.  Monarch National Insurance Company (“MNIC”), our other insurance subsidiary, is licensed as an admitted carrier in Florida. Admitted carriers are bound by rate and form regulations, and are strictly regulated to protect policyholders from a variety of illegal and unethical practices. Admitted carriers are also required to financially contribute to the state guarantee fund used to pay for losses if an insurance carrier becomes insolvent or unable to pay loss amounts due to their policyholders.

Maison Acquisition

On February 25, 2019, the Company executed a definitive agreement for the acquisition of the insurance operations of 1347 Property Insurance Holdings, Inc. ("PIH"). Specifically, the Company will purchase Maison Insurance Company, Maison Managers, Inc., and ClaimCor LLC (collectively, the "Maison Companies"). The purchase price is $51.0 million, which includes $25.5 million in cash and $25.5 million in shares of the Company’s common stock. The resale of the shares to be issued will be subsequently registered and will be subject to a five-year standstill agreement. Additionally, in connection with the pending acquisition, on March 5, 2019, the Company closed on an offering of $100 million of Senior Unsecured Notes due 2029, which bear interest at the annual rate of 7.5%. A portion of the cash from the offering was used to retire the full $45.0 million of outstanding debt (thereby lowering our overall cost of borrowing) and the remainder will be used to purchase the Maison Companies and for other general corporate purposes.

In addition to the purchase price, PIH will receive five-year rights of first refusal to provide reinsurance of up to 7.5% of any layer in FedNat’s catastrophe reinsurance program and a five-year agreement for PIH to provide investment advisory services to FedNat. PIH has also agreed to a non-compete for five years following the closing with respect to residential property insurance in Alabama, Florida, Georgia, Louisiana, South Carolina and Texas.

The transaction, which is subject to the Maison Companies having consolidated GAAP net book value of at least $42 million as of closing and satisfaction of other customary closing conditions, including insurance regulatory approvals in Louisiana and Florida, is expected to close in the latter part of the second quarter of 2019. 

Refer to Basis of Presentation and Principles of Consolidation and below.

Material Distribution Relationships

Ivantage Select Agency, Inc.
The Company is a party to an insurance agency master agreement with Ivantage Select Agency, Inc. (“ISA”), an affiliate of Allstate Insurance Company (“Allstate”), pursuant to which the Company has been authorized by ISA to appoint Allstate agents to offer the Company’s homeowners insurance products to consumers in Florida. As a percentage of the total homeowners premiums we underwrote, 22.8% and 22.8% were from Allstate’s network of Florida agents, for the three months ended March 31, 2019 and 2018, respectively.

SageSure Insurance Managers, LLC
The Company is a party to a managing general underwriting agreement with SageSure Insurance Managers, LLC (“SageSure”) to facilitate growth in our FNIC homeowners business outside of Florida.  As a percentage of the total homeowners premiums, 19.6% and 11.8%, respectively, of the Company’s premiums were underwritten by SageSure, for the three months ended March 31, 2019 and 2018, respectively.


- 9-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

Basis of Presentation and Principles of Consolidation

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”).  The consolidated financial statements include the accounts of FNHC and its wholly-owned subsidiaries and all entities in which the Company has a controlling financial interest and any variable interest entity (“VIE”) of which the Company is the primary beneficiary. The Company’s management believes the consolidated financial statements reflect all material adjustments, including normal recurring adjustments, necessary to fairly state the financial position, results of operations and cash flows of the Company for the periods presented. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company identifies a VIE as an entity that does not have sufficient equity to finance its own activities without additional financial support or where the equity investors lack certain characteristics of a controlling financial interest.  The Company assesses its contractual, ownership or other interests in a VIE to determine if the Company’s interest participates in the variability the VIE was designed to absorb and pass onto variable interest holders.  The Company performs an ongoing qualitative assessment of its variable interests in a VIE to determine whether the Company has a controlling financial interest and would therefore be considered the primary beneficiary of the VIE.  If the Company determines it is the primary beneficiary of a VIE, the Company consolidates the assets and liabilities of the VIE in its consolidated financial statements.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES

Our significant accounting policies were described in Note 2 of our 2018 Form 10-K. Other than the changes noted in "Recently Issued Accounting Pronouncements, Adopted" below, there have been no significant changes in our significant accounting policies for the three months ended March 31, 2019.

Accounting Estimates and Assumptions

The Company prepares the accompanying consolidated financial statements in accordance with GAAP, which requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results may materially differ from those estimates.

Similar to other property and casualty insurers, the Company’s liability for loss and loss adjustment expenses ("LAE") reserves, although supported by actuarial projections and other data, is ultimately based on management’s reasoned expectations of future events. Although considerable variability is inherent in these estimates, the Company believes that the liability and LAE reserve is adequate. The Company reviews and evaluates its estimates and assumptions regularly and makes adjustments, reflected in current operations, as necessary, on an ongoing basis.

Recently Issued Accounting Pronouncements, Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2016-02, Leases (Topic 842).  The update superseded the prior lease guidance in Topic 840, Leases and lessees are required to recognize for all leases, with the exception of short-term leases, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis.  Additionally, lessees are required to recognize a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.  The Company adopted the guidance effective January 1, 2019, by reflecting a $6.1 million right-of-use asset, after-tax, and $6.1 million lease liability, after-tax, on our consolidated balance sheets for our leases in existence as of that date. All of the Company's leases were classified as operating leases and we elected the practical expedient, therefore no adjustment to comparative prior periods presented have been made.  The provisions of this ASU did not have an impact on our pattern of lease expense recognition on our consolidated statements of operations.

Refer to Note 9 below for additional information regarding leases.


- 10-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

Recently Issued Accounting Pronouncements, Not Yet Adopted

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which significantly changes the measurement of credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The update requires entities to record allowances for available-for-sale debt securities rather than reduce the carrying amount, as currently performed under the other-than-temporary impairment ("OTTI") model. The update also requires enhanced disclosures for financial assets measured at amortized cost and available-for-sale debt securities to help the financial statement users better understand significant judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. The update is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. The Company is in the early stage of evaluating the impact that the update will have on the Company’s consolidated financial position or results of operations.

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ASU 2018-15 requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in Accounting Standards Codification 350-40 to determine which implementation costs to defer and recognize as an asset. The update is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. The Company is in the early stage of evaluating the impact that the update will have on the Company’s consolidated financial position or results of operations.

3. FAIR VALUE

Fair Value Disclosures of Financial Instruments

The Company accounts for financial instruments at fair value or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are generally based upon observable and unobservable inputs.  Observable inputs are based on market data from independent sources, while unobservable inputs reflect the Company’s view of market assumptions in the absence of observable market information.  All assets and liabilities that are recorded at fair value are classified and disclosed in one of the following three categories:

Level 1 - Quoted market prices (unadjusted) for identical assets or liabilities in active markets is defined as a market where transactions for the financial statement occur with sufficient frequency and volume to provide pricing information on an ongoing basis, or observable inputs.
Level 2 - Quoted market prices for similar assets or liabilities and valuations, using models or other valuation techniques using observable market data.  Significant other observable that can be corroborated by observable market data; and
Level 3 - Instruments that use non-binding broker quotes or model driven valuations that do not have observable market data or those that are estimated based on an ownership interest to which a proportionate share of net assets is attributed.

If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.


- 11-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

The Company’s financial instruments measured at fair value on a recurring basis and the level of the fair value hierarchy of inputs used consisted of the following:
 
 
March 31, 2019
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In thousands)
Debt securities - available-for-sale, at fair value:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
43,412

 
$
102,550

 
$

 
$
145,962

Obligations of states and political subdivisions
 

 
11,519

 

 
11,519

Corporate securities
 

 
263,385

 

 
263,385

International securities
 

 
22,592

 

 
22,592

Debt securities, at fair value
 
43,412

 
400,046

 

 
443,458

 
 
 
 
 
 
 
 
 
Equity securities, at fair value
 
18,907

 
1,917

 

 
20,824

 
 
 
 
 
 
 
 
 
Total investments, at fair value
 
$
62,319

 
$
401,963

 
$

 
$
464,282

໿
 
 
December 31, 2018
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In thousands)
Debt securities - available-for-sale, at fair value:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
43,918

 
$
83,950

 
$

 
$
127,868

Obligations of states and political subdivisions
 

 
9,767

 

 
9,767

Corporate securities
 

 
268,731

 

 
268,731

International securities
 

 
22,275

 

 
22,275

Debt securities, at fair value
 
43,918

 
384,723

 

 
428,641

 
 
 
 
 
 
 
 
 
Equity securities, at fair value
 
16,037

 
1,721

 

 
17,758

 
 
 
 
 
 
 
 
 
Total investments, at fair value
 
$
59,955

 
$
386,444

 
$

 
$
446,399


Held-to-maturity debt securities reported on the consolidated balance sheets at amortized cost and disclosed at fair value below (and in Note 4) and the level of fair value hierarchy of inputs used consisted of the following:
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In thousands)
March 31, 2019
 
$
3,360

 
$
1,109

 
$

 
$
4,469

December 31, 2018
 
3,809

 
1,155

 

 
4,964


We measure the fair value of our securities based on assumptions used by market participants in pricing the security.  The most appropriate valuation methodology is selected based on the specific characteristics of the security, and we consistently apply the valuation methodology to measure the security’s fair value.  Our fair value measurement is based on a market approach that utilizes prices and other relevant information generated by market transactions involving identical or comparable securities.  We review the third party pricing methodologies on a quarterly basis and validate the fair value prices to a separate independent data service and ensure there are no material differences. Additionally, market indicators, industry and economic events are monitored.



- 12-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

A summary of the significant valuation techniques and market inputs for each financial instrument carried at fair value includes the following:

United States Government Obligations and Authorities - In determining the fair value for United States government securities in Level 1, the Company uses quoted prices (unadjusted) in active markets for identical or similar assets. In determining the fair value for United States government securities in Level 2, the Company uses the market approach utilizing primary valuation inputs including reported trades, dealer quotes for identical or similar assets in markets that are not active, benchmark yields, credit spreads, reference data and industry and economic events.
Obligations of States and Political Subdivisions - In determining the fair value for state and municipal securities, the Company uses the market approach utilizing primary valuation inputs including reported trades, dealer quotes for identical or similar assets in markets that are not active, benchmark yields, credit spreads, reference data and industry and economic events.
Corporate and International Securities - In determining the fair value for corporate securities the Company uses the market approach utilizing primary valuation inputs including reported trades, dealer quotes for identical or similar assets in markets that are not active, benchmark yields, credit spreads (for investment grade securities), observations of equity and credit default swap curves (for high-yield corporates), reference data and industry and economic events.
Equity Securities: In determining the fair value for equity securities in Level 1, the Company uses quoted prices (unadjusted) in active markets for identical or similar assets. In determining the fair value for equity securities in Level 2, the Company uses the market approach utilizing primary valuation inputs including reported trades, dealer quotes for identical or similar assets in markets that are not active, benchmark yields, credit spreads, reference data and industry and economic events.

