10-K 1 a10-k2013.htm 10-K-2013FORTEGRAFINANCIALCORPORATION 10-K 2013



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2013 OR
 
 
o
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 001-35009
Fortegra Financial Corporation
(Exact name of Registrant as specified in its charter)
Delaware
 
58-1461399
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
10151 Deerwood Park Boulevard, Building 100, Suite 330, Jacksonville, FL
 
32256
(Address of principal executive offices)
 
(Zip Code)
Registrant's telephone number, including area code:
 
(866)-961-9529
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, $0.01 par value per share
 
New York Stock Exchange
 
 
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x

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 x    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 x    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer o
 
 
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The aggregate market value of the voting common equity held by non-affiliates of the registrant was $43,969,683 at June 28, 2013 (last day of the registrant's most recently completed second quarter) based on the closing sale price of $6.87 per share for the common stock on such date as traded on the New York Stock Exchange.
The number of outstanding shares of the registrant's Common Stock, $0.01 par value, outstanding as of March 14, 2014 was 20,034,617.

Documents Incorporated by Reference
Certain specifically designated portions of Fortegra Financial Corporation's definitive proxy statement for its 2014 Annual Meeting of Stockholders (the "Proxy Statement"), which will be filed with the Securities and Exchange Commission within 120 days following the end of Fortegra Financial Corporation's fiscal year ended December 31, 2013, are incorporated by reference into Parts III and IV of this Annual Report on Form 10-K.





FORTEGRA FINANCIAL CORPORATION
ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 2013
TABLE OF CONTENTS

 
Page Number
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
Executive Officers of the Registrant
 
 
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
 
Item 15.
 
 
 


1


PART I

FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K ("Form 10-K") contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which are made in reliance upon the protection provided by such act for forward-looking statements. Such statements are subject to risks and uncertainties. All statements other than statements of historical fact included in this Form 10-K are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as "anticipate," "estimate," "expect," "project,'' "plan," "intend," "believe," "may," "should," "can have," "will," "likely" and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating results or financial performance or other events.

The forward-looking statements contained in this Form 10-K are based on assumptions that we have made in light of our industry experience and our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. As you read this Form 10-K, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties (some of which are beyond our control) and assumptions. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial results and cause them to differ materially from those anticipated in the forward-looking statements. We believe these factors include, but are not limited to, those described under ITEM 1A. RISK FACTORS and ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Should one or more of these risks or uncertainties materialize, or should any of these assumptions prove incorrect, our actual results may vary materially from those projected in these forward-looking statements.

Any forward-looking statement made by us in this Form 10-K speaks only as of the date of the filing of this Form 10-K. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

ITEM 1. BUSINESS

Corporate Overview
Fortegra Financial Corporation (references in this Form 10-K to "Fortegra Financial," "Fortegra," "we," "us," "the Company" or similar terms refer to Fortegra Financial Corporation and its subsidiaries), traded on the New York Stock Exchange under the symbol: FRF, is an insurance services company headquartered in Jacksonville, Florida. Fortegra offers a wide array of revenue enhancing products, including payment protection products, motor club memberships, service contracts, device and warranty services, and administration services, to our business partners, including insurance companies, retailers, dealers, insurance brokers and agents and financial services companies. In 2008, the Company changed its name from Life of the South Corporation to Fortegra Financial Corporation. The Company was incorporated in 1981 in the State of Georgia and re-incorporated in the State of Delaware in 2010. Most of the Company's business is generated through networks of small to mid-sized community and regional banks, small loan companies, independent wireless retailers and automobile dealerships. The Company's subsidiaries (100% direct or indirect ownership, unless otherwise noted below) at December 31, 2013, are as follows:
4Warranty Corporation ("4Warranty")
Auto Knight Motor Club, Inc. ("Auto Knight")
Continental Car Club, Inc. ("Continental")
CRC Reassurance Company, Ltd. ("CRC") *
Digital Leash, LLC, d/b/a ProtectCELL ("ProtectCELL"), 62.4% owned
Insurance Company of the South ("ICOTS") *
Life of the South Insurance Company ("LOTS") * and its subsidiary, Bankers Life of Louisiana ("Bankers Life") *
LOTS Intermediate Co. ("LOTS IM")
LOTS Reassurance Company ("LOTS RE") *
LOTSolutions, Inc.
Lyndon Southern Insurance Company ("Lyndon Southern") *
Pacific Benefits Group Northwest, LLC ("PBG")
Response Indemnity Company of California ("RICC") *
South Bay Acceptance Corporation ("South Bay")
South Bay Financial Services, LLC ("SBFS")
Southern Financial Life Insurance Company ("SFLAC"), 85.0% owned *
United Motor Club of America, Inc. ("United")
* = Insurance company subsidiary

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In June 2007, entities affiliated with Summit Partners, L.P., a growth equity investment firm, acquired 91.2% of our capital stock. The acquisition was financed through (i) $20.0 million of subordinated debentures issued to affiliates of Summit Partners and paid off in 2010, (ii) $35.0 million of preferred trust securities maturing in 2037 and (iii) an equity investment of $43.1 million by affiliates of Summit Partners. In addition to acquiring our capital stock in the acquisition, the proceeds from the equity and debt financings were used to repay pre-transaction indebtedness of $10.1 million and pay transaction costs of $5.8 million. We refer to the foregoing transactions collectively as the "Summit Partners Transactions." In April 2009, in connection with our acquisition of Bliss and Glennon, Inc., affiliates of Summit Partners acquired additional shares of our common stock for $6.0 million.

On December 17, 2010, we completed our initial public offering (the "IPO") and began trading on the New York Stock Exchange ("NYSE") under the symbol "FRF". In conjunction with our IPO, we issued 6,000,000 shares of common stock at an IPO price of $11.00 per share, of which 4,265,637 shares were sold by us and 1,734,363 shares were sold by selling stockholders. In connection with the IPO, Summit Partners sold 1,548,675 common shares of stock. At December 31, 2013, affiliates of Summit Partners beneficially owned approximately 63.2% of our 20,912,853 shares of common stock issued.

Business Overview
We began over 30 years ago as a provider of credit insurance products and, through our transformational efforts, have evolved into an insurance services company offering a unique complement of products and services. From 1994 to 2003, through a series of strategic acquisitions and organic growth, we expanded our payment protection client (or producer) base to include consumer finance companies, retailers, automobile dealers, credit card issuers, credit unions and regional and community banks throughout the United States. During this period, we expanded our product and service offerings to include credit property, debt cancellation and warranty service contracts.

We now leverage our proprietary technology infrastructure and internally developed best practices to provide our clients with administration services and insurance-related products. Our services and products complement consumer credit offerings and provide outsourcing solutions designed to reduce the costs associated with the administration of insurance and other financial products. In addition, we offer warranty service contracts through our retail and dealer business partners. These services and products are designed to increase revenues, improve customer value and loyalty and reduce costs for our clients.

We generally target markets that are niche and specialty in nature, which we believe are underserved by competitors and have high barriers to entry. We focus on building quality client relationships and emphasizing customer service. This focus, along with our ability to help clients enhance revenue and reduce costs, has enabled us to develop and maintain numerous long-term client relationships.

Our Business
We specialize in offering products that protect lenders and their customers from death, disability or other events that could otherwise impair their ability to repay a debt. We also offer warranty and other service contracts for mobile handsets, furniture and major appliances, as well as motor club solutions for consumers through our retail, auto, and financing clients. In addition, we provide an assortment of administrative services tailored to insurance and other financial services companies through a virtual insurance company platform. Our business benefits from efficiencies of centralized accounting, compliance, legal, technology, human resources and administrative services.

We offer products marketed under our Life of the South, ProtectCELL, 4Warranty, Continental Car Club, United Motor Club and Auto Knight Motor Club brands. Through these brands we deliver credit insurance, debt protection, warranty and other service contracts, motor club solutions and membership plans to consumer finance companies, regional banks, community banks, retailers, small loan companies, warranty administrators, automobile dealers, vacation ownership developers, credit unions and independent wireless retailers. Our clients then offer these complimentary products and services to their customers in conjunction with consumer transactions. We believe our products and services add value to our clients by increasing their revenues, enhancing customer value and loyalty, and improving their profitability.

We own and operate insurance company subsidiaries to facilitate, on behalf of our clients, the distribution of credit insurance and payment protection services and products. This allows our clients to sell these services and products to their customers without having to establish their own insurance companies, which saves our clients the cost and time of undertaking and complying with substantial regulatory and licensing requirements. Our clients typically retain underwriting risk related to such products either through retrospective commission arrangements or fully-collateralized reinsurance companies owned by them, which we administer on their behalf. While the majority of our revenue is fee-based, we assume insurance underwriting risk in select instances to meet clients' needs and to enhance our profitability. In addition, our insurance company subsidiaries issue contractual liability policies to warranty companies and service providers in relation to warranty and service contracts.

We generate service and administrative fees for administering payment protection products on behalf of our clients. We also earn ceding commissions for credit insurance that we cede to reinsurers through coinsurance arrangements. We elect to cede to reinsurers a significant

3


portion of the credit insurance that we distribute for loss protection and capital management. In addition, we also generate net investment income from our invested assets portfolio.

We also offer a range of administrative services, under our Consecta brand, tailored to insurance and other financial services companies. We leverage our technology, and the capacity and expertise of our operations team, to provide sales and marketing, electronic underwriting, premium billing and collections, policy administration, claims adjudication and call center management services on behalf of our clients.

Recent Business Acquisitions and Divestitures
Our 2013 business acquisitions, discontinued operations and other divestitures are detailed below:

Acquisition in 2013
On February 1, 2013, we acquired 100% of the outstanding stock of RICC, from subsidiaries of the Kemper Corporation ("Kemper") for $4.8 million.  RICC is a property and casualty insurance company domiciled and licensed in California, which we intend to use for geographic expansion.  RICC had, at the time of purchase, no policies in force. All remaining claim liabilities for previously issued policies are fully reinsured by Kemper's subsidiary, Trinity Universal Insurance Company. Please see the Note, "Business Combinations," in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information.

Disposition Resulting in Discontinued Operations in 2013
On December 31, 2013, we completed the previously announced sale of all of the issued and outstanding stock of our subsidiaries, Bliss and Glennon, Inc., a California corporation ("Bliss and Glennon"), and eReinsure.com, Inc., a Delaware corporation ("eReinsure"), to AmWINS Holdings, LLC, a North Carolina limited liability company ("AmWINS") (the "Disposition"), pursuant to the terms of a Stock Purchase Agreement ("Purchase Agreement"), dated December 2, 2013.

As consideration for the Disposition, we received net cash proceeds of $81.8 million, representing gross proceeds of $83.5 million less $1.0 million in transaction fees paid at the time of closing and $0.7 million of cash held by the disposed entities. The proceeds are subject to certain purchase price adjustments as set forth in the Purchase Agreement to reflect fluctuations in working capital, including adjustments for any receivable balances as of the Disposition date that are not collected within one year. For the year ended December 31, 2013, we recorded an $8.8 million gain, net of tax, on the Disposition. Please see the Note, "Divestitures," in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information.

Other Sale of Subsidiary in 2013
In June 2013, we sold our wholly-owned subsidiary Magna Insurance Company ("Magna"), for a gross sales price of $3.0 million, less cash held by Magna, transferred in the sale, of $0.8 million. For the year ended December 31, 2013, the Company recorded a $0.4 million pre-tax gain on the sale of Magna. Please see the Note, "Divestitures," in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information.

The following table summarizes our acquisition and divestiture activity for the year ended:
 
December 31, 2013
(in thousands, except number of transactions)
Acquisitions
 
Discontinued Operations
 
Other Sale of Subsidiary(1)
Number of transactions
1

 
1

 
1

 
 
 
 
 
 
Gross cash consideration (paid)/received
$
(4,795
)
 
$
83,500

 
$
2,976

(1) - Represents the sale of a single subsidiary not considered to be a discontinued operation.

Change in Reportable Segments
Prior to the fourth quarter of 2013, we operated in three business segments: (i) Payment Protection, (ii) Business Process Outsourcing and (iii) Brokerage. In connection with the Disposition in the fourth quarter of 2013, we realigned our reporting structure, to manage our business as a single profit center called Protection Products and Services. Accordingly, we now have one reportable segment. This change is consistent with our Chief Operating Decision Maker's approach to managing our business and related resources. We determined that our Chief Executive Officer is the Chief Operating Decision Maker. The financial results of our single segment are equal to the net income from continuing operations reported in the Consolidated Statements of Income for all periods presented.

Our Competitive Strengths
We believe the following to be the key strengths of our business model:


4


Strong Value Proposition for Our Clients and Their Customers.  Our solutions manage the essential aspects of insurance distribution and administration, providing low-cost access to complex, often highly-regulated markets, which we believe enables our clients to generate high margin, incremental revenues, enter new markets, mitigate risk, improve operating efficiencies and enhance customer loyalty.

Proprietary Technology and Low-Cost Operating Platform.  Our proprietary technology delivers low-cost, highly automated services to our clients without significant up-front investments and enables us to automate core business processes and reduce our clients' operating costs.

Scalability.  We believe that our scalable and flexible technology infrastructure, together with our highly trained and knowledgeable information technology personnel and consultants, enables us to add new clients and launch new services and products and expand our transaction volume quickly and easily without significant incremental expense.

High Barriers to Entry.  We believe that our business would be time consuming and expensive for new market participants to replicate due to the barriers to entry provided by our long-term relationships with clients and other market participants and substantial experience in the markets that we serve.

 Experienced Management Team.  We have an experienced management team with extensive operating and industry experience in the markets that we serve. Our management team has successfully developed profitable new services and products and completed the acquisition of fourteen complementary businesses since January 1, 2008.

While we believe these strengths will enable us to compete effectively, there are various risk factors that could materially and adversely affect our competitive position. See ITEM 1A. RISK FACTORS, included in this Form 10-K for a discussion of these factors.
 
Key Attributes of Our Business Model
 We believe the following are the key attributes of our business model:

Recurring Revenue Generation.  Our business model, which includes the deployment of our technology with many of our clients, has historically generated substantial recurring revenues and positive operating cash flows.

Long-Term Relationships.  By delivering value-added services and products to our clients' customers, and offering fixed-term contracts, we become an important part of our clients' businesses and develop long-term relationships.

Product Diversification.  We have a unique array of protection products attractive to customers in several channels within the financial services industry and among retailers, which positions us to take better advantage of emerging industry trends and to better manage business and insurance cycles than companies that offer a narrow scope of products within one or few marketing channels.

Our Growth Strategy
We believe the following are the key contributors to our growth strategy:

Provide High Value Solutions.  We continue to enhance our technologies and processes and focus on integrating our operations with those of our clients in order to provide our clients with services and products that will allow them to generate incremental revenues while reducing the costs of providing insurance and other financial products.

Increase Revenue from Our Existing Clients.  We will seek to leverage our long-standing relationships with our existing clients by providing them with additional services and products, introducing new services and products for them to market to their customers and establishing volume-based fee arrangements.

Expand Client Base in Existing Markets.  We intend to take advantage of business opportunities to develop new client relationships through our direct sales force, from referrals from existing clients and business partners, by responding to requests for proposals and through our participation in industry events.

Enter New Geographic Markets.  We will look to expand our market presence in new geographic markets in the United States and internationally by broadening the jurisdictions in which we operate, hiring new employees, opening new offices, seeking additional licenses and regulatory approvals and pursuing acquisition opportunities.

Pursue Strategic Acquisitions.  We plan to continue pursuing acquisitions of complementary businesses to expand our service offerings, access new markets and expand our client base.

Competition
Our business focuses on protection products targeted to niche markets within broader insurance and financial services markets. We believe that no single competitor competes against us in all aspects of our operations. The markets in which we operate are generally characterized by a limited number of competitors. Competition is based on many factors, including price, industry knowledge, quality of client service, the effectiveness of our sales force, technology platforms and processes, the security and integrity of our information

5


systems, the financial strength ratings of our insurance company subsidiaries, office locations, breadth of products and services and brand recognition and reputation. Some competitors may offer a broader array of services and products, may have a greater diversity of distribution resources, may have a better brand recognition, may have lower cost structures or, with respect to insurers, may have higher financial strength or claims paying ratings. Some competitors also have larger client bases than we do. In addition, new competitors could enter our markets in the future. The relative importance of these factors varies by product and market. The competitive landscape for our operations is described below.

Our payment protection products and warranty service contracts compete with similar products of insurance companies, financial institutions, warranty companies and other insurance service providers. The principal competitors for our payment protection products include the payment protection groups of The Warranty Group, Assurant, Inc., eSecuritel Holdings, LLC, Asurion, LLC, Global Warranty Group, LLC and smaller regional companies. As a result of state and federal regulatory developments and changes in prior years, certain financial institutions are able to offer debt cancellation plans and are also able to affiliate with other insurance companies in order to offer services similar to our payment protection products. As financial institutions gain experience with payment protection programs, their reliance on our services and products may diminish.

Our business also competes with a variety of companies, including large multinational firms that provide consulting, technology and/or business process services, off-shore business process service providers in low-cost locations like India, and in-house captive insurance companies of potential clients. Our principal business process outsourcing competitors include Aon Corporation, Computer Sciences Corporation, Direct Response Insurance Administrative Services, Inc., Marsh & McLennan Companies, Inc., Dell Services and Unisys Corporation. The trend toward outsourcing and technological changes may also result in new and different competitors entering our markets. There could also be newer competitors with strong competitive positions as a result of strategic consolidation of smaller competitors or of companies that each provide different services or serve different industries. In addition, a client or potential client may choose not to outsource its business, including setting up captive outsourcing operations or by performing formerly outsourced services themselves.

In addition, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 and regulations enacted thereunder permit banks, securities firms and insurance companies to affiliate. As a result, the financial services industry has experienced and may continue to experience consolidation, which in turn has resulted and could continue to result in increased competition from diversified financial institutions, including competition for acquisition prospects.

Regulation
We are subject to the reporting requirements of the Exchange Act, and its rules and regulations, which requires us to file periodic and current reports, proxy statements and other information with the Securities and Exchange Commission ("SEC").

Our business is subject to extensive regulation and supervision, including at the federal, state, local and foreign levels. We cannot predict the impact of future changes to such laws or regulations on our business. Future laws and regulations, or the interpretation thereof, may have a material adverse effect on our results of operations, financial condition and cash flows.

Regulation of our Products and Services
State Regulation
Our insurance company, service contract, and motor club subsidiaries are subject to regulation in the various states and jurisdictions in which they transact business. State insurance laws and regulations regulate most aspects of our business, and our insurance company subsidiaries are regulated by the insurance departments of the states in which they are domiciled and licensed. Our service contract and motor club subsidiaries are regulated by state insurance departments and other agencies where they operate. Our non-U.S. insurance company subsidiaries are principally regulated by insurance regulatory authorities in the jurisdictions in which they are domiciled (i.e., Turks and Caicos). Our insurance products and our business are also affected by U.S. federal, state and local tax laws, and the tax laws of non-U.S. jurisdictions.

The extent of U.S. state insurance regulation varies, but generally derives from statutes that delegate regulatory, supervisory and administrative authority to a department of insurance in each state. The purpose of the laws and regulations affecting our insurance company subsidiaries is primarily to protect the policyholders and not our stockholders or our agents (i.e., businesses that sell our products to their customers). The regulation, supervision and administration by state departments of insurance relate, among other things, to: standards of solvency that must be met and maintained; restrictions on the payment of dividends; changes in control of insurance companies; the licensing of insurers and their agents and other producers; the types of insurance that may be written; privacy practices; the ability to enter and exit certain insurance markets; the nature of and limitations on investments and premium rates, or restrictions on the size of risks that may be insured under a single policy; reserves and provisions for unearned premiums, losses and other obligations; deposits of securities for the benefit of policyholders; payment of sales compensation to third parties; approval of policy forms; and the regulation of market conduct, including underwriting and claims practices.


