10-Q 1 fnhc3311810-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, 2018
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
 Federated National 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 ☒   No ☐
Indicate by check mark whether the registrant has electronically submitted and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted 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 and post such files).     Yes ☒   No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or 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 ☒
Non‑accelerated filer ☐
Smaller reporting company ☐
 
 
(Do not check if a 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 ☒
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 4, 2018, the registrant had 12,719,777 shares of common stock outstanding.






FEDERATED NATIONAL HOLDING COMPANY
TABLE OF CONTENTS
 



- 2-


PART I: FINANCIAL INFORMATION
Item 1.  Financial Statements
FEDERATED NATIONAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)
໿

 
March 31,
 
December 31,

 
2018
 
2017
ASSETS
 
 
 
 
Investments:
 
 
 
 
Debt securities, available-for-sale, at fair value (amortized cost of $434,667 and $422,300, respectively)
 
$
429,457

 
$
423,238

Debt securities, held-to-maturity, at amortized cost
 
5,298

 
5,349

Equity securities, at fair value
 
16,515

 
15,434

Total investments (including $0 and $26,284 related to the VIE, respectively)
 
451,270

 
444,021


 
 
 
 
Cash and cash equivalents (including $0 and $14,211 related to the VIE, respectively)
 
55,591

 
86,228

Prepaid reinsurance premiums
 
87,201

 
135,492

Premiums receivable, net of allowance of $72 and $70, respectively (including $0 and $1,184 related to the VIE, respectively)
 
45,667

 
46,393

Reinsurance recoverable, net
 
146,091

 
124,601

Deferred acquisition costs
 
39,401

 
40,893

Income taxes receivable, net
 
4,699

 
9,510

Deferred income taxes, net
 
4,368

 
307

Property and equipment, net
 
3,797

 
4,025

Other assets (including $0 and $2,322 related to the VIE, respectively)
 
10,130

 
13,403

TOTAL ASSETS
 
$
848,215

 
$
904,873


 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
LIABILITIES:
 
 
 
 
Loss and loss adjustment expense reserves
 
$
236,214

 
$
230,515

Unearned premiums
 
282,397

 
294,423

Reinsurance payable
 
38,489

 
71,944

Long-term debt, net of deferred financing costs of $672 and $749, respectively
 
44,328

 
49,251

Deferred revenue
 
5,924

 
6,222

Other liabilities
 
32,783

 
25,059

Total liabilities
 
640,135

 
677,414

SHAREHOLDERS’ EQUITY:
 
 
 
 
Preferred stock, $0.01 par value: 1,000,000 shares authorized
 

 

Common stock, $0.01 par value: 25,000,000 shares authorized; 12,718,953 and 12,988,247 shares issued and outstanding, respectively
 
127

 
130

Additional paid-in capital
 
139,388

 
139,728

Accumulated other comprehensive (loss) income
 
(3,861
)
 
1,770

Retained earnings
 
72,426

 
70,009

Total shareholders’ equity attributable to Federated National Holding Company shareholders
 
208,080

 
211,637

Non-controlling interest
 

 
15,822

Total shareholders’ equity
 
208,080

 
227,459

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
848,215

 
$
904,873


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

- 3-


FEDERATED NATIONAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
໿

 
Three Months Ended

 
March 31,

 
2018
 
2017
Revenue:
 
 
 
 
Net premiums earned
 
$
82,109

 
$
81,660

Net investment income
 
2,943

 
2,318

Net realized and unrealized investment losses
 
(1,052
)
 
(105
)
Direct written policy fees
 
3,576

 
4,712

Other income
 
5,501

 
4,469

Total revenue
 
93,077

 
93,054


 
 

 
 

Costs and expenses:
 
 

 
 

Losses and loss adjustment expenses
 
46,071

 
56,899

Commissions and other underwriting expenses
 
30,221

 
27,568

General and administrative expenses
 
6,085

 
4,619

Interest expense
 
1,084

 
84

Total costs and expenses
 
83,461

 
89,170


 
 

 
 

Income before income taxes
 
9,616

 
3,884

Income taxes
 
2,371

 
1,435

Net income
 
7,245

 
2,449

Net (loss) income attributable to noncontrolling interest
 
(218
)
 
27

Net income attributable to Federated National Holding Company shareholders
 
$
7,463

 
$
2,422


 
 

 
 

Net income per share attributable to Federated National Holding Company shareholders
 
 

 
 

Basic
 
$
0.58

 
$
0.18

Diluted
 
$
0.58

 
$
0.18


 
 

 
 

Weighted average number of shares of common stock outstanding:
 
 

 
 

Basic
 
12,850

 
13,432

Diluted
 
12,945

 
13,559


 
 

 
 

Dividends declared per share of common stock
 
$
0.08

 
$
0.08


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

- 4-


FEDERATED NATIONAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
໿

 
Three Months Ended

 
March 31,

 
2018
 
2017
 
 
 
 
 
Net income
 
$
7,245

 
$
2,449

 
 
 
 
 
Change in net unrealized (losses) gains on investments, available-for-sale
 
(6,148
)
 
3,710

Comprehensive income before income taxes
 
1,097

 
6,159


 
 
 
 
Income tax benefit (expense) related to items of other comprehensive income
 
1,587

 
(1,445
)
Comprehensive income
 
2,684

 
4,714


 
 
 
 
Less: comprehensive (loss) income attributable to noncontrolling interest
 
(447
)
 
7

Comprehensive income attributable to Federated National Holding Company shareholders
 
$
3,131

 
$
4,707


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


- 5-


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

໿

 
 
 
 
 
 
 
 
 
 
 
 
 
Total Shareholders'
 
 
 
 

 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
Equity Attributable to
 
 
 
 

 
 
 
Common Stock
 
Additional
 
Other
 
 
 
Federated National
 

 
Total

 
Preferred
 
Issued
 
 
 
Paid-in
 
Comprehensive
 
Retained
 
Holding Company
 
Noncontrolling
 
Shareholders'