There were no changes to the Company’s valuation methodology and the Company is not aware of any events or circumstances that would have a significant adverse effect on the carrying value of its assets and liabilities measured at fair value as of March 31, 2019 and December 31, 2018. There were no transfers between the fair value hierarchy levels during the three months ended March 31, 2019 and 2018.

- 13-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

4. INVESTMENTS

Unrealized Gains and Losses

The difference between amortized cost or cost and estimated fair value and gross unrealized gains and losses, by major investment category, consisted of the following:
໿
 
 
Amortized
 
Gross
 
Gross
 
 
 
 
Cost
 
Unrealized
 
Unrealized
 
 
 
 
or Cost
 
Gains
 
Losses
 
Fair Value
 
 
(In thousands)
March 31, 2019
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
144,450

 
$
2,037

 
$
525

 
$
145,962

Obligations of states and political subdivisions
 
11,502

 
88

 
71

 
11,519

Corporate
 
260,844

 
3,693

 
1,152

 
263,385

International
 
22,458

 
213

 
79

 
22,592

 
 
439,254

 
6,031

 
1,827

 
443,458

 
 
 

 
 

 
 

 
 
Debt securities - held-to-maturity:
 
 

 
 

 
 

 
 
United States government obligations and authorities
 
3,567

 
2

 
91

 
3,478

Corporate
 
930

 
8

 
2

 
936

International
 
55

 

 

 
55

 
 
4,552

 
10

 
93

 
4,469

Total investments, excluding equity securities
 
$
443,806

 
$
6,041

 
$
1,920

 
$
447,927

໿

 
 
Amortized
 
Gross
 
Gross
 
 
 
 
Cost
 
Unrealized
 
Unrealized
 
 
 
 
or Cost
 
Gains
 
Losses
 
Fair Value
 
 
(In thousands)
December 31, 2018
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
127,928

 
$
1,091

 
$
1,151

 
$
127,868

Obligations of states and political subdivisions
 
9,870

 
27

 
130

 
9,767

Corporate
 
273,192

 
510

 
4,971

 
268,731

International
 
22,674

 
12

 
411

 
22,275

 
 
433,664

 
1,640

 
6,663

 
428,641

 
 
 
 
 
 
 
 
 
Debt securities - held-to-maturity:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
4,085

 
1

 
158

 
3,928

Corporate
 
986

 
2

 
6

 
982

International
 
55

 

 
1

 
54

 
 
5,126

 
3

 
165

 
4,964

Total investments, excluding equity securities
 
$
438,790

 
$
1,643

 
$
6,828

 
$
433,605



- 14-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

Net Realized and Unrealized Gains and Losses

The Company calculates the gain or loss realized on the sale of investments by comparing the sales price (fair value) to the cost or amortized cost of the security sold. Net realized gains and losses on investments are determined in accordance with the specific identification method.

Net realized and unrealized gains (losses), by major investment category, consisted of the following:
໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
(In thousands)
Gross realized and unrealized gains:
 
 
 
 
Debt securities
 
$
317

 
$
223

Equity securities
 
2,830

 
1,153

Total gross realized and unrealized gains
 
3,147

 
1,376

 
 
 

 
 
Gross realized and unrealized losses:
 
 

 
 
Debt securities
 
(400
)
 
(1,441
)
Equity securities
 
(446
)
 
(987
)
Total gross realized and unrealized losses
 
(846
)
 
(2,428
)
Net realized and unrealized gains (losses) on investments
 
$
2,301

 
$
(1,052
)

The above line item, net realized and unrealized gains (losses) on investments, includes $2.3 million and less than $0.1 million of recognized net unrealized gains (losses) on equity securities for the three months ended March 31, 2019 and 2018, respectively.

Contractual Maturity

Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.

Amortized cost and estimated fair value of debt securities, by contractual maturity, consisted of the following:
໿
 
 
March 31, 2019
 
 
Amortized
 
 
 
 
Cost
 
Fair Value
Securities with Maturity Dates
 
(In thousands)
Debt securities, available-for-sale:
 
 
 
 
One year or less
 
$
17,108

 
$
17,094

Over one through five years
 
198,410

 
199,858

Over five through ten years
 
218,177

 
220,854

Over ten years
 
5,559

 
5,652

 
 
439,254

 
443,458

Debt securities, held-to-maturity:
 
 
 
 
One year or less
 
135

 
135

Over one through five years
 
4,042

 
3,963

Over five through ten years
 
375

 
371

 
 
4,552

 
4,469

Total
 
$
443,806

 
$
447,927



- 15-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

Net Investment Income

Net investment income consisted of the following:
໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
(In thousands)
Interest income
 
$
3,657

 
$
2,887

Dividends income
 
53

 
56

Net investment income
 
$
3,710

 
$
2,943


Aging of Gross Unrealized Losses

Gross unrealized losses and related fair values for debt securities, grouped by duration of time in a continuous unrealized loss position, consisted of the following:
໿
 
 
Less than 12 months
 
12 months or longer
 
Total
 
 
 
 
Gross
 
 
 
Gross
 
 
 
Gross
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
 
 
 
 
 
 
(In thousands)
 
 
 
 
March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
10,279

 
$
8

 
$
32,169

 
$
517

 
$
42,448

 
$
525

Obligations of states and political subdivisions
 
790

 
21

 
5,339

 
50

 
6,129

 
71

Corporate
 
26,723

 
311

 
57,096

 
841

 
83,819

 
1,152

International
 
2,711

 
6

 
5,877

 
73

 
8,588

 
79

 
 
40,503

 
346

 
100,481

 
1,481

 
140,984

 
1,827

 
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities, held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
114

 

 
3,161

 
91

 
3,275

 
91

Corporate
 
80

 

 
173

 
2

 
253

 
2

International
 

 

 
29

 

 
29

 

 
 
194

 

 
3,363

 
93

 
3,557

 
93

Total investments, excluding equity securities
 
$
40,697

 
$
346

 
$
103,844

 
$
1,574

 
$
144,541

 
$
1,920




- 16-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

 
 
Less than 12 months
 
12 months or longer
 
Total
 
 
 
 
Gross
 
 
 
Gross
 
 
 
Gross
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
 
 
 
 
 
 
(In thousands)
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
22,673

 
$
246

 
$
29,727

 
$
905

 
$
52,400

 
$
1,151

Obligations of states and political subdivisions
 
3,254

 
18

 
4,786

 
112

 
8,040

 
130

Corporate
 
160,361

 
3,058

 
53,232

 
1,913

 
213,593

 
4,971

International
 
15,608

 
217

 
4,678

 
194

 
20,286

 
411

 
 
201,896

 
3,539

 
92,423

 
3,124

 
294,319

 
6,663

 
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities, held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
229

 
1

 
3,113

 
157

 
3,342

 
158

Corporate
 
591

 
6

 
90

 

 
681

 
6

International
 
54

 
1

 

 

 
54

 
1

 
 
874

 
8

 
3,203

 
157

 
4,077

 
165

Total investments, excluding equity securities
 
$
202,770

 
$
3,547

 
$
95,626

 
$
3,281

 
$
298,396

 
$
6,828


As of March 31, 2019, the Company held a total of 592 debt securities that were in an unrealized loss position, of which 475 securities were in an unrealized loss position continuously for 12 months or more. As of December 31, 2018, the Company held a total of 1,222 debt and equity securities that were in an unrealized loss position, of which 371 securities were in an unrealized loss position continuously for 12 months or more. The unrealized losses associated with these securities consisted primarily of losses related to corporate securities.

The Company holds some of its debt securities as available-for-sale and as such, these securities are recorded at fair value. The Company continually monitors the difference between cost and the estimated fair value of its investments, which involves uncertainty as to whether declines in value are temporary in nature. If the decline of a particular investment is deemed temporary, the Company records the decline as an unrealized loss in shareholders’ equity. If the decline is deemed to be other than temporary, the Company will write the security’s cost-basis or amortized cost-basis down to the fair value of the investment and recognizes an OTTI loss in the Company’s consolidated statement of operations. Additionally, any portion of such decline related to debt securities that is believed to arise from factors other than credit will be recorded as a component of other comprehensive income rather than charged against income. The Company did not have any OTTI losses on its available-for-sale debt securities for the first three months of 2019 and 2018.

The Company's equity investments are measured at fair value through net income (loss).

Collateral Deposits

Cash and cash equivalents and investments, the majority of which were debt securities, with fair values of $10.6 million and $10.3 million, were deposited with governmental authorities and into custodial bank accounts as required by law or contractual obligations as of March 31, 2019 and December 31, 2018, respectively.

- 17-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019


5. REINSURANCE

Overview

Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. The Company reinsures (cedes) a portion of written premiums on an excess of loss or a quota-share basis in order to limit the Company’s loss exposure. To the extent that reinsuring companies are unable to meet their obligations assumed under these reinsurance agreements, the Company remains primarily liable to its policyholders.

The Company is selective in choosing reinsurers and considers numerous factors, the most important of which is the financial stability of the reinsurer or capital specifically pledged to uphold the contract, its history of responding to claims and its overall reputation.  In an effort to minimize the Company’s exposure to the insolvency of a reinsurer, the Company evaluates the acceptability and review the financial condition of the reinsurer at least annually with the assistance of the Company’s reinsurance broker.

Significant Reinsurance Contracts

2017-2018 Excess of Loss Reinsurance Programs
FNIC’s 2017-2018 reinsurance programs, which cost $174.4 million, included $124.0 million for the private reinsurance for FNIC’s Florida exposure, with prepaid automatic premium reinstatement protection on all layers, along with approximately $50.4 million payable to the Florida Hurricane Catastrophe Fund (“FHCF”). The combination of private and FHCF reinsurance treaties affords FNIC with $2.2 billion of aggregate coverage with a maximum single event coverage totaling approximately $1.5 billion, exclusive of retentions. FNIC maintained its FHCF participation at 75% for the 2017 hurricane season. FNIC’s single event pre-tax retention for a catastrophic event in Florida was $18.0 million.