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Insurance Holding Company Statutes
As a holding company, we are not regulated as an insurance company, but because we own capital stock in insurance company subsidiaries, we are subject to the state insurance holding company statutes, as well as certain other laws of each of the states of domicile of our insurance company subsidiaries. All holding company statutes, as well as other laws, require disclosure and in many instances, prior regulatory approval of material transactions between an insurance company and an affiliate. The holding company statutes, as well as other laws, also require, among other things, prior regulatory approval of an acquisition of control of a domestic insurer, certain transactions between affiliates and payments of extraordinary dividends or distributions. Transactions within the holding company system affecting insurers must be fair and reasonable, and each insurer's policyholder surplus following any such transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs.

Dividends Limitations
We are a holding company and have limited direct operations. Our holding company assets consist primarily of the capital stock of our subsidiaries. Accordingly, our future cash flows depend upon the availability of dividends and other payments from our subsidiaries, including statutorily permissible payments from our insurance company subsidiaries, as well as payments under our tax allocation agreement and management agreements with our subsidiaries. The ability of our insurance company subsidiaries to pay dividends and to make other payments will be limited by applicable laws and regulations of the states in which our insurance company subsidiaries are domiciled and in which they operate, which vary from state to state and by type of insurance provided by the applicable subsidiary. These laws and regulations require, among other things, our insurance company subsidiaries to maintain minimum solvency requirements and limit the amount of dividends they can pay to their respective holding company. Along with solvency regulations, the primary factor in determining the amount of capital available for potential dividends is the level of capital needed to maintain desired financial strength ratings from A.M. Best for our insurance company subsidiaries. Given recent economic events that have affected the insurance industry, both regulators and rating agencies could become more conservative in their methodology and criteria, including increasing capital requirements for our insurance company subsidiaries which, in turn, could negatively affect our capital resources. The following table sets forth the dividends paid to us by our insurance company subsidiaries for the following periods:
 
For the Years Ended December 31,
(in thousands)
2013
 
2012
 
2011
Ordinary dividends
$
2,383

 
$
2,783

 
$
6,956

Extraordinary dividends

 

 
830

Total dividends
$
2,383

 
$
2,783

 
$
7,786


For the year ended December 31, 2013, the maximum amount of dividends that our regulated insurance company subsidiaries could pay under applicable laws and regulations without regulatory approval was $4.0 million. We may seek regulatory approval to pay dividends in excess of this permitted amount, but there can be no assurance that we would receive regulatory approval if sought. Please see the Note, "Statutory Reporting and Insurance Company Subsidiaries Dividend Restrictions," in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information relating to dividend restrictions for our insurance company subsidiaries.

Regulation of Investments
Our insurance company subsidiaries must comply with their respective state of domicile's laws regulating insurance company investments. These laws prescribe the kind, quality and concentration of investments and while unique to each state, the laws are modeled on the standards promulgated by the National Association of Insurance Commissioners ("NAIC"). Such investment laws are generally permissive with respect to federal, state and municipal obligations, and more restrictive with respect to corporate obligations, particularly non-investment grade obligations, foreign investment, equity securities and real estate investments. Each insurance company is therefore limited by the investment laws of its state of domicile from making excessive investments in any given security (such as single issuer limitations) or in certain classes or riskier investments (such as aggregate limitation in non-investment grade bonds). The diversification requirements are broadly consistent with our investment strategies. Failure to comply with these laws and regulations would cause investments exceeding regulatory limitations to be treated as non-admitted assets for the purpose of measuring surplus, and, in some instances, would require divestiture of such non-complying investments. We believe the investments made by our insurance company subsidiaries comply with these laws and regulations.

Risk-Based Capital Requirements
The NAIC has adopted a model act with risk-based capital ("RBC") formulas to be applied to insurance companies. RBC is a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. RBC standards are used by state insurance regulators to determine appropriate regulatory actions relating to insurers that show signs of weak or deteriorating conditions. The domiciliary states of our insurance company subsidiaries have adopted laws substantially similar to the NAIC's RBC model act. RBC requirements determine minimum capital requirements and are intended to raise the level of protection for policyholder obligations. RBC levels are not intended as a measure to rank insurers generally, and the insurance laws in the domiciliary states of our subsidiaries generally restrict the public dissemination of insurers' RBC levels. Under laws adopted by individual states, insurers having total adjusted capital less than that required by the RBC calculation will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy.

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Federal Regulation
Dodd-Frank Wall Street Reform and Consumer Protection Act
In July 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which implements comprehensive changes to the regulatory landscape of the financial services industry in the U.S. Many aspects of the Dodd-Frank Act are subject to rule-making and will take effect over several years, making it difficult to anticipate the overall financial impact on our business, our customers or the insurance and financial services industries.

In addition, in connection with the Dodd-Frank Act, Congress created the Consumer Financial Protection Bureau (the "CFPB"). While the CFPB does not have direct jurisdiction over insurance products, it is possible that regulatory actions taken by the CFPB may affect the sales practices related to these products and thereby potentially affect the Company's business or the clients that we serve.

Gramm-Leach-Bliley Act
On November 12, 1999, the Gramm-Leach-Bliley Act of 1999 became law, implementing fundamental changes in the regulation of the financial services industry in the United States. The Gramm-Leach-Bliley Act permits the transformation of the already converging banking, insurance and securities industries by permitting mergers that combine commercial banks, insurers and securities firms under one holding company. Under the Gramm-Leach-Bliley Act, community banks retain their existing ability to sell insurance products in some circumstances. Privacy provisions of the Gramm-Leach-Bliley Act became fully effective in 2001. These provisions established consumer protections regarding the security and confidentiality of nonpublic personal information and, as implemented through state insurance laws and regulations, require us to make full disclosure of our privacy policies to customers.

Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
Through HIPAA, the Department of Health and Human Services imposes obligations for issuers of health and dental insurance coverage and health and dental benefit plan sponsors. HIPAA established requirements for maintaining the confidentiality and security of individually identifiable health information and new standards for electronic health care transactions. The Department of Health and Human Services promulgated final HIPAA regulations in 2002. The privacy regulations required compliance by April 2003, the electronic transactions regulations by October 2003 and the security regulations by April 2005. Recently, parts of HIPAA were amended under the HITECH Act, and pursuant to these amendments, new regulations have been issued requiring notification of government agencies and consumers in the event of certain security breaches involving personal health information.

HIPAA is far-reaching and complex; interpretation of and proper practices under the law continue to evolve. Consequently, our efforts to measure, monitor and adjust our business practices to comply with HIPAA are ongoing. Failure to comply could result in regulatory fines and civil lawsuits. Knowing and intentional violations of these rules may also result in federal criminal penalties.

Foreign Jurisdictions
A portion of our business is ceded to our reinsurance company subsidiaries domiciled in Turks and Caicos. Those subsidiaries must satisfy local regulatory requirements, such as filing annual financial statements, filing annual certificates of compliance and paying annual fees. If we fail to maintain compliance with applicable laws, rules and regulations, the licenses issued by the regulatory authority in Turks and Caicos could be subject to modification or revocation, and our subsidiaries could be prevented from conducting business.

Regulation of our Administration Services
We are subject to federal and state laws and regulations, particularly related to our administration of insurance products on behalf of other insurers. In order for us to process and administer insurance products of other companies, we are required to maintain licenses of a third party administrator in the states where those insurance companies operate. Through our service offerings we also are subject to the related federal and state privacy laws and must comply with data protection and privacy laws, such as the Gramm-Leach-Bliley Act and HIPAA discussed above, and certain state data privacy laws. We are also subject to laws and regulations related to call center services, such as the Telemarketing Consumer Fraud and Abuse Prevention Act and the Telemarketing Sales Rule, the Telephone Consumer Protection Act, the Do-Not-Call Implementation Act and rules promulgated by the Federal Communications Commission and the Federal Trade Commission and the CAN-SPAM Act. In addition, the terms of our contracts typically require us to comply with applicable laws and regulations. If we fail to comply with any applicable laws, acts, rules or regulations, we may be restricted in our ability to provide services and may also be subject to civil or criminal fines or penalties, litigation or contract termination.

Seasonality
 Our financial results may be affected by seasonal variations. Revenues associated with our products may fluctuate seasonally based on consumer spending trends. Consumer spending has historically been higher in September and December, corresponding to back-to-school and the holiday season. Accordingly, our revenues from our products may be higher in the third and fourth quarters than in the first half of the year. Member benefit claims on mobile device protection are typically more frequent in the summer months, and accordingly, our claims expense from those products may be higher in the second and third quarters than other times of the year.


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Employees
At December 31, 2013, we employed approximately 494 people, on a full or part-time basis. Immediately prior to the consummation of the sale of Bliss and Glennon and eReinsure on December 31, 2013, we had 697 employees. None of our employees are represented by unions or trade organizations. We believe that our relations with our employees are satisfactory.

Intellectual Property
We own or license a number of trademarks, patents, trade names, copyrights, service marks, trade secrets and other intellectual property rights that relate to our services and products. Although we believe that these intellectual property rights are, in the aggregate, of material importance to our business, we believe that our business is not materially dependent upon any particular trademark, trade name, copyright, service mark, license or other intellectual property right. U.S. trademark and service mark registrations are generally for a term of 10 years, renewable every 10 years as long as the trademark or service mark is used in the regular course of trade. We have entered into confidentiality agreements with our clients. These agreements impose restrictions on such clients' use of our proprietary software and other intellectual property rights.

Web Site Access to Fortegra's Filings with the SEC
We maintain an Internet website at www.fortegrafinancial.com. The information that appears on our website is not part of, and is not incorporated into, this Form 10-K. We will make available free of charge on our website our Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act and the rules promulgated thereunder, as soon as reasonably practicable after electronically filing or furnishing such material to the SEC. All filings with the SEC are posted to our website in the "Investor Relations" tab under the section "Financial Information." Upon written request of any stockholder of record on December 31, 2013, Fortegra will provide, without charge, a printed copy of its 2013 Form 10-K as required to be filed with the SEC. To obtain a copy of this 2013 Form 10-K, Contact: Investor Relations, Fortegra Financial Corporation, 10151 Deerwood Park Boulevard, Building 100, Suite 330, Jacksonville, FL, 32256, or call (866)-961-9529.

Copies of all of Fortegra's filings and other information may also be obtained electronically from the SEC's website at www.sec.gov. or may be read and copied at the: SEC Public Reference Room, 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

ITEM 1A. RISK FACTORS
The following are certain risks that management believes are specific to our business. This should not be viewed as an all-inclusive list of risks or as a presentation of the risk factors in any particular order. You should carefully consider the risks described below, together with the other information contained in this Form 10-K and in our other filings with the SEC when evaluating our Company. Should any of the events discussed in the risk factors below occur, our business, results of operations or financial condition could be materially affected. Additional risks unknown at this time, or risks we currently deem immaterial, may also impact our financial condition, results of operations or cash flows.

Risks Related to our Business and Industries
General economic and financial market conditions may have a material adverse effect on the business, results of operations, cash flows and financial condition of our business.
General economic and financial market conditions, including the availability and cost of credit, the loss of consumer confidence, reduction in consumer or business spending, inflation, unemployment, energy costs and geopolitical issues, have contributed to increased uncertainty and volatility as well as diminished expectations for the U.S. economy and the financial markets. These conditions could materially and adversely affect our business. Adverse economic and financial market conditions could result in:
a reduction in the demand for, and availability of, consumer credit, which could result in reduced demand by consumers for our products and our clients opting to no longer make such products available;
higher than anticipated loss ratios on our products due to rising unemployment or disability claims;
higher risk of increased fraudulent claims;
individuals terminating loans or canceling credit insurance policies, thereby reducing our revenues;
a reduction in the demand for consumer warranty service contracts, service contract offerings, mobile device protection and motor club memberships;
individuals terminating warranty service contracts, service contracts, mobile device protection contracts or motor club memberships, thereby reducing our revenues;
our clients being more likely to experience financial distress or declare bankruptcy or liquidation, which could have an adverse impact on demand for our services and products and the remittance of premiums from such customers, as well as the collection of receivables from such clients for items such as unearned premiums, commissions or related accounts receivable, which could make the collection of receivables from our clients more difficult;
increased pricing sensitivity or reduced demand for our services and products;

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increased costs associated with, or the inability to obtain, debt financing to fund acquisitions or the expansion of our business; and
defaults in our fixed income investment portfolio or lower than anticipated rates of return as a result of low interest rate environments.

If we are unable to successfully anticipate changing economic or financial market conditions, we may be unable to effectively plan for or respond to such changes, and our business, results of operations, financial condition and cash flows could be materially and adversely affected.
 
We face significant competitive pressures in our business, which could materially and adversely affect our business, results of operations, financial condition and cash flows.
Competition in our business is based on many factors, including price, industry knowledge, quality of client service, our ability to efficiently administer claims, the effectiveness of our sales force, technology platforms and processes, the security and integrity of our information systems, the financial strength ratings of our insurance company subsidiaries, office locations, breadth of services and products and brand recognition and reputation. Some competitors may offer a broader array of services and products, may have a greater diversity of distribution resources, may have better brand recognition, may have lower cost structures or, with respect to insurers, may have higher financial strength or claims paying ratings. Some competitors also have larger client bases than we do. In addition, new competitors could enter our markets in the future, and existing competitors may gain strength by forging new business relationships. The competitive landscape in which our business operates is described below.

We compete with insurance companies, financial institutions, extended service plan providers, membership plan providers, wireless carriers and other insurance and warranty service providers. Our principal competitors include The Warranty Group, Assurant, Inc., Asurion Corporation, eSecuritel Holdings, LLC, Global Warranty Group, LLC and smaller regional companies. As a result of state and federal regulatory developments and changes in prior years, certain financial institutions are able to offer debt cancellation plans and are also able to affiliate with other insurance companies in order to offer services similar to ours. This has resulted in new competitors, some of whom have significant financial resources, entering some of our markets. As competitors gain experience with payment protection and warranty programs, their reliance on our services and products may diminish.

We expect competition to intensify, which may result in lower prices and volumes, higher personnel and sales and marketing costs, increased technology expenditures and lower profitability. We may not be able to supply clients with services or products that they deem superior and at competitive prices and we may lose business to our competitors. If we are unable to compete effectively, it would have a material adverse effect on our business, results of operations, financial condition and cash flows.
 
Our results of operations may fluctuate significantly, which makes our future results of operations difficult to predict. If our results of operations fall below expectations, the price of our common stock could decline.
Our annual and quarterly results of operations have fluctuated in the past and may fluctuate significantly in the future due to a variety of factors, many of which are beyond our control. In addition, our expenses as a percentage of revenues may be significantly different than our historical rates. As a result, comparing our results of operations on a period-to-period basis may not be meaningful. Factors that may cause our results of operations to fluctuate from period-to-period include:
demand for our services and products;
the length of our sales cycle;
the amount of sales to new clients;
the timing of implementations of our services and products with new clients;
seasonality;
the timing of acquisitions;
competitive factors;
prevailing interest rates;
pricing changes by us or our competitors;
transaction volumes in our clients' businesses;
the introduction of new services and products by us and our competitors;
changes in strategic partnerships;
changes in regulatory and accounting standards; and
our ability to control costs.

In addition, our revenues may vary depending on the level of consumer activity and the success of our clients in selling products.


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Our results of operations could be materially and adversely affected if we fail to retain our existing clients, cannot sell additional services and products to our existing clients, do not introduce new or enhanced services and products or are not able to attract and retain new clients.
Our revenue and revenue growth are dependent on our ability to retain clients, to sell those clients additional services and products, to introduce new services and products and to attract new clients. Our ability to increase revenues will depend on a variety of factors, including:
the quality and perceived value of our product and service offerings by existing and prospective clients;
the effectiveness of our sales and marketing efforts;
the successful installation and implementation of our services and products for new and existing clients;
availability of capital to complete investments in new or complementary products, services and technologies;
the availability of adequate reinsurance for us and our clients, including the ability of our clients to form, capitalize and operate captive reinsurance companies;
our ability to find suitable acquisition candidates, successfully complete such acquisitions and effectively integrate such acquisitions;
our ability to integrate technology into our services and products to avoid obsolescence and provide scalability;
the reliability, execution and accuracy of our services; and
client willingness to accept any price increases for our services and products.

In addition, we are subject to risks of losing clients due to consolidation in the markets we serve. Our inability to retain existing clients, sell additional services and products, or successfully develop and implement new and enhanced services and products and attract new clients, and accordingly, increase our revenues, could have a material adverse effect on our results of operations.

We typically face a long selling cycle to secure new clients as well as long implementation periods that require significant resource commitments, which result in a long lead time before we receive revenues from new client relationships.
The industries in which we compete generally consist of mature businesses and markets and the companies that participate in these industries have well-established business operations, systems and relationships. Accordingly, our business typically faces a long selling cycle to secure a new client. Even if we are successful in obtaining a new client engagement, it is generally followed by a long implementation period in which the services are planned in detail and we demonstrate to the client that we can successfully integrate our processes and resources with their operations. We also typically negotiate and enter into a contractual relationship with the new client during this period. There is then a long implementation period in order to commence providing the services.
 
We typically incur significant business development expenses during the selling cycle. We may not succeed in winning a new client's business, in which case we receive no revenues and may receive no reimbursement for such expenses. Even if we succeed in developing a relationship with a potential client and begin to plan the services in detail, such potential client may choose a competitor or decide to retain the work in-house prior to the time a final contract is signed. If we enter into a contract with a client, we will typically receive no revenues until implementation actually begins. In addition, a significant portion of our revenue is based upon the success of our clients' marketing programs, which may not generate the transaction volume we anticipate. Our clients may also experience delays in obtaining internal approvals or delays associated with technology or system implementations, thereby further lengthening the implementation cycle. If we are not successful in obtaining contractual commitments after the selling cycle, in maintaining contractual commitments after the implementation cycle or in maintaining or reducing the duration of unprofitable initial periods in our contracts, it may have a material adverse effect on our business, results of operations and financial condition. Furthermore, the time and effort required to complete the implementation phases of new contracts makes it difficult to accurately predict the timing of revenues from new clients as well as our costs.
 
Acquisitions are a significant part of our growth strategy and we may not be successful in identifying suitable acquisition candidates, completing such acquisitions or integrating the acquired businesses, which could have a material adverse effect on our business, results of operations, financial condition and growth.
Historically, acquisitions have played a significant role in our expansion into new markets and in the growth of some of our operations. Acquiring complementary businesses is a significant component of our growth strategy. Accordingly, we frequently evaluate possible acquisition targets for our business. However, we may not be able to identify suitable acquisitions, and such transactions may not be able to be financed and completed on acceptable terms. We may incur significant expenses in evaluating and completing such acquisitions. Furthermore, any future acquisitions may not be successful. In addition, we may be competing with larger competitors with substantially greater resources for acquisition targets. Any deficiencies in the process of integrating companies we may acquire could have a material adverse effect on our results of operations and financial condition. Acquisitions entail a number of risks including, among other things:
failure to achieve anticipated revenues, earnings or cash flows;
increased expenses;
diversion of management time and attention;
failure to retain the acquired business' customers or personnel;
difficulties in realizing projected efficiencies;
ability to realize synergies and cost savings;

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difficulties in integrating systems and personnel; and
inaccurate assessment of liabilities.

Our failure to adequately address these acquisition risks could have a material adverse effect on our business, results of operations, financial condition and growth. Future acquisitions may reduce our cash resources available to fund our operations and capital expenditures and could result in increased amortization expense related to any intangible assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt, which could increase our interest expense.

We may lose clients or business as a result of consolidation within the financial services industry.
There has been considerable consolidation in the financial services industry, driven primarily by the acquisition of small and mid-size organizations by larger entities. We expect this trend to continue. We may lose business or suffer decreased revenues if one or more of our significant clients or distributors consolidate or align themselves with other companies. To date, our business has not been materially affected by consolidation. However, we may be affected by industry consolidation that occurs in the future, particularly if any of our significant clients are acquired by organizations that already possess the operations, services and products that we provide.

Our ability to implement and execute our strategic plans may not be successful and, accordingly, we may not be successful in achieving our strategic goals, which may materially and adversely affect our business.
We may not be successful in developing and implementing our strategic plans for our business or the operational plans that have been or need to be developed to implement these strategic plans. If the development or implementation of such plans is not successful, we may not produce the revenue, margins, earnings or synergies that we need to be successful. We may also face delays or difficulties in implementing service, product, process and system improvements, which could adversely affect the timing or effectiveness of margin improvement efforts in our business and our ability to successfully compete in the markets we serve. The execution of our strategic and operating plans will, to some extent, also be dependent on external factors that we cannot control. In addition, these strategic and operational plans need to continue to be assessed and reassessed to meet the challenges and needs of our business in order for us to remain competitive. The failure to implement and execute our strategic and operating plans in a timely manner or at all, realize the cost savings or other benefits or improvements associated with such plans, have financial resources to fund the costs associated with such plans or incur costs in excess of anticipated amounts, or sufficiently assess and reassess these plans could have a material and adverse effect on our business or results of operations.
 