 
Stock
 
Shares
 
Amount
 
Capital
 
(Loss) Income
 
Earnings
 
Shareholders
 
Interest
 
Equity
Balance as of December 31, 2017
 
$

 
12,988,247

 
$
130

 
$
139,728

 
$
1,770

 
$
70,009

 
$
211,637

 
$
15,822

 
$
227,459

Cumulative effect of new accounting standards
 

 

 

 

 
(994
)
 
994

 

 

 

Net income (loss)
 

 

 

 

 

 
7,463

 
7,463

 
(218
)
 
7,245

Other comprehensive loss
 

 

 

 

 
(4,332
)
 

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

 

 

 

 

 
(1,043
)
 
(1,043
)
 

 
(1,043
)
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-


FEDERATED NATIONAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)

໿

 
Three Months Ended

 
March 31,

 
2018
 
2017
Cash flow from operating activities:
 
 
 
 
Net income
 
$
7,245

 
$
2,449

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Net realized and unrealized investment gains
 
1,052

 
105

Amortization of investment premium or discount, net
 
683

 
1,209

Depreciation and amortization
 
371

 
270

Share-based compensation
 
665

 
667

Tax impact related to share-based compensation
 
(77
)
 
(50
)
Changes in operating assets and liabilities:
 
 
 
 
Prepaid reinsurance premiums
 
48,291

 
44,475

Premiums receivable, net
 
726

 
(4,262
)
Reinsurance recoverable, net
 
(21,490
)
 
(1,181
)
Deferred acquisition costs
 
1,492

 
(691
)
Income taxes receivable, net
 
4,811

 
8,123

Deferred revenue
 
(298
)
 
831

Loss and loss adjustment expense reserves
 
5,699

 
(3,773
)
Unearned premiums
 
(12,026
)
 
(1,927
)
Reinsurance payable
 
(33,455
)
 
(24,723
)
Deferred income taxes, net of other comprehensive income
 
(2,290
)
 
1,359

Other, net
 
11,019

 
864

Net cash provided by operating activities
 
12,418

 
23,745

Cash flow from investing activities:
 
 
 
 
Proceeds from sales of equity securities
 
4,262

 
3,704

Proceeds from sales of debt securities
 
73,830

 
124,863

Purchases of equity securities
 
(5,177
)
 
(16,875
)
Purchases of debt securities
 
(138,738
)
 
(139,861
)
Maturities and redemptions of debt securities
 
50,584

 
13,565

Purchases of property and equipment
 
(66
)
 
(314
)
Net cash used in investing activities
 
(15,305
)
 
(14,918
)
Cash flow from financing activities:
 
 
 
 
Payment of long-term debt
 
(5,000
)
 

Purchase of non-controlling interest
 
(16,685
)
 

Purchases of Federated National Holding Company common stock
 
(5,000
)
 
(1,876
)
Issuance of common stock for share-based awards
 

 
1

Dividends paid
 
(1,065
)
 
(1,050
)
Net cash used in financing activities
 
(27,750
)
 
(2,925
)
Net (decrease) increase in cash and cash equivalents
 
(30,637
)
 
5,902

Cash and cash equivalents at beginning of period
 
86,228

 
74,593

Cash and cash equivalents at end of period
 
$
55,591

 
$
80,495


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

- 7-


FEDERATED NATIONAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Continued)
 
໿

 
Three Months Ended

 
March 31,

 
2018
 
2017

 
(in thousands)
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid (received) during the period for:
 
 
 
 
Income taxes
 
$
70

 
$
(6,675
)

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



- 8-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 2018


1. ORGANIZATION, CONSOLIDATION AND BASIS OF PREPARATION
Organization
Federated National 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.   We, through our wholly owned subsidiaries, are authorized to underwrite, and/or place homeowners multi-peril (“homeowners”), personal automobile, commercial general liability, 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.

Federated National Insurance Company (“FNIC”), one of our wholly owned insurance subsidiaries, 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.

Monarch National Insurance Company
The Company organized MNIC to write homeowners property and casualty insurance in Florida and obtained its certificate of authority from the Florida Office of Insurance Regulation (the “Florida OIR”) in March 2015. The Company’s joint venture partners were Crosswinds Investor Monarch LP (“Crosswinds Investor”), a wholly-owned subsidiary of Crosswinds Holdings Inc. (“Crosswinds Holdings”), a private equity firm and asset manager, and Transatlantic Reinsurance Company (“TransRe”), an international property and casualty reinsurance company. The Company and Crosswinds Investor each invested $14.0 million for a 42.4% interest in Monarch Delaware Holdings LLC ("Monarch Delaware") (each holding 50% of the voting interests in Monarch Delaware).  TransRe invested $5.0 million for a 15.2% non-voting interest in Monarch Delaware and loaned an additional $5.0 million in debt evidenced by a promissory note bearing 6% annual interest payable by Monarch National Holding Company (“Monarch Holding”).

On February 21, 2018, FNIC closed its acquisition of the interests in Monarch Delaware held by Crosswinds Investor and TransRe pursuant to the purchase and sale agreement with Crosswinds Investor and TransRe dated November 27, 2017. FNIC purchased Crosswinds Investor’s 42.4% Class A membership interest and 50% voting interest for $12.3 million, and TransRe’s 15.2% non-voting membership interest in Monarch Delaware for $4.4 million. The outstanding principal balance and interest due on the $5.0 million promissory note to TransRe was paid in full. Following the closing, Monarch Delaware and Monarch Holdings were merged into MNIC. With the completion of these transactions, FNIC owns 100% of MNIC.

Also in connection with the Company’s purchase of the Monarch Delaware interests, Crosswinds AUM LLC (“Crosswinds AUM”), a subsidiary of Crosswinds Holdings, will continue to serve as a investment consultant to FNHC for a quarterly fee of $75,000 through December 31, 2018. In addition, subsidiaries of Crosswinds Holdings and TransRe will each have a right of first refusal through December 31, 2018 to participate in FNIC’s catastrophe excess of loss reinsurance program, at market rates and terms, up to a placement of $10.0 million in reinsurance limit in the aggregate from Crosswinds Holdings and to a placement of $10.0 million in reinsurance limit in excess of its placement on FNIC’s current catastrophe excess of loss reinsurance program from TransRe.