FNIC’s private market excess of loss treaties, covering both Florida and non-Florida exposures, became effective June 1, 2017 and July 1, 2017. All private layers have prepaid automatic reinstatement protection, except the FHCF supplemental layer reinsurance contract, which afforded FNIC additional coverage for subsequent events. The reinsurance program included multiple year protection with $89.0 million of new multiple year protection this year and $156.0 million of renewed multiple year protection from last year. These private market excess of loss treaties structure coverage into layers, with a cascading feature such that substantially all layers attach after $25.1 million in losses for FNIC’s exposure. FNIC purchased an underlying limit of protection for $7.1 million excess of $18.0 million with prepaid automatic reinstatement protection. These treaties are with reinsurers that had an A.M. Best Company (“A.M. Best”) or Standard & Poor’s rating of “A-” or better, or have fully collateralized their maximum potential obligations in dedicated trusts.

FNIC’s non-Florida excess of loss reinsurance treaties afford us up to an additional $21.0 million of aggregate coverage with first event coverage totaling $5.0 million and second event coverage up to $16.0 million. The Non-Florida retention is lowered to $13.0 million for the first event and $2.0 million for the second event (for hurricane losses only) on a gross basis though it is reduced to $6.5 million and $1.0 million on a net basis after taking into account the profit share agreement that FNIC has with our non-affiliated managing general underwriter that writes our Non-Florida property business. FNIC’s Non-Florida reinsurance program cost includes $1.7 million for this private reinsurance, including prepaid automatic premium reinstatement protection.

MNIC’s 2017-2018 reinsurance program, which cost $5.0 million, including $3.2 million for the private reinsurance for MNIC’s Florida exposure including prepaid automatic premium reinstatement protection on all layers, along with $1.8 million payable to FHCF. The combination of private and FHCF reinsurance treaties affords MNIC with $109.0 million of aggregate coverage with a maximum single event coverage totaling approximately $68.1 million, exclusive of retentions. MNIC maintained its FHCF participation at 75% for the 2017 hurricane season.

MNIC’s private market excess of loss treaties became effective July 1, 2017, and all private layers have prepaid automatic reinstatement protection, which affords MNIC additional coverage for subsequent events, and have a cascading feature such that substantially all layers attach at $3.4 million for MNIC’s Florida exposure. These treaties are with reinsurers that currently had an A.M. Best or Standard & Poor’s rating of “A-” or better, or have fully collateralized their maximum potential obligations in dedicated trusts.

2018-2019 Excess of Loss Reinsurance Programs
With the February 21, 2018 acquisition of the minority interests of MNIC, the Company has combined both FNIC and MNIC under a single program allowing the Company to capitalize on efficiencies and scale. FNIC and MNIC’s combined 2018-2019 reinsurance programs is estimated to cost $148.8 million. This amount includes approximately $102.7 million for the private reinsurance for the

- 18-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

Company’s exposure, including prepaid automatic premium reinstatement protection, along with approximately $46.1 million payable to the FHCF. The combination of private and FHCF reinsurance treaties affords FNIC and MNIC approximately $1.8 billion of aggregate coverage with a maximum single event coverage totaling approximately $1.3 billion, exclusive of retentions. Both FNIC and MNIC maintained their FHCF participation at 75% for the 2018 hurricane season. FNIC’s single event pre-tax retention for a catastrophic event in Florida is $20.0 million, up slightly from the 2017-2018 reinsurance program and MNIC’s single event pre-tax retention for a catastrophic event is $3.0 million, down slightly from the 2017-2018 reinsurance program.

The combined FNIC and MNIC private market excess of loss treaties, covering both Florida and non-Florida exposures, became effective July 1, 2018 and all private layers have prepaid automatic reinstatement protection, which affords the Company additional coverage for subsequent events. These private market excess of loss treaties structure coverage into layers, with a cascading feature such that substantially all layers attach after $20.0 million in losses for FNIC and after $3.0 million in losses for MNIC. If the aggregate limit of the preceding layer is exhausted, the next layer drops down (cascades) in its place. Additionally, any unused layer protection drops down for subsequent events until exhausted. Given current market conditions, FNIC has elected not to purchase any multiple year protection and terminated the second year of the $89.0 million of multiple year protection that FNIC purchased last year on a two-year basis. FNIC also had $156.0 million of multiple year protection that expired on June 30, 2018. The overall reinsurance programs are with reinsurers that currently have an A.M. Best or Standard & Poor’s rating of “A-” or better, or have fully collateralized their maximum potential obligations in dedicated trusts.

FNIC’s non-Florida excess of loss reinsurance treaties afford us an additional $23.0 million of aggregate coverage with first event coverage totaling $5.0 million and second event coverage totaling $18.0 million, with the incremental $13.0 million of second event coverage applying to hurricane losses only. The end result is a non-Florida retention of $15.0 million for the first event and $2.0 million for the second event though these retentions are reduced to $7.5 million and $1.0 million after taking into account the profit sharing agreement that FNIC has with the nonaffiliated managing general underwriter that writes our non-Florida property business. FNIC’s non-Florida reinsurance program cost will approximate $2.0 million for this private reinsurance, including prepaid automatic premium reinstatement protection.

The Company’s cost and amounts of reinsurance are based on management’s current analysis of exposure to catastrophic risk. The data will be subjected to exposure level analysis at various dates during the period ending December 31, 2018. This analysis of the Company’s exposure level in relation to the total exposures to the FHCF and excess of loss treaties may produce changes in retentions, limits and reinsurance premiums as a result of increases or decreases in the Company’s exposure level.

Quota-Share Reinsurance Programs
FNIC's reinsurance programs also include quota-share treaties. One such treaty for 30% became effective July 1, 2014, and another for 10% became effective on July 1, 2015 with each running for two years. The combined treaties provided up to a 40% quota-share reinsurance on covered losses for the homeowners’ property and liability insurance program in Florida. The treaties are accounted for as retrospectively rated contracts whereby the estimated ultimate premium or commission is recognized over the period of the contracts.

On July 1, 2016, the 30% quota-share treaty expired on a cut-off basis, which means as of that date the Company retained an incremental 30% of its unearned premiums and losses. On July 1, 2017, the 10% quota-share treaty expired on a cut-off basis, which means as of that date we retained an incremental 10% of the underlying unearned premiums and losses. The reinsurers remain liable for the paid losses occurring during the terms of the treaties, until each treaty is commuted.

On July 1, 2017, FNIC bound a 10% quota-share on its Florida homeowners book of business, which excluded named storms, subject to certain limitations including, but not limited to caps on losses associated with occurrences. This treaty is not subject to accounting as a retrospectively rated contract.

This treaty expired on July 1, 2018 on a cut-off basis, meaning that the reinsurer will not be liable (under this agreement) for losses as a result of occurrences taking place after the date of termination, and the unearned premium previously ceded will be returned to FNIC.

FNIC’s quota-share reinsurance program for 2018-2019, is a treaty on FNIC’s Florida homeowners book of business, which became effective on July 1, 2018 on an in-force, new and renewal basis, excluding named storms, and was initially set at 2%, which is subject to certain limitations including, but not limited to caps on losses associated with occurrences. In addition, this quota-share allows FNIC the flexibility to prospectively increase or decrease the cession percentage up to three times during the term of the agreement. Effective October 1, 2018, FNIC elected to increase the cession percentage from 2% to 10% on an in-force, new and renewal basis.


- 19-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

The Company’s private passenger automobile quota-share treaties are typically programs which become effective at different points in the year and cover auto policies across several states. The automobile quota-share treaties cede approximately 75% of all written premiums entered into by the Company, subject to certain limitations including, but not limited to premium and other caps.

Associated Trust Agreements
Certain reinsurance agreements require FNIC and MNIC to secure the credit, regulatory and business risk. Fully funded trust agreements securing these risks for FNIC totaled less than $0.1 million as of March 31, 2019 and December 31, 2018.

Reinsurance Recoverable, Net

Amounts recoverable from reinsurers are recognized in a manner consistent with the claims liabilities associated with the reinsurance placement and presented on the consolidated balance sheet as reinsurance recoverable. Reinsurance recoverable, net consisted of the following:
໿
 
 
March 31,
 
December 31,
 
 
2019
 
2018
 
 
(In thousands)
Reinsurance recoverable on paid losses
 
$
67,629

 
$
45,028

Reinsurance recoverable on unpaid losses
 
234,293

 
166,396

Reinsurance recoverable, net
 
$
301,922

 
$
211,424


As of March 31, 2019 and December 31, 2018, the Company had reinsurance recoverable of $272.9 million and $183.5 million, respectively as a result of Hurricane Michael and Irma. All reinsurers in our excess-of-loss reinsurance programs have an A.M. Best or Standard & Poor’s rating of “A-“ or better, or have fully collateralized their maximum potential obligations in dedicated trusts.

Net Premiums Written and Net Premiums Earned

Net premiums written and net premiums earned consisted of the following:
໿
໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
(In thousands)
Net Premiums Written
 
 
 
 
Direct
 
$
132,233

 
$
134,395

Ceded
 
(11,793
)
 
(20,107
)
 
 
$
120,440

 
$
114,288

Net Premiums Earned
 
 

 
 

Direct
 
$
138,367

 
$
146,442

Ceded
 
(49,583
)
 
(64,333
)
 
 
$
88,784

 
$
82,109




- 20-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

6. LOSS AND LOSS ADJUSTMENT RESERVES

The liability for loss and LAE reserves is determined on an individual-case basis for all claims reported. The liability also includes amounts for unallocated expenses, anticipated future claim development and incurred but not reported ("IBNR").

Activity in the liability for loss and LAE reserves is summarized as follows:

 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
(In thousands)
Gross reserves, beginning-of-period
 
$
296,230

 
$
230,515

Less: reinsurance recoverable (1)
 
(166,396
)
 
(98,345
)
Net reserves, beginning-of-period
 
129,834

 
132,170

 
 
 
 
 
Incurred loss, net of reinsurance, related to:
 
 
 
 
Current year
 
67,048

 
48,459

Prior year loss development (redundancy) (2)
 
721

 
(653
)
Ceded losses subject to offsetting experience account adjustments (3)
 
(930
)
 
(1,735
)
Prior years
 
(209
)
 
(2,388
)
Total incurred loss and LAE, net of reinsurance
 
66,839

 
46,071

 
 
 

 
 
Paid loss, net of reinsurance, related to:
 
 

 
 
Current year
 
14,868

 
22,543

Prior years
 
41,974

 
30,911

Total paid loss and LAE, net of reinsurance
 
56,842

 
53,454

 
 
 

 
 
Net reserves, end-of-period
 
139,831

 
124,787

Plus: reinsurance recoverable (1)
 
234,293

 
111,427

Gross reserves, end-of-period
 
$
374,124

 
$
236,214


(1)
Reinsurance recoverable in this table includes only ceded loss and LAE reserves.
(2)
Reflects loss development from prior accident years impacting pre-tax net income. Excludes losses ceded under retrospective reinsurance treaties to the extent there is an offsetting experience account adjustment.
(3)
Reflects losses ceded under retrospective reinsurance treaties to the extent there is an offsetting experience account adjustment, such that there is no impact on pre-tax net income (loss).