We may not effectively manage our growth, which could materially harm our business.
The growth of our business has placed and may continue to place significant demands on our management, personnel, systems and resources. To manage our growth, we must continue to improve our operational and financial systems and managerial controls and procedures, and we will need to continue to expand, train and manage our personnel. We must also maintain close coordination among our technology, compliance, legal, risk management, accounting, finance, marketing and sales organizations. We may not manage our growth effectively, and if we fail to do so, our business could be materially and adversely harmed.
 
If we continue to grow, we may be required to increase our investment in facilities, personnel and financial and management systems and controls. Continued growth, especially in connection with expansion into new business lines, may also require expansion of our procedures for monitoring and assuring our compliance with applicable regulations and that we recruit, integrate, train and manage a growing employee base. The expansion of our existing business, our expansion into new businesses and the resulting growth of our employee base increase our need for internal audit and monitoring processes that are more extensive and broader in scope than those we have historically required. We may not be successful in implementing all of the processes that are necessary. Further, unless our growth results in an increase in our revenues that is proportionate to the increase in our costs associated with this growth, our operating margins and profitability will be materially and adversely affected.
 
As a holding company, we depend on the ability of our subsidiaries to transfer funds to us to pay dividends and to meet our obligations.
We act as a holding company for our subsidiaries and do not have any significant operations of our own. Dividends from our subsidiaries are our principal sources of cash to meet our obligations and pay dividends, if any, on our common stock. These obligations include our operating expenses and interest and principal payments on our current and any future borrowings. The agreements governing our credit facilities restrict our subsidiaries' ability to pay dividends or otherwise transfer cash to us. Under our credit facility, our subsidiaries are permitted to make distributions to us if no default or event of default has occurred and is continuing at the time of such distribution. If the cash we receive from our subsidiaries pursuant to dividends or otherwise is insufficient for us to fund any of these obligations, or if a subsidiary is unable to pay dividends to us, we may be required to raise cash through the incurrence of additional debt, the issuance of additional equity or the sale of assets.
 
The payment of dividends and other distributions to us by each of the regulated insurance company subsidiaries is regulated by insurance laws and regulations of the states in which they operate. In general, dividends in excess of prescribed limits are deemed "extraordinary" and require insurance regulatory approval. Ordinary dividends, for which no regulatory approval is generally required, are limited to amounts determined by a formula, which varies by state. Some states have an additional stipulation that dividends may only be paid out of earned surplus. States also regulate transactions between our insurance company subsidiaries and our other subsidiaries, such as those relating to the shared services, and in some instances, require prior approval of such transactions within the holding company

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structure. If insurance regulators determine that payment of an ordinary dividend or any other payments by our insurance company subsidiaries to us (such as payments for employee or other services) would be adverse to policyholders or creditors, the regulators may block or otherwise restrict such payments that would otherwise be permitted without prior approval. In addition, there could be future regulatory actions restricting the ability of our insurance company subsidiaries to pay dividends or share services. Please see the Note, "Statutory Reporting and Insurance Company Subsidiaries Dividend Restrictions," in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information relating to dividend restrictions for our insurance company subsidiaries.
 
Our success is dependent upon the retention and acquisition of talented people and the skills and abilities of our management team and key personnel.
Our business depends on the efforts, abilities and expertise of our senior executives, particularly our Chairman, President and Chief Executive Officer, Richard S. Kahlbaugh, and our other key personnel. Mr. Kahlbaugh and our other senior executives are important to our success because they have been instrumental in setting our strategic direction, operating our business, identifying, recruiting and training key personnel, maintaining relationships with our clients, and identifying business opportunities. The loss of one or more of these executives or other key individuals could impair our business and development until qualified replacements are found. We may not be able to replace these individuals quickly or with persons of equal experience and capabilities. Although we have employment agreements with certain of these individuals, we cannot prevent them from terminating their employment with us. In addition, our non-compete agreements with such individuals may not be enforced by the courts. We do not maintain key man life insurance policies on any of our executive officers except for Mr. Kahlbaugh. If we are unable to attract and retain talented employees, it could have a material adverse effect on our business, operating results and financial condition.
 
We may need to raise additional capital in the future, but there is no assurance that such capital will be available on a timely basis, on acceptable terms or at all.
We may need to raise additional funds in order to grow our business or fund our strategy or acquisitions. Additional financing may not be available in sufficient amounts or on terms acceptable to us and may be dilutive to existing stockholders if raised through additional equity offerings. A significant portion of our funding is under our existing credit facility, which matures in August 2017. Additionally, any securities issued to raise such funds may have rights, preferences and privileges senior to those of our existing stockholders. If adequate funds are not available on a timely basis or on acceptable terms, our ability to expand, develop or enhance our services and products, enter new markets, consummate acquisitions or respond to competitive pressures could be materially limited.

Risks Related to Our Products and Services
Our products and services rely on independent financial institutions, lenders and retailers for distribution, and the loss of these distribution sources, or the failure of our distribution sources to sell our products could materially and adversely affect our business and results of operations.
We distribute our products and services through financial institutions, lenders and retailers. Although our contracts with these clients are typically exclusive, they can be canceled on relatively short notice. In addition, the distributors typically do not have any minimum performance or sales requirements and our revenue is dependent on the level of business conducted by the distributor as well as the effectiveness of their sales efforts, each of which is beyond our control. The impairment of our distribution relationships, the loss of a significant number of our distribution relationships, the failure to establish new distribution relationships, the failure to offer increasingly competitive products, the increase in sales of competitors' services and products by these distributors or the decline in their overall business activity or the effectiveness of their sales of our products could materially reduce our sales and revenues. Also, our growth is dependent in part on our ability to identify, attract and retain new distribution relationships and successfully implement our information systems with those of our new distributors.
 
Reinsurance may not be available or adequate to protect us against losses, and we are subject to the credit risk of reinsurers.
As part of our overall risk and capacity management strategy for our insurance products, we purchase reinsurance for a substantial portion of the risks underwritten through third party reinsurance companies. Market conditions beyond our control determine the availability and cost of the reinsurance protection we seek to renew or purchase. States also could impose restrictions on these reinsurance arrangements, such as requiring our insurance company subsidiaries to retain a minimum amount of underwriting risk, which could affect our profitability and results of operations. Reinsurance for certain types of catastrophes generally could become unavailable or prohibitively expensive. Such changes could substantially increase our exposure to the risk of significant losses from natural or man-made catastrophes and could hinder our ability to write future business.
 
Although the reinsurer is liable to the respective insurance company subsidiary to the extent of the ceded reinsurance, the insurance company remains liable to the insured as the direct insurer on all risks reinsured. Ceded reinsurance arrangements, therefore, do not eliminate the obligations of our insurance company subsidiaries to pay claims. While the captive reinsurance companies owned by our clients are generally required to maintain trust accounts with sufficient assets to cover the reinsurance liabilities and we manage these trust accounts on behalf of these reinsurance companies, we are subject to credit risk with respect to our ability to recover amounts due from reinsurers. The inability to collect amounts due from reinsurers could have a material adverse effect on our results of operations and financial condition.
 

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Our reinsurance facilities are generally subject to annual renewal. We may not be able to maintain our current reinsurance facilities and our clients may not be able to continue to operate their captive reinsurance companies. As a result, even where highly desirable or necessary, we may not be able to obtain other reinsurance facilities in adequate amounts and at favorable rates. If we are unable to renew our expiring facilities or to obtain or structure new reinsurance facilities, either our net exposures would increase or, if we are unwilling to bear an increase in net exposures, we may have to reduce the level of our underwriting commitments. Either of these potential developments could have a material adverse effect on our results of operations and financial condition.

Due to the structure of some of our commissions, we are exposed to risks related to the creditworthiness of some of our agents.
We are subject to the credit risk of some of the agents with which we contract to sell our products and services. We typically advance agents' commissions as part of our product offerings. These advances are a percentage of the premium charged. If we over-advance such commissions to agents, they may not be able to fulfill their payback obligations, which could have a material adverse effect on our results of operations and financial condition.
 
A downgrade in the ratings of our insurance company subsidiaries may materially and adversely affect relationships with clients and adversely affect our results of operations.
Claims paying ability and financial strength ratings are each a factor in establishing the competitive position of our insurance company subsidiaries. A ratings downgrade, or the potential for such a downgrade, could, among other things, materially and adversely affect relationships with clients, brokers and other distributors of our services and products, thereby negatively impacting our results of operations, and materially and adversely affect our ability to compete in our markets. Rating agencies can be expected to continue to monitor our financial strength and claims paying ability, and no assurances can be given that future ratings downgrades will not occur, whether due to changes in our performance, changes in rating agencies' industry views or ratings methodologies, or a combination of such factors.
 
Our actual claims losses may exceed our reserves for claims, which may require us to establish additional reserves that may materially and adversely reduce our business, results of operations and financial condition.
We maintain reserves to cover our estimated ultimate exposure for claims with respect to reported claims and incurred but not reported claims as of the end of each accounting period. Reserves, whether calculated under accounting principles generally accepted in the United States or statutory accounting principles, do not represent an exact calculation of exposure. Instead, they represent our best estimates, generally involving actuarial projections, of the ultimate settlement and administration costs for a claim or group of claims, based on our assessment of facts and circumstances known at the time of calculation. The adequacy of reserves will be impacted by future trends in claims severity, frequency, judicial theories of liability and other factors. These variables are affected by external factors such as changes in the economic cycle, unemployment, changes in the social perception of the value of work, emerging medical perceptions regarding physiological or psychological causes of disability, emerging health issues, new methods of treatment or accommodation, inflation, judicial trends, legislative changes, as well as changes in claims handling procedures. Many of these items are not directly quantifiable, particularly on a prospective basis. Reserve estimates are refined as experience develops. Adjustments to reserves, both positive and negative, are reflected in the statement of income of the period in which such estimates are updated. Because the establishment of reserves is an inherently uncertain process involving estimates of future losses, we can give no assurances that ultimate losses will not exceed existing claims reserves. In general, future loss development could require reserves to be increased, which could have a material adverse effect on our business, results of operations and financial condition.

Our investment portfolio is subject to several risks that may diminish the fair value of our invested assets and cash and may materially and adversely affect our business and profitability.
Investment returns are an important part of our overall profitability and significant interest rate fluctuations, or prolonged periods of low interest rates, could impair our profitability. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. We have a significant portion of our investments in cash and highly liquid short-term investments. Accordingly, during prolonged periods of declining or low market interest rates, such as those we have been experiencing since 2008, the interest we receive on such investments decreases and affects our profitability. In addition, certain factors affecting our business, such as volatility of claims experience, could force us to liquidate securities prior to maturity, causing us to incur capital losses. If we do not structure our investment portfolio so that it is appropriately matched with our insurance liabilities, we may be forced to liquidate investments prior to maturity at a significant loss to cover such liabilities.
 
The fair value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. Because all of our fixed maturity securities are classified as available for sale, changes in the fair value of these securities are reflected on our Consolidated Balance Sheets. The fair value generally increases or decreases in an inverse relationship with fluctuations in interest rates, while net investment income realized by us from future investments in fixed maturity securities will generally increase or decrease with interest rates. In addition, actual net investment income and/or cash flows from investments that carry prepayment risk may differ from those anticipated at the time of investment as a result of interest rate fluctuations.
 

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We employ asset/liability management strategies to reduce the adverse effects of interest rate volatility and to increase the likelihood that cash flows are available to pay claims as they become due. Our asset/liability management strategies may fail to eliminate or reduce the adverse effects of interest rate volatility, and significant fluctuations in the level of interest rates may therefore have a material adverse effect on our results of operations and financial condition.
 
We are subject to credit risk in our investment portfolio, primarily from our investments in corporate bonds, preferred securities and municipal bonds. Defaults by third parties in the payment or performance of their obligations could reduce our investment income and realized investment gains or result in the recognition of investment losses. The fair value of our investments may be materially and adversely affected by increases in interest rates, downgrades in the corporate bonds included in the portfolio and by other factors that may result in the recognition of other-than-temporary impairments. Each of these events may cause us to reduce the fair value of our investment portfolio.
 
Further, the fair value of any particular fixed maturity security is subject to impairment based on the creditworthiness of a given issuer. Our fixed maturity portfolio may include below investment grade securities (rated "BB" or lower by nationally recognized securities rating organizations). These investments generally provide higher expected returns, but present greater risk and can be less liquid than investment grade securities. A significant increase in defaults and impairments on our fixed maturity investment portfolio could have a material adverse effect on our results of operations and financial condition.

Risks Related to Regulatory and Legal Matters
We are subject to extensive governmental laws and regulations, which increase our costs and could restrict the conduct of our business.
Our operations are subject to extensive regulation and supervision in the jurisdictions in which we do business. Such regulation or compliance could reduce our profitability or limit our growth by increasing the costs of compliance, limiting or restricting the products or services we sell, or the methods by which we sell our services and products, or subjecting our business to the possibility of regulatory actions or proceedings. In all jurisdictions, the applicable laws and regulations are subject to amendment or interpretation by regulatory authorities. Generally, such authorities have broad discretion to grant, renew or revoke licenses and approvals and to implement new regulations. We may be precluded or temporarily suspended from carrying on some or all of our activities or otherwise fined or penalized in any jurisdiction in which we operate. We can give no assurances that our business can continue to be conducted in each jurisdiction as we have in the past. Such regulation is generally designed to protect the interests of policyholders. To that end, the laws of the various states establish insurance departments and other regulatory agencies with broad powers with respect to matters, such as:
licensing and authorizing companies and agents to transact business;
regulating capital and surplus and dividend requirements;
regulating underwriting limitations;
regulating the ability of companies to enter and exit markets;
imposing statutory accounting requirements and annual statement disclosures;
approving changes in control of insurance companies;
regulating premium rates, including the ability to increase or maintain premium rates;
regulating trade billing and claims practices;
regulating certain transactions between affiliates;
regulating reinsurance arrangements, including the balance sheet credit that may be taken by the ceding or direct insurer;
mandating certain terms and conditions of coverage and benefits;
regulating the content of disclosures to consumers;
regulating the type, amounts and valuation of investments;
mandating assessments or other surcharges for guaranty funds and the ability to recover such assessments in the future through premium increases;
regulating market conduct and sales practices of insurers and agents, including compensation arrangements; and
regulating a variety of other financial and non-financial components of an insurer's business.

Our non-insurance products and certain aspects of our insurance products are subject to various other federal and state regulations, including state and federal consumer protection, privacy and other laws.

An insurer's ability to write new business is partly a function of its statutory surplus. Maintaining appropriate levels of surplus as measured by statutory accounting principles is considered important by insurance regulatory authorities and the private agencies that rate insurers' claims-paying abilities and financial strength. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny, a downgrade by rating agencies or enforcement action by regulatory authorities.
 
We may be unable to maintain all required licenses and approvals and, despite our best efforts, our business may not fully comply with the wide variety of applicable laws and regulations or the relevant regulators' interpretations of such laws and regulations. Also, some regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals or to limit or restrain operations in their jurisdiction. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements,

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the insurance regulatory authorities could preclude or temporarily suspend us from operating, limit some or all of our activities or financially penalize us. These types of actions could have a material adverse effect on our results of operations and financial condition.
 
Failure to protect our clients' confidential information and privacy could result in the loss of our reputation and customers, reduction in our profitability and subject us to fines, penalties and litigation and adversely affect our results of operations and financial condition.
We retain confidential information in our information systems, and we are subject to a variety of privacy regulations and confidentiality obligations. For example, some of our activities are subject to the privacy regulations of the Gramm-Leach-Bliley Act. We also have contractual obligations to protect confidential information we obtain from our clients. These obligations generally require us, in accordance with applicable laws, to protect such information to the same extent that we protect our own confidential information. We have implemented physical, administrative and logical security systems with the intent of maintaining the physical security of our facilities and systems and protecting our clients' and their customers' confidential information and personally-identifiable information against unauthorized access through our information systems or by other electronic transmission or through misdirection, theft or loss of data. Despite such efforts, we may be subject to a breach of our security systems that results in unauthorized access to our facilities and/or the information we are trying to protect. Anyone who is able to circumvent our security measures and penetrate our information systems could access, view, misappropriate, alter or delete any information in the systems, including personally identifiable customer information and proprietary business information. In addition, most states require that customers be notified if a security breach results in the disclosure of personally-identifiable customer information. Any compromise of the security of our information systems that results in inappropriate disclosure of such information could result in, among other things, unfavorable publicity and damage to our reputation, governmental inquiry and oversight, difficulty in marketing our services, loss of clients, significant civil and criminal liability and the incurrence of significant technical, legal and other expenses, any of which may have a material adverse effect on our results of operations and financial condition.
 
Changes in regulation may adversely affect our business, results of operations and financial condition and limit our growth.
Legislation or other regulatory reform that increases the regulatory requirements imposed on us or that changes the way we are able to do business may significantly harm our business or results of operations in the future. If we were unable for any reason to comply with these requirements, our noncompliance could result in substantial costs to us and may have a material adverse effect on our results of operations and financial condition. Legislative or regulatory changes that could significantly harm us and our subsidiaries include, but are not limited to:
prohibiting our clients from providing debt cancellation policies or offering other ancillary products;
prohibiting insurers from fronting captive reinsurance arrangements;
placing or reducing interest rate caps on the consumer finance products our clients offer or including voluntary products in the annual percentage rate calculation;
limitations or imposed reductions on premium levels or the ability to raise premiums on existing policies;
increases in minimum capital, reserves and other financial viability requirements;
impositions of increased fines, taxes or other penalties for improper licensing, the failure to promptly pay claims, however defined, or other regulatory violations;
increased licensing requirements;
restrictions on the ability to offer certain types of products;
new or different disclosure requirements on certain types of products; and
imposition of new or different requirements for coverage determinations.

In recent years, the state insurance regulatory framework has come under increased federal scrutiny and some state legislatures have considered or enacted laws that may alter or increase state authority to regulate insurance companies and insurance holding companies. Further, the NAIC and state insurance regulators are re-examining existing laws and regulations, specifically focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws and regulations. Additionally, there have been attempts by the NAIC and several states to limit the use of discretionary clauses in policy forms. The elimination of discretionary clauses could increase our product costs. New interpretations of existing laws and the passage of new legislation may harm our ability to sell new services and products and increase our claims exposure on policies we issued previously. In addition, the NAIC's proposed expansion of the Market Conduct Annual Statement could increase the likelihood of examinations of insurance companies operating in niche markets. Court decisions that impact the insurance industry could result in the release of previously protected confidential and privileged information by departments of insurance, which could increase the risk of litigation.
 
Traditionally, the U.S. federal government has not directly regulated the business of insurance. However, federal legislation and administrative policies in several areas can significantly and adversely affect insurance companies. These areas include financial services regulation, securities regulation, privacy, tort reform legislation and taxation. For example, the Dodd-Frank Act provides for the enhanced federal supervision of financial institutions, including insurance companies in certain circumstances, and financial activities that represent a systemic risk to financial stability or the U.S. economy.
 
Under the Dodd-Frank Act, the Federal Insurance Office was established within the U.S. Treasury Department to monitor all aspects of the insurance industry and its authority would likely extend to all lines of insurance that our insurance company subsidiaries write.

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The director of the Federal Insurance Office serves in an advisory capacity to the Financial Stability Oversight Council and has the ability to recommend that an insurance company or an insurance holding company be subject to heightened prudential standards by the Federal Reserve, if it is determined that financial distress at the company could pose a threat to the financial stability of the U.S. economy. The Dodd-Frank Act also provides for the preemption of state laws when inconsistent with certain international agreements and would streamline the regulation of reinsurance and surplus lines insurance. At this time, we cannot assess whether any other proposed legislation or regulatory changes will be adopted, or what impact, if any, the Dodd-Frank Act or any other legislation or changes could have on our results of operations, financial condition or liquidity.