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 and commercial general liability insurance products to consumers in Florida. As a percentage of the total homeowners premiums we underwrote,  22.8% and 23.8%, were from Allstate’s network of Florida agents, for the three months ended March 31, 2018 and 2017, respectively.


- 9-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

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, 11.8% and 8.6%, respectively, of the Company’s premiums were underwritten by SageSure, for the three months ended March 31, 2018 and 2017, respectively.

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 (“U.S. 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.

As of December 31, 2017, in connection with the investment in Monarch Delaware, the Company had determined that the Company possessed the power to direct the activities of the VIE that most significantly impact its economic performance and the Company was the primary beneficiary of the VIE.  As such, the Company consolidated Monarch Delaware in its consolidated financial statements.  Refer to Monarch National Insurance Company above, related to our 100% ownership of Monarch Delaware that became effective on February 21, 2018. In accordance with the accounting standard on consolidation, a primary beneficiary that acquires additional ownership of the previously controlled and consolidated subsidiaries is accounted for as an equity transaction and re-measurement of assets and liabilities of previously controlled and consolidated subsidiaries is not permitted. As a result, we accounted for this transaction by eliminating the carrying value of the non-controlling interest to reflect our 100% ownership interest in MNIC as of February 21, 2018. The difference between the consideration paid and the amount by which the non-controlling interest was eliminated has been recognized in additional paid-in capital.

Revisions of Previously Issued Financial Statements

Revisions to the three months ended March 31, 2017, were described in Note 1 and Note 16 to our Consolidated Financial Statements set forth in Part II, Item 8, "Financial Statements and Supplementary Data" included in our most recent Annual Report on Form 10-K for the year ended December 31, 2017 (the "2017 Form 10-K").




- 10-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES

Our significant accounting policies were described in Note 2 to our Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of the 2017 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, 2018.

Accounting Estimates and Assumptions

The Company prepares the accompanying consolidated financial statements in accordance with U.S. 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 on-going basis.

Recently Issued Accounting Pronouncements, Adopted

In January 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”), which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.  In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. Most notably, the combined new guidance required equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. The Company adopted the guidance effective January 1, 2018, by reflecting a cumulative effect adjustment, which increased retained earnings and decreased accumulated other comprehensive income by $1.0 million. This adjustment represented the level of net unrealized gains and losses associated with our equity investments with readily determinable market values as of January 1, 2018. The adoption also resulted in the recognition of less than $0.1 million in our statement income and comprehensive income, which represented the change in net unrealized gains and losses on our equity securities for the first three months of 2018. Although the amount of change in net unrealized gains and losses on our equity securities for the first quarter of 2018 was not significant, we believe this new guidance could significantly increase our earnings volatility going forward.

In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The update allowed a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act. Guidance had previously required the effect of a change in tax laws or rates on deferred tax balances to be reported in income from continuing operations in the accounting period that includes the period of enactment, even if the related income tax effects were originally charged or credited directly to accumulated other comprehensive income. The Company adopted the guidance effective January 1, 2018, by reflecting a cumulative effect adjustment to retained earnings with an off-setting adjustment to accumulated other comprehensive income for less than $0.1 million.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The update replaces all general and most industry specific revenue recognition guidance (excluding insurance) currently prescribed by U.S. GAAP. The core principle is that an entity recognizes revenue to reflect the transfer of a promised good or service to customers in an amount that reflects that consideration to which the entity expects to be entitled in exchange for that good or service. The Company adopted this update and the other related revenue standard clarifications and technical guidance effective January 1, 2018, using the modified retrospective approach. The Company completed the analysis of its non-insurance revenues and has concluded that the implementation did not have any impact on the Company’s consolidated financial condition or results of operations.


- 11-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments a consensus of the Emerging Issues Task Force) to improve the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The update provides guidance on specific cash flow classification issues including the following: (1) debt prepayment or debt extinguishment costs; (2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and (8) separately identifiable cash flows and application of the predominance principle. Previous GAAP did not include specific guidance on these eight cash flow classification issues. The Company adopted the guidance effective January 1, 2018, and the provisions of this update did not have an impact on our consolidated statements of cash flows or results of operations.

Recently Issued Accounting Pronouncements, Not Yet Adopted

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The update will supersede the current lease guidance in Topic 840, Leases and lessees will be 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. Concurrently, lessees will be 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 update is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The guidance is required to be applied using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative periods presented in the financial statements. The guidance is required to be applied using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative periods presented in the financial statements. All of the Company’s leases are classified as operating leases under current lease accounting guidance. The Company expects to elect all of the standard’s available practical expedients upon adoption. The update requires the Company to add the operating leases to the Company’s consolidated balance sheets. The Company does not expect this standard will have a material impact on the Company’s consolidated financial position or results of operations.

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 OTTI model. The update also require 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.
 
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.


- 12-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

The classification of assets and liabilities in the fair value hierarchy is based upon the lowest level input that is significant to the fair value.