The establishment of loss reserves is an inherently uncertain process and changes in loss reserve estimates are expected as such estimates are subject to the outcome of future events. The factors influencing changes in claim costs are often difficult to isolate or quantify and developments in paid and incurred losses from historical trends are frequently subject to multiple interpretations. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made.

During the three months ended March 31, 2019, the Company experienced $0.7 million of unfavorable loss and LAE reserve development on prior accident years in its commercial general liability and personal automobile lines of business, offset by redundancy in the homeowners line of business as a result of lower LAE expenses associated primarily with Hurricane Irma.

During the three months ended March 31, 2018, the Company experienced $0.7 million of favorable loss and LAE reserve redundancy in accident year 2017. The redundancy was the result of lower LAE expenses associated primarily with Hurricane Irma.

As previously disclosed, the Company entered into 30% and 10% retrospectively-rated Florida-only property quota-share treaties, which ended on July 1, 2016 and 2017, respectively.  These agreements included a profit share (experience account) provision, under which

- 21-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

the Company will receive ceded premium adjustments at the end of the treaty to the extent there is a positive balance in the experience account.  This experience account is based on paid losses rather than incurred losses.  Due to the retrospectively-rated nature of this treaty, when the experience account is positive we cede losses under these treaties as the claims are paid with an equal and offsetting adjustment to ceded premiums (in recognition of the related change to the experience account receivable), with no impact on net income.  Conversely, when the experience account is negative, the Company cedes losses on an incurred basis with no offsetting adjustment to ceded premiums, which impacts net income. Loss development can be either favorable or unfavorable regardless of whether the experience account is in a positive or negative position.

7. LONG-TERM DEBT

As discussed in Note 1 above, the net proceeds of the offering discussed in Senior Unsecured Notes below, were in part used to redeem all $45 million of the Company's Senior Unsecured Fixed Rate Notes Due 2022 and the Company's Senior Notes Due 2027. We recognized $3.6 million as interest expense in our consolidated statements of operations for the three months ended March 31, 2019, for prepayment fees, including the write-off unamortized debt issuance costs on the repayment.

Senior Unsecured Notes

On March 5, 2019, the Company completed a private placement offering and issued $100.0 million in principal amount of Senior Unsecured Fixed Rate Notes due 2029 (the "Notes”), pursuant to an indenture dated as of March 5, 2019 (the “Indenture”). The Notes mature on March 15, 2029 and bear interest at a fixed rate of 7.5% per year, payable semi-annually in arrears, subject to increases in the interest rate payable in the event of a downgrade in the credit rating assigned to the Notes. The Notes are not convertible or exchangeable for any equity securities, other securities or assets of the Company or any subsidiary.

The Company may redeem the Notes under certain circumstances as set forth in the Indenture. Prior to March 15, 2024, the Company may redeem the Notes, in whole or in part, at a redemption price equal to 100.00% of the principal amount of the Notes to be redeemed, plus the “Applicable Premium,” plus accrued and unpaid interest on such Notes, if any, on the Notes redeemed, to the applicable redemption date. The “Applicable Premium” is defined in the Indenture to mean, with respect to any Note on any applicable redemption date, the greater of (1) 1.0% of the then-outstanding principal amount of such Note and (2) the excess (if any) of: (A) the present value at such redemption date of (i) the applicable redemption price of such Note at March 15, 2024 (excluding any accrued but unpaid interest), plus (ii) all required interest payments due on such Note through March 15, 2024 (excluding accrued but unpaid interest), computed using a discount rate equal to the Treasury Rate (as defined in the Indenture) on such redemption date plus 50 basis points; over (B) the then-outstanding principal amount of such Note.

On and after March 15, 2024, the Company may redeem the Notes, in whole or in part, at 103.750% in 2024, 101.875% in 2025, and 100% in 2026 and thereafter, together with any accrued and unpaid interest on the Notes being redeemed to but excluding the date of redemption.

If a change in control of the Company, as defined in the Indenture, occurs, the holders of the Notes will have the right to require the Company to purchase all or a portion of their Notes at a price in cash equal to 101% of the principal amount thereof, plus any accrued but unpaid interest.

The Notes are senior unsecured obligations of the Company and will rank equally with all of the Company’s other future senior unsecured indebtedness. The Indenture includes customary covenants and events of default. Among other things, the covenants restrict the ability of the Company and its subsidiaries to incur additional indebtedness or make restricted payments, including dividends, under certain circumstances, require the Company to maintain certain levels of reinsurance coverage while the Notes remain outstanding, and maintain certain financial covenants. These covenants are subject to important exceptions and qualifications set forth in the Indenture. Principal and interest on the Notes are subject to acceleration in the event of certain events of default, including automatic acceleration upon certain bankruptcy-related events.

- 22-



Long-term debt consisted of the following:
 
 
March 31,
 
December 31,
 
 
2019
 
2018
 
 
(In thousands)
Senior unsecured fixed rate notes, due March 15, 2029, net of deferred financing costs of $1,599 and $0, respectively
 
$
98,401

 
$

Senior unsecured floating rate notes, due December 31, 2027, net of deferred financing costs of $0 and $348, respectively
 

 
24,652

Senior unsecured fixed rate notes, due December 31, 2022, net of deferred financing costs of $0 and $248, respectively
 

 
19,752

Total long-term debt, net
 
$
98,401

 
$
44,404


As of March 31, 2019, the Company's estimated annual aggregate amount of debt maturities includes the following:

 
 
Aggregate
 
 
Debt
For the Years Ending December 31,
 
Maturities
 
 
(In thousands)
2019
 
$

2020
 

2021
 

2022
 

2023
 

Thereafter
 
100,000

Total debt maturities
 
100,000

Less: deferred financing costs
 
1,599

Total debt maturities, net
 
$
98,401



8. INCOME TAXES

Our effective income tax rate is the ratio of income tax expense (benefit) over our income (loss) before income taxes. The effective income tax rate was 26.2% and 24.7% for the three months ended March 31, 2019 and 2018, respectively. Differences in the effective tax and the statutory Federal income tax rate of 21% are driven by state income taxes and anticipated annual permanent differences, including estimates for tax-exempt interest, dividends received deduction, executive compensation and other items.

The Company had an uncertain tax position of $0.6 million as of March 31, 2019 and December 31, 2018. The Company does not have a valuation allowance as of March 31, 2019 and December 31, 2018.

We recognize accrued interest and penalties related to unrecognized tax benefits in income tax expense (benefit) in the consolidated statements of operations and statements of comprehensive income (loss). For the three months ended March 31, 2019 and 2018, the Company did not recognize any expenses related to an uncertain tax position and our associated accrued interest and penalties was less than $0.1 million.

- 23-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019


9. COMMITMENTS AND CONTINGENCIES

Litigation and Legal Proceedings

In the ordinary course of business, the Company is involved in various legal proceedings, specifically claims litigation.  The Company’s insurance subsidiaries participate in most of these proceedings by either defending third-party claims brought against insureds or litigating first-party coverage claims.  The Company accounts for such activity through the establishment of loss and LAE reserves.  The Company’s management believes that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, is immaterial to the Company’s consolidated financial statements.  The Company is also occasionally involved in other legal and regulatory proceedings, some of which may assert claims for substantial amounts, making the Company party to individual actions in which extra contractual damages, punitive damages or penalties, such as claims alleging bad faith in the handling of insurance claims, are sought.

The Company reviews the outstanding matters, if any, on a quarterly basis.  The Company accrues for estimated losses and contingent obligations in the consolidated financial statements if and when the obligation or potential loss from any litigation, legal proceeding or claim is considered probable and the amount of the potential exposure is reasonably estimable.  The Company records such probable and estimable losses, through the establishment of legal expense reserves.  As events evolve, facts concerning litigation and contingencies become known and as additional information becomes available, the Company’s management reassesses its potential liabilities related to pending claims and litigation and may revise its previous estimates and make appropriate adjustment to the financial statements. Estimates that require judgment are subject to change and are based on management’s assessment, including the advice of legal counsel, the expected outcome of litigation and legal proceedings or other dispute resolution proceedings or the expected resolution of contingencies. The Company’s management believes that the Company’s accruals for probable and estimable losses are reasonable and that the amounts accrued do not have a material effect on the Company’s consolidated financial statements.

Our significant litigation and legal proceedings were discussed in Note 9 of our 2018 Form 10-K.

Assessment Related Activity

The Company operates in a regulatory environment where certain entities and organizations have the authority to require us to participate in assessments. Currently these entities and organizations include: Florida Insurance Guaranty Association (“FIGA”), Citizens Property Insurance Corporation (“Citizens”), FHCF, Florida Automobile Joint Underwriters Association (“JUA”), Georgia Insurers Insolvency Pool (“GIIP”), Special Insurance Fraud Fund (“SIIF”), Fair Access to Insurance Requirements Plan (“FAIRP”), Georgia Automobile Insurance Plan (“GAIP”), Property Insurance Association of Louisiana (“PIAL”), Louisiana Automobile Insurance Plan (“LAIP”), South Carolina Property & Casualty Insurance Guaranty Association (“SCPCIGA”), Texas Property and Casualty Insurance Guaranty Association (“TPCIGA”), Texas Windstorm Insurance Association (“TWIA”), Texas Automobile Insurance Plan Association (“TAIPA”), Alabama Insurance Guaranty Association (“AIGA”), and Alabama Insurance Underwriters Association (“AIUA”). As a direct premium writer in Florida, we are required to participate in certain insurer solvency associations under Florida law, administered by FIGA.

FNIC is also required to participate in an insurance apportionment plan under Florida law, which is referred to as a JUA Plan. The JUA Plan provides for the equitable apportionment of any profits realized, or losses and expenses incurred, among participating automobile insurers. In the event of an underwriting deficit incurred by the JUA Plan, which is not recovered through the policyholders in the JUA Plan, such deficit shall be recovered from the companies participating in the JUA Plan in the proportion that the net direct written premiums of each such member during the preceding calendar year bear to the aggregate net direct premiums written in this state by all members of the JUA Plan. There were no material assessments by the JUA Plan as of December 31, 2018. Future assessments by the JUA and the JUA Plan are indeterminable at this time.


- 24-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

Leases

The Company is committed under an operating lease agreement for office space with a nine-and-a-half-year term remaining.

The right-of-use asset is reflected in other assets and the lease liability is reflected in other liabilities on our Consolidated Balance Sheets. Lease expense, net of sublease income is reflected in general and administrative expenses on our Consolidated Statements of Operations.