With regard to our payment protection products, there are federal and state laws and regulations that govern the disclosures related to lenders' sales of those products. Our ability to offer and administer those products on behalf of financial institutions is dependent upon their continued ability to sell those products. To the extent that federal or state laws or regulations change to restrict or prohibit the sale of these products, our revenues would be adversely affected. The Dodd-Frank Act created a new Consumer Financial Protection Bureau ("CFPB") designed to add new regulatory oversight for the sales practices of these products. Recently, the CFPB's enforcement actions have resulted in large refunds and civil penalties against financial institutions in connection with their marketing of payment protection and other products. Due to such regulatory actions, some lenders may reduce their sales and marketing of payment protection and other ancillary products, which may adversely affect our revenues. The full impact of the CFPB's oversight is unpredictable and has not yet been realized fully.
 
Further, in a time of financial uncertainty or a prolonged economic downturn, regulators may choose to adopt more restrictive insurance laws and regulations. For example, insurance regulators may choose to restrict the ability of insurance company subsidiaries to make payments to their parent companies or reject rate increases due to the economic environment.
 
With respect to the property and casualty insurance policies we underwrite, federal legislative proposals regarding National Catastrophe Insurance, if adopted, could reduce the business need for some of the related products we provide. Additionally, as the U.S. Congress continues to respond to the recent housing foreclosure crisis, it could enact legislation placing additional barriers on creditor-placed insurance.
 
In recent years, several large organizations became subjects of intense public scrutiny due to high-profile data security breaches involving sensitive financial and health information. These events focused national attention on identity theft and the duty of organizations to notify impacted consumers in the event of a data security breach. Existing legislation in most states requires customer notification in the event of a data security breach. In addition, some states are adopting laws and regulations requiring minimum information security practices with respect to the collection and storage of personally-identifiable consumer data, and several bills before Congress contain provisions directed to national information security standards and breach notification requirements. Several significant legal, operational and reputational risks exist with regard to a data breach and customer notification. A breach of data security requiring public notification can result in regulatory fines, penalties or sanctions, civil lawsuits, loss of reputation, loss of clients and reduction of our profitability.
 
Our business is subject to risks related to litigation and regulatory actions.
We may be materially and adversely affected by judgments, settlements, unanticipated costs or other effects of legal and administrative proceedings now pending or that may be instituted in the future, or from investigations by regulatory bodies or administrative agencies. From time to time, we have had inquiries from regulatory bodies and administrative agencies relating to the operation of our business. Such inquiries may result in various audits, reviews and investigations. An adverse outcome of any investigation by, or other inquiries from, such bodies or agencies could have a material adverse effect on us and result in the institution of administrative or civil proceedings, sanctions and the payment of fines and penalties, changes in personnel, and increased review and scrutiny of us by our clients, regulatory authorities, potential litigants, the media and others.
 
In particular, our insurance operations and certain of our membership and warranty operations are subject to comprehensive regulation and oversight by insurance departments in jurisdictions in which we do business. These insurance departments have broad administrative powers with respect to all aspects of the insurance business and, in particular, monitor the manner in which an insurance company offers, sells and administers its products. Therefore, we may from time to time be subject to a variety of legal and regulatory actions relating to our current and past business operations, including, but not limited to:
disputes over coverage or claims adjudication;
disputes over claim payment amounts and compliance with individual state regulatory requirements;
disputes regarding sales practices, disclosures, premium refunds, licensing, regulatory compliance, underwriting and compensation arrangements;
disputes with taxation and insurance authorities regarding our tax liabilities;
periodic examinations of compliance with applicable federal and state laws; and
industry-wide investigations regarding business practices including, but not limited to, the use of finite reinsurance and the marketing and refunding of insurance policies or certificates of insurance.


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The prevalence and outcomes of any such actions cannot be predicted, and such actions or any litigation may have a material adverse effect on our results of operations and financial condition. In addition, if we were to experience difficulties with our relationship with a regulatory body in a given jurisdiction, it could have a material adverse effect on our ability to do business in that jurisdiction.

In addition, plaintiffs continue to bring new types of legal claims against insurance and related companies. Current and future court decisions and legislative activity may increase our exposure to these types of claims. Multi-party or class action claims may present additional exposure to substantial economic, non-economic and/or punitive damage awards. The success of even one of these claims, if it resulted in a significant damage award or a detrimental judicial ruling, could have a material adverse effect on our results of operations and financial condition. This risk of potential liability may make reasonable settlements of claims more difficult to obtain. We cannot determine with any certainty what new theories of liability or recovery may evolve or what their impact may be on our business.
 
We cannot predict at this time the effect that current litigation, investigations and regulatory activity will have on the industries in which we operate or our business. In light of the regulatory and judicial environments in which we operate, we will likely become subject to further investigations and lawsuits from time to time in the future. Our involvement in any investigations and lawsuits would cause us to incur legal and other costs and, if we were found to have violated any laws, we could be required to pay fines and damages, perhaps in material amounts. In addition, we could be materially and adversely affected by the negative publicity for the insurance and other financial services industries related to any such proceedings and by any new industry-wide regulations or practices that may result from any such proceedings.
 
Our cash and cash equivalents could be adversely affected if the financial institutions with which our cash and cash equivalents are deposited fail.
We maintain cash and cash equivalents with major third party financial institutions, including interest-bearing money market accounts. In the United States, these accounts were fully insured by the Federal Deposit Insurance Corporation ("FDIC") regardless of account balance through the Transaction Account Guarantee ("TAG") program created by Section 343 of the Dodd-Frank Act. The expiration of the TAG program on December 31, 2012, caused the FDIC's standard insurance limit of $250,000 per depositor per institution to be reimposed on January 1, 2013. Thus, our accounts containing cash and cash equivalents may exceed the FDIC's standard $250,000 insurance limit from time to time.

We may be subject to assertions that taxes must be collected based on sales and use of our services in various states, which could expose us to liability and cause material harm to our business, financial condition and results of operations.
Whether sales of our services are subject to state sales and use taxes is uncertain, due in part to the nature of our services and the relationships through which our services are offered, as well as changing state laws and interpretations of those laws. One or more states may seek to impose sales or use tax or other tax collection obligations on us, whether based on sales by us or our resellers or clients, including for past sales. A successful assertion that we should be collecting sales or other related taxes on our services could result in substantial tax liabilities for past sales, discourage customers from purchasing our services, discourage clients from offering or billing for our services, or otherwise cause material harm to our business, financial condition and results of operations.

Risks Related to Our Indebtedness
Our indebtedness may limit our financial and operating activities and may materially and adversely affect our ability to incur additional debt to fund future needs.
Our debt service obligations vary annually based on the amount of our indebtedness and the associated fixed and floating interest rates. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources - Liquidity" in this Form 10-K, regarding the amount of outstanding debt and our annual debt service. Although we believe that our current cash flows will be sufficient to cover our annual interest expense, any increase in our indebtedness or any decline in the amount of cash available to service our indebtedness increases the possibility that we could not pay, when due, the principal of, interest on or other amounts due with respect to our indebtedness. In addition, our indebtedness and any future indebtedness we may incur could:
make it more difficult for us to satisfy our obligations with respect to our indebtedness, including financial and other restrictive covenants, which could result in an event of default under the agreements governing our indebtedness;
make us more vulnerable to adverse changes in general economic, industry and competitive conditions and adverse changes in government regulation;
require us to dedicate a substantial portion of our cash flows from operations to payments on our indebtedness, thereby reducing the availability of our cash flows to fund working capital, capital expenditures, acquisitions and other general corporate purposes;
limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
place us at a competitive disadvantage compared to competitors that have less debt; and
limit our ability to borrow additional amounts for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy or other purposes.


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Any of the above-listed factors could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Increases in interest rates could increase interest payable under our variable rate indebtedness.
We are subject to interest rate risk in connection with our variable rate indebtedness. See "QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - Interest Rate Risk" in this Form 10-K, regarding our interest rate risk and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources - Liquidity" in this Report, regarding the amount of outstanding variable rate debt. Interest rate changes could increase the amount of our interest payments and thus negatively impact our future earnings and cash flows. If we do not have sufficient earnings, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or sell more securities, none of which we can guarantee we will be able to do.

We may enter into hedging transactions that may become ineffective which adversely impact our financial condition.
Part of our interest rate risk strategy involves entering into hedging transactions to mitigate the risk of variable interest rate instruments by converting the variable interest rate to a fixed interest rate. Each hedging item must be regularly evaluated for hedge effectiveness. If it is determined that a hedging transaction is ineffective, we may be required to record losses reflected in our results of operations which could adversely impact our financial condition.

Despite our indebtedness levels, we and our subsidiaries may still be able to incur more indebtedness, which could further exacerbate the risks related to our indebtedness described above.
We and our subsidiaries may be able to incur substantial additional indebtedness in the future subject to the limitations contained in the agreements governing our indebtedness. If we or our subsidiaries incur additional debt, the risks that we and they now face as a result of our indebtedness could intensify.
 
Restrictive covenants in the agreements governing our indebtedness may restrict our ability to pursue our business strategies.
The agreements governing our indebtedness contain a number of restrictive covenants that impose significant operating and financial restrictions on us and may limit our ability to pursue our business strategies or undertake actions that may be in our best interests. The agreements governing our indebtedness include covenants restricting, among other things, our ability to:
incur or guarantee additional debt;
incur liens;
complete mergers, consolidations and dissolutions;
sell certain of our assets that have been pledged as collateral; and
undergo a change in control.
 
Our assets have been pledged to secure some of our existing indebtedness.
Our credit facility, entered into in August 2012, with Wells Fargo Bank, N.A. is secured by substantially all of our property and assets and property and assets owned by LOTS Intermediate Co. and certain of our subsidiaries that act as guarantors of our existing indebtedness. Such assets include the stock of LOTS Intermediate Co. and the right, title and interest of the borrowers and each guarantor in their respective material real estate property, fixtures, accounts, equipment, investment property, inventory, instruments, general intangibles, intellectual property, money, cash or cash equivalents, software and other assets and, in each case, the proceeds thereof, subject to certain exceptions. In the event of a default under our indebtedness, the lender could foreclose against the assets securing such obligations. A foreclosure on these assets would have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
Risks Related to Our Technology and Intellectual Property
Our information systems may fail or their security may be compromised, which could damage our business and materially and adversely affect our results of operations and financial condition.
Our business is highly dependent upon the effective operation of our information systems and our ability to store, retrieve, process and manage significant databases and expand and upgrade our information systems. We rely on these systems throughout our business for a variety of functions, including marketing and selling our products and services, performing our services, managing our operations, processing claims and applications, providing information to clients, performing actuarial analyses and maintaining financial records. The interruption or loss of our information processing capabilities through the loss of stored data, programming errors, the breakdown or malfunctioning of computer equipment or software systems, telecommunications failure or damage caused by weather or natural disasters or any other significant disruptions could harm our business, ability to generate revenues, client relationships, competitive position and reputation. Although we have additional data processing locations in Jacksonville, Florida and Atlanta, Georgia, disaster recovery procedures and insurance to protect against certain contingencies, such measures may not be effective or insurance may not continue to be available at reasonable prices, to cover all such losses or be sufficient to compensate us for the loss of business that may result from any failure of our information systems. In addition, our information systems may be vulnerable to physical or electronic intrusions, computer viruses or other attacks which could disable our information systems and our security measures may not prevent

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such attacks. The failure of our systems as a result of any security breaches, intrusions or attacks could cause significant interruptions to our operations, which could result in a material adverse effect on our business, results of operations and financial condition.
 
The failure to effectively maintain and modernize our systems to keep up with technological advances could materially and adversely affect our business.
Our business is dependent upon our ability to ensure that our information systems keep up with technological advances. Our ability to keep our systems integrated with those of our clients is critical to the success of our business. If we do not effectively maintain our systems and update them to address technological advancements, our relationships and ability to do business with our clients may be materially and adversely affected. Our business depends significantly on effective information systems, and we have many different information systems utilized to conduct our business. We must commit significant resources to maintain and enhance existing information systems and develop new systems that allow us to keep pace with continuing changes in information processing technology, evolving industry, regulatory and legal standards and changing client preferences. A failure to maintain effective and efficient information systems, or a failure to efficiently and effectively consolidate our information systems and eliminate redundant or obsolete applications, could have a material adverse effect on our results of operations and financial condition or our ability to do business in particular jurisdictions. If we do not effectively maintain adequate systems, we could experience adverse consequences, including:
the inability to effectively market and price our services and products and make underwriting and reserving decisions;
the loss of existing clients;
difficulty attracting new clients;
regulatory problems, such as a failure to meet prompt payment obligations;
internal control problems;
exposure to litigation;
security breaches resulting in loss of data; and
increases in administrative expenses.

Our success will depend, in part, on our ability to protect our intellectual property rights and our ability not to infringe upon the intellectual property rights of third parties.
The success of our business will depend, in part, on preserving our trade secrets, maintaining the security of our know-how and data and operating without infringing upon patents and proprietary rights held by third parties. Failure to protect, monitor and control the use of our intellectual property rights could cause us to lose a competitive advantage and incur significant expenses. We rely on a combination of contractual provisions, confidentiality procedures and copyright, trademark, service mark and trade secret laws to protect the proprietary aspects of our brands, technology and data. These legal measures afford only limited protection, and competitors or others may gain access to our intellectual property and proprietary information.
 
Our trade secrets, data and know-how could be subject to unauthorized use, misappropriation, or disclosure. Our trademarks could be challenged, forcing us to re-brand our services or products, resulting in loss of brand recognition and requiring us to devote resources to advertising and marketing new brands or licensing. If we are found to have infringed upon the intellectual property rights of third parties, we may be subject to injunctive relief restricting our use of affected elements of intellectual property used in the business, or we may be required to, among other things, pay royalties or enter into licensing agreements in order to obtain the rights to use necessary technologies, which may not be possible on commercially reasonable terms, or we may be required to redesign our systems, which may not be feasible.
 
Furthermore, litigation may be necessary to enforce our intellectual property rights to protect our trade secrets and to determine the validity and scope of our proprietary rights. The intellectual property laws and other statutory and contractual arrangements we currently depend upon may not provide sufficient protection in the future to prevent the infringement, use or misappropriation of our trademarks, data, technology and other services and products. Policing unauthorized use of intellectual property rights can be difficult and expensive, and adequate remedies may not be available. Any future litigation, regardless of outcome, could result in substantial expense and diversion of resources with no assurance of success and could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Risks Related to Our Common Stock
There may not be an active, liquid trading market for our common stock.
Prior to our Initial Public Offering, there had been no public market for shares of our common stock. The trading activity in our securities is relatively low and our company has a relatively small public float.  We cannot predict the extent to which investor interest in our Company will continue to maintain an active and liquid trading market. If an active trading market in our common stock does not continue, you may have difficulty selling shares of our common stock that you own or purchase.

As a public company, we are subject to additional financial and other reporting and corporate governance requirements that may be difficult for us to satisfy.
We are required to file with the SEC, annual and quarterly information and other reports that are specified in the Exchange Act. We are required to ensure that we have the ability to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis. We are subject to other reporting and corporate governance requirements, including the requirements of the NYSE

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and certain provisions of the Sarbanes-Oxley Act of 2002 ("SOX") and the regulations promulgated thereunder, which impose significant compliance obligations upon us. Should we fail to comply with these rules and regulations we may face de-listing from the NYSE and face disciplinary actions from the SEC, which may adversely affect our stock price.

If our internal controls are found to be ineffective, our financial results or our stock price may be adversely affected.
Our most recent evaluation resulted in our conclusion that as of December 31, 2013, we were in compliance with Section 404 of SOX and our internal control over financial reporting was effective. We believe that we currently have adequate internal control procedures in place for future periods; however, if our internal control over financial reporting is found to be ineffective or if we identify a material weakness in our financial reporting, investors may lose confidence in the reliability of our financial statements, which may adversely affect our financial results or our stock price.

Our principal stockholder has substantial control over us.
Affiliates of Summit Partners collectively and beneficially own approximately 63.2% of our outstanding common stock at December 31, 2013. As a consequence, Summit Partners or its affiliates continue to be able to exert a significant degree of influence or actual control over our management and affairs and matters requiring stockholder approval, including the election of directors, a merger, consolidation or sale of all or substantially all of our assets, and any other significant transaction. The interests of this stockholder may not always coincide with our interests or the interests of our other stockholders. For instance, this concentration of ownership may have the effect of delaying or preventing a change in control of us otherwise favored by our other stockholders and could depress our stock price.
 
We expect that our stock price will fluctuate significantly, which could cause a decline in the stock price, and holders of our common stock may not be able to resell shares at or above the cost of such shares.
Securities markets worldwide have experienced, and are likely to continue to experience, significant price and volume fluctuations. This market volatility, as well as general economic, market or political conditions, could reduce the market price of our common stock regardless of our operating performance. The trading price of our common stock may be volatile and subject to wide price fluctuations in response to various factors, including:
market conditions in the broader stock market;
actual or anticipated fluctuations in our quarterly financial and operating results;
introduction of new products or services by us or our competitors;
issuance of new or changed securities analysts' reports or recommendations;
investor perceptions of us and the industries in which we operate;
sales, or anticipated sales, of large blocks of our stock;
additions or departures of key personnel;
regulatory or political developments;
litigation and governmental investigations; and
changing economic conditions.
These and other factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have sometimes instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management from our business, which could significantly harm our results of operations and reputation.
 
If a substantial number of shares become available for sale and are sold in a short period of time, the market price of our common stock could decline.
At December 31, 2013, we had 20,912,853 shares of common stock issued, including shares held in treasury, with our directors, executive officers and affiliates holding a significant majority of these shares. If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could decrease significantly. The perception in the public market that our existing stockholders might sell shares of common stock could also depress the market price of our common stock. A decline in the market price of our common stock might impede our ability to raise capital through the issuance of additional shares of our common stock or other equity securities.

If securities or industry analysts do not publish research or reports about our business, publish research or reports containing negative information about our business, adversely change their recommendations regarding our stock or if our results of operations do not meet their expectations, our stock price and trading volume could decline.
The trading market for our common stock is influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of our Company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, if one or more of the analysts who cover us downgrade our stock, or if our results of operations do not meet their expectations, our stock price could decline.
 

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Some provisions of Delaware law and our amended and restated certificate of incorporation and bylaws may deter third parties from acquiring us and diminish the value of our common stock.
Our amended and restated certificate of incorporation and bylaws provide for, among other things:
restrictions on the ability of our stockholders to call a special meeting and the business that can be conducted at such meeting;
restrictions on the ability of our stockholders to remove a director or fill a vacancy on the Board of Directors;
our ability to issue preferred stock with terms that the Board of Directors may determine, without stockholder approval;
the absence of cumulative voting in the election of directors;
a prohibition of action by written consent of stockholders unless such action is recommended by all directors then in office; and
advance notice requirements for stockholder proposals and nominations.
These provisions in our amended and restated certificate of incorporation and bylaws may discourage, delay or prevent a transaction involving a change in control of the Company that is in the best interest of our non-controlling stockholders. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging future takeover attempts.
 
Applicable insurance laws may make it difficult to effect a change in control of us.
State insurance regulatory laws contain provisions that require advance approval, by the state insurance commissioner, of any change in control of an insurance company that is domiciled, or, in some cases, having such substantial business that it is deemed to be commercially domiciled, in that state. We own, directly or indirectly, all of the shares of stock of insurance companies domiciled in California, Delaware, Georgia and Louisiana, and 85% of the shares of stock of an insurance company domiciled in Kentucky. Because any purchaser of shares of our common stock representing 10% or more of the voting power of the capital stock of Fortegra generally will be presumed to have acquired control of these insurance company subsidiaries, the insurance change in control laws of California, Delaware, Georgia, Louisiana and Kentucky would apply to such a transaction.
 
In addition, the laws of many states contain provisions requiring pre-notification to state agencies prior to any change in control of a non-domestic insurance company subsidiary that transacts business in that state. While these pre-notification statutes do not authorize the state agency to disapprove the change in control, they do authorize issuance of cease and desist orders with respect to the non-domestic insurer if it is determined that conditions, such as undue market concentration, would result from the change in control.
 