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, 2018

 
Level 1
 
Level 2
 
Level 3
 
Total

 
(In thousands)
Debt securities - available-for-sale, at fair value:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
77,109

 
$
52,601

 
$

 
$
129,710

Obligations of states and political subdivisions
 

 
23,302

 

 
23,302

Corporate securities
 

 
258,518

 

 
258,518

International securities
 

 
17,927

 

 
17,927

Debt securities, at fair value
 
77,109

 
352,348

 

 
429,457


 
 
 
 
 
 
 
 
Equity securities, at fair value
 
16,515

 

 

 
16,515


 
 
 
 
 
 
 
 
Total investments, at fair value
 
$
93,624

 
$
352,348

 
$

 
$
445,972

໿

 
December 31, 2017

 
Level 1
 
Level 2
 
Level 3
 
Total

 
(In thousands)
Debt securities - available-for-sale, at fair value:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
51,219

 
$
46,918

 
$

 
$
98,137

Obligations of states and political subdivisions
 

 
66,266

 

 
66,266

Corporate securities
 

 
240,919

 

 
240,919

International securities
 

 
17,916

 

 
17,916

Debt securities, at fair value
 
51,219

 
372,019

 

 
423,238


 
 
 
 
 
 
 
 
Equity securities, at fair value
 
15,434

 

 

 
15,434


 
 
 
 
 
 
 
 
Total investments, at fair value
 
$
66,653

 
$
372,019

 
$

 
$
438,672

    
The Company’s held-to-maturity debt securities are reported on the consolidated balance sheets at amortized cost and disclosed at fair value in Note 4. Investments in these notes to consolidated financial statements. The fair values of these securities are classified within Level 1 and Level 2 of the fair value hierarchy and consist of United States government obligations and authorities, corporate securities and international securities. The fair value of the securities classified as Level 1 was $3.9 million and $4.0 million as of March 31, 2018 and December 31, 2017, respectively. The fair value of the securities classified as Level 2 was $1.3 million as of March 31, 2018 and December 31, 2017. The Company has engaged a nationally recognized third party pricing service to provide the fair values of securities in Level 2. The Company reviews the third party pricing methodologies on a quarterly basis and tests for significant differences between the market price used to value the securities and the recent sales activities.

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.

- 13-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

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, 2018 and December 31, 2017. There were no transfers between the fair value hierarchy levels during the three months ended March 31, 2018 and 2017.

- 14-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

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, 2018
 
 
 
 
 
 
 
 
Debt securities  - available-for-sale:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
131,292

 
$
231

 
$
1,813

 
$
129,710

Obligations of states and political subdivisions
 
23,535

 
54

 
287

 
23,302

Corporate
 
261,772

 
553

 
3,807

 
258,518

International
 
18,068

 
11

 
152

 
17,927


 
434,667

 
849

 
6,059

 
429,457


 
 

 
 

 
 

 
 
Debt securities  - held-to-maturity:
 
 

 
 

 
 

 
 
United States government obligations and authorities
 
4,161

 
3

 
139

 
4,025

Corporate
 
1,072

 
6

 
4

 
1,074

International
 
65

 

 

 
65


 
5,298

 
9

 
143

 
5,164

Total investments (1)
 
$
439,965

 
$
858

 
$
6,202

 
$
434,621

໿

(1) As a result of the adoption of ASU 2016-01 on January 1, 2018 (see additional details in Note 2) our equity securities no longer have unrealized gains or losses, therefore they are not included as of March 31, 2018.

 
Amortized
 
Gross
 
Gross
 
 

 
Cost
 
Unrealized
 
Unrealized
 
 

 
or Cost
 
Gains
 
Losses
 
Fair Value

 
(In thousands)
December 31, 2017
 
 
 
 
 
 
 
 
Debt securities  - available-for-sale:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
98,739

 
$
244

 
$
846

 
$
98,137

Obligations of states and political subdivisions
 
66,319

 
325

 
378

 
66,266

Corporate
 
239,435

 
2,233

 
749

 
240,919

International
 
17,807

 
136

 
27

 
17,916


 
422,300

 
2,938

 
2,000

 
423,238


 
 
 
 
 
 
 
 
Debt securities  - held-to-maturity:
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
4,160

 
9

 
106

 
4,063

Corporate
 
1,123

 
21

 

 
1,144

International
 
66

 
1

 

 
67


 
5,349

 
31

 
106

 
5,274

Equity securities
 
14,085

 
1,628

 
279

 
15,434

Total investments
 
$
441,734

 
$
4,597

 
$
2,385

 
$
443,946



- 15-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

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, by major investment category, consisted of the following:

໿

 
 
 
 

 
 
 
 

 
Three Months Ended

 
March 31,

 
2018
 
2017

 
(In thousands)
Gross realized and unrealized gains:
 
 
 
 
Debt securities
 
$
223

 
$
570

Equity securities
 
1,153

 
560

Total gross realized and unrealized gains
 
1,376

 
1,130


 
 

 
 
Gross realized and unrealized losses:
 
 

 
 
Debt securities
 
(1,441
)
 
(1,092
)
Equity securities
 
(987
)
 
(143
)
Total gross realized and unrealized losses
 
(2,428
)
 
(1,235
)
Net realized and unrealized gains on investments
 
$
(1,052
)
 
$
(105
)

Proceeds from sale of investment securities were $78.1 million and $128.6 million for the three months ended March 31, 2018 and 2017, respectively.

The portion of unrealized gains and losses for equity securities that was recognized in the line item, net realized and unrealized gains on investments securities for the three months ended March 31, 2018 was less than $0.1 million.

Contractual Maturity

Expected maturities and contractual maturities may differ because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Amortized cost and estimated fair value of debt securities, by contractual maturity, consisted of the following:
໿

- 16-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018


 
March 31, 2018

 
Amortized
 
 

 
Cost
 
Fair Value
Securities with maturity dates:
 
(In thousands)
Debt securities, available-for-sale:
 
 
 
 
One year or less
 
$
50,526

 
$
50,394

Over one through five years
 
207,292

 
205,249

Over five through ten years
 
175,529

 
172,538

Over ten years
 
1,320

 
1,276


 
434,667

 
429,457

Debt securities, held-to-maturity:
 
 
 
 
One year or less
 
730

 
732

Over one through five years
 
3,940

 
3,812

Over five through ten years
 
628

 
620


 
5,298

 
5,164

Total
 
$
439,965

 
$
434,621


Net Investment Income

Net investment income consisted of the following:
໿

 
Three Months Ended

 
March 31,

 
2018
 
2017

 
(In thousands)
Interest income
 
$
2,887

 
$
2,169

Dividends income
 
56

 
149

Net investment income
 
$
2,943

 
$
2,318


Aging of Gross Unrealized Losses

Gross unrealized losses and related fair values for debt securities (and equity securities as of December 31, 2017), 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
March 31, 2018
 