Additional information related to our operating lease agreement for office space consisted of the following:
 
 
March 31,
 
 
2019
 
 
(In thousands)
Right-of-use asset
 
$
8,103

Accrued rent
 
(140
)
Right-of-use asset, net
 
$
7,963

 
 
 
Lease liability
 
$
8,103

 
 
 
Weighted-average discount rate
 
4.71
%

 
 
Three
 
 
Months
 
 
Ended
 
 
March 31, 2019
 
 
(In thousands)
Lease expense
 
$
260

Sublease income
 

Lease expense, net
 
$
260

 
 
 
Net cash provided by (used in) operating activities
 
$
(137
)

The interest rate implicit in our lease was not known, therefore the weighted-average discount rate above was determined by what FedNat would have had to pay to borrow the lease payments in a similar economic environment that existed at inception of our lease while considering our general credit and the theoretical collateral of the office space. In the event of a change to lease term, the Company would re-evaluate all inputs and assumptions, including the discount rate.

Refer to Note 2 above for additional information regarding the implementation of new lease accounting rules on January 1, 2019.

10. SHAREHOLDERS' EQUITY

Common Stock Repurchases

The Company may repurchase shares in open market transactions in accordance with Rule 10b-18 or under Rule 10b5-1 of the Exchange Act from time to time in its discretion, based on ongoing assessments of the Company’s capital needs, the market price of its common stock and general market conditions. The amount and timing of all repurchase transactions are contingent upon market conditions, applicable legal requirements and other factors.

In December 2018, the Company’s Board of Directors authorized an additional share repurchase program under which the Company may repurchase up to $10.0 million of its outstanding shares of common stock through December 31, 2019. As of March 31, 2019, the remaining availability for future repurchases of our common stock under this program was $10.0 million.

- 25-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019


The Company may repurchase shares in open market transactions in accordance with Rule 10b-18 or under Rule 10b5-1 of the Exchange Act from time to time in its discretion, based on ongoing assessments of the Company’s capital needs, the market price of its common stock and general market conditions. The amount and timing of all repurchase transactions are contingent upon market conditions, applicable legal requirements and other factors.

Securities Offerings

In June 2018, the Company filed with the Securities and Exchange Commission (“SEC”) on Form S-3, a shelf registration statement enabling the Company to offer and sell, from time to time, up to an aggregate of $150.0 million of securities. No securities have been offered or sold under this registration statement.

Stock Compensation Plan

In June 2018, the Company filed with the SEC on Form S-8, a registration statement registering 800,000 shares of common stock reserved for issuance under the Company’s 2018 Omnibus Incentive Compensation Plan (the “2018 Plan”).  The 2018 Plan, which was approved by the Company’s shareholders at the 2018 annual meeting, is an equity compensation plan that may be used for our employees, non-employee directors, consultants and advisors.

Share-Based Compensation Expense

Share-based compensation arrangements include the following:
໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
(In thousands)
Restricted stock
 
$
494

 
$
623

Performance stock
 
181

 
42

Total share-based compensation expense
 
$
675

 
$
665

 
 
 

 
 

Recognized tax benefit
 
$
171

 
$
169

Intrinsic value of options exercised
 

 

Fair value of restricted stock vested
 
$
927

 
$
1,187


The intrinsic value of options exercised represents the difference between the stock option exercise price and the weighted average closing stock price of FNHC common stock on the exercise dates, as reported on the NASDAQ Global Market.

Stock Option Awards

A summary of the Company’s stock option activity includes the following:
໿
 
 
Number of Shares
 
Weighted Average Option Exercise Price
Outstanding at January 1, 2019
 
39,017

 
$
3.80

Granted
 

 

Exercised
 

 

Cancelled
 

 

Outstanding at March 31, 2019
 
39,017

 
$
3.80



- 26-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019

Restricted Stock Awards

The Company recognizes share-based compensation expense for all restricted stock awards (“RSAs”) held by the Company’s directors, executives and other key employees. For all RSA awards, excluding relative total shareholder return ("TSR"), the accounting charge is measured at the grant date as the fair value of FNHC common stock and expensed as non-cash compensation over the vesting term using the straight-line basis for service awards and over successive one-year requisite service periods for performance‑based awards.
Our expense for our performance awards depends on achievement of specified results; therefore, the ultimate expense can range from 0% to 250% of target. Our TSR cliff vesting awards contain performance criteria which are tied to the achievement of certain market conditions. The TSR grant date fair value was determined using a Monte Carlo simulation and, unlike the performance condition awards, the expense is not reversed if the performance condition is not met. This value is recognized as expense over the requisite service period using the straight‑line recognition method.

During the three months ended March 31, 2019 and 2018, the Board of Directors granted 140,156 and 130,458 RSAs, respectively, vesting over three or five years, to the Company’s directors, executives and other key employees.

RSA activity includes the following:
 
 
Number of Shares
 
Weighted Average Grant Date Fair Value
Outstanding at January 1, 2019
 
262,334

 
$
18.78

Granted
 
140,156

 
18.03

Vested
 
(51,957
)
 
17.85

Cancelled
 
(10,990
)
 
18.27

Outstanding at March 31, 2019
 
339,543

 
$
18.64


The weighted average grant date fair value is measured using the closing price of FNHC common stock on the grant date, as reported on the NASDAQ Global Market.

Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income (loss) associated with debt securities - available-for-sale consisted of the following:
໿
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
Before Tax
 
Income Tax
 
Net
 
Before Tax
 
Income Tax
 
Net
 
 
(In thousands)
Accumulated other comprehensive income (loss), beginning-of-period
 
$
(5,023
)
 
$
1,273

 
$
(3,750
)
 
$
2,287

 
$
(593
)
 
$
1,694

Cumulative effect of new accounting standards
 

 

 

 
(1,349
)
 
355

 
(994
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassification
 
11,528

 
(2,922
)
 
8,606

 
(7,200
)
 
1,825

 
(5,375
)
Reclassification adjustment for realized losses (gains) included in net income
 
(2,301
)
 
583

 
(1,718
)
 
1,052

 
(238
)
 
814

 
 
9,227

 
(2,339
)
 
6,888

 
(6,148
)
 
1,587

 
(4,561
)
Accumulated other comprehensive income (loss), end-of-period
 
$
4,204

 
$
(1,066
)
 
$
3,138

 
$
(5,210
)
 
$
1,349

 
$
(3,861
)


- 27-


FedNat Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2019


11. EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the period, including vested restricted stock awards during the period. Diluted EPS is computed by dividing net income by the weighted average number of shares outstanding, noted above, adjusted for the dilutive effect of stock options and unvested restricted stock awards.  Dilutive securities are common stock equivalents that are freely exercisable into common stock at less than market prices or otherwise dilute earnings if converted. The net effect of common stock equivalents is based on the incremental common stock that would be issued upon the assumed exercise of common stock options and the vesting of RSAs using the treasury stock method. Common stock equivalents are not included in diluted earnings per share when their inclusion is antidilutive.

The following table presents the calculation of basic and diluted EPS:
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
(In thousands, except per share data)
Net income (loss) attributable to FedNat Holding Company shareholders
 
$
(3,865
)
 
$
7,463

 
 
 

 
 

Weighted average number of common shares outstanding - basic
 
12,795

 
12,850

 
 
 
 
 
Net income (loss) per common share - basic     
 
$
(0.30
)
 
$
0.58

 
 
 

 
 

 
 
 

 
 

Weighted average number of common shares outstanding - basic
 
12,795

 
12,850

Dilutive effect of stock compensation plans
 

 
95

Weighted average number of common shares outstanding - diluted
 
12,795

 
12,945

 
 
 
 
 
Net income (loss) per common share - diluted
 
$
(0.30
)
 
$
0.58

 
 
 

 
 

Dividends per share
 
$
0.08

 
$
0.08


Dividends Declared

In January 2019, our Board of Directors declared a $0.08 per common share dividend, payable in March 2019, to shareholders of record on February 14, 2019, amounting to $1.0 million.

In May 2019, our Board of Directors declared a $0.08 per common share dividend, payable in June 2019, to shareholders of record on May 14, 2019, amounting to $1.0 million.

12. SUBSEQUENT EVENTS

Dividends Declared

Refer to Note 11 above for information related to our dividend declared in May 2019.

- 28-



General information about FedNat Holding Company can be found at www.FedNat.com; however, the information that can be accessed through our website is not part of our report. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to the Securities and Exchange Act of 1934 available free of charge on our website, as soon as reasonably practicable after they are electronically filed with the SEC.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and notes thereto included under Part I, Item 1 of this Quarterly Report on Form 10-Q (the “Form 10-Q”). In addition, please refer to our audited consolidated financial statements and notes thereto and related “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our most recent Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Form 10-K”).

Unless the context requires otherwise, as used in the remainder of this Form 10-Q, the terms “FNHC,” “Company,” “we,” “us” and “our” refer to FedNat Holding Company and its consolidated subsidiaries.

Below, in addition to providing consolidated revenues and net income (loss), we also provide adjusted operating revenues and adjusted operating income (loss) because we believe these non-United States of America generally accepted accounting principles ("GAAP") performance measures allow for a better understanding of the underlying trend in our business, as the excluded items are not necessarily indicative of our operating fundamentals or performance.
 
Non-GAAP measures do not replace the most directly comparable GAAP measures and we have included a detailed reconciliation thereof in "Results of Operations" below.

We exclude the after-tax (using our prevailing income tax rate) effects of the following items from GAAP net income (loss) to arrive at adjusted operating income (loss):

Net realized and unrealized gains (losses), including, but not limited to, gains (losses) associated with investments and early extinguishment of debt;
Acquisition/integration and other costs and the amortization of specifically identifiable intangibles (other than value of business acquired);
Impairment of intangibles;
Income (loss) from initial adoption of new regulations and accounting guidance; and
Income (loss) from discontinued operations.

We also exclude the pre-tax effect of the first bullet above from GAAP revenues to arrive at adjusted operating revenues.

Forward-Looking Statements

This Form 10-Q or the documents that are incorporated by reference into this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are therefore entitled to the protection of the safe harbor provisions of these laws. These statements may be identified by the use of forward-looking terminology such as “anticipate,” “believe,” “budget,” “contemplate,” “continue,” “could,” “envision,” “estimate,” “expect,” “forecast,” “guidance,” “indicate,” “intend,” “may,” “might,” “outlook,” “plan,” “possibly,” “potential,” “predict,” “probably,” “pro-forma,” “project,” “seek,” “should,” “target,” “will,” “would,” “will be,” “will continue” or the negative thereof or other variations thereon or comparable terminology. We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve a number of risks and uncertainties, many of which are beyond our control. These and other important factors may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. Management cautions that the forward-looking statements contained in this Form 10-Q are not guarantees of future performance, and we cannot assume that such statements will be realized or the forward-looking events and circumstances will occur. Factors that might cause such a difference include, without limitation, the risks and uncertainties discussed under “Risk Factors” in our 2018 Form 10-K, and discussed from time to time in our reports filed with the Securities and Exchange Commission (“SEC”).