These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of the Company, including through transactions, and in particular unsolicited transactions, that some or all of our stockholders might consider to be desirable.
 
We do not anticipate paying any cash dividends for the foreseeable future.
We currently intend to retain our future earnings, if any, for the foreseeable future, to repay indebtedness and for general corporate purposes. We do not intend to pay any dividends for the foreseeable future to holders of our common stock. As a result, capital appreciation in the price of our common stock, if any, will be your only source of gain on an investment in our common stock.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

At December 31, 2013, Fortegra Financial leased its principal executive offices located at Deerwood Park Boulevard, Building 100, Jacksonville, Florida, 32256, consisting of approximately 58,000 square feet. In addition, we lease approximately 56,000 square feet of office space in approximately seven locations in the United States. We believe our properties, detailed in the table below, are adequate for our business as presently conducted.
Location
Address
Lease Expiration Date (1)
Fortegra Financial - Executive offices
10151 Deerwood Park Blvd., Building 100, Suites 330 and 500, Jacksonville, FL
April 30, 2022
Fortegra Financial
10475 Fortune Parkway, Building 100, Suite 120, Jacksonville, FL
April 30, 2022
LOTSolutions, Inc.
5435 Highway 1, Marksville, LA
August 31, 2017
LOTSolutions, Inc.
1000 Riverbend Blvd., Suite P, St. Rose, LA
April 14, 2014
United
130 Arkansas Street, Paducah, KY
August 31, 2016
Auto Knight
43100 Cook Street Suite 200, Palm Desert, CA
July 31, 2018
ProtectCELL
39500 High Point Blvd., Suites 125, 220 and 250, Novi, MI
October 30, 2018
PBG
1915 NW Amberglen Parkway, Beaverton, OR
September 30, 2020
(1) - Lease expiration dates represent the current ending date of the current lease period. For some of the leases listed, Fortegra has the option to renew the lease beyond the current expiration date in accordance with the terms set forth in the lease agreement.

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Please see the Notes, "Property and Equipment" and "Leases," in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information.

ITEM 3. LEGAL PROCEEDINGS

The information set forth in the "Contingencies" section of the Note, "Commitments and Contingencies" of the Notes to Consolidated Financial Statements in ITEM 8 of this Form 10-K is incorporated herein by reference.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

EXECUTIVE OFFICERS OF THE REGISTRANT

Fortegra's executive officers, including their age, position held, and principal occupation and employment during the past five years, are as follows:

Richard S. Kahlbaugh, age 53, has been our President and Chief Executive Officer and a director since June 2007 and has been our Chairman since June 2010. Prior to becoming President and Chief Executive Officer, Mr. Kahlbaugh was our Chief Operating Officer from 2003 to 2007. He also serves as the Chairman of all of our insurance company subsidiaries. Prior to joining us in 2003, Mr. Kahlbaugh served as President and Chief Executive Officer of Volvo's Global Insurance Group. He also served as the first General Counsel of the Walshire Assurance Group, a publicly traded insurance company, and practiced law with McNees, Wallace and Nurick. Mr. Kahlbaugh holds a J.D. from the Delaware Law School of Widener University and a B.A. from the University of Delaware.

Walter P. Mascherin, age 59, has been our Executive Vice President and Chief Financial Officer since October 2010. Prior to joining us, Mr. Mascherin worked at Volvo Financial Services for 14 years where he served as Senior Vice President of Organization Development and Workouts from 2009 to 2010, Senior Vice President and Chief Credit Officer from 2006 to 2009, Vice President of Corporate Development (US) in 2006 and Vice President and Chief Operating Officer from 2004 to 2005. Mr. Mascherin holds an M.B.A. from Heriot Watt University, Edinburgh, Scotland and a Business Administration Diploma from Ryerson University, Ontario, Canada.

Christopher D. Romaine, age 42, has been our Senior Vice President, General Counsel and Secretary since June 2011 and was our Associate General Counsel from September 2010 to June 2011. Prior to joining Fortegra, Mr. Romaine acted as Managing Counsel at Toyota Financial Services from 2006 to 2009 and as First Vice President and Senior Counsel at MBNA Corporation from 2002 to 2006. Mr. Romaine holds a J.D. from the University of Pennsylvania School of Law and an A.B., magna cum laude, from Brown University.

Joseph R. McCaw, age 62, has been our Executive Vice President and President of Payment Protection since November 2008. He also serves as the Chief Executive Officer of our insurance company subsidiaries. Mr. McCaw joined us in 2003 as our First Vice President of Finance/Retail. Prior to joining us, Mr. McCaw served as President of Financial Institution Group for Protective Life Corporation. Mr. McCaw holds an M.B.A. from Lindenwood University and a B.A. from Westminster College.

W. Dale Bullard, age 55, has been our Executive Vice President and President of Motor Clubs since January 2013. Mr. Bullard joined us in 1994 as a Senior Vice President and has over 28 years of experience in the insurance industry. Most recently, Mr. Bullard served as our Chief Marketing Officer from May 2006 until assuming his current role. Prior to joining us, Mr. Bullard held various positions at Independent Insurance Group from 1979 to 1994, most recently as a Senior Vice President in 1988. Mr. Bullard holds a B.S. from the University of South Carolina. Mr. Bullard currently serves on the board of directors of the Consumer Credit Insurance Association and previously served as its president.

Robert P. Emery, age 45, has been our Executive Vice President and President of ProtectCELL, since January 2013. Mr. Emery is a co-founder of ProtectCELL and served as ProtectCELL's President from April 2006 to March 2011. Mr. Emery later served as ProtectCELL's COO from March 2011 until working in his current capacity, upon Fortegra's acquisition of a majority interest in ProtectCELL. In addition to his work with ProtectCELL, Mr. Emery is the Owner and President of Emery Electronics Inc., also known as Cellular and More.


23


PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Stockholders
Fortegra Financial Corporation's common stock is listed and traded on the NYSE under the symbol "FRF" and began trading on December 17, 2010. At February 14, 2014, there were approximately 1,913 stockholders of record.

Price Range of Common Stock and Dividends Declared
The table below sets forth the high and low sales prices and the last price for the periods indicated for our common stock as reported on the NYSE Composite Tape and any cash dividends declared:
2013
 
High
 
Low
 
Last
 
Cash Dividends Per Share
First Quarter
 
$
9.63

 
$
8.50

 
$
8.76

 
$

Second Quarter
 
8.89

 
6.17

 
6.87

 

Third Quarter
 
8.70

 
6.55

 
8.51

 

Fourth Quarter
 
8.66

 
6.90

 
8.27

 

 
 
 
 
 
 
 
 
 
2012
 
 
 
 
 
 
 
 
First Quarter
 
$
8.45

 
$
6.49

 
$
8.36

 
$

Second Quarter
 
8.50

 
7.71

 
8.00

 

Third Quarter
 
8.36

 
7.44

 
7.93

 

Fourth Quarter
 
9.17

 
7.94

 
8.89

 


Dividend Policy
Dividends on Our Common Stock
We have not declared or paid cash dividends on our common stock in the past three years and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We intend to retain all available funds and any future earnings to reduce debt and fund the development and growth of our business. Any future determination to pay dividends will be at the discretion of our Board of Directors and will take into account: restrictions in our debt instruments; general economic business conditions; our financial condition and results of operations; the ability of our operating subsidiaries to pay dividends and make distributions to us; and such other factors as our Board of Directors may deem relevant.

Dividends Limitations - Insurance Company Subsidiaries
The ability of our insurance company subsidiaries to pay dividends and to make other payments is limited by applicable laws and regulations of the states in which our insurance company subsidiaries are domiciled and in which they operate, which vary from state to state and by type of insurance provided by the applicable subsidiary. These laws and regulations require, among other things, our insurance company subsidiaries to maintain minimum solvency requirements and limit the amount of dividends they can pay to their respective holding company. Please see the Note, "Statutory Reporting and Insurance Company Subsidiaries Dividend Restrictions," in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information relating to dividend restrictions for our insurance company subsidiaries.

Sales of Unregistered Securities
During 2013 and 2012, we did not issue any unregistered securities.
Issuer Purchases of Equity Securities
As of December 31, 2013, Fortegra had a share repurchase plan, which allows the Company to purchase up to $15.0 million of the Company's common stock from time to time through open market or private transactions. The Board of Directors approved a $10.0 million share repurchase plan in November 2011 and increased the size of the plan by $5.0 million in August 2013. The share repurchase plan has no expiration date and provides for shares to be repurchased for general corporate purposes, which may include serving as a resource for funding potential acquisitions and employee benefit plans. The timing, price and quantity of purchases are at our discretion, and the plan may be discontinued or suspended at any time.


24



The following table shows Fortegra's share repurchase plan activity for the three months ended December 31, 2013:
Period
 
 
 
Total Number of Shares Purchased
 
Average Price Paid Per Share
 
Total Number of Shares  Purchased as Part of Publicly Announced Plan
 
Maximum  Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan
 
 
 
 
 
 
 
 
1,179,634

 
$
7,167,376

October 1, 2013
to
October 31, 2013
 

 
$

 

 
7,167,376

November 1, 2013
to
November 30, 2013
 

 

 

 
7,167,376

December 1, 2013
to
December 31, 2013
 

 

 

 
7,167,376

Total
 
 
 

 
$

 
1,179,634

 
 

Equity Compensation Plans
The information required by this item with respect to the compensation plans under which our equity securities are authorized for issuance is included in "ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS - Equity Compensation Plan Information" of this Form 10-K. Please see the Note, "Stock-Based Compensation," in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information relating to our compensation plans under which our equity securities are authorized for issuance.

Comparison of Cumulative Total Return Since the Company's Initial Public Offering
The following performance graph and table do not constitute soliciting material and the performance graph and table should not be deemed filed or incorporated by reference into any other previous or future filings by us under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate the performance graph and table by reference therein.

The performance graph below compares the cumulative total stockholder return on our common stock with the cumulative total return of the Russell 2000 Index and the Financial Select Sector SPDR Fund for the period beginning on December 17, 2010 (the date our common stock commenced trading on the New York Stock Exchange) through December 31, 2013, assuming an initial investment of $100. Subsequent to our initial public offering in December 17, 2010, we have not declared or paid cash dividends on our common stock, while the data for the Russell 2000 Index and the Financial Select Sector SPDR Fund assumes reinvestment of dividends.


25



Index
December 17, 2010
December 31, 2010
December 30, 2011
December 31, 2012
December 31, 2013
Fortegra Financial - FRF US Equity
$
100.00

$
100.45

$
60.73

$
80.82

$
75.18

Russell 2000 - RTY Index
100.00

100.53

95.05

108.96

149.28

Financial Select Sector SPDR Fund - XLF US Equity
100.00

102.70

85.10

109.28

148.11


ITEM 6. SELECTED FINANCIAL DATA

The following tables set forth our consolidated selected financial data for the periods and as of the dates indicated and are derived from our audited Consolidated Financial Statements. The following consolidated financial data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") in ITEM 7 of this Form 10-K and the Consolidated Financial Statements and related Notes included in ITEM 8 of this Form 10-K. All amounts pertaining to our results of operations and financial condition are presented on a continuing operations basis. Discontinued operations are more fully discussed in the Note, "Divestitures," in the Notes to Consolidated Financial Statements, included in ITEM 8 of this Form 10-K. All acquisitions by Fortegra during the five years ended December 31, 2013 are included in results of operations since their respective dates of acquisition.
Consolidated Statement of Income Data:
For the Years Ended December 31,
(in thousands, except shares and per share amounts)
2013
 
2012
 
2011
 
2010
 
2009
Revenues:
 
 
 
 
 
 
 
 
 
Service and administrative fees
$
172,427

 
$
90,550

 
$
94,464

 
56,254

 
$
31,829

Ceding commissions
32,824

 
34,825

 
29,495

 
28,767

 
24,075

Net investment income
3,050

 
3,067

 
3,368

 
4,033

 
4,756

Net realized investment gains
2,043

 
3

 
4,193

 
650

 
54

Net earned premium
136,787

 
127,625

 
115,503

 
111,805

 
108,116

Other income
736

 
269

 
170

 
156

 
462

Total revenues
347,867

 
256,339

 
247,193

 
201,665

 
169,292

 
 
 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
 
 
Net losses and loss adjustment expenses
41,567

 
40,219

 
37,949

 
36,035

 
32,566

Member benefit claims
46,019

 
4,642

 
4,409

 
466

 

Commissions
154,606

 
128,741

 
126,918

 
92,646

 
70,449

Personnel costs
39,487

 
28,475

 
26,021

 
21,613

 
20,956

Other operating expenses
35,117

 
24,233

 
23,739

 
19,876

 
17,814

Depreciation and amortization
4,858

 
3,275

 
2,662

 
1,173

 
670

Amortization of intangibles
5,527

 
2,742

 
2,819

 
1,828

 
1,711

Interest expense
3,621

 
4,334

 
4,690

 
7,342

 
7,479

(Gain) Loss on sale of subsidiary
(402
)
 

 
477

 

 

Total expenses
330,400

 
236,661

 
229,684

 
180,979

 
151,645

Income from continuing operations before income taxes
17,467

 
19,678

 
17,509

 
20,686

 
17,647

Income taxes
5,660

 
6,716

 
5,947

 
7,079

 
5,817

Income from continuing operations before non-controlling interests
11,807

 
12,962

 
11,562

 
13,607

 
11,830

Discontinued operations:
 
 
 
 
 
 
 
 
 
Income from discontinued operations - net of tax
3,546

 
2,275

 
1,777

 
1,607

 
81

Gain on sale of discontinued operations - net of tax
8,844

 

 

 

 

Discontinued operations - net of tax
12,390

 
2,275

 
1,777

 
1,607

 
81

Net income before non-controlling interests
24,197

 
15,237

 
13,339

 
15,214

 
11,911

Less: net income (loss) attributable to non-controlling interests
1,482

 
72

 
(170
)
 
20

 
26

Net income attributable to Fortegra Financial Corporation
$
22,715

 
$
15,165

 
$
13,509

 
$
15,194

 
$
11,885

 
 
 
 
 
 
 
 
 
 
Earnings per share - Basic:
 
 
 
 
 
 
 
 
 
Net income from continuing operations - net of tax
$
0.53

 
$
0.65

 
$
0.57

 
$
0.85

 
$
0.76

Discontinued operations - net of tax
0.64

 
0.12

 
0.09

 
0.10

 
0.01


26



Net income attributable to Fortegra Financial Corporation
$
1.17

 
$
0.77

 
$
0.66

 
$
0.95

 
$
0.77

 
 
 
 
 
 
 
 
 
 
Earnings per share - Diluted:
 
 
 
 
 
 
 
 
 
Net income from continuing operations - net of tax
$
0.50

 
$
0.63

 
$
0.55

 
$
0.79

 
$
0.71

Discontinued operations - net of tax
0.61

 
0.11

 
0.09

 
0.09

 

Net income attributable to Fortegra Financial Corporation
$
1.11

 
$
0.74

 
$
0.64

 
$
0.88

 
$
0.71

 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
 
Basic
19,477,802

 
19,655,492

 
20,352,027

 
15,929,181

 
15,388,706

Diluted
20,482,652

 
20,600,362

 
21,265,801

 
17,220,029

 
16,645,928

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheet Data: (in thousands)
At December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Cash and cash equivalents
$
21,681

 
$
15,209

 
$
31,339

 
$
43,389

 
$
29,940

Total assets
680,430

 
707,437

 
605,353

 
535,202

 
473,472

Note(s) payable
3,273

 
89,438

 
73,000

 
36,713

 
31,487

Preferred trust securities
35,000

 
35,000

 
35,000

 
35,000

 
35,000

Redeemable preferred securities

 

 

 
11,040

 
11,540

Total stockholders’ equity
166,493

 
145,715

 
127,086

 
119,701

 
77,616


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") represents an overview of our results of operations and financial condition and should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in ITEM 8 of this Form 10-K. Except for the historical information contained herein, the discussions in MD&A contain forward-looking statements that involve risks and uncertainties. Our future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "ITEM 1A. Risk Factors" included in this Form 10-K.

EXECUTIVE SUMMARY
The following provides an overview of events and financial results for the year ended December 31, 2013:

Overview of Events
On December 31, 2012, we acquired ProtectCELL and 4Warranty. Their impact on our financial results began in 2013.

In January 2013, we announced a plan to consolidate our fulfillment, claims administration and information technology functions (the "Plan"). Prior to the Plan, such functions resided in individual business units. The decision was part of our efforts to streamline operations, focus resources and provide first in class service to our customers. During the first quarter of 2013, approximately 40 employee and contract positions were eliminated.

On February 1, 2013, we acquired 100% of the outstanding stock of Response Indemnity Company of California ("RICC"), from subsidiaries of the Kemper Corporation ("Kemper") for $4.8 million. RICC is a property/casualty insurance company domiciled and licensed in California, which we intend to use for geographic expansion. RICC had, at the time of purchase, no policies in force, and all remaining claim liabilities for previously issued policies are fully reinsured by Kemper's subsidiary, Trinity Universal Insurance Company.

In June 2013, we sold our wholly owned subsidiary, Magna Insurance Company, for a sales price of $3.0 million and realized a $0.4 million pre-tax gain on the sale, which is included in our 2013 results.

In August 2013, our Board of Directors (the "Board") authorized an additional $5.0 million increase to the share repurchase plan. This additional authorization expands the existing share repurchase program from $10.0 million as authorized by the Board in November 2011 to $15.0 million. During 2013, we acquired 200,000 shares under our share repurchase plan at an aggregate value of $1.4 million. We believe our share repurchase plan is an effective method of creating stockholder value and a prudent use of available cash.

27



In October 2013, our subsidiary, South Bay entered into a $15.0 million line of credit agreement (the "Line of Credit") with Synovus Bank. The Line of Credit is used for our premium financing product, and allows South Bay to finance up to 90% of the eligible receivable.

On December 2, 2013, we entered into a Stock Purchase Agreement ("Purchase Agreement") with AmWINS Holdings, LLC, a North Carolina limited liability company ("AmWINS"), pursuant to which LOTS Intermediate Co., a Delaware corporation and direct wholly-owned subsidiary of the Corporation agreed to sell all the issued and outstanding stock of its subsidiaries, Bliss and Glennon, Inc., a California corporation ("Bliss and Glennon"), and eReinsure.com, Inc., a Delaware corporation ("eReinsure").

On December 31, 2013, we completed the previously announced sale of all of the issued and outstanding stock of our subsidiaries, Bliss and Glennon and eReinsure, to AmWINS (the "Disposition"), pursuant to the terms of the Purchase Agreement, and recognized a $8.8 million gain on the sale of discontinued operations, net of tax, for the year ended December 31, 2013. As consideration for the Disposition, we received net cash proceeds of $81.8 million, which we utilized on December 31, 2013 to pay off the full amount outstanding under our existing credit facility with Wells Fargo Bank, N.A. See the Notes, "Summary of Significant Accounting Policies - Discontinued Operations" and "Divestitures" in the Notes to Consolidated Financial Statements, included in ITEM 8 of this Form 10-K for additional information.

Prior to the fourth quarter of 2013, we operated in three business segments: (i) Payment Protection, (ii) Business Process Outsourcing and (iii) Brokerage. In connection with the Disposition, in the fourth quarter of 2013, we realigned our reporting structure to manage our business as a single profit center called Protection Products and Services. Accordingly, we now have one reportable segment. See the Note, "Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information.

Overview of Financial Results
Net income attributable to Fortegra Financial Corporation for the year ended December 31, 2013 increased $7.6 million, or 49.8%, to $22.7 million from $15.2 million for the year ended December 31, 2012. Earnings per diluted share attributable to Fortegra Financial Corporation increased 50% to $1.11 for the year ended December 31, 2013 from $0.74 for the same period in 2012. Our 2013 results include the impact of an $8.8 million gain, net of tax, or $0.43 per diluted share, from the Disposition, while 2012 included the $1.0 million benefit from the change in accounting estimate, or $0.05 per diluted share.