 
 
 
 
(In thousands)
 
 
 
 
Debt securities  - available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
61,093

 
$
1,284

 
$
18,399

 
$
529

 
$
79,492

 
$
1,813

Obligations of states and political subdivisions
 
15,762

 
203

 
1,821

 
84

 
17,583

 
287

Corporate
 
198,468

 
3,547

 
5,022

 
260

 
203,490

 
3,807

International
 
14,682

 
152

 

 

 
14,682

 
152


 
$
290,005

 
$
5,186

 
$
25,242

 
$
873

 
$
315,247

 
$
6,059




- 17-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018


 
Less than 12 months
 
12 months or longer
 
Total

 
 
 
Gross
 
 
 
Gross
 
 
 
Gross

 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized

 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
December 31, 2017
 
 
 
 
 
(In thousands)
 
 
 
 
Debt securities  - available-for-sale:
 
 
 
 
 
 
 
 
 
 
United States government obligations and authorities
 
$
52,368

 
$
517

 
$
19,287

 
$
329

 
$
71,655

 
$
846

Obligations of states and political subdivisions
 
32,030

 
221

 
5,676

 
157

 
37,706

 
378

Corporate
 
109,780

 
625

 
6,452

 
124

 
116,232

 
749

International
 
8,935

 
27

 
25

 

 
8,960

 
27


 
203,113

 
1,390

 
31,440

 
610

 
234,553

 
2,000


 
 
 
 
 
 
 
 
 
 
 
 
Equity securities
 
4,312

 
279

 

 

 
4,312

 
279


 
 
 
 
 
 
 
 
 
 
 
 
Total investments
 
$
207,425

 
$
1,669

 
$
31,440

 
$
610

 
$
238,865

 
$
2,279


As of March 31, 2018, the Company held a total of 1,346 debt securities that were in an unrealized loss position, of which 52 securities were in an unrealized loss position continuously for 12 months or more. As of December 31, 2017, the Company held a total of 866 debt and equity securities that were in an unrealized loss position, of which 73 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 2018 and 2017.

As discussed in Note 2 above, beginning January 1, 2018, the Company’s equity investments are measured at fair value through net income. See Note 4 of 2017 Form 10-K for information on how the Company assessed and determined whether unrealized losses on our equity securities were other-than-temporary, which was primarily based on the duration of the decline in the fair value of such securities relative to their cost as of the balance sheet date. The company did not have any OTTI losses on its equity securities for the first three months of 2017.

Collateral Deposits

Investments, the majority of which were debt securities, with fair values of approximately $12.8 million and $12.9 million, were deposited with governmental authorities and into custodial bank accounts as required by law or contractual obligations as of March 31, 2018 and December 31, 2017, respectively.

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 remain primarily liable to its policyholders.

- 18-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

The Company is selective in choosing reinsurers and consider 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
2016-2017 Reinsurance Programs
FNIC’s 2016-2017 reinsurance programs, which cost $179.5 million, included $125.6 million for the private reinsurance for FNIC’s Florida exposure, with prepaid automatic premium reinstatement protection on all layers, along with $53.9 million payable to the Florida Hurricane Catastrophe Fund (“FHCF”). The combination of private and FHCF reinsurance treaties afforded FNIC with $2.2 billion of aggregate coverage with a maximum single event coverage totaled $1.6 billion, exclusive of retentions.  FNIC maintained its FHCF participation at 75% for the 2016 hurricane season. FNIC’s single event pre-tax retention for a catastrophic event in Florida was $18.5 million. In addition, FNIC purchases separate underlying reinsurance layers in Louisiana, Texas, South Carolina and Alabama to cover losses and LAE outside of Florida for each catastrophic event from $8.0 million to $18.5 million. Depending on the characteristics of the catastrophic event, and the states involved, FNIC’s single event pre-tax retention could have been as low as $8.0 million. The maximum pre-tax retention was $18.5 million.
Additionally, the Company’s private market excess of loss treaties became effective June 1, 2016 and July 1, 2016, and all private layers, except the FHCF supplemental layer reinsurance contract, have prepaid automatic reinstatement protection, which afforded us additional coverage against multiple catastrophic events in the same hurricane season. The Company obtained multiple year protection for a portion of its program; as a result, some of the coverage expired on June 30, 2017, and a portion of the coverage will remain in-force one additional treaty year until June 30, 2018. These private market excess of loss treaties structure coverage into layers, with a cascading feature such that substantially all private layers attach after $18.5 million in losses for FNIC’s Florida exposure. 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.
MNIC’s 2016-2017 catastrophe reinsurance program, which ran from either June 1 to May 31 or June 1 to June 30 (13 months), consisted of the FHCF and private market excess of loss treaties. All private layers had prepaid automatic reinstatement protection, which afforded MNIC additional coverage, and had a cascading feature such that substantially all layers attached at $3.4 million for MNIC’s Florida exposure.
2017-2018 Reinsurance Programs
FNIC’s 2017-2018 reinsurance programs, which currently costs $174.4 million, including $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 FHCF.  The combination of private and FHCF reinsurance treaties will afford 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 is $18.0 million, down slightly from the 2016-2017 reinsurance programs.
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 affords FNIC additional coverage for subsequent events.  The reinsurance program includes multiple year protection with $89.0 million of new multiple year protection this year and $156.0 million of renewing 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 currently have 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 affords 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.