- 29-



Given these risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included or incorporated by reference into this Form 10-Q are made only as of the date hereof. We do not undertake and specifically disclaim any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments.

GENERAL

The Company is an insurance holding company that controls substantially all aspects of the insurance underwriting, distribution and claims processes through our subsidiaries and contractual relationships with independent agents and general agents.   We, through our wholly owned subsidiaries, are authorized to underwrite, and/or place homeowners multi-peril (“homeowners”), federal flood and other lines of insurance in Florida and other states. We market, distribute and service our own and third-party insurers’ products and other services through a network of independent and general agents.

FedNat Insurance Company (“FNIC”), our largest wholly-owned insurance subsidiary, is licensed as an admitted carrier, to write specific lines of insurance by the state’s insurance departments, in Florida, Louisiana, Texas, Georgia, South Carolina and Alabama.  Monarch National Insurance Company (“MNIC”), our other insurance subsidiary, is licensed as an admitted carrier in Florida. Admitted carriers are bound by rate and form regulations, and are strictly regulated to protect policyholders. Admitted carriers are also required to financially contribute to the state guarantee fund used to pay for losses if an insurance carrier becomes insolvent or unable to pay loss amounts due to their policyholders.

Through our wholly-owned subsidiary, FedNat Underwriters, Inc. (“FNU”), we serve as managing general agent for FNIC and MNIC.

Maison Acquisition

On February 25, 2019, the Company executed a definitive agreement for the acquisition of the insurance operations of 1347 Property Insurance Holdings, Inc. ("PIH"). Specifically, the Company will purchase Maison Insurance Company, Maison Managers, Inc., and ClaimCor LLC (collectively, the "Maison Companies"). The purchase price is $51.0 million, which includes $25.5 million in cash and $25.5 million in shares of the Company’s common stock. Additionally, in connection with the pending acquisition, on March 5, 2019, the Company closed on an offering of $100 million of Senior Unsecured Notes due 2029, which bear interest at the annual rate of 7.5% (the "2029 Notes"). The cash from the offering was used in part to retire the full $45.0 million of outstanding debt (thereby lowering our overall cost of borrowing) and will be used to purchase the Maison Companies and other general corporate purposes.

Refer to Note 1 of the notes to our Consolidated Financial Statements included herein, for additional information regarding the pending acquisition, including regulatory and other necessary approval and the potential timing thereof.

Material Distribution Relationships

We are a party to an insurance agency master agreement with Ivantage Select Agency, Inc. (“ISA”), an affiliate of Allstate Insurance Company (“Allstate”), pursuant to which we have been authorized by ISA to appoint Allstate agents to offer our homeowners and commercial general liability insurance products to consumers in Florida.

We are a party to a managing general underwriting agreement with SageSure Insurance Managers, LLC (“SageSure”) in which they underwrite our FNIC homeowners business outside of Florida. 

Overview of Insurance Lines of Business

Homeowners’ Property and Casualty Insurance
FNIC and MNIC underwrite homeowners insurance in Florida and FNIC also underwrites insurance in Alabama, Texas, Louisiana and South Carolina. Homeowners insurance generally protects an owner of real and personal property against covered causes of loss to that property. As of March 31, 2019, the total homeowners policies in-force was 296,525, of which 244,228 were in Florida and 52,297 were outside of Florida. As of December 31, 2018, the total homeowners policies in-force was 291,098, of which 246,619 were in Florida and 44,479 were outside of Florida.


- 30-



Florida
Our homeowners insurance products provide maximum dwelling coverage of approximately $3.6 million, with the aggregate maximum policy limit being approximately $6.3 million. We currently offer dwelling coverage “A” up to $4.0 million with an aggregate total insured value of $6.5 million. We continually review and update these limits. The typical deductible is either $2,500 or $1,000 for non-hurricane-related claims and generally 2% of the coverage amount for the structure for hurricane-related claims.

Premium rates charged to our homeowners insurance policyholders are continually evaluated to assure that they meet the expectation that they are actuarially sound and produce a reasonable level of profit (neither excessive, inadequate or discriminatory). Premium rates in Florida and other states are regulated and approved by the respective states’ office of insurance regulation.  We continuously monitor and seek appropriate adjustment to our rates in order to remain competitive and profitable.

In 2018, FNIC applied for a statewide average rate increase of 4.6% for Florida homeowners multiple-peril insurance policies, which was approved by the Florida OIR, which became effective for new and renewal policies on April 20, 2019.

Non-Florida
Our non-Florida homeowners insurance products, produced through our partnership with SageSure, provide maximum dwelling coverage “A” up to $1.8 million, with the aggregate maximum policy limit being approximately $3.6 million.  The typical deductible is either $2,500 or $1,000 for non-hurricane-related claims and generally 2% of the coverage amount for the structure for hurricane-related claims. 

As part of our partnership with SageSure, we entered into a profit share agreement, whereby we share 50% of net profits of this line of business, as calculated per the terms of the agreement, subject to certain limitations.

Other Insurance Lines of Business
FNIC writes flood insurance through the National Flood Insurance Program (“NFIP”). We write the policy for the NFIP, which assumes 100% of the flood risk while we retain a commission for our service. FNIC offers this line of business in Florida, Louisiana, Texas, South Carolina and Alabama. FNIC plans to file for an admitted flood endorsement as an alternative to the NFIP program.

See the discussion in Item 1: “Business” in our 2018 Form 10-K, for additional information with respect to our business.

Regulation

All insurance companies must file quarterly and annual statements with certain regulatory agencies and are subject to regular and special examinations by those agencies. We may be the subject of additional special examinations or analysis. These examinations or analysis may result in one or more corrective orders being issued by the Florida OIR. The Florida OIR has completed their regularly scheduled statutory examination of FNIC for the five years ended December 31, 2015, of MNIC for the period of March 17, 2015 (inception) through December 31, 2015 and of MNIC for the year ended December 31, 2016. There were no material findings by the Florida OIR in connection with these examinations.



- 31-



RESULTS OF OPERATIONS

Operating Results Overview - Three Months Ended March 31, 2019 Compared with Three Months Ended March 31, 2018

The following overview does not address all of the matters covered in the other sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations or contain all of the information that may be important to our shareholders or the investing public. This overview should be read in conjunction with the other sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations herein and in our 2018 Form 10-K.

The following table sets forth results of operations for the periods presented:
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
% Change
 
2018
 
 
(Dollars in thousands)
Revenues:
 
 
 
 
 
 
Gross premiums written
 
$
132,233

 
(1.6
)%
 
$
134,395

Gross premiums earned
 
138,367

 
(5.5
)%
 
146,442

Ceded premiums
 
(49,583
)
 
(22.9
)%
 
(64,333
)
Net premiums earned
 
88,784

 
8.1
 %
 
82,109

Net investment income
 
3,710

 
26.1
 %
 
2,943

Net realized and unrealized investment gains (losses)
 
2,301

 
(318.7
)%
 
(1,052
)
Direct written policy fees
 
2,391

 
(33.1
)%
 
3,576

Other income
 
4,011

 
(27.1
)%
 
5,501

Total revenues
 
101,197

 
8.7
 %
 
93,077

 
 
 

 
 
 
 
Costs and expenses:
 
 

 
 
 
 
Losses and loss adjustment expenses
 
66,839

 
45.1
 %
 
46,071

Commissions and other underwriting expenses
 
28,234

 
(6.6
)%
 
30,221

General and administrative expenses
 
6,311

 
3.7
 %
 
6,085

Interest expense
 
5,051

 
366.0
 %
 
1,084

Total costs and expenses
 
106,435

 
27.5
 %
 
83,461

 
 
 

 
 
 
 
Income (loss) before income taxes
 
(5,238
)
 
(154.5
)%
 
9,616

Income tax expense (benefit)
 
(1,373
)
 
(157.9
)%
 
2,371

Net income (loss)
 
(3,865
)
 
(153.3
)%
 
7,245

Net income (loss) attributable to non-controlling interest
 

 
(100.0
)%
 
(218
)
Net income (loss) attributable to FNHC shareholders
 
$
(3,865
)
 
(151.8
)%
 
$
7,463

 
 
 

 
 

 
 

Ratios to net premiums earned:
 
 

 
 

 
 

Net loss ratio
 
75.3
%
 
 

 
56.1
%
Net expense ratio
 
38.9
%
 
 

 
44.2
%
Combined ratio
 
114.2
%
 
 

 
100.3
%

(1)
Net loss ratio is calculated as losses and loss adjustment expenses ("LAE") divided by net premiums earned.
(2)
Net expense ratio is calculated as all operating expenses less interest expense divided by net premiums earned.
(3)
Combined ratio is calculated as the sum of losses and LAE and all operating expenses less interest expense divided by net premiums earned.





- 32-



The following table sets forth a reconciliation of GAAP to non-GAAP measures:

 
 
As of or For the Three Months Ended March 31,
 
 
2019
 
2018
 
 
Homeowners
 
Automobile
 
Other
 
Consolidated
 
Homeowners
 
Automobile
 
Other
 
Consolidated
 
 
 
 
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
Revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total revenues
 
$
93,651

 
$
20

 
$
7,526

 
$
101,197

 
$
83,305

 
$
4,166

 
$
5,606

 
$
93,077

Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net realized and unrealized investment gains (losses)
 

 

 
2,301

 
2,301

 

 

 
(1,052
)
 
(1,052
)
Adjusted operating revenues
 
$
93,651

 
$
20

 
$
5,225

 
$
98,896

 
$
83,305

 
$
4,166

 
$
6,658

 
$
94,129

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Income (Loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(1,423
)
 
$
(679
)
 
$
(1,763
)
 
$
(3,865
)
 
$
6,941

 
$
(41
)
 
$
563

 
$
7,463

Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net realized and unrealized investment gains (losses)
 

 

 
1,718

 
1,718

 

 

 
(785
)
 
(785
)
Acquisition and other costs
 
(36
)
 

 
(484
)
 
(520
)
 
(176
)
 
(21
)
 
(19
)
 
(216
)
Gain (loss) on early extinguishment of debt
 

 

 
(2,669
)
 
(2,669
)
 

 

 

 

Adjusted operating income (loss)
 
$
(1,387
)
 
$
(679
)
 
$
(328
)
 
$
(2,394
)
 
$
7,117

 
$
(20
)
 
$
1,367

 
$
8,464

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income tax rate assumed for reconciling items above
 
25.35
%
 
25.35
%
 
25.35
%
 
25.35
%
 
25.35
%
 
25.35
%
 
25.35
%
 
25.35
%


- 33-



The table below summarizes our unaudited results of operations by line of business for the periods presented. Although we conduct our operations under a single reportable segment, we have provided line of business information as we believe it is useful to our shareholders and the investing public. “Homeowners” line of business consists of our homeowners and fire property and casualty insurance business. “Automobile” line of business consists of our nonstandard personal automobile insurance business. “Other” line of business primarily consists of our commercial general liability and federal flood businesses, along with corporate and investment operations.
 