Our net income from continuing operations before non-controlling interests for the year ended December 31, 2013 decreased $1.2 million, or 8.9%, to $11.8 million from $13.0 million for the year ended December 31, 2012. Our 2013 net income was lower due to $0.8 million of expense from the Plan, while our 2012 results included a $1.0 million benefit from a change in accounting estimate. The 2013 net income attributable to the ProtectCELL and 4Warranty acquisitions of $4.8 million on a combined basis was largely offset by competitive pressures in other product lines and regulatory changes influencing our clients' marketing and outsourcing activities.

For the year ended December 31, 2013, our revenues increased $91.5 million, or 35.7%, to $347.9 million from $256.3 million for the same period in 2012. Our 2012 revenues included a $5.3 million increase in revenues attributable to the change in accounting estimate. The increase in revenues for 2013 is primarily attributable to the ProtectCELL and 4Warranty acquisitions on December 31, 2012, which accounted for $93.7 million and $3.1 million of the 2013 increase, respectively. In addition, total revenues included increases of $9.2 million in net earned premiums and $2.0 million in net realized investment gains, which was partially offset by lower service and administrative fees from reduced transaction volume under our administration service contracts.

Total expenses increased $93.7 million, or 39.6%, to $330.4 million for the year ended December 31, 2013 from $236.7 million for the same period in 2012. The majority of the increase was due to the ProtectCELL and 4Warranty acquisitions, which added $89.9 million and $1.5 million to expenses, respectively, as well an $8.5 million increase in commission expense, which corresponds with the rise in revenues. In addition, 2013 expenses also included $1.2 million in costs associated with the Plan.

CRITICAL ACCOUNTING POLICIES
We prepare our Consolidated Financial Statements in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP") which requires management to make significant estimates and assumptions that affect the reported amounts of our assets, liabilities, revenues and expenses. See "Use of Estimates" and "Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements, included in ITEM 8 of this Form 10-K for additional information.

We periodically evaluate our estimates, which are based on historical experience and on various other assumptions that management believes to be reasonable under the circumstances. Critical accounting policies are those that are most important to the portrayal of our financial condition and results of operations and require management's most difficult, subjective or complex judgments, as a result

28


of the need to make estimates about the effect of matters that are inherently uncertain. If actual performance should differ from historical experience or if the underlying assumptions were to change, our financial condition and results of operations may be materially impacted. In addition, some accounting policies require significant judgment to apply complex principles of accounting to certain transactions, such as acquisitions, in determining the most appropriate accounting treatment. We believe that the significant accounting estimates and policies described below are material to our financial reporting and are subject to a degree of subjectivity and/or complexity. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors.

Change in Accounting Estimate - Unearned Premium Reserves
During the period ended September 30, 2012, we reviewed our unearned premium reserves in relation to the loss patterns and the related recognition of income for certain types of credit property and vendor single interest payment protection products, and based on our analysis determined that a change to the Rule of 78's method results in a more accurate estimate of net earned premium reserves for these products. The change was accounted for as a change in accounting estimate and was applied prospectively. See the Note, "Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements included in ITEM 8 of this Form 10-K for the effect of this change in accounting estimate on our 2012 results of operations.

Investments
We regularly monitor our investment portfolio to ensure investments that may be other-than-temporarily impaired ("OTTI") are identified in a timely fashion, properly valued, and if necessary, written down to their fair value through a charge against earnings in the proper period. The determination that a security has incurred an other-than-temporary decline in fair value requires the judgment of management. The analysis takes into account relevant factors, both quantitative and qualitative in nature. Among the factors considered are the following: the length of time and the extent to which fair value has been less than cost; issuer-specific considerations, including an issuer's short-term prospects and financial condition, recent news that may have an adverse impact on its results, and an event of missed or late payment or default; the occurrence of a significant economic event that may affect the industry in which an issuer participates; and for loan-backed and structured securities, the undiscounted estimated future cash flows as compared to the current book value. When such impairments are determined to be other-than-temporary, the decrease in fair value is reported in net income as a realized investment loss and a new cost basis is established.

There are inherent risks and uncertainties involved in making these judgments. Changes in circumstances and critical assumptions such as a continued weak economy, a more pronounced economic downturn or unforeseen events, which affect one or more companies, industry sectors or countries could result in additional impairments in future periods for other-than-temporary declines in fair value. See the Note, "Investments" in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information and ITEM 1A. RISK FACTORS - "Risks Related to Our Products and Services - Our investment portfolio is subject to several risks that may diminish the fair value of our invested assets and cash and may materially and adversely affect our business and profitability" and "Liquidity and Capital Resources - Liquidity" contained elsewhere in this Form 10-K.

Reinsurance
Reinsurance receivables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims, future policyholder benefits and policyholder contract deposits. The cost of reinsurance is accounted for over the terms of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves and are reported in our Consolidated Balance Sheets. In the ordinary course of business, we are involved in both the assumption and cession of reinsurance with non-affiliated companies, including reinsurance companies owned by our clients.


We utilize reinsurance for loss protection and capital management. See ITEM 1A. RISK FACTORS - "Risks Related to Our Products and Services - Reinsurance may not be available or adequate to protect us against losses, and we are subject to the credit risk of reinsurers," included in this Form 10-K.
 

Property and Equipment
Property and equipment are carried at cost, net of accumulated depreciation and amortization. Gains and losses on sales and disposals of property and equipment are based on the net book value of the related asset at the disposal date using the specific identification method with the corresponding gain or loss recorded to operations when incurred. Maintenance and repairs, which do not materially extend asset useful life and minor replacements, are charged to earnings when incurred. Depreciation expense is computed using the straight-line method over the estimated useful lives of the respective assets with three years for computers and five years for furniture, fixtures and equipment. Amortization of capitalized software is computed using the straight-line method over the estimated useful lives of five years. Leasehold improvements are depreciated over the remaining life of the lease. We also lease certain equipment and software under a capital lease. Assets under capital leases are depreciated over the remaining life of the lease or their estimated productive lives.

We capitalize internally developed software costs on a project-by-project basis. Software development costs are carried at unamortized cost and are amortized using the straight-line method over the estimated useful life of the software, typically 5 years. Amortization begins when the software is ready for its intended use.

29



Deferred Acquisition Costs - Insurance Related
We defer certain costs of acquiring new and renewal business. These costs are limited to direct costs that resulted from successful contract transactions and would not have been incurred by our insurance entities had the transactions not occurred. These capitalized costs are amortized as the related premium is earned.

We evaluate whether deferred acquisition costs-insurance related are recoverable at year-end, and periodically if deemed necessary, and consider investment income in the recoverability analysis.  As a result of our evaluations, no write-offs for unrecoverable deferred acquisition costs were recognized during the years ended December 31, 2013, 2012 and 2011.

Deferred Acquisition Costs - Non-insurance Related
We defer certain costs of acquiring new and renewal business related to non-insurance subsidiary transactions. These costs are limited to prepaid direct costs, typically commissions and contract transaction fees, that resulted from successful contract transactions and would not have been incurred by us had the transactions not occurred. These capitalized costs are amortized as the related service and administrative fees are earned.

We evaluate whether deferred acquisition costs - non-insurance related are recoverable at year-end, and periodically if deemed necessary. As a result of our evaluations, no write-offs for unrecoverable deferred acquisition costs were recognized during the years ended December 31, 2013, 2012 and 2011.

Goodwill
Goodwill represents the excess cost of an acquisition over the fair value of the net assets acquired in a business combination, and is carried as an asset on the Consolidated Balance Sheets. Goodwill is not amortized, but is reviewed for impairment annually in the fourth quarter, or more frequently if certain indicators arise.

Our goodwill impairment analysis typically involves an assessment of qualitative factors to determine whether it is more likely than not that fair value of our reporting unit is less than the recorded book value. If it is more likely than not, we must perform a quantitative test to determine fair value. If that fair value is less than the book value of the reporting unit, an impairment charge is recorded equal to the excess of the carrying amount of goodwill over its implied fair value. At its discretion, management may opt to bypass the qualitative analysis and perform the quantitative test.

The goodwill impairment review is highly judgmental and may involve the use of significant estimates and assumptions impacting the amount of any impairment charge recorded. The estimates and assumptions may have a significant impact on the amount of any impairment charge recorded.

Because the Company changed to one reporting segment in 2013, management bypassed the qualitative analysis, and determined fair value using market based methods including the use of market capitalization plus a control premium. Management assessed goodwill as of December 31, 2013, 2012 and 2011 and determined that no impairment existed as of those dates.

Other Intangible Assets
We have acquired significant other intangible assets through business acquisitions. Our other intangible assets consist of indefinite-lived trademarks and licenses, and of finite-lived intangibles, including customer related and contract based assets representing primarily client lists and non-compete arrangements and acquired software. Finite-lived intangible assets are amortized over periods ranging from 0.3 years to 15 years. Certain trademarks are not amortized since these assets have been determined to have indefinite useful lives. The costs to periodically renew other intangible assets are expensed as incurred.

Indefinite-lived intangible assets are tested for impairment at least annually, or whenever events or circumstances indicate that their carrying amount may not be recoverable using an analysis of expected future cash flows. Finite-lived intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. These events or changes in circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future cash flows. If an impairment indicator is present, the Company evaluates recoverability by a comparison of the carrying amount of the assets to future undiscounted cash flows expected to be generated by the assets.  If the sum of the expected future undiscounted cash flows is less than the carrying amount, the Company would recognize an impairment loss. An impairment loss would be measured by comparing the amount by which the carrying value exceeds the fair value of the long-lived assets and intangibles.

Management assessed other intangible assets as of December 31, 2013, 2012 and 2011 and determined that no impairment existed as of those dates.


30


Unpaid Claims
Unpaid claims are reserve estimates that are established in accordance with U.S. GAAP using generally accepted actuarial methods. Credit life, credit disability and accidental death and dismemberment ("AD&D") unpaid claims reserves include claims in the course of settlement and incurred but not reported ("IBNR"). For all other product lines, unpaid claims reserves are entirely IBNR. We use a number of algorithms in establishing our unpaid claims reserves. These algorithms are used to calculate unpaid claims as a function of paid losses, earned premium, target loss ratios, in force amounts, unearned premium reserves; industry recognized morbidity tables or a combination of these factors. The factors used to develop the IBNR vary by product line. However, in general terms, the factor used to develop IBNR for credit life insurance is a function of the amount of life insurance in force. The factor can vary from $0.60 to $1.00 per $1,000 of in force coverage. The factor used to develop IBNR for credit disability is a function of the pro-rata unearned premium reserve and is typically 5% of the unearned premium reserve. Finally, IBNR for AD&D policies is a function of in force coverage and is currently $0.15 per $1,000 of in force coverage.

In accordance with applicable statutory insurance company regulations, our unpaid claims reserves are evaluated by appointed actuaries. The appointed actuaries perform this function in compliance with the Standards of Practice and Codes of Conduct of the American Academy of Actuaries. The appointed actuaries perform their actuarial analysis each year and prepare opinions, statements and reports documenting their determinations. The appointed actuaries conduct their actuarial analysis on a basis gross of reinsurance. The same estimates used as a basis in calculating the gross unpaid claims reserves are then used as the basis for calculating the net unpaid claims reserves, which take into account the impact of reinsurance.

Anticipated future loss development patterns form a key assumption underlying these analyses. Our claims are generally reported and settled quickly resulting in a consistent historical loss development pattern. From the anticipated loss development patterns, a variety of actuarial loss projection techniques are employed, such as chain ladder method, the Bornhuetter-Ferguson method and expected loss ratio method.

Our unpaid claims reserves represent our best estimates, generally involving actuarial projections at a given time. Actual claim costs are dependent upon a number of complex factors such as changes in doctrines of legal liabilities and damage awards. These factors are not directly quantifiable, particularly on a prospective basis. We periodically review and update our methods of making such unpaid claims reserve estimates and establishing the related liabilities based on our actual experience. We have not made any changes to our methodologies for determining unpaid claims reserves in the periods presented.

The following table provides unpaid claims reserve information by product line, net of reserves ceded under reinsurance arrangements:
(in thousands)
As of December 31, 2013
 
As of December 31, 2012
 
As of December 31, 2011
Product Type
In Course of Settlement(1)
IBNR(2)
Total Claim Reserve
 
In Course of Settlement(1)
IBNR(2)
Total Claim Reserve
 
In Course of Settlement(1)
IBNR(2)
Total Claim Reserve
Property
$
156

$
2,857

$
3,013

 
$

$
3,534

$
3,534

 
$
213

$
3,189

$
3,402

Surety

89

89

 

204

204

 

173

173

General liability(3)

4,028

4,028

 

3,168

3,168

 

2,167

2,167

Credit life
500

2,188

2,688

 
629

1,573

2,202

 
539

2,267

2,806

Credit disability
199

2,381

2,580

 
145

3,211

3,356

 
204

3,540

3,744

AD&D
161

457

618

 
109

489

598

 
176

614

790

Other

193

193

 
1

56

57

 
1

68

69

Total
$
1,016

$
12,193

$
13,209

 
$
884

$
12,235

$
13,119

 
$
1,133

$
12,018

$
13,151

(1) "In Course of Settlement" represents amounts reserved to pay claims known but are not yet paid.
(2) IBNR reserves represent amounts reserved to pay claims where the insured event has occurred and has not yet been reported. IBNR reserves for credit disability also include the net present value of future claims payment of $1,788, $1,243 and $1,354 as of December 31, 2013, 2012 and 2011, respectively.
(3) General liability primarily represents amounts reserved to pay claims on contractual liability policies behind debt cancellation products.

Most of our credit insurance business is written on a retrospective commission basis, which permits management to adjust commissions based on claims experience. Thus, any adjustment to prior years' incurred claims in this line of business is partially offset by a change in retrospective commissions.

While management has used its best judgment in establishing the estimate of required unpaid claims, different assumptions and variables could lead to significantly different unpaid claims estimates. Two key measures of loss activity are loss frequency, which is a measure of the number of claims per unit of insured exposure, and loss severity, which is based on the average size of claims. Factors affecting loss frequency and loss severity include changes in claims reporting patterns, claims settlement patterns, judicial decisions, legislation, economic conditions, morbidity patterns and the attitudes of claimants towards settlements. The adequacy of our unpaid claims reserves will be impacted by future trends that impact these factors.

While our cost of claims has not varied significantly from our reserves in prior periods, if the actual level of loss frequency and severity are higher or lower than expected, our paid claims will be different than management's estimate. We believe that, based on our actuarial

31


analysis, an aggregate change that is greater than ± 10% (or 5% for each of loss frequency and severity) is not probable. The effect of higher and lower levels of loss frequency and severity levels on our ultimate cost for claims occurring in 2013 would be as follows (dollars in thousands):
 
Sensitivity change in both loss frequency and severity for all payment protection products:
Claims Cost
 
Change in Claims Cost
5% higher
$
14,563

 
$
1,354

3% higher
14,013

 
804

1% higher
13,475

 
266

Base scenario
13,209

 

1% lower
12,943

 
(266
)
3% lower
12,405

 
(804
)
5% lower
11,855

 
(1,354
)

Adjustments to our unpaid claims reserves, both positive and negative, are reflected in our statement of income for the period in which such estimates are updated. Because the establishment of our unpaid claims reserves is an inherently uncertain process involving estimates of future losses, there can be no certainty that ultimate losses will not exceed existing claims reserves. Future loss development could require our reserves to be increased, which could have a material adverse effect on our earnings in the periods in which such increases are made.

Unearned Premiums
Premiums written are earned over the life of the respective policy using the Rule of 78's, pro rata, or other actuarial methods as appropriate for the type of business. Unearned premiums represent the portion of premiums that will be earned in the future. A premium deficiency reserve is recorded if anticipated losses, loss adjustment expenses, deferred acquisition costs - insurance related and policy maintenance costs exceed the recorded unearned premium reserve and anticipated investment income. As of December 31, 2013, 2012 and 2011, respectively, no such reserve was recorded.

Deferred Revenues
Deferred revenues represent the portion of income that will be earned in the future attributable to motor club memberships, mobile device protection plans, and other non-insurance service contracts that are earned over the respective contract periods using Rule of 78's, modified Rule of 78's, pro rata, or other methods as appropriate for the contract. A deficiency reserve would be recorded if anticipated contract benefits, deferred acquisition costs and contract service costs exceed the recorded deferred revenues and anticipated investment income. As of December 31, 2013 and 2012, no deficiency reserve was recorded.

Income Taxes
The calculation of tax liabilities is complex, and requires the use of estimates and judgments by management since it involves application of complex tax laws. We record deferred income taxes in accordance with the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recorded based on the difference between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as temporary differences, and are based on the enacted tax laws and statutory tax rates applicable to the periods in which we expect the temporary differences to reverse.

A deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. In determining whether our deferred tax asset is realizable, we considered all available evidence, including both positive and negative evidence. The realization of deferred tax assets depends upon the existence of sufficient taxable income of the same character during the carry-back or carry-forward period. We considered all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing temporary differences, future taxable income exclusive of reversing temporary differences and carry forwards, taxable income in carry-back years and tax-planning strategies.

Management has evaluated its deferred tax assets to determine realization in the foreseeable future and accordingly, no valuation allowance has been established as of December 31, 2013. The detailed components of our deferred tax assets and liabilities are shown in the Note, "Income Taxes" in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K.

Contingencies
Management evaluates each contingent matter separately. A loss is reported if reasonably estimable and probable. We establish reserves for these contingencies at the best estimate, or, if no one estimated number within the range of possible losses is more probable than any other, we report an estimated reserve at the midpoint of the estimated range. Contingencies affecting us include litigation matters, which are inherently difficult to evaluate and are subject to significant changes.


32


Service and Administrative Fees
We earn service and administrative fees from a variety of activities. Such fees are typically positively correlated with transaction volume and are recognized as revenue as they become both realized and earned.

Service Fees. Service fee revenue is recognized as the services are performed. These services include fulfillment, software development, and claims handling for our customers. Collateral tracking fee income is recognized when the service is performed and billed. Management reviews the financial results under each significant contract on a monthly basis. Any losses that may occur due to a specific contract would be recognized in the period in which the loss occurs. During the years ended December 31, 2013, 2012 and 2011 we have not incurred a loss with respect to a specific significant service fee contract.

Administrative Fees. Administrative service revenue includes the administration of credit insurance, debt cancellation programs, motor club programs, and warranty programs. Related administrative fee revenue is recognized consistent with the earnings recognition pattern of the underlying insurance policies, debt cancellation contracts and motor club memberships being administered, using Rule of 78's, modified Rule of 78's, pro rata, or other methods as appropriate for the contract. Management selects the appropriate method based on available information, and periodically reviews the selections as additional information becomes available.

Our payment protection products are sold as complementary products to consumer retail and credit transactions and are thus subject to the volatility of volume of consumer purchase and credit activities. We receive service and administrative fees for administering payment protection products that are sold by our clients, such as credit insurance, debt protection, motor club and warranty solutions. We earn administrative fees for administering debt cancellation plans, facilitating the distribution and administration of warranty or extended service contracts, providing motor club membership benefits and providing related services for our clients. For credit insurance products, our clients typically retain the risk associated with credit insurance products that they sell to their customers through economic arrangements with us. Our payment protection revenue includes revenue earned from reinsurance arrangements with producer owned reinsurance companies ("PORCs") owned by our clients. Our clients own PORCs that assume the credit insurance premiums and associated risk that they originate in exchange for fees paid to us for ceding the premiums. In addition, our revenue includes administrative fees charged by us under retrospective commission arrangements with producers, where the commissions paid are adjusted based on actual losses incurred compared to premium earned after a specified net allowance retained by us. Under these arrangements, our insurance companies receive the insurance premiums and administer the policies that are distributed by our clients. The producer of the credit insurance policies receives a retrospective commission if the premium generated by that producer in the accounting period exceeds the costs associated with those polices, which includes our administrative fees, incurred claims, reserves and premium taxes. If the net result is negative, we either offset that negative amount against future retrospective commission payments, reduce the producer's up-front commission on a prospective basis to increase the likelihood that it will return to a positive position or request payment of the negative amount from the producer. Revenues in our business may fluctuate seasonally based on consumer spending trends, where consumer spending has historically been higher in September and December, corresponding to back-to-school and the holiday season. Accordingly, our payment protection revenues may reflect higher third and fourth quarters than in the first half of the year.