- 19-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

MNIC’s 2017-2018 reinsurance program costing $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 are 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 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.
In addition to the excess of loss coverages described above, our reinsurance program also includes property 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 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, 2017, FNIC bound a new 10% quota-share on its Florida homeowners book of business, which excludes named storms. This treaty is not subject to accounting as a retrospectively rated contract.
On July 1, 2016, the 30% property 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% property 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 30% and 10% of the paid losses occurring during the terms of the treaties, until each treaty is commuted.
The Company’s private passenger automobile quota share treaties are typically one year programs which become effective at different points in the year and cover auto policies across several states. These 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.
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 $2.7 million and $2.6 million as of March 31, 2018 and December 31, 2017, respectively.
Reinsurance Recoverables
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 recoverables. Reinsurance recoverable, net consisted of the following:
໿

 
March 31,
 
December 31,

 
2018
 
2017

 
(in thousands)
Reinsurance recoverable on paid losses
 
$
34,664

 
$
26,256

Reinsurance recoverable on unpaid losses
 
111,427

 
98,345

Reinsurance recoverable, net
 
$
146,091

 
$
124,601


As of March 31, 2018, the Company had $107.6 million million in reinsurance recoverables as a result of Hurricane Irma. Hurricane Irma made landfall in the United States as a Category 4 hurricane on September 10, 2017. Additionally, 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.


- 20-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

Net Premiums Written and Net Premiums Earned

Net premiums written and net premiums earned consisted of the following:
໿
໿

 
Three Months Ended

 
March 31,

 
2018
 
2017

 
(in thousands)
Net premiums written:
 
 
 
 
Direct
 
$
134,395

 
$
146,051

Ceded
 
(20,107
)
 
(24,137
)

 
$
114,288

 
$
121,914

Net premiums earned:
 
 

 
 

Direct
 
$
146,442

 
$
147,978

Ceded
 
(64,333
)
 
(66,318
)

 
$
82,109

 
$
81,660

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 IBNR.

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


 
Three Months Ended

 
March 31,

 
2018
 
2017

 
(In thousands)
Gross reserves, beginning of period
 
$
230,515

 
$
158,110

Less: reinsurance recoverable (1)
 
(98,345
)
 
(40,412
)
Net reserves, beginning of period
 
132,170

 
117,698


 
 
 
 
Incurred loss, net of reinsurance, related to:
 
 
 
 
Current year
 
48,459

 
60,277

Prior year loss development (2)
 
(653
)
 
2,905

Ceded losses subject to offsetting experience account adjustments (3)
 
(1,735
)
 
(6,283
)
Prior years
 
(2,388
)
 
(3,378
)
Total incurred loss and LAE, net of reinsurance
 
46,071

 
56,899


 
 

 
 
Paid loss, net of reinsurance, related to:
 
 

 
 
Current year
 
22,543

 
18,416

Prior years
 
30,911

 
36,316

Total paid loss and LAE, net of reinsurance
 
53,454

 
54,732


 
 

 
 
Net reserves, end of period
 
124,787

 
119,865

Plus: reinsurance recoverable (1)
 
111,427

 
34,472

Gross reserves, end of period
 
$
236,214

 
$
154,337

(1)
Reinsurance recoverable in this table includes only ceded loss and LAE reserves.

- 21-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

(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.

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, 2018, the Company experienced $0.7 million of favorable loss and LAE reserve redundancy in accident year 2017. The redundancy was the result of additional ceded losses to reinsurers associated with Hurricane Irma.
During the three months ended March 31, 2017, the Company experienced $2.9 million of unfavorable loss and LAE reserve development on prior accident years primarily in its personal automobile line of business, which was driven by adjustments to cession percentages in certain auto reinsurance treaties. 
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 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
See Note 7 of our 2017 Form 10-K for information regarding our long-term debt.
As discussed in Note 1, the outstanding principal balance and interest due on the $5.0 million promissory note to TransRe was paid in full in February 2018. The associated deferred financing costs for this debt of less than $0.1 million were recognized as interest expense in our consolidated statements of operations for the three months ended March 31, 2018.
8. INCOME TAXES
The provision for income tax expense for the three and three months ended March 31, 2018 and 2017 is as follows:
໿

 
Three Months Ended

 
March 31,

 
2018
 
2017

 
(in thousands)
Federal:
 
 
 
 
Current
 
$
3,878

 
$
658

Deferred
 
(2,076
)
 
527

Federal income tax expense
 
1,802

 
1,185

State:
 
 

 
 

Current
 
1,002

 
172

Deferred
 
(433
)
 
78

State income tax expense
 
569

 
250

Total income tax expense
 
$
2,371

 
$
1,435


- 22-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

The actual income tax expense differs from the “expected” income tax expense (computed by applying the combined applicable effective federal and state tax rates to income before income tax expense) as follows:
໿

 
Three Months Ended

 
March 31,

 
2018
 
2017

 
(in thousands)
Computed expected tax expense provision, at federal rate
 
$
2,020

 
$
1,360

State tax, net of federal tax benefit
 
401

 
53

Other
 
(50
)
 
22

Total income tax expense
 
$
2,371

 
$
1,435

The Tax Act makes broad and complex changes to the U.S. tax code, including, but not limited to reducing the U.S. federal corporate tax rate from 35% to 21%. SAB No. 118 provides guidance on accounting for the tax effects of the Tax Act and a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under the FASB’s Accounting Standard Codification (“ASC”) 740 - Income Taxes (“ASC 740”). In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act. We did not record any adjustments to our provisional estimate during the first three months of 2018 and continue to evaluate the Tax Act.
The Company had an uncertain tax position of $0.6 million as of March 31, 2018 and December 31, 2017. The Company does not have a valuation allowance as of March 31, 2018 and December 31, 2017.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense in the consolidated statements of operations and statements of comprehensive income (loss). For the three months ended March 31, 2018 and 2017, the Company did not recognize any expense for accrued interest and penalties related to unrecognized tax benefits. For the three months ended March 31, 2018, the Company recognized no income tax expense related to an uncertain tax position. For the three months ended March 31, 2017, the Company recognized less than $0.1 million income tax expense related to an uncertain tax position.