Three Months Ended March 31,
 
2019
 
2018
 
Homeowners
 
Automobile
 
Other
 
Consolidated
 
Homeowners
 
Automobile
 
Other
 
Consolidated
 
(Dollars in thousands)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written
$
129,283

 
$
(1
)
 
$
2,951

 
$
132,233

 
$
122,815

 
$
6,347

 
$
5,233

 
$
134,395

Gross premiums earned
133,842

 
22

 
4,503

 
138,367

 
132,463

 
8,328

 
5,651

 
146,442

Ceded premiums
(46,031
)
 
(17
)
 
(3,535
)
 
(49,583
)
 
(55,058
)
 
(6,117
)
 
(3,158
)
 
(64,333
)
Net premiums earned
87,811

 
5

 
968

 
88,784

 
77,405

 
2,211

 
2,493

 
82,109

Net investment income

 

 
3,710

 
3,710

 

 

 
2,943

 
2,943

Net realized and unrealized investment gains (losses)

 

 
2,301

 
2,301

 

 

 
(1,052
)
 
(1,052
)
Direct written policy fees
2,298

 
3

 
90

 
2,391

 
1,923

 
1,467

 
186

 
3,576

Other income
3,542

 
12

 
457

 
4,011

 
3,977

 
488

 
1,036

 
5,501

Total revenues
93,651

 
20

 
7,526

 
101,197

 
83,305

 
4,166

 
5,606

 
93,077

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Costs and expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss adjustment expenses
63,330

 
844

 
2,665

 
66,839

 
41,955

 
2,236

 
1,880

 
46,071

Commissions and other underwriting expenses
27,367

 
35

 
832

 
28,234

 
27,356

 
1,860

 
1,005

 
30,221

General and administrative expenses
4,860

 
50

 
1,401

 
6,311

 
4,889

 
125

 
1,071

 
6,085

Interest expense

 

 
5,051

 
5,051

 
100

 

 
984

 
1,084

Total costs and expenses
95,557

 
929

 
9,949

 
106,435

 
74,300

 
4,221

 
4,940

 
83,461

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) before income taxes
(1,906
)
 
(909
)
 
(2,423
)
 
(5,238
)
 
9,005

 
(55
)
 
666

 
9,616

Income tax expense (benefit)
(483
)
 
(230
)
 
(660
)
 
(1,373
)
 
2,282

 
(14
)
 
103

 
2,371

Net income (loss)
(1,423
)
 
(679
)
 
(1,763
)
 
(3,865
)
 
6,723

 
(41
)
 
563

 
7,245

Net income (loss) attributable to non-controlling interest

 

 

 

 
(218
)
 

 

 
(218
)
Net income (loss) attributable to FNHC shareholders
$
(1,423
)
 
$
(679
)
 
$
(1,763
)
 
$
(3,865
)
 
$
6,941

 
$
(41
)
 
$
563

 
$
7,463

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios to net premiums earned:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss ratio
72.1
%
 
NCM

 
275.3
%
 
75.3
%
 
54.2
%
 
101.1
%
 
75.4
%
 
56.1
%
Net expense ratio
36.7
%
 
 
 
 
 
38.9
%
 
41.7
%
 
 
 
 
 
44.2
%
Combined ratio
108.8
%
 
 
 
 
 
114.2
%
 
95.9
%
 
 
 
 
 
100.3
%


- 34-



Revenue

Total revenue increased $8.1 million or 8.7%, to $101.2 million for the three months ended March 31, 2019, compared with $93.1 million for the three months ended March 31, 2018. The increase was primarily driven by higher Homeowners net premiums earned as a result of decreased reinsurance spend and higher recognized gains on our investments, partially offset by the planned reductions in net premiums earned from Automobile and commercial general liability, all of which is discussed below.

Gross Premiums Written

The following table sets forth the gross premiums written for the periods presented:
໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
(In thousands)
Gross premiums written:
 
 
 
 
Homeowners Florida
 
$
103,963

 
$
108,371

Homeowners non-Florida
 
25,320

 
14,444

Automobile
 
(1
)
 
6,347

Commercial general liability
 
(53
)
 
2,514

Federal flood
 
3,004

 
2,719

Total gross premiums written
 
$
132,233

 
$
134,395


Gross premiums written decreased $2.2 million, or 1.6%, to $132.2 million in the quarter, compared with $134.4 million for the same three-month period last year. Gross premiums written decreased primarily due to the decline in the non-core businesses we are exiting, Automobile and commercial general liability, as well as a decline in homeowners Florida, partially offset by the growth in homeowners non-Florida. Our homeowners non-Florida business continues to show exceptional growth year over year, especially in the state of Texas, which is allowing us to leverage our infrastructure and diversify insurance risk. Overall, Homeowners grew 5.3%.

Gross Premiums Earned

The following table sets forth the gross premiums earned for the periods presented:
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
(In thousands)
Gross premiums earned:
 
 
 
 
Homeowners Florida
 
$
112,672

 
$
118,824

Homeowners non-Florida
 
21,170

 
13,639

Automobile
 
22

 
8,328

Commercial general liability
 
1,036

 
2,629

Federal flood
 
3,467

 
3,022

Total gross premiums earned
 
$
138,367

 
$
146,442


Gross premiums earned decreased $8.0 million, or 5.5%, to $138.4 million for the three months ended March 31, 2019, as compared to $146.4 million for the three months ended March 31, 2018. The results are a reflection of our decision to exit the Automobile and commercial general liability lines and were partially offset by a 1.0% increase in earned premiums in Homeowners.

- 35-



Ceded Premiums Earned

Ceded premiums decreased $14.7 million, or 22.9%, to $49.6 million in the quarter, compared to $64.3 million the same three-month period last year. The decrease was primarily driven by lower excess of loss reinsurance spend in Homeowners and lower ceded premiums in Automobile as a result of decreases in premiums earned during the period.

Net Investment Income

Net investment income increased $0.8 million, or 26.1%, to $3.7 million during the three months ended March 31, 2019, as compared to $2.9 million during the three months ended March 31, 2018. The increase was due to fixed income portfolio growth and the improvement in the yield as a result of rising interest rates from portfolio repositioning during the first quarter of 2018, particularly the sale of tax-free municipal bonds, the proceeds of which were reinvested in taxable municipal and corporate fixed income securities with higher coupon rates.

Net realized and Unrealized Investment Gains (Losses)

Net realized and unrealized investment gains (losses) increased $3.4 million, to $2.3 million for the three months ended March 31, 2019, compared to $(1.1) million in the prior year period. We recognized $2.3 million and $0.1 million in unrealized investment gains for equity securities during these respective periods.  Our prior year net realized losses were primarily due to the decision to liquidate certain bond positions, including positions related to tax-free municipal securities.

Direct Written Policy Fees

Direct written policy fees decreased by $1.2 million, or 33.1%, to $2.4 million for the three months ended March 31, 2019, compared with $3.6 million in the same period in 2018. The decrease in direct written policy fees is correlated to lower number of policies in-force in Automobile due to our decision to exit this line, as discussed earlier.

Other Income

Other income included the following for the periods presented:
໿
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
% Change
 
2018
 
 
(In thousands)
Other income:
 
 
 
 
 
 
Commission income
 
$
458

 
(67.5
)%
 
$
1,409

Brokerage
 
3,134

 
(11.5
)%
 
3,542

Financing and other revenue
 
419

 
(23.8
)%
 
550

Total other income
 
$
4,011

 
(27.1
)%
 
$
5,501


The decline in other income was driven by lower commission and brokerage revenue. The year over year decreases in commission income were driven by lower Automobile fee income from the reduction in premiums earned and, to a lesser extent, lower fee income from other areas of the business. The brokerage revenue decrease is the result of lower excess of loss reinsurance spend from the reinsurance program, which became effective July 1, 2018.


- 36-



Expenses

Losses and Loss Adjustment Expenses

Losses and loss adjustment expenses (“LAE”) increased $20.7 million, or 45.1%, to $66.8 million for the three months ended March 31, 2019, compared with $46.1 million for the same three-month period last year. The net loss ratio increased 19.2 percentage points, to 75.3% in the current quarter, as compared to 56.1% in the first quarter of 2018.  The higher ratio was primarily the result of $19.0 million of weather-related net losses in the quarter, which included $18.7 million from the March 2019 hail storm that passed through parts of Florida, including Brevard County.

Commissions and Other Underwriting Expenses

The following table sets forth the commissions and other underwriting expenses for the periods presented:
 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
 
 
(In thousands)
Commissions and other underwriting expenses:
 
 
 
 
Homeowners Florida
 
$
13,222

 
$
14,363

All others
 
5,267

 
4,800

Ceding commissions
 
(2,784
)
 
(3,715
)
Total commissions
 
15,705

 
15,448

 
 
 
 
 
Automobile
 
3

 
1,467

Homeowners non-Florida
 
676

 
186

Total fees
 
679

 
1,653

 
 
 
 
 
Salaries and wages
 
3,322

 
3,766

Other underwriting expenses
 
8,528

 
9,354

Total commissions and other underwriting expenses
 
$
28,234

 
$
30,221


Commissions and other underwriting expenses decreased $2.0 million, or 6.6%, to $28.2 million for the three months ended March 31, 2019, compared with $30.2 million for the three months ended March 31, 2018. The decrease is the result of lower Automobile fees and lower homeowners Florida commissions from the corresponding change in premiums earned across periods. Additionally, lower other underwriting expenses was the result of a reduction in general operating costs, partially offset by higher homeowners non-Florida fees from increased premiums earned.

The net expense ratio decreased 5.3 percentage points to 38.9% in the first quarter of 2019, as compared to 44.2% in the first quarter of 2018. The decrease in the ratio is primarily related to the lower reinsurance spend during the quarter driving higher net premiums earned. Refer to the discussion above for more information.

General and Administrative Expenses

General and administrative expenses increased $0.2 million by 3.7% to $6.3 million for the three months ended March 31, 2019 compared to $6.1 million in the first quarter of 2018. The slight increase was the result of $0.6 million in due diligence and other costs related to the previously announced purchase of the Maison Companies, partially offset by the lower payroll and professional fees as compared to the prior year.