Ceding Commissions
We earn ceding commissions on our credit insurance products. Ceding commissions earned under coinsurance agreements are based on contractual formulas that take into account, in part, underwriting performance and investment returns experienced by the assuming companies. As experience changes, adjustments to the ceding commissions are reflected in the period incurred. Experience adjustments are based on the claim experience of the related policy. The adjustment is calculated by adding the earned premium and investment income from the assets held in trust for our benefit less earned commissions, incurred claims and the reinsurer's fee for the coverage.

We elect to cede to reinsurers under coinsurance arrangements a significant portion of the credit insurance that we distribute on behalf of our clients. We continue to provide all policy administration for credit insurance that we cede to reinsurers. Ceding commissions primarily represent the fees we charge the reinsurers for that administration service. In addition, a portion of the ceding commissions is determined based on the underwriting profits of the ceded credit insurance. The credit insurance that we distribute has historically generated attractive underwriting profits. Ceding commissions also include investment income earned on reserves maintained in trust accounts on the balance sheets of the reinsurers.

Ceding commissions are generally positively correlated with our credit insurance transaction and premium volumes. The portion of our ceding commissions that is related to the underwriting profits of the ceded credit insurance also fluctuates based on the claims made on such policies. The portion of our ceding commissions that is related to investment income can be impacted by the amount of reserves that are maintained in trust accounts and changes in interest rates. Ceding commissions are earned over the life of the policy.
Our experience adjustments, exclusive of investment income, are as follows: (in thousands)
Years Ended December 31,
 
2013
 
2012
 
2011
Experience Adjustments
$
6,872

 
$
8,635

 
$
7,245



33


Net Earned Premium
Net earned premium is from direct and assumed earned premium consisting of revenue generated from the direct sale of payment protection insurance policies by our distributors and premiums written for payment protection insurance policies by another carrier and assumed by us. Whether direct or assumed, the premium is earned over the life of the respective policy using methods appropriate to the pattern of losses for the type of business. Methods used include the Rule of 78's, pro rata, and other actuarial methods. Management selects the appropriate method based on available information, and periodically reviews the selections as additional information becomes available. Direct and assumed premiums are offset by premiums ceded to our reinsurers, including PORCs, which are earned in the same manner. The amount ceded is proportional to the amount of risk assumed by the reinsurer.

 The principal factors affecting net earned premiums are: (i) the proportion of the risk assumed by our reinsurers as defined in the applicable reinsurance treaty; (ii) increases and decreases in written premium; (iii) the pattern of losses by type of business, (iv) increases and decreases in policy cancellation rates; (v) the average duration of the policies written; and (vi) changes in regulation that would modify the earning patterns for the policies underwritten and administered.

 We limit the underwriting risk we take in our payment protection insurance policies. When we do assume risk in our payment protection insurance policies, we utilize both reinsurance (e.g., quota share and excess of loss) and retrospective commission agreements to manage and mitigate our risk.

Commissions
 
Commissions are paid to distributors selling credit insurance policies, motor club memberships, and warranty service contracts, and are generally deferred and expensed in proportion to the earning of related revenue. Credit insurance commission rates, in many instances, are set by state regulators and are also impacted by market conditions. In certain instances, our commissions are subject to retrospective adjustment based on the profitability of the related policies. These retrospective commission adjustments are payments made or adjustments to future commission expense based on prior claims experience. Under these retrospective commission arrangements, the producer of the credit insurance policies, which is typically our client, receives a retrospective commission if the premium generated by that producer in the accounting period exceeds the costs associated with those policies, which includes our administrative fees, claims, reserves and premium taxes. If the net result is negative, we either offset that negative amount against future retrospective commission payments, reduce the producer's up-front commission on a prospective basis to increase the likelihood that it will return to a positive position or request payment of the negative amount from the producer.

Net Investment Income
We earn net investment income from interest payments and dividends received from our investment portfolio, and interest earned on our cash accounts and notes receivable, less portfolio management expenses. Our investment portfolio is primarily invested in fixed maturity securities, which tend to produce consistent levels of investment income. The fair value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. The fair value generally increases or decreases in an inverse relationship with fluctuations in interest rates. Investment income can be significantly impacted by changes in interest rates. Interest rate volatility can increase or reduce unrealized gains or unrealized losses in our portfolios. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Fluctuations in interest rates affect our returns on, and the fair value of, fixed maturity and short-term investments. 

We also have investments that carry prepayment risk, such as mortgage-backed and asset-backed securities. Actual net investment income and/or cash flows from investments that carry prepayment risk may differ from estimates at the time of investment as a result of interest rate fluctuations. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities, commercial mortgage obligations and bonds are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates. Therefore, we may be required to reinvest those funds in lower interest-bearing investments. Conversely, in times of rising interest rates, prepayments slow as borrowers tend to be less likely to refinance borrowings at higher interest rates, which tends to increase the duration of our investment holdings. With the increase in investment duration, we will have less cash flows from prepayments to invest at higher prevailing market rates.

Stock-Based Compensation
We currently have time-based stock options outstanding under our 2005 Equity Incentive Plan and time-based and performance-based stock options and restricted stock awards outstanding under The 2010 Omnibus Incentive Plan. Time-based stock options and restricted stock awards are grants that vest based on the passage of time whereas performance-based stock options and restricted stock awards are grants that vest based on us attaining certain financial metrics. Stock-based compensation expense is measured using fair value and is recorded over the requisite service or performance period of the awards. We measure stock-based compensation expense using the calculated value method. Under this method, we estimate the fair value of each stock option on the grant date using the Black-Scholes valuation model. We use historical data to estimate expected employee behavior related to stock award exercises and forfeitures. Since there is not sufficient historical market experience for shares of our stock, we have chosen to estimate volatility, by using the average volatility of a selected peer group of publicly traded companies operating in the same industry. Expected dividends are based

34


on the assumption that no dividends are expected to be distributed in the near future. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the options. The fair value of restricted stock awards are based on the market price of our common stock at the grant date. We typically recognize stock-based compensation expense for time-based awards on a straight-line basis over the requisite service and on a graded vesting attribution model for performance-based awards. Our current policy is to issue new shares upon the exercise of stock options. Please see the Note, "Stock-Based Compensation" in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information.

Recently Issued Accounting Standards
For a discussion of recently issued accounting standards see the Note "Recent Accounting Standards" of the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K.

COMPONENTS OF REVENUES AND EXPENSES
The following provides an overview of the components of revenues and expenses that are not discussed in our Critical Accounting Policies section.

REVENUES
Net Realized Investment Gains (Losses)
We realize gains when invested assets are sold for an amount greater than the amortized cost in the case of fixed maturity securities and cost basis for equity securities. We recognize realized losses for invested assets sold for an amount less than their carrying cost or when the decline in the fair value is below the cost of fixed maturity securities or equity securities is determined to be an other-than-temporary impairment ("OTTI").
 
 
 Other Income
Other income consists primarily of miscellaneous fees generated by our operations.

EXPENSES
Net Losses and Loss Adjustment Expenses
Net losses and loss adjustment expenses include actual paid claims and the change in unpaid claim reserves and consist of direct and assumed losses less ceded losses. Incurred claims are impacted by loss frequency, which is the measure of the number of claims per unit of insured exposure, and loss severity, which is based on the average size of claims. Factors affecting loss frequency and loss severity include changes in claims reporting patterns, claims settlement patterns, judicial decisions, legislation, economic conditions, morbidity patterns and the attitudes of claimants towards settlements.

 Actual claims paid are claims payments made to the policyholder or beneficiary during the accounting period. The change in unpaid claim reserve is an increase or reduction to the unpaid claim reserve in the accounting period to maintain the unpaid claim reserve at the levels evaluated by our actuaries.

Unpaid claims are reserve estimates that are established in accordance with U.S. GAAP using generally accepted actuarial methods. Credit life and AD&D unpaid claims reserves include claims in the course of settlement and IBNR. Credit disability unpaid claims reserves also include continuing claim reserves for open disability claims. For all other product lines, unpaid claims reserves are bulk reserves and are entirely IBNR. We use a number of algorithms in establishing our unpaid claims reserves. These algorithms are used to calculate unpaid claims as a function of paid losses, earned premium, target loss ratios, in-force amounts, unearned premium reserves, industry recognized morbidity tables or a combination of these factors.

In arriving at our unpaid claims reserves, we conduct an actuarial analysis on a basis gross of reinsurance. The same estimates used as a basis in calculating the gross unpaid claims reserves are then used as the basis for calculating the net unpaid claims reserves, which take into account the impact of reinsurance. Anticipated future loss development patterns form a key assumption underlying these analyses. Our claims are generally reported and settled quickly, resulting in consistent historical loss development patterns. From the anticipated loss development patterns, a variety of actuarial loss projection techniques are employed, such as the chain ladder method, the Bornhuetter-Ferguson method and expected loss ratio method.

 Our unpaid claims reserves represent our best estimates, generally involving actuarial projections at a given time. Actual claim costs are dependent upon a number of complex factors such as changes in doctrines of legal liabilities and damage awards. These factors are not directly quantifiable, particularly on a prospective basis. We periodically review and update our methods of making such unpaid claims reserve estimates and establishing the related liabilities based on our actual experience. We have not made any changes to our methodologies for determining unpaid claims reserves in the periods presented.


35


Member Benefit Claims
Member Benefit Claims represent claims paid on behalf of contract holders directly to third parties providers for roadside assistance and for the repair or replacement of covered products.  Claims can also be paid directly to contract holders as a reimbursement payment provided supporting documentation of loss is submitted to us.  Claims are recognized as expense when incurred.

Personnel Costs
Personnel costs represent the amounts attributable to wages, salaries, bonuses and benefits for our full and part-time employees, as well as expense related to our stock-based compensation. In addition to our general personnel costs, some of our employees are paid a percentage of revenues they generate, which may vary from period to period based on volume. Bonuses for the remaining employees are discretionary and are based on an evaluation of their individual performance, as well as our overall performance.

Other Operating Expenses
Other operating expenses consist primarily of rent, insurance, transaction expenses, professional fees, technology costs, travel and entertainment and advertising, and may include variable costs based on the volume of business we process. Other operating expenses are a significant portion of our expenses.

Depreciation and Amortization
Depreciation and amortization expense is the allocation of the capitalized cost of property, equipment and software over the periods benefited by the use of the asset.

Amortization of Intangibles
Amortization of finite-lived intangibles is an expense recorded to allocate the cost of finite-lived intangible assets, such as purchased customer accounts and non-compete agreements acquired as part of our business acquisitions, over their estimated useful lives.

Interest Expense
Interest expense includes interest incurred on our credit facilities, notes payable and preferred trust securities, net of the impact of the interest rate swap, and is directly correlated to the balances outstanding and the prevailing interest rates on these debt instruments.

Income Taxes
 Income taxes are comprised of federal and state taxes based on income in multiple jurisdictions and changes in uncertain tax positions, if any.

RESULTS OF OPERATIONS
The following tables set forth our Consolidated Statements of Income for the following periods:
(in thousands, except shares, per share amounts and percentages)
For the Years Ended December 31,
 
2013
2012
$ Change from 2012
% Change from 2012
 
2011
Revenues:
 
 
 
 
 
 
Service and administrative fees
$
172,427

$
90,550

$
81,877

90.4
 %
 
$
94,464

Ceding commissions
32,824

34,825

(2,001
)
(5.7
)
 
29,495

Net investment income
3,050

3,067

(17
)
(0.6
)
 
3,368

Net realized investment gains
2,043

3

2,040

nm

 
4,193

Net earned premium
136,787

127,625

9,162

7.2

 
115,503

Other income
736

269

467

173.6

 
170

Total revenues
347,867

256,339

91,528

35.7

 
247,193

 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
Net losses and loss adjustment expenses
41,567

40,219

1,348

3.4

 
37,949

Member benefit claims
46,019

4,642

41,377

891.4

 
4,409

Commissions
154,606

128,741

25,865

20.1

 
126,918

Personnel costs
39,487

28,475

11,012

38.7

 
26,021

Other operating expenses
35,117

24,233

10,884

44.9

 
23,739

Depreciation and amortization
4,858

3,275

1,583

48.3

 
2,662

Amortization of intangibles
5,527

2,742

2,785

101.6

 
2,819


36


(in thousands, except shares, per share amounts and percentages)
For the Years Ended December 31,
 
2013
2012
$ Change from 2012
% Change from 2012
 
2011
Interest expense
3,621

4,334

(713
)
(16.5
)
 
4,690

(Gain) Loss on sale of subsidiary
(402
)

(402
)
100.0

 
477

Total expenses
330,400

236,661

93,739

39.6

 
229,684

Income from continuing operations before income taxes
17,467

19,678

(2,211
)
(11.2
)
 
17,509

Income taxes - continuing operations
5,660

6,716

(1,056
)
(15.7
)
 
5,947

Income from continuing operations before non-controlling interests
11,807

12,962

(1,155
)
(8.9
)
 
11,562

Discontinued operations:
 
 
 
 
 
 
Income from discontinued operations - net of tax
3,546

2,275

1,271

55.9

 
1,777

Gain on sale of discontinued operations - net of tax
8,844


8,844

100.0

 

Discontinued operations - net of tax
12,390

2,275

10,115

444.6

 
1,777

Net income before non-controlling interests
24,197

15,237

8,960

58.8

 
13,339

Less: net income (loss) attributable to non-controlling interests
1,482

72

1,410

1,958.3
 %
 
(170
)
Net income attributable to Fortegra Financial Corporation
$
22,715

$
15,165

$
7,550

49.8
 %
 
$
13,509

 
 
 
 
 
 
 
Earnings per share - Basic:
 
 
 
 
 
 
Net income from continuing operations - net of tax
$
0.53

$
0.65

 
 
 
$
0.57

Discontinued operations - net of tax
0.64

0.12

 
 
 
0.09

Net income attributable to Fortegra Financial Corporation
$
1.17

$
0.77

 
 
 
$
0.66

 
 
 
 
 
 
 
Earnings per share - Diluted:
 
 
 
 
 
 
Net income from continuing operations - net of tax
$
0.50

$
0.63

 
 
 
$
0.55

Discontinued operations - net of tax
0.61

0.11

 
 
 
0.09

Net income attributable to Fortegra Financial Corporation
$
1.11

$
0.74

 
 
 
$
0.64

 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
Basic
19,477,802

19,655,492

 
 
 
20,352,027

Diluted
20,482,652

20,600,362

 
 
 
21,265,801

nm = not meaningful

REVENUES
Service and Administrative Fees
Service and administrative fees for the year ended December 31, 2013 increased $81.9 million, or 90.4%, to $172.4 million from $90.6 million for the year ended December 31, 2012. The increase resulted primarily from $82.8 million and $3.1 million in 2013 revenues attributable to ProtectCELL and 4Warranty, respectively, which was partially offset by a $3.0 million decrease in our insurance company client revenues and motor club membership revenues of $1.6 million.

Service and administrative fees for the year ended December 31, 2012 decreased $3.9 million, or 4.1%, to $90.6 million from $94.5 million for the year ended December 31, 2011. The decrease resulted primarily from a $5.6 million decrease in our motor club membership revenues and $0.7 million related to the sale of Creative Investigations Recovery Group, LLC ("CIRG") in July 2011.  This decrease was partially offset by a $2.7 million increase in administrative fees from our acquisition of PBG in October 2011.

Ceding Commissions
Ceding commissions for the year ended December 31, 2013 decreased $2.0 million, or 5.7%, to $32.8 million from $34.8 million for the year ended December 31, 2012. This decrease primarily resulted from the change in accounting estimate, which increased 2012 results by $2.8 million. For the year ended December 31, 2013, ceding commissions included $25.0 million in service and administrative fees, $6.9 million in underwriting profits and $0.9 million in net investment income.

37



Ceding commissions for the year ended December 31, 2012 increased $5.3 million, or 18.1%, to $34.8 million from $29.5 million for the year ended December 31, 2011. This increase primarily resulted from improved underwriting results due to growth in earned premiums and favorable loss experience along with additional administrative fees earned from increased insurance production in 2012, and the change in accounting estimate, which accounted for $2.8 million of the increase. For the year ended December 31, 2012, ceding commissions included $25.6 million in service and administrative fees, $8.6 million in underwriting profits and $0.6 million in net investment income.

Net Investment Income
Net investment income totaled $3.1 million for the years ended December 31, 2013 and 2012, respectively. The amount of invested assets increased in 2013 compared to 2012, which was offset by a decrease in yields for the 2013 period. The yield on the investment portfolio at December 31, 2013 was 1.83% compared to 2.67% at December 31, 2012.

Net investment income for the year ended December 31, 2012 decreased $0.3 million, or 8.9%, to $3.1 million compared to $3.4 million for the year ended December 31, 2011. The decrease from 2011 was principally due to lower income earned on fixed income securities and to a lesser extent a lower amount of income earned on cash. The yield on the investment portfolio at December 31, 2012 was 2.67% compared to 2.88% at December 31, 2011.

Net Realized Investment Gains
Net realized gains on the sale of investments totaled $2.0 million for the year ended December 31, 2013 compared to net realized gains of $3.0 thousand for the year ended December 31, 2012. The increase for 2013 was due to higher levels of investment sales occurring in 2013. The net gain for 2012 included a $16.0 thousand net realized loss attributable to an OTTI charge for the write-down of a single equity security.

Net realized gains on the sale of investments totaled $3.0 thousand for the year ended December 31, 2012 compared to net realized gains of $4.2 million for the year ended December 31, 2011. The decrease for 2012 was due to higher levels of investment sales occurring in 2011 that were not repeated in 2012. The net gain for 2011 included a $0.2 million net realized loss attributable to an OTTI charge for the write-down of ten equity securities.

Net Earned Premium
Net earned premium for the year ended December 31, 2013 increased $9.2 million, or 7.2%, to $136.8 million from $127.6 million for the year ended December 31, 2012, with the change in accounting estimate increasing net earned premium by $2.5 million for the 2012 period. For the 2013 period, direct and assumed earned premium increased $29.9 million resulting from increased production from existing and new clients distributing our credit insurance, warranty, and auto products, and from geographic expansion. Because of this increase, ceded earned premiums increased $20.8 million, or 8.9%, for the year ended December 31, 2013. On average, we maintained a 64.9% overall cession rate of direct and assumed earned premium for the year ended December 31, 2013 compared with 64.5% in 2012.

Net earned premium for the year ended December 31, 2012 increased $12.1 million, or 10.5%, to $127.6 million from $115.5 million for the year ended December 31, 2011, with the change in accounting estimate increasing net earned premium by $2.5 million for the 2012 period. For the 2012 period, direct and assumed earned premium increased $38.4 million resulting from increased production from existing clients and new clients distributing our credit insurance and warranty service contracts and geographic expansion. Because of this increase, ceded earned premiums increased $26.3 million, or 12.8%, for the year ended December 31, 2012. On average, we maintained a 64.5% overall cession rate of direct and assumed earned premium for the year ended December 31, 2012 compared with 64.1% in 2011.

Other Income
Other income for the year ended December 31, 2013 increased $0.5 million, or 173.6%, to $0.7 million from $0.3 million for the year ended December 31, 2012. Other income for the 2013 period includes $0.2 million of interest income from our premium financing program for South Bay, which began late in 2013.

Other income for the year ended December 31, 2012 increased $0.1 million, or 58.2%, to $0.3 million from $0.2 million for 2011.


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EXPENSES
Net Losses and Loss Adjustment Expenses
Net losses and loss adjustment expenses for the year ended December 31, 2013 increased $1.3 million, or 3.4% to $41.6 million, from $40.2 million for the year ended December 31, 2012.  Our net losses and loss adjustment expense ratio of 30.4% in 2013 was similar to prior periods. The increase in net losses and loss adjustment expenses was primarily driven by increased earned premiums. For the 2013 period, our direct and assumed losses increased by $4.4 million, or 5.1%, as compared with the same period in 2012. For the 2013 period, our ceded losses were higher by $3.0 million, or 6.6%, compared with the same period in 2012, partially offsetting the increase in direct and assumed losses. On average, we maintained a 54.2% and 53.5% overall cession rate of direct and assumed losses and loss adjustment expenses for the year ended December 31, 2013 and 2012, respectively.