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 know 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

- 23-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

probable and estimable losses are reasonable and that the amounts accrued do not have a material effect on the Company’s consolidated financial statements.
The Company is a party to a Co-Existence Agreement effective as of August 30, 2013 (the “Co-Existence Agreement”) with Federated Mutual Insurance Company (“Mutual”) pursuant to which we agreed to certain restrictions on its use of the word “FEDERATED” without the word “NATIONAL” when referring to the Company and FNIC. In response to Mutual’s allegations that our use of the word “FED” as part of our federally registered “FEDNAT” trademark infringes on Mutual’s federal and common law trademark rights, in July 2016 we filed a declaratory judgment action for non-infringement of trademark in the U.S. District Court for the Southern District of Florida seeking a declaration that our federally registered trademark “FEDNAT” does not infringe any alleged trademark rights of Mutual and that Mutual does not own any trademark rights to the name or mark “FED” in connection with insurance services outside of Owatonna, Minnesota. In response to Mutual’s demand for arbitration against us alleging a breach of the Co-Existence Agreement, on February 16, 2018 the arbitrator agreed that our “FEDNAT” trademark does not infringe on Mutual’s federal or common law trademark rights. As a result, we have begun the process of re-branding the Company and certain of its subsidiaries to use the “FEDNAT” name. The arbitrator also required us to cease using the Federated National name within 90 days. The Company was unable to reach agreement with Mutual as to the timing of the name change ordered by the arbitrator and therefore two proceedings have been filed as a result. Mutual has filed a petition to confirm the award in federal court in the District of Minnesota. The Company has moved to dismiss that action on the bases that the Minnesota court does not have subject matter jurisdiction and may not exercise personal jurisdiction over FNHC. A hearing is set for June 6, 2018. The Company has also filed a motion to confirm the arbitration award in part and to vacate it in part in federal court in the Northern District of Illinois, which is where the arbitrator is located, to confirm that part of the award ruling that the Company’s “FEDNAT” trademark does not violate Mutual’s trademarks or the Co-Existence Agreement, and seeks to vacate that portion of the award that requires the Company to cease using the “Federated” in its name within 90 days on the basis that arbitrator exceeded his authority by requiring the Company to change its name in 90 days. There can be no assurances as to the outcome of this matter.
On March 2, 2017, the Company filed a complaint in Broward County, Florida court to enforce the terms of the restrictive covenants set forth in the Amended and Restated Non-Competition, Non-Disclosure and Non-Solicitation Agreement dated August 5, 2013, as amended, entered into between Peter J. Prygelski, III and our company during Mr. Prygelski’s employment with us and set forth in the separation agreement he entered into in connection with his separation from our company. We believe that he accepted employment with a competitor in contravention of these restrictive covenants and therefore the Company is seeking injunctive relief, declaratory relief and damages. Mr. Prygelski has also filed an arbitration seeking declaratory relief as to his obligations under the above-referenced agreements and to recover the remainder of his severance and health insurance premium reimbursements. Because the Company is seeking monetary relief, the Company filed a counterclaim in the arbitration seeking damages and recovery of separation payments. The litigation seeking injunctive relief and the companion arbitration related to damages are ongoing. The final hearing on the arbitration is scheduled for May 14, 2018. There can be no assurances as to the outcome of this matter.
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 Joint Underwriters Insurance 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, 2017. Future assessments by the JUA and the JUA Plan are indeterminable at this time.

- 24-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

Leases
The Company is committed under various operating lease agreements for office space. FNHC and its subsidiaries lease certain facilities, furniture and equipment under long-term lease agreements. Additional information about leases can be found in Note 9 to our Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data,” of the 2017 Form 10-K.

10. SHAREHOLDERS' EQUITY

Common Stock Repurchases
The Company may repurchase shares in open market transaction or under Rule 10b5-1 trading plans 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 March 2017, the Company’s Board of Directors authorized a program to repurchase shares of common stock of FNHC, at such times and at prices as management determined advisable, up to an aggregate of $10.0 million of common stock through March 31, 2018. This authorization was fully expended as of March 31, 2018.
In December 2017, the Company’s Board of Directors authorized an additional share repurchase program under which the Company may repurchase up to $10.0 million (plus $0.8 million remaining from previous authorization) of its outstanding shares of common stock through December 31, 2018. During the three months ended March 31, 2018, the Company repurchased 322,865 shares of its common stock at a total cost of $5.0 million, which is an average price per share of $15.49.  As of March 31, 2018, the remaining availability for future repurchases of our common stock under this program was $5.8 million.
Stock Compensation Plan
In April 2012, the Company’s Board of Directors adopted, and in September 2012 the Company’s shareholders approved, the Company’s 2012 Stock Incentive Plan (the “2012 Plan”). The 2012 Plan permits the issuance of up to 1,000,000 shares of the Company’s common stock, subject to adjustment as provided for in the 2012 Plan, in connection with the grant of a variety of equity incentive awards, such as stock options and restricted stocks. Officers, directors, executive management and all other employees of the Company and its subsidiaries are eligible to participate in the 2012 Plan. Awards may be granted singly, in combination, or in tandem. The 2012 Plan will expire on April 5, 2022.
Share-Based Compensation Expense
Share-based compensation arrangements include the following:
໿

 
Three Months Ended

 
March 31,

 
2018
 
2017

 
(in thousands)
Restricted stock
 
$
665

 
$
667

Stock options
 

 

Total share-based compensation expense
 
$
665

 
$
667


 
 

 
 

Intrinsic value of options exercised
 
$

 
$
7

Fair value of restricted stock vested
 
$
1,187

 
$
1,350

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.

- 25-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

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, 2018
 
50,351

 
$
3.72

Granted
 

 

Exercised
 

 

Cancelled
 

 

Outstanding at March 31, 2018
 
50,351

 
$
3.72

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, 2018 and 2017, the Board of Directors granted 130,458 and 96,454 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
Outstanding at January 1, 2018
 
297,543

 
$
20.57

Granted
 
130,458

 
$
16.25

Vested
 
(53,571
)
 
$
22.15

Cancelled
 
(16,539
)
 
$
18.25

Outstanding at March 31, 2018
 
357,891

 
$
18.86

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.