- 37-



Interest Expense

Interest expense increased $4.0 million to $5.1 million for the three months ended March 31, 2019, compared with $1.1 million in the prior year period, primarily due to the result of $3.6 million of prepayment fees, including the write-off of remaining debt issuance costs, related to our repayment of the $45 million of Senior Notes issued in December 2017, during the quarter. Refer to Note 1 and 7 of the notes to our Consolidated Financial Statements included herein, for additional information regarding the debt retirement and new debt issued.
  
Income Taxes

Income taxes (benefits) decreased $3.8 million, to $(1.4) million for the three months ended March 31, 2019, compared to $2.4 million for the three months ended March 31, 2018. The decrease in income tax expense is the result of lower taxable income during the current quarter as compared to the first quarter of 2018.
໿

LIQUIDITY AND CAPITAL RESOURCES

Overview

Our primary sources of funds are gross written premiums, investment income, commission income and fee income.  Our primary uses of funds are the payment of claims, catastrophe and other reinsurance premiums and operating expenses.  As of March 31, 2019, the Company held $468.8 million in investments. Cash and cash equivalents increased $36.2 million, to $100.6 million as of March 31, 2019, compared with $64.4 million as of December 31, 2018, as discussed below, primarily due to the net proceeds of the offering, after redemption of our legacy $45 million principal amount. Total shareholders’ equity increased $2.6 million, to $217.9 million as of March 31, 2019, compared with $215.3 million as of December 31, 2018 due primarily to bond appreciation recognized during the first quarter of 2019, partially offset by net loss.

Historically, we have met our liquidity requirements primarily through cash generated from operations. On March 5, 2019, the Company closed on an offering of $100 million of Senior Unsecured Notes due 2029, which bear interest at the annual rate of 7.5%. The net proceeds of the offering were in part used to redeem all $45 million of the Company's Senior Unsecured Fixed Rate Notes due 2022 and the Company's Senior Notes due 2027. Additionally, the remaining cash from the offering will be used to purchase the Maison Companies for and other general corporate purposes, including potential repurchases of shares of our common stock and managing the capital needs of our subsidiaries. Refer to Notes 1 and 7 to the notes to the Consolidated Financial Statements included herein, for additional information regarding the Notes as well as the pending acquisition of the Maison Companies.

Among other things, the 2029 Notes contain customary covenants that limit the Company's ability to enter into certain operational and financial transactions, including, but not limited to incurring additional debt above certain thresholds. The Company's actual debt to capital ratio as of March 31, 2019 was approximately 31%.

Statutory Capital and Surplus of Our Insurance Subsidiaries

As described more fully in Part I, Item 1. Business, Regulation of our 2018 Form 10-K, for discussion of the Company’s insurance operations are subject to the laws and regulations of the states in which we operate.  The Florida OIR and their regulatory counterparts in other states utilize the National Association of Insurance Commissions (“NAIC”) risk-based capital (“RBC”) requirements, and the resulting RBC ratio, as a key metric in the exercise of their regulatory oversight.  The RBC ratio is a measure of the sufficiency of an insurer’s statutory capital and surplus.  In addition, the RBC ratio is used by insurance industry ratings services in the determination of the financial strength ratings (i.e., claims paying ability) they assign to insurance companies.  As of December 31, 2018, FNIC’s statutory surplus was $161.7 million and as of March 31, 2019, our statutory capital of FNIC was $154.7 million. 

Based on RBC requirements, the extent of regulatory intervention and action increases as the ratio of an insurer’s statutory surplus to its ACL, as calculated under the NAIC’s requirements, decreases.  The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200.0% of the ACL amount.  The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150.0% of the ACL amount. The third action level, ACL, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70.0% of the ACL amount. FNIC’s and MNIC's ratios of statutory surplus to its ACL was 329.9% and 774.4%, respectively, as of December 31, 2018.


- 38-



Cash Flows Discussion

We believe that existing cash and investment balances, when combined with anticipated cash flows and the proceeds of our debt offering as described above, will be adequate to meet our expected liquidity needs in both the short-term and the reasonably foreseeable future. We believe the combined balances will be sufficient to meet our ongoing operating requirements and anticipated cash needs, and satisfy the covenants in our senior notes. Future growth strategies may require additional external financing and we may from time to time seek to obtain external financing. We cannot assure that additional sources of financing will be available to us on favorable terms, or at all, or that any such financing would not negatively impact our results of operations. We expect to continue declaring and paying dividends at comparable levels, subject to our future liquidity needs and reserve requirements.

Subject to our compliance with capital requirements as described above, we may consider various opportunities to deploy our capital, including repurchases of our common stock if such repurchases represent a more favorable use of available capital.

Operating Activities

Net cash used in operating activities decreased to $6.8 million in the three months ended March 31, 2019 compared to net cash provided of $12.4 million in the same period in 2018. This decrease reflects higher expenses paid, including those related to losses and loss adjustment expenses, and lower net premiums collected in the first three months of 2019 as compared to the corresponding period in 2018. 

Investing Activities

Net cash used in investing activities of $6.5 million in the three months ended March 31, 2019 reflected purchases of debt and equity investment securities of $64.9 million, partly offset by sales, maturities and redemptions of our debt and equity investment securities of $59.0 million. Net cash used in investing activities of $15.3 million in the three months ended March 31, 2018 reflected purchases of debt and equity investment securities of $143.9 million, partly offset by sales, maturities and redemptions of our debt and equity investment securities of $128.7 million.

Financing Activities

Net cash provided by financing activities for the three months ended March 31, 2019 of $49.4 million primarily reflects issuance of long-term debt, net of issuance costs, of $98.5 million, partly offset by payment of long-term debt of $48.0 million. Net cash used in financing activities of $27.8 million for the three months ended March 31, 2018 primarily reflects purchase of non-controlling interest of $16.7 million, payment of long-term debt of $5.0 million, and repurchase of our common stock of $5.0 million.

Impact of Inflation and Changing Prices

The consolidated financial statements and related data presented herein have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the inflationary effect on the cost of paying losses and LAE.

Insurance premiums are established before we know the amount of losses and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate premiums, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation may also affect the market value of our investment portfolio and the investment rate of return. Any future economic changes that result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred losses and LAE and thereby materially adversely affect future liability requirements.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with GAAP, which requires us to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results may materially differ from those estimates.

We believe our most critical accounting estimates inherent in the preparation of our financial statements are: (i) fair value measurements of our investments; (ii) accounting for investments; (iii) premium and unearned premium calculation; (iv) reinsurance contracts; (v)

- 39-



the recoverability of deferred acquisition costs; (vi) reserve for loss and losses adjustment expenses; and, (vii) income taxes. The accounting estimates require the use of assumptions about certain matters that are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, our financial condition, results of operations, and cash flows would be affected.

There have been no significant changes to our critical accounting estimates during the three months ended March 31, 2019.  Refer to Part II, Item 7: “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates” included in our 2018 Form 10-K for a more complete description of our critical accounting estimates. 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Our investment objective is to maximize total rate of return after federal income taxes while maintaining liquidity and minimizing risk. Our current investment policy limits investment in non-investment-grade debt securities (including high-yield bonds), and limits total investments in preferred stock, common stock and mortgage notes receivable. We also comply with applicable laws and regulations that further restrict the type, quality and concentration of our investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common equity securities and real estate mortgages.

Our investment policy is established by the Board of Directors' Investment Committee and is reviewed on a regular basis. Pursuant to this investment policy, as of March 31, 2019, approximately 96% of investments were in debt securities and cash and cash equivalents, which are considered to be either held-until-maturity or available-for-sale, based upon our estimates of required liquidity. Approximately 99% of the debt securities are considered available-for-sale and are marked to market. We may in the future consider additional debt securities to be held-to-maturity securities, which are carried at amortized cost. We do not use any swaps, options, futures or forward contracts to hedge or enhance our investment portfolio.

There have been no material changes to the Company’s exposures to market risks since December 31, 2018. Please refer to the 2018 Form 10-K for a complete discussion of the Company’s exposures to market risks.

Item 4.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2019.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness

Our management and our audit committee do not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all errors or all instances of fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of the control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control gaps and instances of fraud have been detected. These inherent limitations include the realities that judgments and decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions.

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Part II: OTHER INFORMATION

Item 1.  Legal Proceedings

Refer to Note 9 to our Consolidated Financial Statements set forth in Part I, “Financial Statements” for information about legal proceedings.

Item 1A.  Risk Factors

There have been no material changes from the risk factors previously disclosed in Part I, Item 1A, “Risk Factors,” of the Company’s 2018 Form 10-K.  Please refer to that section for disclosures regarding what we believe are the most significant risks and uncertainties related to our business.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

(c)
Issuer Purchases of Equity Securities. The following table sets forth information with respect to purchases of shares of our common stock made during the quarter ended March 31, 2019 by or on behalf of FNHC. All purchases were made in the open market in accordance with Rule 10b-18 or under Rule 10b5-1 of the Exchange Act.
໿
 
 
 
 
 
 
Total Number of
 
Approximate Dollar
 
 
Total Number
 
Average
 
Shares Purchased
 
Value of Shares That
 
 
of Shares
 
Price Paid
 
as Part of Publicly
 
May Yet Be Purchased
 
 
Repurchased
 
Per Share
 
Announced Plans
 
Under the Plans (1)
January 2019
 

 
$

 

 
$
10,000,000

February 2019
 

 

 

 
10,000,000

March 2019
 

 

 

 
10,000,000


໿
(1)
In December 2018, the Company’s Board of Directors authorized an additional share repurchase program under which the Company may repurchase up to $10.0 million of its outstanding shares of common stock through December 31, 2019. As of March 31, 2019, the remaining availability for future repurchases of our common stock was $10.0 million.
໿


Item 3.  Defaults upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not applicable.

Item 5.  Other Information

Not applicable.

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Item 6.  Exhibits
Exhibit No.
Description
31.1
31.2
32.1
32.2
101.INS
XBRL Instance Document**
101.SCH
XBRL Taxonomy Extension Schema Document**
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document**
101.LAB
XBRL Taxonomy Extension Label Linkbase Document**
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document**
________________________
* Filed herewith.
** In accordance with Rule 406T of Regulation S-T, these interactive data files are deemed not filed for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act of Exchange Act, except as shall be expressly set forth by specific reference in such filing.



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
FEDNAT HOLDING COMPANY
 
 
 
 
 
 
By:
/s/ Michael H. Braun
 
 
 
Michael H. Braun, Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
 
 
 
/s/ Ronald Jordan
 
 
 
Ronald Jordan, Chief Financial Officer
 
 
 
(Principal Financial Officer)
 

Date: May 8, 2019


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