Net losses and loss adjustment expenses for the year ended December 31, 2012 increased $2.3 million, or 6.0% to $40.2 million, from $37.9 million for the year ended December 31, 2011. Our net losses and loss adjustment expense ratio of 31.5% in 2012 was similar to prior periods. The increase in net losses and loss adjustment expenses was primarily driven by increased earned premiums and warranty claims. For the 2012 period, our direct and assumed losses increased by $4.6 million, or 5.6%, as compared with the same period in 2011. For the 2012 period, our ceded losses were higher by $2.3 million, or 5.2%, compared with the same period in 2011, partially offsetting the increase in direct and assumed losses. On average, we maintained a 53.5% and 53.6% overall cession rate of direct and assumed losses and loss adjustment expenses for the years ended December 31, 2012 and 2011, respectively.

Member Benefit Claims
Member benefit claims for the year ended December 31, 2013 increased $41.4 million, or 891.4%, to $46.0 million, from $4.6 million for the year ended December 31, 2012. The increase resulted principally from ProtectCELL’s cost of member benefits claims attributable to the cost of replacement devices and associated claims handling and fulfillment costs.

Member benefit claims for the year ended December 31, 2012 increased $0.2 million, or 5.3%, to $4.6 million, from $4.4 million for the year ended December 31, 2011. The increase for 2012, compared to 2011, resulted from higher than expected claims paid for one Auto Knight program that was terminated in 2012.

Commissions
Commissions for the year ended December 31, 2013 increased $25.9 million, or 20.1%, to $154.6 million, from $128.7 million for the year ended December 31, 2012. The increase in 2013 resulted primarily from $16.9 million and $0.4 million in commissions attributable to ProtectCELL and 4Warranty, respectively, and comparable period over period growth of $13.0 million from the revenue increases in credit insurance and warranty service contracts, while 2012 was higher due to the additional $3.9 million of commission expense resulting from the change in accounting estimate.

Commissions for the year ended December 31, 2012 increased $1.8 million, or 1.4%, to $128.7 million, from $126.9 million for the year ended December 31, 2011. The increase for 2012, compared to 2011, resulted from growth in net earned premiums and from the change in accounting estimate, which increased commissions for 2012 by $3.9 million.

Personnel Costs
Personnel costs for the year ended December 31, 2013 increased $11.0 million, or 38.7%, to $39.5 million from $28.5 million for the year ended December 31, 2012. The increase resulted principally from $9.8 million and $0.1 million from ProtectCELL and 4Warranty, respectively, and $1.2 million in non-recurring costs associated with the Plan, which were partially offset by the impact of the decrease in headcount associated with the Plan. Total employees of our continuing operations at December 31, 2013 were 494, compared to 397 at December 31, 2012 (which excludes the employees of ProtectCELL and 4Warranty). Stock-based compensation expense included in personnel costs totaled $0.7 million for the years ended December 31, 2013 and 2012, respectively.

Personnel costs for the year ended December 31, 2012 increased $2.5 million, or 9.4%, to $28.5 million from $26.0 million for the year ended December 31, 2011. The increase resulted primarily from $1.9 million for the 2011 PBG acquisition and the increased headcount across the business. In addition, the sale of CIRG in 2011 reduced personnel costs in 2012 by $0.3 million. Total employees of our continuing operations at December 31, 2012 increased to 397 (which excludes the employees of ProtectCELL and 4Warranty) compared to 355 at December 31, 2011. Stock-based compensation expense included in personnel costs totaled $0.7 million and $0.6 million for the year ended December 31, 2012 and 2011, respectively.

Other Operating Expenses
Other operating expenses for the year ended December 31, 2013 increased $10.9 million, or 44.9%, to $35.1 million from $24.2 million for the year ended December 31, 2012. These expenses increased primarily due to ProtectCELL and 4Warranty, which added $8.3 million and $0.6 million, respectively, while our specialty products and direct-to-consumer initiatives added $1.2 million.

Other operating expenses for the year ended December 31, 2012 increased $0.5 million, or 2.1%, to $24.2 million from $23.7 million for the year ended December 31, 2011. Other operating expenses declined by $2.6 million led by transaction costs and other one-time

39


expenses decreasing $0.4 million and $1.4 million, respectively. These improvements were offset in part by the impact of a full year of other operating expenses from PBG, which we acquired during the final quarter in 2011. For 2012, PBG's other operating expenses were $2.1 million compared with other operating expenses of $0.3 million for 2011.

Depreciation and Amortization
Depreciation and amortization expense for the year ended December 31, 2013 increased $1.6 million or 48.3% to $4.9 million from $3.3 million for the year ended December 31, 2012. The increase for both periods compared to the same prior year periods was due to higher levels of depreciable and amortizable assets in service during 2013 compared to 2012, with $1.1 million of the increase attributable to internally developed software.

Depreciation and amortization expense for the year ended December 31, 2012 increased $0.6 million or 23.0% to $3.3 million from
$2.7 million for the year ended December 31, 2011, with the increase attributable to higher levels of depreciable and amortizable assets in service during 2012 compared to 2011.

Amortization of Intangibles
Amortization expense on intangibles for the year ended December 31, 2013 increased $2.8 million or 101.6% to $5.5 million from $2.7 million for the year ended December 31, 2012. The increase was primarily due to the 2012 acquisitions of ProtectCELL and 4Warranty, which increased amortization expense on intangibles by $2.4 million and $0.3 million, respectively.

Amortization expense on intangibles decreased $0.1 million or 2.7%, to $2.7 million for the year ended December 31, 2012 from $2.8 million for the year ended December 31, 2011. The decrease for 2012 was primarily attributable to certain intangibles becoming fully amortized.

Interest Expense
Interest expense for the year ended December 31, 2013 decreased $0.7 million, or 16.5%, to $3.6 million from $4.3 million for the year ended December 31, 2012 and was positively impacted by a lower interest rate on outstanding borrowings in 2013 compared to 2012. The decrease in rate was slightly offset by higher outstanding borrowings during 2013, resulting from additional borrowings associated with the acquisitions of ProtectCELL and 4Warranty, when compared to the 2012 outstanding borrowings. In addition, 2012 interest expense was higher due to a $0.7 million charge to interest expense for previously capitalized transaction costs associated with the termination of the SunTrust Bank, N.A. revolving credit facility in August 2012.

Interest expense for the year ended December 31, 2012 decreased $0.4 million, or 7.6%, to $4.3 million from $4.7 million for the year ended December 31, 2011 and was positively impacted by a lower interest rate on outstanding borrowings and our new credit facility with Wells Fargo Bank, N.A., which took effect on August 2, 2012. Interest expense in 2011 included the write-off of $0.3 million for capitalized issuance costs associated with the redemption of preferred stock. These decreases were partially offset by a $0.7 million charge to interest expense for previously capitalized transaction costs associated with the termination of the SunTrust Bank, N.A. revolving credit facility in August 2012.

Gain (Loss) on sale of subsidiary
In June 2013, we sold our 100% interest in Magna Insurance Company and realized a gain of $0.4 million.

On July 1, 2011, we sold our wholly-owned subsidiary, CIRG, for a sales price of $1.2 million, for cash and a $1.1 million secured note receivable. For the year ended December 31, 2011, we recorded a $0.5 million loss on the sale of CIRG.

Income Taxes
Income taxes for the year ended December 31, 2013 decreased $1.1 million, or 15.7%, to $5.7 million from $6.7 million for the year ended December 31, 2012, with the decrease primarily attributable to a lower level of pretax income. Our effective tax rate was 32.4% for the year ended December 31, 2013 compared to 34.1% for the same period in 2012 because of the rate impact of the ProtectCELL non-controlling interest.

Income taxes for the year ended December 31, 2012 increased $0.8 million, or 12.9%, to $6.7 million from $5.9 million for the year
ended December 31, 2011, with the increase primarily attributable to a higher level of pretax income, and a beneficial tax true-up in 2011. Our effective tax rate was 34.1% for the year ended December 31, 2012 compared to 34.0% for the same period in 2011.

See the Note, "Income Taxes" in the Notes to Consolidated Financial Statements, included in ITEM 8 of this Form 10-K for additional information and a reconciliation of the items impacting our income taxes and our effective tax rate.

During 2012, we were under examination by the Internal Revenue Service ("IRS") for the 2010 and 2009 tax years. In February 2013, the IRS completed its field audit and in March 2013, we received notice from the IRS that the audit report has been fully approved. We have agreed to those findings and paid $57.0 thousand, which was expensed during the first quarter of 2013.


40


Divestitures - Discontinued Operations
On December 31, 2013, we completed the previously announced sale of all of the issued and outstanding stock of our subsidiaries, Bliss and Glennon and eReinsure, to AmWINS (the "Disposition"), pursuant to the terms of the Purchase Agreement, and recognized an $8.8 million gain on the sale of discontinued operations, net of tax, for the year ended December 31, 2013. As consideration for the Disposition, we received net cash proceeds of $81.8 million for the Disposition, representing gross proceeds of $83.5 million less $1.0 million in transaction fees paid at the time of closing and $0.7 million of cash held by the disposed entities. We utilized the cash proceeds received on December 31, 2013 to pay off our existing credit facility with Wells Fargo Bank, N.A. As a result of the Disposition, we no longer operate in the businesses of wholesale insurance brokerage and selling or licensing of a computerized system or platform for the negotiation and/or placement of facultative reinsurance. Further, we have agreed not to compete with the Bliss and Glennon and eReinsure businesses for five years, and have agreed not to solicit former employees of the divested businesses. The following table provides the amounts related to discontinued operations in the Consolidated Statements of Income for the following periods:
(in thousands)
For the Years Ended December 31,
 
2013
 
2012
 
2011
Income from discontinued operations:
 
 
 
 
 
Revenues:
 
 
 
 
 
Brokerage commissions and fees
$
36,823

 
$
35,306

 
$
34,396

Net investment income
22

 
1

 

Other income
40

 

 

Total revenues
36,885

 
35,307

 
34,396

Expenses:
 
 
 
 
 
Personnel costs
20,251

 
20,173

 
18,526

Other operating expenses
5,778

 
6,121

 
7,401

Depreciation and amortization
615

 
658

 
415

Amortization of intangibles
1,929

 
2,211

 
2,133

Interest expense
2,318

 
2,290

 
2,951

Total expenses
30,891

 
31,453

 
31,426

Income from discontinued operations before income taxes
5,994

 
3,854

 
2,970

Income taxes - discontinued operations
2,448

 
1,579

 
1,193

Income from discontinued operations - net of tax
3,546

 
2,275

 
1,777

Gain on sale of discontinued operations:
 
 
 
 
 
Gain on sale of discontinued operations before income taxes
14,739

 

 

Income taxes - gain on sale of discontinued operations
5,895

 

 

Gain on sale of discontinued operations - net of tax
8,844

 

 

Discontinued operations - net of tax
$
12,390

 
$
2,275

 
$
1,777


See the Notes, "Summary of Significant Accounting Policies - Discontinued Operations" and "Divestitures" in the Notes to Consolidated Financial Statements, included in ITEM 8 of this Form 10-K for additional information.

Presentation of Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA")
In this Form 10-K, we present EBITDA from continuing operations and Adjusted EBITDA from continuing operations. These financial measures as presented in this Form 10-K are considered Non-GAAP financial measures and are not recognized terms under U.S. GAAP and should not be used as an indicator of, and are not an alternative to, net income as a measure of operating performance. EBITDA as used in this Form 10-K is net income before interest expense, income taxes, net income attributable to non-controlling interests, depreciation and amortization. Adjusted EBITDA from continuing operations, as used in this Form 10-K means "Consolidated Adjusted EBITDA" which is defined under our credit facility with Wells Fargo Bank, N.A., which in general terms means consolidated net income before non-controlling interests, consolidated interest expense, consolidated amortization expense, consolidated depreciation expense and consolidated income tax expense, relating to continuing operations. The other items excluded in this calculation may include if applicable, but are not limited to, specified acquisition costs, impairment of goodwill and other non-cash charges, stock-based compensation expense, and unusual or non-recurring charges and items that affect comparability of results. The calculation below does not give effect to certain additional adjustments permitted under our credit facility, which if included, would increase the amount of Adjusted EBITDA from continuing operations reflected in this table. We believe presenting EBITDA from continuing operations and Adjusted EBITDA from continuing operations provides investors with a supplemental financial measure of our operating performance.

In addition to the financial covenant requirements under our credit facility, management uses EBITDA from continuing operations and Adjusted EBITDA from continuing operations as financial measures of operating performance for planning purposes, which may include, but are not limited to, the preparation of budgets and projections, the determination of bonus compensation for executive officers, the analysis of the allocation of resources and the evaluation of the effectiveness of business strategies. Although we use EBITDA from continuing operations and Adjusted EBITDA from continuing operations as financial measures to assess the operating

41


performance of our business, both measures have significant limitations as analytical tools because they exclude certain material expenses. For example, they do not include interest expense and the payment of income taxes, which are both a necessary element of our costs and operations. Since we use property and equipment to generate service revenues, depreciation expense is a necessary element of our costs. In addition, the omission of amortization expense associated with our intangible assets further limits the usefulness of this financial measure. Management believes the inclusion of the adjustments to EBITDA from continuing operations and Adjusted EBITDA from continuing operations are appropriate to provide additional information to investors about certain material non-cash items and about unusual items that we do not expect to continue at the same level in the future. Because EBITDA from continuing operations and Adjusted EBITDA from continuing operations do not account for these expenses, its utility as a financial measure of our operating performance has material limitations. Due to these limitations, management does not view EBITDA from continuing operations and Adjusted EBITDA from continuing operations in isolation or as a primary financial performance measure.

We believe EBITDA and Adjusted EBITDA are frequently used by securities analysts, investors and other interested parties in the evaluation of similar companies in similar industries and to measure a company's ability to service its debt and other cash needs. Because the definitions of EBITDA and Adjusted EBITDA (or similar financial measures) may vary among companies and industries, they may not be comparable to other similarly titled financial measures used by other companies.

The following table presents a reconciliation of income from continuing operations before non-controlling interests to EBITDA from continuing operations and Adjusted EBITDA from continuing operations for the following periods:
 
For the Years Ended December 31,
(in thousands)
2013
 
2012
 
2011
Income from continuing operations before non-controlling interests
$
11,807

 
$
12,962

 
$
11,562

Depreciation
4,858

 
3,275

 
2,662

Amortization of intangibles
5,527

 
2,742

 
2,819

Interest expense
3,621

 
4,334

 
4,690

Income taxes
5,660

 
6,716

 
5,947

EBITDA from continuing operations
31,473

 
30,029

 
27,680

Transaction costs (1)
203

 
601

 
989

Corporate governance study

 

 
248

Restructuring expenses
1,299

 

 

Relocation expenses

 

 
207

Statutory audits

 

 
98

(Gain) loss on sale of subsidiary
(402
)
 

 
477

Legal expenses
520

 

 
360

Stock-based compensation expense
1,228

 
954

 
747

Change in accounting estimate

 
(1,509
)
 

Adjusted EBITDA from continuing operations
$
34,321

 
$
30,075

 
$
30,806

(1) Represents transaction costs associated with acquisitions.
 
 
 
 
 

LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of its business operations, including working capital needs, capital expenditures, debt service, acquisitions and other commitments and contractual obligations. We historically have derived our liquidity from our invested assets, cash flows from operations, ordinary and extraordinary dividend capacity from our subsidiary insurance companies, our credit facility and investments. When considering our liquidity, it is important to note that we hold cash in a fiduciary capacity as a result of premiums received from insured parties that have not yet been paid to insurance carriers. The fiduciary cash is recorded as an asset on our Consolidated Balance Sheets with a corresponding liability, net of our commissions, to insurance carriers.

Our primary cash requirements include the payment of operating expenses, interest and principal payments on debt, capital expenditures and acquisitions. We may also incur unexpected costs and operating expenses related to any unforeseen disruptions to our facilities and equipment, the loss of key personnel or changes in the credit markets and interest rates, which could increase our immediate cash requirements or otherwise impact our liquidity.

Our primary sources of liquidity include our total investments, cash and cash equivalent balances, availability under our revolving credit facility and dividends and other distributions from our subsidiaries. At December 31, 2013, we had total available-for-sale and short-term investments of $138.8 million, which includes restricted investments of $16.5 million. In addition, we had cash and cash equivalents of $21.7 million and $86.7 million of available capacity on our credit facility. At December 31, 2012, we had total investments of $118.1 million, which included restricted investments of $17.9 million. In addition, we had cash and cash equivalents of $15.2 million and $34.3 million of available capacity on our revolving credit facility. Our total indebtedness was $38.3 million at

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December 31, 2013 compared to $124.4 million at December 31, 2012. The decrease in our outstanding indebtedness was due to the utilization of the proceeds from the Disposition to pay off the full balance on the Wells Fargo Bank, N.A. credit facility.

On August 2, 2012, we terminated our existing $85.0 million revolving credit facility with SunTrust Bank, N.A. and entered into a new credit facility with Wells Fargo Bank, N.A., which is described in the sections below, "$75.0 Million Credit Facility" and "$85.0 Million Revolving Credit Facility."

We believe that our cash flows from operations and our availability under our revolving credit facility, combined with our low capital expenditure requirements will provide us with sufficient capital to continue to grow our business over the next several years. We intend to use a portion of our available cash flows to pay interest on our outstanding debt, thus limiting the amount available for working capital, capital expenditures and other general corporate purposes. As we continue to expand our business and make acquisitions, we may in the future require additional working capital to meet our future business needs. This additional working capital may be in the form of additional debt or equity. Although we believe we have sufficient liquidity under our revolving credit facility, as discussed above, under adverse market conditions or in the event of a default under our revolving credit facility, there can be no assurance that such funds would be available or sufficient, and, in such a case, we may not be able to successfully obtain additional financing on favorable terms, or at all, or replace our existing credit facility upon maturity in August 2017.

Cash Exceeding Federal Deposit Insurance Corporation ("FDIC") Limits
We maintain cash and cash equivalents with major third party financial institutions, including interest-bearing money market accounts. In the United States, these accounts were fully insured by the FDIC regardless of account balance through the Transaction Account Guarantee ("TAG") program created by Section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). The expiration of the TAG program on December 31, 2012, caused the FDIC's standard insurance limit of $250,000 per depositor per institution to be reimposed on January 1, 2013. Thus, our accounts containing cash and cash equivalents after January 1, 2013 may exceed the FDIC's standard $250,000 insurance limit from time to time.

Our cash balance, including restricted cash, exceeding the FDIC standard insurance limit totaled $18.9 million at December 31, 2013. At December 31, 2012, our cash balances in money markets accounts, which were our only cash balances subject to limitation under TAG, exceeding the FDIC standard insurance limit totaled $8.2 million. To date, we have not experienced any loss of, or lack of access to, our cash and cash equivalents or our restricted cash. Although we periodically monitor and adjust the balances of these accounts as needed, the balances of these accounts nonetheless remain subject to unexpected, adverse conditions in the financial markets and could be adversely impacted if a financial institution with which we maintain an account fails. We will continue to monitor the depository institutions at which our accounts are maintained, but cannot guarantee that access to our cash and cash equivalents will not be impacted by, or that we will not lose deposited funds exceeding the FDIC standard insurance limit due to, adverse conditions in the financial markets or if a financial institution with which we maintain an account fails.

Share Repurchase Plan
We have an active share repurchase plan, which allows us to purchase up to $15.0 million in total of our common stock to be purchased from time to time through open market or private transactions. For the year ended December 31, 2013, we repurchased 200,000 common shares with an average price of $6.79 per share and a total cost of $1.4 million compared to 508,080 common shares at an average price of $7.72 per share at a total cost of $3.9 million for same period in 2012. See ITEM 5 and the Note, "Share Repurchase Plan," of the Notes to Consolidated Financial Statements, included in this Form 10-K, for more information on the share repurchase plan.

Regulatory Requirements  
Dividends Limitations
We are a holding company and have limited direct operations. Our holding company assets consist primarily of the capital stock of our subsidiaries. Accordingly, our future cash flows depend upon the availability of dividends and other payments from our subsidiaries, including statutorily permissible payments from our insurance company subsidiaries, as well as payments under our tax allocation agreement and management agreements with our subsidiaries. The following table sets forth the dividends paid to us by our insurance company subsidiaries during the following periods:
 
 
For the Years Ended December 31,
(in thousands)
2013