- 26-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

Accumulated Other Comprehensive Income
Accumulated other comprehensive income consisted of the following:
໿

 
Three Months Ended March 31,

 
2018
 
2017

 
Before Tax
 
Income Tax
 
Net
 
Before Tax
 
Income Tax
 
Net

 
(in thousands)
Accumulated other comprehensive income, beginning of period
 
$
2,287

 
$
(593
)
 
$
1,694

 
$
3,324

 
$
(1,201
)
 
$
2,123

Cumulative effect of new accounting standards
 
(1,349
)
 
355

 
(994
)
 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income before reclassification
 
(7,200
)
 
1,825

 
(5,375
)
 
3,605

 
(1,404
)
 
2,201

Reclassification adjustment for realized and unrealized losses (gains) included in net income
 
1,052

 
(238
)
 
814

 
105

 
(41
)
 
64


 
(6,148
)
 
1,587

 
(4,561
)
 
3,710

 
(1,445
)
 
2,265

Accumulated other comprehensive (loss) income, end of period
 
$
(5,210
)
 
$
1,349

 
$
(3,861
)
 
$
7,034

 
$
(2,646
)
 
$
4,388


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,

 
2018
 
2017

 
(in thousands, except per share data)
Net income attributable to Federated National Holding Company shareholders
 
$
7,463

 
$
2,422

 
 
 

 
 

Weighted average number of common shares outstanding - basic
 
12,850

 
13,432

Net income per share - basic     
 
$
0.58

 
$
0.18


 
 

 
 

 
 
 

 
 

Weighted average number of common shares outstanding - basic
 
12,850

 
13,432

Dilutive effect of stock compensation plans
 
95

 
127

Weighted average number of common shares outstanding - diluted
 
12,945

 
13,559

Net income per share - diluted
 
$
0.58

 
$
0.18


 
 

 
 

Dividends per share
 
$
0.08

 
$
0.08

Dividends Declared
In February 2018, our Board of Directors declared a $0.08 per common share dividend, payable in June 2018, to shareholders of record on May 1, 2018, amounting to $1.0 million.

- 27-

Federated National Holding Company and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2018

12. VARIABLE INTEREST ENTITY

Refer to Monarch National Insurance Company in Note 1 above, for information about how we acquired 100% of Monarch Delaware; therefore, as of February 21, 2018, Monarch Delaware became a wholly-owned subsidiary instead of a VIE. Prior to February 21, 2018, FNU through the Monarch MGA Agreement, directed the activities which most significantly impact the Monarch Entities’ insurance operating company, MNIC. MNIC’s activities directed by FNU through the Monarch MGA Agreement included underwriting and claims. As a result, MNIC was a VIE prior to February 21, 2018, because the equity holders (i.e., FNHC, Crosswinds Holdings and TransRe owned 42.4%, 42.4%, and 15.2%, respectively, of Monarch Delaware), as a group, lacked the characteristics of a controlling financial interest.

In addition to having power to direct the activities which most significantly impacted MNIC, FNHC had the obligation to absorb the losses and/or the right to receive benefits that potentially could be significant through its 42.4% indirect equity interests in MNIC through Monarch Delaware and Monarch Holding.

As a result, FNHC was the primary beneficiary of MNIC, resulting in Monarch Delaware, MNIC’s indirect parent company, consolidating into our financial statements.

The carrying amounts of Monarch Delaware, which could only be used to settle obligations of Monarch Delaware, and liabilities of Monarch Delaware for which creditors did not have recourse included the following:
໿

 
December 31,

 
2017

 
ASSETS
 
 
Investments
 
 
Debt securities, available-for-sale, at fair value
 
$
25,111

Equity securities, available-for-sale, at fair value
 
1,173

Total investments
 
26,284

Cash and cash equivalents
 
14,211

Reinsurance recoverable
 
3,323

Prepaid reinsurance premiums
 
2,481

Premiums receivable, net
 
1,184

Deferred acquisition costs
 
1,722

Other assets
 
2,322

Total assets
 
$
51,527


 
 
LIABILITIES
 
 
Loss and loss adjustment expense reserves
 
$
6,356

Unearned premiums
 
8,752

Reinsurance payable
 
1,802

Debt, net of deferred financing costs
 
4,930

Other liabilities
 
1,825

Total liabilities
 
$
23,665


Earned premiums and loss and LAE, attributable to Monarch Delaware, from January 1, 2018 to February 21, 2018, were $2.3 million and $2.3 million, respectively. Earned premiums and loss and LAE, attributable to Monarch Delaware for the three months ended March 31, 2017 were $2.7 million and $1.8 million, respectively.

- 28-


General information about Federated National Holding Company can be found at www.FedNat.com; however, the information that can be accessed through our web site 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 web site, 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, reference should be made 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, 2017 (the “2017 Form 10-K”).
Unless the context requires otherwise, as used in this Form 10-Q, the terms “FNHC,” “Company,” “we,” “us” and “our” refer to Federated National Holding Company and its consolidated subsidiaries.
Forward-Looking Statements
This Form 10-Q or in documents that are incorporated by reference 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 2017 Annual Report on Form 10-K, and discussed from time to time in our reports filed with the Securities and Exchange Commission (“SEC”).
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 decline 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
Federated National 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. We, through our wholly owned subsidiaries, are authorized to underwrite, and/or place homeowners multi-peril (“homeowners”), personal automobile, commercial general liability, 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.

Federated National Insurance Company (“FNIC”), one of our wholly owned insurance subsidiaries, 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. MNIC was founded in 2015 through a joint venture. On February 21, 2018, FNIC acquired the interests in MNIC’s indirect

- 29-


parent company, Monarch Delaware Holdings LLC (“Monarch Delaware”) from our joint venture partners (see “Joint Venture,” below, for more information).

Joint Ventures